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Thank you Marjorie. Good morning everyone and welcome to Northern Trust Corporation’s fourth quarter 2022 earnings conference call. Joining me on our call this morning are Mike O’Grady, our Chairman and CEO; Jason Tyler, our Chief Financial Officer; Lauren Allnut, our Controller, and Mark Bette, Briar Rose, and Grace Higgins from our Investor Relations team. Our fourth quarter earnings press release and financial trends report are both available on our website at northerntrust.com. Also on our website, you will find our quarterly earnings review presentation, which we will use to guide today’s conference call. This January 19 call is being webcast live on northerntrust.com. The only authorized rebroadcast of this call is the replay that will be made available on our website through February 18. Northern Trust disclaims any continuing accuracy of the information provided in this call after today. Please refer to our Safe Harbor statement regarding forward-looking statements on Page 13 of the accompanying presentation, which will apply to our commentary on this call. During today’s question and answer session, please limit your initial query to one question and one related follow-up. This will allow us to move through the queue and enable as many people as possible the opportunity to ask questions as time permits. I’d like to start by thanking our teams across the company for their strong execution throughout the year in the face of significant global, political and market turmoil. It is our partners’ unwavering focus on supporting our clients in uncertain and volatile times like these that truly differentiates Northern Trust. For the full year, revenue was up 5%, including trust fee growth of 2% and our return on average common equity was 12.7%. Excluding the impact of $303 million in charges detailed in the presentation, revenue for the full year grew 8% and our return on equity was 14.9%. Fourth quarter results reflected trends that were consistent with those we saw through the first three quarters of the year, namely on a year-over-year basis weaker markets pressured our trust fees, but this was more than offset by strong increases in net interest income. Within our wealth management business, assets under management and advisory fees grew sequentially in the fourth quarter. Total fees declined, however, due to the lag affect of markets, strategic price reductions in our index funds, and shifts in client allocations out of liquidity products. Overall, new business generation in wealth management was healthy in 2022; however, we did see some deceleration in the second half of the year as market activity waned. We continued to execute on our growth strategy in wealth management, including increasing the size and effectiveness of our sales force, expanding our digital marketing efforts, and leveraging the differentiated capabilities of the Northern Trust Institute. In asset management, assets under management were up sequentially but fees declined due to the outflows we experienced in our liquidity and indexed products as a result of the impact of both weaker markets and clients seeking alternatives. We did see solid increases in alternative funds throughout the year, including year-over-year growth of more than 20% in the fourth quarter. Our ETF complex also continued to perform well with year-over-year organic growth of 12%. Our product launches during the year focused on ESG capabilities, including three new ESG funds in the fourth quarter. Within asset servicing, we delivered a solid finish to the year. We saw healthy momentum throughout the year with our whole office offering as investment managers are increasingly considering outsourced solutions in the face of continued margin pressure and the challenging macroeconomic environment. Whole office integrates our global asset servicing platform with innovative partners facilitating access to new technologies, services and solutions. One recent client win offers an insight into what differentiates us in the marketplace. After an exhaustive RFP process during which we conducted a complete review of a large U.K.-based asset manager’s front to back operating model, we were selected to provide a holistic full suite of core asset servicing, capital markets and data, and analytics products and services. This client was particularly impressed with our ability to digitalize their investment process to maximize the value of their data. We learned that this client chose us because of our combination of market-leading tools and first rate client service. We also saw continued strong demand for our integrated trading solutions offering throughout both the quarter and the year. In 2022, the number of clients on the platform increased 20% year-over-year to nearly 100. Our [indiscernible] transition backlog that we spoke to you about last quarter started to transition in during the fourth quarter and our pipeline remains strong. Expense growth continued to be elevated in the quarter, reflecting investments in people and technology to strengthen our resiliency, advance our digital modernization efforts, and drive growth in the business, all critical initiatives but the level of growth is too high. Some of the charges we announced today reflect early steps we are taking to bring down the trajectory to better align with the current operating environment and create capacity for profitable growth. To underscore our commitment, we recently launched a dedicated office of productivity to reinforce our approach to driving efficiencies throughout the company. Jason will provide more color on this in his prepared remarks. In closing, as we begin 2023, we remain well positioned to navigate the ongoing macroeconomic and market uncertainty from a position of strength. Our focus is on driving organic growth, improving our productivity, and continuing to bolster our foundations. Thank you Mike, and let me join Jennifer and Mike in welcoming you to our fourth quarter 2022 earnings call. Let’s dive into the financial results of the quarter, starting on Page 2. This morning, we reported fourth quarter net income of $155.7 million. Earnings per share were $0.71 and our return on average common equity was 5.9%. Our results were unfortunately impacted by the inclusion of $266 million in pre-tax charges which reflect $199 million in net income impact and $0.94 in earnings per share impact. These charges included the following on a pre-tax basis: $213 million of investment security losses related to the intent to sell certain available for sale debt securities, which were subsequently sold in early January; $32 million of severance-related charges; $14 million of occupancy charges related to early lease exits, and $6.8 million of pension settlement charges. Also recall that in the first quarter of this year, we implemented an accounting reclassification of certain fees which continues to impact the year-over-year comparisons, as noted on this page. Let’s move to Page 3 and review the financial highlights of the quarter. Including the charges previously mentioned, year-over-year revenue was down 8%. Expenses increased 13% and net income was down 62%. In the sequential comparison, revenue was down 13%, expenses were up 8%, while net income was down 61%. Excluding the charges previously mentioned, year-over-year revenue was up 5% and expenses increased 9%. Excluding the charges previously mentioned, on a sequential basis revenue was down 1% and expenses were up 5%. Let’s look at the results in greater detail, starting with revenue on Page 4. Year-over-year unfavorable currency translation reduced our revenue growth by approximately 200 basis points. Trust, investment and other servicing fees representing the largest component of our revenue totaled $1 billion and were down 6% from last year and down 3% sequentially. Our trust fees continued to be unfavorably impacted by the weaker equity and fixed income markets and unfavorable currency movements. As a reminder, a significant portion of our trust fees are recorded on a month or quarter lag basis, so this quarter’s performance is largely reflective of the third quarter’s market performance as well as the months of October and November. The year-over-year and sequential declines in all other remaining non-interest income are primarily driven by the $213 million pre-tax investment security loss due to the intent to sell certain available for sale debt securities. These securities were subsequently sold in early January 2023, which I’ll describe in more detail in a few minutes. Net interest income on an FTE basis, which I’ll also discuss in more detail later, was $550 million and was up 48% from a year ago and up 5% sequentially. Let’s look at the components of our trust and investment fees on Page 5. For our asset servicing business, fees totaled $588 million and were down 6% year-over-year and down 3% sequentially. Within asset servicing, custody and fund administration fees were $406 million, down 11% year-over-year but importantly they were flat sequentially. Custody and fund administration fees decreased from the prior year quarter primarily due to unfavorable markets and unfavorable currency translations, partially offset by new business. Assets under custody and administration for asset servicing clients were $13 trillion at quarter end, down 16% year-over-year and up 6% sequentially. The year-over-year decline was primarily driven by unfavorable markets and currency translation. The sequential increase was primarily driven by favorable markets and currency translation. Investment management fees within asset servicing were $124 million, up 9% year-over-year and down 9% sequentially. Investment management fees decreased sequentially primarily due to asset outflows and unfavorable markets. Investment management fees increased from the prior year quarter primarily due to lower money market fund fee waivers partially offset by asset outflows and unfavorable markets. Assets under management for asset servicing clients were $898 billion, down 25% year-over-year and up 3% sequentially. The year-over-year decline was driven by asset outflows, weaker equity and fixed income markets, and unfavorable currency translation. The sequential growth was driven by favorable markets and currency translation partially offset by asset outflows. Moving to our wealth management business, trust, investment and other servicing fees were $454 million, down 7% compared to the prior year and down 5% from the prior quarter. Within the regions, the year-over-year declines were primarily driven by unfavorable market impacts and asset outflows partially offset by the elimination of money market fund fee waivers. Sequentially the decline within the regions was primarily driven by unfavorable markets, asset outflows, and a strategic re-pricing initiative. With global family office, the year-over-year growth was driven by lower fee waivers and new business, partially offset by unfavorable markets. The sequential decrease was mainly related to asset outflows, unfavorable markets, and the re-pricing initiative. Assets under management for our wealth management clients were $351 billion at quarter end, down 16% year-over-year and up 5% on a sequential basis. The year-over-year decline was driven by primarily by unfavorable markets and asset outflows. The sequential increase was primarily due to favorable markets. Moving to Page 6, net interest income was $550 million in the quarter and was up 48% from the prior year. Earnings assets averaged $134 billion in the quarter, down 10% versus the prior year. Average deposits were $116 billion and were down 14% versus the prior year, while loan balances averaged $42 billion, up 6% compared to the prior year. On a sequential quarter basis, net interest income grew 5%. Average earnings assets were up 1%. Average deposits declined 2% while average loan balances were up 2%. The net interest margin was 1.63% in the quarter, up 64 basis points from a year ago and up 5 basis points from the prior quarter. The prior year quarter increase is primarily due to higher average interest rates. The sequential increase is primarily due to higher average interest rates partially offset by an unfavorable balance sheet mix. Turning to Page 7, on a year-over-year basis expense growth benefited by approximately 300 basis points due to currency translation. As reported, expenses were $1.3 billion in the fourth quarter, 13% higher than the prior year and 8% higher than the prior quarter. The current quarter’s expenses included $53 million in charges. These charges in part reflect steps we’re taking in conjunction with the launch of our office of productivity. To shift away, we approach and manage our expenses. Through this initiative, we expect to leverage data and analytics to help us better understand the efficacy of our spending so as to optimize our cost base and drive greater efficiencies throughout the organization. We’ll update you on our progress in the coming quarters as appropriate. Excluding charges in both periods, expenses in the fourth quarter were up 10% year-over-year and up 5% sequentially. Also, recall that the current quarter includes the impact of the previously mentioned accounting reclassification, which increased other operating expense by $8.6 million compared to the prior year. Compensation expense was up 15% compared to the prior year and up 6% sequentially. The year-over-year growth was primarily driven by higher salary expense in part due to inflationary pressures, and the previously mentioned severance-related charges partially offset by favorable currency translation. The sequential increase is primarily due to the aforementioned severance-related charges and higher salary expense, partially offset by lower incentives. Employee benefits expense was down 4% compared to the prior quarter and down 6% sequentially. The year-over-year decrease was primarily driven by lower ongoing pension expense partially offset by higher medical costs. The sequential decrease was primarily due to lower pension costs, including the lower pension settlement charge relative to the prior period partially offset by higher medical costs. Outside services expense was $233 million and was up 4% from a year ago and up 5% sequentially. The year-over-year increase was primarily driven by higher technical services costs, legal services and consulting services, partially offset by lower third party advisory fees and sub-custodian expense. The sequential increase was primarily due to higher technical services costs and legal services, partially offset by lower sub-custodian expense and consulting costs. Equipment and software expense of $229 million was up 17% from a year ago and up 8% sequentially. The year-over-year and sequential growth are both primarily driven by higher software costs due to continued investments in technology as well as inflationary pressures, and higher amortization. We also recognized a $3.8 million termination charge associated with our mainframe strategy. Occupancy expense of $66 million was up 27% from a year ago and up 28% sequentially. The year-over-year and sequential growth were both primarily driven by the previously mentioned $14 million of charges related to early lease exits. Other operating expense of $108 million was up 37% from a year ago and up 31% sequentially. The year-over-year increase was primarily driven by higher staff-related expense, business promotion, and miscellaneous expense. The sequential increase is primarily due to higher business promotion, supplemental compensation plan expense, and miscellaneous expenses in the current period. Turning to the full year, our results in 2022 are summarized on Page 8. On the right margin of this page, we outline the charges that we called out for both years. Included in these items, net income was $1.3 billion, down 14% compared to 2021, and earnings per share were $6.14, down 14% from the prior year. In 2022, these charges had a $227 million impact on net income and a $1.08 impact on earnings per share. In 2021, these charges had an $18 million impact on net income and a $0.07 impact on earnings per share. Full year revenue and expense trends are outlined on Page 9 and include the charges previously mentioned. Trust, investment and other servicing fees grew 2% in 2022. The growth during the year was primarily driven by lower money market fee waivers and new business, partially offset by unfavorable markets and unfavorable currency translation. Net interest income grew 36%. Average earnings assets during the year decreased by 10% while the net interest margin increased 64 basis points, driven by higher average interest rates. The net result was revenue growth of 5% in 2022 compared to 2021 and expense growth of 10%. Excluding these charges in both periods, revenue for the full year was up 8% from the prior year and expenses were up 9%. Turning to Page 10, our capital ratios remain strong with our common equity Tier 1 ratio of 10.8% under the standardized approach, up from the prior quarter’s 10.1%. Our Tier 1 leverage ratio was 7.1%, up from 7% in the prior quarter. A decrease in net unrealized losses in the available for sale securities portfolio and less foreign exchange volatility were the primary factors in this quarter’s increase in capital ratios. Accumulated other comprehensive income at the end of the quarter was a loss of $1.6 billion. During the quarter, we returned $158.9 million to common shareholders through cash dividends of $158.8 million and share repurchases of $0.1 million. In early January of this year, we sold $2.1 billion of higher capital consuming, lower yielding, non-HQLA debt securities and reinvested the proceeds into lower capital consuming, higher yielding HQLA assets. This repositioning offered the unique opportunity to de-risk our portfolio, free up capital, and improve our liquidity ratios while simultaneously generating more attractive returns. We’ll pause for a moment to allow the opportunity to signal for questions, but while we do, we’ll take our first question from Glenn Schorr from Evercore. Please go ahead. Good morning. I guess I’ll try and focus on deposits. So the interest bearing down 12%, the non-interest bearing down 48% year-on-year, but there’s a clear declining impact on a sequential basis, so I’m curious, a much higher rate paid and a decelerating outflow of deposits, how can you help us think through what to expect in 2023 on both attrition, mix and betas for deposits? Thank you. Sure, well let me--you know, there’s a lot going on with the balance sheet, with the repositioning as well, so let me give you a couple of the key ingredients and then let me know if there’s additional detail you’d like. Just on volume, we saw volume up--down left to 116. We still think that that 110 to 115 is a good starting point for first quarter, and as you know, the quarters have some seasonality. We usually get a spike at the end of fourth quarter, first quarter gets some build from tax preparation, and in the second quarter we’ll start to see outflows as clients pay taxes. But as you think about first quarter at least, 110 to 115 is still a good range. Then let me take beta in three different--or rates, really, in three different parts. First beta, and you noted that beta was high. We’d indicated we thought it would be at this point in the cycle, and we still think that that’s a pretty good indication of what we’ll look like over the course of the next three months. Beta for interest-bearing deposits was 75%, 80%, it was in line. We do anticipate that to be similar. Balance sheet repositioning, that takes $2 billion, a little bit more at what was about 2% or 2.25%, then it reinvests it on the short end of the curve a couple hundred basis points higher. Right now, we’re mostly overnight, but we’ll continue to think about what we want to do with that from a non-HQLA perspective. But at least the starting point you should be thinking about is moving that $2 billion to overnight. Then just lastly as we’re talking about rate, just a quick reminder the runoff on the portfolio is just over a billion dollars, and you’re moving that from 2%, 2.25% to higher rates we’re repositioning as we mature securities to the short end, so there’s a similar pickup there. Then last thing on outlook, just as you think about first quarter, just remember that day count costs us about $8 million going from fourth quarter to first quarter. Those are the big ingredients. Hopefully that’s helpful. Maybe just a follow-up, a similar question on average earning assets up 1% quarter-on-quarter. Should we feel in the range of stable now, or I guess-- Yes, it’s hard to tell. I mean, I think about it very much from--obviously, as you know, it’s a liability-driven balance sheet, and so the common carry on deposits is really what’s driving the size of average earning assets in general. What we saw in the quarter, it certainly does look like things have--like client behavior has settled and leveled out a little bit, but we’re not calling it flat at this point. We’re still operating in a way that we’re anticipating some muted but continued decline. That’s why that 110 to 115, that’s really the drive--you should think of that as the driver of average earning assets. Hi, good morning. I heard all the commentary around the expenses and the efforts to slow the growth rate as we go forward here, but maybe you could help us understand maybe the pace at which you think you can do that, because when I strip out the one-timers from the expense ratio, it still looks like the expense ratio moved up a bit, around 400 basis points Q-on-Q. How should I think about the trajectory from here? Does it stabilize where it is, is there still some push up from here, or should we expect that the arc begins to come down in 1Q? How should we think through that? Well, it doesn’t stay where it is, and it certainly doesn’t increase over time. That expense ratio needs to come down. You’re talking about, I assume, expense to trust fees, and so a few-- Yes, a few things to think about. One, and we can get into more detail on it, but in the short run at least from an expense perspective as we think about what first quarter is going to look like, I can give you some thoughts there, just as you start to model out what does it look like. Compensation is obviously our biggest line, and so we’ve got to start there. We’ve got the $30 million, which you indicated even pulling that out, so what does that look like going forward, we actually think that in general, that line item should start to flatten out in the near term as some of those severance-related activities come online, and we should get a benefit from that. To your question on timing, we should get a benefit on it this year. We’re not going to get the benefit of it right away, but a significant portion, more than half of the actions we’re going to take with severance, we’re anticipating to take place by the end of the first quarter, so we’re going to start to see benefit of that. We’re going to backfill some of those roles, but they’re not going to be in expensive locations. This is very--this is less about us addressing FTE or headcount and it’s getting at what the economics are, which is the salary run rate line for the business showing up in comp. We’re going to get a benefit of that this year, and so as you think about first quarter, don’t forget that we’ve also got retirement-eligible incentives coming online. That hits $50 million in that quarter, but that’s very predictable and seasonal. The other dynamics for compensation, I’d call it a wash as we think about going into first quarter. Then equipment and software is where we’ve seen a big uplift over the last couple years, and we talked a few weeks ago externally about the fact that we thought that line would be at about $225 million. It came in higher at that at $229 million, but that difference--100% of that is the $3.8 million contract termination we decided to do very late in the quarter. Otherwise, we feel like that line item is starting to flatten out as well. We’re going to have--we will have a step-up as we come into first quarter, but we think beyond that, that line item is going to flatten out. That’s obviously where all of our depreciation is, but we’re going to see an uplift of about $12 million in first quarter in equipment and software. One hundred percent of that is coming from depreciation and amortization, but other than that, we’re anticipating that line item to start to flatten out. We’re not going to see this kind of growth going forward. Then the other side of it is, as we think about trust fees and growth in the business, that’s going to help the ratio that you started with as well. Yes, I would just add, Betsy, to your point, it is about trajectories and curves, if you will. We’ve been on a downward trajectory with trust fees as a result of the factors that Jason has gone through. Obviously we’re trying to drive that the other way, primarily through growth. When it comes to NII, we’ve had a strong trajectory up. That’s not likely to carry through into the new year or into 2023, just as a result of the rate cycle. Then looking at the expenses, as Jason went through there, we’re clearly trying to bend down that expense growth curve without a doubt through the productivity office, but also just in every day in how we operate the business. And that curve bend downwards sounds like it’s a second half--like, we’ll see that more in second half than in first? Yes, I think that’s right, because as Jason’s saying, some of these things, there’s actions that we already took in the fourth quarter which we had talked about in the previous call, the intent to get going on those, and then more of them that are happening in the first quarter as well, and then carrying through. So you’re right - by the time you see the impact, it’s delayed relative to the actions. Productivity office - you know, helpful that we’re seeing that emerge, but what are the objectives, right? What are the metrics that they’re looking to drive? You gave some generally kind of high level comments on how to think about bending the curve and whatnot there in response to Betsy’s question, but really, expenses have been a bit out of control - just being blunt, especially relative to the peer group and especially relative to the revenue trends. Investors are really--I’m getting hit a lot this morning, people looking for some more details, better understanding, and what specific metrics you’re using and how we can make sure to--that you’re hitting your goals when you’re pushing through to make these changes. Yes, I can--first of all, the thing that we look at to litmus test how we’re doing from an expense management perspective is still expense to trust fees, and even pulling out the charges from this quarter, being anywhere near 120, that’s not where the business is going to be in the long run. That’s going to come down. Then you start to think more tactically, how does the productivity look to do that, and just to be--you know, just to say what are the numbers associated with it, historically we have talked about productivity matching inflation. When inflation was at 1% or 2%, we felt like we were doing that really well. With inflation at 8% or 9%, we are not going to get productivity to that level, but we should absolutely have productivity above 2% of our expense base. Second, every group in this company has productivity goals. We go through it all the time, every year in our planning process, and then next if you start to just think tactically, how is this office going to get at this work, where are the buckets that we’re going to get at, I’ll give you how the group is laid out. First of all, it’s technology - that’s the largest component and the fastest growing expense item we have. That’s $1.4 billion, and so we have to--we’ve got to get at technology costs. We accomplished a lot in 2022 and 2021, but we’ve got to do it efficiently, and that means determining how we’re purchasing, how we’re developing technology, how we’re consuming it, how we’re delivering it. Two is vendor strategy and how we’re thinking about engaging with our partners externally. Three, investment governance - there are areas around the company where we’re investing in growth for the business, we’re investing to get deeper and stronger, but we’ve got to accomplish those things but at the same time test whether or not we still want to be investing at the same rate, at the same timing. Then lastly, fourth is a big pillar is workforce analysis, and a couple things there. You already see us getting at larger severance than we normally take, and that should get to 300, 400 positions that will be impacted. That’s why we’re focused on driving productivity across operations, and then a step earlier than this, we took out hundreds of technology-related contractors in fourth quarter, just as an indication of how aggressively we’re getting at this internally, and that’s a big effort to do that. But again, we accomplished a lot and now it’s time to turn the corner on it. Yes, and Brennan, I would just add, I think Jason described it well, but think about it as bottoms-up and top-down, right, which is each of the groups, as Jason was saying, they have to have their productivity initiatives that work their way up to their productivity goals that are in the plan. The top-down part is the productivity office, which is doing things that can cut across the enterprise and also have the structure to work with the groups to help them meet those productivity initiatives. That’s the approach to it, and again this is--we always have productivity as a part of the planning process, but as Jason is saying, when you have inflation like we do, you have to be able to ramp up those activities in order to get greater efficiencies. Sure, sure, and everybody is dealing with inflation and it’s certainly troubling and it’s weighing on the results for that question. That was a lot of color and I appreciate that color, Jason and Mike. I would encourage you please to provide some actual metrics, though, to the investment community so that we can measure your progress, understand what your goals are, and actually have some visibility in order to think about where you’re going and what you’re trying to do, not just from a conceptual perspective but from a numbers perspective, because I think that would really help in improving the confidence. One follow-up question would be on wholesale funding. I just took a look - you know, wholesale funding was up again this quarter. Should we think about it getting back to the 2019 levels where it was, like, mid-6% of the funding side of the balance sheet? Is that reasonable, because it still looks like there’s a little ways to go to get there, or is this the upper end of the range and are you trying to limit that growth? There’s not--there’s nothing strategic that we’ve been doing in that area to bring it down, and so it is instructive as you’re doing to look back at more historical levels. It’s not to say that’s the target, but it is to say that where we are right now is not reflective of any strategy that we have for lower levels. Maybe I’ll pivot a little bit. I was hoping to spend a couple minutes on the wealth management and the global family office trends. You guys highlighted outflows, client outflows, asset outflows I think in both of those for the quarter. Wealth management tends to kind of ebb and flow, but global family office historically, I think, has been a source of stronger organic growth, so maybe help us unpack what’s driving the outflows in both of these businesses, and maybe also hit on the strategic price reductions that you mentioned, how much of that is fully captured in the Q4 results. Is there any kind of negative carryover effect into Q1 as we think about fees, and again maybe a little bit more color on the reasons behind these pricing reductions and what you ultimately expect to achieve there. Sure, so let’s just walk the fees, because that’s probably what--is kind of how you’re framing the question. Fees down roughly $20 million for the quarter, right, half of that is markets and then a quarter of it is the re-pricing that we mentioned earlier. As this group knows extraordinarily well, in the asset management side of the business, fee compression is still persistent, and so we have not done those types of reductions a lot recently. We want to make sure that we’re priced appropriately, and so with some of the indexed products, we took a--we took fee reductions, that’s only on the product side, not on the advisory side. Those are done, so there’s a step down there, no incremental benefit going forward and, at this point, no plans to do more. The other quarter of the decline was outflows, and that was--but that was product-related outflows, so really client repositioning in the money market space, in the liquidity space. We’ve seen a journey there for our clients across both wealth as well as asset servicing. It’s very closely aligned to what we saw in deposits of large decline as we came into COVID, and decline as markets gained more confidence and then started to redeploy assets into risk assets. The way we litmus test the business in wealth is to think about our advisory fee, frankly, not the product side but what are the assets and what are the fees related to the advice we have with clients. That’s gone well - in the quarter, client flows for wealth management from an advisory perspective overall were positive. On a linked quarter and year-over-year basis, the net new business and flow activity that we track was positive - low single digits, but it was positive, so the business is not in decline. What we’re seeing is a lot of clients deploying away from their historical mix of using our money market funds and then, in this quarter, re-pricing of product. Got it. As you think about pricing broadly for the products, not the advisory component, but if you think about the money market offering, given the fact that money market funds are actually giving a pretty healthy yield, is there any thought around reducing your money market fees as well to become more competitive to maybe capturing more of those flows or prevent folks from leaving and seeking better yield options net of fees? We look at it all the time. It actually--it’s more--that comes more into play on the institutional side, and we’ve got a really--we’ve got a very large and successful money market mutual fund business. We do a lot of liquidity work for our clients, and so even now there are some strategic waivers that we have in the institutional side of the business, where we’re working pricing to ensure that we’re as attractive as we can be. But it’s not just pricing that clients look at. On the institutional side in particular, they look at size and they look at the underlying quality of the assets. A lot of the ultra-large investors have investment policy restrictions on how big they can be within a fund, and so the fact that we’ve got funds that are $40 billion, $50 billion, $60 billion, it enables those large investors to put money to work, and so the competition set is a little bit lower on the institutional side. We’re above that threshold, so in the long run, that’s very good for us. There will be ebbs and flows based on other factors, but in the long run it’s good. On the wealth side, that’s just going to ebb and flow with the business. Traditionally it’s been more aligned, this is just a period of time where our clients, they’re also thinking about deploying to building their own treasury portfolios, laddering in portfolios there, and then potentially other products, they’ll use ultra short. We do have high confidence that the mix of the usage of this product is going to come back to where it was historically, and you’re exactly right - it’s a very attractive engagement for us economically. Hey, good morning guys. Jason, sorry to come back to NII, but I was just wondering, can you kind of put that all into context for us in terms of if the balance sheet’s shrinking, you get a little bit of help from the repositioning, can NII grow from here based on what you still expect on the rate curve? I guess that would be the question. Thanks. Yes, I appreciate you pushing on that. The answer is yes, it can absolutely grow from here, and we anticipate that throughout the year, it will. I don’t think first quarter is going to see--I’m not sure it’s going to see meaningful growth, but the trajectories are still in our favor. The balance sheet repositioning in and of itself is--that’s an attractive lift, and then betas are not 100%, and so with the Fed actions, we’re going to do well. We’ve also got the runoff which helps us too, so the only offset to that is volumes. That’s what--you know, we’re not sure what that’s going to look like, but even that remained relatively flat, right--it was at the top end, maybe a tiny bit above what our anticipation was last quarter. Okay, thank you. My follow-up to that is how do you think about incremental betas from here in terms of deposit cost increases? You had said you expected a decent move up this quarter - you did get that, so how do we just understand that mix of deposits and the beta that you’re looking at? Thank you. Sure, yes. I mean, the mix, I don’t--we haven’t seen that changing dramatically, but you’re raising an interesting point, which is that the betas are actually different depending on the currency that you’re talking about, so I just think that’s something that’s important for people to think about it. Most of the way the industry also calculates beta is on just the interest-bearing portion. I think it’s instructive to think about the total beta as well, because as we’ve talked about, the mix of interest bearing to non-interest bearing changes over time, and so that has an effect as well. But the betas on the institutional side, I think you’ve got to call them close to 100% at this point. It varies by currency, but I think you’ve got to call it close to 100%. Then on the wealth management side, it’s less than that, and you can imagine for us to get to a blended level that I’m talking about in kind of that 70% to 80% range, wealth is closer to 50%, and the institutional side closer to 100%. Maybe just to also ask about NII, actually more to focus on that deposit growth trend, and you talked about 110 to 115 in 1Q. As you come into second quarter, maybe it’s hard to assess this early, but what type of headwind would tax payments be on that? Then sort of a related question would be to what extent do you want to, or do you think you need to defend those wealth--those strategic wealth deposits and raise the beta further as we get into 2023? I’ll go in reverse order. We’ve talked about heavy defensive wealth deposits. The economics are important and that’s the--those are the things we want to be doing with our clients, hard stop, and so we’re going to do everything we can to defend those. They’re largely relationship driven, but there is--also, there are pockets where our clients look really aggressively at rate, and so we’ve got good governance and infrastructure to make sure we’re doing what we can to maximize that. Then throughout the year, you’re just asking how are we thinking about it over the course of the year, we’ve tended--you can go back and look historically at first quarter to second quarter and see what kind of decline there has been. We don’t think--we don’t anticipate anything different this year, and then what I can tell you is that from there, we don’t expect--we have more of a flattish outlook, but we’ve got to just remember that that second quarter decline does take place, and history should be a pretty good judge. Yes, that’s helpful, and maybe just on expenses, you mentioned the equipment and software up $12 million in the first quarter. Is that from the 229 level in 4Q, or is that 225 ex-the charge? Hey, good morning. Maybe just a little bit on the pension accounting. Did that get triggered again this year, and should we expect more charges this year? Every year we come into it and we don’t expect there to be--to trigger settlement accounting, and it’s ironic because in 2021, we had the thresholds but then we did a larger RIF, and those ended up triggering, and then this past year, it was interest rates going up significantly that led to a higher level of retirements than we anticipated. In no year do we anticipate it at this time, but the bad news is we’re in the exact same boat this time, which is that we look at the thresholds with our outside actuaries, with our consultants, but we can’t predict with high degrees of certainty what the experience will be from a retirement perspective. We have to let that play through. That said, what we experienced in ’21 and ’22, we had not experienced prior to that, and so it’s not like this is something that--it’s happened the last two years, but if you look over the last 10 years, it hasn’t happened outside of these last two years. That’s how we think about it. It seems like more of a trend certainly than what we’re planning or anticipating. Okay, and maybe just on capital, you had a nice sequential improvement in capital ratios. You didn’t really do much in the way of buybacks in ’22. Do you see that being a bigger part of the EPS story this year? Yes, at some point. If you think about the framework we’ve used historically, and I’ve talked about it a lot, there’s no red flags there. We don’t have to have all of those components of the framework saying green. We look at it in combination at any given point in time, and we’re at 10:8 right now. We also still have $1.6 billion in AOCI - that will come down a little bit, actually in a chunk because of the securities repositioning, because we did that after the quarter, so we’ve got, call it a $1.4 billion that’s going to be accreting into capital over time. The returns in the business are still strong, and so there’s no reason we wouldn’t be back at some point. Good morning guys. On the fee side, I just wanted to check in on organic growth and the competitive landscape, you know, this quarter and into ’23 for both the institutional and the wealth businesses. Thanks. Sure, so I’d say different stories there. We talked about wealth a little bit earlier, and if you think about just the core underlying business, really focusing more on the account management side, then the business had a very strong first half of the year and the second half of the year was weaker. We’ve also noted GFO was much stronger than the regions, but again that’s going to ebb and flow over time; but organic growth the way we have calculated it and communicated it historically was negative in the regions for the quarter, and call it flat for GFO--actually, slightly positive GFO if you think about it on a year-over-year basis. It at least gives you a sense of where that business is. But then again, from the advisory side, even both for the year-over-year and at the end of the quarter, the advisory fees did well, and so the core business there is strong. We think it’s the product mix and other factors leading to the way we’ve calculated organic growth as being negative. In asset servicing, different story - we talked at the early part of the year that we felt the pipeline was good. That pipeline has started to on-board in fourth quarter, and we feel good about the growth in that business. The proxy there should be more custody and fun servicing fees, just as I talked about account management fees in wealth management, the proxy--the same corollary there is custody and fund servicing. That was a positive in fourth quarter, it was actually really attractive. We had new business that Mike talked about early coming online in the business to the tune of kind of mid single digits, and we feel like that business is back to its historical organic growth rate. That’s evidenced by what we on-boarded. The one not on-boarded business we have right now is higher than our three-year average, and the pipeline of business they have, that they’re still bidding on in late stages, is higher than the three-year average for the business, so a lot of positive signs in the asset servicing business from an organic perspective. That’s helpful. Just on that starting to on-board business in asset servicing, I think in the past you had talked about that not really coming online until the second half of ’23, so is that a pull forward there? Yes, I’m sorry - it was early ’22 that we talked about there being business in the back half of the year that was on-boarding, so that did come into play. We do have right now--there is a chunk of business that we know is on-boarding in the short run. The pipeline is good, and then you go out farther to the end of ’23 and there’s another chunk of large business that we’re anticipating to come on in a couple different areas fourth quarter, and even into first quarter of ’24. The pipeline for that business at various stages is looking good. Hi. On the expenses, oh my - I get it. You guys are dealing with the first decline in both stock and bond markets in over 50 years. You said you’re preserving growth by investing in people and tech. There’s inflation, but wow, this is the worst quarterly operating leverage that I can recall for you guys. For the year, it was negative operating leverage of 500 basis points, and even cost has grown twice the pace of revenue growth. I guess what I’m looking for is more assurance that expenses haven’t gotten away from you. I get it - at the high level, you said--you know, it looks like you’re right-sizing headcount with severance, you took out hundreds of tech-related contracts, you have some kind of mainframe strategy. I have to tell you, I just don’t understand what that means from a bottom line standpoint. I guess the question is, you’ve said your expenses to trust fee ratio of 120% is unacceptable, but what is acceptable and when should you get there - like, 2024, 2025? What kind of sense of urgency do you have, because this is not the Northern we’ve gotten to know over the past long while, aside from your resiliency through tough times. Thanks. Mike, it’s Mike. To your point, if you go back a number of years, where we were at levels that were like this, it’s been a long time, and that’s why it is considered unacceptable where we are. We were effective in driving that ratio down into an area where, yes, we thought it was within that range for us to be able to continue to operate, and that’s kind of that 105 to 110 range. We have the same objective now of getting it back into that range. That calculation is a numerator and a denominator, and we’re trying to drive both of those. Beyond the challenging environment on the fee front, which is going to happen at various times, we’re trying to drive the organic growth there, and as much as we had good growth in the year, it was not one of our stronger organic growth levels, so challenged on the numerator both, I would say conditions, but also what we did on our part. Then on the other side, from an expense perspective, as Jason said, we got a lot done not just this year but the last couple of years in really making, call it the company more resilient, and I’ll get into a little more detail on that; but just contextually if you think back a few years with the pandemic and the last couple of years, the technology infrastructure of the company is just critical to your ability to be just what you said, which is resilient and there for your clients in any set of conditions, and so that’s required a lot of investment in technology. Some of it, if you think about it, you have to be able to operate completely remotely, and so you have to invest to be able to do that, and you also have to be reliable for clients, so when it comes to modernizing all the technology you have, it does require investment on that front. In the meantime, we also push forward with our digitalization efforts, which is much more the client-facing part of that which is essential to being competitive and essential to growing. It’s been very active across that. Some of that is, call it non-discretionary, right - it needs to be done to be able to do what I said. Other parts of it, you do have more discretion in the speed, particularly around the digitalization front, and you’re looking at the returns that you’re going to get for that. We talked about things like Matrix, which has been a meaningful investment which will drive both productivity but also will drive our capabilities, and therefore revenue and organic growth on that front. The same thing is happening in wealth management, where we have to make sure that our interface with our clients is frictionless, as Steve would say, in the technology interface with the clients. That part of it, again, we can pay some, and that’s part of what we’ll have to do on the technology front. The last part of it is just the need for efficiencies around the technology spend and then just more broadly, which we’ve done many times and need to just increase the focus on execution around those, what I’ll call more traditional ways to drive productivity. You asked the question on, okay, when does it get into that range, is it ’23, is it ’24? I don’t know, because I don’t know exactly what’s going to happen with the numerator and the denominator, but that’s what we’re driving towards, is to get it into that range and, in the meantime, also trying to drive profitability, meaning driving pre-tax margins above 30%. That’s kind of the view and the plan. Can you give any specifics for the year? I know it’s not always your style, but in terms of expense growth for the year or what the savings are from the elimination of all the tech contracts, or even just if I think of investing along a J-curve, seems like you’re on this tech journey, like a lot of others are, and some are still in the investing phase and some are in the harvesting phase. When do you think you go from investing to harvesting on this broader tech strategy, which seems to be impacting your expenses? Yes, so I’ll answer both but then let Jason add, too. We are clearly in the investing stage, but I would say--you know, and you’re always investing of course in that, because the needs change over time, etc. But from a cresting perspective, etc., we’re more towards that than we are away from it, if that makes sense. In other words, we have gotten a lot done in the last couple of years on that front, so that’s my view. Then as far as the expenses, we talked about for the year expenses at 9%, so that’s the part where we’re saying that doesn’t work, and so how do we bring that down. Now, there is still going to be growth in expenses for the year because there’s certain aspects that just carry into the year, right? You do have base pay increases that flow in and you do have some of the technology costs that are amortizations that just come into the year, but outside of that, you’re trying to do everything you can with productivity to offset other increases. Well, I can give you a little bit more color on the year, if it’s helpful, and whatever information is helpful, obviously I’m happy to give what we see at this point. But one thing as you’re thinking about the next several quarters, not just the next one, is outside services was elevated and lots of things happening there is fourth quarter. Some of that is episodic, some of that has--I’m sorry, other expense, some of that is episodic agency expense, supplemental pension plan. Some of those have more of a longer term trend, so think travel, marketing - that was actually up $8 million over third quarter, that’s likely going to stay elevated. But some of these were episodic, and so we don’t think we’re going to see other expenses at $107 million. It should even--that should quickly unless-- and some of it’s out of our control because things like the supplemental pension plan are market affected. But that should get to below $100 million and hopefully stay that way going forward. Then you just think about the impact also of compensation. Just to give you some color there, we know base pay is going to come online in second quarter - that’s going to be a $20 million lift, and then to severance activity, we think that’s going to help us help offset that a little bit, probably $5 million to $7 million on a quarterly basis starting in second, third quarter. Then we’ll have some additional hiring, but that’s going to be in line with the growth of the business. That at least gives you a sense of some of the line items. The last thing, visibility on equipment and software, the depreciation lift that we got coming into first quarter, that levels out a lot. There’s some growth, call it a couple million dollars a quarter after that, but nowhere near this level, so a lot of the--that’s where you get to what’s the impact of that hundreds of contracts coming out. We’re starting to flatten that depreciation and amortization line which sits within equipment and software, which has been the fastest grower. It’s just reflective that we’ve gotten a lot of work done. Hi Jason. Coming back to the expense topic and conversation, on the salaries, can you share whether this--the cost of those salaries, is it going more to entry-level folks or is it more your senior people? Then second, are you at risk of losing people, which is why you had to bump up salaries? Maybe a little more detail about just the salary portion. Yes, so two very different dynamics happening. The actions we’re taking this year are not across the board, much more targeted than they have been historically and very centered, frankly, around technology and some operations-oriented functions, effectively. That just gives you a sense of where we’re going. Then to why we’ve had some of the increases, some of the salary increase we had last year obviously was an inflation-related higher than average merit increase, but a lot of the growth we had last year was doing off-cycle adjustments to retain talent, specifically in the wealth management business. We think that that’s largely done at this point. You can never claim with certainty that that’s fully over, but that was meaningful. You know how important that franchise is to us and how important that talent base is, and so we were going to defend that base. That episode, that seems to be over at this point and we’re more to a business-as-usual growth rate across the organization, but we’re identifying areas where we can get significant salary run rate savings and getting after those aggressively. Very good. Then as a follow-up, can you share with us on the sale of the fixed income portfolio which resulted in losses that you reported, can you give us some color on what types of securities were sold and the yields of those securities, and then by reinvesting the proceeds from that sale, how long will it take you to earn back that loss that you had to take to exit the portfolios? What we looked for were securities that had the combination of a couple things: one, poor RWA treatment, and secondly lower coupon, lower yield, and third that they still had significant time to maturity. That bucket ended up being $2 billion, $2.5 billion. The coupon on those was in the 2% to 2.25% on average, and the reinvestment of those coming in at--you know, think about earnings on reserve balances at the Fed in the 4.5% range at this point. In terms of the payback on that, it’s more like 3.5 years, but remember from a regulatory reporting perspective, we had already stripped out the unrealized loss in that portfolio, and so the drivers of this were very largely around the opportunity to improve capital ratios, not that we needed to improve capital or liquidity - we didn’t, but seeing the opportunity to benefit CET-1 in the form of lower RWA treatment coupled with improved liquidity ratio, and at the same time not hurt the economic value of your earnings stream, was very attractive to go after, and that’s really what led us to do this. Hey, good morning. Gerard actually asked my question, but I did want to clarify one item relating to the securities portfolio repositioning, which is whether you have any appetite to actually engage in further repositioning of the book from here. Well, we would have appetite, frankly, because it’s an attractive thing to do, but at the same time, we feel like we’ve harvested just about everything that’s there. I’m glad you asked the follow-up because as soon as I finished, I realized Gerard, and now you might be interested in just a little bit more color - corporate bonds within the $2 billion was about half, munis and mortgage-backed securities were about a quarter each, just so you know. But it’s an attractive time to go after something like that given the yield curve and the ability to change non-HQLA assets to HQLA assets, pick up capital, pick up liquidity and no impact from an economic perspective, and in fact making it positive. Great. Hey, good morning. I just wanted to follow up on one of the capital and ensure purchase questions from earlier. I looked at your capital ratios - you’re well above your minimums, which is consistent with how you’ve always managed the capital, but you’ve got a number of tailwinds on that front, and Jason, you mentioned that you plan to resume the buybacks at some point. But I guess it seems to me that there’s really no time like the present, so my question is, should we expect the share repurchases to engage in a more meaningful way in the first quarter? When we think about the full year, what are the guardrails we should consider for your capital ratios as we think about modeling capital return from here? Sure, so we won’t comment more on timing, and if I get to the guardrails, it’s instructive, I think, to look--and again, none of these are 100% determinative, they’re just part of how we think about it, but these are the factors we think about. Look at the absolute levels, which tells you to look at history, look at where we are relative to peers and then relative to regulatory perspectives - we look at those things. Then the other dynamic is that RWA has been less predictable than pre-COVID, and we used our balance sheet to be there for our clients. We were one of the few institutions that actually let RWA increase over the last several years, and it’s because we wanted--our clients had loan demand and they wanted us to be there in FX activity and set lending, and we did that because we had--it was because we were able to, because we had the capital strength and flexibility to do that. That’s the thing that we’re also looking forward on, to make sure that we’re not missing any significant changes in client demand that might impact our behavior. But you’re right in that sitting at 10:8, it’s a much better position, and then back to this concept of $1.4 billion in AOCI pulling a par over the next several years, plus the return on equity in the business is still attractive, so we’re still each quarter accreting capital, so no reason we won’t be in the market at some point. If I can just follow up on that, Jason, the loan balances were down about 2.5% sequentially. It sounds like--I guess, how are you thinking about that loan demand from here? Our view is it sounded like it was kind of softer going forward, but you kind of alluded to the fact that maybe you wanted to be there to meet client demand, so are you expecting that loan demand to pick up here in 2023? Then I guess just one other follow-on on the capital side, how do you think about inorganic actions here in terms of capital allocation? Do you see any other opportunities to change your strategic asset mix and scale so that perhaps that could be another avenue that you’d consider on the capital allocation front? Sure, so on loan demand, I always remind people, it’s super spiky. On the base of business we have and the clients that we have that can come with really significant asks, and we’re happy to do it because a lot of times, they’ve got potentially billions of dollars in assets, and then they might have a liquidity need and they don’t want to liquidate the asset, it’s a great opportunity for us to help them at very large dollar amounts, it solidifies relationships well. We just don’t look quarter to quarter at loan volumes as much as I think it’s appropriate to for other institutions. In general, our growth expectations are for more of a business-as-usual growth rate. We do anticipate some growth this year in the business, not a ton but more business-as-usual. Then on capital, there’s no problem we’re trying to fix in mix or scale. Frankly in capability, we’re just thinking opportunistically. If things come up, we’ve got the capital to be able to look at it. We’ve talked about having more of a bias at this point towards wealth management. We’ve done some things from an acquisition perspective in asset servicing over the last several years - they’ve gone well, but we’ve got a whole product circle there that we feel good about than we do in wealth, but the more we can bring on attractive wealth clients that don’t necessarily have the holistic product approach that we can bring, it’s a great opportunity for us to create value, and so that’d be top of the list, but no problems we’re looking to solve from a mix or scale perspective. Great, thanks for taking my follow-up. Maybe to switch gears a little bit, just on the wealth side, to what extent are you seeing any impact from some of your entrepreneur clients that may have had lower valuations in their private businesses, or in their public businesses? Are you seeing any kind of pullback from those clients? Is it significant or is it really just not that big a deal? Brian, it’s Mike. I would say we definitely are seeing a different perspective on the part of the clients that you’re talking about, or prospects, right? I mean, a lot of the activity in 2021, beginning of 2022 was as a result of business owners who were selling their businesses, were monetizing assets, and so that was an uplift for us. With the reduced activity that you’re seeing of IPOs and market activity there, but then also certainly in the private marketplace lower activity there, definitely it’s had an impact for us of just less market opportunity for us. Okay, thanks, and then just one more on expenses - a lot’s been asked and answered, but just in terms of the on-boarding for the asset servicing pipeline, should we expect what is typically in the business, where you have some on-boarding expenses ahead of when the contracts are installed and generating revenue? Is that something also that might create some noise for 2023, given the 4Q larger, chunky mandate that I think you’re bringing on? Yes, a couple things. One, nothing that we’d call out at this point. If that changes, we’d call it out for you. In some instances, even, some of those expenses are capitalized in long term contracts, and so--but nothing at this point that we’d want you to be thinking ahead on.
EarningCall_1501
Good day, and thank you for standing by. Welcome to the Richardson Electronics Earnings Call for the Second Quarter Fiscal Year 2023 Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. Good morning, and Happy New Year. Welcome to Richardson Electronics conference call for the second quarter of fiscal year 2023. Joining me today are Robert Ben, Chief Financial Officer; Wendy Diddell, Chief Operating Officer and General Manager for Richardson Healthcare; Greg Peloquin, General Manager of our Power & Microwave Technologies Group and our newest business unit, Green Energy Solutions; and Jens Ruppert, General Manager of Canvys. As a reminder, this call is being recorded and will be available for playback. I would also like to remind you that we'll be making forward-looking statements. They're based on current expectations and involve risks and uncertainties. Therefore, our actual results could be materially different. Please refer to our press release and SEC filings for an explanation of our risk factors. We're extremely pleased with our strong financial performance in the second quarter. Despite global economic challenges, rising interest rates, supply chain delays, and recession fears, sales in the second quarter of fiscal 2023 exceeded our expectations and were up 22.1% over Q2 of last year. There were times we had teams working in six and sometimes seven days a week to ensure we met customer demands. Sales growth was particularly strong in Green Energy Solutions. Sales of our patented ULTRA3000 capacitor modules increased as the microwave tubes for a synthetic diamond manufacturing and Power Management Solutions for electric cars and locomotives. Sales were also strong for the semiconductor wafer fab market in Canvys displays. There are many programs in the works to adapt to changing market conditions and continue this growth. Bob Ben, Chief Financial Officer, will first review our second quarter financial performance in more detail. Then Greg, Wendy and Jens will provide more detail on the quarter and key growth initiatives. I will review our financial results for our second quarter and first six months of fiscal year 2023, followed by a review of our cash position. Net sales for the second quarter of fiscal 2023 increased 22.1% to $65.9 million compared to net sales of $54.0 million in the prior year second quarter due to higher net sales and our Power & Microwave Technologies, or PMT, Green Energy Solutions, or GES, and Canvys business units, partially offset by slightly lower sales in our healthcare business unit. PMT sales increased by $3.8 million or 10.2% from last year's second quarter, driven by growth from our manufactured products for our semiconductor wafer fabrication equipment customers and distributed products for RF and microwave applications. Net sales for GES increased $7.4 million or 150.3% from last year's second quarter, GES combines our key technology partners and engineered solutions capabilities to design and manufacture products for fast-growing green energy market and power management applications. Canvys sales increased by $0.9 million or 10.2% due to strong customer demand in North America. Richardson Healthcare sales decreased $0.2 million or 4.7% due to a decrease in parts sales, partially offset by increased equipment and CT tube sales. Total company backlog was $192.6 million in the second quarter of fiscal 2023, up from $146.9 million at the end of the second quarter of fiscal 2022. Gross margin for the second quarter was 33.2% of net sales compared to 32.7% of net sales in last year's second quarter. PMT's margin increased to 34.5% from 33.7%, and GES margin increased to 33.9% from 32.3% primarily due to product mix. Canvys' gross margin decreased to 29.7% from 31.8% because of product mix and foreign exchange effects. Healthcare's gross margin was 23.2% in the second quarter of fiscal 2023 compared to 24.5% in the prior year second quarter due to product mix. Operating expenses were $14.7 million for the second quarter of fiscal 2023 compared to $13.1 million in the second quarter of fiscal 2022. The increase in operating expenses resulted from higher employee compensation, including incentive expense from significantly higher operating income and higher travel costs. Operating expenses as a percentage of net sales decreased to 22.3% during the second quarter of fiscal 2023 compared to 24.3% during the second quarter of fiscal 2022. The company reported operating income of $7.2 million or 10.9% of net sales for the second quarter of fiscal 2023 versus operating income of $4.5 million or 8.4% of net sales in the second quarter of last year. Other expenses for the second quarter of fiscal 2023, including foreign exchange, partially offset by interest income were $0.1 million compared to other income of $0.2 million in the second quarter of fiscal 2022. Income tax expense was $1.5 million for the second quarter of fiscal 2023 or a 21.5% effective tax rate versus $0.6 million in the prior year second quarter due to the use of federal NOLs in fiscal 2022. Net income was $5.5 million or 8.4% of net sales for the second quarter of fiscal 2023 as compared to a net income of $4.1 million or 7.6% of net sales in the second quarter of fiscal 2022. Earnings per common share on a diluted basis in the second quarter of fiscal 2023 were $0.39 compared to $0.30 per common share on a diluted basis in the prior year's second quarter. Turning to a review of the results for the first six months of fiscal year 2023. Net sales for the first six months of fiscal year 2023 were $133.5 million, an increase of 23.9% from $107.7 million in the first six months of fiscal year 2022. Net sales increased by $8.7 million or 11.2% for PMT, $13.3 million or 177.9% for GES, $2.9 million or 16.5% for Canvys and $0.9 million or 16.5% for Richardson Healthcare. Gross margin increased to 33.6% from 31.5%, primarily reflecting a favorable product mix in PMT and GES, decreased component scrap expenses and improved manufacturing absorption in healthcare, partially offset by unfavorable product mix and foreign currency effects for Canvys. Operating expenses were $28.9 million for the first six months of the fiscal year, which represented an increase of $2.3 million from the first six months of the last fiscal year. The increase was due to higher employee compensation and travel expenses. Operating income for the first six months of fiscal year 2023 was $16.0 million or 12.0% of net sales as compared to an operating income of $7.3 million or 6.8% of net sales for the first six months of fiscal year 2022. Other expense for the first six months of fiscal 2023, including interest income and foreign exchange, was $0.5 million as compared to other income of $0.1 million for the first six months of fiscal 2022. The income tax provision was $3.6 million during the first six months of fiscal 2023 or a 23.4% effective tax rate versus $0.7 million in the prior year's first six months due to the use of federal NOLs in fiscal 2022. The company reported net income of $11.9 million or 8.9% of net sales for the first six months of fiscal year 2023 versus $6.8 million or 6.3% for the first six months of fiscal year 2022. Earnings per common share on a diluted basis in the first six months of fiscal 2023 were $0.83 compared to $0.50 per common share on a diluted basis in the prior year's first six months. Moving to a review of our cash position. Cash and investments at the end of the second quarter of fiscal 2023 were $31.1 million compared to $35.6 million at the end of the first quarter of fiscal 2023 and $40.5 million at the end of fiscal 2022. The company continued to invest in working capital to support its growth initiatives. Inventory grew to $97.4 million from $89.1 million at the end of the first quarter of fiscal 2023 to support continued increases in sales. Accounts receivable increased to $34.9 million from $32.6 million at the end of the first quarter of fiscal 2023 due to the high sales growth. Our DSO was 38 days versus 39 days in the first quarter of fiscal 2023. Capital expenditures were $1.3 million in the second quarter of fiscal 2023 versus $0.8 million in the second quarter of fiscal year 2022, approximately $0.5 million related to investments in manufacturing, $0.3 million for our facilities, $0.3 million for our IT system and $0.2 million was for our healthcare business. We expect a higher level of capital expenditures in fiscal 2023 as we make additional investments in our manufacturing capabilities and facilities. We paid $0.8 million in cash dividends in the second quarter. In addition, based on our current financial position, our Board of Directors declared a regular quarterly cash dividend of $0.06 per common share, which will be paid in the third quarter of fiscal 2023. Now I will turn the call over to Greg, who will discuss the results for our PMT and GES business groups. Both of our strategic business units, Power & Microwave Technologies, or PMT, and Green Energy Solutions, or GES, drove strong growth in our second quarter. Our GES Group had exceptional growth as the demand for green energy applications such as wind energy, electric vehicles and energy storage continues to grow. We continue to apply and focus on resources to this extremely important strategic business unit and growth opportunity for Richardson Electronics. GES sales were up 150.3% in Q2 of FY '23 at $12.3 million versus $4.9 million last fiscal year, and our current backlog is $52.5 million. Gross margin also increased to 33.9% versus 32.3% in the same period last fiscal year. As mentioned previously, this group houses numerous successful products such as the ULTRA3000, electric locomotive battery modules, the ULTRAGEN3000 and products using synthetic diamond manufacturing. In addition, we've had numerous products in design, prototype and beta testing. This strategy, developing niche products and technologies, is key to our long-term success. The growth of customers and products in GES continues as several major OEMs are in weekly discussions with our engineering team in the development of energy storage products and other green energy applications. We plan to announce several new products in the first half of calendar 2023. Sales for the Power & Microwave Technologies Group in the second quarter of fiscal 2023 increased 10.2% to $40.6 million versus $36.8 million in Q2 last fiscal year. Our gross margin also increased in the quarter to 34.5% versus 33.7% in Q2 last fiscal year, which was mainly due to continued success in our RF and wireless infrastructure business and a very strong quarter for our semiconductor wafer fabrication equipment business. Our Engineered Solutions strategy is led by our global technology partners such as Qorvo, MACOM, Anokiwave, LS Materials, Amogreentech and Fuji Semiconductor. Key tube manufacturers and partners include CPI, Thales, the Nisshinbo Micro Devices, previously known as NJRC, and Photonis. Each of our global partners helps us meet and manage customer requirements. Our team has done an excellent job identifying and cultivating these relationships. We will continue to review and add partners that fill technology gaps in our offering and support our growth. Often through these partnerships, we're able to identify opportunities for new products that we design and manufacture in-house, increasing the value we provide to customers and allowing us to capture more revenue. We continue to invest in our infrastructure to support our growth. We are bringing talented design engineers, field engineers and making investments to enhance our manufacturing capabilities through our organization. Our growing in-house design, engineering and manufacturing teams are doing a great job supporting the increased demand for current products and new product designs. The team also supported product designs for key growth markets, focusing on GES such as the ULTRA3000, ULTRAGEN3000 and a power management module for electric locomotives. I am pleased with the progress we are making. We will continue to identify, develop and introduce new products and technologies for green energy and other power management applications. Our growth strategy has proven to be highly successful over the years, and we will continue to develop new products as well as increase our customer base, revenue and profits by capitalizing on our existing demand creation infrastructure. While we're excited about the future, we remain challenged by longer lead times and constraints on the overall supply chain. This affects both our component business and Engineered Solutions products. We are strategically investing in inventory that should position us to fill the pipeline and ensure we can meet our customers' needs, while we collaborate closely with both our customers and suppliers. We are also experiencing some headwinds and some markets are showing a slowdown from the highs we hit in 2022. However, we continue to grow both our top and bottom lines by gaining market share, introducing new products and technology partners and expanding the value we provide our customers. I cannot stress enough the value of Richardson Electronics model to our customers and suppliers. Our unparalleled capability and global go-to-market strategy are unique to the power and RF microwave industries. We have developed a strong business model, including legacy products and new technology partners that fit well with our engineered solutions capability. Through our steadfast and creative focus on customers, we will continue to excel by taking advantage of opportunities when they arise. The combined backlog of PMT and GES is strong at $141.4 million, and the execution of our strategy has never been better. There is no question that our customers and technology partners need Richardson's products and capabilities and support more than ever. With that, I'll turn it over to Wendy Diddell to discuss Richardson Healthcare. Second quarter sales for healthcare were $2.9 million, a slight decrease of 4.7% versus Q2 of FY '22. In the final week of the quarter, two ALTA tubes were held up due to a canceled flight, and we were not able to recognize the revenue. On the bright side, these sales are a nice start to Q3. Had these shifts as planned, Q2 revenue would have been above the prior year period, and we would be discussing a record sales quarter for the number of CT tube units sold. CT tube sales were helped by strong demand in China for the ALTA750 D&G as well as Straton Z tubes sold as betas in the Americas. Sales in the quarter were also higher for CT systems when compared to Q2 last year. Gross margin in the second quarter declined to 23.2% versus 24.5% in Q2 last year, primarily reflecting a lower percentage of higher-margin part sales. While CT tubes remained in production throughout the quarter, we did experience a significant equipment issue, which prevented us from making our CT tube production goals. This resulted in a small negative manufacturing variance. We've resolved the issue and are back in full production. We are making steady progress on the Siemens repaired tube program. This is a series of four tube types, including the Straton Z, MX, MXP and MXP46. The Siemens installed base is considerably larger than Canons and there are no third-party replacement options for these tube types. The Straton is currently in beta site testing. -- and we remain on track to fully release the repaired tube pending submission of FDA paperwork. We anticipate the Siemens MX series will follow in the first half of calendar year 2023. As noted in prior calls, the Siemens program is a critical element for our healthcare business unit to reach its goal of providing positive operating contribution to the company by Q4 of FY '24. In addition to our Siemens program, we are evaluating several new programs that will further improve CT tube sales and factory utilization. These programs include reloading tubes in Brazil, a market where we currently have no tube sales, and partnering with an international company to reload and sell several other tube types in the Americas. These programs may have a positive impact on our revenue in FY '24, depending on how quickly we can validate and achieve regulatory approvals. We remain cautiously optimistic about our ability to break even or provide positive operating contribution by the fourth quarter of FY '24. We continue to monitor our progress, and we will make the necessary adjustments to achieve this goal. I will now turn the call over to Jens Ruppert to discuss the results for Canvys. Canvys, engineers, manufactures and sells custom displays to original equipment manufacturers in industrial and medical markets throughout the world. Canvys delivered an outstanding performance with sales of $10.1 million for the second quarter of fiscal 2023. We Strong customer demand, primarily in North America, drove the 10.2% increase in sales over the same period last year. Gross margin as a percentage of net sales was 29.7% during the second quarter of fiscal 2023 compared to 31.8% during the second quarter of fiscal 2022. The decrease in gross margin was primarily related to the product mix and foreign currency effects. Our backlog remains very healthy, which we expect to support strong sales throughout fiscal 2023 and into fiscal 2024. Given the number of projects currently in the engineering stage, we are well positioned for continued growth. Our expectations assume no impact from current supply chain obstacles and demand is not negatively impacted by recessionary pressure. We continue to deal with extended lead times for selected components from our Asian suppliers. To compensate for this, our inventory on hand increased during the quarter. It is important to note that all our monitors are customer and our inventory is allocated for specific customer orders. So we believe there is a minimal risk to carrying slightly higher inventory levels. During the quarter, we received several new orders from both existing and first-time medical OEM customers. Some of these applications include cell analyzer, cardiac pulsed field ablation, super pulse laser systems used in lithotripsy, robotic-assisted surgery, medical device control, monitors for dental treatment chair, prostate biopsy systems, surgical navigation to track instruments throughout the procedure, laser systems that treat corneal arterial disease and monitors used in radiation therapy. In the nonmedical space, our products are used in a variety of commercial and industrial applications. This includes control room monitors for the public transportation space, human machine interfaces, HMI, for packaging machines in the food industry, for radiation measurement systems and for process automation. I am very proud of our teams around the world, and I'm extremely pleased with the exceptional operating performance. Our strong and growing customer relationships, along with the backlog position us for future growth. From the variety of customers and applications as well as the value of orders from existing and new customers, it is clear we offer our global customers outstanding products and localized service. While our sales organization stays focused on new opportunities, I stay focused on improving the operating performance of the division. Maximizing cash flow and improving Canvys' profitability is an ongoing priority. We continue to work closely with our partners to meet the demands of our customers, particularly with the challenges brought on by industry-wide supply chain delays. As you've heard from the business unit managers, there are many programs fueling our growth. This product market and geographic diversity provides a natural hedge against economic challenges and global political tensions. Many of you are aware of the recent CHIPS Act and its impact on the semiconductor industry. This act prevents U.S. semiconductor wafer fab equipment manufacturers from shipping certain advanced technology equipment to China. While we know this will have an impact on our business in calendar 2023, we're confident that our financial performance will be -- remain strong for the balance of our fiscal year. All our manufacturing employees are cross-trained and can be moved to different areas to meet significant growth and demand for our green energy solutions. By reallocating resources, we can meet demand while maintaining our core competencies in the semi market and cost controls. We remain firmly committed to our employees who have helped shape our path to success and to our partners and our shareholders. With our focus on customer-driven solutions that help improve the environment, we expect strong year-over-year revenue and earnings growth throughout the remainder of fiscal 2023. Hi, Wendy and Richard and everyone else. Congratulations on the great quarter again I'm just curious, I mean, you touched on the semiconductor. So -- what kind of visibility do you have there for the rest of the year? And sort of when do you think you will have visibility into next year in terms of the demand for semiconductor? So we have good visibility for the rest of our fiscal year. So Q3 and Q4, we feel very strong about, including opportunities with the semi market, but that's about as far as we're able to see right now. Okay. And I understand you're sort of -- you have a very strong demand in the GES that might make up for any softness in the semiconductor. Can you just talk about maybe some opportunities in the GES that is a little bit further out that you might not have talked as much about? Yes. So the GES program, as I mentioned, has introduced a number of products that are getting huge traction. We also have a number of products in the pipeline -- and if we look at the introduction, the SAM for those products and when these beta site testing will be completed and go into production orders, we're very confident that any gross margin dollar reduction that we'll get from Lam or the semiconductor wafer fab market will more than make up with current products that are getting traction with other customers, but also some new products we're introducing in Q3. Okay. Thank you. And I think in your remarks, you talked about some slowdown from highs. Was that related to semiconductor or was that related to something else? Or can you sort of elaborate on that? Yes, mainly in reference to the semiconductor wafer fab market. As you know, we had record quarters for the past four quarters with our semiconductor wafer fab market. So we're looking at, based on information from them that there could be a slowdown in FY '24. Okay. Thank you. And in terms of Canvys, I don't think you mentioned what the backlog stands at for Canvys right now at the end of the quarter? Yes. Yes, sure. Absolutely. So the backlog is actually up very much. It's the second highest backlog level we have since ever. It's $49.4 million. So pretty happy with that. Okay. I'm sorry. Okay. still a good increase. And Wendy in terms of the healthcare, it seems like you had some -- I mean the flights were also have those being shipped in this quarter instead, but also some issues with the production. How much did that stall you and...? Yes, that's a good question. In the quarter -- the production -- the equipment that caused us some problems within the last month of the quarter. And overall, it cost us maybe 1% of margin. So it wasn't significant. We were really doing well through the first part of the quarter in terms of producing tubes. So it was a small blip. But again, maybe a percentage point in the gross margin. And then one last question, if I may. So the OEM that you work with, are they single searching with you? Or are they also working with other partners? On the GES side, on the products we have today, for example, the ULTRA3000, we're exclusive with the four top owner operators of GE wind turbines in North America. So almost all of our products since we are unique, it's a unique technology. We do have competitors, but the business we have today, we are a sole source. Yes. No, I just wanted to congratulate you on the quarter as well. I'm sure you're disappointed as all of us are by the less than enthusiastic response that market has given you. But my question is for Bob Ben. I noticed of the $30 million in cash, $5 million shows up as being invested in short term. Given the recent uptick in short-term rates around the world. Is there any additional opportunities to invest some of the cash to provide return? Hi Denis, that's a good question. We do have an investment committee that looks at that each quarter. And we were able to get, as you were noting the increase in interest rates. We were able to get an increase in rates. But still, the markets have not moved up that substantially in rates. So -- but we're consistently looking at it. And as you noted, we have $5 million of that invested. I might add, too, that -- we're -- as you know, we're a very global company, and we have many locations around the world. And so our cash is located in many different countries. And so most of it is here in the U.S., of course, where we have the $5 million invested. But Other than that, I believe we have some invested in China, but the rest is used to operate the business. So I mean, what prevents you from buying real short-term bills or whatever. I mean you could still keep it basically accessible and still earn something on it. Even the European money market rates are up to a couple percent. I mean... Sure. And as I noted, we're consistently looking at that. But again, we do have -- we have many locations around the world, approximately 25 in many different countries so we need the cash on hand to operate and run the business. But when we can, we do invest it, but we can only do that for so long. Okay. Well, I mean I understood a while ago when the rates were so low, but as they've come up quite a bit, and I think you need to sharpen the pencil a little. I have a few questions. What you're doing with electric trains when I would -- if I would take a train to Manhattan, there's electric lines above the train and people are not shoveling coal into an engine or burning wood for power. So can you maybe explain to everyone basically the electrification effort and what your role would be in it. And then I have a couple of other questions. Well, right now, our current program and products that we're working on is our partner's Progress Rail. They're in the process of designing and manufacturing electric vehicles, both for North America owner operators and their Brazil location for international. We do everything from build the battery modules that will go into the train itself to the battery modules and the racks to the third part we're doing and that part we're doing here in LaFox is building the entire superstructure, which includes controlling circuitry, fire suppression, the whole thing. They have -- or that market, if you will, has an edict by 2030 to decarbonize. I don't have the percent right with me today of their diesel locomotives. So we're also working on products, everything from starter modules that will be put into the diesel locomotives to get the percent of that product dream by 2030. So for the electric locomotive market, we are designing and manufacturing, if you will, the battery modules that will replace the diesel engine. Right now, we've been awarded three different trains -- I'm sorry, four different trains through Progress Rail. And we continue to work with them on a weekly basis for the design and implementation for them. But they are prototypes. Going forward, if you look at this, this is probably today on the books over $25 million of prototype orders. So you can kind of see the opportunity here once this becomes, as you mentioned, commonplace to convert all the diesel locomotives to electric. On the electric vehicle, also, we have products that we have designed into VinSmart, which is in Vietnam, which is an electric car manufacturer. And we also have a number of programs and strong business going on with Triton, who is the largest North America manufacturer of charging stations. So that's kind of what we're playing now. Obviously, that's a multibillion-dollar market. And one thing that Richardson has done a good job of, I think, is finding niche products and niche applications through our component suppliers, but also our internal engineering capabilities to offer true value as this market is launched. And we are right at the cusp of it. We are in the middle of it. And so we're very excited, not only about FY '23, but the future of these type of products that will also expand in other applications as we learn the technology. Yes. It's interesting when people think of moving aside from trains, when people think of automotive electrification, your name doesn't come up. So I think my guess is over the next few quarters sequentially, hopefully, you can discuss more of what you're doing in that area. Yes. It's interesting. We're really not in the ultracapacitor battery business. We're in power management. And so yes, this is probably a huge -- obviously, a huge opportunity, but there's other power management products that we're looking at for forklifts and other products like that because as things turn to green, the entire power management section, as you can see with the locomotive, needs to change. And we have a unique ability, so much experience with battery technology. I mean we've been dealing with ultracapacitors for almost 20 years. And we have some key people on staff that are very knowledgeable. And so really, we're not looking for standard products so much, but just niche products that are unique to the customer to help them win market share. In this case, Progress Rail is on that run rate. Okay. It was a month or so ago, the company had a news release regarding becoming a global distributor for -- I don't have the press release in front of me, but for a company involved in gallium-based circuitry. Can you maybe flush out what that could mean for the company? Yes. You've seen over the past probably six years, a number of press releases of technology partners we're signing to, as Bob had mentioned, we are a true global company. And these smaller companies that have a unique technology based on -- and also add that to our unique capability for niche products need somebody to take those products to market. It's an engineering sale. It's very little distribution, if you will, where we design the components into customers. And I'll use the ULTRA3000 as a prime example. We are working with the customer on an ultracapacitor component. And out of that came their need for an ultracapacitor module. And so we have a very strong lineup of technology partners. Gallium is a startup company. However, it's a group of engineers. I've been in this power RF business for going for 35-plus years. They got some real key people. Gallium nitride, which is their key technology is the technology of choice both for 5G and power management applications. And one of the things we're seeing, all the products I've been talking about here for, specific the last three years, all are going to want remote monitoring. And that's the next step of our product. We have the key RF and wireless component suppliers in the world that we work with on developing key products that will add to our portfolio where all these products that we have today that are going 300 feet up in a wind turbine or 20 miles out on a solar farm or some locomotive going across Wyoming, they'll be able to remotely monitor the battery, the power of the system itself. And so it's just an iteration of our model. That's the model. It's -- we lead with technology partners and with a very unique capability internally for RF power and power management, we're able to come up with these niche products to support these applications. Okay. Well, I think it was, well, at least three quarters ago during one of your conference calls, the stock was $11 in a fraction, and I said someone was not happy where the stock was, and I said that people like the stock more at $17 than $11. So I guess I'll do it again. I think people will like the stock more. The stock is roughly $19.97 is the ask, I think I'll like it more at $29.97 than $19.97. And I'm willing to wait for that, no problem. Good morning. This is -- I'm enjoying the ride here. I got a couple of questions. The change in the backlog, I'm wondering if you can just give me an idea what that represents. Are you guys better able to keep up with the order flow where there are customers holding back until the end of the calendar year. What does that small drop in the backlog represents? I'll add to it from a PMT and GES point of view. Most of our business, specifically on the green energy side is project-based. So we'll get large bookings one quarter and then three quarters from them when we get the components in, we'll have huge shipments. And that's just kind of the ride. And if you just look at FY '22, the four quarters, we went from an $84 million backlog to $152 million backlog. Well, to get to 150% growth, we finally got the components we need it because I think I mentioned already that the lead times and supply chain issues, lease stuff we're looking at have not improved much. And so it's really a project-based cyclical type thing. We're going to have huge bookings. For example, in the fourth quarter of just in May of last year, we had $1.68 million, and this time around, we're a little over $1 million, So it's just kind of cyclical in terms of what we're able to get out of the factory to the customer in the quarter and based on their timing of bookings of the next session. For example, we were awarded about $15 million of new business for electric locomotives in Q2. However, that does not show up in our bookings because we do not book that until we have scheduled delivery of the product. So if that was in there, our book-to-bill would be way over on our backlog, we'd actually be up quite a bit in the quarter. So just the nature of the business. So let me rephrase then things are just going to be kind of lumpy and you really can't read anything into it. I wouldn't read a lot into it a fluctuation of 5% to 10% in our backlog, I wouldn't read anything into that based on the forecast that we're seeing and the traction we're getting. It's just that the way it's ordered our backlog will fluctuate, yes. Got it. The green energy, the sales were up about 50% from the prior quarter. Is that something we can expect to continue throughout most of this year? I mean is that the type of growth we're looking at here? Or that's kind of an anomaly and things are going to slow up a bit? Yes. One thing I know about forecast, they're going to be wrong, they're going to be high or low, but I can tell you in Q3 based on the backlog and scheduled shipments and the forecast builds, we'll see something very similar to that in Q3. That's about my visibility that I can give you right now. All right. And then I got one more, and it goes back to the press release and my favorite line here, "We believe sales and profits will continue to significantly increase in fiscal 2023." I'm just looking for a little clarity on that. Is that significantly increased quarter-over-quarter from the comparable quarter last year and what is significant? Yes. So I'll take that one first. So over prior year, yes, we believe we will see increases. And for us, I think we usually say in the 10% to 15% range increases, Q3 and Q4 are solid. And that's about as far as we're taking our forward-looking forecast right now, but it looks good. Congratulations again on another great quarter. Just my first question I had is, I guess, can you kind of speak here kind of any updates just on the more near-term kind of innovations and opportunities within the ultracapacitors. I'm kind of thinking more specifically the work you're doing with Siemens as well as some of the applications on cell towers, -- any kind of update on those? Sure. So, let's just start from the top in terms of both ultracapacitors, but also as you know some of the major programs lithium-ion phosphate but it's the same program. So on the ULTRA3000 was getting our calendar year 2023 forecast from our customers, and it looks like that business is going to be up in the 20% to 25% range in 2023. Just to add to that, today the life of the program, we've shipped and have in the field over 30,000 ULTRA3000. So the second part product talk about look quick, if you could like the ULTRAGEN3000 that's used in three different applications. One is T-Mobile continues to test that product company like T-Mobile is going to do a little bit longer testing, need a little bit of data. Before we implement that, we we're giving a proposal to a very large critical facility environment here in Illinois on the ULTRAGEN3000. But the big one is using the ULTRAGEN technology as in generators. But as a starter module we are working with two of the larger electric vehicle manufacturers in the world, put together starter modules for them. And both sites in December have received the prototype product for that. In addition to that, so we're introducing a couple new products in Q3, we do have beta site testing started with Siemens-on-Siemens ULTRA3000 modules for suppliers also such as Siemens, [indiscernible], Codex from European suppliers. That program is up and running very well. And then also we'll be introducing the ULTRAUPS3000 says in the wind turbines for their power supply that they also currently use led acid batteries, which they're asking to replace. And finally an update on this program. It keeps getting traction. Most of our businesses with owner operators that do not have contract with GE for services, we have been contacted and approved. GE is going to put our product in their portfolio products for all the GE Wind -- starting at the end of January. We're very excited about that on paper absolutely, but right now, we don't know, as we develop this program. So you look at the ULTRA3000 still going strong as people through Phase 1, Phase 2, Phase three of the rollout with their sites. The ULTRAGEN3000 technology that we've developed and is patent pending, that's getting good traction in terms of beta sites and other products. The UPS and the multi-brand will be introduced in Q3. And then finally the program we have with GE directly is also very exciting going forward. So that's kind of an overall summary of the current products that we're looking for short term, which means 2023, both revenue. Fantastic. A lot of exciting things in motion. I guess the other question as you guys mentioned really kind of still full throttle in terms of production getting orders out, employees working six to seven days a week. And prior quarter, you mentioned you made a lot of kind of progress in bringing in more people and bringing you more labor. I guess is that something you continue to be a focus? And how you're kind of thinking about that going into the year? So on the HR side, yes, we have continued to hire. But what we're doing now is making sure we've mentioned that there's going to be some slowdown in the semiconductor market. So we've made sure everybody we've hired is cross-trained and they can now be moved from, for example, the semi production into green energy productions and even into healthcare production. So we'll continue to hire strategically, which is primarily engineering position with all of the programs Greg has mentioned. We're constantly looking for different types of engineers to supplement the team. But from a production standpoint, we'll work within the confines of who we have right now. Well, we have probably close to 100 all in now when you consider our field engineers and our application engineers and our development engineering. And I guess the last question and you guys got us a lot, but just maybe a little bit different angle or a little bit of different aspects to it as within the semi wafer business, I mean, what are you kind of seeing from your customers? I mean, I know you said you have clarity through Q3, Q4 for your fiscal year, but what are you kind of hearing from your customers and from their business? Are they kind of information or insights you are getting from that? Yes. So they look at the overall market, and they're doing cash provide again a nice product to that market. And so it's hard for them to extrapolate what -- how that affects our business with them. So right now, the visibility we have is that we're going to be fine and strong for the balance of the fiscal year. But going forward, they're seeing their end customers and also the China issue, Ed mentioned, there could be a slowdown, but they haven't been able to pass that exactly how that affects our numbers, and that's what Wendy was talking about some of visibility and the forecast for FY – The market doesn't want to give you respect. You guys have the [Rodney Dangerfield] for a successful investment I want to couple things real quick. One, wind power last year was a tough year, wind power in Europe, winds changed direction, and they didn't deliver a lot of projects actually ended up not getting done or getting pushed out. Are you seeing an improvement in the market this year in Europe with everything that's been going on and clean the winds returning to their normal courses? Yes. So right now 95% of our business is North America. The products I mentioned for Nordex, Senvion and Suvion, they're two of the three largest manufacturers of wind turbines in Europe, and they're pushing us very, very hard for this product. So this product is, in essence, a replacement product that they need to get done to get those lead acid batteries out. So our market share is small enough that we feel that the market growth will be very strong for us, but the market itself is all based, to me, what I've seen and heard is on subsidies. And there's a lot of push to get certain things done so they can collect their subsidies for 2022 at the end of the year, which was part of our large shipments and work in three shifts because we need to get those products to them in this fiscal year. So rollouts of new wind turbines, I don't think it's accelerating much, but the upgrading or refurbishing, they call it, using our products, whether it be the ULTRA3000 or the UPS or our shunt, which is a product we've developed GE specifically, that seems to be continuing, based on their forecast, 2023 is going to be another strong year for us. Okay. There seems to be a lot of misunderstanding. In fact, when you started to talk about the semi cap equipment space and the idea that there was uncertainty beyond the next two quarters, the market immediately sold your stock off pretty aggressively. Can you give people a better understanding of kind of the role that plays. And as you said, everyone is cross-trained. Do you actually think the issues in semi-cap equipment, if they do show up in the next fiscal year, will do anything to really slow your overall growth? Or will they simply allow you to take those people who aren't being utilized in semi-cap equipment or might not be utilized and push them over to these other faster-growing areas? Yes. I don't think it's going to slow our goals of 10% to 15% growth going forward, our internal numbers. The semiconductor wafer fab market historically, and I'm talking about the last 20 years that I've been involved in and also in this company always is it's always been cyclical. It runs for about a year to 18 months of the upside and then it slows down quite a bit for like nine months to a year. It's just this last run has been close to 2.5 years. But I think the slowdown is going to go back to not 2.5 years, it will be nine months to a year. But if we look at just internal projections about what it could be and then what we're have on the books with a strong backlog and new products, et cetera, in terms of profit dollars, gross margin dollars and top line, I don't think it's going to have much effect at all. In fact, we'll more than overcome it based on the numbers that we've been talking about so far in this call. Yes. I mean the call sounds exceptionally bullish the stock market reaction seems to be one I want to talk. I would say that it would help a lot of investors if they had someone who could tell them what they're supposed to think. So if you guys could get some sell-side coverage, that would actually be nice because most people in my business can return to someone else to actually interpret results and prefer to act in the sort of thing, but that's only 40 years of experience working in the micro-cap. I wanted to talk to you guys about the battery, the electric vehicle market, both from a car perspective, which is very interesting. How big do you think that opportunity can become? How unique is your offering? And do you see that as an offering that will become -- have a broader appeal beyond the people you're currently working with? Yes. numerous electric transformations, whether it be locomotives or forklifts, and I think our niche is going to be these larger type of niche products. The electric vehicle power market, is this so saturated, everybody going after it? Obviously, it's a multibillion dollar market, and that's why everybody's going after it. Our current capabilities are, again, similar to wind turbines or electric locomotives as we have a niche product, it's a charger module that we -- we sell VinSmart along with some other controlling circuitry. But that today is probably a $3 million to $4 million opportunity for us, and we have about $2.5 million backlog. The charging stations are a little bit higher opportunity for us because we can develop unique products for charging stations specifically. But the electric car market, that's just -- it's like the handset market, which is the other part of my career. It's just saturated and lower margins and everybody wants at it. We don't have a ton of value today on the electric car market other than our component designing capabilities, working with these customers to help them build systems. But our size is going to be on solar, wind, power management applications that are a little more high power, a little more niche. And with the charging stations, what do you think the economic value you could you could have per charging station? I mean that's going to be a huge growth market going forward. Right. And as we all know, the car market completely outweighs the infrastructure to get you charged up to be able to drive across North America or Europe. So what it's going to be, I think, is similar to what we saw with the growth of these other products I've just talked about, where the customers are going to say, "Hey, you helped us design in all these components, can you build the module? Can you build -- in some cases, we did it at one time when it was in infancy, I actually build charging stations for the customer. Like we do stuff for Lam, we do stuff for Caterpillar and Progress Rail. So our value will be anywhere from component designing to building and designing modules, to potentially building a larger portion of the actual charging station itself as more and more niche customers come out to try to support that market. Can we talk about, with Progress Rail, one of the things a strike to obviously, you commented on how the industry -- the rail industry is looking at basically going kind of carbon neutral pushing forward. You're working with progress, which is Cat and [indiscernible] their installed base that I can use that phrase here in the diesel use of electric locomotive business. Do you know? I believe it's 25,000 in North America, 25,000 diesel locomotives. What portion of that is Progress Rail -- between them and Wabtec, I think it's probably going to be divided up 60-40. But right now, the number that we heard from Progress Rail is about 25,000 diesel locomotives in North America that could convert over the next number of years between now and 2030. To add to that, their forecast to us was about 50 electric locomotives over the next three to five years was the conversion they were talking about. And so what they would be seeing therefore is given the idea that they're talking about like a 10-year -- 7- to 10-year ramp, towards getting the 25,000, what you would expect to see is that 50 or so over the next few years and then almost you go parabolic after that? Yes, absolutely, yes. Yes. In fact, like I mentioned before, for example, the program we have with Progress Rail out of Brazil, when that locomotive is done, which will be in their forecast, we're shipping now the guts of it, if you will, but they'll build the final train and introduce it to the customer in November of next year -- or this year, it will be the largest electric vehicle in the world. And so to be involved with that capability and program on a weekly basis, and I think when that -- even that -- just that hits, we're going to see a big uptick. And then you're going to see, like you said, three to five years just booming as the acceptance of the product and subsidies and everything take place. And so we're looking at, depending on the size and power of the locomotive and your role in it, $1 million to $3-plus million a copy? Exactly. Like I mentioned before, we build either the module itself with the ultracapacitors or lithium ion. We then build the structure, which is like putting them in racks, and then some controlling circuitry. And then the third thing is the superstructure, which is literally the guts, the engine -- taking the diesel engine out and putting in a lithium-ion phosphate-based structure. And so yes, depending on that, it's anywhere from $1 million to $3 million per train. And so when we're looking at the math, I mean this is one of the issues why I think it would be great to get some people telling my peers how to think you're looking at a market that literally as we go in the next four or five years, you're going to get meaningfully more revenue out of the electric locomotive business than you get as a company today. And you're not going to lose anything else. You're not going to lose the wind tower, you're not going to lose any other aspects of the business. Yes. That is the opportunity that we're looking at. And part of this business in terms of NPI, which again, this is new product, this is new disruptive technology that's going forward is you need to get whether you call it a beta site, a sponsor or a partner. And if you just look at this, and I was talking to somebody yesterday about it, I had three phone calls on Monday, and one was with Siemens, one was a Caterpillar and one with NextEra. And they're they it. I mean, to have them -- and not only is just beta site partners, I mean -- or beta site companies to test this product, I mean, we have calls every week. We're partners. And out of that -- so you got the upside of what we know. But out of that, just think about all the other applications that a Caterpillar is going to look at or that a Siemens is going to look at. We're learning so much from them on what they need -- and again, we're a very unique company that has -- we're public. We're couple of $100 million. But these programs that we're dealing with just could jump this company to huge numbers. And at one time, we were at what, yes, $600 million. Well, it’s actually it’s not just largely than Lam, but from going larger than Lam. If I do my math right, if you assume that it’s roughly 50-50, 60-40 split, so you’re talking about something in the to 10,000 to 15,000 progress rail diesel out there. They’re the incumbent. You would think they’re likely to have a chance to what we what we saw with Union Pacific and some of their work, they went - they were Wabco and they went back to Wabco, it appears. So if you’re looking at that and you say $1 million to $3 million on something that’s $10 million to $15 million, we’re talking about if you’re going to fill it in four or 5, let’s, say, six years, you’re talking about thousands of engines a year potentially. I mean I was back in my own hedge fund days, I’d be talking to my private capital guys about showing up in your town and talking about taking this company private because. I mean, this, to me, you’ve got a great business, makes you a ton of money it would be nice to get your cash flow positive in the U.S., so you can do some things whether it’s investing capacity or, quite honestly, buy your stock like a fool because of the way it’s priced. But as I said, I do hope that we’re able to get some people out to help you [indiscernible] the story because this is the best story I hear. Yes. I mean this is – this rail business alone is – has the potential to be – take you guys on revenues to north of $1 billion, I would think. Yes. And then it goes from there yes. Keep up the good work, keep executing on the – all these things. It’s fascinating that you guys constantly find new areas and new niches to expand in while you have so much on the table already. Very interesting hearing from everyone in the Q&A thus far. Can you maybe help those of us that are new to the story, understand what was it from a business standpoint that occurred in 2021 timeframe that enabled your inflection to profitability? I think maybe part of the frustration of people watching the stock price is folks are concerned whether this is a permanent inflection or a temporary inflection. That's strictly a function of the cyclicality of the semi cap equipment market. So maybe if we could roll back four quarters and talk about what happened there? And maybe if you could, big picture, talk about whether that's, in your view, a sustainable inflection and how that's sustainable. Happy to do that. First of all, as Greg mentioned, at one time, we were $700 million and 1,000 employees and losing money hand over fist. And so we ended up selling the security systems business to Honeywell, it's $75 million, and we sold the RFPD business to Arrow for $238 million. And roll it back to $140 million company and then started to invest in trying to figure out what we wanted to be when we grow up. And it's really listening to our customers, what we call engineered solutions. And every time a customer comes to us and said, we need this module, we need this piece of equipment, we try to design it for them. We have, as Wendy mentioned, nearly 100 engineers and all with a tremendous amount of experience in power management. It isn't rocket science. It's our customers telling us what they need, and that's where the ultracapacitor business has come from. When turbine operators telling us they want to replace lead acid batteries and -- the now with cell towers in the same area. Actually Progress Rail saw the patents that we have in the ultracapacitors that go into wind turbines, and they were building these electrical locomotives with lead acid batteries and wanted to know if we could provide something to replace the lead acid batteries. Our engineers looked at it and said, well, it's a lower current, but you can use lithium iron phosphate batteries to replace it, and we designed a unit for them. and we've been selling them those products for battery compartment for about three years. And ultimately, now they're bringing the production of those electric locomotives in the United States, and they asked us if we could build the entire battery compartment. And those battery compartments are over $1 million a piece. And it's one to 10 in each electric locomotive, every one of these opportunities came out of customer-driven demand. And as we get into selling somebody like Caterpillar, they keep coming at us with more and more products that they want us to design and build for them. And that just hundreds of customers. We have 20,000 customers all over the world, and customers are coming to us all the time about design this for us, design that for us, and that's what's made the success. So we went from 2011 at $140 million, adding these various products up to $160 million where we broke even. At $176 million, we made a profit. And then the next year, we were up at, what, about $224 million. And you can see this year, we'll be over $260 million and the profits that the customers have taught us these products and the profits that are coming from it. So that's a long drawn-out speech, but that's it. It's not rocket science, it's customers telling us what they want us to build and we have the engineering team and the experience to do it. If you could be a little bit more specific, though, in 2021 specifically, I understand the evolution, but what was the catalyst in '21 that drove that inflection in net margin? The ultracapacitor business. We have been selling ultracapacitors for a company called Maxwell for about 15 years, and Maxwell was sold to Tesla. And Tesla took them out of the commercial industry and used their entire production for their automotive industry. So we went looking -- we had about a $3 million business in ultracapacitors, and we went looking for another source and found a division of LG in Korea called LS Materials, and we wrote an exclusive with them for ultracapacitors. And at the same time, NextEra, which is the largest wind turbine operator in the United States, also had been working with Maxwell to replace lead acid batteries, and they went to LS Materials and referred to us. And we spent two years working with them, designing the ultracapacitor modules to replace the 18 modules, the GE wind turbines. And over a period of time, we've gotten two patents on that product. And as Greg said, we've shipped over 30,000 of those modules to date. And now all the wind turbine operators are buying from us. It's a little bit like a bridge club. You've got NextEra is the biggest one that has 10,000 or 11,000 wind turbines and service. But right behind it, you have RWE, you have Enel, Invenergy and on and on. And so that builds -- business that's just built up from there. And then the people and the cellular towers who also have these UPS, uninterrupted power supplies, they came to us and said, "Well, can you replace the lead acid batteries for us? and so it's just been from one customer telling another that's built this business -- and we're just the tip of the iceberg. The opportunity is incredible. I think you can add to that, Ed, that when I look at the sales canvas also grew during that period, has got a strong margin. They grew -- they growing almost $5 million, which adds to the top line growth and more profitability. And Canvys is the same concept. These are medical OEMs coming to us and saying, "Can you build this custom display for us that goes into equipment like a linear accelerator for cancer treatment that we sell to Varian now owned by Siemens or laser-guided surgery equipment that we sell to Medtronics and so forth and so on. So we have a reputation for being able to use our engineering capability to supply all of these requirements for the customers. Not the ones we're dealing with now Maxwell was, but currently, there's other ones are that make ultracapacitors are private, but they don't make the actual modules themselves. And that's another interesting topic is who used to be competitors of Maxwell have now contacted us for other projects using their ultracapacitors as an integrator. And I think somebody mentioned on the call, we don't have a reputation right now being in the electric vehicle market, which is fine because I think the opportunity for power management applications is higher. But what we are getting is a reputation both from electric modules is to be an integrator of ultracapacitors into all kinds of products. That's like you've seen, the UPS, the ULTRA3000, the ULTRAGEN, the locomotives, we're kind of a design and an integrator of ultracapacitors in niche products like Ed mentioned, that the customer needs for their system. Okay. And last one for me, guys. In terms of the Lam exposure and the semi cap exposure, is that confined to the Power & Microwave? Or is that across Power & Microwave GES Healthcare and Canvys? Yes, in a previous call, you had mentioned an order you were expecting for ultracapacitors from -- for wind mills. Is there an update that you can provide on that? Yes. We received the first order from a company called NextEra that we were just discussing. And they are the largest wind turbine operator in the United States. They have about 10,000 GE wind turbines in service, and they're adding about 1,000 a year. And so we worked with them for two years and have two patents on the device that actually is unilaterally interchangeable with the GE module. So there's 18 modules in each wind turbine, and our device will actually replace one of those modules and work with the other 17 lead acid modules as necessary. So after a couple of years working with them, they had them in beta sites for about a year. They gave us an order for $10 million. So it's basically $10,000 a wind turbine, if you will. And now, as I mentioned, the other wind turbine operators have come to us and they're buying from us as well. And that business just continues. We probably did, what, $15 million in that business last year? Yes, thing like we shipped almost 16,000 units so far this fiscal year. But one thing to add to that, the order that I mentioned probably on the last call, we did receive that. It was a multimillion dollar order, which was Phase II for NextEra that was booked and shipped in the quarter. As I mentioned earlier, they needed to get that into their wind turbines. So they did about a 30-day beta site testing on a kind of a version of the ULTRA3000 that was for a different turbine model. Our engineers were able to redesign it within weeks, get them the product. They tested it for 30 days and then we received the orders. And going back to what Wendy said, we worked double and third shifts to make sure they got those products by the end of November. So I believe that was the order I mentioned that we were expecting in the quarter Q2 that we did get and we did ship it, which is part of the reason for the 150% growth. I think it was last night when I realized this is just my own opinion. The easy way to understand the Richardson Electronics story is that maybe four or five quarters from now, plus or minus, there's going to be a crossover when the GES segment, the green electric is going to be more than 50% of the operating income for the company. And at that point, I think there would be a dramatic rerating of your stock as far as PE multiple other metrics. Obviously, right now, everybody, at least the way the stock is acting, is paranoid about the semiconductor, but it could be maybe four or five quarters from now, that won't even be in people's heads. They're just going to be thinking about, does your company deserve a 20 or 30 PE multiple. And based on the numbers that I was looking -- sorry? Okay. Well, I was looking at the only published research, I was looking at the last Sidoti piece, and I kind of ballpark for calendar '24, you may be close to doing $2 in earnings. And even if I reduce that to $1.80, people are going to be thinking you're like green-energy company and 20x above $1.80 is a little bit higher than where your stock is now Anyway, that's really my only thought other than I'd like to purchase one of those machines that makes the diamonds because I have a few people that would like some diamonds. A couple of -- a call or two ago, you talked about the replacement tube business for medical imaging and the indication was it was losing $5 million or $6 million a year, which with 12 million shares out is something neighbored of $0.40, $0.50 a share. You talked about the ability to bring that to breakeven or profitability over, say, the next four to eight quarters, where do we stand in shrinking that loss and pushing it towards profitability? yes. Good question. So while everybody was talking, I was looking at that exact same question. And in the current fiscal year -- last year, we lost a little over $5 million, almost $5.5 million. This year, we're trending better. And while we'll still have a loss in FY '23, it should be in $3 million to $3.5 million. So that's $2 million improvement to the bottom line. And then we still are trending and believe we should be able to hit that breakeven point by the fourth quarter of FY '24. The Siemens program is coming along. When that gets launched, and then I mentioned a couple of other things that we're looking at to kind of get a little breathing room, we feel that we'll be at that point by, again, fourth quarter of FY '24. We're not changing our anticipation there. So this fiscal year, you're losing pretax about $0.25 a share. And by the end of next fiscal year, you'll be breakeven and have the ability to make profit? This has been kind of bugaboo for you guys. So getting this to where it's actually making -- generating good revenue and profit and becoming a profit center would be a huge shift. And it puts, as I say, right now from this year, pretax puts into the next year gives you $0.15, $0.25 a share in pretax earnings power as in your pocket, which is a nice thing to have. On the GE turbine business, you mentioned -- you spoke a little bit briefly about the rollouts that you're going to be in every one of these GE turbines. I guess, can you give us a little bit more color on what could potentially go wrong there? Is it delays coming from GE that might prevent some of these rollouts in the next few quarters? Or is it a substitution of a competitor module? I guess what's preventing you from being a little bit firmer on the guidance coming out of GE specifically? Well, two things. One, the only hiccup that we've seen, like I mentioned, we have over 30,000 units in the field with little to no RMAs. So the product technically is amazingly sound. Again, we have -- still have issues with piece parts. And so the only thing that could slow that down would be a hiccup in our ability to get piece parts to build the product, but the backlog and the dates that we currently have, along with the forecast they've given us, there's no indication that I can see that would slow the program down other than our ability to make them fast enough to fill their needs. And as I mentioned before, it's very project-based. So as I just mentioned, literally we got the orders in November and they wanted them shipped at the end of the month, a multimillion dollar order. So that's how it goes. So the other part of it is we really don't know the upside of the GE agreement. Today, about half of the GE fleet has service contracts. That's part of the fleet that we couldn't address. So we virtually, with this program with GE, doubled our SAM, the market we can service. So from what I see right now, there's only upside in terms of demand and exclusivity. As Ed mentioned, we have two patents on the product, which is one of the reasons GE has decided not to build their own or even look at building their own. So yes, just at the end of the day, like we've been experiencing for the last couple of years, it's piece parts and the ability to get the supply chain to the point where we can meet the customers' demands as they request them. There's no other questions in the queue. I'd like to turn the call back to Mr. Ed Richardson for closing remarks. Thank you, Catherine. As we close out our 75th anniversary celebration, and this has been our 75th year. We're more excited than ever about the future, as you can tell by our conversation. Please give us a call and plan to visit if you have any questions that a heck of a lot easier to show you what we do and to tell you about it. We'd love to show you our manufacturing and engineering facility, and you're welcome to visit us at any time. We look forward to our ongoing discussions and to sharing our fiscal 2023 third quarter performance with you in April. Thanks very much. If you have further questions, give us a call.
EarningCall_1502
Good morning, everyone, and welcome to CapStar Financial Holdings Fourth Quarter 2022 Earnings Conference Call. Hosting the call today from CapStar are Tim Schools, President and Chief Executive Officer; Mike Fowler, Chief Financial Officer; Chris Tietz, Chief Credit Policy Officer, Executive VP of Specialty Bank. Please note that today's call is being recorded. Replay of the call and the earnings release and presentation materials will be available on the Investor Relations page of the company's website at capstarbank.com. During the presentation, we may make comments, which constitute forward-looking statements within the meaning of the federal security laws. All forward-looking statements are subject to risks and uncertainties and other factors that may cause the actual results and performance or achievements of CapStar to differ materially from those expressed or implied by such forward-looking statements. Listeners are cautioned not to place undue reliance on forward-looking statements. A more detailed description of these and other risks, uncertainties and factors are contained in CapStar's filing with the Securities and Exchange Commission except as otherwise required by applicable law. CapStar disclaims any obligation to update or revise any forward-looking statements made during this presentation. We would also refer you to Page 2 of the presentation slides for disclaimers regarding forward-looking statements, non-GAAP financial measures and other information. Good morning, and thank you for participating on our call. We appreciate your interest in CapStar. We're pleased with our results for 2022 and the quarter. We reported earnings per share of $1.77 and our return-on-equity of 10.7%, strong loan growth NIM expansion disciplined expense control and low-credit costs each contributed. In line with our capital allocation efforts we also returned a record $17.9 million to shareholders through dividends and share repurchases. What is significant is within the annual numbers we had $2.7 million of loss related to mortgage and the wire loss, and TriNet was breakeven. We're in a complex operating environment, but our mortgage and TriNet divisions are outstanding businesses that have strong earnings power in the right markets. As we mentioned last quarter, we had two operational losses of which one for 732,000 was fully recovered this quarter. We remain optimistic that we will have a recovery also related to the wire later this year. As an aside, I will mention the FBI, the TBI and the Cleveland Tennessee Police Department have identified the fraudster and have put out a national indictment which is unusual as they typically are limited to 500 miles. The TBI also intends to add the individual to the Tennessee top 10 most wanted list. In contacting our core FIS, this individual's online credentials showed up across their operating system attempting to penetrate other banks. He also attempted to defraud another Tennessee Bank a few weeks after us. Assuredly, he is part of a larger network and he is trying to impact a number of banks. In the third quarter, we reported $0.47 per share and a return on equity of a 11.8%. As noted, our earnings included the recovery of 732,000 related to one of the operational errors. It is subject to appeal but our Counsel feels it is more likely than not that the opinion will remain favorable to CapStar. The appeal process could continue through year-end. Loan growth for the quarter remained strong at 11.1% average and 8.6% in the period linked-quarter annualized when you exclude the TriNet balances that we moved this summer and our holding in loans held for investment. Our markets remain strong although lending has begun to slow due to the impact of higher rates. As a bank, we are being cautious with the uncertain economic and funding outlook having pulled back on CRE last summer tightening some underwriting criteria and maintaining our discipline on loan spreads. We have a strong loan engine an advantageous markets that continue to be in a conservative nature. Our credit metrics remained strong which Chris Tietz will cover later. We have three past dues we are addressing, two of which have been problem loans for a while. We are performing active portfolio management with higher rates to identify customers early who might become a problem now or in a slowing economy. As we communicated last summer depositors became very aggressive in the second quarter of 2022 and that continues today. One of the biggest competitors to date has been the U.S. Treasury and Treasuries were individuals have pulled money from banks into treasuries. We are working hard to offer competitive rates and products to maintain and attract new depositors while not cannibalizing the portfolio. It is as challenging as I have seen it. More recently, banks have stepped up to wholesale prices on their deposits and you face a situation that you either have to match or lose the relationship. We hope this will slow as the Fed slows but margin pressure will likely continue in the near-term through the first half of 2023. Until then deposit rates will continue to rise, we will work hard to get as much offset as we can on the loan side. Some of the specific actions we're taking related to deposits include, we are monitoring competitor bank rates in our markets and their specials. To-date it appears our betas are in line or a little lower than our local competition. We are proactively discussing each customer request that comes to the table. We're requiring the primary deposit relationship on all new loans. We are calling on all relationships where a deposit was not obtained historically. We're calling on all customers for accounts that they might have elsewhere. Lastly, we've changed our incentive plan to require a certain level of funding percentage to loans for each banker in market. Our highest paying category has always been deposits and specifically DDA. This will also ensure our great staff our outstanding bankers and not just outstanding lenders, encouraging them to call on deposit only customers as much or more as borrowers. As it relates to fees, mortgage volumes remain at historical lows nationally. We have a tremendous mortgage company and team and are monitoring local and national markets. We reduced staff in the third quarter and have an opportunity to evaluate that further. Again, we have a strong division and do not want to be shortsighted but it is something we are discussing. TriNet was paused in third quarter 2022 due to the unusual rate environment. We will be testing a limited pool in the first half of 2023 with a different rate structure and risk protocols. We do not have a tolerance for further losses. So volumes might be lower, but we want to ensure we have a gain on sale. We're very excited about our new SBA expansion. From my experience, SBA is something you should really be committed to or not do it. CapStar has had a limited investment to-date and demonstrated some success overtime. In fourth quarter 2022, we were approached by a top 10 team that elected to join us. Overtime, we are planning that they can generate $2 million plus of quarterly gain on sale. There are three other revenue components that Chris will discuss later but that is the most visible component. In the past, we've cited $16.5 million as our non-mortgage expense noninterest expense range. Recently, we've been running under that and this team adds another approximate 800,000 a quarter of noninterest expense to include commissions that would go with their revenues. Lastly, we've worked hard to put CapStar's capital to use in a productive manner. By entering new markets and growing loans, increasing our dividend and buying back stock. We renewed our buyback this week albeit at a lower level of $10 million. We feel that is prudent with the uncertainties with the economy at the moment and we'll continue to evaluate as the year progresses. So on Page 5 a few quick comments on financial results for the quarter. We reported net income of $10.3 million, $0.47 a share. As Tim noted Q4 results do include a 700,000 recovery related to one of the two third quarter operational losses. Total revenue was $31.2 million in Q4. That is up $2.4 million versus Q3. So recall that Q3 did include $2.1 million of realized and unrealized losses related to selling or transferring to held investment the remaining TriNet loans, which were in held for sale. Expenses were $16.3 million for the quarter. They were down $1.3 million versus the prior quarter. But again, as Tim noted, recall that the prior quarter did include $2.2 million of operational losses, partly offset by an $800,000 voluntary executive bonus reversal. On Page 6, I'd just point out a few metrics. So we did report pretax pre-provision as a percent of assets of 1.86%. We reported return on assets of 1.31% and reported return on tangible equity of 13.6%. And we will go through Chris will review the credit metrics obviously later in the presentation. On Page 7 in terms of net interest income and net interest margin after rising materially in the second quarter and the third quarter where we benefited modestly from Fed hikes and remixing the asset shifting excess cash into loans as Tim noted, the fourth quarter net interest margin 344 was down 6 basis points versus the third quarter primarily due to two factors on the deposit side. One was a mix shift into higher cost categories and one of customer funds, which we'll talk about on the next slide. And number two is additional deposit pressure from increases in customers seeking alternatives but also from an increased an increasingly competitive local deposit market. And I would say some of that is from local competitors locally based competitors within our footprint. I've been surprised somewhat to see more aggressive pricing both on promotions and on an exception basis from a much larger regional players and from some very large national players, haven't seen that until recently. Overall, our deposit beta increased to about 40% in Q4. And as Tim alluded to we have seen NIM pressure later in the quarter. And that does suggest likely near term NIM pressure in the next one to two quarters. On Page 8 in terms of deposits, total deposits were roughly flat. I would say in terms of deposit pricing, we have seen our betas and as Tim said, we actively monitor competitor pricing through S&P. We monitor standard rates, we monitor promotional rates and we monitor exception rates through what we're hearing from our bankers. And we certainly as we've seen in prior cycles and as we expected we have seen betas increase the deeper, the Fed has gone into their Fed hiking cycle. In terms of balances, we did see customer balances decline this quarter by $156 million. We saw about $60 million in our correspondent banking division, as our correspondent bank clients are deploying our excess liquidity but we also saw $97 million in other bank customer balances decline. We offset that this quarter with $160 million in broker deposits. And from a price from a cost standpoint as you can see on the chart our deposit costs rose 58 basis points to an average of 1.2%. If we look at Page 9, in terms of loan growth and loan yields, we continue to have solid loan growth. The bar chart on the left is our reported loan balances. The first forward the Tim referred to in terms of our held-for-investment loan growth that is excluding the TriNet transfer from its removing TriNet loans that we have had in held-for-investment. Normally, those are in held for sale. So we did remove the TriNet impact from the 11.1 average growth and the 8.6%, end-of-period, without excluding those, you can do the math the period-end is a little bit under 4% without adjusting for TriNet. We continue to see strong loan production. It is down a bit from last quarter I believe that we're continuing to see solid loan production $150 million in Q4. And the pipeline remains strong across our markets, commercial pipeline $450 million. As we've said on the last call and I know we're hearing more of this in the industry, we are being more disciplined and somewhat limiting our loan growth maintaining disciplined pricing which I would say we've seen more challenges on the deposit side from a pricing standpoint, we've seen I would say the summary expects the flip side of that on the loan side middle of last year when the Fed was hiking 75 basis points, every meeting ratio going up sharply along the curve, as we mentioned on earlier calls we were remaining disciplined, but seeing more competitive pricing that hadn't caught up to where market rates have gone. I think with the Fed slowing and the yield curve flattening and inverting, we're seeing competitive pricing more in line with where the markets are I think giving us more comfort and ability to achieve our targeted spread on the loan side. Our loan yield did increase this quarter 41 basis points and we did achieve in terms of originations for the quarter match-funded spread against wholesale funding against home loan funding 2.39% as of the time of funding. On Page 10 related to non-interest income mortgage revenue as you know has been down sharply from a year ago, with the increase in mortgage rates. We do believe at this point mortgage revenue reflects limited volume in-line with national trends. Margins however, have started to rebound and are returning to what we view as more normal levels. As Tim mentioned, TriNet which we had announced previously, we had paused and third quarter that remained paused through the fourth quarter. But as Tim said, we are now testing a limited pool in the first quarter, as he said, we have no appetite for additional losses, and these are originated to sell, we're cautiously optimistic that our testing will be successful and will lead to potentially further expansion of that business, but SBA lending revenue, as Tim said, very excited about that. Chris will talk about that more in a few minutes. You certainly see the results the recent SBA expansion in terms of fourth quarter revenue, where fourth quarter SBA lending revenue is up a little bit under a $1.5 million up about 900,000 from last quarter. Turning to Page 11, and non-interest expenses adjusting for -- well again we reported $16.6 million that includes the recovery that Tim had mentioned of 700,000 operational loss from Q3. That is down from $17.9 million last quarter. But recall as Tim mentioned, last quarter did include $2.2 million of operational losses and partially offset by 800,000 voluntary executive bonus reversal. A good part of the increase in adjusted expenses versus last quarter is the additional SBA or costs related to the additional SBA hires, which again are very excited about and I will turn over to Chris to discuss now. Turning to Page 12, we are excited to announce additions to our SBA team under the leadership of its newly appointed Director, Marc Gilson. Marc is assembling a team of seasoned professionals that I have been impressed with in every interaction. This team generally comes from high production SBA lenders with volumes writing them in the top-tier of national lenders. Their primary target is the origination of SBA 7A loans generally with a 75% government guarantee where we will intend to sell the guaranteed portion for a fee. As shown in the chart on Page 12, while we are pleased with the historical trend in growth in the SBA Group, we felt that it had potential for more. Please note that of the $2.5 million in SBA net fees for 2022 over half of this was earned in the fourth quarter. While net interest income will change with variable-rate pricing we believe that the fourth quarter provides good insight into near term expectations for fee growth. Last quarter, we provided guidance to you of $750 to $1 million in fees for the fourth quarter. With the addition of this new team, we were able to exceed that guidance at $1.4 million for the quarter. Having said that, we believe that the near-term average will be in the $1 million to $1.5 million range per quarter on a growth trajectory to $2 million per quarter as the team settles in and gains cadence and efficiency in their process. In addition, we continue to recruit new business development officers coming from efficient well-run lenders demonstrating long term credit loss experience below the SBA averages. Execution is the key in this arena to be sure we maintain the SBA guarantee. We believe that we must have strong investment in revenue production, robust underwriting and approval support and a strong and seasoned servicing team. With this in mind we believe our strategy is sound, with the goal of staffing our team with seasoned SBA lenders but we are also adding the oversight of an SBA specific post-closing loan review by an external accounting firm to mitigate execution risk and to hold us accountable to strong expectations. Now turning to risk management. On Page 14, we are pleased with continued improvement in our overall level of criticized and classified loans having achieved a 50% reduction for the year from 2.64% of loans at December 31, 2021, to 1.31% of loans at December 31, 2022, and that reflects a 27% reduction for the fourth quarter. Of note, approximately 60% of the criticized and classified loans outstanding at year end 2021, we paid-off or upgraded in the course of 2022. We are encouraged by this improvement in overall asset quality. There are some data points relating to the level of impaired and doubtful loans and past dues that warrants some additional insight. First, let me remind you of the evolution of problem loans, often they start exhibiting red flags with us either through identification of borrower operating results, giving us pause for concern or delinquency or a combination of both. Upon identification of concern such borrowers will generally be rated special mention and may migrate up or down from there overtime. Once a loan migrates to substandard, as I've indicated in prior quarters calls it often takes 18 to 24 months to resolve the situation. Approximately 38 of the 41 basis points in impaired loans are in three borrowing relationships in active workout status. These loans are impaired and have been subjected to impairment review with approximately $700,000 in specific reserves applied to the account to account for potential loss. These three impaired relationships also account for 41 of the 50 basis points in past dues. Despite the negative migration in that small number of credits, we remain encouraged with overall asset quality for the following reasons. The improving trend in special mention and substandard loans is a favorable leading indicator for future asset quality in the near-term. With each of these two categories, at 25 basis points and 65 basis points respectively, they represent historically low levels, which buffers us against the impact of potential deterioration in uncertain economic times. Adjusting for these three relationships in active workout past dues would be an exceptionally good 9 basis points continuing a favorable trend from prior quarters. So let me step into the three relationships I've mentioned. The total of these three relationships is approximately $8.9 million. All of this $8.9 million approximately $5 million is a single relationship where the primary collateral is real estate. This relationship came to us through an acquired institution. The remaining two loans totaled $4.9 million and our SBA guaranteed transactions originated in 2020 with $3 million of SBA guarantees retained on our balance sheet, mitigating us against risk of loss. Subjecting these three loans to impairment reserve or review, we have accounted for $700,000 of potential loss in a specific reserve accounted for in our provision of $1.5 million for the fourth quarter. Turning to Page 15 with the impairment of the loans previously discussed, our provision expense of $1.5 million takes us to 113 basis points at 12.31 including fair value marks. As you know, like others, we adopted CECL on January 1. Our general guidance is that the impact of the conversion to us is in line with other banks as to the expectation for direction of change in the allowance for credit losses under CECL in coming periods we would expect it to be driven by macroeconomic conditions with modifiers based on the direction of risk in our own portfolio assessment from period-to-period. I'm really proud of our team and look forward to 2023. Since the onset of the pandemic the environment continues to bring new challenges and we continue to work hard to address each one and improve the bank along the way. Hi, good morning guys. Appreciate taking the question. Wanted to start-off with the margin and just your expectations for the first half of the year. And if you had the December margin that would be helpful. And then just maybe thinking about the spread of 2.39%, that seems a little lighter than what I think you would have been the case you be comfortable with previously. Just want to make sure I understood if that was primarily on the lending side that you're not being able to accelerate the yields as fast or if that's just deposits or such so more expensive. Thanks. So, I'll start on the loan spread first and I'll let Mike talk about the margin. And good question. Thank you for the question. You can sort of just do it on a napkin or an excel. But if you take a 200 basis points spread, right, and then you got to multiply, just take $1 million and multiply it by 2% you're assuming that is your spread minus your FTP cost. If you're going to assign some level of credit expense, some level of operating expense and then taxes today at 20%, to me you really want to get a 200 basis point spread. I mean there's times where other banks I remember when I was in Memphis there was competitors that would do large churches over there at 110 basis point spread. If you think about that, if you're going to have operating expenses, commissions, expenses and taxes you're not going to get a 125 ROA. So it's just been a rough rule of thumb for me, Brett, in my career that on the commercial side, I try and get my teams to do a minimum of 200, sometimes we don't. Last if you go back to the fall of 2021, I think that fourth quarter our commercial spreads were 250 basis points from my memory in that range. As we enter the spring of 2022, you might remember me mentioning that we have extreme discipline and probably too much. And we wanted to hold tight at that and as rates went up, banks did not move their market rates to match the underlying rise and FHLB sort of base rates. So the rates we put on the spreads, we put on the first half of last year I think from memory, we're in the 170 range. And so, I'm actually pleased that this quarter was 239 again I think that would be great in a normal operating environment, so I'm glad to see that we need to keep trying to get as much as we can. I saw someone put out a note on home bank in Arkansas, I don't follow them that their new production was at 7.1%. And they talked about how they were trying to make up some of it on the loan side, we need to do that as well and our deposit strategies, but I am pleased with the 239. Now I will turn it over to Mike to talk about the margin and I think that December is a good question. Right. So thank you, appreciate the question. So our margin in December at compressed to about 335. We did see deposit pricing pressure pick up late in the quarter. And we saw the beta related to Fed moves pickup in the quarter. We are hopeful that some of that is competing with banks that are sort of getting ahead of the Fed's next move from a pricing standpoint. But we clearly saw deposit pricing pressure on an exception basis. And if promotion basis pick up late in the quarter. And one thing I would say in terms of margin as Tim said, we've always targeted on the loan side is spread over home loan match-funded, the home loan. When rates were at historic lows it was very difficult to get much spread on the deposit side, even with deposit pricing, getting more aggressive we are getting more spread on the deposit side to contribute to the margin than we did when rates were at historic lows. Even the wholesale rates, we've been tapping which have been brokered not home loan, add to a year they've ranged 30, 40, 50 basis points below match funded wholesale home loan and our deposit pricing, we are trying to be flexible in terms of responding to competitor offers and competitor exception rates to retain profitable customers and to potentially attract broad relationships we will never go really to or above our wholesale alternatives. So even if more aggressive deposit pricing, we are still getting reasonably attractive spreads on the deposit side, the less so than a little bit earlier in the year. Okay. That's helpful. And then wanted to just turn to the SBA business and wanted to make sure I understood the pace of the improvement to the $2 million quarterly number, what that might look like and then I've heard some banks say that they are less optimistic on SBA, in the current environment. And so I just wanted to make sure I understood the decision to the bulk of it and just what the expectations might be from a credit perspective. Sure, Brett, this is Chris. A couple of things that I'd note. If you compare SBA over time, this is a period like every other fee business where margins have been under pressure, okay? Alone that guaranteed portion that you could sell for 10% to 12% are premium, say a year or two years ago might go for something around 8% premium or less. And I suspect that impacts the expectations of some of these lenders out there in the space and so on. So as to the trajectory for growth, I think it will be fairly rapid. I am optimistic that we will be at that run-rate that I mentioned of about $2 million by the end of the year, but I think that we need another quarter or two to settle in at current levels before we push the envelope on that. And Brett, I might add that, I mean, we understand we're running a public company and there's different mandates from different investors and we want to build a great company and we want to build an institution to last, and so this is one of those that as we continue to improve our performance this actually came to us, we didn't go seeking for it. And so you have to evaluate it as an investment and I would say we don't want to do anything that's not profitable or accretive to our value, but look at we don't pretend to think will be Live Oak, but look at the great institution, they've built with this product over time. So spreads and different things will come and go. These are people that we referenced and checked and very great reputations, they've done it a long time from top 10 SBA units and so we're going to -- we want to go fast, and we want to go slow, right? We want to generate the earnings, but we also want to do it the right way where we've got a quality business and it continues to build the brand of CapStar and make it a well-rounded financial institution. Okay, that's great. If I could sneak in one last one Chris, just on CECL, you mentioned the implementation, and I think 3Q I think your reserve on CRE was 85 basis points. With CECL it seems like we could see some rebuilding of reserves for the industry assuming using Moody's model et cetera. So Chris, wanted to hear if you anticipate of kind of a building of reserve levels and somewhat of an uncertain environment from current the 1.03%. Thanks. Well I think, yes, it's hard to answer that. What I would say is that, CECL is so heavily tied to national macroeconomic trends and that has been the most resilient and predictable kind of indicator of loss overtime. So, I mean we have the opportunity to modify that based on qualitative criteria. You mentioned commercial real estate, for instance, specifically again, I'll remind you that our underwriting model for commercial real estate has and continues to be a high equity model, which we believe mitigates us against anomalies in the business cycle and cyclical risks from higher rates and lower valuations. Could I add maybe to what he is asking. And we have Jeff Moody here, our Controller as well, so correct me if I get off track here, but we are adopting as of January 1, and of valuing the -- and evaluating the banks that have adopted previously the -- I don't know the correct term. But the adjustment for seesaw appears to be in line with what other banks have had when they've adopted. And I think that - reserves tend to go up, but I don't - I think that's more from the adoption of CECL I don't think it's anything due to the environment for the current economy, and I think investors should expect something in the range to what other banks have had when they adopt it. And then I'm not an expert on it, but as the macro environment changes one way or the other, that will determine your question Brett, but nothing I would say, nothing more so and Jeff, please correct me. I think nothing more so than normal adoption levels that maybe we've seen from other companies. Thank you. And one moment for our next question. And our next question comes from Graham Dick from Piper Sandler. Your line is now open. Just wanted to circle back to the margin conversation quickly as you mentioned that at December margin at 3.35% and betas accelerating during the month? When you guys look to the beginning of this year I guess 1Q and maybe into 2Q, a little bit would you expect the margin to be about that 3.35% level or above it or size of large kind - how you'll see it trending in the near term? Well - I mean - this is Tim, I apologize as a conservative person. I would follow recent trends I would love to be able to promise to you that it was going up and we want it to go up as much as anybody, and we're going to we've been working very hard and we're going to continue working hard, as you know, this is a sort of a macro and industry item and it's challenging. So we're going to work hard. We've been tempering our loan growth and really focusing on pricing to main spread and then and we're going to be working extra hard on those projects that I mentioned to you. So I don't have an answer to give you as a conservative person. I think that we're probably viewing that will be probably that level or slightly down and we're hoping that that as the Fed slows its rate increases hopefully this the next six months. Hopefully that will slow banks from raising and some level of calm as Mike said, hopefully, some of these banks are getting ahead to the next increase. But I wouldn't want to lead you otherwise I'm under-promise and over-deliver kind of person and it's a challenging operating environment right now on the deposit side. Okay, that's helpful. And I guess, specifically on the loan side, you mentioned home bank getting 7.1% just wondering what you guys are seeing on new production today that's in the pipeline and what you can expect to see hit the balance sheet this year in terms of loan yield and then also I guess if you could share what your pricing wholesale or brokered CDs at right now that would be helpful as well? Okay, so we'll start with, I'll ask Kevin Lambert, who is here who is our Chief Credit Officer, he may pitch in on not a specific deal, but just general, maybe 5.20%, 5.25% kind of rates you're seeing Kevin. And then maybe Mike can pitch in on brokered CDs so, Kevin. On the - as far as the rates go - we'll probably - you have seen rates that range in the 6% to 7% and higher kind of range. All right and yes Kevin and on the brokerage side. I would say looking at pricing as of Monday we have been issuing really generally out to about nine months. So I would say nine month rates right now, we'd be issuing around 4.65% all in six months, we would be issuing around 4.50% to 4.55%. Three months around 4.30%. And again, each week we compare the curve on our out - on our brokered to home loan, we also compare it looking at - Fed funds futures. So, where those are suggesting rolling overnight home loan borrowings will be over the course of the year. And we're trying to be very prudent in terms of tapping the most cost effective source to do that and broker continues to be yes right now six month about 45 basis points under our home loan about 20 under where fed's funds futures are. So that hopefully gives you a sense for the current wholesale pricing we're looking at. Definitely, that's very helpful. And I guess, just one quick one on expenses. I just wanted to know what the mortgage banking unit expense was this quarter? Our teammate, Glen Rhodes is here I believe it was around $1.5 million, is that approximate approximately $1.5 million Graham. And again - I think our gentleman that runs that he is tremendous. I think this was the lowest gain on sale, he may have had in history and he's a real pro and it's just that's an issue as I'm sure you're hearing from other banks, they're just limited to no volume. And fortunately the spreads came back - for the volume you get, but there is additional, we're actually interviewing a person we've interviewed her twice this week from another mortgage company that got laid-off in town. The big companies are doing that and there is a potential - of maybe some further reductions. We did reduce about $400,000 on operating expense, but it's a balance of again. We really have an outstanding mortgage company, it's not a monoline that we blew up for the - when I say blew up expand we didn't expand it for the refi environment it's really a purchase money high-quality shop in metro Nashville. And hate to damage that for short-term earnings, but we'll continue to monitor it with Hart Weatherford and with Chris Tietz. Yes and Graham, I'll point out that we view March and April as being important kind of watershed periods to gauge where we see the rest of the year going we are seeing a pickup in applications, of course, rates have come down margins on the gain on sale have gone up at this point, we're encouraged by the application volumes, the declining rates. The resilience incumbent in the quality and quantity of housing demand in our markets particularly Middle Tennessee, where we're really - have historically been a top five kind of mortgage originator for the market. And thank you. And one moment for our next question. And our next question comes from Kevin Fitzsimmons from D.A. Davidson. Your line is now open. So appreciate all the information here and we've talked a lot about margin, but if we look at dollars of NII are we likely in the first half of the year if loan growth is more limited. So overall balance sheet growth is more limited and the margins under pressure is that likely - that dollars of NII will be flat to down in the first half of the year and maybe - and are you hopeful it goes from goes to flat to up in the back half of the year? Well, definitely on the backside and on the first side. I'd like to see that you know I think one issue, is just managing just overall liquidity and the quality of the balance sheet. You know the - in the fourth quarter Mike mentioned our correspondent division, other banks are having the same issue. So there is, pros and cons to correspondent balances because they are having issues too with customers. And so our correspondent balance is we're about half the decline. We had some customer decline CapStar historically had some really large metro Nashville. I don't want to call it hot money, but more rate sensitive money and that's some of what has been leaving. So I would say, Kevin from Tim's perspective, what I would love to happened as I hope the correspondent sort of settles down, one strategy, I didn't mention when I listed them as we do have a new correspondent banker that - I announced previously. He was the top correspondent banker at First Horizon. I don't want to scare you he actually had $700 million in deposits in his portfolio. So we're going to be working with him hopefully, we can stem and grow correspondent hopefully the core customer deposits. You know that the larger more rate sensitive may be have fled and definitely second half to your question, but I would love to see in the first half, we're we can begin to add deposits. It may come at a thinner spread, where maybe we can outgrow some of this on NII, even though it hurts margin a little bit, that would be the goal. Want to monitor the trends of fourth quarter to make sure there's, not further customer declines. Okay, that's helpful. And that's kind of leads into my next question that I was going to ask you about loan-to-deposit ratio here is about 86% given your outlook for loan growth and what you just said about deposits, is it seems like the goal is mostly fund loan growth with deposits. But obviously deposit side is larger. Keep in mind -- keep in mind, you know that's sort of public reporting or regulatory reporting that our loan to customer deposit ratio is probably more 90%, 95%. When you report deposits, especially in this environment for our bank and others, brokered CDs are reported in deposits. So when you look at that chart in our PowerPoint of the loan-to-deposit ratio in the 80 range, that's with the benefit of $150 million or so of brokered CDs already. So I would say our core if you want to call it that our core loan-to-deposit ratio is probably around 95% or so, right now. I think in that range. You know, back when we first met when I was at SouthTrust, I'm pretty sure our loan-to-deposit ratio was 115 or 120 and I'd have to go back, that's how banks used to run back then. I don't think that's well-thought-out today, so we generally have from memory our Board approved policy for wholesale funding is 25% of assets. And so obviously, the best balance sheets in America are banks that are 100% customer loans and 100% customer-funded. So I think up to 95% to a 100% customer-funded. And then have availability on that 25%. And right now we're using some of that 25%. So as I said, the customers and the 95% range and we do have that. So I think in this environment, you're going to use some wholesale. I think you are going to use some brokered CDs, especially with our type bank and balance sheet, but I really look forward our team has done anything we've asked them to do and I'm actually looking forward to getting involved myself this spring and trying to get correspondent going with Chuck on our new guy. And hopefully, the most rate-sensitive has slowed and we start to get some traction. On that same topic, Kevin, just because we forgot to bring it up I know it's unrelated, but talking about the best balance sheet of customer on both sides, this is sort of irrelevant to today's discussion that we showed our Board this quarter. CapStar shared national credits this quarter. I think our 0.3% of our loans, which we've really turned the loan side to a customer balance sheet and that would be my goal on the deposit side, long term. And thank you. And one moment for our next question, please. And our next question comes from Feddie Strickland from Janney -- Just want to go back to expenses for a second and make sure I understand the expense guide. If I back out that $1.5 million in mortgage expenses from the fourth quarter numbers. I think I get about $15.9 million, $16 million in the fourth quarter of 2022 is kind of the core bank expenses and that's actually down a little bit in the quarter? But your guidance seems to imply expenses ex mortgage are going to rise to $17.4 million on a quarterly basis. Are we going to see that all occur starting in the first quarter or is that sort of an average quarterly rate for the year? And just - if you average all the quarters together, that's what you'll yet? First of all, good job and good math because that's pretty much what we came up with. So yes, so CapStar to me is a little unusual versus some of the other banks that we've got these fee businesses. And so sometimes - it's frustrating even internally to get your arms around it because I'm used to maybe just a bigger steadier balance sheet - and more of the fees on the deposit service charges which are steady. So that's why in the past we've said, hey, $16.5 million. I mean we don't want to - I don't want to be ultraconservative, but also I want to under-promise and over deliver. So we've generally been under that $16.5 million a little bit. I know there were some questions after third quarter. But that's generally what we came up with in fourth quarter is that we've continued to operate under that range that we put out there when you reverse the recovery in fourth quarter, we also got about $15.8 million. If you put $1.5 million on that, it's like you said remember there'll be the $800,000 additional for the SBA. And then remember in first quarter FICA comes back. So that is a number that comes back in. And secondly, fourth quarter didn't have any executive incentive accrual because we had backed out $600,000 or $800,000 in third quarter and then did not do any in fourth quarter. So I can get with you offline, but you generally are on track Feddie, but just keep in mind you've added back the recovery, you've got FICA tax coming back. I think the executive accrual runs when is it $200,000 or $250,000 a quarter. It's about $250,000 a quarter Feddie for the executive loan that wasn't enforced. So you've got the $15.8 million, you had $800,000, you've got FICA and then you got the $250,000 that sort of gets you to your core and then you've got the $1.5 million of mortgage on it which that doesn't really have a lot of variable in it. There's some. Not far underneath that would be the core run rate just to run the business that again we could continue to look at throughout the year if it stays slow. Got you. And I guess on mortgage, if that's a little better, the expenses will be a little higher, but the revenue will be a little higher because you'll have better gain on sale you know? Correct, correct. That's absolutely - excuse me, I got a frog in my throat. That's exactly correct that and - if you look at fourth quarter, I think there was $600,000 perhaps in fees on mortgage. So there'd be some commission in that number and so forth. But you are correct that if that went up and you would get associated revenue same thing with SBA. The number I gave you of the $800,000, that does have some commissions sort of for the $1.5 million level. But if it went up to $2 million, $2.5 million, $3 million there would be additional revenues for that expense. Got it. And then just one last one from me just more broadly speaking, when you're talking about internal investment, is that going to be focused more on augmenting your existing markets or are you considering further expansion in new markets either with an IPO or team left out or what have you? Well, I would say before this rate environment, like if we go back to whenever fourth quarter of '21 or last December, my view to the management team and our Board is we have enough right now. And we've done - this was a fabulous company that had a lot of positive aspects to it and perhaps we've changed the strategic direction a little bit. We've maybe changed the culture a little more towards performance and it was a great company to start with, but profitability was a little lower, growth was a little slower. So wanted to do these investments and I think they've worked. I don't think we covered it specifically but Chattanooga and Knoxville today are almost $500 million banks. They are bigger than Athens and FCB. I think Athens we may have bought for $100 million and FCB, we may have bought for $80 million handed out shares, so that's almost $500 million bank that we didn't handout shares on. So I think we have enough. I would have said that before the rate environment. And my goal really would be to continue to maximize those markets and maybe look for bankers in those markets, but we already have a great team. We don't need a lot more bankers and so we've got a wonderful team in those markets and they we need to keep getting customers like they've done with that $500 million. And really fund it and get the deposit side, that's the emphasis even before the rate environment. SBA I don't know if somebody came with a new line-of-business today, we have enough going on with our core markets and our current fee businesses. I don't think we would step into a new fee business. This was really that we were already in SBA. I think we've had some wins, but it was sort of here and there and we thought this would really solidify what we are attempting to do. And thank you. And we have a follow-up question. One moment please. And a follow-up question comes from Brett Rabatin from Hovde Group. Your line is now open. Hi guys. Just one quick follow-up. You talked about the competition in the markets and clearly you had two players. I think, trying to get ahead of the curve for this year in terms of growing our deposit base by being aggressive. And so you can make an argument that those two suppliers in particular did some of the heavy lifting in 4Q as opposed to doing it in 1Q and 2Q. And so you could say, well, maybe, maybe the linked-quarter changes and pressures on the funding slowed from the pace in the fourth quarter particularly in Middle Tennessee or you could make an argument for that anyway. I'm just wanted to get your perspective on that thesis and what you're seeing maybe today versus in December on competition. Thanks. Well, I'll comment first and then Mike can comment. I'll just say first of all, we've got outstanding competitors in Nashville and Tennessee and I think everybody does a great job, and so I think, everybody is fighting through this, the same way. I think you could make an argument to that. I think it goes back to Kevin Fitzsimmons. You know, if I can see that attrition is facing are slowing down, I would be for the same thing. I know it's not what we all want or I want long-term, but I think you know we are a great bank or the third or fourth largest bank in the state and have a long future. And you are in this for the long-term, but I think there is markets where it's not the goal isn't to have the nice margin, it's to have growth in earnings and a good ROA and ROE. So, I think they're doing a good strategy. I don't follow all of their exact balance sheets. But we have seen that I'm not sure if that's what they were doing or I think it's more what Kevin was asking earlier. I think they're just sort of ploughing through it and saying in the short-term environment we're going to grow NII and it's going to cost us to do it. And overtime that will set allows and I'm hopeful we can get there in the first half of the year. Yes, thank you, Tim. And I would add to that I think I might have mentioned, I might have touched on this a little bit earlier and discussing the margin. Again, hard to predict but I did mention to your point that we have seen competitor pricing including from, I think some of the banks you had in mind more aggressive, we don't know to what extent that may be, I mean we've seen banks in our markets that are trying to get ahead and deal with their liquidity challenges. I don't know to what extent the rates we're competing with might be getting ahead of the next Fed move. We hope that is the case. And -- but we don't know so that is certainly a possibility. We hope to see that and which would give us some potential upside in Q1. But as Tim said, I think we want to be conservative and cautious in any outlook we provide, so I would say, time will tell. We are monitoring conditions really day by day. We have very active dialog with people in the field on what they're seeing. And so we do hope that the rates that we've been competing with will slow. And thank you. And I'm showing no further questions. I would now like to turn the call back over to Tim Schools for closing remarks. Okay, this concludes the call and we appreciate everybody taking time out of their day today to listen and speak with us. Have a good weekend.
EarningCall_1503
This conference is being recorded today, December 12, 2022. The earnings press release accompanying this conference call was issued after the market close today. Before we get started, I’d like to read a disclaimer about forward-looking statements. This conference call may contain, in addition to historical information, forward-looking statements within the meaning of the Federal Securities Laws regarding MamaMancini’s. Forward-looking statements include, but are not limited to, statements that express the Company’s intentions, beliefs, expectations, strategies, predictions, or any other statements relating to its future earnings, activities, events, or conditions. These statements are based on current expectations, estimates, and projections about the Company’s business, based in part on assumptions made by Management. These statements are not guarantees of future performance and involve risks, uncertainties, and assumptions that are difficult to predict. Therefore, actual outcomes and results may and are likely to differ materially from what is expressed or forecasted in the forward-looking statements due to numerous factors discussed from time to time in this report and in other documents which the Company files with the U.S. Securities and Exchange Commission. In addition, such statements could be affected by risks and uncertainties related to factors beyond the Company’s control. Matters that may cause actual results to differ materially from those in the forward-looking statements include, among other factors, the loss of key Management personnel, availability of capital, and any major litigation regarding the Company. Finally, this conference call contains time-sensitive information that reflects Management’s best analysis only as of the date and time of this conference call. The Company does not undertake any obligation to publicly update or revise any forward-looking statements to reflect future events, information or circumstances that arise after the date of this conference call. As this is my first quarter as CEO of MamaMancini’s I wanted to thank my Leadership team and our Board for the opportunity to help lead this storied Company. I’ve used the past three months to spend time in the field, speaking with consumers, customers, and our sales partners. It is inspiring to hear what our brands mean to them and how they’re using them to thrive during the pandemic and make family time even more special. I’m proud of our team and prouder of the quality and breadth of our portfolio. Thank you. Now back to business. Throughout the third quarter, we continued to execute, delivering what we believe is a sustainable return to profitability, further building the foundations for a national deli solutions company, all with the goal of accelerating and expanding our existing portfolio brands while strategically leveraging incremental consumer-driven innovation and accretive near-in acquisitions to fill out gaps in our portfolio. Our vision is to become a one-stop-shop for prepared foods for grocery, mass, club and convenience channels, addressing the $30 billion-plus food service and prepared foods market with our grocer partners. This approach fits well with the significant pandemic-related lifestyle changes that consumers faced in the last three years, with many focusing more than ever on quick, clean, and fresh meals made with better ingredients at a price more affordable than eating out. On the other side of the counter, retailers continue to face significant supply chain and labor challenges and are seeking labor-efficient, reliable solutions for their hot bar, deli, and grab-and-go offerings. As the country continues to evolve stronger out of the pandemic, recessionary pressures will continue to focus our consumers and retailers on high quality, easy to prepare, and affordable meal solutions, all of which MamaMancini’s delivers on. We feel our offerings position us well for any expected macroeconomic forces. The realization of our goal to shape MamaMancini’s into a one-stop-shop for these deli prepared food solutions has required a step change in our corporate structure in many ways. My immediate term focus has been and will continue to remain on the continuous improvement of our three C’s strategy: cost, controls, and culture. On the cost front, we have designed and implemented new approaches to cost management, driving noticeable improvements in procurement, manufacturing, and logistics management capabilities. As Matt will mention later, our efforts to more efficiently manage labor costs, particularly overtime, outbound logistics, and cold storage are realizing noticeable returns, allowing us to reinvest in our business. Commodity costs continued to improve in the quarter as well, providing significant tailwinds for our margin profile. While Q3 gross margins improved over 1,100 basis points as compared to the first half, we believe there is even more opportunity to drive operational efficiencies across both of our facilities. On the controls front, we brought in our new CFO, Anthony Gruber, to help build a strong foundational finance rigor along with the entrepreneurial spirit critical to succeed. We put new financial and operational controls in place to help our teams and provide agility for sales and operations staff. The weekly and monthly cadence of meetings as well as the clear and actionable KPIs we put in place are allowing our teams to communicate easier, make decisions faster with more information. Our quality and consumer engagement playbooks are bringing us closer to the consumer to understand their evolving needs and usages. We’re rolling out our new sales broker scorecards so we can all be clear on expectations and track progress to our mutual goals. Our enhanced approach to costing and pricing are already driving margin expansion, and we expect to continue to capture this profit growth, while also reinvesting some of this new margin to serve as rocket fuel for our accretive marketing and trade promotions. Last, but certainly not least, building a company culture that is geared for and incentivizes profitable growth. Our people are at the core of what we do, and hiring, promoting, and retaining talent is paramount to our long-term success. We speak of our vision often, to reaffirm, reinforce, and remind all of our employees of our one-stop-shop deli solution strategy. We have performed full talent assessments for our Management, investing in our people, and upgrading our talent, not only to support today but to build for tomorrow. Our new CFO is just the beginning. We have already started to build out the finance function. For example, our new Controller started today, as well as filling critical needs in logistics and soon procurement. All of this will not require long maturation. It’s happening as we speak. Our team’s enhanced commitment to quality, including my personal favorite, our monthly grandma quality meetings to ensure our products are as good as mama made them are already being realized and is what drove us to once again win number one in four categories during the 2022 QVC Customer Choice Awards. The results we have seen in the short time since I started at MamaMancini’s has been unprecedented. Supported by strong organic growth as well as growth from our recent acquisitions, we made a sustainable return to profitability and achieved our previously announced goal of $100 million annualized sales run rate, a full quarter earlier than expected. In addition, while it’s still very early, preliminarily, the fourth quarter is shaping up well and we are on a healthy trajectory moving into Calendar Year ‘23 and beyond. Turning to specific wins in the third quarter, we launched into three new customers and drove double-digit new items into existing customers, half of which were through our cross-selling of our new T&L products into legacy relationships. Our goal is to grow the average items carried per store several fold, to make it easier for consumers to find our products on the shelf as well as making our logistics more efficient. Looking ahead to the fourth quarter, we have already successfully sold in and received orders from three new customers and shipped an incremental double-digit portfolio of new items into existing customers, further expanding the breadth and depth of our coverage. Overall, we see a bright future for both our top and bottom line results. While we are aware and actively discuss potential headwinds, particularly in recessionary pressures and commodity inflation, we believe we are building a more resilient, flexible organization that is prepared to pivot as needed. In summary, we have seen increasingly strong momentum in recent months. I firmly believe that we are well-positioned to build significant additional momentum in Calendar Year ‘23 as we drive organic growth, grow the team, expand our capabilities, and seek to become brilliant at the basics. As we continue to fill the deli case, we are evaluating a corporate name change to better reflect our platform Company model. This is all with the goal of building sustainable value for our Shareholders over the long term. I look forward to further achievements as we seek to realize MamaMancini’s significant untapped potential. With that, I’d like to now turn the call over to Anthony Gruber, our recently appointed Chief Financial Officer to walk through some key financial details from the third quarter of Fiscal ‘23. Anthony? Revenue for the third quarter of Fiscal 2023 increased 137% to a record $25.7 million, as compared to $10.9 million in the same year-ago quarter. The increase in revenue for the third quarter was driven by organic growth across all divisions, chiefly through cross-selling as well as by inorganic growth through the acquisition of T&L and Olive Branch. Gross profit increased to a record $6.6 million or 25.5% of total revenues in the third quarter of Fiscal 2023, as compared to $2.7 million or 24.4% of total revenues in the same year-ago quarter. Gross profit increased in the third quarter back to targeted levels based on normalization of commodity costs, successful pricing actions, and strong sales growth. The Company continues to identify procurement and logistics efficiencies and cost savings through stronger buying power created through the acquisition of T&L and Olive Branch. Operating expenses totaled $5.1 million in the third quarter of Fiscal 2023 as compared to $2.7 million in the same year-ago quarter. As a percentage of sales, operating expenses decreased to 19.7% in the third quarter of Fiscal 2023 as compared to 24.4% in the same year-ago quarter. Operating expenses as a percentage of sales benefited from synergies created through the acquisitions of T&L and Olive Branch. Income from the equity method investment in Chef Inspirational Foods totaled $0.1 million in the third quarter of Fiscal 2023. Net income for the third quarter of Fiscal 2023 totaled $1.1 million or $0.03 per diluted share as compared to an approximate breakeven in the same year-ago quarter. Adjusted EBITDA, a non-GAAP term, increased to $2.1 million for the third quarter of Fiscal 2023 as compared to $0.3 million in the same year-ago quarter. Cash and cash equivalents as of October 30, 2022 were $3.5 million as compared to $0.9 million at January 31, 2022. Taken in tandem with our credit line, which we paid down by $1.5 million in the quarter, and positive $3 million in cash flow from operations in the quarter, I’m comfortable with our liquidity position relative to our near-term requirements. This completes my prepared remarks. I’d like to now turn the call over to Chief Operating Officer, Matt Brown, for an operations update. Matt? Operationally, Fiscal Q3 was everything we had hoped for and planned. Price increases that were proposed in Q2, were implemented in Q3 as retailers and consumers recognized that the rise in commodity prices had to be passed along and shared equally. Just as the price increases went into effect, commodity prices on our largest purchase proteins fell back from Q2 highs, accentuating the margin tailwinds. This provided for higher margins in the plant and at the market level. As Adam mentioned earlier, I have been tasked with handling the first of the three C’s: cost. Sitting back and watching commodity price normalize in Fiscal Q3 was not an option. Our KPIs drive us to keep finding more economical and efficient ways to be productive. To that end, my Management team continued to chip away at labor overtimes and was able to pick up yet another point of margin against cost of goods sold, representing greater than 100 basis points in savings over the quarter. Another C that Adam did not mention but is critical to the success inside the operation is consolidation. We’ve been addressing the need to take advantage of synergies across our business units, helping to gain efficiencies spanning every aspect of the supply chain. In Fiscal Q3, we created a dedicated shipping team to focus on consolidating both inbound and outbound freight across our New Jersey and New York facilities. This team was successful in sourcing three new carrier options, creating competition that was able to reduce overall freight costs by 200 basis points in Fiscal Q3. Another consolidation focus during the quarter was on our third party storage. As MamaMancini’s Holdings is first and foremost a manufacturer and marketer of deli solutions, we recognize that we currently leverage the expertise of others when it comes to cold storage. We have utilized multiple locations to hold raw materials and pre-shipped finished goods in an effort to maximize our production capabilities in our plants. However, the saying too many chefs in the kitchen is fitting when recognizing that spreading products across multiple sites can be counterproductive. Fiscal Q3 began the process of consolidating these third parties down from six to four strategic locations, eliminating additional storage costs that were not creating value. We continue to research our cold storage options, including, but not limited to, investing in a centralized facility between the business units that we would control. Our dedicated costing models have empowered the sales team to make smarter decisions with regards to pricing products to our retailers that not only reflect fair perceived value to shoppers but also provide margin to invest back to help promote our products and keep us top of mind. Our East Rutherford pricing models are nearly complete and we hope to take this learning to Farmingdale over the next quarter. Finally, in Q3, I took our Management team to PACK EXPO International in Chicago where we walked the show in a continued effort to find better technology to further increase the plant’s efficiencies. We came away with multiple opportunities and started putting ROI documents together that will be addressed with the Board over the next coming weeks. That does conclude my remarks. Before we begin our question-and-answer session, I’d like to turn the call back to Adam for some closing remarks. Adam? The significant revenue growth we saw this quarter reflects our transition to a national deli solutions company, a vision I outlined on our last earnings call. Our profitability, which certainly benefited from significant sequential commodity cost improvements and successful pricing actions, was concurrently driven by a keen eye on cost controls and synergy realization. As we move through the holiday season and into ‘23, I anticipate the third quarter will have marked the beginning of a sustainable return to profitability for MamaMancini’s as we prepare to embark on the next leg up on our growth trajectory. Yes, in terms of what you put in place with the information and the controls throughout the organization, how have you seen your employees evolve into becoming more productive and inquisitive, as well as getting feedback from the end customers? Yes, I think it’s been great. So I think what’s happened is that winning helps. It’s always a lot easier when you’re winning. The team’s inspired, the operations team, both in Farmingdale and East Rutherford. The sales team, obviously it’s easier to sell in when you have a product that’s moving with better velocities, getting greater distribution. Inside our main corporate offices, people are excited. They’re enjoying what they do and they like what they see. The opportunity to actually cross-sell different products – so for all intents and purposes, we have doubled the portfolio – allows us to sell in multiple products to our customers. So overall, I think we feel great. I really do believe that there’s a lot of excitement and the best is yet to come. In terms of increasing the number of products per customer and per store, are you looking at what the customer needs are or are you focusing on expanding? I know you’re Northeast and Southeast and a little bit less in the Midwest and West. Is there any push to get Midwest and West location-wise, or you just really want to get those SKUs out to new and existing customers? Yes, a couple of things. So the first one is, we’re national today. A number of our club customers and others are national. I know that we have a big West Coast customer actually that’s selling our products now. We got our first orders for Q4, which I will share at the next meeting. Definitely from a national perspective, we’re there. To your other question, what I think has been great is, we have a great reputation in the field. So Dan Mancini for example, Dan is literally the guy going to many of these calls, and there’s nothing like Dan talking about MamaMancini’s products. We’re good listeners. We have good service. So another thing, credit to Matt and his team, is that the service levels we provide are great. So it’s really easy for a customer that—I’m going to make it up, say they already have our meatballs or our sausage and peppers, they know we have quality. They know we have service. It’s, "Hey, by the way, do you have some chicken or do you have some grilled vegetables or do you have some paninis?" We now have all of those. We didn’t have them before. So that’s how we’re getting in. The customers see the quality, see the service and quite honestly, it’s easier for them. If they make one phone call to fill the entire deli case, that’s much easier than having to call 25 people to do that. That’s the vision. That’s our strategy, and it’s working. Are you seeing that happen even faster than what they want from you in terms of their—like you talked about their labor supply and labor shortage? So are you seeing things evolve even faster than maybe a year or so ago? Yes. So currently I’m three months into the role and while I’m not going to tell you what I thought a month ago or a year ago, what I think we’re seeing is that we’re being responsive. You brought up a great point. For example, in the past we have been selling these kits, which allow the customers’ labor to be doing some of the prep work on-site. As labor got tighter, we responded and created our Meals for One program, which allows the customer to really to do no prep work on site. So what I think is really special about our sales team, we’re good listeners, understanding different customers want different things. The beauty is we’re able to provide those things to fit the needs of each customer. So I think the word is agility – to our sales force and equally so, to our operational team. So it’s the balance, and Matt and I have these conversations all the time around how do you balance agility and meeting the needs of our customers with managing complexity, right? In a perfect world, we’d sell all 2.4 ounce meatballs or grilled chicken 24 hours a day. That would be the best from an operational standpoint, but obviously we don’t want to do that. We want to meet the needs of our customers. So it’s that balance between meeting the needs of our customers with the efficiency that we’re trying to get from an operational standpoint. From just the overall, the G&A expense, are you happy with where that is and it might just increase incrementally as you are able to leverage up well past that $100 million mark? Yes. I think the word that we all love around the office is absorption. So as we’re growing more and more top line revenue, that’s allowing us to do one of two things. It allows us to drive down our SG&A, but then equally, it allows us to build capabilities. I am extraordinarily passionate about building capabilities within the organization. I’ve been here three months. You already see that with Anthony, our new CFO, who is doing an amazing job. I mentioned that just today, we hired a Controller. So the goal that we have as a Leadership team is to drive top line revenue. That’s going to allow us to invest additional capabilities in the G&A level without seeing it actually go up on a percentage basis. One last one. How have some of the initial tests gone with the Meatballs in a Cup for convenience stores and other customers? Yes, it’s going well. It’s actually wonderful. So we’ve mentioned in the past that we had a couple of tests going. We actually just got another test of a major grocer that’s in place and another full authorization—it’s not even a test—a rollout to another major grocer. So we’re seeing that, which is wonderful, but equally, I think it’s important, we’re doing it very intentionally with the right cadence, because we’re learning a lot. What we’ve been able to do is we’ve been getting feedback from both customers and consumers. One of the things that we heard back is that we wanted a longer shelf life. We were able to do that. Because we didn’t just go all the way out to market full bore with our first product, we were able to identify those pieces of feedback and we’ve already addressed it and have a solution for it. So now we’re able to go out with a much longer shelf life. Customers are really loving that. So what I’d say is, I do believe it’s something that’s going to be big for 2023, but we’re going to do it very intentionally such that we roll it out, and we have the right product for our consumers. With the color on orders that you’ve given for the fourth quarter, and continual improvements in cost, could you expect a sequential growth in earnings for the fourth quarter? Yes. I think the fourth quarter, just first of all, is historically a softer quarter on the top line, so there’s a little bit of seasonality. We do feel good. We continue to grow customers. So I do feel that we’re going to be able to achieve our goals of this $100 million run rate. I feel good on the top line. Turning to the bottom line, I feel equally as good. We mentioned earlier a number of price increases. There are actually more coming in January that have already been sold in. Matt and his team’s doing an amazing job from an operational standpoint. Freight, incredible. We hired a new person, a new woman in freight and she’s really doing an incredible job, more than 100 basis points of improvement already in freight. Matt mentioned the overtime and the labor improvements. So we’re still staying in line with what we said, which is mid-20s gross margins and probably mid-to-high single digits for the bottom line. I think we could continue to do that. We’re seeing—like I said earlier, I see more opportunity ahead than I do behind. There are no further questions in the queue. I’d like to hand the call back over to Adam Michaels for closing remarks. Thank you, operator and thank you again to each of you for joining us on today’s earnings conference call. We look forward to continuing to update you on our progress as we strive to deliver value to our Shareholders and execute upon our vision of a national one-stop-shop deli solution provider. Happy holidays to all. Thank you. Ladies and gentlemen, this does conclude today’s teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.
EarningCall_1504
I’m Laura Martin. I’m the Senior Internet and Media Analyst. I’m happy to welcome to my stage, the CEO of fuboTV, David Gandler. David was appointed Chief Executive Officer of Fubo in April of 2014. Prior to joining Fubo, David served as the Vice President, Ad Sales at DramaFever, which was a video streaming service acquired in 2016 by Warner Brothers. He also held position at Scripps Networks Interactive, Time Warner Cable and Telemundo. David received his BA from Boston University. Okay. So let’s start with a couple of personal questions. What is the most unusual thing about your background that no one in this room knows about yet? … unusual thing, it’s just my passion for media. And I think, I worked in media in every possible way. You can imagine, as you said local and national. Yeah. Really. I loved about that. Okay. Fair. So my New Year’s resolution this year is acquiring advice from other people like their best advice. So I’ll frame this question… … like what do you wish you’d known at 18 that you now know, that you would advise yourself or what’s the best advice you ever got professionally, like, when you think of black of crusher life, give me some… … probably not to trade your long-term view or what you want most for something that you believe you need at a particular moment. So don’t trade the long-term for the short-term, because it’s short-term. And so, I think, for me that was the less than that I’m still dealing with and the advice I think is difficult to follow, because I know what the long-term plan is. Unfortunately, in the short-term things change, recessions, stocks go down, things happen and -- but if you are really focused and stay the course, I think, that you will ultimately successful. As for what I would tell an 18 year-old is, you have to make decisions quickly. High quality decisions as quickly as possible and trust in those decisions and I think you -- a lot of people will always tell you, you’re wrong, you don’t know, I don’t believe it, and unfortunately, that’s how businesses were built. That’s how startups succeed and I think that’s something that, I wish that someone push me harder when I was 18 and but most people will tell you take the safe round, so. Look, I think, I’d like to say, analysis paralysis, because the thing about extrapolating data is a, if you have a certain view, it’s tough to remove that when you’re making assumptions, you are building a model and if you think this product is terrible, it’s going to turn 20%, it doesn’t actually work. What I tell the team is that, it’s better to be directionally correct, because it’s -- none of these decisions that you make are finite, right? You can always, gaming here an example. From Fubo, I still believe it’s a great idea. Yeah. Sorry. Wagering, yeah, and at the time we were talking about wagering, I mean, I still like it. Unfortunately back then money capital was cheaper free. Today, it’s not, right, stock prices are high, then they’re low and so you have less and less opportunity to kind of build out what you were thinking was going to be the right play. When I look at it, I am like, okay, I have 96% of my viewers watch sports, okay? I want to amortize my subscriber acquisition cost. How do you do that? You offer multiple products, example, Uber and Uber Eats, right? You’ve already acquired the customer for your car service and now you offer another service and you don’t to reacquire them. So all the rationale, the interactivity leads to retention and all of that holds true, but in the public markets when you think about the return on capital, it’s not going to take a month. So that going to take a year, it could take two years to three years. That’s how things get built. You can just overnight build something. And so, it was -- I still believe the right thing to do, unfortunately, wrong time, you have to pull back and… And just know one of the distinct you sell, when you come public you sort of sell your soul to this quarterly, I’ve had a couple CEOs on stage. They have advice to themselves about this. Yeah. This is sort of one of the debt trades with the double you make when you come public that you have to manage the quarters, right? No. What I am saying. What I think is it look, there are always going to be trade-offs and there’s a lot of value of being public, because I don’t want to sort of bring the conversation to what we do in business. But look we have -- we’re burning cash… Right. What did you see us do in the last two weeks, we won, dropped AMC Networks. We immediately raised prices $5. We added the regional sports networks, added another $10.99. Why, because we’re a public company. We get asked the same question, when do you turn and when you self-funding. When do you turn positive cash flow? So there are decisions that you get forced into that are not bad for the business, right. So in every scenario you have to take the good with bad. The interesting thing is, I think, if you’d asked me like, what don’t you like about it? I would say that… Employees, they want it now. They want a bonus today. They want everything yesterday. You talked to an investor, when you’re going to be free cash flow positive. When you’re going to do this? When you’re going to win gaming? When you’re going to and you have all these questions that come out you from every angle, Board members, investors, employees, children. I mean, literally everybody wants everything the same day and that I think is very difficult to deal with and so you have to manage expectations, and at some point, it’s just not manageable and you get a gaming scenario where you are -- we were live in New Jersey for six days. I mean, but directionally, I still believe it was a good idea and we did start to see what we thought we would see unfortunately to be continued. … everyone, macro is macro. I think for the company what I’m excited about, tough to get excited about advertising and all those things, but the one thing that I think where we sell most is on the technology side. I am very excited about the tech platform. The stuff we’re doing in artificial intelligence. I’m really happy about ChatGPT, because, I think, it really starts to create interest in AI, like, we’ve known that AI was valuable for cars and all kinds of things, but for like direct-to-consumer, there’s so much to do. So there is, like, we’re now starting to and we’re going to release a beta version sometime in either late 2023 or early 2024 in France to test it, because we don’t want to launch anything here in the U.S. But we’re doing things like indexing every single frame of every video. So the machine is reading everything and every frame. So what does that mean? So if you were to ask Fubo, can you show me every soccer goal that was scored from the left-side of the field? It will go in and because it’s accumulating its own metadata on a frame-by-frame basis, it’s able to tell you that. You can ask it show me. 20 minute clip of every goal touchdown pass that I missed over the last two days. So things like that. One point on purpose. How do you turn that into money and if it -- you can’t turn it into money, why do you do it? Well, there is -- yes, you can and there’s two things. One, it improves engagement. It improves retention in a world where you have very limited content differentiation in the aggregation business. You need to differentiate via product. I’m sure you know this already, but Fubo won the JD Power award for customer satisfaction, not easy to do against, like, a YouTube TV for instance, especially when we are more expensive than any of the other products in the market. Actually, I think, DirecTV is -- stream is more expensive, but I think we’re probably a little bit more, just I think with YouTube and Hulu, I think, we’re the most expensive product. So it improves engagement, improves retention. You can also charge for this type of feature, because it’s a real value add. It can be added part of another bundle, like, so if you bought, like, I can make an all the stuff, it’s there. If you have like a sports bundle with RedZone, you can add this capability in. So, I look at it like a DVR. Something premium, it’s could be promotional in nature. But, I think, it’s -- the things that you can do with that, you can also see this chair from Ethan Allen might be on an HDTV channel and then programmatically you could pay Ethan Allen, say, hey, this chair just now was in this frame, do you want to run your ad? Do you have creative? I mean there’s so many ways in which that this can work… …that similar to ChatGPT is, you don’t even know all the capabilities and all the features that can be developed, but I’m already seeing like use cases, there’s many use cases. One of the most disconcerting thing, I just got back from CES was, if you upload videos and letters from your dead loved ones, the AI will in real-time render them and answer 10,000 questions in there person with their cadence with their word choice. That’s how AI is being used today and then interesting? It’s like everything else. You have asset classes that are supposed to work in a certain way and then you have people that take advantage of them and right? So there’s -- I think there’s always going to be good and bad. Our job is to focus on what we believe customers want and try and figure out a way to leverage it appropriately. You see a big lift in your subs when NFL starts every September. So how does that affect your growth going forward, because it’s a five-year deal for them I think, because I heard comments? I’ll stop short there. Why I wouldn’t do that deal. I will say, we never had the Sunday Ticket. So I’m not sure it has any material impact yet. It had -- it was available. I think everyone in this room knows and beyond that, probably, maximum of 2 million customers. And so, look, again, I -- what I believe is and then we can talk about what we did in a very similar timeframe, which is the Sinclair sense. So there’s a lot of questions around that. I would say that most customers prefer their home team. Which is why we can talk about Sinclair shortly. And so if you live in San Francisco, chances are you’re 49ers Fan. So, I think, that there’s probably a very small audience. We know it’s $2 million. So maybe with Google, it’s $3 million. But at $2 billion, I think, that’s a pretty significant ticket. Especially patent -- if you look at the Amazon ratings on Thursday night, it will be interesting to see how they perform, which have been, I would say... Yeah. But I think the thing, maybe it doesn’t affect Fubo directly, but the fact that these huge deep pocketed monopolies are dabbling in sports should scale should out of all of us, because they have unlimited resources, so... They no longer have $50 billion plus in their balance sheet, evaporated in two years. Couple of bad deals here in there. Soft advertising markets, soft cloud market and then you scratch your head and go, I don’t understand what just happened. 24 months ago we were the kings. So I look at it very simple. We -- I believe in aggregation. I think every business should have aggregation. If you want airplane tickets or hotels, you go to Expedia. If you want to have every song then you go to Spotify. If you want to have every channel, you go to a virtual or cable, whatever it is. But if you want to go to a store that has lots of products, you go to Walmart, Target, you don’t go to a the milk store, you go to a store that has product. So, I think, it’s -- what we’re offering is more effective and more efficient, and the dabbling is dabbling at best… …because the real -- I think what happens is when you dabble you end up spending a lot of money and then someone upstairs says, okay, why have you been doing this, stop it. We saw this with Sony PlayStation Vue in 2000… We saw it -- well, I can tell you, we saw with Facebook in 2019 when they did two things, they acquired a Friday Night Baseball and then they acquired LaLiga rights in India and that was the end of that. I think we saw with Twitter, obviously, much smaller company. I don’t know what -- it makes sense, because if you think about Amazon, and as I said this very recently, people don’t go to Amazon for Thursday Night Football. Well, they don’t go to Prime. I know everyone says, oh, but it’s Prime, it’s Prime. We all go there because of delivery. That’s why we’re there. I don’t know anybody in this room or in any other room that said, you know what, Thursday Night Football. That’s it. I’m getting Amazon Prime. So I don’t know, is that true, see… I mean, we all agree, but the stock is at $1.86. Anyway, it is what it is. So I feel very comfortable competing. We have 55,000 sporting events and I think while YouTube announced the Sunday Ticket… … Fubo announces the Sinclair Sense. We are now the lowest cost provider in the United States for local sports. Now, why am I excited about that, because I believe in the primacy of sports, I think, we were one of the first to position ourselves as sports historically. And I believe the TAM for regional sports customers is significantly exponentially greater than it is for a Sunday Ticket. … 2022 showed us the rise of these, they are basically linear TV channels run on their general streaming platform and they have like 40 minute ad loads. So they look a lot more like… … which the consumer keeps having to take action to watch the next thing? So my question is, with the rise of FAST, which really is growing very quickly compared to AVOD and I expect to continue this year. Does that hurt you, because you’re running linear TV more than AVOD, which really is clearly differentiated from a virtual HDTV? … and I love the fact that it’s linear. Linear to me is very important. If you think about an analog to linear TV channel, again I go back to Spotify. If you listen to like rap caviar or any of these channels, they are linearized playlists for you, because why you’re lazy or are you just, just want to listen to music, you like Jazz, you don’t know what song, they give you Jazz channel. I would say the beauty of linear TV is the fact that, I don’t know what to watch. I know I like reality TV. I turn this thing on and it gets… …all this like this is a no brainer. Oh, you like food, no problem, here is like 50 shows on, this is how many ways you can make a Hotdog. So, I actually like linear and what we’ve been doing and this is related to our cost structure, we have been adding, we added 60 free ad-supported channels, FAST channels to our platform. And we’ve started with ones that look very similar like cable channels. So if you look at our guide, very closely. We have surrounded Food Network, for instance, with Tastemade, Gusto TV and all these other sort of food type programming. So like in the olden days, you’d have CNN and BBC are next to each other. You’ve done that here in well too. So in our world when you are watching a channel and you want to kind of browse while, we call it, beaten browse watching. So if you swipe your Apple remote up, there is this like lower third that comes up with these -- all these little kind of images of channels… And you can kind of browse this, way you’re watching, sounds great. And so now when you do that, next to food is like a bunch of these. There are hundreds and hundreds of FAST channels. To me this reminds me of very old school beginning of cable days. Nothing will change. Just remember, it will all go back. Because the cost to produce video content is very expensive and I think we’ve learned over the last seven years that. If you take the affiliate fees out of CBS or NBC, they’re all under water. If you take the ad… If you take the ad side of that business, again, under water -- you need both of those. I am glad Netflix is finally learning new look. So what I’m doing now is putting all of these FAST channels into these bundles so that I can better negotiate rates in my renewals. Well, because if you are a customer who likes NFL and you are a huge foody and we lose the Food Network and I have… Yeah. There could be programs have like some guy cooking in the South of France. He’s got like 10 shows linearized. Then what I can do is, I can say, yes, this channel has gone, but here is 50,000 other shows or channels. So we’ve been sort of getting that ready. That’s on one-side. On the other side, we have 50% of the ad load is ours, which is important, because we only get 2 minutes to 3 minutes of ads in the cable space. Now if you tell me you like to watch people grilling in early May then we will send you to, why would we send you to the cable grilling show. It just makes it highly lucrative and also makes you scratch your head and say, why am I doing this again, if you’re putting your content somewhere else on your own platform and charging a lot less than wholesale. You start to kind of question the value, which is really why you see the deterioration in the cable bundle. It’s because -- it’s not because people don’t like bundling and they don’t like the sort of experience. It’s because, when you move a show like Below the Deck first run on Peacock and someone is… So then you start to say, well, what’s going on here. But the FAST Channels that are good will eventually cost money. Why, because they’re going to say, I want to continue to improve my programming. We’re going to say, wait a minute, out of the 100 channels we have this channel in particular does a really good job, let’s pay them $0.01, let’s pay them $0.02. And we get the 50% of the ad load and so I think the business is evolving a bit and we’re sort of preparing for that future is still be the gateway to television. Interesting. Questions from the audience, let me just take a break and ask for questions from the audience. Anything, should we keep going. [Inaudible] slice, I get the slicing it down, comparing now kind of content plates. My -- I will -- when I think of FAST, I will say, somebody is going to be channels for, I am Track and Field fans. There will be the Track and Field FAST Channel and it will… Are you experiencing with these, like, you said, cooking example in May. So add little Illustrations, is there enough advertising coming in recognizing that… So, look, you know what, it’s very interesting, I tried to explain the difference between cable and why I think we can get to $50 million of advertising revenue or we call it ad ARPU per customer. It’s because when you sign-up for Fubo we have your credit card and you’re paying upwards of $70, I think, it’s $74.99 now, most recently… … once you’re in, it’s our job, the platform takes over and has to allow you to find the content that interests you most. So we already know that you’re going to watch whatever Monday Night Football, your watch FOX News or MSNBC and then there’s things that you really like and it’s our job to be able to find that. So if you watched the Olympic channel and you watch the 100 yard dash, all of a sudden, you’re going to start to see a Track and Field popping up and we’re going to figure out how much we need to turn-on of Track and Field for you or how much we need to pull back, the machine will do that. And so eventually what happens is, we want to get people to watch less broadcast television, because we don’t have any ad inventory and we actually want to push you to things that you like. So just like Spotify, if you listen to one Jazz, you’ll see in your feeds, you’ll start to see chill Jazz or comfort Jazz or sleepy Jazz and they start to build these channels for you based on your history. We’ve invested a lot of money into the tech platform, because I think it’s going to be able to do lots of things. So for me having more channels is going to be better, because it allows me to really find the things that you like, which become sticky and from your perspective on advertising, if we’re making money on Monday Night Football, Fox News, MSNBC and then we’re making another -- because we have twice as much inventory we don’t need as many users and so that makes it really valuable for us. The advertisers saying to you, yeah, I don’t, the numbers don’t have to be so big, but I like the people that are watching, because they are the spenders, the one that don’t mind spending too much... So there’s a couple of things here, one is we have the most expensive, one of the most expensive streaming services in the United States. So advertisers already know our customers have money. They know we love sports. All of our customers watch sports. If we can get HOKA to buy a schedule across all of our programming and then also provide them with some capabilities within the running channel, I’ll actually take it further, what if HOKA wanted to produce like a Peloton videos… …and put them all on and sold it on channel would be not. I mean we have infinite capacity, which makes our advertising business, I think, that much more valuable than cable, because the difference between Fubo and cable is one, you only have 40 head ends, in cable you can only advertise on 40 channels, because it’s too expensive to have all the hardware. With us it’s infinite. So we can have FAST channels. So we can actually monetize more hours than what cable could. So if you believe the average revenue per user and cable is somewhere between $12 per sub, and I don’t know, $20 per sub, I think, I don’t know, we are LTs or some of these. But I would say, about $13 to $15, then why couldn’t we at least get to $13 to $15 with addressable, infinite capacity, FAST Channels, et cetera. I would say that. I think what we said at the end of the third quarter was we had a very good September. If I am not mistaken, I think, we said it was a record breaking September and then we also provided -- John provided guidance that’s only when we get in trouble. We also provided guidance that we felt fourth quarter was pretty good, pretty good to good okay. I mean, again, I don’t want to talk about Q4, but the guidance was the guidance. So, John, obviously felt comfortable with that guidance, so I think that that probably speaks well to fourth quarter. I think for Q1, it’s tough to tell, because we’re only like nine days in, but when I look at the first nine days of last year versus the first nine days of this year, I am like, not so exciting. Is it having an impact all the stuff going out to NFL, normally there is a lot more positive excitement as we go into the Football weekend. No. I think, well, what happens is people start watch. So, anytime there’s like a war or anything like that, people just they jump into the news and also… Pretty much okay. The ad side of the business, I think, for us, again, I don’t have a crystal ball, but I would say that, we’re probably in a better position than most for a couple of reasons, one demo. … 18 to 49, probably, closer to 42 based on our data. That’s number one. Number two is, when in doubt go to sports. So we’re very heavy sports calendar. So I anticipate that is going to be very positive for us relative to everybody else. And then I think the third thing is probably tied to that the fact that we -- as a service we’re more addressable. So I think that if you need greater attribution then you’re probably going to skew towards companies that can provide you more visibility into what you’re buying versus less. So, again, that doesn’t mean we’re going to crush, it doesn’t mean we’re going to do really well. All I’m saying is that, I think, companies are going to not pull out completely, but pullback. And so the question is, if you’re going to pull back, where do you pull back. Because now we are -- we have to -- these deals have to make sense. Number one. Number two, we know the RSN market. We have Nesson, Madison Square Garden Network, Marque. And so I think the YouTube Play actually helped us, because given what they’ve just bought, they’re going to be very focused on that asset. Because they have to be around someone is in trouble. And on our side, it’s more differentiation then sports. It’s tonnage. But I think that. Look, people watch baseball. And as I said, the TAM for local -- like the way I look at regional sports is, when you look at ratings, you’ll see Nielsen ratings on a national basis. I look at ratings on a market-by-market basis and if you take ESPN’s national ratings and you look at them on a market-by-market basis yeah. Like if you just apply the DMA size to the national rating and just line them up. You’ll see that the RSNs actually, I would say, more than 50% of the time outperform ESPN. Yeah. So, again, I don’t know if we’re going be ready to package all. I don’t know if this is the year to package all this inventory. But I like it because sports CPMs are going to be higher. I like it because it allows us to continue to differentiate our brand and our product. And I think over time, I’m hoping with Diamond Sports taking over, they’re going to want to engage customers more… …and I think we’ve proven over and over that were first to market with a lot of capabilities and features. And my hope is to demonstrate that let us work on the tech side and help you figure out what are the things that will drive more engagement for baseball for basketball. That’s more of a long-term. The short-term is differentiated product, lowest cost service with regional sports contract. …who has a question before we go to Ryan Reynolds. Anybody. Okay. Let’s do Ryan Reynolds. So I don’t get it. To me this is just another use of money in other tributary that has nothing to do with anything actually. So tell me about why Ryan Reynolds? … is gold. That’s all I can say. And so we’ve been talking about this for over a year. I think he’s probably him, Kevin, Hart and the Rock, probably three of the biggest stars… … hundreds of millions of followers, when he says watch this people do, buy this people do and so having him part of our group, I think, is important. It’s a FAST Channel. So it’s ad supported. It’s relevant. I think this is actually the biggest disruptions since having the Oprah Winfrey channel on cable, because this is a major star that has creative control with Fubo veto power. But again, the guy knows what he is doing. We’re not going to tell them how to create when he has great movies and… What I will say is that, Ryan pays for Ryan nonsense, if that’s what you’re calling it. I don’t think Ryan is nonsense. I think he is genius. What I mean by that is that, hopefully, there’ll be some news coming out in the next, call it, 30 days to 60 days. But the goal is, because he is everywhere and every CMO wants to work with them that every time we produce the show, it will be immediately underwritten by an advertiser. So if you think and I hope you don’t think is that, especially in this environment, hey, Ryan, here is the $15 million, go produce a show for FAST Channel. That’s not the case. That’s not even how he think. I actually thought they had like a six fixture exclusive deal with Netflix. I didn’t know he was out of that contract he can do… We have a very interesting deal. We have first look for non-scripted and Paramount has first look at scripted and we are 50% co-owners of all the IP… … which is important. And I think part of our FAST strategy is to own something that might also over time give us some leverage. Okay. It says, if I give you charter or any of the others, they all have News 12 or New York 1 news or… So it sounds we got wrong in all this -- all the streaming stuff as you have to have Roku good there too. You have to have exclusive programming, they go down… There has to be one asset in that whole sort of ecosystem that has value. I will give you one reason. I met a… No. I met a guy, a waiter, who weights in the summer time, lives in South America, collects U.S. dollars, puts it under his pillow. And I realize that is not fair. He should not be diluted because we build a bridge or we decide to cancel all student loans or we decide to do send rocket somewhere. That is not everybody’s problem. That is the U.S. problems, the U.S. taxpayer problem. If I’m a foreigner and I don’t know what to do and I don’t want to be hold into a euro, a dollar or Yuan.
EarningCall_1505
Hello and welcome to today’s Silvergate Capital Corporation Fourth Quarter 2022 Earnings Conference Call. My name is Bailey and I will be the operator for today’s call. [Operator Instructions] Thank you, operator, and good morning, everyone. We appreciate your participation in the Silvergate Capital Corporation fourth quarter 2022 earnings call. With me here today are Alan Lane, our Chief Executive Officer; Tony Martino, our Chief Financial Officer; and Ben Reynolds, our President. As a reminder, a telephonic replay of this call will be available through 11:59 p.m. Eastern Time on January31, 2023. Access to the replay is also available on the Investor Relations section of our website. Additionally, a slide deck to complement today’s discussion is available on the IR section of our website. Before we begin, let me remind everyone that this call may contain certain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These include remarks about management’s future expectations, beliefs, estimates, plans and prospects. Such statements are subject to a variety of risks, uncertainties and other factors, including the COVID-19 pandemic that could cause actual results to differ materially from those indicated or implied by such statements. Such risks and other factors are set forth in our periodic and current reports filed with the Securities and Exchange Commission. We do not undertake any duty to update such forward-looking statements. Thank you, Hunter, and good morning, everyone. As many of you know, we provided select preliminary and unaudited fourth quarter financial metrics on January 5th. Before I dive into our [Technical Difficulty] I want to provide a recap of what happened in the digital asset industry in recent months and its impact on Silvergate. Significant over leverage in the industry has led to several high-profile bankruptcies and sparked a crisis of confidence and lack of trust across the entire digital asset ecosystem. As a result, many industry participants have shifted to a “risk off” position across digital asset trading platforms. To that end, we saw a modest decline in Silvergate’s digital asset customers in the fourth quarter, a trend that we expect to continue in 2023 as the digital asset industry undergoes further transformation. In turn, total deposits from digital asset customers declined to $3.8 billion at December 31, 2022, compared to $11.9 billion at September 30, 2022. Average deposits were $7.3 billion with a high of $11.9 billion and a low of [Technical Difficulty] billion during the fourth quarter. As of December 31, 2022, approximately $150 million of Silvergate deposits were from customers that had filed for bankruptcy. In order to satisfy these deposit outflows, we took commensurate steps to ensure that we were maintaining cash liquidity in excess of digital asset related deposits. We initially utilized wholesale funding to satisfy outflows, and subsequently, we sold debt securities to accommodate sustained lower deposit levels and maintain our highly liquid balance sheet. Importantly, we currently maintain a cash [ph] position in excess of our digital asset related deposits, and customers know they can access 100% of their deposits. Tony will provide more color on the security sales and balance sheet management strategy in a few minutes. Turning to our core offerings, the Silvergate Exchange Network, or SEN, despite the significant decline in deposits, transfer volume on the SEN was $117 billion, an increase of 4% on a sequential basis, demonstrating that our platform continues to serve as critical market infrastructure for the digital asset industry. The SEN has operated uninterrupted 24 hours a day, seven days a week. Turning to SEN Leverage. Total approved commitments declined 23% to $1.1 billion compared to $1.5 billion at the end of the third quarter. In addition, we experienced a range of outstanding SEN Leverage balances during the quarter between $282 million and $377 million with an average outstanding balance of $328 million. All of our SEN Leverage loans continued to perform as expected with no losses or forced liquidations. Looking ahead, we expect to maintain existing utilization for SEN Leverage in 2023 and expect commitments to shrink to approximately $400 million by the end of the second quarter of 2023. As we discussed on our Business Update Call, we are taking several decisive actions to ensure our business remains resilient during a sustained period of lower deposit levels. To that end, we are in the process of evaluating our product portfolio and customer relationships with a focus on profitability. As it relates to our customer base, after a thorough analysis, we have made the difficult but deliberate decision to offboard certain non-core customers in the coming weeks. Importantly, we are prioritizing and remain committed to our core customers who routinely transact on the SEN. While our valuation is still being conducted, we believe the impact of these customer exits will not exceed 10% of our digital asset related deposits. We will also be eliminating certain products that have become too costly or complex. We have concluded that product such as digital asset custody and certain cash management services, which are used by a minority of our customers and require significant resources to operate, can no longer be offered profitably. While we remain focused on providing innovative solutions, reducing our product portfolio will allow us to better serve our core institutional digital asset customers. Moving forward, our product offering [ph] consists of our most value-added solutions and reflect what we do best, with solutions like the SEN, wires via our proprietary API and deposit accounts. In addition, we made the difficult decision to reduce our workforce by approximately 200 people or 40%. We estimate aggregate costs associated with the reduction in force of approximately $8 million, primarily consisting of severance payments, employee benefits, and related costs. We expect to incur the majority of these charges in the first quarter of 2023. Taken together, we believe that focusing on providing a streamlined offering to our core customers and managing expenses will help Silvergate return to profitability in the second half of 2023. While we are narrowing our focus, I want to emphasize that Silvergate's mission has not changed. I recognize that we've made some difficult decisions recently, but we are confident that these changes will enable us to serve our core customers in a responsible and profitable manner. We are committed to maintaining a highly liquid balance sheet with minimal credit exposure and a strong capital position, ensuring maximum flexibility for our customers. We continue to believe in the digital asset industry and stand ready to support our customers. I'll now turn the call over to Tony to review our financial results in more detail before we take your questions. Tony? Starting on slide 3 with our key financial results. Silvergate reported a net loss attributable to common shareholders of $1 billion or loss of $33.16 per common share. Excluding [Technical Difficulty] and derivatives, impairment charges and restructuring charges, adjusted net income available to common shareholders was $15.1 million or $0.48 per adjusted diluted share. Tier 1 leverage ratio was 5.36%, based on average assets of approximately $15 billion and continues to exceed the well capitalized standards as defined by federal banking regulations. We expect our Tier 1 leverage ratio to improve over time as we reduce wholesale funding and the resultant size of our balance sheet. In addition, book value per common share was $12.93. Moving on to slide 5. As we disclosed earlier this month, total deposits from digital asset customers declined to $3.8 billion during the quarter, compared to $11.9 billion in the third quarter and $14.1 billion in the fourth quarter of 2021. Average digital asset customer deposits were $7.3 billion in the quarter, down 40% compared to last quarter. As a result of the crisis of confidence the industry experienced, we saw higher volatility in our deposit base as the range of deposits during the quarter widened within a high of $11.9 billion to a low of $3.5 billion. Our weighted average cost of deposits for the quarter increased to 77 basis points compared to 16 basis points during the third quarter. As Alan mentioned, we initially utilized wholesale funding to satisfy outflows. The annualized cost of digital asset deposits remained at zero, reflecting our low cost digital asset deposit strategy. As we have said before, deposits with Silvergate have been and continue to be safely held. At the end of the fourth quarter, we held total cash and cash equivalents of $4.6 billion, which is in excess of deposits from digital asset customers. Our business is designed to accommodate deposit inflows and outflows under a range of market conditions. Turning to slide 6, net interest income was $53.7 million in the fourth quarter, a decrease of $27.2 million compared to the third quarter, and an increase of $15.5 million compared to the fourth quarter of 2021. Net interest margin was 1.54% for the fourth quarter compared to 2.21% in the third quarter and 1.11% in the fourth quarter of last year. As we outlined in our business update earlier this month, we sold debt securities for cash proceeds in order to accommodate sustained lower deposit levels and maintain our highly liquid balance sheet. We sold $5.2 billion of debt securities during the quarter, resulting in a loss on the sale of securities of $751.4 million. This sale included available for sale securities as well as certain securities that were previously identified as held to maturity. Our securities portfolio had an average outstanding balance of $9.8 billion with a corresponding yield of 2.61% for the fourth quarter down from an average balance of $11.8 billion at the end of the third quarter with its corresponding yield of 2.09%. As of quarter end, our securities portfolio had a balance of $5.7 billion. As part of our risk management strategy, we hedged approximately 35% of our interest earning assets to protect against downside interest rate risk. Looking ahead, we expect to sell a portion of these securities estimated to be $1.7 billion in early 2023 to reduce wholesale borrowings, which resulted in the recognition of impairment charge of $134.5 million in the fourth quarter related to the unrealized loss on those securities expected to be sold. Subsequent to the end of the year, we sold approximately $1.5 billion of securities, and as always, we will continue to evaluate our balance sheet and liquidity management needs, which will depend on deposit flows and customer behavior. Turning to slide 7, non-interest loss for the fourth quarter of 2022 was $887.3 million compared to non-interest income of $8.5 million in the prior quarter and $11.1 million in the fourth quarter of 2021. Losses on securities were $885.8 million and losses on derivative were $8.7 million, resulting from the sale of debt securities and related derivatives and impairment charge during the quarter. Excluding these losses on securities derivatives, adjusted non-interest income for the quarter was $7.2 million. As a result of the strategic actions Alan outlined earlier, we expect quarterly net interest income and fee income in 2023 to trend lower than adjusted fourth quarter 2022 levels. Slide 8 shows non-interest expense for the quarter of $238.5 million compared to $33.2 million in the prior quarter, and $25.7 million in the same quarter of last year. The increase sequentially and year-over-year primarily resulted from $196.2 million impairment charge on developed technology assets we acquired earlier in the year, as well as increases in salaries and employee benefits attributable to a $3.7 million restructuring charge related to exiting the mortgage lending product during the fourth quarter of 2022. Excluding the impairment on intangible assets and restructuring charges, adjusted non-interest expense for the quarter was $38.6 million. As Alan discussed, earlier this month, we announced the reduction in force of approximately 200 employees or 40% in order to account for the economic realities facing the business and industry today. We estimate the aggregate cost associated with the reduction in force of approximately $8.1 million, primarily consisting of severance payments, employee benefits and related costs, and expect to incur the majority of these charges in the first quarter. Cost savings associated with the reduction in force are expected to be $7 million to $8 million per quarter. Our expense base in the first half of the year will continue to be assessed as we evaluate individual vendor contracts and other costs as a result of the strategic actions that Alan mentioned. We expect expenses in the second half of the year to be lower compared to the first half of the year. We recognized the tax benefit of $24.3 million for the fourth quarter of 2022, reflecting an effective tax recovery rate of 2.3% compared to an expense of $13.5 million for the third quarter of 2022 with a corresponding effective tax rate of 23.7%. The income tax benefit recorded in the fourth quarter of 2022 was driven by the loss recognized during the quarter and the resulting reversal of prior period income tax expense incurred during the first three quarters of the year, partially offset by a charge from the transition to a 100% valuation allowance on deferred tax assets. As a result of losses incurred during the quarter, we've established a deferred tax asset balance of $342 million and applied a 100% valuation allowance against this asset. The deferred tax asset balance associated with net operating losses will carry forward indefinitely and can be utilized against 80% of future taxable income. While this was a tough quarter in light of significant challenges in the broader digital asset industry and difficult decisions we had to make as a company, we remain committed to serving our core customers. We look forward to providing further updates on our business throughout 2023. I have a few things I want to get to, but I'll let some of my colleagues ask on the others. The one I want to start on was kind of your comment about deposit flows in customer behavior driving decisions around selling securities. And I'm just -- I guess I'm curious, what the recent update is on both. I mean, it seems like you sold some but not all of the securities that you earmarked for sale when you pre-released earlier this month. And I'm just curious if there's any update to deposit flows and customer behavior that you're willing to provide at this point? Yes. I'll touch on the deposit question and turn it over to Tony for the securities question. So, on the deposit question, Mike, we are not -- we're going to stick with our standard approach here, which is to not provide any guidance whatsoever. As I think, abundantly clear in the fourth quarter, any guidance in this initiative is speculation. And in similar fashion reporting on deposit movement in a two-week period is not indicative of what we might expect for the entire quarter. And so, we don't want to provide any update at this point that would cause people to think that deposits are going to be surging higher or that they're going to be lower. The SEN continues to [Technical Difficulty] 24/7. We continue to maintain cash on balance sheet in excess of all of our deposits in this initiative. So, our customers know that they can access their deposits 24 hours a day, seven days a week. If they bring additional deposits on as some customers have, we're going to continue to hold those in cash on our balance sheet. And if customers choose to withdraw, as some have, they know that they can have 24/7 -- well, they can have access to move those 24/7 over the SEN or they can withdraw them via wire transfer during normal banking hours, and we stand ready, willing and able to assist our customers with their liquidity needs, which is the primary function that Silvergate has provided to this ecosystem since we got into this business nine years ago. Yes, sure. Thanks, Alan. So, Mike, as we disclosed, we anticipated selling approximately $1.7 billion of securities and had recorded an impairment charge for that sale, which is part of the loss. And as Alan said, we're only two weeks into the year, but we did execute on that plan. We've sold $1.5 billion of the billion $1.7 billion that we have earmarked. And so, that's transpired in the first two weeks of the year. And beyond that, as Alan said, it's early -- it's too early in the quarter to guide further. But, as we said, we have earmarked those securities for sale. The purpose was primarily to reduce borrowings. And that's what we've done as of point in time. Thanks. Got it. Helpful. And then just for my second question. I appreciate all the commentary, Alan, around how you're kind of refocusing the business and trying to right size the OpEx side for the new kind of lower deposit level. I'm just curious though, the kind of focusing and removing some functionality that's more expensive and non-core is element. But then the other element, right, is making sure you're getting paid for what you're providing appropriately. And I'm just curious, when you think about the SEN, when you think about SEN Leverage, when you think about everything that you still are conducting, how are you thinking about the ROI on those products? As I think, maybe some of the risk factors around just taking deposits seem a little bit more amplified in this business than a typical commercial deposit. Just curious what your updated thought processes are there. Yes. So, as Alan mentioned in his prepared comments, some of the products that we offer today have just become too costly or complex to continue offering. So, as with any [Technical Difficulty] business, you make assumptions about customer adoption of new products and when they don't scale the way that you anticipated, sometimes it's -- you need to make course corrections. So, digital asset custody is an example of that for us. It's a very competitive space and difficult to differentiate yourself. Kind of switching gears to the cash management solutions that we mentioned. We don't want to provide more details at this time related to that because we want to make sure that we notify some of our strategic partners and customers first. But, what I can tell you is fee income's going to be lower in 2023. But, when you peel back the onion, you'd note that the margins on some of the products that we’re not -- that we would need to continue to invest in, we just won't continue to do that. And so, we do expect a boost of profitability by discontinuing those products despite an overall decline in fee income next several quarters. The other thing, Mike, that's worth mentioning on this topic is that as we do offer the SEN and wires and other products that are critical to our core customer base, we do expect those products to generate significant fee income. But that is difficult to predict as, it's often dependent on market conditions. So, sort of everything's on the table in terms of how to monetize the platform. But I'd say more work is probably needed in order to say exactly how we're going to do that beyond the way we do today, which is through deposits. Thanks for the question. Thank you. The next question today comes from the line of Joseph Vafi from Canaccord. Please go ahead. Your line is now open. Hey guys. Good morning. Thanks for the extra color here in your report. I just wanted to circle back maybe, Alan, to some of your comments you made a couple of weeks ago on the pre-release. And I know you're not providing guidance, but kind of a broad rule of thumb is to continue. A couple weeks ago you said to look at where Silvergate’s deposit base was, perhaps six or eight quarters ago and kind of extrapolate out interest income today based on that same level of deposits. Then just wanted to make sure you think that that kind of rule of thumb still makes sense and then I have a follow-up. Yes. Joe, I really appreciate you asking for that clarity because I don't -- that's not what I meant when I was referring back to, as you said, six or eight quarters ago. I wasn't at all focused on like the interest income, the net interest income side of things. It was more reflective of -- my comments a couple weeks ago in this regard were more reflective of the fact that it was only a little over two years ago that we were essentially this size in terms of deposits, and therefore, we have a pretty good idea as to what staffing level will be required in order to support this adjusted size. And also kind of embedded in that observation and tying this back to some of the comments that Ben was just making, also reflective of the fact that we expect to have fewer customers and also a streamlined product set, which are all very similar to kind of where we were a couple of years ago. And so, my comments of a couple weeks ago were really meant to just share with you all that we've been here before in terms of running a profitable company in -- that it has fewer customers and lower deposits, but that still serves this ecosystem with the critical infrastructure that we provide. As to the interest rate environment, we're in a very different interest rate environment today versus where we were back then. You may recall that interest rates essentially went to zero shortly after that, like kind of eight quarters ago, when the pandemic hit. And during most of our growth throughout 2020 and 2021, we were in a zero interest rate environment with the three-month treasury yielding less than 10 basis points. And so, today, we're in a much different interest rate environment. And so, we're not at this -- we never try to predict interest rates. We just try to understand how different interest rate environments might impact our business. And we're certainly going through that same analysis today with a lower balance sheet, but a higher interest rate environment. Sure. Thanks for that color, Alan. Then maybe a follow-up, I mean, obviously you're maintaining a super liquid balance sheet right now with cash in excess of deposits, which is not something historically that you've done. Is there -- can you provide maybe some guideposts for us on to when you know that -- the balance sheet kind of may normalize over time here relative to maybe shrinking down that overly liquid balance sheet and cash in excessive of deposits? Thanks. Yes. It's a fair question and I'll just go ahead and take this one too and just say that I'll mention the same thing I always mention, which is, we don't provide guidance and it's really difficult to predict. But, let's just focus on kind of why are we doing this right now? And it really goes back to the thing that we've been saying for the last couple of weeks, which is this industry has experienced a significant crisis of confidence across the ecosystem because of all of the over-leverage in the system and some of the bad actors and the bankruptcies et cetera. And so, when market participants are looking in this ecosystem and they're trying to determine who can we trust, we want to make sure that our customers know that we are holding 100% of their deposits in cash on our balance sheet so that they can access that cash up to a 100% of their deposit. And so, it really is meant to instill confidence. We also -- the other part of that confidence is to communicate to our customers that we are still committed to this ecosystem. Many of the customers that we service today are customers that we onboarded in 2014 and 2015 and 2016. Many other banks have come into the space during our nine-year tenure. Some have left, some have expanded their operations, and then contracted. What we are trying to communicate is that we are here. We are here for the long haul. We are here to serve our core customers with the core products that they utilize every day, and they can have confidence that we have 100% cash on balance sheet. And so, when will that change, not for the foreseeable future. I don't know if that's one quarter, two quarter, all year long. We want to instill confidence in the ecosystem and especially with our customers. And so, I really appreciate you asking the question, so we could drill down on that a little bit more. Thank you. The next question today comes from the line of Steven Alexopoulos from JP Morgan. Please go ahead. Your line is now open. I want to start on tangible book value, which was $12.93 in the quarter. In terms of a new baseline, I just wanted to confirm that we shouldn't expect any additional charges or impairments in the first quarter beyond the $8 million restructuring charge you called out, which could further reduce tangible book value? Yes. Hey, Steve. Thanks for the question. With respect to this tangible book value per share, as I indicated previously, we recorded an impairment for $1.7 billion in security sales. And that's already embedded in there. There's puts and takes as always with tangible book value. As Alan's indicated a couple times, we don't provide forward guidance. And it's early, really early in the quarter to try to give a guide path there. But there are puts and takes, and another example is the deferred tax carry forward of $342 million that we disclosed. That's not built into the tangible book value because we've taken valuation allowance for it, but it's certainly there in terms of tax losses that are available to offset future income. So, again, it's early. We don't provide guidance, but appreciate the question. Okay. Thanks, Tony. And then for my follow-up, I don't know if you guys heard the Signature call this morning, but in the Q&A session, they had a question on AML/BSA. And they indicated that for FTX it was more of a made off situation. They specifically said not an AML/BSA issue. Do you guys see this the same way as it relates to Silvergate, not an AML/BSA concern? Yes. Steve, unfortunately, I did not get a chance to listen to the Signature call, so I don't have the context for how they referenced it. But, we're just not going to comment at all on any kind of FTX related matters. And so, from my perspective, we should just focus on our core business and all of the things that we're doing to help this ecosystem, and let all that other stuff kind of work its way out. Thank you. The next question today comes from the line of David Rochester from Compass Point. Please go ahead. Your line is now open. Hey. Good morning, guys. You guys had a lot of moving parts on the balance sheet in the fourth quarter that would impact the margin moving forward. And I know you don't want to give any guidance on the NIM. But, can you just give some of the spot yields and costs at the end of 4Q for the major average balance sheet lines? I think that would be helpful. And if you happen to have the yield on the securities that you're selling in the first quarter that you've already sold, that would be great as well. Yes. Thanks for the question, Dave. So again, I think, with -- if you look at the balance sheet, broadly speaking, given the disclosures that that we made, the cash and securities are the overwhelmingly large components of the balance sheet and the securities -- the cash yields are in line with federal funds rate. With the securities, what I'll say is, as of yearend, we were close to about 80% of the securities portfolio, being floating rate -- floating rate securities. And in the first two weeks, as I indicated, we sold about $1.5 billion of what was left in the book. And I think the 80%, I mean, will trend a little bit higher. But -- and so for a portfolio that's government issued or all agency backed and primarily mortgage backed -- mortgage backed and other types of securities, you probably could figure out what the yield is there in relation to the federal fund's rate. But, as we said, the bulk of our asset -- earning assets are adjustable rate. But as we've also said, the makeup of the balance sheet going forward, subject to change as the year evolves. So, sorry, can't be a little bit more clear, but, that's about as much as we could provide at this point in time, early in the quarter. Okay. I appreciate that. And then just one follow-up. Can you just talk about bigger picture, the implications of this 100% valuation allowance on the DTA? Are you guys basically saying that the outlook at least near term for profitability is more negligible or maybe you're predicting a loss? And then, how far out does that analysis go? How far out do you guys need to look on that valuation test? Thanks. Yes. Thanks Alan. Yes. So Dave, as far as that valuation allowance goes, so in the near-term, I mean it's -- as I said earlier, we've got a deferred tax allowance or deferred tax asset balance of $342 million driven by both, the losses that we've incurred in the fourth quarter and some of the accrued losses that we anticipate in 2023. So, from a tax perspective, with some of those accrued losses that will be realized in ‘23, the allowance is one of those things that's done on a year by year basis. So, at this point in time, we've assessed a 100% allowance, implying that there's probably not taxable income in 2023. But beyond that, you shouldn't read too much into it because it's an allowance that could be reevaluated every year end. And that valuation allowance could change every year end. So, it's not set in stone at a 100% going forward. And from a tax perspective, as we've disclosed those losses are -- have indefinite carry forward for federal tax purposes. And so, there's future value there to the extent that there's future taxable income. I appreciate all the incremental color this morning. And I know you also mentioned in the slide deck that the headcount reduction will drive a $7 million to $8 million reduction in comp. I guess, as we think about the core expense number going into the back half of the year, given that you also mentioned you're exiting from the custody and cash management businesses, what should we -- how should we think about the core expense number as we exit the one-time expenses that you're making over the next couple of quarters? I'm going to turn it over to Tony in just a second, but I want to clarify one thing. We are not exiting all of the cash management services, but just certain cash management services, and we have not yet disclosed which services those are. But, you could go back and contemplate Ben's comments around some of the products that when you launch certain products, you make some assumption as to the customer adoption of those products, et cetera, and then as you move through time you have to reassess those. And so, -- but I wouldn't want anybody to think that we're no longer going to provide cash management services. That is core to what we do. And the SEN, the 24/7 API enabled SEN that our customers have come to rely on will still be operational with API wires, et cetera. And we'll be able to provide more color as Ben mentioned, once we notify some of our key partners and our customers. We don't want to get ahead of being able to have individual conversations with all the appropriate folks. But back to the expense question, Tony, you want to take that? So, yes, as you indicated, the guidance that we provided was a $7 million to $8 million per quarter save related to the headcount reduction. As it relates to other core expenses, as we indicated in our prepared remarks. I mean, we were intentional about saying the second half of the year because, as you can appreciate, there are a lot of embedded costs and overhang coming into the new year, a lot of the challenges in ecosystem were towards the back end of the quarter. So, as Alan had said, we're evaluating different products and services, we're evaluating vendor contracts, we’re evaluating all of those items that would drive core expenses. And so, at this point in time we're not in a position yet to give further guidance. But, as you indicated we do intend to evaluate all categories and look to get to a good core expense base for the second half of the year. Thanks. But, is it fair to take the $33 million expense base from 3Q, remove the $7 million to $8 million, and then assume that you would move lower from there? Is that fair? It's not so straightforward because as you may or may not know, I mean, we were increasing headcount throughout the year. And so, some of those headcount increases were in flight at the beginning of the quarter -- at the beginning of the fourth quarter. So, it's like most things, it's not that straightforward. And there's -- there are many moving parts and there are a lot of puts and takes, as always. So, appreciate the question, but at this time, that's about all the guidance we can give. Got it. And then, just a quick question on the deposit side. In the past you've mentioned that about 45% of your deposits come from the top 10 clients. I would assume that concentration number has gone down meaningfully. Would you have that number as of the end of the fourth quarter? Yes. Let me jump back in and kick this over to Ben. We'll certainly disclose more detail in our 10-K as we always do when it's filed. I'm not sure we're ready to disclose deposit concentrations today. But, Ben can probably provide a little bit of color on our customer base. So, Ben, do you have anything to add? Yes. That's right, Alan. So, I'm not sure if we're planning on disclosing that number going forward. But, when you do look at the table that shows the number of customers by category and the corresponding deposits, you can see that they've gone down in every category. And so, we're certainly mindful of concentrations, but what we've seen is really -- as we've said many times before, kind of a crisis of confidence and risk off across the entire industry. So, I think from that table, you can probably see that deposits across the board in every segment are down. So, not much more we can add beyond that at this point. So, I'm looking at the end of period balance sheet. And even if I take into account the security sales in the first quarter, it looks like you'll still have around $5.3 billion in wholesale funding or around 50% of the balance sheet. So, I know you don't want to provide guidance on deposit flows, but it seems from the outside looking in that either you're managing the balance sheet towards the sharp rebound and deposits in the near term, or you need to sell substantially more securities than you have done or earmarked so far in order to bring the funding profile back in line. So, assuming that 50% wholesale funding was higher than you or the regulators are comfortable with, and maybe you can correct me if I'm wrong there. Are there any guardrails that you could provide about how you plan to work that down and to what level? Yes. Well, it's a fair observation. And I think I've said, if I didn't say it on the -- in the Q&A session of the last call a couple weeks ago, I certainly addressed this question in follow-up calls, which is that your observation is correct when -- if you just zoom out -- and the way I frame it is, let's not make it specific to Silvergate, but let's just talk about the fact that in general banks like to have their core deposits in excess of their non-core funding, which is, you've alluded to, wholesale funding, whether that be short term borrowings or brokered CDs. And so, at this point, we're not providing any further guidance. And so, the comments that you made about how you might interpret us managing our balance sheet is an opinion that you're expressing, but it's not necessarily indicative of how we're thinking about it. I would just go back to everything I've said already, and I don't want to repeat it all for everybody, but we are managing the balance sheet to make sure that our customers know that they have access to a 100% of their deposits. And we're going to do that for the foreseeable future. And as Tony mentioned, our securities portfolio, what remains of our securities portfolio is overwhelmingly adjustable rate. And it is all government agency, either government issued or government agency sponsored investment security. So, we feel very good about our current balance sheet position. Got it. Appreciate that. And then maybe kind of dovetailing off of the last comment you made on the securities portfolio on the balance sheet. You guys have been profitable at this level of non-interest bearing deposits in the past. But I think one thing that's different now is you've sold a lot of the duration in the balance sheet and looking ahead, it seems like the strategy of maintaining a lot of digital currency deposits are all in cash, presents a lot of downside interest rate risk, if we see rates kind of normalized back to -- well, something approximating what, you know, what we see in the current forward curve today. So, how are you guys thinking about mitigating downside interest rate exposure with a significantly higher cash position, which, Tony, maybe you could talk about the -- your ability to hedge kind of like fed funds rate type cash. Yes. So, well, yes, no, that's an inappropriate observation. As -- first thing I'll say is yes, we do have, and we've disclosed that we've got derivatives in place to mitigate downward -- downward moves in interest rates. So, that's obviously part of it. So, that that becomes an important component of balance sheet management strategy as it relates to NIM going forward. But also, as Alan said, for the foreseeable future, we want to make sure that we've got cash in place for customers. But I kind of want to reinforce the point that with all of our securities being government issued or government agency backed, they also continue to be fully pledgeable for liquidity. And so, all those things that we've put in place that we've talked about for several years continue to be in place. Perhaps the proportions change, but we're mindful of managing interest rate risk. As Alan said, we don't predict rates, but we try to plan for all the outcomes and the size of the derivatives that we've got is part of that strategy. The next question today comes from the line of Jared Shaw from Wells Fargo. Please go ahead. Your line is now open. I guess looking at capital, especially Tier 1 leverage took obviously a big move down. You commented in the opening comments about rebuilding that organically. Is that organic growth rate going to be enough to satisfy your expectations or need for Tier 1 leverage in terms of trying to get closer to a double-digit Tier 1 leverage ratio, or should we think that there may have to be some additional capital raising or other alternatives looking at? Yes. Jared, I appreciate the question. I'm going to ask Tony to comment in just a minute. But the one thing that I would point out is -- and again, of course, we're not going to provide guidance on if and when we might quote unquote, raise capital. But, I think Tony will touch on this. It's important to recognize that, number one, our risk based capital ratios continue to be extremely robust, which is reflective of the very low credit risk on our balance sheet. But importantly that Tier 1 ratio is based on average asset. And so, it's really important to think about that as we move into the first quarter here. And without stealing anymore Tony's thunder. Tony, do you want to address that in a little bit more detail? Yes. Thanks, Alan. Thanks for the question, Jared. So, yes, as Alan mentioned, that -- the Tier 1 leverage ratio that we disclosed, 5.36, it's based on average assets approximately $15 billion, as I mentioned in my prepared remarks. But the balance sheet ended at $11.3 billion. So, on a pro forma basis with the Tier 1 capital that we had at year end, that would imply an entry point above 7%. And then, with the further guidance of -- or subsequent event disclosure that we've sold down $1.5 billion in securities to reduce wholesale funding, that implies a further reduction. So, that's kind of step one in terms of the organic path of rebuilding the Tier 1 leverage ratio. And then, my follow-up, I guess just on the securities portfolio, what is the -- after the sale, what's the expected cash flow quarterly from that and the remaining duration? Yes. So, I don't have the expected cash flow handy, in terms of expected duration, I mean, we were -- we had disclosed approximately four years as an expected duration in third quarter. That's substantially reduced. It's closer to 1 -- at present 1 to 1.5. And in reference to, again, what Alan was mentioning in terms of risk-based capital ratios, a significant amount of those securities are now at zero risk weight or 20% risk weight. So, significant change between the third and fourth quarter end. Thank you. Also on the call you did not hear from Signature, they suggested a bit of a de-emphasis of the digital landscape, and you are clearly trying to indicate a continued importance relative to how you are doing your business. I just wanted to think about that in the context of the offboarding of clients that you mentioned. Can you just give us a sense? I assume this is a relatively small number, and can you give us any sense of the additional scrutiny that's been taken to make this decision? Yes. George, I'm going to pass it over to Ben for that first part of your question. But as to additional scrutiny, let's just dispel that right now. And let's just frame it in the context of we've been doing this business with the full -- focused on regulation and risk management for nine years. We went into this business very intentionally in 2014. We engaged with our regulators that year to say this is -- and at the time, as I've said many times before, it was Bitcoin only. And we were essentially describing to our regulators at the time, this is what Bitcoin is. These are the types of institutional market participants that are coming into this space to invest in Bitcoin. Obviously, that has expanded now to other digital assets such as Ethereum, Stablecoins, et cetera. But for the entire tenure of this business, we have been operating with a fully regulated offering, and with the requisite regulatory scrutiny, if you will, in terms of looking at our program every single year. And so, any decisions that we're making to trim products and/or customers are really business decisions and not related to any specific scrutiny, as you said. But Ben, do you -- would you like to comment further? Yes. So, thanks for the question, George. It was a difficult decision to offboard some of our non-core customers. It was our choice though. And I think it's an example of our focus on operating a profitable business in 2023. As with any business, over time, you end up accumulating customer relationships that simply aren't profitable because even they end up being smaller than what they had originally expected, or they don't end up using your core products. Consistent with the comments Alan was just making, it probably isn't a surprise to anyone that there are significant compliance and operational costs associated with every customer that we serve. So now more than ever, we want to be deliberate in working with clients that are adding value to the platform. Maybe the last thing I'll say is that -- and I think it is important to highlight that while we expect to offboard some of our non-core customers, we do expect that if there's a negative impact to deposits fee income and send metrics, that it'll be less significant than you might expect because these are smaller relationships overall and tend not to use our core products. But thanks for the question. So, my follow-up is related to the broader market. Obviously, none of us are smart enough to know the future per se, but very quickly Bitcoin and the broader crypto markets have turned higher. I'm just curious if we could talk about your flexibility to grow again potentially aggressively, if that is the environment in front of us. Not saying that it is, just curious if you have the flexibility that you've had in the past to move forward. Yes. George, it's a fair question and I might tie the answer to one of the earlier questions that where one of your colleagues was commenting on the composition of our balance sheet at year-end. And clearly, as we work to reduce the wholesale funding, that by definition then makes room for deposits to grow. And again, I know you're not asking us to predict the future. I agree with your comments. It's impossible to predict. But, as Ben mentioned, we are focused on making sure that we are providing the critical services to our core customers and that we do in fact have room for them to grow their deposits when this turns around. And I do believe it's when, not if. But I'm also not predicting when that will happen. If past is prologue, this industry tends to go in four year cycles and 2023 might continue to be a kind of a sideways market for this overall ecosystem. But that will give us the time we need to retool the business, and we will be leaner and meaner and ready to go. Thank you. This concludes today's question-and-answer session, so I'd like to pass the call back over to Alan Lane for any closing remarks. Please go ahead. All right. Thank you very much, Bailey. Well, I just want to thank everybody for joining today and just want to again express our appreciation for all of the support that we get from our great customers. And we look forward to providing additional updates as we move through 2023. So, thank you, everybody. Have a great day.
EarningCall_1506
Thanks, everyone. We'll get started here. I'm Robbie Marcus, the medtech analyst at J.P. Morgan. I'm very happy to have Medtronic as our next company here. I'm going to call up Geoff Martha, Chairman and CEO, and then we'll do a little Q&A after. Geoff? All right. Thanks, Robbie. Okay. Thanks for the introduction, Robbie. And thanks to all of you for joining the Medtronic presentation this morning and what looks like to be a packed house. And despite the rain or at least the threat of rain, it wasn't nearly as bad as we were told. It's great to be back in-person here in San Francisco. And before I get started, I do want to remind you of some disclosures, including that I'll be making some forward-looking statements today that may -- and may reference some non-GAAP financial measures. And I encourage you to read these disclosures, which are also available on our Investor Relations website as part of this presentation. Okay. So let's get going here. So today I want to update you on the steps that we're taking to set up Medtronic for durable growth. While it hasn't yet translated into our financial results, we have an aggressive transformation underway in the company and I'll share with you today how the actions that we're taking get at the root causes of what's held Medtronic back. And cover some of the proof points that these changes are working. I'll talk about how we're improving our operations, supply chain and quality and working to make our scale and synergies across the company actually count. We're also implementing changes to how we allocate capital and how we think about the portfolio, including divesting non-core assets and all of this is geared toward getting to faster and more durable growth. And as we look at the portfolio, I'll share with you how we're thinking about our mix of businesses, how this leads to a mid-single digit organic revenue growth company and how we expect growth acceleration starting now in the back half of our fiscal year. And when I think about what has held Medtronic back over the years, I could sum it up in these areas. One, structuring and culture; two, market selection; and three, quality and operations. So starting with structure, we've taken decisive action as I've talked about to reduce the organizational complexity through our new operating model. We've eliminated group and region structures. We've empowered our businesses and more recently centralized our global operations. Regarding culture, we've brought in several new external leaders who bring much needed capabilities in certain areas, but also just as if not more importantly a fresh perspective. And we've put in place a much stronger performance based incentive program. When it comes to market selection, we've implemented changes to how we allocate capital to ensure we're prioritizing investments in high growth and high return areas. And we've also sharpened our focus on portfolio management, implementing rigorous processes that look at both additions and subtractions. And finally, with quality and operations, we've been urgently enhancing our capabilities, including bringing in new leadership and implementing new systems. And as these actions continue to take hold, I fully expect to see improved financial performance and improved shareholder value creation over time. Now in order to change the culture of a company, it has been very important to bring in fresh thinking. Fresh thinking from the outside, often from outside our industry. In operations and quality, I talked about how we hired Greg Smith over a year and a half ago to lead our global operations and supply chain. And Greg has brought in underneath him new leaders as we embark on centralizing this function to drive efficiencies, while at the same time improving our resiliency and our quality. And in certain of our businesses, we need better operators. And to do this, we did elevate some leaders within the company, but also brought in other leaders from outside the company. Finally, we're strengthening our functions, including strategy, digital innovation, IT and FP&A and by hiring strong external talent. These new leaders combined with our existing leadership team are driving the changes across the company. Another part of our transformation is turning our scale into an advantage. And we're focused on three specific areas: global ops and supply chain, leveraging technology, like batteries, robotics and catheter delivery systems across multiple of our businesses and sales, sales to larger healthcare systems which keep getting bigger where we are becoming a partner of choice through our contract and supply chain management as well as our data exchanges. Looking specifically at the progress we're making on global ops and supply chain, we centralized these functions to create efficiency and leverage our scale, moving from 13 supply chain and manufacturing organizations down to just two. We're modernizing our operations planning systems, including our [SIOP] (ph) capabilities to get ahead of supply chain risk. And we're focused on consolidating our vendors to drive efficiencies, while at the same time ensuring redundancy. And we believe that all of this will lead to a competitive advantage for Medtronic, one where our scale is leveraged and from which all of our businesses will benefit. Now another part of our transformation agenda is improving our capital allocation across the company. To disproportionately allocate capital, to high growth and high return opportunities, while ensuring that all of our businesses get the appropriate level of investment that they need to compete in their respective markets. We're doing this through increasing our level of R&D and we target R&D growth at or above revenue growth. And as you can see in this chart, we've grown R&D at 5% over the past five years, 5% a year, including a 10% step up in FY '22. And then we supplement our organic R&D with smart tuck-in acquisitions, as well as utilizing minority investments, strategic partnerships and even incubators. And when it comes to capital allocation, we're prioritizing returning capital to our shareholders. We target a minimum return of 50% of our free cash flow primarily through our dividend, which we've increased every year for 45 years. And we won't hoard cash on our balance sheet. So to the extent we can't find attractive tuck in M&A, we will look to return capital to our shareholders by repurchasing our shares. Now portfolio management is an important part of our transformation agenda and critical to achieving the durable growth I'm talking about. We've put in place a regular cadence of evaluating our portfolio and you've seen the results as we've announced both additions and subtractions. On the divestiture side, we've announced three businesses over the past eight months that we intend to divest that together account for 8% of our revenue. And on the tuck in acquisition side, we most recently closed the acquisitions of Intersect ENT, as well as Affera. Excited about both of these. And you can see how we are taking a very targeted approach on our tuck-ins. So one example is in our cardiac ablation solutions business, where we're using these acquisitions to create scale in this high growth market. And most recently, with the addition of Affera's -- with Affera and their mapping and navigation technology, and also Acutus's left heart access portfolio. So as we go forward, you can expect us to continue to make disciplined tuck-in acquisitions when it makes sense and also divest non-strategic assets. So we have an aggressive transformation agenda like I've spoken about from our work in reducing organizational complexity, to improving capital allocation and enhancing our capabilities. We're working to leverage our scale and implement new focused capital allocation and portfolio management processes. Now I realize that you're not seeing this come through in our overall financials yet. I get that. But we're seeing signs of progress in certain businesses. And let me talk you through a few proof points. You're seeing these green shoots in certain businesses, in particular, those that are in our neuroscience portfolio, because in these businesses we implemented changes earlier, prior to taking them to the entire company when I first became CEO. So let's talk about neurovascular. This business was really a beta for the operating model that we now have in place across the company. When neurovascular came in from Covidien, it was standalone. And we kept it that way. Allowing them to have the focus that they needed to compete and win in the marketplace. We also disproportionately funded their innovation due to the market opportunity, which is proven to be a wise decision as they've really pioneered the ischemic stroke market and remained a leader here. And this experience of a focused operating unit within Medtronic led us to what we did with our Cranial and Spinal technologies business. Here we combined our spine and neurosurgery businesses to make one entity, given that close linkages between these businesses and the new business model where we're using the enabling technology to pull through implants, we put these two businesses together and we brought in a new leader to run the business. We also added to the CST portfolio with strategic tuck-in acquisition, including Mazor Robotics, Titan Spine and most recently, Medicrea, which brought in an AI guided preoperative planning software as well as customized hardware. And it's this ecosystem of spine hardware and enabling technology, which we now call [ABLE] (ph) has allowed us to extend our lead in the spine marketplace. And it's a -- this is an example of how we intend this model to work. And as you can see in both of these examples, we're realizing the benefits of the changes that we have made and they're paying off in both -- in terms of revenue growth, as well as market share wins. Now I can tell you similar stories about several other businesses like ENT and others, but the important point to take away is that, over time we expect even more of our businesses to demonstrate the benefits of the transformation agenda, whether that's ensuring their current strong performance is durable, like our cardiac rhythm business or when we're talking about a turnaround like with diabetes. And you'll be able to track these very clearly as they accelerate our growth over time. These proof points are real and they're exciting, but we recognize as a whole we haven't been delivering the growth we should over the past few quarters as we've had a few headwinds that have held us back. The good news is that, we have line of sight to these headwinds resolving and some sooner than others, but we haven't line for all of them resolving. For example, ventilator sales, we've had a recent headwind impacting our first half growth by roughly 60 basis points given strong COVID related sales in the prior year. However, these difficult comparisons, they abate as we go through the back half of our fiscal year. Another that I'll call out is China VBP. We get a lot of questions on that. We've gone through VBP now in coronary stents and in our spine business and have a few other businesses that are now going through provincial tenders. However, we expect that as we exit this fiscal year, over half of our China revenue will have been through VBP and we expect to reach approximately 80% by the end of our FY ‘24, giving us a new albeit lower revenue base to grow from going forward. Overall, our guidance assumes our headwinds become less in the second half of our fiscal year, leading to accelerated revenue growth. And aiding this accelerated revenue profile are several key drivers that are expected to accelerate our growth over the next six quarters. This page with one exception are all drivers that are either here today or will have a meaningful impact on the second half of FY ‘23 and into our FY ‘24. The one thing that is a little further out is Ardian, but we are expecting regulatory and reimbursement catalyst over this time frame. And I'll point out the recent news that our pivotal data from the Pulsed AF trial studying our Pulse Select PFA catheter has been accepted as a late breaking clinical trial at ACC in March and we expect to be one of the first, if not the first PFA catheter in the U.S. market. You should take away that we have many drivers, as you can see on this page across all four segments and several of these pipeline catalysts, like I said earlier, are here now, right, already on the market. These growth drivers are real and exciting for our top line growth even into next fiscal year. And we -- but as we move down the P&L for FY ‘24, we do want to remind you and our investors of some of the things we talked about on our last earnings call. Macro factors combined with the imperative to ensure we invest for the long term will create significant EPS headwinds for our next year. Now we're working to partially mitigate these headwinds through significant expense reductions, but inflation, interest, FX, and the increased R&D investments that we want to make are reducing our earnings power in the near term. Now over the long term, our transformation agenda is setting us up for durable growth. So let me walk through how we think about our businesses and our overall growth formula going forward. On the bottom of the page, you have our durable growth businesses, which are established leaders in their markets and make up 50% of our revenue. These are big businesses with nice synergies that drive disproportionate amount of our profits and our cash flow. And we need to ensure that we continue to invest appropriately in each of these. And to get the company to the overall growth profile that we want, on top of this, we need to invest in our highest and largest growth opportunities and these are in secular growth markets. To do this, we use cash flow from the four businesses highlighted below to help fund these high growth opportunities because they require disproportionate amount of investment. And I'm going to talk through in more detail about both of these groups of businesses over the next couple of slides. So let's start with our highest growth areas. I'll start with Structural Heart. Here we have a strong position in the TAVR market where we just launched our latest generation TAVR valve, Evolut FX in the U. S. and we're investing in future growth drivers in the Mitral and Tricuspid spaces. We also have leadership position in neurovascular market that I talked about earlier where we continue to gain share in a double digit growth market. In diabetes, while we remain under a warning letter in the United States, we are driving consistent mid-teens growth in international markets and we recently completed 100% of our warning letter commitments and are prepared for FDA reinspection. And cardiac ablation solutions, I mentioned earlier this one as well, how we're assembling a full suite of products for this space, including bringing multiple pulsed field ablation catheter to the market. And in surgical robotics, we've made very meaningful progress over the past few quarters as we expand to new geographies and specialty indications. And just last month, we announced our first enrollment in our U.S. IDE trial and expect to be a strong player in this multibillion dollar market. At the same time, we have established leadership positions in our largest businesses that make up about half the company, as I said. So in Cardiac Rhythm Management, we continue to win share with our micro family of leadless pacemakers and we're gearing up for the CE Mark approval of our Aurora EV-ICD here in the second half of our fiscal year. In CST and our ENT business, I mentioned earlier the impact of our ABLE technology ecosystem is having in the spine market, but the ENT business also drafts off this enabling tech technology in areas like navigation and powered instruments to drive its market leadership. And in surgical innovations, we have resolved the acute supply chain challenges that have held this business back over the past three quarters and we expect to recapture share going forward. Now pulling this altogether, this slide shows you how we're thinking about the portfolio and how we can deliver mid-single digit revenue growth over the long term. Starting with our established market leading businesses, this makes up about half the company and we've been consistently growing 3% to 4% percent prior to the pandemic. And we expect them to grow at this rate going forward, given the durability of these businesses. And as I mentioned, these are big businesses and they drive a lot of the economics in both in terms of profits and cash flow to feed other investments. On the other hand, you have our highest growth businesses. Which are also our largest growth opportunities. These are growing collectively 10% plus pre COVID. And we expect them to grow in the high single digits, if not, higher going forward as we capitalize on each of these growth opportunities. We're well positioned in these markets, but they do require a lot of investment. And in the middle, you have what we're calling our synergistic businesses. They don't fit any one growth profile, nor do any one of these have the economic impact of our established market leading businesses. But collectively, they deliver mid-single digit growth and have strong ties to other businesses in the company. So for example, our Neuromodulation businesses. Here we leverage the strengths of our broad implantables franchise and we're building on our implantables base and investing to drive innovation in areas like closed-loop spinal cord stimulation and closed-loop DBS. Another example in cardiac diagnostics where we're evaluating opportunities to potentially expand this business, which leverages technologies from our CRM business and we're looking to expand it into new diagnostic areas. And you'll also notice the businesses that we've announced for divestiture, which make up 8% of the revenue and that rounds us out. So this is our portfolio today. We continue to evaluate it, but we like how this portfolio is shaping up. And this is what gives us the confidence in our ability to deliver durable growth over the long term. So to conclude, we are urgently forging a path towards durable growth. Our aggressive transformation agenda is getting at what has held us back at the heart of what's held us back. And we expect that this to result in the creation of a durable growth company. We expect our revenue growth to accelerate in the near term as we overcome headwinds and realize the impact of our growth drivers that are here today, on that page I showed you across all four segments. And we're also working to turn our scale into an advantage. And we expect all of this to drive improved execution, financial results and shareholder value over the long term as we deliver on our operating initiatives and our growth drivers. So with that, I'll have the several others on my management team join me on stage and Karen, Sean, Bob, Brett, Que, and I are happy to take your questions that I think will be moderated by Robbie. Great. So thanks everyone. Maybe we could start it off. I was thinking Medtronic is probably the largest medtech company around the world with the touches more on market. So I thought it'd be good and I realize you're intra quarter and you're clearly not preannouncing fiscal third quarter. But what's your latest sense of what trends are looking like around the world? China is a big one where there is a lot going on and just have you seen a return to normalization in most markets in medtech? Well, like we said in our last earnings call, most of the markets have returned. We called out a couple that hadn't. And we don't -- and since our earnings call today, we haven't seen a lot of change. So like with the ones that we called out that hadn't fully returned are TAVR, coronary PCI, SCS or SI, some certain procedures within our surgery business that are more elective and GI. And most of those are unchanged so far, except coronary has gotten slightly better in the last couple of weeks. Really, this is one that we're kind of scratching our head as to what happened, why it's slower, but it is coming back. And as you mentioned, the China dynamic with the COVID there is new since our call. I can tell you this, it's -- a couple of things. One, it's moving as you guys read the headlines like I do and it's moving fast. And I can tell you, talking to our leadership there, we have like 4,500 employees. I mean, it's ripped through our company quickly, like unbelievably quickly. But from a supplier side, they have a different approach. Our supply chain hasn't -- we haven't seen issues yet there. People are going to work with symptoms. So it's a whole different world. But it will impact cases, so -- on the end markets side and we're watching this closely as it evolves. But our hope is that, it's going to be short lived, but it's something that's evolving and we're kind of watching closely. No. You said well. I would -- the only thing that I would add is just on China, even though we're watching it closely, we're continuing to track within our expectations for the quarter. Great. Good add. As we look back over the past year, I think there were a couple product issues that we're all well versed in. As we look over the next 12 months, you had a slide up there with a lot. What's the new product launches that you're the most excited for? And I think what we all care about most is, what could be the most impactful for Medtronic? Well, I think in terms of impact, it's the totality of them. I mean, if you look across, there's a lot. And since I became CEO, these things were further out, and now with the exception of Ardian, we're not really counting on much in our FY ‘24 from Ardian. The others were all -- they're either on the market or close. And from a long term perspective, I'm excited about our diabetes products in the U.S. I'm seeing what we see in Europe and around the world, the patient clinical results as well as the patient experience. And we just see the market turning back to this AI automated and some delivery, whether it's a pump, a patch or a pen. And we have a very strong position there. So getting those products back in the market, obviously, you have to get through this FDA inspection. That's very exciting. Hugo is exciting too. I know there's a lot of skepticism out there, because it took us so long to get this product out there and other competitors have struggled to get competitive system out there against the -- against da Vinci, but we're getting really good feedback. And I think we have something to build from here. I’m to see that ramp. But the impact is going to come from the totality of everything, including some of the -- just the -- it's not one product like in our CST business or ENT business where they've got this ecosystem of technology that creates a moat around them, just seeing those business models really extend their lead versus their competition is something I'm excited about. Getting the diabetes warning letter lifted is absolutely very important factor for helping Medtronic growth going forward. You said in the slides that you've completed everything and you've invited the FDA to come inspect. Is there any way to think about how long it may take or from now to approval? What's a good benchmark maybe for the industry? I realize it's impossible for you to say exactly. Maybe I'll introduce Que. This is her first JP Morgan. She's really excited to meet you in person, Rob. So I'll introduce Que and maybe have here answer that one? Robbie, thanks for the question. I mean, look, we don't have a crystal ball. I think we feel very confident about being ready for the FDA. And it's really in the hands of the agency on their resource levels. COVID is also an impact in the wintertime. And so it's really a resourcing. They've indicated to us that this is a priority for them. And so, our anticipation is that, it will be I think what Geoff has said previously is, it's months, not quarters. So we're waiting when they can come back in. Okay. Maybe I'll touch on fiscal ‘24. You had a slide up there and whether Geoff or Karen. First question is, do you think Medtronic can return to 5% plus organic sales growth next year? You had a long list of headwinds to consider down the P&L. Do you think Medtronic can grow on the bottom line next year? Let me take the beginning, I’ll let Karen answer. I mean, look, I think what I'm excited about right now as we sit here today is, the improvements that we've made in our supply chain issues and quality issues, the product launches and the revenue acceleration that we're seeing. I wish it were faster, but each quarter it’s getting higher and we're excited about the back half of the year and exiting the year in that mid-single digit range. So we're not -- it’s too early to provide guidance for next year, I don’t want to get into that right now. But on the top line, just excited about removing some of the headwinds, fixing some of our kind of execution issues on the operations side, at the same time these products are hitting exiting the year mid-single digit and we will not hit the guidance for next year. But it will be a tougher year from an EPS perspective and I'll let Karen maybe tackle that one. Yes, absolutely. And again, I'll reiterate, it's too early to give guidance for next fiscal year. We're still in our planning cycle. We still have two quarters to go this fiscal year. But as we look ahead, it does start with the top line as Geoff mentioned and we should exit the year as we expected, in mid-single digit territory, which helps, because the earnings power starts with the top line and helps with the top line. That said, we are facing continuing headwinds into next year, including inflation, currency, interest, taxes, and all of those headwinds will play a role. We are focused on driving significant expense reduction next year and we're working on those plans right now to take both fixed cost and variable cost out of our base. Our new operating structure, I think helps us get at those costs a little bit better. Where it shakes out, too early to give you specifics at this stage, but we'll keep you posted as we move through the rest of this fiscal year. And as Geoff said, next year will be a tougher earnings year, just given all of those headwinds. Geoff, you guys have been fairly active in smaller sized M&A and you recently announced a divestiture -- spin of the patient monitoring business. How far along are you in your portfolio review? Should we expect potentially more actions from Medtronic, both -- either additions or subtractions in calendar 2023? Well, I think in the near term, I mean, look, first of all, divestitures take a lot of -- a lot more work to execute not the analysis, but the execution. And so, I think given we've got three, our dialysis business, our patient monitoring business and our respiratory interventions business, which has our ventilators among other products, that's a lot. That totals 8% of our revenue and there's some operational entanglements we've got to undo. So I think over the near term from a divestiture standpoint, I wouldn't count on others. However, that being said, the portfolio review, as I mentioned in my commentary, it's ongoing. It's not like a date that says, okay, as of the state we're done. It's part of our ongoing process here. On the tuck-in acquisition side, those are a little bit less in our control. And if there's certain things we've been tracking, we try to get ahead of processes and things like that. So you could see more on the tuck in M&A side. But on the divestiture side, I'm not saying no. But I think it's unlikely in that time frame. Okay. You do have a fairly robust balance sheet right now. So where does M&A relative to share repurchase investment or dividend fall? Yes, we are pleased with our strong balance sheet and financial strength. And our capital allocation priorities haven't changed for a very long time. We're going to focus on continuing to drive tuck-in acquisitions to help us grow our top line, make it more durable. We're also going to continue to balance returns to our shareholders. And you've seen us do that over the recent history. This past -- since FY '21, there was a slide that Geoff showed that show that we've spent $3.3 billion on tuck-in M&A and we've spent $3.7 billion on share repurchase all since FY '21. So it is very balanced and you can expect that to continue going forward. Great. Maybe I'll open it up if the audience has questions. Shy crowd today. Good. I'll keep going here. Renal denervation was a product you announced data for later last year. You know, this had been a product that went through several development cycles. It's filed, I believe, with the FDA or soon to be filed with the FDA. This is one where the trial results probably didn't end up as everyone expected, given you had lots of positive, positive, positive data and then maybe some conflicting evidence. Do you feel like this can still be a multi-billion dollar type of product and over what timeframe? Yes. I'm going to let Sean just give you the details here. I'd just say that we are bullish on this, and I'll let Sean explain why. We're -- I know there's skepticism out there, whether it be on FDA approval or less so on that, but more so on reimbursement. And I just don't think at this point we have so much to talk about in terms of the product approvals. I think we've chosen leadership team just to not engage on the debate and just prove -- and just make it happen. But I'll let Sean explain why we're bullish on this and why our customers are bullish on it? Yes, Robbie, I think that's the most encouraging thing what Geoff just said there. We still hear from customers, patients, especially that there's still an intact, very strong value proposition here. And I think what -- we ran into a pandemic. We had the ability to know that patients took more medications in the treatment on them, they weren't supposed to, but they did. And we have proof of that urine and blood samples that said that worked. And that's really the crux of the whole problem. You can get your blood pressure down if you take your medicines. All these medicines have been approved for years and years, they exist, yet patients aren't getting their blood pressure goal. And when you take your medicines, it's very hard to stay on them. I think of Ardian like, implanting a pill forever that you never have to remember to take that has zero side effects and as far as we know doesn't wear off. So we got six years of data showing that it's safe longitudinally, which is what payers care a lot about and that it remains efficacious longitudinally. So I think really the value proposition didn't change, the timing did. So will it take us longer to garner the kind of reimbursement or regulatory approvals that we're anticipating? It may. But I think with a billion plus people having hypertension, the opportunity is still very compelling. Can you hear me? I was thinking in terms of the actual growth, is it coming mainly from just the issues that you laid out in terms of your headwinds? Or are you assuming any changes in the underlying markets, maybe a stronger U.S. or China back stronger? Or is it purely an internal dynamic in terms of accelerating the growth? And then I'll ask my second question. In terms of margins, which you implied would be a tough year next year. Obviously, a lot of medical device companies have seen a hit to gross margins over the last couple of years. Do you expect to get back to the higher margin -- gross margin level over the next couple of years as some of these headwinds abate and perhaps are you getting better pricing because of some of the actions you've taken with the hospitals and so on? Thank you. I’ll start on the top line one and hand it off to Karen. I mean, we're not assuming any like big acceleration in markets, right, in the end markets. As a matter of fact, our last quarter guidance, we called out a few of the segments that we're in that hadn't come back all the way. We just said for the back half of our year, we're just assuming they stay where they are at 95% or whatever it is. So we're not assuming that any acceleration of markets, it's mainly just our two things. It's the combination because we have a ways to go that the gap is on our top line growth from where it should be is significant. And so part of it is these issues that we've had. Some more market like the supply chain issues, some of our own supply chain issues are quality issues, those going away. Products coming back on market that we're on hold for quality reasons or on our SI, our Surgical Innovations business coming back from very acute supply chain. So you have that headwind abating, which is meaningful. I mean, very meaningful. And on top of that, you have that one page that showed all those products approvals that have we been talking about for several quarters that are now here, with the exception of Ardian, everything on that page is either on the market or very close. So that's what's really driving the top line improvement. Headwind is going away and some of these tailwinds. None of them are -- we're not counting on one home run. This isn't a [indiscernible] moment for those baseball fans. There's a lot of singles -- at the Medtronic base of revenue those things are singles, doubles and there's quite a few of them. We don't need any one of them to hit. So that's really the top line. Again to you point -- guide other than through the back half of the year and we'll exit at mid-single digits. But on the bottom line, I don't know if you want to add on the top line too – I'll just talk about the margins because you answered the top line well, Geoff. On gross margin, yes, we have seen a decline in gross margin over the last few years like many companies. And it's driven in large part by the significant inflationary challenges and supply chain challenges that we have had. On top of that, we've had currency challenges too. When we look at gross margins going forward, we're not necessarily expecting to get all the way back to pre COVID levels anytime soon. We've got continued inflationary pressures next fiscal year, which will impact our gross margin. And yes, we have been focused on pricing offsets and we've been doing actually a very good job offsetting the typical pricing impact and challenges that we faced every year of our history. We've talked in history about pricing impacting us between 100 basis points and 200 basis points a year. And with the very significant and concerted pricing focus that we have this year, we're taking that to neutral, which is a pretty big change. That said, we continue to have the FX inflationary pressure that will hurt our gross margin. But as we think about top and bottom line growth going forward, driving the margin stability is the first support. And then slowly increasing it over time on the gross margin level is what we're going to be focused on. Yes. The question was, do we see us getting back to the higher margin levels in the next three to four years? Our margin pre all this happening was around 70% our gross margins. We're pretty far off that at this stage. And so do we see getting back there over the next three to four year? Not necessarily is what I'm saying. But stability first and then slight improvement every year from there. And there's four things, because the formula that got us to the 70%, I think that formula there's a number of market based issues and things that put pressure on it. So what we're doing, four things. One, Karen mentioned is price. So this is something we've made meaningful improvements on over the last couple of quarters. The second is our cost of goods sold. We brought -- we changed our operating structure like when we centralized our operations we brought Greg Smith in 18 months ago. This is before the market external forces on supply chain turned upside down. We made that move primarily initially for cost of goods sold reduction every year that’s meaningfully better than we've done over the past 20 years. Like every year cost of goods sold as we centralize and employee technology to lower cost of goods sold. Some of the progress has been distracted on because now we're focused on resiliency more than anything right now. But that will come back to fold. The others that we mentioned in my commentary, more expense reductions, G&A across the company, the new operating model kind of makes that a little bit -- opens up opportunities for us to do that. And then the fourth is, it gets back to this market choice issue as we and our capital allocation, we are allocating capital not just to the highest growth, but the higher margin businesses. So things like our TAVR business, which the bigger it gets, the better our profitability mix gets. So those four things, price, cost reductions, G&A reductions and mix through decisive capital allocation are like more of something that we're really focused on versus pre COVID, it wasn't as big a focus.
EarningCall_1507
Good morning, ladies and gentlemen, and welcome to the Currency Exchange International 2022 Q4 and Year-End Financial Results Conference Call. At this time, all participants 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 Tuesday, January 24, 2023. I would now like to turn the conference over to Mr. Bill Mitoulas, Investor Relations Manager at CXI. Please go ahead, sir. Thank you, Michelle. Good morning, everyone. Welcome to the Currency Exchange International conference call to discuss the financial results for the fourth quarter and full year of 2022. With us today are President and CEO, Randolph Pinna; Group Chief Financial Officer, Gerhard Barnard; and Chief Financial Officer of Exchange Bank of Canada, Alan Stratton. Alan will begin with his brief comments on EBC's fourth quarter performance, followed by Gerhard, who will provide an overview of CXI's overall financial results and his latest perspective on the company's operations. Randolph will then provide his commentary on CXI's strategic initiatives, sales efforts and business activities, after which we'll open it up for your questions. Today's conference call is open to shareholders, prospective shareholders, members of the investment community, including the media. For those of you who may happen to leave the call before its conclusion, please be advised that this conference call will be recorded and then uploaded to CXI's Investor Relations website page, along with the financial statements and MD&A. Please note this conference call will include forward-looking information, which is based on a number of assumptions, and actual results could differ materially. Please refer to our financial statements and MD&A reports for more information about these factors that could cause these different results and the assumptions that we have made. Thank you, Bill. Firstly, I'll state that we are very pleased with the performance of the bank in Q4 as it continued to generate both growth in revenue and profitability. Q4 revenue of $5.6 million was $3.2 million or 137% higher than it was back in Q4 of 2021. This growth was driven both by the payment segment and the banknote segments. Our payments revenue grew 72% on a functional currency basis from Q4 2021. And that growth has been driven primarily from the acquisition of approximately 300 new payments clients over the course of the fiscal year by our growing sales team. We offer both spot and forward exchange contracts to companies across a broad range of industries. And as two thirds of Canada's gross domestic product is derived from importing and exporting, there is a larger market for foreign exchange services in the country. The banknote segment has continued to grow in step with the recovery in international travel and tourism. On October 1, the federal government removed the vaccination requirement for travelers entering Canada, eliminating the last travel restriction related to COVID-19 in the country. However, there do remain certain countries, including the United States that maintain a vaccination requirement for foreign nationals upon entering the country. Despite that, the demand for U.S. dollars in Canada grew significantly in Q4 as travel to the U.S. increased. Statistics Canada reported that Canadian travelers increased their travel spending abroad by $2.2 billion in calendar Q3, most of which was in the United States. A significant portion of the growth in banknotes is due to expansion of trade with foreign financial institutions, enabled by EBC's participation in the Federal Reserve Bank of New York's foreign bank international cash services program. September 2022 marked our first full year operating in that program, and we have seen successive quarterly growth in volumes. It does take longer to onboard new foreign clients than a domestic one as we conduct due diligence around the risks associated with money laundering and tourist financing for both countries and institutions. However, once the client is onboarded, our experience has been that they increase their volumes over time as we build experience. Our focus is on building long-term relationships with these institutions as we anticipate they will provide a predictable volume of trade over time. The focus is on clients with regular activity and large value trades as the cost for processing and shipping scale down as weight and value increases. As a result, the proportion of the variable costs relative to revenue is higher than our domestic business, which means that we need higher volumes to generate the economies of scale and operating leverage. According to the Federal Reserve, there is approximately at the end of 2021, $2.1 trillion in U.S. currency in circulation doubled from what it was 10 years ago. This means that the addressable market for U.S. dollars continues to grow, which provides a significant opportunity for EBC in the years ahead. For fiscal 2022, the bank generated $17.2 million in revenue, an increase of $9.8 million or 131% over the prior year. This revenue growth allowed the bank to generate its first full year of profitability. And as a result, we were also able to recognize $1.2 million in deferred tax assets that were related to losses the bank had generated in previous years. In our view, 2022 marks the year that EBC has become financially sustainable, which should also make it easier to secure a line of credit with a major financial institution. I'll close by saying I am excited about the prospects for the bank and to being able to contribute to executing against its growth strategy in a prudential manner. Thank you, Alan, and thank you, everybody, for joining us on this call today. Firstly, I would like to personally start off and just congratulate Alan on his appointment as the CFO of Exchange Bank of Canada, and thank you for discussing Exchange Bank's results. I will now present an overview of the group's results of the most recently completed fourth quarter as well as for the year ending the 31st of October 2022. For the consolidated CXI Group, these results are presented in U.S. dollars unless otherwise noted. CXI had another very strong quarter and a record fiscal year with year-over-year growth in gross revenue of 117% or $66.3 million and net earnings before tax of nearly $14.2 million coming from a loss in the previous year. Demand for foreign currencies increased significantly in the fourth quarter as international travel rebounded strongly on the pent-up demand and continued to strengthen into 2023. CXI effectively resolved the delays in processing shipments that experienced in the summer of 2022. The group is well positioned to execute its strategic plan and deliver another competitive year. Now let's look at the consolidated performance for the three months ended October 31, 2022, before I get back to the group's stellar yearly results. CXI generated strong revenue for the three months ended 31st of October 2022 of $19.8 million, a 96% increase over the same period in the previous year. This increase reflects the acquisition of new customers in both the banknotes and payments product lines as well as a significant improvement in the demand of foreign currencies as governments in Canada and the United States, as Alan mentioned, and other nations relaxed or eliminated many policies that serve to prevent or discourage international mobility. Payments revenue increased by 53% to nearly $3.4 million in the three months ended October 31, 2022, from $2.2 million in the same period of last year. This demonstrates CXI's success in acquiring new client relationships in both the United States and Canada processing nearly 29,000 payment transactions, representing $3.2 billion in volume in the three month period ending 31st October 2022. This compares to roughly 21,200 transactions or $2 billion of volume in the previous year. Payments represented a 17% share of revenue, and this reflects the successful execution of the group's strategic initiative to develop scale in international payments. Now revenue in the other product line banknotes more than doubled, increasing by 108% to $7.9 million in the three month period ending to $16.4 million during the same period in 20220. The growth is attributable to three main drivers. Firstly, consumer demand of foreign currencies have significantly improved as restrictions on international travel have eased over the past year between August and October of 2022, approximately 200 million travelers passed through the TSA checkpoints in the United States airports, approximately 94% of the pre-pandemic levels. This is an increase of 21% from the same year - same time last year. Secondly, the group was successful at increasing its market share, as indicated by the increase in new wholesale clients and developing its direct-to-consumer footprint through new locations, including agents and its online FX platform. And thirdly, the group has increased its penetration into the global banknote trade particularly driven, as Alan has mentioned, particularly driven by the Exchange Bank of Canada's participation in the Foreign Bank International Cash Services or as we call it the FBICS program with the Federal Reserve of New York. Now during the 3-year period ended 31st of October 2022, operating expenses increased by 54% to $14.4 million compared to $9.4 million for the three months period ending 2021. The variable costs included posting and shipping, sales commissions, incentive compensation, bank fees and third-party technology fees increased 84% to $5.1 million compared to $2.7 million. This is largely due to the increase in transaction volumes. There has also been a significant rise in shipping fees due to a higher mix of international banknote trade, including fuel surcharges. The group recovers some of the shipping costs through fees that it charges to its clients. In some cases, it is built [ph] into the commission and the group has implemented some price increases to compensate for these higher shipping costs. The ratio of total expenses to total operating or to total revenue for the three months period ended October 31, 2022, was 74% compared to 92% for the three months period in the prior period, reflecting the growth in revenue outpacing the growth in expenses. The group recorded net operating income of $5.4 million for the three months ended October 2022, significantly higher than the net operating income generated in the same period of the prior year of less than $1 million. This reflects the group achieving economies of scale to a much greater extent when compared to the prior pandemic period. The group generated $4.4 million in net income during the three months ended October 31, 2022, which included the recognition of $1.2 million in future tax benefits related to non-capital losses incurred in the previous year by EBC. Now let's take a look at the consolidated performance for the year ended 31st October 2022. The group generated record revenue of $66.3 million for the 3 years ended October 2022, a 117% increase over the same period last year and most importantly, 59% higher than the year ended 2020 - 31st of October 2019, the last fiscal year prior to the pandemic. The increase from the prior year reflects not only an improvement in the demand of foreign currencies as international travel recovers, but also the acquisition of new clients in both banknotes and payment product lines. The group achieved net operating income of $18.7 million for the year ended 31st October 2022 versus a net operating loss of $48,000 in the same period in the prior year. The group earned $11.8 million or $1.83 per share in the year ended 31st October 2022, a significant improvement from nearly $13 million or $2.01 per year. Payments revenue increased by 61% to $12.4 million in the year ended October 1, 2022, from $7.7 million in the same period in 2021. This demonstrates the group's success in focusing on the growth of payments through key client relationships in both the United States and Canada. The diversification strategy has been a significant factor in the group's resilience in the face of the pandemic and its turn to profitability. The group processed over 149,000 payment transactions, representing close to $5 billion in volume in the year ended 2022. That represents 36,000 or 38% more payment transactions and an increase of nearly $1.58 billion or 47% in volume compared to the previous year. The revenue from both banknotes grew 136% to $22.9 million in the year ended - in the year ended October 31, 2021, to $53.9 million during the current year. So that is that 136% increase. The growth is attributable to three main drivers. Firstly, consumer demand for foreign currencies improved as restrictions on international travel have eased. Secondly, the group experienced success in increasing its market share, as indicated by the increase in new clients and the effective execution of its strategic plan. And thirdly, the group has increased its penetration in global banknote trade. The revenue growth has been consistent in both Canada and the United States and across all channels. While the recovery in consumer demand for foreign banknotes is encouraging, the group expects future demand to fluctuate based on the risk often - of transmission from COVID-19 variants, inflationary impacts, as well as the risk of a recession. By geography, the U.S. accounted for $49 million of the group's revenue, an increase of 112% or $25.9 million compared to last year. At 73%, its share of revenue was fairly consistent with last year. That reflects the group's ability to grow at the same rate in Canada, where Exchange Bank of Canada nearly grew its revenue - grew its yearly revenue to $17.2 million, as Alan has mentioned, an increase of 131%. The group is very pleased with the growth in both Canada and United States, Exchange Bank of Canada began operating under its Federal Reserve Bank of New York's, Foreign Bank International Cash Services or FBICS in short in the fourth quarter of last year, as Alan mentioned. And this program has helped the bank develop its international trade of U.S. dollar notes with foreign financial institutions. Now during the year ended 31st of October 2022, operating expenses also increased by 55% to $47.6 million compared to $30.6 million for the previous year. Variable costs included posting and shipping, sales commissions, incentive compensation, bank fees and third-party technology fees, and those increased to 136% to $16.6 million compared to $7 million in the previous year. This is largely due to an increase in transaction volumes. There's also been a significant increase in shipping fees due to a higher mix of international banknote trades and fuel surcharges. Salaries and benefits increased 44% to $25.4 million from $17.7 million, a total of $3 million or 40% of the increase relates to an increase in variable compensation. Sales commission being the largest contributor to that variance of roughly $2.1 million, where the balance relates to other incentive compensation, driven primarily by the improved - improvement in the group's performance. The remaining 60% variance is partially related to incremental growth in headcount, which increased to 344 in the year ended 31st of October 2022 compared to 272 in the comparative year. It is also driven by inflation in base salaries and wages as the group implemented broad-based increases in May of 2022 to address the general wage inflation. Postage and shipping increased 208% to $8.4 million from $2.7 million. And it is primarily attributable to the increased volumes associated with the banknote product line in addition, increases levied by carriers due to inflation and fuel charges. These costs have also increased as a result of higher trade with international parties, which require airfare, armored carriers and third-party processing fees. Legal and professional fees increased 46% to $4 million from roughly $2.8 million and are primarily attributable to higher costs related to tax, audit and professional services, including search fees to recruit certain key roles. The group's implementation of Oracle NetSuite is on track for going live in the second quarter of 2023, and it accounted for nearly $0.5 million in cost. The group also incurred cost for the regulatory compliance program in EBC. Bank charges - bank service charges increased 46% to $2.2 million from $1.5 million, primarily related to increases - increased volumes for payment activities. These charges are primarily offset by fees collected on payments, which are captured in revenue. The increase is lower than the relative increase in the group's payment revenue as the group negotiated lower fees paid to counterparties to process certain wire payments that took effect on January 1, 2022. Information Technology. That increased 34% to $2 million from $1.5 million, primarily reflecting non-capitalized computer equipment purchases for new staff and replacing older equipment, as well as variable costs associated with the increased payments volume as the group relies on third-party technology providers to deliver those products. The remainder of the increase is due to an increase in investment in cloud-based technologies such as new customer relations management software implemented in 2022 as well as cybersecurity. Stock-based compensation increased 12% to $1.1 million, and it includes an expense recognized in relation to employee stock option plans, RSU and DSU awards. The group recorded expenses of $0.7 million related to RSU and DSU awards and nearly $0.5 million as the amount of stock options vested [ph] during the year in 2022. The RSUs and DSUs are both based on the fair market value of the group's common stock and are subject to variable accounting tweak [ph] Losses and shortages increased nearly 600% to $0.6 million from $0.1 million and it is primarily related to shipment losses, shipments lost in transit that the group self insures. In addition, the group did recognize a loss of about 50,000 as related to a Berkeley [ph] in one of its retail branches during the year. Travel and entertainment expenses increased 153% to $0.5 million as conferences, trade shows, in-person business meetings continue a progressive recovery through the remainder and - through the remaining - and they remain below pandemic levels. A portion of the travel expenses related to the group having subdivided the cost of certain employee subsidize, the cost of certain employees to travel to work by car [ph] who prior to COVID-19 pandemic used public transit. The affected employees are primarily supporting the vault operations and cannot carry out their jobs functions from home. So the group discontinued this practice in May 2022. The foreign exchange losses decreased by 57% to $0.3 million from $0.7 million and reflects the company's progress in managing its foreign denominated balances between the time of recognition and settlement and incorporating such balances into its hedging program. Foreign exchange gains and losses associated with foreign currency inventory and unrealized gains and losses on foreign contracts are included in calculating commission revenue. Other general and administrative expenses increases were mainly driven by increases in office supplies, licenses and fees, utilities and other related costs. This reflects a return to normal operating hours at most retail locations, the opening of new branches, higher inflation and expansion into new state jurisdictions. The group recorded an income tax expense of $2.4 million in the year ended October 31, 2022, in comparison to nearly $1 million in the prior period. This is related to the increase in net income before tax. The statutory rate is 26%. However, the effective tax rate is 17.4%, which is primarily due to the application of previously unrecognized non-capital losses from prior years being applied to reduce taxable income in Canada for the year ended 31st of October 2022 to zero dollars. In addition, the group recognized as Alan mentioned, a future income tax benefit related to unused non-capital losses from prior years that may be applied to taxable income generated in Canada in future periods. These non-capital loss balances will expire in the years ended 31st of October 2040 and '41. Now let's review the balance sheet where there has been a significant increase, 33% and cash holdings to $88.5 million from $67 million last year, primarily due to an increase in banknote inventory to support the higher volumes required with the recovery in travel and also higher holding account balances. There has also been an increase of $1.4 million in deferred tax assets due to a benefit being recorded in relation to historical operating losses incurred by Exchange Bank of Canada that's now been recaptured. Given the unpredictable nature of demand and the significant increase in volumes, the group held higher inventory balances of certain currencies during the last quarter to mitigate the risk of running out. We are also reviewing inventory at consignment clients related to demand and reducing levels on currencies that don't meet turnover thresholds. Thus, we anticipate that our average inventory levels will decline, although there are susceptible to high peaks, especially at our trade and international banknotes continues to grow. The remainder of the group's working capital balances at year-end were in line with norms. There has been growth in holding account balances as a result of growth in business volumes, and those are offset by funds in bank accounts. Other assets included $3.2 million in outstanding receivables related to the employee retention credit claim in 2021. Happy to say these funds have been received in December of 2022. The group has had a total available balance of unused lines of credit of close to $55 million at year-end. Lastly, it's worth noting that the group's net equity position as at year-end was $69.3 million, an increase from the $58 million of the previous year. This exceeded the $66.3 million net equity position in January - 2020, the last reporting period before COVID. The group's financial performance reflects a remarkable turnaround from the losses generated in the prior year. I would like to conclude my discussion reiterating CXIs core values of customer first, integrity, passion, collaboration and innovation. And I personally believe that these values that our team lives and demonstrates daily out there in the branch network, kiosks and working from home, together with our strategy, we'll create an even brighter future for the group and its stakeholders. Thank you. Thank you, Gerhard. Thank you, Alan, and thank you, everyone, for being on this call so early, especially those out West. We really appreciate your attention and involvement with CXI. Before I go into the details of our businesses, I actually want to take it up a level and talk about people and strategy. To begin with, I'm very delighted and welcome Gerhard as our Group CFO. We've worked together already four months, and we feel like we're best friends. It's been a great relationship to begin with, and we look forward to a long future ahead. I'm also very happy to see that Alan has dropped the interim role. He has completed his role being interim Group CFO, as well as at the bank. And we're very proud to announce that Alan is our permanent bank CFO. He's done a very good job, and we're very happy with his work at the Exchange Bank of Canada. So again, we have a very strong management team. There's no more interim roles. We have a very strong Board of Directors. I'm very pleased with the team we have put together. About the strategy of our group. This has really driven our company in the last few years because of the pandemic and the challenges it's given us. Because of this strategy, which I'll remind you, has four major pillars, which is our consumer, direct-to-consumer division, our Exchange Bank of Canada and its FX banking. It's OPOP [ph] as we call it, one provider, one platform and our international expansion. We do have the fifth pillar, which we've been investing heavily into, which is upgrading to Oracle's NetSuite. We're implementing a treasury management system called Kyriba. We've invested to increase and improve our cybersecurity because that is always a big threat, and we are continuing to invest last year as well as this year in further structural improvements to ensure the company can continue to grow safely and soundly for our investors. The strategic plan, as analyzed actually made us reorganize the group structure. I'm very proud of the leaders of our company. Matt Schillo, as you probably know, has been our Chief Operating Officer since day one of the company, and he ran all of last year, the entire banknote business for the Consumer Division for Exchange Bank of Canada, as well as CXI's core business of wholesale to banks. Matt Schillo is now the Managing Director to lead the entire unit of our Consumer Division. Wade Bracy, who at the start of CXI was our CFO and migrated into being the Treasurer and has done many roles in the organization. Wade Bracy, led all of last year, the payments for both the bank and CXI. Wade has been promoted to be the Managing Director of the wholesale unit of CXI. That leads Exchange Bank of Canada. James Devenish was hired 3 years ago with a goal to grow the bank, improve its sales culture and operations and now is leading - James Devenish is now leading the entire bank's operations and sales teams. As well as this just as importantly is our second line, which involves compliance and risk. Dennis Winkel has successfully assumed the role of - he has been the Chief Risk Officer for the last 4 or so years. He's also assumed the role of the Chief Privacy Officer. He's also helping out with the compliance in the U.S. with some oversight to Catherine Shepardson, who's been successfully leading the entire compliance team of the U.S. for the last 12 years. So with the people and structure in place, a solid strategy and the systems to support it, our businesses are ready for a strong year ahead. We do have to invest in our year. So I'll start with Exchange Bank of Canada. First, as we've heard several times today, it's profitable, consistently profitable, which is a huge win for everybody involved. This has been partly led because of the FBICS program of the Federal Reserve Bank. While it is based in New York in the last few months, we've actually have tested and are utilizing the Federal Reserve Bank's Miami facility because that does improve shipments and reduce shipping costs. We're very happy with that relationship. The banknote business, as we've always known, is the largest part of Exchange Bank of Canada. It is growing on both sides, both domestically. We are entertaining additional financial institutions for our core foreign currency services, and we're seeing strong demand for a second vendor to distribute U.S. dollars since the Canadian banking system has both Canadian dollar and U.S. dollar general ledgers, there is a need for U.S. dollar cash. And we will see the domestic business in Canada continuing to grow in banknotes. Internationally, we've seen strong demand. We are continuing to expand, both in Europe as well as in South and Central America. You'll see the company adding additional customers in Brazil, the Dominican Republic. Over in Europe, we've highlighted and started to look at customers in Eastern Europe, such as the country of Georgia. We are working on potentially having customers in Hungary and Poland and some other select countries. Each country does get a thorough review. It is approved first by the management team. And then the Board of Directors will have final approval of any new jurisdiction that we may consider to have customers in. Now moving to the payment business. This is where we will continue to invest heavily into our expansion of our relationship banking in Canada. We have built a strong team both in Montreal as well as in Toronto, but we are investing with a minimum of six new sales people in Exchange Bank this fiscal year. As you know, sales people can take up to a year to become profitable. That we have made this conscious decision to continue to invest both in systems and in people to ensure that we can continue a solid growth for our shareholders. And moving into CXI. It too is led by banknotes. I'd like to start with the consumer division because the consumer division was a very strong contributor to revenues last year, and it is anticipated to contribute again this year. The consumer division has three pieces to that. First, it's the company-owned stores. As you know, we shed over a dozen stores during the pandemic, and we selectively added back a few new stores, some select maybe from another competitor that had exited the market. Most recently, we have just opened in this fiscal year, we opened our newest location in New Jersey, near the Newark Airport, bringing our company-owned stores to 38 locations. We will be very careful as we continue to explore potential new stores as we look for high tourist areas, but also require a lower rent so that we can afford to be in business and offer a reasonable price. Another area, which has seen a lot of growth and this is one of our big areas of expanding the consumer division is our agent relationships. As you now know, we have over 23 - acting 23 airport locations, including just most recently the JFK - GFK [ph] Terminal 8, so we're now in Terminal 7, Terminal 3 and Terminal 8 at JFK, we're at Newark Airport, Chicago, Charlotte, and a handful of other airports as well. Those airport relationships are managed by local operators, utilizing CXI's platform, brand and oversight. Additionally, we have agent locations like the Duty Free America and AAA. This national expansion of agent locations continues to be a successful way to grow the consumer division without the cost and risk associated to long-term leases and fixed rents. Lastly, our online store is now licensed to be able to sell and has authority to sell to 38 states, representing over 70% of the U.S. market. This allows for people to order currency online and have it shipped to their home or office. This is another way to continue to expand. We're very proud that Matt Schillo is leading this unit as the Managing Director and has full accountability of the profitability of each of those pieces of the consumer division. He has plans to continue to improve the marketing and expansion and reach of our direct-to-consumer offering in the United States. Also on banknotes, just like Exchange Bank of Canada, we do have demand for select clients utilizing CXI's facilities in Miami for international banknote services. We will see us continuing to expand in the Caribbean and select other jurisdictions as we did - deem safe. So now moving over to the payments for CXI. We have our core service of banks. We call it OPOP, one provider, one platform, where we have integrated into core systems like Fiserv, both of the Jack Henry systems, and we are working on two other core banking software integrations. Additionally, we have select integrations into proprietary networks of select financial institutions. This investment, which we will continue to do in this fiscal year into our IT, cybersecurity and integrations allows for our payment business to tap into existing flow of payments and switch the provider from a big major bank to a select organization like ourselves. And lastly, I'm going to answer one of your questions, you guys ask it every time. I'm going to talk about M&A. We do not have a merger hot ready to talk to you. Although this group reorganizational structure allows each of the three managing directors to run their business, free giving me a little more time to work with owners to show those owners why it is beneficial for them to work and merge into the CXI Group, allowing those owners to continue to do what they do best, which is to grow their customer base, increase their revenues while benefiting from the strong back office and second line of defense that our company has in place with our people as well as our systems. We do have five active discussions going on. Again, nothing is hot enough to announce. However, we're excited about the potential partners that may join the CXI Group. So that concludes my update on the businesses and our group structure and the people. I open it up for questions. I apologize that we went a little long today, but we had a lot to talk about, and I welcome any questions you have. I also do want to remind you that our Annual Shareholder Meeting will be March 23rd in person - on March 23rd at the KPMG offices on Bay Street in Toronto. We will allow for digital attendance as well, but we hope to see you in person once again, like we used to do pre-pandemic. So please respect the two question rule because we have limited time, and I would like to hear from as many potential - or shareholders or potential shareholders that have a question. So if you could open up the floor, Michelle, I look forward to answering their questions. Thank you, sir. Ladies and gentlemen, we will now conduct the question-and-answer session. [Operator Instructions] Your first question will come from Robin Cornwell of Catalyst Research. Please go ahead. Hi, good morning. And congratulations on a great year. I just have - my first question is two parts. It's the global banknote trade. You last quarter indicated the - about a $2 million revenue in the quarter. Can you give us an idea what that would have been this last quarter? While he's doing that, to save time. He'll - he got - large got a bunch of notes here. So we'll let him get into those. Go ahead... So banknotes in the last quarter, if we just look at that quarter its been - you're focusing on Exchange Bank consolidated, it's about $16.4 million in that quarter, combining wholesale and retail. That's the consolidated number. And the - in that business, Randolph, I'm curious, is there a characteristic in that business that is there any seasonality? Is there any restriction on growth? I guess looking at the broad picture of that – that business because it looks like it's very exciting to you? It is a very exciting business. The restrictions on growth are around our risk appetite. We are only working with countries and banks that are very well rated and have a lower risk rating. So higher - mid to higher risk rated countries. We are choosing at this time not to work with. The other restriction is capital. Some of the banks have a large volume that we do not have the asset size to participate in. So there is some restriction on some of the major large banks to compete with. However, it is a big market, and we will continue to selectively expand that market. As far as seasonality, it does, as we've seen with CXI's customers in the Caribbean, we've seen that the winter months, the Caribbean is busier when it's hot down south and it's less busy. So there is some seasonality to it. But for our group, because these jurisdictions may have a different seasonality than what we experienced in North America, it has been complementary. Did that answer your question? I don't know... That's great. That's terrific. Thank you. And the second question really was an outlook for staffing. What do you see for 2023? Well, we don't need another CFO. We have two now. And so you'll see that the full payroll of '23, I think that's a very good question that will - I want to highlight to the shareholders that we did implement two raises in '22, one unbudgeted unscheduled, but it was a defensive move that I required our company to do to ensure that our hard-working people and our busiest year ever were compensated fairly, and we didn't lose too many. Luckily, we haven't, touch wood. And then at year-end, which is now taking the effect of this year, we did do another rate. It is just a reality that our North America, if not the whole world, is experiencing stagflation. And we must - we need to compete and keep our hard-working, talented staff, fairly paid. As far as new hires, yes, we will be hiring mostly in the sales and technology area, both as I already called out, that James is going to be hiring a minimum of six. He's looking for experienced FX bankers that are ready to work hard and join the FX team at Exchange Bank and Chris Johnson, who continues to lead the CX sales team is also looking to add select people. He's identified an experienced partnership person that's going to be joining us here shortly, as well as additional salespeople. Paul Ohm, who's running the IT department since the start of the organization is also selectively looking for experienced technology people to allow us to continue to do the integrations into the core systems or the proprietary networks that we've identified. So there will be continued investment. Also, as you can imagine, with all this first-line growth, both Catherine and Farzana, who is our Chief Compliance Officer at Exchange Bank, are continuing to invest in to experienced people in the compliance and risk areas. And so we will continue to see - the shareholders will continue to see that our company will continue to invest in systems and people to enable us to get to the next level, which we clearly have in mind ahead of us. Did that answer... Yeah. Thanks, guys. Good morning. A couple of questions for me. I just wanted to maybe get a sense of almost on Q1 here for fiscal '23. The travel chaos around Christmas and the headlines are obviously pretty negative. But looking at TSA [ph] numbers that helps - actually quite positive. Maybe just get an indication from what you guys saw so far in the first quarter and maybe relative to 2019 levels or even last year levels, what you saw so far? So Jim, we try not to give guidance. I can confirm living - I live between Toronto and Orlando, I think you know, living more in Orlando was a very busy Christmas season. And so that trend that we had last year has - has been there. But it is our slower time, if you know historically, is CXI's seasonality, the first quarter is usually one of the slowest quarters. And so it - that has not escaped us that the fact that we are in our first quarter of our new fiscal year. So I don't know if that answered your question, but to be - you said 20 - how this year as a whole looking, we don't know. Again, the war scares me personally, all this inflation and recession and all the mass layoffs we're hearing in the news, do scare me. So we do have to take a realistic look at our year when we look ahead. However, we have our strategic plan. We know the four areas of our focus, we'll continue to execute on our strategic plan. I was happy to see that Delta and United both put out guidance for their shareholders to show they are expecting a record summer. The Disney Resorts are showing a high occupancy over the summer. So there are some indications that we could have a strong year, but we will stay focused on costs and growing revenues. Okay. Thanks, Randolph. And then you mentioned, obviously, investing in the business and hiring a number of salespeople and senior people to keep this growth going. How do you feel like that might play out on the margin side and the expense side? Do you think we've obviously seen expenses climb here with increased revenue and the operating leverage come through to the bottom line. I just want to maybe get an idea of not specifics, but are you still comfortable with the margins you've been generating here? Or do you think you need to make specific investments here to accommodate further growth? It's the latter. I would see that we - in the short term, that you might see expenses growing faster than we would all want. However, we do see it as the time is now to make these investments, like we are converting our systems to NetSuite. We are implementing Kyriba. So those are onetime costs that you saw last year, it was $0.5 million. You'll probably see it another something like that this year to support the successful implementation of these core systems. We're also investing into an automation system in our compliance around LCTR and CTR reporting and that stands for large cash transaction reporting. So we are doing some investments. So in short term, you might see our efficiency ratio, margin slip a bit from where it was, but that's - we anticipate just being short term. The sales teams are very focused to grow revenues. As James likes to say, revenue solves a lot of problems. And so we will continue to focus our top line as well. However, as the CEO, it's my responsibility to ensure that we have the safe and sound structure of the organization, which includes the systems and the people, both in the first line to get the sales and the second line to make sure they're good sales that we can be proud of, we will continue to invest in that manner. So hopefully, that helps to answer your question, Jim. Fantastic job on the quarter and the year, and congratulations to the whole team. Randolph, I'm just curious, as we have discussed, there is a significant upside opportunity in the company if Exchange Bank of Canada can be authorized by its regulator to take deposits and then you would need lines of credit and you would be able to lower your overall cost of funds and generate net interest, more in net interest margin. Have you given any more consideration to that? Do you think that's a reasonable prospect for 2023? Where are you at in discussions with your regulators? Have you initiated that yet? No. We've discussed this at the board, Stephen. And well, it seems interesting, it's a complete change of our bank structure, which was more a B2B bank. We are planning on updating our business plan selectively that might have us be consumer-facing. We have not done any of that work yet. We've done a lot of preliminary work, but it is not - I can confirm that there is no intent for Exchange Bank of Canada in the - you were talking about this year - at all this year or even the following year to become a deposit-taking institution. We are not interested in taking the deposits or lending that's a business for our customers. And so we are focused on improvements to Exchange Bank's business plan to allow for further expansion in its core areas, but it's not in deposit taking or in lending. But I appreciate the reminder. But at this time, the bank will stay focused as Canada's foreign exchange bank, our specialty service of foreign exchange to banks and corporations across Canada. Okay. Thank you. And then the follow-up on that is, would you potentially lose business if you did that against the - some of the larger banks that you do - do business with today? Yes. We're not sure of the impact. I mean having a consumer division in CXI could be viewed as a competitor to some of our large national banks. Luckily, our clients since it's specific for foreign currency services do not feel threatened by CXI, not to mention, we only have 38 branches, whereas one of our big top 10 U.S. banks have 1,000 branches. So we're not a threat, whereas if we became a deposit-taking institution, they might be. But again, this economically, we were not in that space. That's a really change of our second line and oversight capital requirements. It's a major change to our business. And at this stage, we are not interested in trying to become that type of financial institution. We'd like to be what we are Exchange Bank, a transactional bank money for money. And that's our focus for the foreseeable in our current strategic plan. Well, you're certainly ultimately successful at that singular focus. So I just wanted to congratulate the team and good luck on another great year coming. Thank you. Yeah, thanks. Just one quick follow-up. You mentioned the losses shortage is 620,000 for the year, obviously, up quite dramatically. I suspect largely due to volumes. But I mean, is there a rule of thumb here? Is that – have a typical level that you should expect to lose every year or get stolen, I guess, in some cases? Well, we - so no, that's not a usual level. Unfortunately, I will not use names, but there was a well-known shipping company that had an issue. I'm told that they have cracked that. And so we would not see that high level of theft. We've also implemented armored car shipments in key markets like L.A., San Francisco and New York City, as well as South Florida. And that will reduce the amount of going in the self-insured overnight a manner in which we've shipped currencies. So we do not - it's a good point to bring up. We hope that, that's where we can have an extra $0.5 million in this year that we did - we lost last year. But you will - it's normal that some packages get lost or stolen or shredded. There's all kinds of horror stories that you would be shocked to hear about, but there is losses and that is, of course, of our business, but it had always been running around maybe 100 grand. Now with volumes higher, yes, that could maybe get to 150 or 2, hopefully not more than that. But this last year was an unusual year with a band of fees. And - but we believe that's under control now. And so we hope that we would not see that high level again this year. Yes, Randolph, the discussion just now about self-insurance you know, raises to me, business opportunity. Have you considered setting up a U.S. captive insurance company yet because that could be a very positive financial investment based on what you're just talking about. We have not. Maybe we'll have a call offline and we can discuss that further. But no, right now, we are looking at alternative insurance methods as opposed to us just self-insuring. But we - this is a focus of each of our managing directors to look at their operations and minimize the risk associated to them. I appreciate that suggestion. Yes, I'll be happy to talk to you about it offline. I think it's potentially about a 40% return on investment, and it could really benefit you, especially if you've had a loss like that just recently. Thank you. Again, I'm sorry, we went the full hour, but it was a good conversation today. I appreciate it if something has come up, Gerhard and I will be going on the road a little bit to meet some of the shareholders in person because I'm a firm believer if people should hopefully be at the office more than not. And I would like to get back to meeting people, shaking hands and introducing Gerhard personally. I think a lot of you know, Alan, but Alan's in Toronto every day. So you're very welcome to stop by and say hello to him. I'm there next week as well. So I would be - I welcome any opportunity to discuss the business further for you. And I thank all of you for your support of CXI Group. Ladies and gentlemen, this does conclude the conference call for this morning. We would like to thank you all for your participation and ask that you kindly disconnect your lines.
EarningCall_1508
Hello, and welcome to the KVH Industries Q3 2022 Earnings Call. My name is Laura, and I will be your coordinator for today's event. Please note this call is being recorded. And for the duration of the call your lines will be on listen-only. [Operator Instructions] Thank you, Laura. Good morning, everyone, and thank you for joining us today for KVH Industries' third quarter results which are included in the earnings release we published this morning. Joining me on the call are the company's Chief Executive Officer, Brent Bruun; and Chief Technology Officer, Bob Balog. Before we dive in, a couple of quick announcements. First, if you would like a copy of the earnings release, it is available on our website and from our Investor Relations team. If you would like to listen to a recording of today's call, it will be available on our website. If you are listening via the web, feel free to submit questions to ir@kvh.com. Further, this conference call will contain certain forward-looking statements that are subject to numerous assumptions and uncertainties that may cause our actual results to differ materially from those expressed in these statements. We undertake no obligation to update or revise any of these statements. We will also discuss certain non-GAAP financial measures, and you'll find definitions of these measures in our press release as well as reconciliations of these non-GAAP measures to comparable GAAP measures. We encourage you to review the cautionary statements made in our SEC filings, specifically those under the heading Risk Factors in our 2021 Form 10-K, which was filed on March 11 and Form 10-Q, which is expected to be filed sometime this afternoon. The company's other SEC filings are available directly from the information section of investors on our website. Before turning the call over to Brent, I would like to briefly comment on the delay in filing our 10-Q for the third quarter. On August 9, we signed, announced and closed the sale of our inertial navigation business to EMCORE Corporation. In the Form 12b-25 that we filed on November 10, we noted that as a result of the added demands on our financial and accounting personnel due to the sale, we were unable to file our 10-Q in a timely manner. Without going into all the details, I can tell you that having the inertial navigation business in the same legal entity and same set of accounting books as the mobile connectivity business, having shared vendors closing the sale mid-month and complying with our reporting obligations to EMCORE under both the sale agreement and the transition services agreement, all made the disaggregation of results a complicated and lengthy process. However, we have completed that process and believe we are in a good position to move forward. Thank you, Roger. Good morning, everyone. We wrapped up a very positive and exciting third quarter that was highlighted by solid financial results, the sale of our inertial navigation business, the launch of our new TracNet H Series, and we also completed a lengthy competitive process, which resulted in a five-year renewal of our U.S. Coast Guard contract. Financially, it was a good quarter. Excluding any contributions from inertial navigation, we recorded $35.2 million in revenue, up 2% from the third quarter of last year. In aggregate, gross margin of 37.1%, which includes airtime gross margin of 44.2%, a new record. Adjusted EBITDA of $4.1 million, non-GAAP EPS of $0.07 per share, and we ended the quarter with more than 6,800 airtime subscribers. However, our growth was slower than anticipated, continued supply chain challenges, slowed shipments while economic and inflationary pressures seem to be impacting some new orders. We're also seeing increased competitive pressure particularly in the leisure marine market. KVH is in a good position to respond to these challenges. The restructuring we embarked on in March is working. After the inertial navigation divestiture, we implemented additional restructuring initiatives that resulted in further annualized savings of approximately $2 million. Overall, we have made significant positive progress in reducing operating expenses. Third quarter OpEx on a reported basis was $14 million, an 11% decrease versus Q3 of last year. As discussed during our call in August, we sold inertial navigation assets to EMCORE, which resulted in net proceeds of approximately $52 million. Over the last four months, we've unwound inertial navigation from our operations. These efforts touched on almost every department in the company, including sales and service, marketing, human resources, IT and data systems, facilities, engineering and finance, which has proven to be the most difficult. We are still in a transitionary period, but the bulk of this effort is now behind us. We continue to evaluate the best use of the proceeds from the transaction and the best path forward, including assessment of strategic alternatives for the company. We can now focus on the success and growth of our core business. On that front, we completed some outstanding initiatives and achieved strong results during Q3. First, U.S. Coast Guard selected us to deliver global communications for their small cutter fleet. We won this five-year contract renewal through a competitive bid process. The contract is worth as much as $69 million and supports more than 140 vessels and platforms. U.S. Coast Guard cutters will continue to use our TracPhone V7-HTS terminals and our global HTS network. We're proud to have delivered superior communications to the Coast Guard for more than 12 years and are thrilled to be keeping crew and ships connected for the next five. Additionally, we look forward to pursuing other connectivity and service opportunities with Coast Guard. In July, we introduced our new track – in July, we introduced our new KVH ONE hybrid network and TracNet H Series terminals. Every TracNet terminal includes fully integrated VSAT, 5G cellular and shore-based Wi-Fi, an industry first. These channels are managed by our unique intelligent channel-switching technology, which considers the cost of service, data throughput and connection quality. The result is a seamless and automatic process that enables users to enjoy connectivity without having to worry about what service is active. TracNet is the long-term foundation for what we believe will be a vibrant hybrid connectivity ecosystem that takes advantage of faster the cellular services and new technologies to support the growing demand for data. That's why every TracNet system is capable of integrating additional third-party channels, such as user-supplied SIM cards for local cellular services. L-band backup services such as Iridium service, and in the future, LEO and MEO constellations. All these features are managed with our automatic hybrid switching to deliver a multichannel communication service that will support future connectivity solutions. TracNet is shipping and feedback from customers is positive. The systems are easy to install, offer affordable airtime plans that are easy to understand and delivers a seamless hybrid experience. Financially, we continue to make progress in our connectivity business. We recorded airtime revenue of $27 million, an 8% increase in comparison to the same period last year. We achieved record airtime margins of more than 44% and third quarter KVH Elite subscriptions were up 60% over Q3 of last year. However, during the quarter, we faced lower-than-anticipated VSAT and satellite TV terminal orders and shipments because of the dual impact of ongoing supply chain challenges and inflationary pressures. As a result of the supply chain issues, we entered Q4 with more than $2.1 million in TVRO and $300,000 in VSAT systems backlog. The supply chain issues are steadily clearing and we expect any backlog we have entering Q1 will be based on customers not wanting or needing delivery until next year. We're also seeing challenges in the market. For example, in Alaska, where we support a large portion of fishing fleets, the king crab season was canceled due to unexpected and significant declines in crab stocks. The Baltic Index, a leading indicator for the commercial markets has been cut by two-thirds since the beginning of the year. And we are experiencing competitive pressure from new entrants into the market, especially in the leisure market. As a result, we will be slightly more conservative with our expectations for the remainder of the year and as we look at 2023. Roger will share additional insights on this in his comments. Nevertheless, we remain confident and enthusiastic about our business. We continue to roll out new features to expand the capabilities of the TracNet H Series. These include value-added services such as an ultracompact DC power below-deck unit, ideal for smaller yachts and regional commercial vessels. The ability to support both alternate primary and backup communication channels all managed through our intelligent hybrid hub, a new enterprise-grade cybersecurity option, a new cloud-based e-mail system that will offer tremendous flexibility and customer self-service and sports link stats or new real-time sports statistics new service for crew morale and entertainment. We're also in discussions with other third-party providers to deliver additional services over our network. These are vital competitive differentiators for our KVH ONE hybrid network and TracNet systems, especially as new connectivity services are rolling out. It's important to remember that these new services are simply data pipes with none of the critical tools and services required by commercial fleets and other customers. KVH ONE offers tools that – as well as integration with these new services. We're making the maritime hybrid connectivity ecosystem a reality. So to wrap things up, our restructuring efforts are building a healthy foundation for KVH sustained growth. We are steadily moving forward profitability and we can now focus entirely on our core business and strengths. Customers are thrilled with our innovative hybrid product line and we continue to introduce complementary value-added services and expanded integrations with third-party services. We are carrying out these strategic efforts with the goal of returning value to shareholders and I believe our results demonstrate that we are on the right path. Thanks, Brent. First, I'd like to note that unless I specifically state otherwise, my comments will relate to our continuing operations, which exclude the results of the inertial navigation business prior to the sale. With that, as Brent mentioned earlier, our third quarter revenue came in at $35.2 million, increasing $0.8 million from the $34.4 million recorded in the third quarter of 2021. Our gross profit margin was 37% for the third quarter of this year as compared with 35% in the third quarter of last year. Service revenue for the third quarter was $28.5 million, an increase of $1 million or 4% from $27.5 million in the third quarter of last year. This increase was primarily due to a $2.1 million increase in mini-VSAT broadband airtime revenue primarily offset by a $1 million decrease in content service sales, which was largely due to the sale of our radio business in April of this year. As Brent noted, airtime revenue grew to $26.7 million, or approximately 8% over the third quarter of last year and total subscribers passed 6,800. As a reminder, total subscribers include those who have temporarily suspended their service. Airtime gross margin was 44%, which is up eight percentage points from a year-ago. This increase is due to a combination of factors, primarily the growth in our subscriber base. Although we are very pleased with the results, we expect that going forward, our target for airtime margins will continue to be in the high 30s. Product revenue for the third quarter was $6.6 million, a decrease of $0.2 million or 3% from $6.9 million in the third quarter of the prior year. This decrease in product sales was primarily due to a $0.4 million decrease in VSAT product sales and a $0.2 million decrease in TV land product sales, partially offset by a $0.4 million increase in maritime TV product sales. The decrease in land-based TV receive-only units was primarily due to supply chain issues which led us to allocate scarce raw materials to our higher-margin marine TV products. The decline in VSAT sales was primarily due to the level of last year's sales of units for customers migrating to our HTS network. We sold 138 units in Q3 of last year to these customers. However, supply chain issues also impacted our VSAT sales and we believe that we could have shipped an additional 90 units if sufficient raw materials had been available. Operating expenses for the quarter were $14 million, down $1.6 million or 11% from the third quarter of last year. This quarter includes approximately $450,000 in cost related to our September restructuring. So on a recurring basis, we were about $2 million less than a year-ago. You may recall that for Q2, we were about $1.9 million less on a recurring basis. These improvements are a direct result of changes we made in March, and we are now seeing the full benefit of those actions. I should note that consistent with past practice, we did allocate a portion of our corporate OpEx to the inertial navigation business prior to the sale. Absent any changes in our remaining business, those costs would have come back to continuing operations in Q4. However, the cost reduction actions we took in September will more than offset those. At the operating income level, these changes in revenue, margins and operating expenses resulted in a net loss from operations of $1 million which was a $2.5 million improvement compared with the $3.5 million loss recorded in the third quarter of 2021. The $1 million loss included the $450,000 of costs associated with the September restructuring and so adjusting for that, a recurring loss would be $500,000 to $600,000. Our bottom line net loss from continuing operations was $0.1 million compared to last year's net income of $3.7 million. However, last year's income included $7 million of other income due to the forgiveness of our PPP loan. On a non-GAAP basis, which excludes amortization of intangibles, stock-based compensation and other nonrecurring costs, such as unusual non-operating fees, foreign exchange translation, transaction gains and losses and employee termination costs, related tax effects and changes in our valuation accounts and other tax adjustments. After those adjustments, we had net income of $1.2 million compared with a net loss of $1.4 million last year. EPS for the third quarter was a net loss of $0.01 per share compared with net income of $0.20 per share in the same period last year. Non-GAAP EPS for the third quarter was income of $0.07 per share compared to a net loss of $0.07 per share last year. Our adjusted EBITDA for the quarter was a positive $4.1 million compared with a positive $0.8 million in the third quarter of last year. For a complete reconciliation of our non-GAAP measures, please refer to the earnings release that we published earlier this morning. Net cash used in operations was $1.5 million compared to $1.9 million provided by operations for the third quarter of last year. Capital expenditures for the quarter were $3 million. And for the full-year, we expect capital expenditures will be in the range of $14 million to $16 million, the majority of which is driven by AgilePlans shipments. Cash provided by financing activities was $0.6 million and cash received from the sale of the inertial navigation business with $55 million, resulting in an ending cash balance of approximately $70 million which includes approximately $2.4 million of cash collected for inertial navigation customers after the sale and is, therefore, owed to EMCORE. With respect to our outlook for the full-year and our second quarter earnings release, I had said that we expected adjusted EBITDA to be between $11 million and $15 million. Our first half on a consolidated basis, including inertial navigation was $6 million, and with $4.1 million from continuing operations this quarter, that would give us $10.1 million year-to-date. Even taking just continuing operations for the first nine months, we're at $9.5 million. As such, we remain comfortable that we will be over $11 million. However, the high-end of the range is more – looking more like $14 million and $15 million. With respect to revenue, I had said that we expected mobile connectivity revenue growth between 6% and 9% on a pro forma basis adjusted for the sale of the radio business. Brent described a number of challenges that we're seeing related to demand. And as a result, we are being a bit more conservative and expect revenue growth between 5% and 6% for our continuing operations. Finally, we continue to make progress towards our goal of operating income profitability. Last year, we lost $8.5 million in the second half of the year. We had a goal of breaking even in the second half of this year, assuming supply chain problems didn't persist. Unfortunately, they did, and as previously noted, our revenue expectations for the full-year have come down a bit. As such, we do not expect a breakeven for the second half. The Q4 comes in similar to Q3. We have a second half loss of around $2 million. And while there's risk in that, there is certainly opportunity to do better as well, and we are working very hard to do so. This concludes our prepared remarks, and I will now turn the call over to the operator to open the line for the Q&A portion of this morning's call. Laura? Thank you. [Operator Instructions] We'll now take our first question from Ric Prentiss at Raymond James. Your line is open. Please go ahead. Hey. A couple of questions. First, you mentioned that you are targeting the service margins in the high-30s versus what's been coming up in the more like mid-40s. What do you attribute that to as far as it – what's the main items driving that? Well, the main items are we want to generate more pure revenue and margin dollars. So it's really a focus on market penetration and being able to effectively price our services in line or with market expectations as well as to try to generate more volume. Okay. So it really is the volume driving it and appreciate the color on the guidance update. Do you have the visibility that you're starting to see what 2023 could be looking like now that we're sitting here in early December? I'll let Roger answer the detail, but we're in the midst of pulling our budget together. We're not really in a position to provide any type of guidance for 2023 at this point. I think that's something that was exactly what I'm going to say is that we are finalizing it. There are still some things kind of moving around a little bit, but we're obviously working on that. And as Brent said, though, it's kind of premature at this point to provide any guidance publicly. Right. But supply chain pressure is still kind of continuing out there. You called out some competition pressure as well. So we should, I think, assume maybe those are going to continue for at least a little while on supply chain and maybe longer term on the competition. Yes. On the supply chain side, I don't want to jinx ourselves, but it seems to be easing up a bit. We see within certain areas, things easing up being easier to find parts, scarce parts, but that could change going on considering what's going on in China with COVID, it's still really hard to say. It's hard to say, but what we anticipate is being able to clear our backlog. And as I indicated in my comments, any backlog that we go into next year which will be based on customer timing as opposed to us not being able to ship any product. And Bob Balog is with us, and he actually runs our operations team. So do you have anything you want to… Yes. We – aside from that, we've also taken some pretty aggressive steps for component management, critical component sourcing and things like that, that sort of ensure that we don't run into minimize unexpected problems. So we've taken some pretty serious steps there. Okay. And last one for me is the $64,000 question, I guess, $69 million question. You're sitting with a lot of cash on the balance sheet. It sounds like some needs to go with the sale since you got paid after the close. But what's the time frame to be looking at strategic alternatives? What's on the table as far as potential things that might be in the realm of being considered? I think that you could probably guess the realm we want to generate growth for the business, as I indicated through the margins. We're not in a position to disclose specifically what we're considering. I think that we'll probably be in a better position for the next call three months from now. And that's about as much as we can say. Yes. I think the Board is still evaluating everything. And so there's really kind of no change. So there's – I just sort of reiterating what we said before that the Board is evaluating all strategic alternatives. Nothing is off the table. Everything is being considered. And obviously, the objective is to create the most value for shareholders. Hi. Thanks for the question. Clarification on your Coast Guard win, how does that compare versus your historical business there with that fleet? Is it pretty similar? So it's very similar. It's a renewal, but it also includes some opportunity to sort of grow the relationship with respect to a program they have called morale, welfare recreation, which we've provide some to them in the past, but there's an opportunity under this to sort of expand that. Got it. Great. And in terms of your new kind of OpEx levels you hit in the quarter of some great progress there toward profitability. With the cut in R&D, is that something you feel is sustainable going forward? And are there any impacts there on kind of your roadmap forward from the changes? When you say the cut in R&D, I mean, one thing to recognize is that the R&D group had historically supported both the Inertial Nav and the mobile connectivity sides of the business. Obviously, with the sale, a number of folks in the R&D side moved over to EMCORE. And so the remaining folks we have here are solely focused on mobile connectivity. But I'll let Bob... Okay. So in regard to R&D, we took some measures earlier in the year to focus and we reduced it both with the inertial navigation and mobile connectivity. We feel it's a team that we have in place is more than capable of fulfilling our service and product roadmap. And on a go-forward basis, as indicated by some of the product releases and additional services that we're introducing with KVH ONE and the TracNet series that we – they're more than properly staffed. Want to add anything? I would echo all I can add to that is I can echo exactly what Brent just said, we're more focused, we're delivering products unscheduled. We're pretty comfortable about that going forward. Yes, we're in pretty good shape. Okay. Great. And on the competitive front, you talked about leisure that just coming from some of the larger players like Inmarsat and Marlink and guys like this. Or is it new entrants? Got it. Helpful. And then in terms of – last question, in terms of the macro, like how should we – how should investors think about the macro impact on the, I guess, specifically leisure probably is the most impacted by potential macro headwinds, whether that's inflation or just recessional type impacts? Yes. I think when you talk about inflation and recession, which we're not in one yet, and hopefully, we don't go into one. The leisure marine market is definitely impacted, right? Because these are for entertainment and leisure by definition, is monies that are spent to for recreation. The nice thing about our business is the vast majority of our revenues are generated through both commercial and then we talked about the Coast Guard with our military and government business. So, although we're very focused on that piece of the business. It's a very small portion of our overall revenue or small portion, I would say variable, but a small portion. Thank you. We'll now take our last question from Chris Quilty at Quilty Analytics. Your line is open. Please go ahead. Thanks, Brent. I just want to follow up on that last point. You used to report the mix of commercial versus – well, I should say, commercial as a percentage of many VSAT shipments. And if I remember the last time you reported, it was order of magnitude, 65%. Does that mix – that's still indicative of the mix you're seeing today? We've – 65% is probably a bit low for merchant. It's probably closer to – I don't have the exact numbers. So Roger, maybe you do, but I know it's… Right. And when you talk about the Baltic Index being down and obviously that's an indication of some commercial market weakness shipping market. Are you still seeing the same number of RFPs out there? Or have you seen that come down how in any way, has the competitive market changed for those larger deals? I'd say it's pretty consistent on a year-over-year basis. RFPs have actually come down quite a bit over the last five years or so. But on a year-over-year basis, I'd say it's pretty consistent. Great. And the overall guidance for mobile connectivity taking it down, is that primarily product? Or is it evenly split between product and service? Well, here again, when we talk about product sales, that's truly units that we've sold, right? Many of our product shipments are Agile based and they're included within our airtime components. But to answer your question concisely, it would be both, but – and it's just a slight decrease, not a significant decrease. Great. And your network operating costs, having made the crossover here? Or do you see those being relatively stable or growing in accordance with new customer ads? Or do you have large block buys that are planned? How should we think about that on a go-forward basis? Great. And I missed on the very front end of the call. Did you provide the gross margin specifically for the mini-VSAT service? Good. And I guess final question here. When you think about some of the strategic alternatives at hand. Obviously, there's a lot of smaller maritime service providers out there that's one path. But you've historically been more focused on product line extensions, things like KVH Watch. Is there a philosophical preference for one direction over another? Our philosophical direction right now is that we've built this new H Series, we have a KVH ONE hybrid network, which we have on our own dedicated 5G/LTE capacity, as I indicated from a cost perspective, a customer can go buy a local SIM, and many times that could be very competitive. But we feel we have the right data pipe, the rate tools internally with what we're rolling out to expand those, whether it be through internal development efforts or through working with other third-party value-added service providers. I think with regard to your question about a philosophical preference, it's really around what's going to maximize value, where can we create value. And I think one of the things that we're looking at is the suite of value-added services that we provide which are sort of more or less unique to us and where we have a competitive, a strong competitive advantage and enhancing that suite of value-added services. Thank you. There are no further questions in queue. I will now hand it back to Roger Kuebel for any additional or closing remarks. I think that's all. Thank you. I appreciate everyone joining the call. I appreciate the questions and look forward to continuing to deliver great value for shareholders. Thanks all.
EarningCall_1509
Doing great, doing great. If there are questions that you want to ask in the audience, just please be sure to hit the button just below the white arrow, just so we make sure that the question gets webcast for the broader audience. Did you have a good holiday? All right, all right. Well, we're approaching I think one year following deal close and I asked – I suspect the strategic rationale for why you did the deal is still very much intact. But we're even getting questions on that front from investors, right. People are so pessimistic about streaming, you know there's just big questions that are out there. So I'm just going to ask you to just sort of describe the strategic rational at the time of the deal. Has anything changed in terms of the strategic logic for the transaction? And then, things that you've learned over the last year that you think are most salient that maybe you didn't know a priority. Yeah, we've learned a lot. Let me take a step back and set the table a little bit if you don't mind. The conference here is really timely for us this year, because the beginning of 2023 really marks the beginning of a new chapter for us; we're closing chapter one, we're opening chapter two. You are 100% right, there was a lot of discussion last year around what was going on with Warner Bros. Discovery; what was going on in the industry? Our team has worked really, really hard throughout the entire year, literally 24/7 in many parts of the company. We had to come in strong and make very swift decisions. David put a top leadership team in place and in a way we were able to take advantage of the fact that a new team was starting as a new combined management team for a new combined company, and we took advantage of that, and we took the courageous decisions that had to be made, and what’s interesting to me is that a lot of that was seen through the lens of synergy, integration, you know the debt, etcetera. The reality is it had very little to do with that. The industry change that has been going on over the past 18, 24 months has been pretty dramatic and the new team that David put in place with CEO’s for each of the business units, they just did what had to be done, which is take a fresh look at what's working, what's not working, what parameters have changed? How are we going to look at content investments? Where are we going to spend? How are we going to collaborate across this integrated portfolio? And they quickly made the right decisions to set the company up. So 2022 was a year of restructuring. 2023 is going to be a year of free launching and building on the great foundation that was laid last year. And to get to the point of the strategic thesis, I think it's not only intact. I think the long term earnings potential of this combined company may actually be greater than what we thought we were going to find when we initially started debating this deal and put together our initial models. And the way David had laid out the three strategic pillars, the unrivaled ability to generate world class content on the one hand, an unparalleled distribution footprint with access to all monetization windows and cash registers around the world on the other and then combining those two with a professional one company management approach. That's intact, and we're actually seeing a lot of great proof points that are starting to come through. On the content side, we talked a lot last year about the enormous success that HBO has had with 37 Emmys and Warner Brothers TV as well with another 10 or 11 awards on top. We were going into 2023 with a much greater slate. We're going to be ramping up production across large parts of the company. You'll see twice as many theatrical releases. We've got some exciting games coming up. So on the content side, we're in great shape. On the distribution side, we've always been very clear that we're viewing Warner Brothers Discovery as one portfolio, a balanced portfolio of media assets and media outlets if you wish, never sort of going all in on D2C, never going all in on linear or theatrical. It's about the combination of all of these platforms and we've seen very positive signals. The theatrical world has obviously recovered, not you know to the pre pandemic levels, but a very solid year relative to the performance in ’20 and also ’21. On a linear side, our affiliate teams have worked 24/7 throughout the fourth quarter. We renewed deals worth more than 30% of our U.S. affiliate revenue in the fourth quarter, across the affiliate landscape, bringing the entire value of this portfolio to the table. Got these deals coterminous and it's just a great proof point for the value that our linear portfolio is bringing to affiliates and to our consumers, our viewers and that gives me a ton of confidence. We got a lot of questions about what's going on in the linear world. Sure, there's a lot of longevity in that business and I think the deals that we've been able to strike are a wonderful testament to the value of that business. But also on the D2C distribution side, the teams are really working hard at getting that combined product launch in the spring and they are on track. That's going to be very exciting to finally bring together our Discovery+ and HBO Max. But we've also made significant progress within the existing technology footprint. We've seen continued subscriber momentum through the fourth quarter and that is despite a certain amount of pullback on the branding and marketing side, obviously in an anticipation of the new product launch, so that's very pleasing. We've launched the Amazon deal in the fourth quarter, but across the board, we've seen better engagement, better churn than we had originally modeled. So net-net we put out this long term vision for the D2C business as one additional element of an integrated media portfolio with a U.S. breakeven in 2024 and then a billion of global profits in 2025. If anything, I mean, we're doing a little better than what we had modeled out, than when we put that together and so great progress on that front as well. And then maybe most importantly, I can't emphasize enough the idea of managing this company professionally as one company. That's been the most fascinating part of the journey that we've been on for the past eight, nine months. The top team that David has put in place, you know some of the greatest creators in the industry, running their own business units, but with the greater benefit for Warner Brothers Discovery in mind, there is so much data that historically hasn't really been used in the decision making and the team is collaborating really well when we discuss winnowing, when we discuss allocations. We're in the second or third inning when it comes to setting up the tools and processes. But the team is collaborating really well. And importantly, from my perspective, we really have command and control over the business now. There were some surprises in the first months of the combination as you know, but you know we put out the guidance for this year in the summer and I've been very, very pleased with all of our operating trends over the second half of the year. And as such, I feel confident that we'll get to those improvements that we've been talking about, much better cash flow generation, growing the process, flowing through the value capture from our transformation activities and I think we're really on track for a lot of asset value creation and free cash flow generation. So, with that in mind and with the scale that we have, with the creative talent that we have, the global distribution footprint, if anything, as I said at the very beginning. I think the thesis is stronger today than it was 18 months ago. Super interesting. This – you know this – listening to investors is interesting. I'm just going to sort of tell you, sort of a quick narrative, but when interest rates were very low, of course, everyone just wanted growth and then interest rates went higher and everyone wanted profits. And, what's been interesting is we started to get questions from investors where they are saying people shouldn't do DTC. We should just have a bunch of media companies to become wholesalers, right. They should just feed their content to others, right, and that's what I meant by people sort of challenging the strategic rationale of the deal. But what I'm hearing from you is it's, no change in message, no change in strategy. We're just executing and willing to you know reiterate all of those long term targets. And look, but as I said Jason, the truth is in the middle, right? I mean, we’ve been very, very clear. I mean David said in the very beginning of this journey, something like, we're not in it to - or we're not trying to win the spelling war. About how good the content is, not how much and there's no doubt to me. Look, we got a lot of public noise about some of the content write-offs that we took, which is a reflection of an industry that went overboard and that went on a spending frenzy. There was a lot of thinking of, let's do more and more and more, not necessarily let's do the exact right things. Let's do what works. We've said before, we have the ability, the benefit to be Monday morning quarterbacks here and Mike and Pam on the film side and Channing and Casey and Kathleen, they are all going in and taking stock. It's a new day. They are looking at what works, what doesn't work. They made these decisions. We took a little bit of time to make sure that we do it properly. For some of the titles we found new homes elsewhere, etcetera, that's why this took six, seven months. But I think we've come to great solutions and most importantly, we're done with that chapter. That was very important to all of us to really use 2022, you know leave the purchase accounting behind us, leave those initial strategy changes behind us, get it all out there in terms of our restructuring estimates and then be able to turn the page and move forward. And again, I think the team has laid a great foundation and really excited about the growth from here. Okay, so with that behind us, there's also the macro environment and of course everyone has been on pins and needles since March I would say of last year about this broader economic slowdown. And I think even you have sort of – your firm has made some comments about maybe less visibility into the ad market in the past. So can you just talk about your view of the broader sort of ad market and as you sort of talk about those long term targets that you talked about on the DTC side or overall leverage. What sort of macro environment are you contemplating? And against that backdrop, we had actually been pretty clear since as early as last summer about the ad market being a risk factor and we spoke about it. The good news is that, you know when we put together our guidance for this year, you know that was a scenario that was in mind and we you know actively managed the company from as early as August, September with these environments in mind. So that's back to the command and control point, you know no big surprises here. That said, in the meantime, you've heard from others as well that the trends have just not been great and I think it's fair to say that trends have also not gotten better. If anything, gotten worse through the course of the fourth quarter from a U.S. ad market perspective. And while we're seeing some small green shoots for Q1, I wouldn't want to call the turn here yet. It’s a little more mixed, good and bad internationally with some - we've got some markets that are equally negative, such as the U.K., Germany, but we have other markets like Poland, Italy, Latin America for a wide part of the of the footprint there that are actually doing fairly well. But again, what matters to me is this is short term noise. Yes, it's obviously high margin flow through of these revenues, but I have no doubt it's going to come back. And again if anything, the most recent experience with you know our affiliates and the deal renewals shows that there is an enormous value in that ecosystem and we've always seen it come back, and I have no doubt that when it comes back – and I'm not going to make a prediction, you know if that's going to be in Q1, Q2 whatever, we'll find out. I don't know that any better than anyone else, but I have no doubt that when it comes back, we're going to be participating disproportionately just because of this enormous reach of our portfolio. The ability to optimize content spend across this this broader network portfolio. And frankly the fact that we're still in the ad market monetization, that we still have catch up potential that we've been able to chip away again and again for the past couple of years. That's great. On synergies, you recently raised the long term synergy target from three to $3 billion to $3.5 billion and said $2 billion of that will come this year. Based on the work that's underway, I assume nothing's changed on the synergy front. You still feel good about that? Yeah. Look, this is actually one of the most inspiring parts of this combination for me. We're essentially doing the same thing again that we've gone through with Scripps and Discovery. We've got a proven methodology. We've got an experienced team that's done this before and I was just exchanging emails over the holidays with a number of the individual initiative owners. And it's just, it's so great to see what you can unlock with a delayer organization with people feeling that they actually have the ability to make a real impact. To come up with an idea, put a price tag on it and then and then grab the ball and run. It's absolutely amazing, it's contagious and it's spreading through the organization. And as I said earlier, you know we set this original $3 billion target. Obviously the pipeline is much, much fuller than that and that's why you know raise the expectation to $3.5 billion in terms of delivery. We're still adding ideas to that funnel and I have full confidence in what we said earlier that we're going to see at least $2 billion of additional value capture flow through. But I also want to reiterate that was - this started as a synergy program. It’s really a continuous improvement program. We are just consistently and continuously looking at how we're running the business, how we're running the company? What makes sense? What doesn't make sense and we're setting up the company for you know future growth and value creation, regardless of you know the integration or the transaction in and of itself. But there’s a lot of opportunity and as I said before, part of the upside here is that we're really integrating five or six companies given the very divisional set up and frankly, you know suboptimal system and process set up for large parts of legacy Warner Media. So, in terms of the $12 billion adjusted EBITDA guide for this year, you I think recently sort of – relatively recently added a caveat of assuming a normal ad environment and I was just wondering if the sort of slight erosion in ad market that you've talked about that’s sort of happening now, if we end up in just a sort of a plain vanilla recession, you know not a COVID recession, not a great financial crisis recession, just a plain vanilla recession, how would you help investors sort of frame? How they should think about the downside of that $12 billion dollar number. If it's not a normal ad environment, it’s just a normal recession. Well, what is a normal recession? So, we're still working through the various scenarios and haven’t finalized a budget, so I want to be careful here with sort of giving out any new numbers. But a couple of things I think that are worth considering to your point from the perspective of how should investors think about it. You know the ad market environment clearly is the number one swing factor, you know positive and negative, and as I said, I'm not calling the turn here for Q1 and we'll wait and see. The things that we're focusing on is what we control and there's a lot of very positive building blocks that are going to come through. We've already covered the incremental $2 billion in value capture for next year. There is going to be as we indicated before, significant improvement in the profitability of the of the D2C business, and again, just taking a step back, we've got this amazing combination. We're making the tech investments that are necessary, but that's essentially just one time, you know resetting it to a new technology backbone and then obviously you got to keep maintaining that, but it's an investment that we're making right now and then you know we very soon should have a state of the art set up there. On the content side, I have no doubt that we’ll always be more efficient than anyone else, because we have that great access to talent, to creativity. We have a massive IP library that we can exploit. We have the data to inform decision making here, and frankly we have this global footprint that we're utilizing our content on, not on one single platform. So I think we're going to – we're always going to have a competitive advantage here. And then frankly one thing that we have started leveraging much more and that we're going to see more of next year as well is this enormous marketing power that the company has. We're reaching you know tens of millions of people every day in the U.S. alone, and we're harnessing that to get behind our key content priorities, etcetera. So that's going to be a significant positive driver for next year as well. You know on the revenue side as I said before, you're going to see a very significant increase in film output, content in general, games as well. So there are a lot of positive building blocks that we at least to a large extent control. The big negatives or question marks are what the environment is going to be like? I'm not going to lay out any sort of you know base case, upside/downside case scenarios. You guys all know that as well or better than I could model it, but that's really the question mark right now. Okay. So I don't feel like you gave yourself enough credit early on in the conversation, and that when investors were clamoring for growth, you guys always focused sort of on this DTC business, you know being from profits and for being more balanced. But I want to ask you a question about content spending. You said theatrical releases will go out, but what do you think is going to happen to aggregate contentment spinning across the whole industry? Do you feel like we will look back on 2021, 2022 and say, wow, that's the high watermark and everyone will begin to get a bit more disciplined and content spending will go down in the aggregate, not just on DTC, but just in the aggregate? Well, I wouldn't go so far to call it a high watermark, but what I will say is, you know as you all saw very publicly, we shaved off a lot of the excess last year, and I think that's something that everyone else in the industry is going to go through. We're coming from an irrational time of overspending with very limited focus on return on investment and I think others are going to have to make some adjustments that we frankly you know have behind us now, but I think that is going to be a factor. For us though, you know we've right sized the content spend again. I think we have a huge advantage in the enormous amount of data from all the different consumer touch points that we have. I think we're going to get a lot better in allocating capital and we have every intention to continue spending. Content is the life blood of this company. We are a content company. Again, we've got the ingredients in place. It's obviously a hit driven business, you win some, you lose some. But if you look at the creative lineup that David has been able to assemble. This is a first flight lineup of creative talent and I got so much positive feedback on some of the announcements. James Gunn and Peter Safran are working on a DC lineup and are you know getting close to being able to communicate with the plan. We got Channing, we got Casey Bloys with his winning team in place, so we've got that. Some of these changes might take some time, obviously given the lead times for content, but we've got the team in place, we've got the most iconic IP and brand portfolio that I could think of. We've got a global footprint, we've got the data and we're putting in place the management system to bring this all together. So from the perspective of the ingredients being in place, I don't think we could be in a better position and now we got to execute. How much on content spending, since we don't really know how the linear business will fare, right? And we don't really know exactly how the DTC business will fare for the industry. How much fungability would you say that there is across those two buckets? I mean clearly sports is sort of a contractual piece that'll just push to the side, but as investors sort of think about how much flexibility you have in terms of where you direct the funds for new content, how would you characterize that? Well, to your point about sports, there is some flexibility there as well that we can talk about, but look, I think that's one of the great strengths of what we're putting together here. We've got this massive library and we've got all these platforms and one area where you know if you look at what we did last year, we made a lot of you know small steps into experimentation. There was a Thanksgiving West Wing Marathon on HLN. You know those are the kinds of things that's small individually, but you got to try these things. We've got this massive library; we've got this portfolio of networks. That was one of the big drivers for the success of the scripts discovery merger that we were able to play with programming strategies a little bit. Kathleen has perfected this and what's exciting right now is that the new team's willingness and ability to cooperate and talk about, you know you got that in your library, can I try this here and to talk about the windowing and to for the first time ironically, to bring together all the data that we have and all the knowledge that we have about you know what works, what demos were sort of over indexing, etcetera. We can bring that all together and so as such, I think there is going to be an enormous amount of flexibility and you've seen in some of our decision making already that we're willing to take that perspective and make rational decisions and we don't have to have everything, every last title fully exclusive. There may be other ways to monetize internally and you know at times externally as well and we're willing to you know run the numbers and form a strategy and make those decisions. And come to the right answer. You want to touch on the sports point? You brought up sports where you said there was some flexibility. Look, I mean yeah, we do have flexibility in most of the deals, at least from a simulcast perspective. Again, I think what's important for the sports discussion is that linear is still by far the most important platform for our sports monetization by a wide margin, right. So you know some of these discussions about the transition seem a little premature, because the linear reached to us, even the most successful streaming case studies. But it's important to have that flexibility. It's important to be able to experiment, to dip a toe in the water and you know we've seen some real success in the streaming space for sports in Europe, where with our Eurosport asset, the Olympics deal, we found a way, you know not as a fully integrated bundle, but as a sell through tier to generate some value. So it's important to have that flexibility there as well. But again, the other point is, you know for a decade or so, especially in the U.S., you know the big rights are going to be locked up on linear, so there's a lot of longevity there as well. Okay. When you bring Discovery and HBO sort of under a single app this year, what is it – are there any sort of – it feels like something that sounds easy to do, but actually seems pretty complicated when you think about it. So can you spend a second and just talk about some of the things investors should think about and some of the tactics you're pursuing to sort of minimize the disruption as that occurs? Well, the most important point is the decision that we've already made a while back, which is to rebuild the whole thing. I mean and that was a little frustrating, because we all wanted to get out and you know get the new – get the products combined, but the reality is you only get one chance for a first impression with the consumer and we're not going to launch something that's not adequate and I have great confidence in the team. They are moving this project along. We're going to come out with a great product from a consumer experience perspective and that's frankly the biggest holdback for HBO Max right now, that the experience is not where it needs to be. We have made… Sorry, when you say the experience is not where it needs to be, is that just in terms of the user interface, is it in terms of sort of software flexibility that the consumer has within the… ? I don't want to go too deeply into the sausage making, but it’s both sides. It's also I think the product team as well. Let's just say it's not – it's not manageable as efficiently as you would like a modern day technology product to work. But more importantly from a consumer perspective, and we've made great progress but you know given this example before of the end card where you did not – you know after finishing a season did not get the recommendation for what's next. So we've got this bifurcation of the greatest content in the world, not getting Five Star ratings for content, but then a subpar consumer experience. The team has made some improvement and the exciting thing is that even without relaunching the full technology stack, we're seeing improvements in our metrics. Engagement is coming up, churn is better. As I said, through the fourth quarter, you know we've retained more with the House of the Dragon gross ads than we had originally modeled. So there's a lot of positive, green shoots, but definitely more to do. Then the second point is again, the fundamental thesis of this combination is the synergy between the event driven HBO Max, HBO content on the one hand, and then the daily engagement. Hours and hours of daily engagement from, Discovery+ and again, we've done some content ingest experiments here and are pleased with the early results. And again, to your point, we're going to we're going to make it as seamless as possible. There's a whole team that's focused on how to manage the transition for the existing different types of HBO Max subscribers, different types of Discovery+ subscribers, and I'm confident that we'll manage that appropriately, take the time. But the key thing is to sort of – you're focused on is sort of trying to minimize the churn as this transition occurs. Is that the right way to think about it? Okay, all right. So we talked a little bit earlier about the street being very focused on profits and one of the things that I was struck by is just the enormous disparity and the profitability. And I'm just going to pick two companies of Netflix's DTC business versus Disney’s. And as I've gone through the numbers as carefully as I can, I talk to the byside, everyone sort of agrees that that disparity is really mostly an ARPU issue that seems to be the consensus. And it just raises the question of, are the new DTC apps that are launching? Do they have sort of the right pricing or do you think they are sort of priced too low because everyone was in this sort of catch up phase to try and get sufficient scale, whereas Netflix did this over a 12 year period or something. It was land grab. I want to – before I answer the ARPU part of that question, I want to go back to profitability overall. I mean as – I want to be absolutely clear, we put out this trajectory that we're working towards and everything I've seen since we put that out has been in line, if not better with what we put in the plan. You know we are more efficient on the marketing side than we modeled. Again, we've rectified a lot of that content exuberance as I would call it. I think we're going to get you know a great technology platform going and we're seeing the most important point starting to happen, which is getting that churn rate down you know. So I feel very, very good about the – let’s call it the infrastructure and cost side of the business, but to get to the core of your question, there's no doubt that these products are priced way too low. I think JB or David maybe on one of our earnings calls. When they do the detail here saying, look, the idea of collapsing seven windows into one and selling it at the lowest possible price doesn't sound like a very smart strategy, and I think you know there was this partly capital market fuel phase of land grabbing. You couldn't lose enough money and couldn't grow subscribers fast enough. I think that's behind us. And if you look at trend lines over the past 24, 36 months a number of the players have started gradually bringing up prices. So I think there is a there is a there is a building consensus that you know this phase of dumping pricing is over. And again, I think we're bringing something to the market. We will with the combined product bring something to the market that I have no doubt is going to be the best streaming product in the marketplace and we're not priced at that level right now in the U.S. more so internationally. Again, a lot of the initial push when HBO Max was rolled out internationally was strive for the largest number of subscribers, not necessarily value. So there's a lot of, opportunity, I think, as deals come up to adjust pricing on the positive side. And then as you know ARPU is more than just pricing. The ad monetization for the ad like tier I think is a major factor with a number of elements. We'll get more engagement, more subscribers, but then importantly pricing power, CPM upside from better reach, better scale, better data, better targeting. So I think there's a lot of upside opportunity from an ARPU perspective in the industry. Seems like that's one thing the industry has done really well in terms of for you guys and everyone else. Just sort of setting the difference between the ad tier and the ad free tier such that the economics or your neutral to positive right in terms of the… [Cross Talk] It's classic segmentation and that's why David has been talking a lot about a fast segment in the market that historically we haven't served very well yet, but that we're going to do more for. But there's the premium segment that there's the ad light, a little more price focused and tolerant for advertising and then there is a segment of people that are not going to be willing to pay. And like no one else, we have the ability to cater to all of those audiences with a very well segmented product and content offering. Okay. I think there's a growing hypothesis on the buy side that after we saw Thursday Night Football go to Amazon and Sunday ticket go to Alphabet. Then more and more sports are going to go you know over the internet as opposed to linear. And then the question becomes, if sports are going to be consumed over the internet as opposed to a linear package, some sort of streaming service, should it be bundled inside the DTC offer and people say, oh – some people say, oh, that would be great. It keeps engagement up and it lowers churn. And another investor says no, no, no, you're just going to go down the same sort of path that we went on the linear side, where the non-sports fan is going to be subsidizing a sports fan, because the sports costs are going to be so expensive inside this app. And so there's a fillet - it seems like a once in a lifetime opportunity to sort of correct past sins or adjust the business. But at the other time I could see it being quite enticing to say, well we're just going to layer in sports and we have to get the churn down. So can you can you just – do you agree with that sort of construct first of all, and then do you have any emerging hypotheses in terms of what the right answer is. I generally do agree, frankly because we've seen some success with that tiered approach and in our own European operation. And then also if you look at just generally TV markets that are – they are better or worse, the markets that are a little more a-la-cart in Europe, yes, they've – well, we’ve never gotten to that level of monetization, but they are also holding that value much better today than the markets were – you know it was an absolutely stuffed turkey with everything and everybody had to take it all, and so… But for us importantly, a couple of points I want to make. Number one, sports is a key part of our strategy. We've got this great global footprint with a strong presence in the U.S., but also Latin America, Europe, so it's a natural place for us to play. But number two, we're always going to be super disciplined. It’s easy to overspend on trophy assets. We've got a great sports rights portfolio and we'll look at everything, whatever comes up and we'll look at it, through the lens of financial discipline and strategic discipline. And again as I said, I think we're bringing a lot to the table given the capabilities that we have and given the reach we can create across platforms and across the globe and so I feel very good about our position in that business. So you've talked about 30%, I think 35% to 50% of EBITDA converting to free cash. Can you just talk a little bit about the swing factors that cause that number to be lower or higher? Is it just a simply function of we spend more on content than we amortize or is it more nuanced than that? No, it's more nuanced. That is part of it, frankly. The single biggest factor is to just generate more profit, you know because with a higher EBITDA number you know cash conversion automatically comes up and that's the core part of our plan. And as I said, we've got a lot of initiatives lined up, that's a super important point. You mentioned another one, the balance between content amortization and content cash then, which is something that is well and this, let’s call it in this industry. You know there was a lot of focus on the P&L, not so much on the balance sheet and cash flow and I think we can rectify that, and as a matter of fact we have taken some measures to bring those two a little closer together, which is healthier for the business in the long run. But there is a lot of other below the line opportunity as well, but over time from delevering from finishing up our restructuring. Those are important factors that are going to go away; lower interest expense, lower restructuring cash out. But I also see an opportunity in working capital. Again, it's something that hasn't been a huge theme in the industry. We're putting in place the instrumentation to properly manage for free cash flow, which hasn't been in the place in the past and there is enormous opportunity there, you know once we get all that in place and as I said, I mean very, very pleased with the command and control that we've been able to implement already. I'm seeing great improvement in this company's cash generation against that target for next year with 33% to 50%, but remember we've also said, long term I think the cash generation capacity of the company is even greater than this and we're chipping away at that opportunity. Then you know obviously there's a lot of focus on leverage and some of our discussions as I said before, I'm very, very happy with the capital structure that we put in place. Long dated, cheap debt, we don't have a lot of maturities coming up. We don't have a lot of variable interests, so I feel great about that, coupled with the cash generation potential of the combined company. And we've also started a review. As David has said several times, we're not looking at any strategic asset sales, but beyond that there is opportunity. There is – there's a real estate portfolio where there may be, better structures for us to just generate some liquidity and we're in the process of analyzing a lot of the – call it, you know less visible noncore, parts of the portfolio.
EarningCall_1510
Good morning. I'm James Gordon, JPMorgan European pharma and biotech analyst. And today, I've got the pleasure of introducing the GSK presentation. You're going to hear from GSK, CEO, Emma Walmsley, and we can have the Q&A after in this presentation room. Thank you very much, James. Good morning, good afternoon to anyone that's watching a very Happy New Year to you all. And let me say, of course, how absolutely wonderful it is to be able to attend today's conference in person. Please turn to our usual cautionary statement regarding forward-looking statements: first, and then please turn to slide three. Today, I want to leave you with four key things: firstly, GSK is now a focused global biopharma company with a unique strategy focused on the prevention and treatment of disease. We are a world leader in infectious diseases with an exciting pipeline of vaccine and anti-infective medicines and an emerging portfolio based on the science of the immune system. We are delivering the step change in performance and competitive outlook that we promised and will meet our performance goals for the decade ahead, delivering health impact sustainably and at scale. Please turn to slide four. One year ago, I told this conference that 2022 would be a landmark year for GSK with the prospects of the most significant corporate change for the Company in 20 years, alongside a new chapter of competitive and profitable growth. And I am pleased to say that we delivered on all aspects of our commitment. GSK is now a focused global biopharma company with the ambition and purpose to unite science, technology and talent to get ahead of disease together. It's a company focused on the science of the immune system, human genetics and advanced technologies with world-leading capabilities in vaccines and medicines development across four key therapeutic areas. Through ongoing improvements in R&D productivity and operating performance, we're unlocking the potential of GSK. And our bold ambitions are reflected in our commitment to attractive growth and a significant step change in delivery over the medium term. And through the demerger of Haleon, a world-class consumer health care business in its own right, we've strengthened our balance sheet, creating additional flexibility to invest in growth and innovation. Turning to slide five. We've delivered exceptional progress in our transformation and performance and there's more to come. In innovation, we've built a pipeline of 65 vaccines and specialty medicines, many with the potential to be first or best-in-class, and we've strengthened our pipeline and platform capabilities with smart business development. We've also achieved industry-leading milestones, including the approval and launch of the first long-acting HIV medicines and the U.S. FDA regulatory submission acceptance of the first RSV older adult vaccine candidate. In performance, alongside the successful Haleon demerger, we delivered strong double-digit growth in sales and adjusted operating profit in the first nine months of 2022. We raised our full year guidance twice -- our mix has improved with vaccines and specialty medicines representing nearly two-thirds of our sales now, partly due to the tremendous performance of our shingles vaccine, Shingrix. This all puts us well on track to deliver our attractive medium-term growth commitments. And we also made excellent progress on trust, consistent with our high ambitions for patients and our people. We maintained our number one position in the Access to Medicines Index for the eighth consecutive time. And we ranked second in the industry in the S&P Corporate Sustainability Assessment. Turning to slide six. To sustain this step change in growth-based performance, we're prioritizing our investment in vaccines and specialty medicines, which we expect to grow to around three-quarters of our revenue by 2026. General Medicines, our primary care business will still remain an important part of GSK, optimized for profitability and cash flow. By prioritizing investment in vaccines and specialty medicines, we'll realize the increasing opportunities across the prevention and treatment of disease. Here, we believe we are uniquely positioned in terms of our strategy and capabilities. Turning to slide seven. We're focused on four core therapeutic areas: infectious diseases and HIV represent around two-thirds of our pipeline and are our primary focus for R&D. In immunology, respiratory and oncology, we're taking a focused and pragmatic approach, prioritizing programs using human genetics, functional genomics, AI and machine learning to drive probability and pace of success. We're ambitious and agile in our commitment to deliver smart business development to support future growth, too. Our focus is on vaccines and specialty medicines that address high unmet medical needs and deliver, of course, on our R&D strategy. Turning to slide eight. We start from a strong leadership position in infectious diseases, specifically in vaccines and HIV. In the last 12 months, the combined sales of our vaccines, HIV and anti-infectives portfolio exceeded GBP13 billion, around $17 billion, and that excludes the Pandemic solutions. Together, these categories now account for over half of GSK sales. We supply the broadest vaccine portfolio in the industry. We lead innovation in HIV and we play a continuing and meaningful role in antibiotics through familiar established brands such as Augmentin. Importantly, this combined portfolio is delivering strong growth with vaccines up 20% in the first nine months of ‘22 and HIV up 9%. Turning to slide nine. We have a long history of innovation in vaccines. We vaccinate 40% of the world's children. We helped to drive the adult vaccine market with our groundbreaking shingles vaccine, and we've built a leading position in global health with relevant innovation, scale, access and tiered pricing. We've built our leadership in vaccines over many, many years, and we supply 25 vaccines across 160 countries with market-leading positions in multiple key categories, including pediatrics, meningitis and shingles. We have world-class manufacturing, regulatory and technical expertise, creating high barriers to entry in this highly attractive category. Vaccines require significant initial capital investment, large community-based trials in healthy subjects and complex manufacturing. And all of this results in long durable life cycles with no medicine like patent cliffs. Governments also increasingly recognize the value of vaccination programs in preventing disease, reducing the burden of hospitalization of course, and contributing to population health and therefore, economic growth. We have a deep, innovative pipeline of vaccines. In ‘22, our pivotal RSV data was a key highlight in a strong year of R&D delivery, which also saw us gain the first WHO prequalification from malaria vaccine and its relentless innovation that drives our growth. With the help of more than 50 new product launches, our vaccines business has grown sales at a 10% compounded annual growth rate since 2000. And over the period ‘21 to ‘26, we expect it to deliver at least high single-digit CAGR, excluding pandemic sales. Turning to slide 10. Technology is at the very core of our strategy. We have the broadest suite of vaccine platform technologies available, allowing us to select the right approach to develop the best vaccine for each pathogen, whether it's a virus or bacteria. Among the many we have at our disposal; we have three key platform technologies. Our adjuvant portfolio is a particular area of strength for GSK. We're applying the AS01 adjuvant used in Shingrix and several pipeline opportunities, including our RSV vaccine for older adults. The second platform is mRNA, where we're pursuing advances through our collaboration with CureVac and are increasing internal capabilities. The third platform is MAPS technology, which stands for Multiple Antigen Presentation system. This allows us to target complex pathogens that have multiple serotypes. With the help of this powerful suite, we built an industry-leading vaccines pipeline, which I'll highlight here on Slide 11. This vaccines pipeline includes 23 projects, most of which have first or best-in-class potential. Among the 15 mid- to late-stage development opportunities, we have several promising vaccine candidates based on high unmet patient needs and attractive commercial potential. We're excited about our meningitis ABCWY vaccine and our next-generation 24-valent pneumococcal vaccine. Our earlier stage pipeline includes innovative vaccine approaches to important diseases including our first mRNA candidates and targeted immunotherapy against herpes simplex. For today, though, I'm going to focus on our RSV candidate for all the adults, which we consider to be best-in-class. Turning to slide 12. The unmet need here is very significant. RSV is responsible for 420,000 hospitalizations and 29,000 deaths annually in developed countries. RSV disease is a substantial burden in the elderly with almost half of all U.S. cases seen in the. Our groundbreaking pivotal data demonstrated unprecedented efficacy in older adults with 94% protection against severe RSV disease. Importantly, efficacy was high and consistent against RSV A and B strains in people in their 70s and those with comorbidities. This last group is highly significant as over 90% of adults hospitalized with RSV disease have underlying medical conditions. These patients suffer the most and have the most significant impact on health care costs. We submitted these data as part of a comprehensive package, which includes data demonstrating that the vaccine can be safely and effectively co-administered with an influenza vaccine. We've already received acceptance of our regulatory submission by the U.S. FDA, the EMA and the Japanese regulators. And in the U.S., we're undergoing a priority review with a PDUFA date of the third of May 2023, which puts us on track for the important ACIP meeting in June. Given the scale of the unmet need and our potential to positively impact the health and well-being of vulnerable adults, we're confident our RSV vaccine represents a significant commercial opportunity for GSK with multibillion pound Shingrix-like annual potential. Turning to slide 13. Moving from vaccines to anti-infectives, we are well placed to meet some of the biggest global challenges. Chronic hepatitis B is associated with close to 1 million deaths annually and hundreds of millions of people are living with this disease. Our antisense oligonucleotide better reverse in has the potential to provide a first-in-class functional cure for this disease. We recently presented data that showed that Bepi alone or in combination can deliver a sustained reduction in viral DNA and surface antigen key efficacy measures. We expect to start a Phase 3 study this half year and we'll update you more next month. Antimicrobial resistance also represents a critical threat to global health and well-being of so many. It results in more than 1.2 million debt annually, and that's expected to grow to GBP10 million by 2050. We have a portfolio of agents addressing several resistant bacterial infections. Our most advanced asset is gepotidacin, which has the potential to be the first novel antibiotic, oral antibiotic for uncomplicated urinary tract infections in more than 20 years. Following the early stop of the two pivotal studies for positive efficacy, we plan to file a new drug application in the U.S. for Gepo in the first half of this year. Turning to slide 14 to HIV. We continue to be at the cutting edge of developing new options for patients for treatment and prevention. This slide lists several accomplishments that speak to our pioneering innovation. I'm not going to mention all of them, but I want to highlight that we developed and launched the first second-generation integrase inhibitor, the first two-drug regimen, the first long-acting injectable regimen for HIV and the first long-acting injectable for PrEP. Turning to slide 15. Our HIV portfolio is going to transform in the next decade as our pioneering innovation advances the standard of care. Over the five years to 2026, we expect our HIV business to grow at a mid-single-digit CAGR driven by our two-drug regimen, Dovato and by increasing contributions from our long-acting agents Cabenuva and Apretude. By 2026, we estimate long-acting regimens will generate around GBP2 billion of our sales around one-third. By the second half of the decade, we expect cabotegravir to increasingly replace dolutegravir as the foundational integrated inhibitor in our portfolio, and this will allow us to manage the loss of exclusivity of dolutegravir at the end of the decade. So, while dolutegravir-based products currently account for less than 20% of GSK sales, we expect this proportion to decline substantially to around mid-single digits by the time of the LOE. Additionally, we have a very exciting development pipeline of innovative medicines that may offer new self-administration and ultra-long-acting options. Together, we expect these to sustain our leadership position and drive growth as we look into the next decade. Turning to Slide 16. In June 2021, a we set out commitments to grow sales and adjusted operating profit. I think it's -- yes, thank you and adjusted operating profit by CAGRs of more than 5% and more than 10% over the period to 2026. We also provided granularity on the expected outlook by business as well as for our operating margin and our cash generation. And we are delivering on all of these commitments. Our 2022 guidance is for 8% to 10% sales growth, and adjusted operating profit growth of 15% to 17%. Each of our businesses is performing in line with or ahead of our medium-term objectives, and our margin and cash flow are all trending positively. And as a reminder, we have negligible exposure to losses of exclusivity over this medium term. So, we remain highly confident that we will deliver the significant step change in performance that we promised. Turning to slide 17. Taking all together, the dynamics in our business, attractive medium-term growth from vaccines and specialty medicines, increasing contributions from our late-stage pipeline assets and our very manageable LOE exposure we are very confident in our ability to deliver our long-term sales ambitions. And I remind you that this sales ambition doesn't include the benefit of our developing early-stage pipeline or business development for which we have now increased capacity following our demerger. We expect GSK to be a growth company, not just for the medium term, but through this decade and beyond. Turning to slide 18. And how we deliver this growth matters deeply to us. At GSK, we continue to be guided by our purpose to unite science, technology and talent to get ahead of disease together. Integral to this is running a responsible business, which builds trust and reduces risk for sustainable health impact, shareholder returns and supporting our people to thrive. We've prioritized our resources to focus on the six material areas depicted here. And as I mentioned earlier, our leadership and progress in access to medicines and sustainability have been recognized in external rankings. Over the next decade, we will deliver health impact sustainably and at scale with an ambition to positively impact the lives of 2.5 billion people. Turning lastly to slide 19. To summarize, as we enter 2023, GSK is a focused global biopharma company that is ambitious for patients and its people and has a unique strategy based on the prevention and treatment of disease. We have compelling prospects as a world leader in infectious diseases with an exciting late-stage portfolio of vaccines, anti-infectives and specialty medicines and an emerging pipeline based on the science of the immune system. We are delivering a step change in performance and growth. And most importantly, we are very confident that we will sustain growth through the decade and beyond to deliver human health impact at scale. We have a very exciting future ahead of us together. With that, I'm going to ask my colleagues, Ian, Tony, Luke, Deborah and David, to join me up here, James, and we'll move to Q&A. Thank you very much. Just as a reminder while people are taking their seats, so this is a Q&A where you can ask questions couple of ways, you can register for your questions through the websites and I can readout your questions, but also if you're in the room and you want to raise your hand as long as I can see you, we'll get mic in front of you. Maybe Emma, do you want to introduce you up on the stage with. This is the dream team in the industry. We have -- I'll go from my left. So, David Redfern, who leads all of our corporate development and also chairs Dave. Tony Wood, our Chief Scientific Officer, to leading R&D. Luke Miles, Chief Commercial Officer; Deborah Waterhouse, the CEO of ViiV, our HIV business, and Iain MacKay, our CFO. Great. Thanks very much. Does anyone have a question they'd like to start with? In that case, I'll go to the first question I had, which was just in terms of the priorities within the pipeline and from a therapeutic perspective. So, oncology seems to be listed towards the end in terms of focus areas. So, can you talk about where is the focus now? Is oncology going to be a big part of GSK going forward? Or is it less of a story now and more of the story is going to be anti-infectives? Well, maybe I'll start answering that and then perhaps Tony, you can pick up on how we think about allocating capital, both organically and inorganically. When we laid out the strategy for change at GSK to drive this transition into being a growth and a profitable growth company again, a big part of that was reinvesting in R&D and driving a shift in the portfolio. And for that, we said we wanted to move away from being more of a general medicines business to really prioritizing specialty medicines and vaccines. And that has already been a big shift in 2018. I think specialty medicine and vaccines were 44% of our business. They're now at two-third. We'll get to them being three quarters. It's important for the economic mix, but it's also where a lot of innovation and new technology platforms are coming through. Within Specialty Medicines, we've consistently said that there are four key therapy areas, and that's in infectious diseases, HIV, which is, of course, a big business for us and the key infections disease and then immunology respiratory and oncology. Now in our pipeline, two-third of it today is in infectious diseases and HIV. So be fair to say that's where our priority is, but we remain extremely committed to these other areas of our specialty portfolio and are excited about some of the things that are coming through. But I think it would be fair to say that in share of voice and both the actual size of the business today and contribution to growth, it's a bit smaller, but some exciting things happening, both inorganically in terms of our progress. I mean on oncology, we've got Ruby coming through, but also -- sorry, organically, but also inorganically when we got the launch of momelotinib, for example, a great deal that was done there in oncology. But Tony, do you want to talk a bit about how you see allocation of R&D resources. Yes. So perhaps I'd start by emphasizing that our focus remains across the core four therapeutic areas that Emma described, we have at the R&D business, the integration of everything from vaccines and including medicines. And capital allocation across that portfolio is really driven by where we see opportunity to make a meaningful difference to standard of care. And that occurs at a late-stage portfolio meeting that Luke and I both co-chair. And so, what you see in the evolution of the portfolio that Emma described is the consequences of that data-driven decision process. Underpinning that, of course, we have our technology platforms and investments there. But fundamentally, we're looking to allocate capital in a way that can best deliver with regards to meaningful difference in standard of care. Maybe one of the products you mentioned was you filed your older adult RSV vaccine. You're not the only company going after older adult RSV, so how are you thinking about the competitive set up? Why will someone use the GSK product versus a competitor product? And maybe if someone could also talk about duration of protection, is this going to be a job where you have to get jumped every year? Or could this be a product which gives you longer protection? Yes. Well, so again, I'm going to -- there are two aspects to that. One is there's a huge amount of unmet need I'd like Tony to talk about the comprehensive data package that we have. And then perhaps, Luke, you can talk appropriately since it is a competitive situation about how we see the market prospects and our excitement and ambitions there. In the end, in all my experience, having more than one player is rarely a bad thing, especially when you're creating a new market and especially when you have a stronger data packages, we think we do, and we look forward to continuing to generate. But maybe you can talk about Yes, let me just begin by reiterating the strength of the package, particularly in the context of those most at risk. So, 94% vaccine efficacy in those with comorbidities and in the above 70 age group, looking across the broader population above 60 vaccine efficacy in excess of 80% in both the A and B strains. Early data suggesting that flu occurs without deleterious effect on either administered vaccine and immunological data suggesting that we should see protection into a second season. Obviously, we're waiting on vaccine efficacy data to substantiate that, and we're very hopeful that we'll be able to bring that second season data as part of our June ACIP presentation. Yes. I mean I think, as Emma said, the presence of two companies is likely to drive rapid expansion and adoption. I think the initial usage of these vaccines is going to be propelled by high-risk individuals. We've done a lot of market research on the known profile of the competitor as well as ours. And when you move beyond the basic headlines in the aggregate groups and look at high-risk subgroups, physicians see a distinct difference between these two vaccines. I think to Tony's point, I think the biggest variable at this point is ultimately going to be coverage in the second year. I will have that ideally before we actually go through the final ASIP process in June of this year. And I think, again, the presence of the adjuvant gives us some encouragement there. Competitively, we've indicated that we think the pricing range is going to be somewhere between high dose flu and Shingrix. And then finally, I think we're very comfortable competing with the other company. We compete with them in the meningitis B area. We get three-fourth of those patients in the U.S. So, we're very much looking forward to the competitive and scientific exchange. I think the only other thing I'd add on ours is, I think we are seeing over what the world has experienced in the last few years, just this huge emergence of exciting vaccine technology, but also recognition particularly for older vaccine vaccination is no longer something that's just for babies. And every government family business recognizes that prevention is cheaper and better than treatment. So anything we can do to keep people out. So you are hearing much more noise about RSV. And of course, the IRA has removed co-pay for older readouts as well, which is a great move forward, and hopefully will reduce one of those barriers to access that was being talked about earlier. And a couple of audience questions here. One is on RSV. So I think there's two parts to the question. One is, what are your thoughts on the $2 billion number as peak sales opportunity that Pfizer has put out? And the second part of the question is, where would revenues peak in the U.S.? And then where would incremental grow from? How are you thinking about ex-U.S? When would the product peak in the U.S.? I guess I'll ask about U.S. uptake and then what about ex-U.S.? And how are you thinking about the ex-U.S. on to? So, I think peak in the U.S. is at least a decade away. If you look at classical penetration of vaccines and adult populations in the U.S. before cover about two-thirds of adults had a regular vaccination. Primarily flu. To Emma's point, I think COVID has raised the awareness of people who historically may have had cardio metabolic complications would not naturally connect that to a respiratory risk. COVID has now made those people more aware of the consequences of an infection with a respiratory pathogen. So, I think that is going to drive multiyear growth at least a decade of continuing penetration. Of course, the cohort is replenished each year as people age. In terms of ex-U.S., I mean, I think if you look at what we've done across the portfolio, particularly with Shingrix, we're now reporting 40% of our revenue is ex-U.S. with a very tight pricing corridor. So, I think there is a sizable opportunity for RSV outside of the U.S., and we intend to fully develop that. Thank you and another question here. The question is, what does hidden in plain sight mean in terms of the size of an acquisition and it top and bottom-line accretion? I think maybe they're talking about recent comments about the sort of deals that GSK were looking for? Yes. It's probably an Australian prodigal song. But essentially, that's something that is, as it suggests in plain sight but necessarily overlooked, I think the example of the acquisition of Sierra Oncology, you had a validated mechanism. You had a distinct unmet need in terms of patients who are suffering myelofibrosis, a clear understanding in terms of the correlation between anemia and the infusion and life expectancy and a mechanism in the form -- product in the form of ruxolitinib that actually made that worse. And so Sierra Oncology was there at a reasonable price with a validated mechanism prepared for filing. So that to me was hidden in plain sight. People have seen the deal documents. We were able to execute that transaction very quickly. So that's the type of transaction that we mean by plain sight. I think tebipenem is another one, small-scale transaction, a clear pathway to approval. There were some challenges from the FDA. The market cap of that company collapsed, we are able to pick up a Phase 3 asset at a very attractive price and collaborate with an excellent company to bring hopefully that to patients. I've also had a question about HIV. And maybe this is one for Deborah, it could be interesting, which is, what are the next things that you're going to be doing with injectables? You've talked about the current launches going well. But what could you take forward next year? What are you most excited about? So if I think about how we believe our pipeline is going to unfold, we're going to build on, I think, the quite phenomenal innovation that we've delivered over the last few years. So the pipeline is mainly focused on long-acting injectables and it's really focused on patient unmet need. So what are people living with HIV tell us or those who are at risk of acquiring HIV. They would like a self-injectable. So actually, they love long acting, but they really don't want to have to go into a physician's office to get that medicine and the longest gap possible between administration. So, we've kind of got two waves of innovation that we will be working through over the coming years. Kind of the next wave is based on cabotegravir. So everything we do is based around an integrated inhibitor because the high barrier to resistance makes us believe that, that medicine has to be at the heart of what we do, both in terms of prevention and treatment. So we've got cabotegravir, and then we will add to cabotegravir either a broadly neutralizing antibody, a capsid, a different formulation of rilpivirine or a maturation inhibitor. And we're working our way through the clinical data that will help us select for the self-administered and the ultra-long-acting and the next generation of prevention from that selection of medicines. And by the middle of ‘24, we'll have the clinical data that tells us what we need to take into Phase 3 to meet those target medicine profiles. The really important thing to remember is, though, that's not where we're stopping, we have a third-generation integrated inhibitor, which we have in-licensed from Shionogi, our long-term partner. So we partnered with them on dolutegravir, cabotegravir, and now the third generation. And that's integrate has really long ultra-long-acting properties, six months plus probably. And again, we'll work on this medicine, and we'll look at the partner options that we have. And again, that will then take us through the end of the decade, all the way to 2040. And that will obviously also be at the heart of our prevention endeavor. So I think what you're going to see is us taking innovation to the next level, constantly with people living with HIV in mind, and that will see us through the loss of exclusivity of dolutegravir. When we did our business investor update in June, none of this pipeline was factored into the evolution of GSK's growth. And still, we could grow through the loss of exclusivity of dolutegravir. Now what we've got is within ViiV an opportunity with our pipeline to actually replace the revenue that we will lose with dolutegravir when it loses exclusivity. That will be replaced in large part by the new pipeline that's coming through. So, our confidence grows every day as we see really compelling clinical data, some of which we've shared in the past and some of which will be shared this year and early next year, so really great opportunity. I think this is a profoundly important point for people to understand. First of all, dolutegravir itself through the transition of the portfolio that Deborah's leading is going to be by the time it comes off patent, which isn't -- we've given outlooks to '26. It's not like something happens in '26. It's more towards the end of the decade and then it's in mid-single digits. And we have this really exciting emerging optionality on several new assets coming through. And we have such a strong track record of pioneering successfully in our innovation in HIV. I think it's -- there are lots of reasons to be watching this carefully together over the next 18 months or so. Thank you. I've also been asked to ask about Shingrix. So, clearly, lots of growth at the moment, I think you said record sales, but how much longer is it going to be a big growth driver. Are you going to run out of people to vaccinate in the U.S.? There are a lot of people over 50 in the world. So we've got this gift that will keep on giving. Isn't it? Absolutely. There may actually be some people here over 50. But yes, I mean, if you look historically at Zostavax, they've vaccinated 22 million Americans in 10 years. We've achieved 23 million with two doses, 33 million with one dose. So, I think there's several years of growth left. I mentioned earlier in terms of expansion beyond the U.S., that expansion initially has been driven by countries like Germany. We don't have full market access in all the European countries. We expect to achieve that over the next couple of years. We have early penetration in Japan that has a significant time to run. And then, of course, with China right now, we're available in a couple of hundred cities. But as you can imagine, that's not a priority for the health care system, we would expect to reengage in that process. And then finally, you've got emerging markets. So, you need to think of this as three distinct stages. First stage is the U.S. and Europe, then the second stage is really negotiating with governments in those types of markets to expand beyond that. And then the final phase is in emerging markets. And then the final point is that we look at activity extending out to 10 years, there will be a point at which it makes sense to re-challenge those patients to boost them. And as you can imagine, that's an opportunity that we're seeking to explore in the future. Thank you. One other question I've received about vaccines is competition from mRNA vaccines. So how are you thinking about that in terms of Shingrix? And also, what about for RSV, is that a significant threat for your RSV program? Yes. I mean, Tony, perhaps you can talk about -- I mean, as I said in my presentation, mRNA is a very important platform. Shingrix has 10 years of efficacy data and over 90% efficacy. That's hard to catch up on. We do believe there is going to be a place for mRNA in respiratory. And let's see beyond that as well. Obviously, there's some emerging data coming through in other diseases we watch carefully, but we're excited to be making progress in mRNA. So, do you want to pick up how you see that and our options there? Yes. So, I'm encouraged with the Phase 1 data we're seeing in our CureVac collaboration, both with regards to COVID and flu, expect to be able to move both of those programs into multivalent Phase 2 studies in the middle of this year. So, I'm looking forward to seeing progress across that front, and we'll be able to present more data on the Phase 1 readouts later around this quarter. Obviously, in RSV, as we said earlier, we're looking forward, hopefully, to having our two-year data. And then a third year will follow after that in terms of duration of protection, which is obviously something when you look at relative technologies particularly in respiratory disease. We've got a good track record on with our adjuvant technology. Great. Thank you very much. I think we're just about out of time. So, I'm looking forward to this RSV data and later recommendation. Thanks very much, everyone.
EarningCall_1511
Good day, and thank you for standing by. Welcome to the Newtek Investor Conference Call. At this time all participants are in a listen-only mode. After the speakers’ presentation there will be question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. Thank you, operator. Good morning, everyone. My name is Barry Sloane, President, Chairman, Founder, CEO of Newtek Business Services Corp. We appreciate everybody attending an update on the pending acquisition of National Bank of New York City. For those of you that would like to follow the presentation along today in PowerPoint form, please go to our website, newtekone.com. Go to the Investor Relations section, and you will see the presentation is positioned there, will also be archived dated December 12, 2022. Joining me on today's call is Nick Leger. Nick is a Chief Accounting Officer of a publicly traded company, Newtek Business Service Corp.; and John McCaffery, who is the CFO of the soon to be formed, Newtek Bank in North America. We certainly appreciate everyone joining on today's call. I would like to forward to Slide 1 of the presentation as well as Slide 2, which really relates to the notes regarding the forward-looking statements, comments, and a special note regarding the financial illustration and targets that we prepared here today. The purpose of today's call, obviously, is to update analysts and investors in the pending acquisition of National Bank of New York City as well as the transformation of the company from 1940's Act, Business Development Corporation, into a financial holding company under the 1933 Act. Clearly, this is an important and valuable transformation to the company and all of its stakeholders, including its shareholders. On Slide 1 and Slide 2, we talk about a lot of the estimates and expectations that we have made to being able to put this particular presentation and illustration together. A lot of work went into it. Obviously, some of the things we have previously estimated, things such as originations of nonconforming loans of $600 million in 2023, $1 billion in 2024; 7(a) originations, which in this year looks to be somewhere in the neighborhood of $775 million of fundings with fairly modest growth in 2023 and 2024, probably exceeding $800 million, maybe to $900 million; the 504 originations, of which we have previously indicated, we'll close around $150 million-ish of loans this year. Very modest growth in calendar year 2022, 2023 to come up with these illustrations. And we've also obviously forecasted the portfolio of companies, which are the nonbanking activities, which will be sitting up at the holding company. So a lot of work went into being able to provide this particular illustration. We all realize that we're dealing with fairly fast-moving market conditions. And we will – once the anticipated close date of the bank is finalized, we'll talk about when the expectation of that is. We will come out with a very granular forecast what the bank holding company and the bank would look like, which will break down things like deposits, categories, growth, precise cost of funds. But this particular illustration today is to give the market a very good sense of where we think we can ultimately deliver the bank holding company and the ownership of the bank based upon everything that we have in place. Clearly, the organization has been working very hard to get legally accounting, the software, the ability to open a bank accounts online, digitally with a mobile application. So when the bank does open in January, we'll be ready to go. We obviously also had to take over the management of the core operating platform and manage it in our own cloud. We've hired a significant amount of staff, which we'll talk about today, as well as obviously broadening the product menu to include, what I call conforming C&I loans and conforming CRE loans to add to the complement of things that we have historically done such as 504 lending, 7(a) lending, et cetera. We're really excited also about delivering The Newtek Advantage. We'll talk about that, as well as our digitized, technology-enabled manner to do online banking without brokers, branches, BDOs or bankers. I'd like to move forward to Slide 3 and focus on the actual acquisition of National Bank of New York City. I think it's important to note, we put out an 8-K recently that we've extended our agreement with National Bank of New York City for a close date ranging from January 3. I believe the other date is January 23, and that is the anticipated estimated date. Then we will actually own the bank. So we're looking at anywhere between a couple of weeks to 45 days away, to get that transaction consummated. Obviously, we've entered into an agreement to acquire National Bank of New York City that was previously announced, for a price of $20 million, which is approximately 1x tangible book paid in cash. We have received, as we previously reported, the conditional regulatory approvals from the Federal Reserve and the OCC, and we believe that we will meet all those conditions, and Newtek Bank North America will operate as a subsidiary under the bank holding company. We think this is a terrific opportunity for us and our shareholders. The bank has been family-owned, very well managed, very clean bank. The bank, according to core reports, only has one nonperforming loan, a little over $3 million in balance. We've recently appraised the real estate that are lean behind that loan. It's a north of $5 million. So very, very clean bank portfolio, primarily of New York City-based CRE loans, and probably $120 million, $130 million of deposits. Some of them are termed out. That should be somewhat helpful to us going forward. We have some customary conditions. We're very comfortable that those will be met. It shouldn't be an issue. Important, the management team of the bank will be – and I say the very senior management team, obviously, because the bank is primarily family run, family-owned – will be stepping aside. The Board will resign and will be replacing the bank Board with nine very qualified bank board members. The bank holding company Board will remain as a public company transitions from a publicly traded BDC to a financial holding company. Important to note, there's no core conversion. We're going to be sticking on the current platform, Fiserv Premier. We used Apiture, our terrific technology integrating organization, to give us the mobile account opening, online bank opening and to work with our existing tech team to integrate The Newtek Advantage. So not a lot of disruption there relative to accounts. So we're very, very excited about this acquisition, which is very close to being finalized. On Slide 4 – and obviously, we continue to put these illustrations out there because until the deal closes, a lot of things could move around. Although we are very, very close right now and believe that, obviously, our illustrations that we previously put out and now believe are no longer relevant, both in March and August of 2022 obviously, this is much closer, much sharper focus. But I think it's important to note, when you look at Slide 4, we are starting off with a very well capitalized financial holding company and bank subsidiary, and that is what we are targeting for we are at the holding company, you're looking at $1.1 billion of total assets. You're looking at 18% to 22% TCE ratio, 19% to 21% CET1 ratio, and total capital ratio is about 20%, 25%. We think that, obviously, these are incredibly reasonable pictures and estimates of what the bank holding company, which will elect financial holding company status will look like. And at the bank, the bank is around $200 million worth of assets. We'll be putting in between cash and unencumbered assets, probably another $50 million approximately at the close. That will get total asset size up to $245 million, $250 million. But you could see, very well capitalized. And we do plan on utilizing this capital over time. I think it's important to note that. I think it's also important to note that, at the holding company, you will have Newtek Merchant Solutions, which currently has an NAV somewhere between $135 million to $150 million, and Newtek Technology Solutions probably also has a net asset value net of debt of around $25 million to $30 million. Those will be hold at the bank holding company. Those entities would not be part of our tangible book going forward. So that's important that, that gets included from a BDC perspective, but it's not part of book going forward. However, those assets are quite valuable, and so, generate close to $20 million of EBITDA and cash flow this year. In addition, the holding company will have the payment processing business, tech solutions business, the insurance agency, the payroll business and our joint ventures of nonconforming loans. So the holding company will be very well diversified, give us additional types of income, additional types of cash flow, and needless to say, we're extremely excited about the structure. One other thing that I would like to point out and illustrate, Newtek's Small Business Finance. Our current SBLC, which is – currently obviously sits and owned by the publicly traded company, will remain there based upon technical issues that I won't get into too much at this point in time, relative to 23A issues, the Fed and the OCC level. It was difficult, which required an exemption to actually put the debt – securitized debt versus the loans into the bank. So that's going to be sitting up at the holding company under regulatory – continued regulatory supervision, but will be in a runoff mode, and the new originations will be done at the bank level. So it's important to understand how these things are laid out. And when we re-up the number post the close, we'll be able to really get into a more granular presentation for analysts or investors, but I want to be able to talk to it so people get a real good understanding of how we're laying out, what it looks like, what we anticipate, what we believe and what we expect. I'd like to go now forward to Slide 5. The earnings target illustration, particularly from a consolidated Newtek financial holding company. I would also like to point out, which we'll talk about, we have publicly stated to a press release, we do plan on renaming. The holding company, NewtekOne, will explain that whole rebranding strategy within the context of this presentation. I think it's important to note, when you look at these profitability targets of fiscal year 2023 and fiscal year 2024, we're very excited about the types of returns that we can generate with respect to ROAA, and ROATCE. These are clearly not returns you see normally within a banking environment. Well, if we were going to be doing residential mortgages and car loans and home equity loans, which are very competitive, very, very thin margins and really can only be done by successfully the big banks would scale, the Wells Fargo to JPMorgan, you couldn't get these kinds of numbers just because the margins are so thin, and then you don't have those economies of scale. However, the types of things that we do that are unique and novel, we've developed an expertise over the course of 20 years, the 7(a) lending, the 504 lending, and we will complement them with what I call conforming C&I and conforming CRE loans in the bank, to have a nice diversified portfolio. We'll be able to generate these types of returns. So we're very, very excited about that. In addition, you've got the nonbanking activities at the bank holding company that do not eat a lot of capital, with the exception of the nonconforming lending business out of the JV, which we'll talk about. But clearly, the Merchant business, the Tech Solutions business really does not need much capital at all. Merchant, really nothing. Solutions – Technology Solutions does at time have some CapEx, but it's really not a lot. The Payroll business, no, the Insurance Agency business, no. The nonconforming business through joint ventures does utilize capital going forward. But it gives us – you could see that we have a lot of levers, a lot of flexibility in the organization. And these are things we've been doing for a long period of time, and now we're able to roll them up and position, not just from an operational perspective or a marketing perspective or an organizational perspective, but also delivering these solutions to our customers through The Newtek Advantage, which we'll talk quite a bit about. I think once again, when you look at these profitability targets and the capital ratios, this is a unique holding company. It has a lot of assets, lot of cash flow. Consequently, it also has a lot of debt. I'd say a lot of debt relative to a normal bank holding company which has almost no assets and very little debt, and really relies upon the dividend solely of the bank, dividend up to be able to make the interest payments. So I think it's important to note that we will be very much a unique organization. So when you look at the profitability targets for fiscal year 2023, obviously, these targets are at the financial holding company. We actually believe that they will be higher within the bank. However, in 2023, return on average assets, 3% to 4%, return on tangible common equity between 18% and 22% in our first year of operations. Obviously, you could see in 2024, that will expand, we believe. We put bank cost of deposits 2.75% to 3.5%. Now early on, we'll probably be doing more of the expensive types of deposits, probably in the first quarter or two. And then, we'll really start to gain steam by getting deposits in from our Merchant processing accounts. We have 15,000 of them. In the Payroll business, we probably have 800 or so unique business clients, probably with 11,000 employees that we do payroll on. That is the deposit fertile opportunity for us. We probably have close to 80,000 clients that are paying us, and 2.2 million referrals in the database. So I keep asking – getting asked the question, where are you going to get deposits from? Boy, we have a lot of targets. And the spread between, obviously, institutional money and core deposits is very wide and very valuable. So we do see these ratios changing. Obviously, our ratios are going to be quite different because this is deposits to total funding, and it's a financial holding company, which we already indicated. We have a lot of assets and a lot of debt, so where this might not be the normal good number for a normal bank that's got nothing at the bank holding company or doesn't have these nonbanking activities. Our nonbanking activities generate a lot of cash flow, and they also have some very modest amount of leverage on this, which we feel pretty comfortable about. Earnings per share or after-tax EPS range up, first year, $1.70 to $2.00; second year, $2.80 to $3.20. We're excited about the growth. We believe that's achievable. Obviously, we will be utilizing the excess capital that we put into the organization. As you could see, we've indicated that the bank itself will start up with about $250 million of total assets. We do believe that, within our plan that's been approved, that could grow to $735 million after 12 months, $1.2 billion after 24 months, $1.5 billion after 36 months. So we're excited about that we actually have something in place that allows us to be able to utilize the capital and grow the business. Obviously, as we get our sea legs under us and further develop staffing, technology, capital utilization, these numbers do start to grow. And these numbers, in my opinion, don't fully reflect the value of The Newtek Advantage and us being able to take market share from other participants in the market. So once again, very, very excited about these financial numbers, particularly the growth in earnings per share that we do believe – anticipate is achievable. When you go to Slide 6, you could take a look at the mix, and we're very proud of the mix relative to what I'll call the bank earnings and revenue versus the financial holding company. Obviously, the financial holding company will be participating in the income stream that comes off the nonconforming business and the joint venture, primarily funded by the fundings that we did recently as well as securitizations. But we like this mix. We think it's a great mix, and it really diversifies once again our revenue stream. We're excited about the nonbank revenue that's going to be coming in on a reoccurring basis. We're excited about the joint ventures we put together. We recently put out a press release of us securing $300 million worth of leverage lines, which are being used to close the transaction, which require a cash payment to the current owner of the bank as well as really well capitalizing the bank at its inception. And once again, we're really, really excited about our ability to reduce certain dependencies and diversify. Clearly diversify our funding sources to grow our business using more inexpensive debt versus the BDC model, which requires regular equity raises. When we closed our BDC and transitioned in 2014, I believe, the share count was somewhere around 14 million shares, give or take. Today, we're 24 million, approaching 25 million. So clearly, we have to constantly issue shares to keep the leverage ratio intact for a BDC. I do want to point out, when you go into our history, and we became a public company in September of 2000, we were 1933 Act company, all the way through November of 2014, and that suited us well. And the company made a strategic decision that we should convert from a 1933 Act company into BDC. Not an easy task, very difficult, and we have to go through a shareholder transformation in addition to transforming a lot of our operations, the accounting, legal. This isn't easy. So the management and the Board of Newtek historically, when the two roads are in front of it, it doesn't take the easy road. It takes the right road. And we're confident that we are on the right road, although this is the easy road. I will point out that when we did do the BDC, the stock traded off fairly sharply initially. And then it did – history may or may not repeat itself, but all of the marketplace will have to determine that. But it did rebound pretty quickly in a couple of months. And that transformation to the shareholder base is something that we expected. Obviously, we didn't expect the Fed to also raise rates by 4% and to have the types of inflation that we've got right now. But with that said, we feel very, very good about, at this point in time, being able to grow our business using more retail deposits, using more debt leverage, and also have the ability to retain earnings. So we're very pleased with where we are today, and that's really from just a pure financial perspective. Then, when you go to the next slide in the presentation, Slide 7, this is the current depiction of what The Newtek Advantage will look like. And The Newtek Advantage, this is something that we believe is – and we'll argue this and deliver it and continue to develop it. It will give independent business owners and according to the Small Business Administration, whether you want to call them SMEs or SMBs or where they got five employees, 50 employees or 1,000 employees – we're going to be giving these businesses relationships. What does that mean? Well, most of these clients, if they do know anybody at the institution that they give their money to, it's maybe a new business banker that typically can't solution anything. It's got to bring multiple assortment of people. Well, when they get The Newtek Advantage, which they will have, and it will be delivered methodically over the course of time, but every depositor will get The Newtek Advantage. They're going to get these relationships. They're going to get a licensed insurance agent, not a call center. They're going to get a payment specialist. They're going to get a payrolls and health specialist. They're going to get a tech solution specialist. They're going to get a deposit specialist. They're going to get a lending specialist and they'll get a relationship manager. So they'll be able to pull somebody up on a camera, on a screen and be able to visually have that conversation when they want to have that conversation, and to be able to schedule an appointment. So they get those relationships. They're going to get analytics. Well, what are those analytics? Well, they'll be able to see their web traffic data and statistics, unique visitors, total visitors, time on the site, bounce rate, how effective their site is. They'll be able to store all their organizational documents in the Newtek Advantage. By the way, everything I'm telling you about, exists. It will be part of 1.0. They'll be able to go to The Advantage and make payroll. They'll be able to – in the event that they are processing payments with us, get all their Merchant data, all in one place. What is the Merchant data? They'll be able to look at batches from the day earlier. They'll be able to look at chargebacks, refunds, slicing and dicing, AmEx, Visa, debit, credit. These are all things exist, but they exist in the Merchant silo or they exist in a Tech Solution silo or they exist today in the Payroll. So they're all being pushed up right through to the Newtek Advantage, and a real simple question. Our staff will be trained to offer the Advantage to our clients and the client will say, what's the Advantage? Boom, here it is. And they'll be able to see, gee, I didn't know you do all these things, and you could have it in one place, that's terrific, in addition to what you basically get with a bank. Listen, I've got to make a comment at this point. Is a depository account of commodity? Does it really make that much of a difference, whether your money is sitting at Bank A, Bank B, Bank C? It's a depository account. I mean, you could dress it up. Now I'm not saying there aren't differentiators in the consumer business or in the Fortune 1000 with different platforms and treasury functions and certain ways to move money around P2P, et cetera. But in this environment, our customers typically shoved into the retail segment for those people that are familiar with banking, and they're just not really well treated. We're going to be giving the client the Newtek Advantage. They're going to be getting an asset. We believe this will be a gem, and we're excited to roll it out and make it happen. We're unlocking 20 years of value. And by the way, this is not just software. This is software, people and process that has existed for over a decade, it's been developed, the staff uses it and it functions. And we've also begun conversations with many institutions to white label list for their benefit. Unlocking this value, is, we believe, tremendous upside. So we would white label this for a $1 billion organization, a $100 billion organization, and we would be provisioning the Payroll, the Payments, the Insurance, et cetera, because these are all the entities that sit up at the bank holding company. So we're very, very, very excited about the Newtek Advantage. Going to Slide 8 – a lot of the questions, and we're trying to answer as many questions as we can today – relate to, are you staffed? Can you manage this? When are you ready to open? Well, we're ready. We're ready for the curtain to go up. Obviously, when you look at Slide 8 and Slide 9 and Slide 10, we've got the right executive team to manage policies and procedures, risk, supervisory issues. Nick Young will become President of the soon to be established Newtek Bank. Nick's been with the company currently for 18 months. So it's not like he's walking indoor and the curtain is going up. So he's had a lot of opportunity to understand the organization and to get us positioned to take over the reins of National Bank of New York City, which will become Newtek Bank North America. Peter Downs and Nick has been with us 18 months. Peter Downs will be with the company coming January – well, actually be July, 20 years, two decades. A lot of banking experience with Peter Downs. He's our Chief Lending Officer, also President of Newtek Small Business Finance. Thrilled to have John McCaffery as our CFO of Newtek Bank North America. John, I believe, has been with us about six months. And John's been working directly with Nick Leger, our EVP and Chief Accounting Officer of the publicly traded company, soon to be named NewtekOne. David Simon, President and COO of Newtek Merchant Solutions. David will also have a dual role, in-charge of Director of Deposit Acquisitions in the bank. David has got a lot of banking experience, sat on two Citibank boards, and was very, very involved with both Citibank and Visa, Visa, in particular, which is a more recent stop, where he was Global Head of Small Business and Medium Enterprise Business over at Visa. John Vivona recently joined us. I think John's been with us three or four months as Chief Compliance Officer of Newtek's soon to be created Newtek Bank N.A. Really excited about John, a lot of experience here. John has made an offer, it's been accepted to BSA officer, and we'll be hiring a fraud officer shortly. So we're very well set up to be positioned to manage the risk of taking deposits. Brian Moon. I believe Brian has been with the company, I think, three years, maybe four. Brian's Treasurer and SVP, joins us from the investment banking world, and Brian has worked with our organization in modeling, treasury functions and some capital markets activity. Kelvin Lui, I believe, around nine to 12 months. Kelvin is Chief Digital Officer, and Kelvin has been terrific in working with Apiture to get us up and running with the mobile account opening and online banking within hopefully – I would say, hopefully, but within, I'd say, five to six minutes, you should be able to open up the required bank accounts here at our organization. And obviously, then John's team takes over with respect to all the KYC issues and the follow-up and making sure that these are the types of accounts that are supposed to be banking with our institution. We recently brought on Tom Soucy. He will be running our C&I lending book reporting directly to Peter Downs. Tom's had a lot of experience in the business and has had great track record formally working with Nick Young, both in IBERIA and Sabadell. Brian Lawn has been with our organization, I believe, about two years. And Brian previously had a senior position at Peoples United Bank in the commercial real estate area. That's where he will be spending his time as the Head of CRE lending, also reporting to Peter Downs. Mike Ogus, 39 years of banking. Mike sits on several of our committees. So moving forward to Slide 11 and hopefully, I've given you a good snapshot of what we look like, and we will open this up to Q&A. We believe that we're clearly worth a look and maybe more than a look with respect to NEWT. We're progressing towards the full operational, financial and shareholder repositioning to the transformation of our organization from a BDC, 1940 Act company to a financial holding company. We're confident that it's in the shareholders' best interest to make the acquisition, which we obviously will do, and be positioned as a business solutions company, important to note to the 30 million independent business earners across the United States. And to add banking and depository services, in addition to Tech Solutions, in addition to Lending in addition to Insurance, Payroll Health and Benefits, technology, et cetera. So we are a solutions company. We make our clients more successful. We're the one company that makes them more successful. We're the one company for all their businesses. We're the one company they need to partner with. We've been around a long time. We publicly traded since September 2000. We're established since January of 1998. We've survived 2008, 2009. We survived the pandemic. This is a company that has historically been able to manage its risk very well, as well as importantly to know we've managed transitions. These transitions are not easy. So transitioning from a 1933 Act company into a 1940 Act company, and then a 1940 Act company back into a 1933 Act company. I'm telling you, we don't do that for fun. We do it because we believe strongly it is in all our stakeholders' best interest. As a quick comment. I do speak to shareholders quite frequently. I've had shareholders telling me, you're doing this because you want management, including yourself to be paid more. I can't tell you how silly that question or comment is. Acquiring a $200 million, $250 million bank is not a blueprint for paying yourself more money, okay? It's not. However, what we do with that organization and delivering value to shareholders will be – and we will obviously look to grow the business. And with management owning 5.5% of the outstanding shares, it loved the dividends it used to get. But there are times when you want to invest in your platform. And what we've been able to demonstrate when we transitioned into a BDC, which enabled us to raise more capital on cost effectively because that was the right structure for the business at the right time. We grew the business. We grew the earnings. We grew the dividend. Well, guess what? It's time to make the change now. That's what we believe, and we've studied that. And this is not something that feathers anyone's nest by doing this. A matter of fact, it's been a job. It's been a hope, but we believe very strongly that we now have the benefit of taking the existing business. So the business methodology all went back to 2000, and mission statement is the same in 2014. It's the same today, provide those solutions, and this is the best structure. And frankly, I think many people feel that dividend paying stocks are the way to go. And therefore, growth is out of favor. Well, you know what they say, buy low, sell high, not the other way around. So I think you just need to take a look at what we're trying to do and figure out whether this makes sense for you or not. We certainly appreciate – some people like dividend stocks and some people liking growth stocks, but we firmly believe this is in the best interest of all the shareholders, and that's why we've done it. Obviously, as a financial holding company, we think we can reduce our cost of capital, which is now – this is – if this isn't clear, then we haven't really done a good job on these calls. But selling shares and issuing BDC notes in the current market, we think that the current structure will be better suited to reduce our cost of capital and grow the business accordingly because we are a growth company. We're really appreciative with the management team and all that the associates of Newtek have been able to do. In addition, we'll be able to retain earnings which were restricted by – from a BDC perspective, based upon the RIC requirements to distribute between 90% to 100% of the taxable income. And as most people know, BDCs are really not eligible for mutual funds with respect to – certain mutual funds can buy other mutual funds, certain mutual funds cannot buy BDCs. So typical institutional ownership in BDC is very limited. And there are some funds that get penalized by the AFFE requirement. So this should open up the base, and BDCs are not in the Russell and not in the S&P 500. So it is estimated by some sources, there could be up to $1.5 million or $2 million worth of additional buying, but just getting it to the Russell 2000, if that does happen. So we believe, once again – we talked about management interest being aligned, The Newtek Advantage business portal, really excited about it. Please understand we have approximately 80,000 customers in the book that are currently paying us in some way, shape or form, $2.2 million of referrals. And you don't think we're going to be able to try to get some of their deposits demand that's just out there. That's a phone call away. That's an advantage call or an e-mail solicitation away. I don't need new business bankers begging to have a meeting or a lunch. We've got a lot of opportunity to bring in deposits with the existing people that really do know us and recognize that the Advantage is an asset, that the Advantage is an advantage that they can't really get anywhere else. We talked about our name change to NewtekOne. We're excited about being the one company for all your business needs, the one partner that enhances your level of success, and the one company that provides you with the necessary state-of-the-art solutions to be able to grow your business. And once again, we look at providing solutions. We want to be a solutions-based company that also provides banking services. And when you look at our organization and you look at our return on tangible common equity, and the types of returns that we believe we can drive, this isn't a 1x book, 1.25 book with really narrow margins. If you keep hitting those growth numbers, which we've seen in the BDC market, we've clearly seen that in the BDC market that if you grow the dividend, grow your earnings, you'll be rewarded. So we believe we'll be able to do that in this financial structure as well. I think it's important to note that we really look forward to competing against other depositories and partnering with the depository sharing of technology and unlocking that value. So a lot of opportunity. We're excited about it. We wanted to give shareholders and analysts an update today. And if there are any questions today, operator, we'd love to take them. And that concludes the presentation for today. Congrats on the approvals. Good stuff. Could you get a little deeper into the weeds about the deposit strategy? I know you glanced on it briefly, but if you could talk a little bit more about that, I'd appreciate it. Sure. So, look, I think it's important to note, we'll be capped obvious for a second – we're not a bank. So I've had some people say, how many deposits you're going to get in the first quarter, the second quarter? It's like, hey, it's great to be a financial guy, but at the end of the day, we're operators, and it's going to take time. So we will most likely use what I would refer to as internet-based methods of gaining deposits early on. And then we will begin to work the customer base that we have existing, like, for example, in the Merchant services business, being a payment processor. Now we can – where we're not conflicted, open up deposit accounts, potentially move money in the same day, bundle things together for deposits, whether it's months of free payroll, a terminal, a POS system. We have so much opportunity to gain deposits with the existing base. However, we will use the more expensive money, but it's in part of our plan to reduce our dependency on that more expensive money. And that's where you'll see that margin expansion start – we do want to be realistic on those lower cost deposits. One thing I also want to note, the environment of frictionless money movement is becoming more and more prevalent. So, more and more institutions today really have the ability to move money over from a noninterest-bearing checking account, and one of the big boys into your organization, and we're seeing that a lot. So there's a pretty big margin right now between zero and three or four, and if the balance sheet are big enough, they're meaningful, and it takes five or 10 minutes to move over into an interest-bearing account. People are doing it. And the good news is, between things like Payroll and the connectivity, e-commerce, Merchant services, a lot of opportunities. So we're really excited about the ability to demonstrate that we can really gather good, solid deposit base and have this well integrated into our solutions. In addition, historically, we've made a loans we've never taken to pause. Well, now we can do that. And we got between 3,000 to 4,000, I think, existing borrowers, and we did 26,000 PPP loans. So we've got a lot of people that we can have conversations with that – now as well. So deposit gathering is important to us. We're measuring the metrics quarter-to-quarter. I wouldn't expect huge growth there in first and second quarter, but you should start to see things perk up Q3, Q4. If the question relates to the bank, I would say that the minimum would probably – over the course of 36 months would be probably around 10% to 10.5%. So there's – just given the type of assets that you invested, there's no reason to keeping materially higher levels of capital? Well, those numbers for most banks would be considered exceedingly well capitalized. I think that – for our institution, I think it's important to note, we're starting with a blank slate relative to the bank, but with a 20-year track record. So we're very pleased that we were able to position ourselves with the regulators and a plan and be able to demonstrate that we could start this thing off with really good reserves, manage the business, generate really good returns and be well capitalized. So no, there's really no need for us to really push those numbers at this point in time. And we've got plenty of time to deal with that. I mean, obviously, when you're looking at the ratios of the bank, TCE ratio, 30% to 33%, CET1, 38% to 42%, total capital 38%. So we got a lot of business to be done. And we have a 20-year track record in the selected areas. Now you take these selected areas and then you put on what I'll call the AAA conforming, I refer to that as conforming bank-type credit, [indiscernible] properly bulletproof credits and you blend them together. We're going to have a very well-diversified, nice portfolio that's frankly barbelled somewhat. But I think it's important to note, we've been through 2008, 2009 with SBA lending as well as the pandemic. So we have a pretty good feel for how these markets do act in poor environment. So I think it's once again important to note that – we do know how to manage risk being out of that. Listen, if you can manage your funding and your capital in a nonbanking environment, this becomes – I won't say easy, nothing in life is easy, but it's easier. And then as a follow-up question, for all the services you're going to be offering, what percentage of revenues do you think they will account for the [indiscernible] organization? Thank you, Chris. So on Slide 6, there was a pretty good – and that wasn't done on a granular basis. And that is something that we'll do shortly after the close because everything will consolidate, so we do plan on really being very granular and showing what Payments will be, what Payroll will be, what Insurance Agency will be, what the JVs will be. But I mean, broadly speaking, we think that the bank will probably contribute about 50% of the revenues. Today, that's probably closer to – we don't have a bank, but I would say lending activity is probably closer to 65% with a lot of it driven by gain on sale. So that becomes much more diverse going forward. But when you look at the Merchant business today, it generates about $16-ish million of EBITDA in 2022, Tech Solutions, probably $3.5 million to $4 million. The Insurance Agency and the Payroll business a little under that. The joint ventures are clearly an important area of growth, which is the recent financing lines that we put in place and close, are really important going forward. And I want to complement the Newtek management team where people are really having a hard time getting funding. Our partners were great. We thank Webster Bank, we thank Deutsche Bank, we thank Capital One Bank, we thank Santander, Bank United, all of our partners that really helped us. And they're not providing money to everybody, and that's going to be an important area of growth for us. We feel very good about that. Now one shouldn't be really startled by those numbers because although the numbers are big, the average loan size in the nonconforming book is, call it, $5 million. So where we'll probably do 1,300 to 1,400 units in 7(a), to do $600 million, you need 125 units or so, give or take. So – and understand, we're going to be using the current infrastructure. We're going to be using the current referral sources. So the operational leverage that we get out of the current infrastructure that we've built over 20 years, it's going to be immensely valuable to the organization, obviously, into all of our stakeholders and customers, which we're excited about. Congratulations on getting a close date probably approved. I mean one question – I mean you've been very clear on this presentation, these kind of – these are earnings target illustrations, and you'll give more detailed guidance later. Can you give us any color on how much more work needs to be done to come up with the detailed guidance? Because I'm trying to get a sense obviously, there's still an enormous amount of work to be done. The profitability targets in the presentation may be very, very rough, right? Versus if it's just crossing T’s and dotting I’s on the guidance, then we should have a lot more confidence in the profitability target. So can you tell us – give us any indication of how much confidence we should have the guidance will align with the profitability targets versus these are just theoretical? Good question, Robert. I appreciate it. Look, I think our organization has been historically a good estimator of future activity. And, Robert, as you can imagine, I got the lawyers on one chair – on one shoulder, I got shareholders on other shoulder, okay. So your question is like spot on, bull's eye, right between my eyeballs, so I appreciate it. Look, we obviously did a lot of work on these numbers. And we understand that it's important when we provide information to the market, there's work behind it, there's thought behind it, there's modeling behind it. There's best case, worst case, et cetera. So we were comfortable enough to put this out. With that said, my question to you is, what's Chairman Powell going to do this afternoon? I don't know. Do you know? So yes. Well, okay, then I'll hold you to that. I will call you later and see if you're right. But the 10-year is moving 20 basis points in the morning. And spreads were widening and now they're contracting. So just from the standpoint of really being full disclosure to investors and sort of explaining that there's a lot of volatility out there, that has nothing to do with Newtek, right? That's the key. It has nothing to do with Newtek. We've got to take that into account. I think that what we put out is a very good illustration and impression of where we're going to be. We have year-end, there's things moving around. There's things closing, but we feel very comfortable with the illustration. And historically, we've been pretty good at really – and we've done this for 22 years of public company. So I think that this presentation today is useful to stockholders, and that's why we did it. I appreciate that color. You have historically been pretty good on the 7(a) origination numbers, for example. But obviously, that's not all the bank is going to be doing. So more wheels on this chariot than previously, but I appreciate that color. I do have one on the – is it the intention to give going forward – I mean you talked about the kind of the NAV of the processing business, et cetera. Are you going to give a pro forma book value or just tangible book going forward? I mean, how are you going to incorporate your assessment of value of those businesses into your presentation or – go ahead. Sure. So I mean my understanding is there are institutions that actually put out things like adjusted book which are non-GAAP. And yes, the reality of it is, when you take the nonbanking activity, which most banks don't have, and they're going into the book of zero, and arguably, they were $150 million to $170 million, you may want to explain that to the market because as you know, Robert, at one point, we traded at 2x to 2.5x NAV. And for most of our BDC life, we traded above NAV, despite the fact that nobody ever thought we could trade at a premium to NAV. I mean, who are you? You don't look like any other BDC? You were kind enough to model us being different. So we believe that when you grow earnings, and we anticipate it, you're going to ultimately get your number and the – there will be bank investors that will – if they look at what's the value of the book, blah, blah, blah. But listen, if you want to buy banks at 3.25 to book or 1 to book and trade the 1 to 1.25, 1.5, we're probably not the cup of tea with respect to – but by the way, if we look like the other 9,000 financial institutions, I'm not doing my job, and Newtek hasn't fulfilled its mission. So frankly, I think that is why we're a solutions company that also provides depository services and Payroll services and Merchant services and Tech – so these are the services we're going to provide. And by the way, we also take your deposits, which is great. Kind of a two-part question, a little more longer-term growth from the inorganic side. What's your take or desire on longer-term acquisitions? And second part of that same question is, do you look to sort of stay in the asset-light branchless model? Thanks. Yes. So both really good questions. Historically, I'll call this – the bank trade is the only way you could create value as you merge. You layer your fixed expenses on a bigger asset base, you squeeze the cost out. Well, I don't know, I think that's history. And also, the one real – amongst many benefits, National Bank of New York City will be a really good integration for us. They've been helpful, cooperative, and there's not a lot of fixed expense. There's no long-term leases. There's really no long-term obligations that lock us in. It will be on a relative basis, easy integration versus merging into $1 billion or $2 billion bank with bankers and branches and a culture that's just immovable. We've had really good dialogue, obviously, with the owners, the sellers and the employees of the bank that have been really helpful and cooperative in doing this. So I think that's important. It would be – we're always going to look to be opportunistic, but it is not in our plan to do acquisitions. First of all, we've got plenty of loan growth opportunity. We've demonstrated that over our history. And we feel strongly we're going to be able to grow deposits with our existing book of relationships. So the reality of it is, the only – in our view, based upon how we do the business versus the other 9,000 institutions, the only value would be the customer list and the brand. The way they do business night and day versus how we do the business, which is no bankers, no brokers, no branches, no BDOs. So that's not what we want. And the good news is we actually have a plan that goes into that. So when we ultimately go out and we report metrics and you look at our efficiency ratios and our ability to grow when you look at our margins, we shouldn't trade like anybody else in – we should trade like a solutions company, not like a traditional bank and bank holding company that makes 30-year fixed rate mortgages, home equity loans and tries to take people's money and not pay them any interest. Very cool. Thank you. Second question more macroeconomic observational. What's your take on small business appetite for new loans currently, let's say, over the last couple of months? Well, we've had really good growth numbers for Q2 and Q3. And listen, at the end of the day, we obviously live in a macro market, but the technology and the methodology that we have built with our partners, the UBSs, the Morgan Stanleys, the Stifel Banks, Raymond James, credit unions, trade associations, it's working. So we're seeing borrowers that are concerned about the economic slowdown that normally wouldn't borrow there. They've got liquidity, but they're afraid that things might slow in the next four to eight quarters. They want the extra cushion and they're creditworthy and they have unencumbered assets. Those are good loans. I mean, I hate to say it, but you don't want to make loans to the person that's like run out of gas at the gas station when they get to the pump. You want to have it with half tank or three quarters of a tank. So there's good opportunity. There is loan demand, importantly, for people that can withstand an economic downturn, and we're seeing that. We've indicated on recent calls that our credit scores, particularly in recent vintages are higher than they've historically been, so we're able to tighten. Our loan sizes are smaller, which is good. We're getting more diversification. So we feel pretty good about the environment for loan demand. I had a question kind of about your origination mix on the loan side. You mentioned may be doing some more conforming C&I, CRE to diversify the portfolio. Can you kind of walk us through your view on what the origination mix will look like over time, maybe year-end or something, especially like what percent of SBA? So without getting – like pinpointing it, Tim, I think that you're probably looking at in 2023, $200 million to $300 million, what I would call traditional banks, CRE, your multifamily loans, self-storage, things like that, and traditional C&I lending, 30% equity down, three to five-year maturity, fully guaranteed, great cash flow, those sort of bulletproof credits that banks do in tight margins and really low charge-off rates. I will add – I know people look at us, oh, gee, you're just a 7(a) lender, which we are, we do a nice job of it. By the way, after today's adjustment, the gross coupon on the portfolio will probably be rolling up to like 10.5%. So people don't realize it, but those floors above prime on the uninsureds are very valuable. So it's attractive. Obviously, when you start to do the nonconforming, you're competing when you got to get rates that are lower. So you're not at 10.5, you're 5, 6 and 7, and you've got a short M schedule, and you've got all the covenants in there that our borrowers and the other programs hate and are willing to pay the higher rate on. But our plan in working with the regulators and having a diversified portfolio and diversified risk is to put on that business – it's less profitable, but it really balances the portfolio out, which is important. We think it overall diversifies us, gives us that spread income, which is nice, and we'll be growing that part of the business as we go forward. The other thing, too, is if you think about the maturation, you could start somebody off with a 7(a) loan, then going to a 504 loan, then to a nonconforming loan and then maybe go into a conforming C&I or CRE loan. So we really cover the aspects of the business as they sort of mature over time. It's a really neat – and it's just what banks don't do, particularly for the more early-stage businesses that we've cut our teeth on over 20 years. Right. Okay. That’s helpful. And do you guys expect to hold more guaranteed than you are right now? Or any plans to change that? No. I think that we will probably be a seller of guaranteed for the foreseeable future. I mean that could change. It depends on the market and things, but now we think – continue to be a seller. It produces the highest return on equity. Right. Okay. And I know you won't – you're not really talking about the deposit growth rate you expect or anything, but do you think your deposit growth can keep up with your loan growth? Okay. That’s helpful. And the last question I had was on, if you have any guidance or range you can give us on G&A or like an efficiency ratio target, anything like that? Not prepared to do that at this point in time, but it will be – at the bank level, it will be obviously, as we grow. That's the big thing. I just got to remember, we're starting off with a boatload of capital. But you get into the second year, it will be very – people will look at and go, how do you get there? Well, if you don't have those branches, you don't have these new business bankers that arguably are extremely expensive and don't add a lot of value component, but you're basically dealing with the solutions experts that are on camera, we're able to generate tremendous economies and efficiencies. So I'm not prepared to do that. We don't want to get too granular on this call, but we'll have some very exciting efficiency numbers, and we will highlight and showcase that. That's a real important aspect to what we're doing. We're going to be able to demonstrate that we are a technology-enabled bank that really is, number one, able to extract data and put it into the right format to make a decision, but we really don't need the expensive sales and marketing effort that most financial institutions go after, with branches and bankers and brokers and BDOs all over the place. Hi, Barry. So there were certain closing conditions by National Bank of New York City. How do you feel about meeting those conditions? And also any color you can give us – share with us would be beneficial. Sure. So regarding certain closing conditions that were in the original agreement – I mean, there was one, for example, that required the repayment of the existing BDC debt. That's something that can be waived. So there isn't anything that I see – we're in discussions. Well, we've concluded those discussions. There isn't anything I could see from their side or outside that's problematic at all. So anything that you might have seen that's there in the original agreement that was done a long time ago, we're dealing with. So no, we feel very good about the Jan 3 – Jan 2023 date of closing this transaction. Okay. And another note. I've been a shareholder since 2006, so I saw you manage the great financial crisis. And maybe that was more of a surprise than anything to most people. So fast forward to now, I think everybody knows that because the Fed fund rate has gone 4% in record time – up to 4% at record time, I think most people think there's going to be a recession, whether it's deep or shallow, whatever. What kind of things are you basically preparing for and managing your business as you probably have these warning signs going forward? Well, look, I think that it's – nobody has a crystal ball, but we all do have opinions. And look, I think – I don't know the exact date, but I would say about 18 months ago for the first time where we had fixed rate exposure in the 504 business and the nonconforming business, we opened up hedging accounts to be able to hedge the pricing duration of loans that we originated, and obviously worked out very well. And when those get funded in a bank structure, you'll be able to obviously ladder deposits, to ease although bank advances, et cetera, through that particular mechanism. So we've got really good, smart people that obviously are sharp with banking experience as well as capital market experience. And I think from our perspective, we do believe that credit criteria in 2023 and 2024 with respect to the existing portfolio, will be more difficult. So I mean, if you were to say, Barry, where do you think your charge-offs might wind up being your loan loss reserves? Without saying what that is, it wouldn't be imprudent for us to go up 1.5 to 1.75x where historically, we've been assuming that things will get worse, that would make sense. Those are the things we think about. Those are the things that we utilize when we put out illustrations and ultimately a forecast. So as somebody that started on Wall Street in 1982, when the current coupon, Ginnie Mae was a 15 and Fed funds were double digit. And this is not foreign to me, and these things can happen. So we try never to be surprised and expect the unexpected. The good thing about what we do, Marc, is we're in areas that just really aren't heavily trafficked in. It makes it harder to get ourselves positioned historically, particularly as a nonbank, getting people to finance the business because it's not a simple, easy answer as our analysts will tell you, they have a lot of modeling. So it's been hard, but we made it. And life is going to get a lot easier going forward, and we'll really be able to focus a lot of the management's efforts on the blocking and tackling and really letting people know that we are an advantageous organization to really provide a myriad of solutions in addition to taking their deposit money, of which when they deal with the other institutions, they get nothing. They leave their money there, they hope they get a loan and they really don't get a lot else. We're going to give them an advantage, whether it's storing their docs with us, whether it's doing payroll, whether it's the analytics, whether it's the transactional capability. So yes, we feel pretty good about where we are, and we are expecting the unexpected going forward. Good morning, Barry. I don't know – I don't mean to be a pain in the side or anything, but I just don't understand why there's no clarity as to what is to happen in the transition between the BDC and BHC for the current noteholders? Would it be long to think that the refinancing to eliminate the 1940 Act BDC leverage protections is a condition that needs to be satisfied before you can leverage up to a BDC as a BHC? And if it is wrong, then what alternative actions will be utilized to satisfy the preconditions of closing terminology into the stock purchase and proxy statements? I just don't understand what's going to happen? And Doug, you're not a pain. And I appreciate understanding your patience. I know you're frustrated, but you also need to understand that we have an obligation in the note, in the indenture, to perform, and we've done that. And the notes are fine, they're current, and they're in good shape. There is one covenant in the note, and it is a leverage ratio covenant. It's not a BDC or a non-BDC covenant. We've talked about this previously. So relative to the flexibility that we have, as long as we're in compliance with that note, we will act accordingly within the best interest of all of our stakeholders, which includes creditors like yourself to make sure we pay you and all the other bondholders on a timely basis. And we – I mean, I think it's somewhat evident that those notes will need to be refinanced at some point in time. Until that date comes, we're going to do what's in the best interest of all the stakeholders. From a creditor standpoint, as long as we pay the note timely, we're performing our obligations. And apart from that, if I had a total crystal ball with respect to the capital markets, how things are going, we would have done already. Now relative to the condition between the seller and the buyer, we could waive that. If it's in our best interest, we can waive that. I'm not going to go any further than what I've told you today, except that I believe that we will continue to perform according to the terms of the indenture, and it is, I would say, more likely than not, given the acquisition that the one covenant that exists in the notes, which is with respect to the leverage ratio, will ultimately have to be satisfied with the refinance at some point in time. But it is conceivable. I'm not saying it will happen or it won't. And you want to know, well, why won't you tell me? I can't tell you, A, what I don't know, and I can't give you "inside information" relative to what may or may not happen. But it is conceivable if the acquisition could occur and those notes can still be outstanding. And Doug, I'll be honest with you, I'm not answering anything else, so you could ask it to me, but it's unlikely I'm going to give you an answer. So go ahead, ask your question. Actually, I gave you a really good answer. I did. You may not like it, but I gave you a really good answer. Well, I guess what I was trying to get at next on the same question is that, that point in time, even if it is not as having to do with the closing, that point in time will be when you attempt to or want to raise your leverage ratios higher than is required by the 1940 Act – that's allowed by the 1940 Act. Isn't that right? I think your question was, if you're in a position where that covenant would be violated, are you likely to refinance the notes then? Is that your question? Basically, I suppose. I mean, I assume you're saying that it's probably not going to happen as a precondition of the stock purchase. So yes, that's the next area of protections that seems to be there, and that's what I want to understand. So my answer to the question that I illuminated on is, yes. And relative to the second question, that's a condition between the seller and the buyer. It's got nothing to do with the bondholders. Okay. That didn't make any sense to me. I don't know who the seller and the buyer are in this case, but this is probably not the right... Seller is the seller of the bank. The buyer is Newtek, and the bondholders – we have an obligation to the bondholders, which is to make sure that we're in compliance. And we anticipate and will endeavor to continue to be in compliance and make sure that, that does not get violated. And I understand your position, you'd like to get the make-whole premium or whatever it is you want to do. I understand it. But our obligation was to pay the note and pay it timely. That's all I can tell you. Yes. Good morning, Mr. Sloane. I'm a stockholder. So let me just ask you some simple questions. Basically, I purchased the stock for the dividend. I understand the dividend is going to be adjusted downward. But where would you see the dividend being in a year from now compared to where it is now? Thank you. And I appreciate the question. And look, I want to be clear to everybody on the call. We know it's great questions. We don't filter them. I can tell, we take them all. And we try to be transparent. We've been doing this for two decades. And I appreciate everyone that's invested in the company. I think we've historically done a good job for shareholders. I think from your perspective, you bought the stock for the dividend. We went through a process of soliciting votes. We got 89% of the vote to withdraw our election as a BDC. So obviously, a majority of the stockholders believe it was our best interest to ultimately buy the bank, convert to a bank holding company withdraw. Now the bank currently does not exist. The bank should exist or anticipated in January, then it's real. The only party that can actually declare a dividend is the bank Board. I can't. I've given the market a sense that we will think about paying a dividend that's equivalent to the higher end of the range of bank holding companies that are similar. But I say that it's December 14 by the time the deal closes, and this gets declared and – we're going to have a conversation with the Board. It would be imprudent for me and totally inappropriate for me to put a number on this because I can't declare it. I have a sense of things, and I've tried to give that. So that's kind of what I've said. And I think that because we've been that transparent almost from the beginning, investors that – solely only wanted to get the dividend – only. They've exited. And we believe that the total return will benefit in the current structure, which is why; A, management and the Board thought it was good to buy the bank while it went out and got an 89% vote and why we've done the transaction. So I certainly understand your frustration. Look, in the event that you believe in management and that they're right – now you also understand you've got this transformation of shareholders, you've got a bear market, you've got financials being bad, you've got rates going up 4%. So I mean if you want to blame me for the stock price solely and nothing else, you can do that. But I think my point is we would like – we've likely indicated to the market, and it's only an indication, that the company will have a dividend. I'm being very clear, the only party that can declare that dividend is the bank Board. By the way, it's easier for me to say that today because now, I believe that we project it to the regulators in our plan that that's part of our plan. So I feel better about it today than I did down the road. That's why people wanted more certainty. It's like, how do you have certainty when you know your plan isn't approved? So this isn't easy to do. Anyway, we're trying as best as we can. I appreciate your question. Did I answer it for you? Yes. I understand what you said, and I understand the dividend is going down, but as the stockholder, I'm going to stick with you guys for a while because I understand we're going to go to growth mode, but I still like growth as well as the dividend. So you did answer my question. I don't know why people can't understand that. I mean management owns 5.5% of the – I get those dividends. I love those dividends. All right. Well, look, this has been terrific. Really thankful for all the thoughtful questions, the update, the analyst participation. We're going to work hard with our head down. We're running to the finish line, and we look forward to delivering. And thank you very much. Appreciate all your time today. Thank you.
EarningCall_1512
Good day, everyone and welcome to the Vivos Therapeutics Second and Third Quarter 2022 Earnings Conference Call. At this time participants are in a listen-only mode. A question-and-answer session will follow management’s remarks. This conference call is being recorded and a replay of today’s call will be available on the Investor Relations section of Vivos’ website and will remain posted there for the next 30 days. I will now hand the call over to Julie Gannon, Vivos’ Investor Relations Officer for introductions and the reading of the Safe Harbor statement. Please go ahead. Thank you, operator. Hello everyone. And welcome to Vivos’ Therapeutics second and third quarter 2022 earnings conference call. A copy of our earnings press release is available on the Investor Relations section of our website at www.vivos.com. With us on today’s call are Kirk Huntsman, Vivos’ Chairman and Chief Executive Officer; and Brad Amman, Chief Financial Officer. Today we’ll review the highlights and financial results for the second and third quarter of 2022, as well as more recent developments and Vivos' plans for 2023. Following these formal remarks, we will be prepared to answer your questions. I would also like to remind everyone that today’s call will contain certain forward-looking statements from our management made within the meaning of Section 27A of the Securities Act of 1933 as amended, and Section 21E of the Securities and Exchange Act of 1934 as amended, concerning future events. Words such as aim, may, could, should, project, expect, intends, plans, believes, anticipates, hopes, estimates and variations of such words and similar expressions are intended to identify forward-looking statements. These statements involve known and unknown risks and are based upon a number of assumptions and estimates which are inherently subject to significant risk, uncertainties and contingencies, many of which are beyond the company’s control. Actual results, including without limitation the results of Vivos growth strategies, operational plans, including cost savings plans and plans to generate revenue, future potential results of operations or operating metrics, and other matters to be addressed by Vivos management in this conference call, may differ materially and adversely from those expressed or implied by such forward-looking statements. Factors that could cause actual results to differ materially include, but are not limited to the risk factors described in other disclosures contained in Vivos filings with the Securities and Exchange Commission, including the risk factors and other discloses in our Form 10-K for the year ended December 31, 2021 and our first, second and third quarter 2022 Form 10-Q, all of which are accessible on the Investor Relations section of the Vivos website, as well as the SECs website. Except to the extent required by law, Vivos assumes no obligation to update these statements as circumstances change. Finally please be aware that the U.S. Food and Drug Administration has given certain Vivos appliances 510(k) clearance to treat mild to moderate OSA. Any reference herein regarding Vivos Treatment or the Vivos Method should be viewed in that context. Treatment of patients with severe OSA are performed off label at the soul discretion of the treating doctor and are not part of the Vivos treatment protocol. Now, at this time it is my pleasure to introduce Kirk Huntsman, Chairman and CEO of Vivos. Kirk, please go ahead. Thank you, Julie. Before we begin, I want to thank you all for joining us today and for your patience as we've worked through the revenue recognition review that delayed the filings of our second and third quarter financial results. Given the nature of that process, we were unfortunately limited in what we were able to say publicly, which was as frustrating for us as I'm sure it was for -- were most of you. However, we can now report that the upshot of our ASC 606 review is that our prior and current results of operations have only minimally been impacted. No revenue was lost, and we will now be recognizing revenue, particularly VIP enrollment revenue over a slightly longer period of time. Additionally, we believe that our controls and procedures will be stronger for having gone through this process. In a moment, I'll turn the call over to our Chief Financial Officer, Brad Amman, who will spend some time talking a bit more about this and walking you through the highlights of our financial results for the second and third quarters. After that, my goal today is to tell you about some of the exciting things that are happening at Vivos and to discuss the steps we've been taking in order to ensure our company's continuing development, and most of all, to give everyone on today's call some more insight as to why we're so optimistic about our future. Then we'll be happy to take your questions. When we're finished, I hope you'll all leave today's call with a better sense of why we believe Vivos is succeeding far beyond what is currently being recognized by our valuation in the capital markets and why this company has a very bright future with the potential to lead the market for sleep apnea treatment. Thank you, Kirk and good afternoon everyone. Today, I'll review the financial highlights of our second and third quarter 2022 financial results. For information on our results for the six months ended June 30th, 2022 and nine months ended September 30th, 2022, I'll refer you to our earnings release which was distributed earlier today and our 10-Q reports, which will be available on the SEC filings portion of the investor relations section of the Vivos website at vivos.com/investor-relations. Today, we reported second quarter 2022 total revenue of $4.2 million compared to $4.5 million for the second quarter of 2021. This year-over-year decrease was due to lower revenue from VIP enrollments related to the lingering effects of COVID-19 variant resurgences as well as typical second quarter seasonality in the dental industry, which was offset to a considerable degree by increased appliance revenue we generated during the quarter. During the second quarter of 2022, we enrolled 58 VIPs and recognized revenue of approximately $1.2 million compared to 73 VIP enrollments for revenue of $2.4 million during the same period last year. Year-over-year enrollments were impacted by COVID-19 variant resurgences that began toward the end of 2021. These resurgences presented challenges for dentists' offices, which were operating at lower capacity and with limited staff with these hurdles persisting throughout the second quarter of 2022. We began to see this impact subside during the month of June. Also, as it relates to the ASC Topic 606 revenue recognition protocols, we reevaluated our existing revenue recognition policy for VIP enrollments, and along with our independent audit committee, determined that our existing revenue recognition policy was not consistent with the guidance in ASC 606. After analyzing our VIP contracts using the five-step process of ASC 606, we determined that for VIP enrollment contracts, we were required to separately identify the performance obligations and recognize the revenue as the performance obligations are satisfied or over the customer life as applicable. We now evaluate each contract separately for applicable factors in meeting the definition of a contract under ASC Topic 606. As Kirk mentioned, however, it is very important to note that the actual impact on our company and our results of operations, both past and going forward, is relatively limited, including that no prior audited financial statements required a restatement. During the second quarter of 2022, appliance revenue rose 28% due to the price and volume increases as Vivos sold 3,321 total oral appliance arches for a total of approximately $2.1 million compared to 3,082 oral appliance arches during the second quarter of 2021 for a total of approximately $1.6 million. And for the second quarter of 2022, we had approximately $200,000 incentive revenue compared to $100,000 for the second quarter of last year and approximately $200,000 in our orofacial myofunctional therapy revenue compared to virtually none in the prior year due to the introduction of those orofacial myofunctional therapy services late in the first quarter of 2021. Gross revenue was $2.6 million for the second quarter of 2022 compared to gross profit of approximately $3.6 million for the comparable period in 2021. Gross margin for the second quarter of 2022 was 62% compared to 81% during last year's second quarter, primarily driven by higher costs associated with appliances due to increase in cost of raw materials and VIP enrollments from new incentives deployed to increase VIP enrollments. As we mentioned on prior earnings calls, we continue to refine our sales, marketing and promotional efforts with potential VIPs not only to increase revenue, but to improve our gross profit and margins. This includes our expanded social media and digital marketing efforts that Kirk will talk about in more detail later on. Sales and marketing expense was $1.7 million for the second quarter of 2022 compared to $1.4 million for the second quarter of 2021. The increase was primarily due to new marketing campaigns, updating marketing materials for investors and consumers and enhancements to the Vivos website, offset by a decrease in sales commissions related to lower VIP enrollments. General and administrative expenses were approximately $7.7 million for the second quarter of 2022 compared to $6.1 million for the three months ended June 30, 2021. The year-over-year increase was mainly due to higher headcount and expenses associated with being a public company as well as increased travel and event expenses related to improving conditions with respect to COVID-19. Net loss was approximately $7 million for the second quarter of 2022 compared to approximately $4 million for the second quarter 2021. The year-over-year increase was primarily from higher G&A and sales and marketing expense due to the factors I just discussed. Turning to our third quarter results, we reported total revenue of 4.4 -- $4.2 million compared to $4.5 million for the third quarter of 2021. The year-over-year decrease was due to lower revenue from VIP enrollments as well as lower management revenue from the MID clinics, Medical Integration Division clinics, which were offset by increased appliance revenue that we discussed earlier -- that we recognized earlier in the quarter. During the third quarter of 2022, we enrolled 56 VIPs and recognized revenue of approximately $1.6 million compared to 56 VIP enrollments for revenue of approximately $2.3 million during the same period last year. Note that the difference in revenue with the same number of VIPs enrolled is attributable to our new revenue recognition policy, which has the net effect of pushing some VIP enrollment revenue out over a somewhat larger and longer period of time. Year-over-year enrollments were impacted by COVID-19 variant resurgences I mentioned earlier, as well as the change in our revenue recognition methodology that we adopted during 2022. During the third quarter of 2022, appliance revenue rose 20% due to volume increases as Vivos sold 3,057 total oral appliance arches for a total of approximately $1.9 million compared to 2,996 appliance arches during the third quarter of 2021 for a total of approximately $1.6 million. And for the third quarter of 2022, we had approximately $100,000 incentive revenue, consistent with what we reported in the third quarter of last year, and approximately 400 in our orofacial myofunctional therapy revenue compared to $200,000 in the third quarter of 2021 as those services were introduced during the first quarter of 2021. Gross profit was $2.5 million for the third quarter of 2022 compared to gross profit of $3.2 million for the comparable period in 2021. Gross margin was 59% for the third quarter of 2022 compared to 70% during last year's third quarter, reflecting higher costs associated with appliances and VIP enrollments and a longer period over which we are recognizing enrollment revenue. Sales and marketing expense decreased by $900,000 to $1.1 million for the third quarter of 2022 compared to $2 million for the third quarter of 2021. This decrease is due to approximately $600,000 reduction in digital campaigns and approximately $700,000 decrease in materials and product samples, offset somewhat by expenses related to improving the Vivos website, increased sales commissions and additional print media marketing and marketing supplies. General and administrative expenses were approximately $6.6 million for the third quarter of 2022 compared to $6.5 million for the third quarter of 2021. The slight year-over-year increase was mainly due to the growth of the company, combined with higher headcount and expenses associated with being a public company, as well as increased travel and event expenses related to improving conditions with respect to COVID-19. Net loss was approximately $5.4 million for the third quarter of 2022, relatively flat compared to the third quarter of 2021. The year-over-year flatness was due to the factors I just discussed. Now turning to our balance sheet and statement of cash flows. Cash burn from operations for the nine months ended September 30, 2022 increased approximately $5 million over the nine months ended September 30, 2021. This increase is due primarily to the increase in our net loss during the period, an increase of approximately $900,000 in accounts payable and accrued expenses from consulting, legal and third-party lab fees associated with the increased production of our Vivos appliances, an increase of approximately $0.5 million in prepaid expenses, offset by a decrease of approximately $200,000 in accounts receivable and the return of about $0.5 million in a tenant improvement allowance related to the buildout of our Vivos Institute training facility here in Denver. For the nine months ended September 30, 2022, net cash used in investing activities consisted of capital expenditures for software of about $700,000 related to the development of software for internal use, which is expected to be placed in service in 2023. As of September 30, 2022, the company had approximately $6.7 million of cash and cash equivalents, which may not be sufficient to fund the operations and strategic objectives of the company over the next 12 months. Accordingly, the company has been exploring options for suitable additional financing that will replenish our capital resources and help drive our business in 2023. With additional financing as well as additional cost savings measures we have implemented during the second half of 2022 to address our cash burn, we continue to anticipate having sufficient financial resources to meet our capital requirements, fund operations and continue executing on our growth strategy. Further, as a result of cost savings initiatives, we expect to achieve permanent SG&A expense reductions on a go-forward basis. Additionally, we work to increase our revenues, which Kirk will speak to in more detail momentarily. We also continue to explore different types of financing strategies to support growth and extend our cash runway, including other debt financings given our recent stock price performance. In summary, we are encouraged by recent momentum we've seen in our business that Kirk will talk about shortly as well as increased contribution from newer revenue streams such as our strategic collaboration with Nexus. That concludes the financial overview. Now, I'll turn the call back over to Kirk to share some recent updates and talk about long-term growth prospects. Thank you, Brad. Today marks the end of a long and arduous journey over the past six months. As almost all of you know and are keenly aware, the net result of our recently completed revenue recognition review was essentially a first quarter revenue adjustment of less than $200,000 in our favor. That's it. No restatement of prior years, no findings of managerial misconduct, no revelations of wrongdoing. Just a minor revenue adjustment and a new formula for pushing the recognition of a portion of revenue further out into the future. So, let me be clear about this without going into all the details. In order to satisfy certain highly technical provisions of an accounting standard that even the experts themselves couldn't always agree upon and which require management to make certain highly subjective estimates, in the end, we spent six long months and significant financial and time resources only to end up pretty much where we began. While we are grateful that the outcome was a relatively minor adjustment and that our policies and procedures were improved, which will serve us well going forward, it is cold comfort viewed against the time, resources and capital markets credibility, which we lost along the way. Having said all that, this long and arduous process is now behind us. We do not expect to have any further issues related to this topic. So if nothing else, that is cause for celebration. Now let me briefly review why we believe our core proprietary technology and services platform will continue to disrupt and eventually dominate the global market for breathing and sleep disorders such as obstructive sleep apnea, or OSA. There is broad acceptance of the ultimate potential to address OSA globally. Conservative estimates place in the market at over 1 billion OSA sufferers worldwide or about one out of every eight people. Ironically, as diagnostic technologies improve and become more ubiquitous, those estimates continue to rise. In our own rather extensive sleep testing here in the U.S. and Canada, we see nearly one out of two of all patients testing positive for the condition. Today, an estimated 90% of OSA patients are prescribed CPAP as the medical gold standard treatment. When used, it can work well, but no one wants to use it every night for the rest of their lives. And most patients eventually stop using it after several months. For patients who are CPAP intolerant or non-compliant, the next step options are even more limited and less appealing. So, there can be no doubt that for whoever puts forward a clinically effective product or treatment solution at an attractive price point that patients actually want, the payday could be substantial. In short, we have that very thing here today at Vivos. Our products and services meet all the key criteria. They work. They are cost effective. And when patients are given all the options, we find they are preferred over alternative treatments. In the past, we haven't been able to prove that to the satisfaction of some. But just this year, we've moved beyond small or limited studies published in low impact journals to larger studies in top tier medical journals such as sleep medicine where statistically significant results were achieved. In the past year, Vivos also presented original research on our flagship CARE, C A R E, oral appliance devices at the top three academic sleep medicine meetings in the world, the World Sleep Congress by the World Sleep Society, SLEEP 2022 by the American Academy of Sleep Medicine and SLEEP Europe 2022 by the European Sleep Research Society as well as at the Greater New York Dental Meeting. At these conferences, Vivos presented two database reviews, demonstrating significant benefits of care device used in treating adult OSA. And regarding use in the management of pediatric OSA and promoting healthy nasal breathing in children. We also presented some of our latest data regarding the use of our CARE devices in the treatment of adult headaches. Seven additional papers with similarly supporting data showing statistically significant results have either been published or submitted and are pending publication in other peer reviewed journals. Vivos created and has begun enrollment in an academic integrated provider program, providing access to academic researchers to study Vivos' proprietary products in an open source format. Vivos has also continued its aggressive pursuit of clinical trials, and several potential teams and sites have been identified and are in the planning phases. One noteworthy and very practical application that has come about through our research and ongoing development has been the introduction of a key diagnostic technology called rhinomanometry. You may recall that Vivos is the exclusive dental market distributor in the United States and Canada for the only FDA cleared rhinomanometer available. So we have highly differentiated products and technologies that actually work and have been working for over a decade in over 31,000 patients. We have broad out-of-network insurance coverage for medical payers as well. What we haven't had is a therapeutic product line that could address the needs of patients at lower price points. To address that need, we recently announced several exciting new additions to our product line and services to allow far more patients to receive treatment through our provider network. These new products allow us entry into several new product and equipment categories where we've never before had a presence. We now have a broader range of price point offerings that are being rolled out that significantly decreases the friction per patient and makes it easier for dentists to get patients into the Vivos ecosystem and that stimulates our growth. With product lines now ranging from diagnostics to CPAP, to mandibular advancement and treatment with all the devices and the Vivos Method, we now have a product and path for treatment for the vast majority of patients. We often hear the question, if Vivos treatment is so great, why haven't many more dentists integrated Vivos into their practice? That's a great question. We often ask ourselves the same. So, it's important to note that our Vivos integrated practice or VIP enrollment efforts to date have been focused on attracting only the very best dentists available, those who had the clinical confidence and success to adopt and integrate something like Vivos into their practice. They are typically the ones who get the overall picture of what this can mean for their practice and their patients and who see the value in our initial training and enrollment fees that can be as high as $50,000. Now that we've established a broad core network of over 1,650 Vivos trained dentists across North America, we can now begin bringing in more dentists at lower introductory prices for limited programs that will attract many more doctors and allow them to test the waters with our company and our products. As a direct result of creating many more lower cost points of entry, in 2023 we expect to see more dentists than ever before becoming customers of Vivos and purchasing products and services. Keep in mind also that Vivos is still relatively new to dentistry. We are roughly where aligned technology was in their early days as they rolled out Invisalign. And recall that their stock likewise dropped nearly 90% from their IPO price before rebounding and eventually peaking out at over $600 a share. Adoption of any new medical technology takes time and perseverance. Inspire Medical was first spun out of Medtronic back in 2007. And while both companies currently enjoy much greater valuations than we have, we believe our overall market opportunity, our products and our technology are superior and will ultimately prevail in the market. Keep in mind that important growth pivots for each of these companies came when they began driving patients who are asking specifically for their products to train providers. We are continuing to get our name out so that more and more patients specifically ask for our products. In that regard, we recently successfully piloted and rolled out a new program called Treatment Navigator, which is already showing great promise. This program supports dental offices and provides each new patient and advocate who assist them in navigating the many different steps involved in the patient journey, coordinating medical and dental diagnostic appointments, insurance pre-authorizations, furthering education and treatment planning and generally coaching the patients through treatment. The Treatment Navigator's role is effectively to act as an extension of the VIP practice, taking a significant load off the provider's team. Under the guidance of the appropriate health care professional, Treatment Navigators assist and motivate patients to obtain the right treatment for them. Treatment Navigators also leverage the power of our Vivos AireO2 EHR, which is electronic health record software platform, to facilitate communication and collaboration amongst providers to file medical and dental insurance claims and to record patient progress throughout. You may recall that our Vivos AireO2 EHR software program is the only full-featured medical dental practice management system on the market today, configured specifically to accommodate the treatment of breathing and sleep disorders. Doctors pay additional fees to Vivos for our Treatment Navigator service. Over the course of 2023, we expect to see this program evolve into a significant revenue and profit source for the company. Currently, we have taken over 70 applications from VIPs to join this program, and we are systematically rolling this program out across the country. Our initial results from our Treatment Navigator pilot tests demonstrate that we can deliver a valuable service to our VIP offices, solving one of their primary issues of staff shortages and turnover. Now all they have to do is screen patients coming through their hygiene departments and then allow the Treatment Navigator to manage the logistics and get the patient ready for treatment. In addition, our Treatment Navigators assist patients who come through our social media website or other marketing campaigns to find answers and get into the Vivos ecosystem. Now I'd like to turn some attention to our Q2 and Q3 results, starting with our two key metrics of VIP enrollments and plans to [indiscernible]. During the second and third quarters of 2022, macroeconomic factors, including heightened inflation and rising interest rates, continued to put pressure on our business and the practices we serve. These factors, along with the lingering impacts of COVID, led to dentist delaying enrollment with Vivos and fewer patients going through the doors of our VIP offices. This impact has not been limited to Vivos. It's been felt throughout the dental industry. Other companies in the dental industry have experienced similar challenges due to the economic environment. For example, Align Technology experienced a significant decrease in their aligner revenue by 8% quarter-over-quarter during Q3 and down 13% over the previous year. Here at Vivos, we saw our appliance sales peak at an all-time record in June, only to fall back somewhat in Q3. Despite these headwinds, we are not satisfied with maintaining relatively flat performance here in 2022 and have taken significant steps to get us back on the path to growth. To that end, we have reorganized and downsized staffing at all levels. We have made cuts or renegotiate relationships with vendors. And whenever possible, we have turned expense line items into new revenue streams. I will discuss these efforts in greater detail here in a moment. Digging deeper into our performance beyond the income statement, there are several noteworthy achievements. In terms of new provider enrollments, we enrolled 58 and 56 new providers in Q2 and Q3, respectively. And while that's down 12% year-over-year due to the reasons I just mentioned, enrollments in the second quarter increased by 81% over the first quarter. Also, while the total enrollments were relatively flat in Q3, we have increased our sales conversion rate and expect to keep improving upon this trend. One factor in our improved closing rate is a new 0 interest financing program for new VIPs. The cost now for a qualified dentist to become a Vivos integrated provider or VIP is now as low as $750 a month. Moreover, pre-registrations for the next year in January, February and March for our sleep medicine revolution events are nearly sold out. Having such events fully booked out that far is unprecedented for us and something we see as a favorable trend. Let's move on for a moment now to home sleep test and case starts, which are both key performance metrics. The VivoScore home sleep test we offer to our VIPs from SleepImage are a core advantage because they offer an easy and affordable way for patients to obtain a clinically accurate and diagnostic quality assessment of their breathing and sleep. VivoScore home sleep test for Q2 and Q3 of 2022 were two times the rate of the same period in -- the same periods in 2021. This means that thousands of patients a month are discovering that they have some form of OSA, and we'll need to figure out what to do about it. Our primary test now is to find ways to assist our VIPs to get those patients into meaningful dialogues about their condition and ultimately close more cases and get more of those patients in the treatment. That is precisely why we put together our Treatment Navigator program. MyoCorrect enrollments for Q2 and Q3 were up two and a half times over the same period last year. The strong growth in this program not only provides a consistent and growing revenue stream for the company, but it also helps patients have a better overall experience with treatment. Overall, new appliance start -- new appliance case starts are down slightly from the prior year. To date, our VIPs have treated over 31,000 patients with the Vivos Method. Vivos continues to make excellent progress in the dental service organization, or DSO channel, with active pilots in three DSO organizations, which represent over 457 practices under management. Pilot programs are starting with four additional DSOs, representing an opportunity of another 519 locations. We are in advanced contract discussions with an additional 17 DSOs, representing another 5,500 locations. That's 24 distinct DSOs and almost 7,000 practices. Now as many of you know, I was the founder of one of the very first DSOs and helped to pioneer the DSO model of providing business and clinical support to independent dentists. Over this past summer, I was privileged to speak at one of the largest DSO conferences this year where I shared why Vivos is a significant opportunity to the DSO community. Because the DSO market is so important, I'm going to highlight this again, also sharing the positive impact to Vivos. First, the DSO corporate model is to acquire practices, increase EBITDA and sell at a higher multiple. Second, sleep dentistry is the biggest opportunity to increase EBITDA since aligners and implants. Third, a typical DSO practice that screens just two patients per day, four days a week would test 32 patients a month. Half of those will test positive, and half of the positive group should start treatment, yielding top line revenue of just under $1 million per practice. Now to understand the impact of this, you should know that the field of dentistry has largely become a commodity market with little remaining opportunity for new revenue or margin growth. That being the case, nowhere else in all of dentistry is there an opportunity to grow that even comes close to what Vivos is offering. Point number four, estimated net EBITDA margins of 30% to the DSO per practice would net the practice $300,000 annually. Since DSO multiples are typically about 10x of EBITDA, this one practice could translate to a $3 million increase in the overall DSO valuation. Now for a relatively small 35-location DSO, the integration of Vivos into their workflow could add $100 million to their firm valuation. Point number five. Now let's look at the impact to Vivos. Each DSO practice that performs to the above metrics would generate about $192,000 in annual revenue for this company. Point number six. A moment ago, I mentioned the three DSO practices that we were in pilot test with today and that they represent 897 total practices under management. If just 20% of those practices became Vivos' providers, it would add approximately $34 million of Vivos -- annual revenue to Vivos. We see no reason why that number would be limited to 20%. And given the compelling economics outlined above, we expect much greater penetration over time. What is becoming very clear from our pilot test is that the opportunity for Vivos with respect to DSOs is everything we expected and perhaps even more. When coupled with our Treatment Navigator program, the ROI for both DSOs and Vivos is unparalleled. Now on the regulatory front, earlier this year Vivos was cleared through the Canadian Ministry of Health and Health Canada to sell devices in Canada with even broader specifications. And as our research and clinical data becomes more widely accepted, more regulatory doors are opening for us. In the second quarter of 2022, Therapeutic Goods Administration, or TGA, in Australia issued clearances for our devices to treat adults and children for all indications inclusive of OSA regardless of severity. For those of you not familiar with the TGA, it is Australia's equivalent to the U.S. Food and Drug Administration. This is a significant development for us. Not only does this pave the way in many international markets, but this also provides further validation of our technology. We continue to move forward seeking clearance here in the U.S. as well as international regulatory agencies. We are optimistic that our clinical data will continue to be well received and that the necessary regulatory approvals going forward will not be a variant. Speaking of international markets, we are in late-stage negotiations to take our technology into Dubai and the Middle East and are in the early stages of going into India and Southeast Asia. Our penetration into the Australian market is also going well now that we have full regulatory approval. We note that these opportunities have come to us by way of dentists and others who have come to the U.S. for training at our institute and have now desire to take this life-changing technology back to their home countries and regions. So there, you have just a glimpse of why we believe the future of Vivos has never been brighter. From the latest research that continues to elevate and substantiate our technology, to our revised and streamlined new business model and product lines, which will accelerate our scale up to new and exciting regulatory approvals in worldwide markets, we continue to make strides and progress. Now, obviously, we will need additional capital to achieve those objectives and realize the potential I've just outlined. Along the same lines, our primary focus throughout this year has been to ensure we position ourselves to achieve positive cash flow as soon as possible. To accomplish this, we have taken a series of steps to streamline expenses while also creating new revenue opportunities. Our internal structures and process -- processes have been significantly revamped with a focus on near-term ROI. On the cost cutting front, we disassembled the company and reorganized in new ways that we believe will be more efficient and cost effective going forward. Vendor relationships have been reassessed and/or renegotiated. What were once expense line items have now been turned into revenue opportunities wherever possible? The net effect of all these efforts has been a reduction approaching $1 million per month and our cash burn from its peak in the first quarter to where we are today. Also, we expect to see the impact of our new revenue streams gradually take shape throughout 2023 and contribute significantly to our profitability. As previously mentioned, our goal is to achieve cash flow breakeven in the next 12 to 18 months. Meanwhile, we are doing everything we know how to be great stewards of the capital we have available. And as Brad mentioned, we have been exploring additional financing options. We believe we have a good solution available, and we hope to announce something in the near future. Another important result of the reorganizing of our business from the ground up has been a general simplification in what we do and how we do it. Our training is more streamlined and intently focused on the essentials, so that ramp-up times for new providers are as brief as possible. Our messaging to the world at large is crisper and clearer. Patients in search of real solutions are finding us and being directed into Vivos trained practices. Over the past several months, we have been aggressively pursuing additional capital financing options. And as I said, we hope to have something to announce on that front very soon. The company has been actively exploring options for suitable additional financing that will replenish our capital resources and help drive our business plan forward in 2023. In prior earnings calls, we highlighted our strategic pivot towards direct-to-consumer marketing efforts that began in the latter part of 2021. Today, I am pleased to announce that we're working in close collaboration with our marketing partners. We have successfully piloted a marketing initiative to drive more new patients into Vivos training provider practices and to generate more case starts. This program has exceeded our forecast and is consistently delivering between 30 and 50 qualified new sleep apnea patients per month into each participating office. To put that into perspective, that number of total new patients would be above average for a typical general dental office. We are beginning to roll this new consumer marketing program out to our entire VIP provider network. From a company standpoint, we could see a significant financial impact across the board with almost no incremental investment. Also along the direct-to-consumer front, we are announcing the formation of an independent firm called [indiscernible] that seeks to leverage social media influencers to generate awareness of the many benefits from the use of our highly effective Vivos guides in guiding the craniofacial growth and development of pediatric patients. Their stated goal is to put 25,000 children into treatment using Vivos products. This company is led by some of our most prolific and supportive Vivos doctors and former company executives who have witnessed firsthand over several years just how impactful and life-changing our products can be. Vivos is the exclusive supplier of products to [indiscernible]. Finally, more of our VIPs should begin to receive greater reimbursements going forward because more patients will now be eligible to have coverage for their Vivos treatment. This is due in part to a strategic alliance Vivos recently entered into with a company called Nexus Dental Systems to create what is expected to be one of the most comprehensive medical billing services in the dental industry. This collaboration is expected to provide both companies' provider networks with greater access to both in or out-of-network billing with all major medical insurance companies, facilitating case acceptances, insurance billing procedures and reimbursement. Again, this creates additional important revenue stream for Vivos. We believe that these combined efforts will create additional awareness with dentists, improve VIP enrollments, case starts and revenue. In closing, we believe our future at Vivos remains bright for the reasons I just outlined above. We continue to grow despite a challenging environment. We have a number of initiatives underway to drive additional revenue growth, increase VIP enrollment, expand our offerings and open up new revenue streams for Vivos, including our recent collaboration with Nexus. At the same time, we are conscious of costs and have taken the necessary steps to generate permanent cost savings while shortening our path to cash flow profitability. We intend to stay the course and look forward to updating you on our progress. Again, we want to thank our shareholders for their patience as we work through our recent rev rec challenges. This is now behind us with a positive outcome, and our eyes are squarely focused on the future. Thank you and good afternoon. Obviously, I'll go through the 10-Q, so I'll keep my questions relatively general. Second and third quarter revenues looked about in the $4 million range, which imply annual rate of about $16 million. I guess the first question is, what do you think you would expect for an organic growth rate when you think about Q4 of this year and the first half of next year? How do you expect that growth -- what kind of range should we be thinking about? Well, hello, Scott, thank you for the question. I would say that what we have seen throughout this year has been -- as we mentioned earlier in the year, there were some headwinds associated with what we were doing. It seems to have lightened up. We seem to see sort of a rebounding effect going on here in the fourth quarter and we hope to see that extend into next year. I would say that the impact of the staffing issues that occurred during COVID continue to plague dental offices. And we think that with our Treatment Navigator program that we'll be able to mitigate some of those effects. We also -- what we don't know yet is how quickly some of these new revenue streams will ramp up for us, but I would expect to see us ramp up over the course of next year in a very organic way to where we would be well above the $4 million threshold certainly by this time next year. And I realize that's what we have going -- that's what it was this past year. But I would expect to see these other revenue streams kick in, and I think they can be somewhat substantial. Okay. And maybe another way to ask a similar question. You talked about cash flow breakeven in 12 to 18 months. What rate of revenue do you think gets you there? If you think about your first breakeven quarter and annualize that revenue number, what do you think that is? Well, I think the run rate number is probably in the neighborhood of $25 million, perhaps $30 million. I think as we look at our forecast internally, that's probably what it's going to take to get to cash flow breakeven for us. And so, again, we've trimmed out a lot of costs. We think we can run pretty lean and still grow revenue. And we'll continue to evaluate this literally on a month-to-month basis as we go forward. Okay. So, would you say gross margins kind of trending around 60% right now? That used to be higher than that. What do you think is more reflective going forward, the 60% range, or do you think it would be back to 70%? My guess would be somewhere in the 60% range going forward. We have some opportunities to improve that. But I think to be safe and conservative, I would say right now that I don't see where the margins will -- I don't see a lot of further erosion, but I think 60% is probably a conservative gross margin forecast. Okay. So, I'm just kind of doing the math in my head, 70% gross margin, $7 million a quarter. Getting to breakeven, it would imply you'd probably have to cut another $2 million out of expenses. Is that a fair assessment? Do you think -- do you have room to cut that out? Or I mean, either you cut it out or you grow into it with leverage. But to breakeven at $7 million a quarter, I think you're going to have to make some cuts. Is that fair? I think that's fair on the back of the napkin. And so, let's see what happens. We have some pretty high margin revenue streams coming online, which we hope will improve our margins a little bit further. So, let's see what happens. We've got room yet to go to cut expenses if we need to, and we're prepared to do that as we evaluate month-by-month going forward. Okay. Great. I will wrap it up there and talk after going through the 10-Q. Thank you for taking the question. Okay. Great. Good afternoon everyone. Maybe to continue there, can you expand a little bit more on the cost cuts that you do want to take place, the ones that you have planned, the ones that you take if you absolutely need to? And just the thoughts around those cost cuts and how it would or would not impact revenue growth on the go forward. So, what we've done, as I mentioned and I don't know at this point came across clearly or not, but we've really reorganized from the ground up and have taken a sort of a ground up approach of things. So, we've -- where we had opportunities to eliminate positions or personnel, we did that. And we -- largely, we took into account our practice advisory model, which was the source of a lot of our overhead. Remember -- you might remember this, Alex, that we -- in Q1, we spent a lot of time gearing up our practice advisory services in order to send people out into the market to retrain some of these staff, people that had been lost by the dental profession, and some of our best providers had just lost their teams and they were just -- they stopped producing. So, we geared up. And we probably took on a lot of overhead related to that, that we found a better way with this -- with our Treatment Navigator program. We turned that expense line item into a profit center. So, we let some of the -- after that initial surge, we let some of the practice advisers go, and we turn the remaining ones over into Treatment Navigators. And the Treatment Navigators, actually, as they pull patients through the process of getting into treatment, that actually turns into a profit center for us. So, we took a raw overhead and turned it into a profit center. So I would say that, that single effort, which is still nascent and coming out of the gate here, it's not showing up in our third quarter yet because that's when -- that was the quarter we started piloting this. But here in the fourth quarter and going forward, it's got a nice margin to it. The service has a good margin to it. We have a tremendous amount of interest in it, and we think that'll be a good thing going forward. Now having made those cuts, as that program comes back online -- as it grows rather, we're going to need to hire more Treatment Navigators. So -- but these Treatment Navigators will be hired to be immediately accretive and profitable to the organization. So, whereas we didn't have a clear ROI on our practice advisor group, we now have a very definitive and defined ROI on these new Treatment Navigators going forward. And so we think that that's going to help a lot our new product lines that we brought on board, the growth of our MyoCorrect services, which has pretty good margins, the growth of our billing services, I think those things will allow us to grow organically. And as we add staff going forward in the future, it will be because the demand is there and we can deploy personnel with an immediate ROI attached to that. So, I'm hopeful that, that is the model we'll be able to execute on. That's what our mandate is. Everything has been geared now towards short-term ROI and immediate accretive deployments of resources and personnel. So that's how I would answer that. One other item to what Kirk said was in our VivoScore rings. In 2021, we used VivoScore as a loss leader in really a tool to help VIPs hit the ground running and start up their screenings of their patients. In 2022, we initiated six months of no cost lease included with the VIP program, the enrollment program. And then we start charging them after the 6 months $79.95 a month per ring. So, we can start to turn that loss leader business model into a revenue generator. And we're starting to see the revenue from those ring leases starting to grow here in the last half of the year. Okay. Understood. And then maybe refresh us on the big studies to watch here going forward. I know there was a Stanford head-to-head study going against CPAP. Just any update around the big studies? Any other head-to-head studies we should be watching? Well, we've been supremely frustrated over the Stanford trial progress. And it's a bureaucratic nightmare to get through that. I can't really tell you what the status is because honestly, we don't know. We keep nudging them along and trying to get everything accomplished through the administrative process that they have there with their internal IRB, et cetera. And it just seems like there's one roadblock after another. So, we are -- we're continuing to look at that. We're continuing to -- I mean every day, we effectively compete against alternative treatment modalities. We -- and every day, we take patients out of CPAP, get them off their CPAP machines. We compete in the real world against Inspire and against all these other treatment modalities every day. To get some hard data on that, one of the things we mentioned but we didn't elaborate on is that we're establishing a university based research network of university researchers that will be able to conduct open source research using Vivos products, and they can pick and choose how they want to do that. So, if they want to put a research project together that compares Vivos against CPAP or against other alternative modalities, then they can certainly do that. We are supremely confident in the efficacy of our treatment and protocols. And so, we've opened it up in an open source format. We've had good response from several different universities, dental departments and others to conduct this research, and we're very excited about that going forward. So, I wish I could give you some good news about Stanford, because it's one we've talked about. It feels like we've been talking about that every quarter for the last two years. And it just seems to just die in the bureaucracy there at Stanford. We had to rewrite the protocol about six or eight months ago, but it just doesn't seem to get any traction. So, we're going to continue to look for alternatives. We have some ideas around other institutions. If we can't get that particular study to go through at Stanford, we've had some inquiries from some other institutions to do similar work. So, we'll keep that up. And research is an important part of what we want to do here. Obviously, with the seven pending papers, there's a lot of stuff that's gone on. When you see what we're about to publish and release, I think you'll be very happy with what we'll be able to say. It'll help our regulatory environment. It'll help our credibility with payers. It's just going to lead to a lot of good things. So. And we have reached the end of the question-and-answer session. I'll now turn the call back over to management for closing remarks. Well, we would just like to thank everyone for being here this afternoon. I apologize for my voice. I'm a little under the weather today, and I appreciate you bearing with me as I cough through some of these things. Look, we believe that our future of Vivos remains bright for all the reasons that we've just outlined. We continue to grow. We continue to navigate a challenging environment. We look forward to sharing our continued progress with each of you in the future. So, thank you and have a great day, and happy holidays.
EarningCall_1513
Thank you for standing by, and welcome to the Pilbara Minerals December 2022 Quarterly Investor Conference Call and Webcast. All participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session first for teleconference participants followed by online questions from webcast participants. [Operator Instructions] I would now like to hand the conference over to Pilbara Minerals, Managing Director and CEO, Mr. Dale Henderson. Please go ahead. Thanks very much. Hello, everyone, and welcome to the Pilbara Minerals December quarterly activities call. I'd like to start by first acknowledging the traditional custodians on the land, which our business operates. And Perth, that's the Whadjuk Noongar people and up north where our operation is, the Nyamal and Kariyarra people, we pay our respects to their elders past, present and emerging. Moving to introductions. Our presenters today, of course, myself; we've got Brian Lynn, our Chief Financial Officer; Vince De Carolis, our new Chief Operating Officer is with us; and Alex Eastwood, our Chief Commercial and Chief Legal Officer. Also in the room today, supporting us is, we've got Greg Jason, Assistant CFO; Gavin Spoors, Investor Relations; and we've got Nicholas Read from Read Corporate. Thank you all for joining us today and we are looking forward to taking you through our update and moving to Q&A. So the outline for the call will follow the usual format. I'll give some opening remarks, I'll then hand to Vince to talk about the operations, I'll then talk about the projects and chemicals, progress that we've made, and then we'll hand to Brian for the financials and lastly, back to myself for some comments on the market and closing comments. We will then move to Q&A, which will be in two parts. The analyst call which will be approximately 30 minutes and then we'll move to the webcast for approximately 20 minutes, which will be moderated by Alex. So moving to Slide 2. What an amazing quarter we've had. The December quarter for 2022 the best quarter to date for the operation. Step up in production tons to 160,000 for the quarter. Sales of 148,000 step up in the prior quarter. The realized price for the quarter, a big step up there, and then from a unit cost perspective, a modest decrease. So great set of numbers for the quarter and big credit to the full operating team and extended business for bringing that home. Now moving to Slide 3. [If that strong pricing time] strong volumes is equaled to a strong balance sheet to the tune of $2.2 billion, being at 62% increase on the prior quarter, big step up there as a function of, as I say, that strong volume and strong pricing. Other highlights for the quarter included the offtake price reviews were completed as part of the normal cycle, which has resulted in some improved pricing outcomes, which take effect from effectively December pricing moving forward. The capital management framework for the business was established and deployed to market, which was inclusive of our inaugural dividend policy. In the funding category, we were successful in securing the $250 million debt facility from the Australian government to support the P680 expansion project of which – and that funding, I'd say, it's a real coup for Pilbara with [long-standing] debt, competitive terms. And importantly, it's government endorsement of our critical minerals project, which we think bodes well for the business as we look to reach outwards to the global market in the years to come. In the projects category, the Board approved the pre-FID funding for the P1000 project to the tune of $38 million to support long-lead procurement and engineering. And then in the chemicals category, progress and two [Audio Gap] continues there, which I'll speak to later. And then there is consummating the joint venture with Calix for our Mid-Stream Demonstration Project. So great to get that signed up and we locking arms with our friends and partners of Calix. Lastly, a quick update on executive recruitment. We have been going flat out in that category, obviously, Vince coming on Board as our new COO, it's the first cab off the rank, and welcome Vince. But our other executive roles that we are employing for are vastly progressed and those roles being the Chief Sustainability Officer, Chief Development Officer, the new CFO, the new – Brian, big shoes to fill and our new Project Director. So we are flat out. I'm an interview machine for the last couple of weeks, but we are getting there and looking forward to announcing those appointments in the weeks to come. So moving from highlights now to Slide 4. For those who are new to Pilbara, just a very quick introduction and speak to strategy. Pilbara is building an Australian powerhouse in lithium battery materials production. We've got a Tier 1 asset, Tier 1 location, the Tier 1 team, and it's all coming together at the perfect time. With that Tier 1 asset, we've got is a massive hard-rock pigmentite system, one of the largest on the globe, and it's in a Tier 1 location. Our southeast of Port Hedland, one of the largest bulk export ports globally, and of course, domicile in Western Australia, one of the best mining precincts you could hope for globally, which has all the mining and technical support you could hope for as a miner and operator. And then the Tier 1 team, we've got a fantastic development and operating team whose skills were forged during the downturn, and they are the key ingredient, which is unlocking the value that Pilbara was creating and most recently, of course, the ramp up of the Ngungaju operation, which of course, was the Altura operation and of course, deploying that expertise to scale as we step into the expansion of P680, P1000. And as I say, all of this is coming together at the perfect time, fantastic confluence of events and Pilbara is poised like no other to thrive in those burgeoning market. What's our mission? Our mission is to be a leader in the provisioning of sustainable battery materials products. Now strategy to deliver on that has four legs. First and foremost, it's about delivering on our commitments, making sure the operating platform is shooting the lights out and I'd like to say and like to thank this quarter – [case in point]. Secondly, it's about achieving the full potential of the Pilgangoora operation. This is about ensuring that we – first and foremost that we are extending that resource to full extent through drilling this massive Tier 1 asset. By the way, you'll note in section six of the report that we are busy drilling further. So I am looking forward to saying how that goes. But having extended the resource, then it's about matching that with right processing capacity. And of course, in the first instance, this P680 to P1000, but of course on the assumption that more growth than the asset that would afford more growth in the production capacity. Obviously work to be done to confirm that, but we remain optimistic. Our leg three is about extracting more values, more value per lithium units through our chemicals participation. And in this regard, the first cabs off the rank are our POSCO joint venture for the development of a 43,000 ton lithium hydroxide plant in South Korea. Then there's a joint venture with Calix for the R&D project for the mid-stream project, the production of high-grade lithium salt from the mine site. But we look to do more in this category. The more we can add value per lithium units for downstream integration that creates more value to channel back to our shareholders. Moving down to the fourth leg of our strategy, diversifying revenue beyond the Pilgangoora operation, so that enclose us expanding beyond our base asset, so when you roll all of that together, we think it's a strategy grounded and fundamental value creation trained on our mission. It's an absolute privilege and we, Pilbara continues to have a fun time ahead as we step through these growing leaps as we expand this impressive base that we already have. In my opinion, there is no better growth story on lithium, but I might say, I am slightly biased. And with that, that sums up pretty much our strategy. So that's said at the high level, now at this point, I will hand to Vince who will offer us a bit more detail about the operation for the quarter we've just had. Over to you, Vince. Thanks, Dale. Starting with safety on Slide 5. We've had a good quarter. A key lead indicator Safety Interactions has seen improvement on the prior quarter, and that's a key focus for us indicating increasing engagement with our workforce. And on the back of that, our lag indicator, the Total Recordable Injury Frequency Rate has also improved quarter-on-quarter sitting at 3.5 [indiscernible] we've commenced our graduates program with several inaugural participants who will hopefully someday be our future leaders. Moving on to Slide 6. Production and sales, we’ve had a strong quarter as you can see in the graph in both sales and production. In mining, we've had a consistent ore supply to the processing plants. However, this hasn't been without its challenges in the quarter. The main challenges have included some equipment availability, resource levels with the current hot market and some mining hygiene control practices. For the quarter, we have mined a slight reduction on the prior quarter at 7.4 million tons. But importantly, the ore supply volumes to the processing plants have been maintained. However, suboptimal mineral feed at times has occurred and that impacted the processing plant recoveries. Moving on to the processing plants, both Pilgan and Ngungaju have performed well and consistent in both availabilities and throughput rates. Recoveries have also been consistent, albeit down on target and between the high-60s to the low-70s and that's dominantly dependent on the mineral feed. Moving to Slide 7, and just to finish off on another quick news story. Very pleased to report that we commissioned and energized our new six megawatt solar plant, representing our first step in decarbonization, which looks fantastic out on the plant. Thanks very much, Vince. Now moving to Slide 8, a quick update on our expansion, that’s leg two of our strategy. That’s the P680 project, earthworks, effectively complete, procurement well underway and we are maturing and coming near the finalization of the execution contract for that project. Obviously moving as quickly as we possibly can to bring that project to life, still targeting that September quarter ramp up, which remains on track. But we did revise the capital estimate for the project during the quarter, which was announced last couple of weeks back. That project remains full steam and we look forward to bringing that to life in due course. As it relates to the P1000 expansion, as I mentioned in the highlights, the Board approved pre-FID funding of $38 million to support procurement and early engineering and the full FID for that expansion, we are on target to have that approved and out the door back of the current quarter in the March quarter. So it's foot down on the expansion and we are keeping the throttle jammed wide open to make the most of this market. Now moving from Slide 8 to Slide 9, just to update on the chemicals, the third leg of our strategy. As it relates to the POSCO, Pilbara joint venture construction is absolutely underway in South Korea. You can see from the picture on the left hand side of that slide. The team there is absolutely focused on schedule and deliver that project. Myself and Tony Kiernan at Chair had the privilege and benefit of being there in November, so it's great to get on the ground and talk to the team and see the progress. And as you can see, it's well underway and they remain – Pilbara, POSCO remain on target for that quarter four ramp up of commissioning commencement for the first train of that plant. So excited to see that unfold in the months ahead. Moving to Mid-Stream joint venture. As I mentioned in the highlights, that agreement was finalized during the quarter for the development of the demonstration plant. And for those not familiar with the Mid-Stream Project, what this is about is doing more processing of our product at the mine site, producing a different product to market, a superior product to market, I believe because for several reasons. First and foremost, a big step down in carbon energy intensity; two, a big step up in the concentration of the lithium units; and three, leaving behind the aluminum silicate waste at the mine site will be readily handled. That aluminum silicate waste is part of the existing spodumene product, which has to be handled by our customers. So those three benefits for the product we think are material and with all of that, obviously that step up and we will see concentration offers a reduction in transport volumes. There is a lot of benefits which can flow from this, if we get this right plus doing some more value add onshore, we think makes good sense. So we like what we see in terms of the test work. We like what we see in terms of the study work. The big step we need to do is this demonstration plant, which is about deploying the unit step process at scale and validating effectively unit cost, reducing the volumes of the products, so we can test the market for pricing and iron out any process learning. So as much as we are excited about it, we very much put R&D on the can and others will recall when we were successful and some grant funding for this project as well. So it's an exciting project. It has the potential to change the future of our business and that of the industry remain cautiously optimistic, but as I say, it's R&D and we are delighted to have that joint venture finalized with our friends at Calix and well done to Alex and the commercial team for getting that across the line in the quarter. Now, that completes the chemicals update. And at this point, we'll move to Slide 10, and I'll hand over to Brian for the financials. Right. Thanks, Dale and good morning, everyone. I probably just quickly give a very high level summary of the financials for the quarter, offer some commentary around selling price, costs, cash positions, and then a little bit on the capital management framework. So in summary, I think in the June quarter, I described the June quarter as transformational for the company. I think I described the September quarter as pleasing from a financial perspective for the company. Well, I would describe the December quarter as an absolute cracker from a financial perspective for the company. The business generated very healthy operating margins. This led to an $851 million improvement in the company's cash position. And we stand with about $2.2 billion in the bank at December 31, 2022. This is really all driven on sort of the key metrics and all key metrics were better than what we have done in the September quarter, so we had a lift to production tons. We improved our sales tons and healthy improvement in our U.S. dollar realized price, and we also managed to lower our unit operating costs as well. We also ended that quarter with a net cash position to net of debt of just over $2 billion. And as Dale mentioned before, we took the opportunity, given the continued growing cash position to establish a Capital Management Framework which was disclosed to the market in November. On selling prices and operating margins, a really important outcome for the quarter was a completion of the price reviews with our customers, and this when combined with what was an ongoing positive market. Hence an average selling price of US$5,668 per ton was achieved with 148,000 to 149,000 tons of product sold at an average grade of 5.4%. The equivalent SC6.0 reference price for this product was US$6,273 per ton. So a fairly significant increase compared to the September price, it was about a 33% increase. The average realized price in Australian dollar terms was also bolstered compared to the September quarter because of a returning depreciation in the Australian dollar. I think it depreciated by about 4%, which obviously helps our revenue line. So these strong pricing outcomes supported obviously a very strong operating margin at the Pilgangoora operations, so we achieved a margin in Australian dollar terms of about $7,400 per ton, and that's equated to about $1.1 billion of margin. In terms of operating costs, the unit operating costs that we generally referred to, which excludes freight and royalties, and that was in Australian dollar terms of $579 per dry metric ton, which was a 5% improvement on the September quarter. So I think about operating costs within our business, I think operating costs continue to be outlined where they were sort of 12 months ago and still are being impacted by labor shortages, particularly in the WA mining sector. Supply chain disruptions continue and there is this general inflationary pressure being experienced and obviously we continue to incur high mining costs as we invest more in the mining space, particularly in moving more waste. Just thinking about the quarter, we did, however, get some benefits compared to the September quarter. So the lift that we had in production, which is about 10% obviously gives us economies of scale when it comes to cost, and most of that production lift was actually spending down the Ngungaju plants. So most of the extra times came from the Ngungaju plant, which was pleasing. We had a lot of maintenance costs during the quarter with one less shutdown compared to the September quarter. And we also benefited from lower diesel costs and particularly as a result of the reinstatement of the government's temporary reduction in the fuel tax credit, which equates to about $0.23 per liter. We include the freight royalty costs and the unit cost, the December quarter at a unit operating cost of A$1,169 per ton, and this was about 6% higher than the September quarter that was really – that increase is really driven by an increase in royalties. So with the higher selling price we achieved, we end up paying about $130 per ton in royalty costs. Pleasingly though, we did see a reduction in the cost of freight as pressures in the shipping markets starts coming off during the December quarter. Turning to Slide 11, and just some commentary around the cash position. As I mentioned, very healthy cash position of $2.2 billion, an increase of $851 million over the quarter. So key movement was the cash operating margin from the Pilgangoora operation, so that was about $950 million. We spent about $73 million on capital, and that's across capital waste development movements, the P680 project and our sustaining and capital development projects. We paid about 10 – just a bit more than $10 million in relation to the syndicated facility agreement we have in place. So that's across both principle and interest with US$5 million principle payment made during the quarter. And we also had about $11 million worth of payments under various leasing arrangements. This is worth noting that – we are talking about the cash position that the company has not yet commenced paying tax. So our first tax payment, which will be about $90 million, is due in February 2023, when we actually lodge FY2022 tax return. And once that tax return is lodged, we then enter into the monthly tax installment process with the ATO. So then we'll be start becoming a regular taxpayer and obviously with that building and franking credits as well. Within the quarterly, just to highlight, we have noticed that we are considering our FY2023 guidance that we previously provided in August. Obviously our key metrics are all sort of probably above guidance at the moment, so we are taking the time at the moment to review our FY2023 guidance, and we'll release an update on that when we release our half-year results in the late February this year. Lastly, just some commentary on the capital management framework. As mentioned with the growing cash position, we took the opportunity to structure capital management framework, which we released to the market in November. Now that framework is designed to firstly prioritize current operations, making sure that we maintain a strong balance sheet through all commodity cycles. We deliver on sustainability commitments and initiatives, and we pay sustainable dividend to our shareholders. Within that capital management framework, we disclose our inaugural dividend policy, and the view of the company is that we will apply that dividend policy to paying a fully frame dividend for the first time based on the FY2023 financial results. Now with the company's current strategy to grow and diversify the business, which Dale alluded to before. Cash flows will also then be allocated to growth paths that we think will deliver longer term shareholder value. So in the sort of – in the next sort of 12 to 18 months, we will be allocating capital to obviously the P680 expansion project, the P1000 expansion project, which we'll be releasing our FID decision on shortly. The downstream joint venture with POSCO for the chemical facility in South Korea, the mid-stream project in joint venture with Calix and we will also be looking for other downstream lithium chemical opportunities. Obviously, if it continues to be excess funds beyond those requirements, then that cash will be allocated towards either debt reduction or for further returns to shareholders in the form of special dividends or share buybacks. Thanks, Brian. And the cracking quarter indeed and given that we've just completed the finance sections, probably, just to thank Brian for what an amazing journey of course for those [indiscernible] Brian signaled his intent to transition from Pilbara for his incredible six years and what a journey to, and you just heard it there to be talking about the steps we are taking for this business around dividends, the cash flow, which has being generated and Brian has been the CFO who stewarded that journey from a finance perspective, from the [indiscernible] to go the other side of the globe to raise the first financing, the $100 million U.S. Nordic Bond and here we are today A650 company with strong cash flows and amazing future. So Brian, well done to you mate and congratulations on stellar chapter, you'll definitely missed, but we thank you for your amazing work on behalf of the Board or the team. And I would also just say Brian continue to support us on a bit of a part-time basis, so we're still going to be twisting his arm to help us out, so he is not going completely, but thank you, Brian. And now just moving to market update. So in this space, look, we thought just be worthwhile just off of Pilbara’s view of the market. And look, there's nothing particularly surprising of what I'm going to step through here. There's plenty of commentators in this space, but we did want to offer our perspective of what we see unfolding and hopefully provide some confidence and assurance to those listening who are trying to make sense of some of the divergent opinions out there. So firstly, we'd start with the fundamentals with lithium remain incredibly positive. The world is absolutely converting in terms of the renewable energy transition. And as it relates to the EV subset being the key demand subset for lithium at this point in time, it continues to pick up pace, and it's absolutely moved from a China story to a global story. And that rate of change has been through the – increase through the likes of the inflation reduction act and the U.S. government policy, so on so forth. So the long-term shift seems well fueled, that’s a structural shift well underway. That being said, in the near-term horizon, and particularly when we look back the last two months, there has been some pullback. We've seen the 15% reduction in chemicals pricing from those highs in November. But when we say 15%, that's coming off a high $80 mark down to sort of a high $70 mark, and then when you start to ask yourself, what drove that well, largely Chinese centric, it was the COVID unlocking going from the zero COVID policy to actually where the gates were lifted. And that coupled with the EV subsidies being removed and taken it back, plus we're heading into Chinese New Year. The sum of those things have equated to approximately a 15% reduction. My suggestion I'd put to you is 15% reduction of those highs is not that bad, but very healthy pricing. And I had been asked six months ago for a prediction around China pulling up the gates and going from a zero COVID policy to fully letting COVID integrate into the society, to be honest, I think the impact has been pretty modest. All things considered would be my personal view. But where does the market hit? Well, that's the big question. Now from our perspective, the insight we can offer is we're positive about the outlook, and the reason we're positive is first and foremost, there's demand indicators and demand remain strong. As we look to supply, we of course, keep a close eye on the emerging supply and the various analysts and commentators in this space, and what gives us a lot of comfort is bringing supply to market is incredibly hard. We know that because we've done it and it will not be easy, it is not straightforward, it does not matter which raw materials lithium supply that you're dealing with whether it be hard-rock or clay, they're all difficult, they're all bespoke and it's not capital helps, but it does not guarantee speed. So when we start to consider supply versus demand, as we look forward, we feel we're in a good position and we'll see how we go. There is uncertainty in the market, but the long-term shift remains positive. And yes, unfortunately or fortunately, that is the establishment of a new industry and we've seen lithium has been a little bit volatile. But what I would put to you is if you want to participate in lithium, the place to go with a large operator who knows what it's doing, who's got a base of expansion, who's got other demand to grow further downstream, and that's exactly what Pilbara offers. So we think we're incredibly well placed and we're positive about the outlook for the market and we look forward to continuing to grow our business into this demand set. Moving now from the market. Just a final couple of comments. Great quarter, cracking quarter, as Brian characterized, strong pricing, strong production, cost base where we heading in the right direction, flying through to a very strong balance sheet, projects on track, chemicals projects underway, fall into a strong lithium market, albeit recently tampered by the COVID changes in China. So fantastic quarter, thank you for all our shareholders and particularly those longstanding shareholders who supported us in the downturn, we’ve not forgotten you. Hi, Dale and Brian. Congratulations on great quarter, and Brian, congratulations on your contribution to the company. Just looking at your production, on annualized rate, you've got about 580 on a 6% basis, which is about a 12% improvement, I calculate. Understanding the seasonality in the Pilbara region, I'm just wondering if you can talk through, how seasonality will affect your production going forward and what the remaining two quarters will look like, should we expect them to hold at these levels? Thank you. Yes. Hi, Thomas. Thanks for your question. As it relates to guidance, we will be updating our guidance on the half-year, so we'll provide some detail on that one there. Thanks, Dale. And then just a second follow-up. Just focusing on those questions around the debt facility provides extra flexibility to expand and diversify further down the material supply chain. I'm just thinking about what that means in terms of regional exploration and M&A that could be on the cards. Do you see further downward pressure on price as an opportunity to acquire people in the region given some of the negative macro news? So yes, Thomas, as it relates to that leg four of our strategy around diversification beyond the Pilgangoora asset, it's fair to say we're very early in that thinking. And you would've noted, in terms of the executive appointments I noted, recruiting a Chief Development Officer, you could read into what that means. But it's fair to say, yes, we don't have a [indiscernible] point of view, I should say, on the where to next, but of course, we're starting to progress a lot of the homework around what that looks like. But you'd have to say, Pilbara has a couple advantages, others don't. Of course, we've got a very healthy business, first and foremost. Secondly, we like to think we've [learned] some very valuable skills in the space of hard-rock lithium processing, and we have a spread of very important strategic relationships in the space. So the contact combination is highly valuable and very useful if looking to expand into another asset or operation. But as I said, no decisions at this stage. Brian, do you have anything to add? Thanks for that. And just a quick one just on the BMX strategy. You sold 25,000 tons this quarter up from 15. I'm just wondering if you could provide any commentary on sort of how many tons you expect to sell in the quarters to come. Yes. Thomas, look, the BMX platforms of course gone really well for us. We've not provided any guidance as to what proportion of production tons we will deploy on it. And the reason is we want to retain that flexibility. We of course, consider all the different avenues to market, which include a) BMX, a spot sales, b) tolling is a possibility and c) working with our existing customers, so all of the above remains available to us. But yes, no guidance on that one. Hi, Dale and Brian. Thanks for the update and again, echo Tom's comments. Brian, great work on what you've done so far with the company. Two for me, please, if I could, just firstly, on your time in career, Dale. I was just keen to better understand how the downstream was kind of progressing on the ground there and what key milestones we should kind of expect as we move towards commissioning at the end of this year? And then secondly, just kind of following up a little bit on Tom's question around the M&A piece. To what extent do you need – would you look at kind of domestic versus offshore in terms of future downstream opportunities and how important is partnering versus being a sole operator? Thanks. Yes. Okay, thanks, Hugo. Yes, in terms of downstream milestones, well, for the POSCO joint venture, the key one is that, commissioning commencement on the December quarter for train one. The train two is the commissioning commencement on the following year. So those are probably the key ones to watch for. And as that project moves forward, we of course, will be providing a deeper level of insight as to progress and the next set of milestones. Moving to your second question on M&A, to what extent do we value domestic versus offshore? Well, yes, look, obviously, our backyard is the best place you could go in terms of – we know the area well. As to offshore, there's many options out there, but one of the things we're very sensitive to is our offering to the market being a Tier 1 asset and a Tier 1 location. We'd consider very deeply our next step around making sure we didn't dilute that offering, but yet can't give you a steer as to one over the other, in the months to come, we'll provide a bit more insight into how we think about M&A and that leg four of our strategy. Good day, guys. Happy New Year everyone as well. Just if I could ask another question on the guidance. Can you talk through exactly what is driving the stronger performance? Maybe you can talk to the current mining and processing capacity across both the plants before you add the 100,000 tons from the December quarter? Thank you. Yes, Levi, I'll offer a view here and then Vince might want to fill. Yes, what's guiding the – and Happy New Year to you too, mate. In terms of the stronger performance, I'll put it down to just rhythm and routine coming together both the mining and processing, that being said for the quarter that the mining had its challenges, which Vince offered some insight to. And what we see here, frankly, is more optimization and opportunity to come, which Vince and the team are very, very focused on. And we look forward to moving further up the curve in due course, which of course, that's what our operating team is tasked to. Do you think you want it? Yes. Good day, Dale and team. Don't want to labor the point too much, but just on that guidance, I guess it is under review with the financial result, it was a very strong first half. So what are the key moving parts that are kind of concerning you, that's not giving you the confidence to come out a bit earlier with an updated guidance? It looks like that will go up towards a top end of the range or even beyond. Are you thinking more changes in grade profile, catch up in plant maintenance, just trying to get a sense of those key levers there? Yes. Thanks, Al. Look, I think there's been a couple of things which occupy our mind in the space. One is about optimization of the mine plan. We've been busy recutting many different versions of that to maximize our production. That's one element, which of course then sort of feeds into a plant optimization piece. The other bit, which is probably worth noting, is the season we've had has not been too bad in the way of cyclones and wet weather. It's been – and remain very, very mild, which has been nice. And frankly, I think this has actually helped a little bit more than we were expecting for the production outcomes we've had, that's been an overlay. And yes, we're obviously computing our guidance as we speak. In half years, we'll be here before you know it, we're targeting late February for those. So that's not too long away. Yes. We'll be patient. Just another one on pricing, so there was a solid price in the quarter not much guidance for next quarter and do note your announcement before Chrissy, on those successful renegotiations. But was there – in those renegotiations, was there any major changes in contract mechanics? And I'm wondering if you could comment on any benefit from lags with respect to spot prices, which as you mentioned have rolled over? Yes, are you able to indicate roughly where the price might sit today, if you ran the numbers? Yes. Al, sorry, we don't – we've never given guidance on pricing first and foremost as to what were those changes and the formulas. Yes, unfortunately, we can't give you any insight there either, so sorry about that? That's all right. And just finally, saw a bit of CapEx inflation at Pilgangoora, one of your peers has just announced an upward revision. I was just wondering if you could give us any sense of how the POSCO hydroxide plants going with respect to planned budget. Yes. Sure, Al, so far so good schedule and budget for the POSCO joint venture, but I just added it is early days in terms of the progress of the project. As you can see from that photo, things are underway. But yes, the lion's share of the builders has yet to come. We will of course keep the market informed as that progresses, but yes, nothing of concern at this point. Sure. Thanks. Good morning, Dale and team. I just want to say, carry on from Al’s question on pricing and forgive me if the answer is as braced this time around again. But as you said, clearly, the chemicals pricing has fallen by maybe 15% since you made that announcement in late December. So I guess, how do we think about – how that realized price that you quoted $6,300 a ton. How does that move proportionally relative to those reference prices or to those benchmarks? I mean, is there anything that you reference in those major offtake contracts that means that your realized price shouldn't move proportionally to what we can see on chemicals pricing? Yes. Thanks, Matthew. The price reviews that we announced during the quarter gives you a bit of a feeling for the relative change. I appreciate we haven't given insight into the mechanics, and the reason there isn't is because we can't. But as to is this additional factor which would take it out of whack of the prevailing market pricing. The answer is no. The intent to all the formulas is that it follows the market movement and making sure that Pilbara’s shareholders are receiving the appropriate value as that market ebbs and flows. So there's no sort of lift fuel factor integrated in there. Got it. Thanks. I appreciate this commercial sensitivity, so thanks for the additional color there, Dale. Secondly, again, on the FY2023 guidance, but more on the CapEx guidance, I guess particularly the amount that you've spent in the first half versus what you previously quoted this full-year guidance. I suppose the question is, obviously the run rate in the first half was a lot lower than what you might imply by guidance, were you always expecting such a large second half SKU in the spend rate when you set that capital budget or do you now need to rethink, I guess CapEx guidance as well as potentially production guidance? And then I suppose, maybe to partly answer the question is, is it really just a question of timing of the cash outflows or is there anything else going on there in terms of that spend rate? Yes. Sure. I'll offer a view and Brian might want to add in this space. Firstly, it was always going to be skewed to the right just the function of the timing of the bill that's first and foremost. Has there been some sub elements of drift to the right? Yes, but nothing untoward. Brian, did you have anything you want to add to that? Yes. Look, Matthew, that's right. In terms of the P680 project, I think most of the first half was about doing engineering works and those sorts which take time, but don't actually consume a lot of cost. It's once we get into the real bill, which is what's about to happen now is when we start really incurring those costs. But put aside the P680 projects in terms of all the other capital items, I think we're largely in line with where we thought it'd be probably maybe a little bit behind, but not significantly different. And my expectation is that whatever the gap is for the first half, we'll make up in the second half. So a lot of it is around the timing of the P680 spend. Okay. That's great. Thanks very much Vince. And then thirdly, maybe just quickly, can I ask on concentrate inventory at the end of December, you've been producing more than you've been selling for, I guess, probably four of the last five quarters. Is that just a natural consequence of that ramp up in production? And more of a timing question or are there any logistics constraints or anything else that's driving that inventory build? Thanks. Thanks, Matthew. No the inventory builds aren't anything untoward at the moment. As to logistics bottlenecks, probably everything's been going okay, load out through the port has its moments of course. But, yes, nothing which gives us cause for concern. Matthew, sorry, it's Brian. Just one other point on that, it's probably worth noting. There was one cargo at the end of the quarter, which was meant to go out in the December quarter, in the month of December, right at the end. But due to sort of port, the way the vessels lined up in a port a bit of congestion that particular cargo, which was, I think it was about 15,000 tons fell into the first couple of days of January. So if that cargo had actually left the port, then clearly our stocks or our sailors and our production would've been fairly similar. So it's really just around timing. Got it. Thanks very much, Brian. And yes, it would also echo the other analyst comments. All the best for the future. Thanks very much. Good morning, Dale and the team. Congratulations on the strong quarter. Just two questions for me and – if I may. The first one is just around the deferred stripping. At the start of the year, financially you indicated that you are doing some catch up on that. Just wondering how that is going. Just want to have some high level color on the per strip profile for the next 12 months? I'll come back with the second one. Yes. Hi, Austin. Thanks for your question. The high level stripping has typically been around a five to one ratio for the year we're in. That being said, we have, during the course of the year, reworked our mine plans a few times and with the objective of opening up more ore options. So we we're deep into that. So there has been some shifts to the mine plan, which of course plays through to strip ratios. Okay, cool. Thanks. Does that mean that the strip ratio will come down? And also just a follow-up. Do you need to build some mine ore inventory just ahead of the P680 commissioning, which is around like the September quarter this year? Got it. The second question is around the price negotiation. Just in terms of the frequency, I don't know if there's any comment for when you're going to have the next major discussion with your key offtakers? Yes. We don’t sorry, go ahead on that one either Austin, given that each of the review mechanisms are unique to those offtake agreements. But we can say that, yes, they're semi frequent I guess you could say. They're more than an annual review. Thank you. The next question is from Tim Hoff from Canaccord. Please go ahead. My apologies. The next question is from Glyn Lawcock from Barrenjoey. Please go ahead. Good morning, Dale. Just on the December quarter, is it possible to provide us with the head grade, the recovery and the product grade from the plant in the quarter? Okay. You're not prepared to. Do you expect any major changes from the December quarter into the March quarter in the June quarter of those three? No. Okay. I'll try and push a little bit more on the pricing. You actually did give guidance in your results or the announcement on the 21st of December, you said you'd get 6,300 when applying current pricing reference data. Now that reference data has fallen 15%, if prices – if those reference data don't move, would you still get 6,300? Well pricing reference data at that time that matched, that would be within that guidance. That would be the way to think about it. We don't guide on price. The obvious reason that the market moves and we cannot offer more detailed information into those formulas because they're commercially sensitive. I think the other key point there is that the market data using for the pricing is current to the relevant time of the shipment. Pricing is provisionally priced and then a final price. So whatever the times of the shipments are is going to be the market data that you're going to use. I appreciate that. So I guess I'm just asking is when you made that comment, current pricing or reference data, would those pricing data above where we're currently seeing the reference data today then? Yes. Glyn, I think the answer to that is yes. I mean the idea of those pricing formulas is to try and work off a hydroxide and carbonate price and reference through to spodumene concentrate price. So clearly if your reference price is to a hydroxide or carbon price and those prices are moving, then our price moves. That's the way to think about it. Yes. Perfect. Yes. So you wouldn't get 6,300 if the current pricing reference data stays where it is. That's all I'm making sure I'm clear on. And Dale, just a final question. What's your thinking behind waiting till August 2023 for the maiden dividend? I mean, by then you're probably going to have close to $4 billion plus of cash in the bank, it would appear. You are paying tax as of, I think you said February, I think on the call. Why wait, I mean, you could prepay some tax and pay a dividend and announce a dividend in February. So just why the wait? Thanks. Yes, hi. I'm just interested in your comment earlier about bringing supply to market is really difficult, looking for some color there. I mean, is it just the usual shipping issues which every commodity has been plagued with for the last year or whatever, or a year or more, is there more to that's specific to Lithium? Yes. Thanks, Anthony. Yes, my comment was more directed at the later and that lithium and let me give you the hard-rock given is our wheelhouse. Yes, lithium hard-rock is a natural resource has a lot of nuance, which is unique to that resource. So then the challenge becomes a matching, a bespoke process path to that natural variation in the ore body. And then that challenge is just further compounded by the fact that the nature of hard-rock material, it's challenging in terms of hygiene control. So the mine practice around that require a lot of effort, a lot of accuracy, the ore body, knowledge and management, a lot of effort and accuracy, which is a learned process over time and then into the processing plant. It's a learned process and an optimization process, which commences once that project is actually built and operating. So there's quite a journey of test work and then operating practice and operation to really optimize all of that. And then in addition to that, then you've got the just the more practical elements that you just mentioned about being an operator in a competitive environment, the other logistics challenges and so on and so forth. So, yes, my comment was, as I say, more directed around the nuance of the mineral concentration for hard-rock. So what we envisage is for the new operators, they have to go through that learning journey. And it's very hard to shortcut that. So that's not something that's amended anytime soon then, or, but it's all – sounds like it's all within your control though? Yes. Well, it is, but it takes time and it takes grassroots, test work flow sheet, modeling, deep understanding, lots and lots of field test work. And if you look back at our historic journey, where we are today, so the product of years of work and effort in this space, and as I say, there's no real shortcuts. Is it in new control? Yes. But there's a lot of effort, which is so hard to shortcut or accelerate. Thank you. Good day, Dale, Brian, and everyone. Thank you for taking my question. My first question is, may I have the production volume breakdown by Pilgan and Ngungaju during the quarters? And another question from me is, Ngungaju volume is this still on track tech now or part of volume is already secured by some offtake tons? Thank you. Good day, David. So firstly, yes, we're not segregating the processing asset volumes and the reason we're doing that is we consider the operation as one, and we report one set of numbers sort of flying from that operation. As to available production tons outright, again, we think of the operation as one, so the Ngungaju operation and combination with the Pilgan. And as to what is those available offtake tons, we've guided in the past that once we're expanded to the P1000 being a million tons per, there's approximately 400,000 tons unallocated. And once we're in that expanded format, which of course, we could afford us opportunities around could be vanilla offtake, could be other downstream joint ventures, POSCO, or other types of transactions. Hi, Dale and team. Good morning. So you noted that you're not giving away any – unexpected pricing next quarter. Perhaps, can you give some color on inventories at the moment? Comments on what you are hearing from customers? I mean, you're producing a 5.3% product and I think, when you set guidance, you were looking at a 5.7%. So demand for lower grades seem to be strong. And secondly, when can we expect another BMX auction? Okay. Now in terms of what are we hearing about an inventory. We have anecdotal scraps of information, so let me make that clear upfront, but we don't hear of large volumes of inventory in the system, at least in the next step of the supply chain, which is pleasing to hear. And I note that that opinion seems to be throughout some of the commentators notes elsewhere as well. As to grade, we've guided that we've progressively been tweaking down the target product grade, that that's just a function of wanting to maximize lithium units to market. As to the next BMX sale, we haven't guided on that and we're keeping our powder dry so to speak around the timing of that. And moving forward, we're not looking to disclose BMX auctions as we have in the past which we consider business as usual. So you're moving forward, probably, yes, in order to disclose those and [indiscernible]… Okay. And then my second question was just on the P1000 project, so it looks like you pushed back FID there by about a quarter, I think. What was the driver of that delay and what are the final pieces you need to get essentially on or what are you working on to make that decision? Yes. The drivers for the delay. Well, there's a few things, Kate, but we just wanted to – in a nutshell, just take a little bit more time just to bear down some of the estimates. We're of course conscious around the fact we don't want to add more time to the overall schedule. We want to obviously ramp-up the operation to full extend as quickly as we can. And that's why we went forward and the Board approved the pre-FID funding to maintain that schedule. Good day, Dale. That's disappointing that you are going to stop reporting BMX numbers going forward. Yes, it's been a great platform that you've helped develop and personally I think increased disclosures always positive for the industry, but hopefully you might reconsider. But anyway, my question was on the tolling discussions. I was hoping you might be able to provide a bit more of an update there. It seems like everything's pretty aligned for a deal here where you've got big prize in terms of the economics and anecdotally, there's plenty of spare conversion capacity in China still, and obviously your layer on your very strong operating performance, which frees up some of those uncontracted volumes. So can we expect anything more wholesome in terms of tolling in the short-term? Thanks. Yes. Good day, Ben. Yes, sorry to disappoint you on the BMX. Yes. It's to the tolling, yes, look, we've got the team busy doing work on it. But, yes, unfortunately I can't often too much insight at this point. Thanks for that. Good morning, all. I guess just in light of the sort of current mining challenges you've alluded to at current production levels, I'm just interested how that is sort of flowing into the P1000, thinking given you'll need to move a significant amount of dirt to get there. And I guess are you committed to that level of expansion or is that still something that could be tweaked? Yes. Joshua, yes, as to P1000, we're absolutely committed to that. As to the mining volumes, the run rate that we're moving – needs to go up a little bit more, but not massively from where we are. As to the challenges we've had, part of the explanation is, is we have been going through a period of effectively establishing our own operator – operation with – we had MACA mining, which we'd progressively tapered down, and we've been tapering up our own fleet, albeit it is supported with equipment higher contractors and some service contractors and drill and blast, being some drill and blast. So there has been, I guess you'd say some teething elements around establishing the operation. But as shift-to-shift, week-to-week, month-to-month, it's getting better and better and the team is beating those operational roots down. So we see continued progress. So there's no cause for concern about being able to resolve those challenges we've had and make sure we've got an efficient mining operating platform to support P1000. Yes. Thanks for letting me to have the follow-up. I can't get much out you on the spot pricing, but just wanting to get an update on where Tantalite markets are at the moment. Notice that your shipments pick back up after a quiet couple of quarters and does have a – can have a material impact on the cash cost through the by-product line. So any color on that would be helpful. Sure. Thanks, Al. Welcome back. As to Tantalite, from a production volume perspective, it's been slightly down on where we wanted it to be principally around two reasons around the – we've got some maintenance work, which was deferred, which meant to happen on the quarter being and we've had to defer that. That's one element. The other element is just the concentration of tan units coming into the ore feed, has ebbed and flowed at different points, which translate to production volumes. As to the latest pricing, I'm looking around the room, has anyone got the latest pricing? I'm sorry, I don't have the latest pricing at this stage. But as you'd expect, our tan relatively speaking, the team's focus is on lithium. It's not lost on us at the benefit of those Tantalite credits, however, but it doesn't by proportion, lithium gets the focus. Thank you. We will take the final two phone questions before moving to webcast questions. The next question is from Michael D'Adamo from Canaccord. Please go ahead. Hi, Dale. Just wanted to query your strategy around ore movement. We've seen the mining rates have been hardening the processing rates for a while. Are you guys building a low grade stockpile or is it some sort of blending and raw management strategy? Yes. Good day, Mike. All of the above is the answer there. Yes, the operation is a blending operation, where the team mixes minerals effectively. So as a function of that, there is this sort of stockpile build as a function of mineral type, and there's also a stockpile build, which relates to the ore or the host-rock to ore body interface, we call that content. There's also a stockpiling which clears around that as well. So yes, there is stockpiling. Dale and team happy new year and congrats on a strong quarter. Just a follow-up on BMX pricing. Obviously your house served as a great leading indicator when prices were rising and has helped out on the contract negotiation. But now in a falling pricing backdrop, is this part of the – so just trying to understand, is this part of the strategy trying to sustain your realized prices, just could you give us a bit more color on this decision to not to publish the pricing anymore? Okay. Alex, look, firstly, as to where does the price goes, falling versus rising versus staying the same. I don't think anyone knows that, so probably the first point. The second point is to the rationale of not looking to disclose on the BMX platform, the thinking there is, by proportion, it's not a big part of our business as to the visibility of that pricing. Of course, it finds its way out into the market in any event. Obviously the price reporting agencies are all over the stuff whether we disclose or not disclose. So from our perspective, shining the spotlight on it through ASX releases is not required and not necessary in terms of the activities in our business. Thank you. There are no further telephone questions at this time. I'll now hand over to Pilbara Minerals’ Chief Commercial and Legal Officer, Mr. Alex Eastwood to MC webcast questions. Okay. Thanks very much. And welcome everyone, and thanks for all your questions. We do have quite a few questions. And I'd say a number of them have already maybe touched on, we've touched on certain topics or some of these questions can be consolidated, so I'll just try and go through them methodically. The one that's – we've got quite a few questions about dividends, which I think we have touched on, but essentially, perhaps Brian, you could just relay the message there, the questions concerned about timing of the dividend and in particular, which month and whether there's even a possibility of increasing the ratio payout of the dividend given a very healthy cash position? Sure. Thanks, Alex. On the question on the payout ratio, I don't think that would be increased. I think we do want to try and at this point allocate as much of the cash to growing the business. So I think that needs to be the emphasis of the business for the next 12 to 18 months. In terms of the timing of the dividends, we do refer to the fact that the first dividend is going to apply to the FY2023 financial year. Yes, the Board is still considering exactly what that timing is going to be. So that decision is going to be made, but yes, there is a possibility that there could be an interim dividend and then a final dividend paid later on, that still is under consideration. The Board and the company are very aware of the buildup of cash that is going on and clearly interested and keen to return some of that money to shareholders. So we just need to find the right balance there and obviously part of that is also just being cognizant of the level of tax being paid and the franking credits that might be available. Yes. Thanks, Brian. And one on the same theme, capital management, we have a few queries about the possibility of a buyback as opposed to a dividend or in conjunction with the dividend. Could you provide some commentary on that? Yes. Look, it's part of the considerations, yes, we clearly keep an eye on the company's share and share price and I've got some value triggers, if you like, where we would think about buybacks. But again, I'd sort of emphasize that I think we're better to deploy the capital and trying to grow the business. I think we've got a lot of very good opportunities ahead in the next 12 to 18 months, which are being explored by bringing the right people into the company to try and make the most of those opportunities. The P1000 project, once it's up and running, we're going to have in the vicinity of 350,000 to 400,000 tons of available tons, which aren't committed, clearly that's some leverage that the business should be using to try and grow. And I would've thought that's probably where the efforts of the business need to be, including where we choose to spend the money. Thanks, Brian. I'll start – questions come through as to in relation to Ngungaju as to whether there's any updates on the Ngungaju plant in terms of production predictions, et cetera? The questions come through – quite a few questions about strategy, which I think might be easy to consolidate, but essentially a few questions about strategy to diversify further downstream and also strategy to diversify potentially into other commodities like copper. And there's particular line inquiry about North America being particular favorable opportunity given there's a lot of junior emerging within companies in North America. There are some advantages in North America from an ESG point of view. So really people are just asking for a bit of commentary about that, Dale. Yes. Sure. Thanks, Alex. Yes. So as it relates to diversification part through downstream, within lithium, our view is it makes really good sense to be integrated downstream for several reasons, but the most important of which is it enables a higher proportion of value to be created for our shareholders. Second benefit is, it puts in place a co-dependency between raw material supplier and that downstream converter and effectively hardwires you into the supply chain. So that's another key strategic advantage. The other pieces around downstream, we of course consider is geographic diversification and also having alignment as it relates to sustainability credentials and working with that counterparty to pursue that aim. And the POSCO joint venture is really casing point. So we think continued downstream makes really good sense for our business, and we will continue to explore and think through that aspect. Moving to other commodities. In this category, look, we haven't made any decisions as to where to next in terms of diversification beyond the Pilgangoora asset. As I mentioned earlier in the call, we're definitely working through a process of turning our mine through this. And as I mentioned earlier, we've got a Chief Development Officer coming into the business who'll be obviously leading up this function. So what's the space? But as I say, no decisions in this category, but do we see opportunity as it relates to the renewables energy shift and the need for more copper and the line? Yes, of course, we're believers in that as we are in lithium. Moving to North America as a perspective opportunity, yes, absolutely North America clearly has got some great assets. That being said, in many parts of North America, it is very much a pioneering challenge, they do not have some of the benefits we enjoy in Australia or particularly Western Australia with an established mining industry and engineering and technicals plus all of the logistics and support infrastructure. What Western Australia has is hard to beat. So in some parts of North America, they don't have that. And from an approval standpoint, again, that's probably not as good as we enjoy here. But all said and done is the prospective emerging area. Yes, but we would, I think it will take time. Are we interested in it? It's certainly on the cards as all other opportunities as I said earlier, we haven't made any sort of decisions as to where we'll go over, yes, North America is certainly higher up the list than other parts of the globe. Thanks, Dale. Next questions come through, concerning port capacities. The question is what is the company doing to improve the rate of loading product at the [indiscernible] of Port Hedland with P1000 not too far away, it seems the current rate of loading by the load out bulk system maybe too slow? Yes. Thanks, Alex. So as it relates to port out load, now both case using retainer boxes, it's fine and works as a methodology by which to out load concentrate both at our current production levels, but also at the expanded production levels for P1000. However a bulk out load system is absolutely a better methodology in terms of moving high volumes and unit cost. Now in this category, we are engaged with PPA and it's well known that lumps point is to be developed and the government flagged funding couple $100 million last year to go towards the development of that port facility. We are in discussions with PPA as you'd expect to support and influence the fostering forward of that development. And yes, we will look to work with the PPA with the view to hopefully help get a bulk out load system in store for the purpose of concentrate and certainly PPOs very receptive and keen to form a solution there. So for the long game, and let's not forget we've got a multi-decade operation, we are thinking the full course of time, that's where we'll head. Thanks, Dale. A question about P680, essentially, what are your plans to maintain and accelerate the P680 project and what do you anticipate the annualized production rate will be after the P680 project is commissioned? So P680 for us the team to accelerate. I think they would go. What do you mean we already are? We've asked the team to go at warp speed as it relates to the speed of not only the delivery of P680, but P1000. And we are bullish on lithium and we are bullish on our position to expand our operating platform and we think we have an incredible opportunity to capitalize in this market. But to capitalize in this market, we have to get that additional expanded production capacity in place as quickly as we can, and that's what we are geared up to do. And on the same theme for P1000, the question is, as lithium prices are so high, is upgrading the facilities to 1 million tons per annum your first priority? More lithium units to market is priority one. So as per the strategy outlined at the start operating platform, number one, to expand that operating platform as rapidly as we can and yes, the sooner we can do that, the more units to market, we can enjoy that pricing. I guess the sky is the limit with the cap bank. What does Pilbara have available? And broadly speaking at the expanded P1000 cases, it's mentioned earlier, there's 400,000 tons approximately of unallocated tons, so that 400,000 tons could go through different pathways to market, one of which could be the spot sales through BMX. However, as mentioned earlier in the call, we are a fan of downstream integration because we see that as a better avenue to create more value for our shareholders through the extracting value through that next processing step. Yet to be determined. I would say in that regard, I think BMX has been absolutely massive step forward, very helpful for the industry to provide a trusted representation of price discovery. Certainly, spoke previously about we like the idea that it's grown into an industry platform, that that's certainly a possibility and it's an open question as to where we take that platform. Okay. Question about Calix. Does the Calix demonstration plan become a usable for operations, if the demonstration is proved actually viable? The short answer is yes. Yes, the scale of that demonstration of plant is such that it will produce material volume product to the tune of about 3,000 tons of migrate lithium salt. So subject to the pricing of that product and subject to the unit cost through that facility, we anticipate there would be healthy margin to be made. Obviously, that depends on the market, in which case you would keep that running. I think a bigger question is if it's a compelling economic proposition, well, how do you go to scale? And if you are going to scale, what does that mean for that demonstration plan? Or we haven't made decisions around this, but certainly it's to be worked through and flow through. And just going back on BMX, a question came through around sort of timing, the next auction, will there be one in January? And volumes, 5,000 tons versus 10,000 tons. And a question also around, why on occasion we've accepted pre-bid auction pricing? I must give this one to you. As to timing and volumes we haven't guided in that regard for BMX and was mentioned earlier in the call, we've purposely kept our auctions available to us such that we will pick what's best for our shareholders. As to the strategy of accepting pre-bid versus going to auction, I'd say BMX has been a process of discovery not only in the deployment of the system itself, but also how to best engage with the market. And what we've been doing is exploring both those options of the direct bid, but also the pre-bid auction and we haven't formed a view of what's best, but it's just been a different strategy which we've chosen to explore. Question now, perhaps Brian, this one can be directly to you is, what is the current profit margin sales? And I suppose with increased supply coming from competitors is the margin likely to fall over the next 12 months? I talked on the profit margin was for the December quarter. So yes, the margin – the operating margin is really the realized price, which was US$5,668. So if you convert that to Australian dollars, it's probably, I don't know, getting revenue per ton of about just over $8,500 a ton. Our cost per ton is the $1,169 per ton in Aussie dollars. So the difference between those two is the margin you're making per ton. So that's about just over 7,400 I think. So that times, the 148,000 tons we sold is the margin for the December quarter. But margins going forward are really dependent on what the market's doing and what the market price is and that's not just about selling price you get, but obviously if the whole mining industry comes off, then the expectations that your cost come down as well. So as a business what we are going to do is look after our costs as much as we can, and that is the best way to protect margin. Thanks, Brian. Next question is what percentage of sales are China based and therefore what's the impact of COVID to these? Sure. So the current proportion of sales to China is quite high in the order of 95%. However, that will change as joint venture with POSCO begins to ramp up by which point that would be approximately one-third, two-third to China, depending where we've got to with the P1000 expansion. But ultimately at P1000, I mentioned there's approximately 40% of production profile unallocated. So that of course is a key consideration. So the forward view P1000, it might be 30% China, 30% South Korea and the balance to go somewhere. Yes. Thanks, Dale. Question about grade, we noted the quarterly average grade was 5.4 sold. The question really is what was the grade that was actually produced during the quarter? Yes. Well, first and foremost, we've got drilling underway at Pilgangoora, so yes, section 6 of the quarterly provides a bit of detail around that. So Johnny Holmes, our longstanding Exploration Manager, is back out there working the rigs hard and we're looking forward to seeing how he goes in the coming months with a view to doing a new reserve later in the year. So we can touch with that goes well, and we're quite positive on that. As to more regional exploration, we've been doing a little bit, but that’s fair to say the activities have been fairly minimal in that regard given we are concentrating our efforts where we can make maximum value as quickly as possible, and that's first and foremost at our base asset, trying to keep the foot down and do everything we can to expand that as rapidly as we can. And just another question around that asking when we – about expanding reserves, there is a question about do we have initial results indications, but I don't think we are in a position to disclose those, but perhaps just comment on the intention about exploration to expand the reserve base. Yes. So we're busy drilling now. As to that reserve update approximately August, now I'd expect the timing after that reserve update. No ballpark number. But obviously as we look to disclose the FID, later in the quarter, we'll, obviously, the capital verdict for that will be part of that decision. Sure. So the flash calciner, we think is potentially a big step forward for the calcination of spodumene product. Well, hope we think it's a big step forward is, firstly, it's electrically fired and therefore you can plug in green energy effectively and contrast the conventional rotary kiln, big, long horizontal kiln, either gas fired or coal fired, so very carbon energy intensively. So we think that swap from hydrocarbons to electric is, firstly that the first big benefit. The second big benefit is that the nature of a vertical kiln we see has a benefit in the way it actually enables the alpha to beta phase conversion of the spodumene particle because the vertical calciner enables the product to fall, it's affected the – particles are effectively dislocated from the other particles, which means that one of the challenges that you get in a rotary kiln is a particle-to-particle contact, which affects what's called the eutectics, which is a fancy way of saying the temperature properties change and you have issues around melting it all equals lithium loss. So what we've observed through test workers, the vertical kiln is superior in this regard. So those are probably the two big advantages. And probably the third big advantages would be thermal control of that vertical kiln given that it's electric, you've got more ability to control the temperature, which therefore means you can dial-in more strongly control the required temperature for your phase conversion for that spodumene. In contrast, back to the rotary calciner, which has the big jet engine of flame that has a thermal gradient because it has a thermal gradient, you get variation and the phase change property. So in a nutshell, those are the probably the three key parameters, but all said and done, at the end of the day, it will remain a cost game for competition. So unit cost will always matter, and hence why we need to get our demonstration plant built so that we can make sure that it can compete on the global stage. Thanks, Dale. So we're at the home run now. Two final questions. First one, would we consider building our own lithium chemical plant? Okay. And the final question, which I think is a good question to sort of close out the session is can we provide some commentary about Pilbara’s market valuation noting that we are obviously producing significant revenue and have great prospects of expansions compared to say some of our other peers. Is there a message to existing our prospective shareholders as to why to invest in the Pilbara? Sure. Well, where do you start? I think, as I said in some of my opening comments on the strategy slide, Pilbara has got an incredible offering in this space. Pilbara best and foremost is developing an enormous Tier 1 asset and a Tier 1 location. And we've got this remarkable opportunity to scale up this operation into a growing demand set for lithium. And the barriers to entry are high, processing of lithium is very challenging, and Pilbara has a technical advantage, technical and operating advantage, and has got a demonstrated track record of delivery. So that would be a couple of key reasons. And then further, we dealt well down the path of downstream integration with partners we met, the likes of POSCO. We've been in this space for a long time moving forward rapidly with the development of our joint venture chemicals plant and [indiscernible] South Korea, which is at the doorstep of the existing battery material supply chain being LG Chem, SK Innovation, so on and so forth. So we stand poised to benefit from that. And then we are getting into the likes of the midstream project, which is novel, but look at has real potential to make a real dent and carbon energy intensity. And if we can get that right, we think that will go really well now. And to our knowledge, there is no other operator or business in this space tackling this head on and Pilbara is focused on this and doing everything we can to drag the cart forward now. That goes well, of course that benefits will flow back to our shareholders. So the combination of the above means that Pilbara who has an absolutely unique offering to market that in my opinion, no one else does. And the remarkable thing is we're only partway up this growth curve, and that's without turning our mind to the next steps of growth beyond the Pilgangoora asset, leveraging our strengths around balance sheet, technical aptitude so on and so forth. So gee, where do you stop? So that's it in a nutshell. So pls fill your boots and thank you very much for that last question. And my final comment is, yes, thank you to all who joined the call today and again to those longstanding shareholders. Thank you for your support and we look forward to updating at the half-year late in February. Thank you very much for your time. Back to the moderator.
EarningCall_1514
Welcome back. I'm Tom O'Malley, U.S. Midcap Semiconductors and Semiconductor Capital Equipment Analyst. Really happy to have David Goeckeler and Wissam Jabre here, CEO and CFO of Western Digital. Thank you for being here, guys. I know, right. A lot of these conversations, this week have been slower going, I'm sure that this one will be action packed. So thank you for making the time. Really appreciate it. So why don't we start out with some disclosures, and then we can get into the questions. Thanks, Tom. Great to be here. So we will be making forward-looking statements and I ask you to refer to our SEC filings for the risks associated with these statements. We will also be making references to non-GAAP financials and a reconciliation of our GAAP and non-GAAP results can be found on our website. Perfect. So with that, why don't we start with just an update of the state of the world of the memory market? More specifically, you obviously saw your U.S. competitor talk last week about historic declines on the pricing side, some of the weakest market that they've really seen in their history. You guys obviously haven't revised, I'm not talking about that today. But I just want to hear your take on what's going on and what you've seen over the past couple of weeks since you last spoke? Yes. So let's start at a high level, I'll talk a little bit about us and then we'll go through the market and we can go through the individual markets we play in, because I think we do have quite a bit of visibility. So first of all, I mean, cyclical business, that doesn't surprise anybody. We're in a down cycle. I think everybody knows that it's particularly sharp one, we started talking about that several quarters ago. I will say I feel good about everything we've done over the last couple of years prepare for this time. We've been making a lot of changes inside the company. We've invested in our balance sheet to be stronger, we knew a down cycle is coming. We've invested heavily in the JV, which is a huge part of our business. And I think that our foundational technology is really showing through right now. And we have a much better portfolio. And you know, we've changed the organization structure and the leadership team inside the company, we have a lot more agility to kind of manage through that. And I think that's showing up. So we'll talk a little bit more about that. As we start going through the markets. So first of all, let's start with consumer, I would say the consumer was the first market we saw get soft, earlier this year. And we're in that market, I would say stabilized. We're in a seasonally strong quarter. Although we're in a down cycle here, the memory market, as we saw made this comment a while back, we're not canceling Christmas. So we still have a holiday season and so it's still a seasonally good quarter. Again, one of the things we've invested in a lot over the last couple of years is our brand, SanDisk, SanDisk, Professional, WD Black, and that part of the business is really shining in the NAND business right now. We're maintaining our brand premium as far as share as well. So but we seen -- we saw that business kind of maybe one of the first ones into a correction. And you know pricing is not great, pricing is kind of it is what it is. But the business is performing much more predictable than it was a couple of quarters ago. So that business seems to have stabilized a little bit. The PC market, we talked about that a lot last quarter. It was probably the second big market, we saw correct, mid-summer, very sharp correction. In the September quarter, we saw customers taking way below product of the true demand. As we talked about in our earnings call we're now seeing, I would say that market is maybe bumping along the bottom a little bit. We're seeing a little bit of sequential growth in units. I wouldn't be surprised that goes wiggles up and down for a couple of quarters still. A good news there, we're seeing elasticity kick in, in the NAND market 54% year over year increase in bits. We're seeing that one terabyte dye come into the sweet spot of the market. So we see good demand there. When we start shipping back to true demand, whatever that is coming out of this, we'll see some acceleration in that business. And then the final, the final business that is going into correction is the data center. The big especially U.S. hyperscalers have moved into inventory correction mode, I would say midway last quarter. We expect that to be a two to three quarter process. We see that in -- we see that more right now in ACD business quite frankly, in capacity enterprise. We're still selling a lot of volume into enterprise SSD. That's been a big -- that's been a good story for us. Over the last couple of years, we've talked a lot about a qualification in the hyperscale sector. That part of the business will go through an inventory correction as well. So, I'd say that's the earliest one in it. And then I would say the backdrop of all of that, on a macro perspective is China. China has been, very quiet, not a lot of activity in China and all of the markets for quite some time now. I think it's encouraging to see what we're seeing in China over just the last couple of weeks, seem to be coming out of the zero COVID policy. We'll see how that translates into the business as we go through '23. But it certainly would be good to see some activity come back there. Helpful. So that's the State of the Union today, you've talked about some of the markets datacenter, you mentioned a couple quarters of recovery. But something that I think would be really helpful is just looking into the next year. What are your expectations from those end markets in terms of growth, and this is just on the demand side, when you're looking into next year is your anticipation that you said two quarters for datacenter, do you see a recovery there? How about on the consumer on the smartphone side, you obviously are doing a bit better than your competitors in some of the retail market. But just your basic assumptions, when you look out into next year. Look, I mean, my -- again, start at the highest level, I've said this many times, we're more technology enabled and technology dependent than we've ever been before as a society. I think the pandemic showed that we can all rely on technology much more than we were going into it. I think for all of us in the technology business, a lot of use cases that we were all very comfortable with working remotely, things like that, video conferencing, like these things came to every industry now. I mean, I remember many years ago, talking about with the medical industry, would you ever go to the doctor remotely? And turns out like for several use cases, you can do that. And so I think everybody has adopted a lot more technology. We're clearly going through a correction from a pandemic-induced surge in demand and also supply chain, a little bit of supply chain chaos where everybody was accumulating more inventory. And now we're going into -- are we going in a recession? Are we going into recession, how long is it going to be? Inflation is higher, interest rates are up. So we're going into a more constructive environment. And I think all of our customers are correcting between this very high consumption and like what is true demand going to be by dipping down below it. So I think as we go through '23, we'll start to see corrections in all these markets. I think in -- I think the data center market continues to grow. I mean we continue to have good growth there. There's an inventory correction. I'm a believer. One of the reasons I came to Western Digital. I'm a believer the cloud wins, the cloud wins in almost every scenario. We're using more of the cloud because it's just a fundamentally different way to distribute technology. And so I expect as we go through '23, that market will come back. I think PCs, well, the PC manufacturers will get back to shipping to what true demand is. I think everybody is trying to figure out exactly what that is. How long is the downturn going to last? How do I model it versus other downturns, so people are taking a very conservative stance? But I think we'll see demand come back there. And the same thing with the mobile market. I mean I didn't talk about that earlier. In mobile, in the NAND market, mobile is doing its job, which is it takes up a lot of supply. So we stay qualified in all of those markets. Units are down. But in a down market, you want to be in those businesses, so you have a lot of home for your bids, and I think that will recover as we go through '23 as well. Clearly, in the NAND market we're going to have to get through the demand coming back and then the inventory coming out of all of our businesses. But maybe Wissam can talk a little bit about all the countermeasures we're taking around CapEx, where the industry is really adjusting significantly below what true demand is right now. It's a perfect lead-in. So we've talked on the demand side. you obviously have supply so as well, and I write these down because it's the three tenants. You have three levers on the supply side. You got capital, utilization and inventory. So why don't we start on the capital side because that's most useful. So you've already seen, both from the JV and others, utilization cutbacks, talking about CapEx spend reductions into next year. There's a real fear out there that you may not have one rational player. Could you, one, address do you think this industry is more rational? And then talk about what you're doing on the capital side to address the current market conditions. Yes. Well, let me talk about the capital side, that's sort of more relevant to what we're doing. We've taken down our capital targets or CapEx targets for the year by -- our plan by around 20%. And so that basically impacts both the NAND side of the business, as well as on the HDD side. And when you look at our gross CapEx, we had planned for the year initially, to be at around $3.2 billion. Now we're aiming to be at around $2.7 billion, and we continue to work through these things as weeks and quarters come -- keep going. With respect to other actions we've taken on this. Like, for instance, on the hard drive side, we have reduced our manufacturing capacity for the client business by around 40%. And so that basically takes out some of the fixed costs. In fact, we continue to focus on taking down our fixed costs on the hard drive manufacturing side so that we can -- as the cycle turns up, obviously, we'll be able to be even more profitable. With respect to the NAND side, also as part of the reduction, roughly speaking, for the year, our cash CapEx is -- we're planning to be around 30% lower than what we had planned at the beginning of the year. Look, let me -- I'll take on your question about the industry. Look, I can speak for our company, right? I can't speak for other people's company. I really can't speak for the industry in general. But when we look at investment, we look at bit growth, and we kind of know it from the inside of the nodal transitions and how hard they are and the investment required. We see pretty rational behavior across the board. And so what we're looking at from the inside is we're seeing like an enormous amount of CapEx reductions pushing out nodes, even some players doing underutilization. That's something that we still have an option to do in the future, and we may, depending on how demand signals come in for next quarter, but we can keep the volume up now because of the portfolio strategy. But everybody's taking down CapEx. And bit growth is going to go down quite a bit. So -- and like I said, it feels really bad right now because the market is in a down cycle, but we're all still using technology. We're all still using technology more than we did before the pandemic. People still need to store a lot of data, and so I think that when you look at the structure over a multiyear period, it's a pretty good setup for how we come out of this. Yes. I think the other lever that I want to talk about is the inventory side. I think you guys have been more aggressive, highlighting certain pockets at the low end of the market, not necessarily the low end of the client side of the market where you guys could be more successful. One, can you talk about why you're able to do that? And what pockets of strength are you seeing right now? Because you've clearly guided, bid assumptions a bit stronger than some of your competitors in the near term, and you've called out clients. So where are you seeing that inflection in the marketplace in the late near term? Yes. I think we think -- I've been talking about since I got here, a very big focus on having a diverse portfolio. Very important to have as many outlets for our supply as possible and then mix to the best outcome for our shareholders. And so we've had a good start -- we're talking only about now. Let's start with the consumer business, right? We have a very good consumer business. I think we have enviable brands in the market. If you're a photographer, and that's your hobby, you're going to go out and buy a very expensive camera, you're going to buy a SanDisk professional card to put in that. That's not the time to save extra $10 on buying an inexpensive card. So we have brand value there. We've built brands like WD Black over the last couple of years, for the gaming enthusiasts know that, that's the high premium brands they want to give -- deliver them the best experience. So we have a consumer market that through cycle performs. And especially in times like this, the brand premium, that ability to -- pricing is not great, but we still get brand premium, providing an outsize percentage of profitability in the portfolio. On the other side, you have markets that may be taken enormous number of bits, mobile. We've gotten qualified in enterprise SSD. These markets are maybe a little more cyclical. But in a down market, you can still get a lot of volume going into those markets. And then maybe between those you've got the client SSD market, where we've built a very good portfolio in client SSD. We've managed the transition of that market from one technology, hard drives, to another technology client SSDs, we have that. And then you mix in some IoT in that, some automotive, you mix in gaming. And we've got a lot of places where we can put our supply. And I think in the down market, that strategy of having a broad portfolio where we can get both volume and margin, is working for us. That's an explicit strategy we put in place. And then underlying all of that, go back to the JV. We've got scale, our JV partner. We're very happy with our technology road map. It's a very specific goal of ours to be able to get a bit growth at the lowest capital per bit. And again, I think in the down market, that strategy pays off. And it starts to shine, and you get that foundational technology supporting the margin in the business. It's a perfect lead-in as well. I think the last I want to talk to was utilization. You've seen competitors already dial back utilization and talk about delays or at least push outs of technology road maps. One, can you talk about why being in the structure of the JV that you're in helps you in these scenarios in terms of utilization where you can make decisions and still be a beneficiary of the broad based production? And two, do you guys think that you need to delay any technology transitions given that you've seen others do it as well? So the JV gives us scale. So I mean, in a business like our scale is extraordinarily important, and not just scale in manufacturing, but scale in R&D investment. So we -- for our share of the bits we have to put in the market, we kind of punch above our weight because we have -- with our JV partner, we're one of the largest providers in the market. And that means we have -- we invest together on the BiCS road map. So we got their engineers, our engineers, making sure we build the best foundational technology, we can. We feel very good about that. High-quality, low CapEx -- the lowest CapEx investment possible to get the bit growth we need. So that supports the business. But then when we go to we look -- we go to market separately. Obviously, we go to market separately. And then we have -- we've been talking about these go-to-market synergies. We have the scale of the HDD business plus the NAND business, we can go to market together. We get some scale on that side on the go-to-market side. So when you add that all up, we've been able to find homes for our bids where it doesn't make economic sense to draw down utilization. Just for us. Now that can change every week. We reserve the right to do that in the future. Like we get new demand signals every week. And if we think we need to take that countermeasure in the market, we will. Then the JV is structured in a way that we can make independent decisions about how we're going to utilize the fab And the cost of those decisions is appropriately allocated to each part. So it gives us the benefit of scale, and it gives us the flexibility of what we need to do in our market. So I have one more on NAND, and then I'll promise we'll move to the other side of the house. I haven't heard you, at least in-person on call talk publicly about the Chinese restrictions thus far. One, can you just give me your take on what those restrictions mean in terms of the NAND market long term? Do you think that China can still be a viable player in this market given the restrictions that have come out? And two, you've seen 1-year licenses given to non-domestic producers of China. So essentially, producers of China producing in China, but not Chinese entities. What do you think in terms of the outcome of those licenses will be? Do you think that you'll see additional licenses granted? Or will that shift the market dynamic as well, both those sides? So I'll start by saying, like every country is going to look out for their national economic and security issues. And it's our job to understand what those rules are and play by them. And we take it very seriously, and we stay very close to it. And it's very clear that there's been some very significant regulatory policy put in place. I think it will have a very significant impact on the market. I think it's not yet completely clear how fast it will happen and how intense it will be. But there's no doubt, it's a fundamental structural change to the market, if it holds like -- it looks like it is now. And again, I think this is when you look through this very severe down cycle we're in -- again, I think we're in like this unprecedented time of coming out of a pandemic and going potentially into a recession and going into a different fundamental monetary policy era. And so we're seeing this very sharp correction. But when you look through that, you see all the players in the industry, significantly reducing CapEx. And then you see this potential, very substantial structural change that's happening because of government regulation. And I think you could see a very different industry as we come out of this. Now the licenses on other competitors' fabs in China. I don't have any particular insight to that than anybody else in the room has. It's just obvious there's more to be concerned about if you're -- if that's where you have major investments, you've got to pay a lot closer attention to what countries are doing to -- again, they're looking out for their national and security -- economic and security interests. That's a political thing. All of us in the business community need to stay close to it and try and interpret it. It's still very early, but the early indications are it is a fundamental change in the market. Helpful. All right. I promised we'd switch that so we can go over the side of the house. So the HDD business units. So in terms of the correction, it felt like HDDs came a bit earlier, where you saw some signals of weakness, at least on the consumer side or on the client side. So can you talk about -- are there any material differences between end demand on the NAND side of what you're seeing on the HDD side? Have you begun to see any recovery on the HDD side before the NAND side? And that's part one. And two is you've obviously seen a material mix shift towards the near line end market. You had recently called out inventory at the hyperscalers. You've made those comments on the NAND side as well. There's clearly some correction going on there. Can you just update us on that side of the house if you're seeing anything different? Yes. So let's talk about client HDD first. I mean the pandemic gave us several signals on client SSDs that have now completely reversed. So the pandemic started, all of a sudden, everybody needed a new device. And all of a sudden, we had a surge -- still 10%, 12% of that market was HDDs and we had a surge in this demand signal, we need much more -- many more client HDDs. We went through that. And then maybe what was it 1.5 years ago now, not quite that long ago, we had this chia phenomenon where all of a sudden, we're going to have cryptocurrency based on time and space. And everybody needed an HDD, and we woke up one day and all the HDDs in the world disappeared. We're trying to figure out -- like people are buying HDDs like crazy. So another -- a little bit of a false signal of demand in client. So now here we are. All that has cleared and client HDD, if you drew a line pre-pandemic of what the decline was. And you do it through the pandemic, you'd now find the client HDDs are below that trend line. So the move off of HDD in the client has accelerated. Wissam can say a little bit about -- I mean I think you said a little bit about we've now restructured that business, right? We're fundamentally taking fixed costs out. Absolutely we've taken fixed cost out, especially on the client side because we don't see the demand coming back. So we've reduced that capacity by around 40%. That has a benefit, obviously, from a cost perspective to us, approximately annualized $40 million to $50 million. We probably won't see it in the short term, given that we are in the down cycle. But as the business starts coming back, it should give us a bit of a tailwind. So we've had this long period of the rise of the cloud on the back of the decline of clients. And cloud is more exabytes, fewer units. Client was lots of units that are now falling away, and we're making these adjustments in the business. We're taking capacity out. We're just -- we don't need as many units, we won't in the future. So client HDD, I don't think we're going to talk about all that much in the future. The business is going away. That's fine. Now cloud is where all the action is. And first, let's start with China. That kind of went into a correction. Some of it inventory driven, some of it is just macro driven. It's just been very quiet for quite some time now. That's persisted. We talked a little bit about maybe there are some reasons to be optimistic there, but it's very early. We'll see how that plays out as we get into '23. So the big action is in the hyperscale market, U.S. hyperscale market. They were consumed -- same story, through the pandemic consuming, and turns out, building inventory. Now going through a correction, inventory correction, very sharp, just like we talked about the PC manufacturers. You got to get from up here to down here, draw a straight line between. And you're just going to like reset very quickly. And so we're going to see a couple of quarters of very, very low demand, and then we'll come out of that, and we'll get back to the growth of the cloud. It was the last market to kind of go into the correction, I think it will get through it in 2 or 3 quarters. And then we'll be back out of it. Like I said, I'm not worried about long-term cloud demand. And in the meantime, we've taken structural fixed costs out of the business. When the volume returns we're optimistic about that. And we haven't even talked about the portfolio. We've got 22 terabyte drives. We've got 26 terabytes ultra SMR drives, the world's going to SMR. We feel like we're very well positioned from an innovation point of view. No matter what's happening in the market, upmarket, down market, sideways, innovation, you've got to continue to innovate, you've got to continue to bring a better value proposition to your customers. That's how you get rewarded, and that's something we've spent an enormous amount of time on in both businesses. So similar characteristics, HDD market a couple of quarters, I think you said on the NAND side from the cloud side, very similar as well a couple of quarters. I was saving this question, we've covered SSDs, but I wanted to really focus on the data center side on HDDs. So that mix shift is now exacerbated where I think 65%, 70% of exabyte are now near line drives, data center related. So you're saying a couple of quarters. That takes us through the end of this year into next year. Is your assumption for cloud growth next year, a positive number or a negative number when you look at all of '23? I know it's a very difficult time to put a finger on it, but just your assumption going into the year, do you think you can see growth from cloud customers? I think we can see growth from cloud -- it's very difficult to put your finger on it because we got -- there's inventory on their side. But again, I think that year-over-year, you're going to see CapEx investment on their side, you're going to see the cloud grow. I'm not worried about the cloud growing in the midterm and long term. I think we just need -- we need to get through this inventory correction. It is very severe. It's not to be made light of. It is very severe. On the NAND side, once we get through it, we're going to have to get the inventory off of all of the supplier side, but we will get through it, and I think the industry is set up to do quite well. We're taking a lot of costs out of it right now, and I think that will be very good believer in the role of storage in all of our lives. And again, we've kept our foot on the accelerator of innovation. And I think the portfolio is in the best shape it's ever been in. And we'll grow out of it and will grow into a very good portfolio. From an industry dynamic perspective and also from a cost perspective, there's been a long-term goal from the industry for a 30% gross margin plus HDD business, right? And you've seen in upswings -- at least several quarters of sustainable profitability, largely is a function of mix shift towards near line. But can you just talk about longer term, is that a realistic goal? This was clearly a massive portfolio of demand as you guys just talked about. You really were only the 30 -- over the 30% mark for a couple of quarters. Is that an achievable goal? And why do you think that, that 30% gross margin target is the right one in the future? Yes. I mean our gross margin target for the hard drive business is still the 31% to 34% that we laid out at Investor Day. We haven't moved from that. We do see -- we do have a lot of actions that we're taking to get us there over time. Obviously, we're going to continue to innovate. Innovation drives a lot of things, including our ability to provide better value to our customers and be able to rely a little bit more on value-based pricing. But also innovation gives us reduced cost from a common platform perspective, for instance, and other types of actions that would help us from a manufacturing side. So anyway, you have the benefit on the top line, the benefit in the cost structure. And also all the actions we've been -- we've taken on the client side, and we've taken -- we continue to take further action with respect to our fixed cost to continue to chip down -- chip at it and bring it down. And so those actions as the volume comes back, should help us start trending towards that long-term goal. Helpful. And I think we have time for one more here. I think I'd like to ask this question. And particularly like a company like you guys have so many diverse product sets, and there's a lot of moving pieces in terms of supply and demand. What's a key message that you want to give out to investors through this conference here? And what do you think people are missing on the story today? Obviously, with the stock trading the way it has, there's clearly value that needs to be unlocked, but I want to hear what you guys have to say in terms of what people are missing of those? We're a very different company than we were two years ago. I mean, two or three years ago. Again, we've invested in the JV. We've invested in our balance sheet. We have retired $2.7 billion worth of debt. We're stronger in this down cycle. We've built a better portfolio. We're now qualified in the enterprise SSD market, which was a goal for the company for a long time. On the HDD side, our capacity enterprise road map, I think the decisions that have been made over the last five years of like we're going to have to get from 20 to 30 and layering in ePMR and OptiNAND and ultra SMR. Maybe everybody didn't understand exactly when we launched each one of them, how they were all going to work, but now we're seeing them all accumulate and give us a unique product set in the market. We've also built more agility into the company. We've organized differently. We have a different set of leaders. I think we have more agility. We just saw we were able to sequentially reduce our OpEx very significantly when we saw this coming and position ourselves well. So I think in general we're a more resilient, more agile company that's in a much stronger position. We're in a severe downturn right now. When you look through that and you see we're going to come out of that we're going to be in a very, very strong position. Well, I appreciate having you both here, and thank you for the candid thoughts amidst this tougher time, but thank you very much, guys.
EarningCall_1515
Good day and thank you for sending by. Welcome to the VOXX Fiscal 2023 Third Quarter Results Conference Call. At this time all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. [Operator Instructions] Thank you, Michelle. Good morning and welcome to VOXX International's Fiscal 2023 third quarter conference call. Yesterday, we filed our Form 10-Q and issued our press release and this week we will be posting an updated investor presentation. Documents can be found in the Investor Relations section of our website at www.voxxintl.com and I will be more than happy to send them along upon request as well. Today we'll have prepared remarks from Pat Lavelle, President and Chief Executive Officer and Michael Stoehr, Senior Vice President and Chief Financial Officer. After which, we'll open up the call for questions. I would like to remind everyone that except for historical information contained herein, statements made on today's call and webcast that would constitute forward-looking statements are based on currently available information. The company assumes no responsibility to update any such forward-looking statements, and I would like to point you to the risk factors associated with our business, which are detailed in our Form 10-K for the period ended February 28, 2022. Thank you, Glenn and good morning, everyone. As you know, we had the CES show last week and I just returned. And I have to say it was great to see that the show was back at full strength with an estimated 120,000 people in attendance this year. As many of you know, CES by far the biggest event of the year for the CE industry. And last year while we were live at the show, the attendance was a fraction of what it normally is. And getting back to close to pre-COVID numbers is good for the industry and we hope a sign of things, good things to come. As for our Q3 results, our sales came in approximately 25% less than Q3 of last year, and roughly around 25% less than what we projected what happened. On the automotive OEM side, our customers still have difficulty securing chips and in one case, with Stellantis, we lost production and revenue for part of November and most of December as a result. We plan based on customer projections and when they can't keep production lines up and running due to supply chain issues, it impacts us. In the automotive aftermarket and in the CE segment declines were primarily driven by softness in the economy, higher interest rates, a slowdown in discretionary spending, and how the retailers have been responded. We're anticipating the most recent moves by the Fed will continue to slow the economy as we look out over the next few quarters. Though again, we should have more sales of Onkyo and Pioneer Products, which should help offset some pressure and lead to growth and bottom line improvements. Our gross margins were down 90 basis points versus last year, but up 270 basis points sequentially compared to the second quarter. We've instituted a number of programs to improve gross margins, not just price increases, and we expect margins to continue to trend upwards. Our operating expenses were down over 20% compared to last year's third quarter, and over 11% sequentially. We have been vigilant in our capital allocation, and we've taken a lot of costs out of our business. Now, similar to when COVID hit, some of the reductions will be temporary and we will be adding some expenses back as our business normalizes, and we see more stability in the economy, but we're looking at every part of our operations to see where we can reduce or improve efficiencies and lower our cause base. So, sales were below expectations. Margins were down year-over-year, but trending upwards, and we significantly lowered our overhead resulting in an operating profit of $2.3 million and an adjusted EBITDA of $9 million in the quarter. As for the segments, I'll start with Automotive. Automotive sales were down $13 million with OEM sales up modestly and aftermarket sales driving the decline. While OEM grew year-over-year, growth was held in check by the supply chain issues based by our customers, and I estimate we lost between $9 million and $10 million of projected sales, with the biggest shortfall at Stellantis. Rear seat entertainment programs with Ford and Nissan are progressing, but at lower volumes than projected, and we have new vehicle models coming online over the next few quarters with several customers. Additionally, new programs with Subaru for remote start kits help drive the year-over-year improvement. We were also awarded a new interior lighting program from another major OEM, an award estimated to be approximately $30 million over five years. We expect to begin this program in Q4 of this fiscal year starting on a few vehicles with a plan to expand onto six or more over the lifetime of the award. As for the aftermarket, we expected some softness, but not at the levels we experienced. Several categories were down due to less foot traffic at retail, but it was really the aftermarket security category where we had the biggest shortfall. Softness at retail hurt sales and a good portion of our distribution base had inventory left over from last year. So, the volume of ordering has also been slower as they know they can get supply when they need it. Additionally, approximately 50% of our aftermarket remote start and security business is with new car dealers, and there simply aren't enough cars on the lots. We had a lot working against us in Q3 on the automotive side, but despite it all, the segment posted a $3.1 million pretax profit versus $4.8 million in Q3 of last year. Looking ahead, we expect the segment to grow, but there will be some issues as our customers work through capacity constraints. The sheer volume of programs continues to grow, and even with conditions as is, this should generate OEM growth near term with much larger growth prospects ahead as the market improves. We have also taken costs out of our operations and have worked to mitigate the higher cost of doing business. These actions, coupled with our New Mexico production facility, which is now operational, it also leads to improved gross margins, especially with more normalized volume. As for the Consumer segment, sales declined by approximately 27% and approximately 90% was in premium audio. Again, the economy is soft and retailers are buying differently based on excess inventory levels. This had a big impact on sales as premium home theater systems domestically were down over $30 million and other consumer sales were down over $9 million in Europe. Offsetting this decline was an increase in sales of Onkyo and Pioneer Products, which made up for most of the European softness. Demand remains very high for Onkyo and Pioneer and we expect growth to be more prevalent in the quarters ahead. I'll add that we also had some supply chain and production constraints during Q3, which curtails some projected sales, but we are working closely with our partner sharp and our other suppliers to ramp up production to serve not only North America, but open up production globally in India, China, Japan, and the EMEA region. I've said this before, I believe we can regrow this business to over $200 million in the next few years. Prices of products have gone up significantly due to inflation and the supply chain, in-store traffic is lighter than pre-COVID times. Retailers have been struggling with inventory levels for most of the year, and many are missing their numbers. Retail purchasing has slowed and buying patterns are changing as they know that they can secure inventory when needed and discretionary spending is down. Although, consumer holiday related spending from November 1 to December 24th rose by 6.7% according to MasterCard SpendingPulse, the electronics category declined by over 5% and the survey didn't even account for automotive, which we know is in recessionary territory. We expect conditions will improve and while the market may be volatile, we have a lot of new and exciting products coming to market under various consumer brands. The Klipsch reference, premier Subwoofers and Cinema One Sound Bars will be introduced this year. Klipsch powered monitors, the sevens and the nines in a series of Klipsch and McLaren branded speakers and audio systems as part of our ongoing partnership and relationship with McLaren. New Onkyo, Pioneer and Pioneer Elite and Integra receivers will be introduced this year and a host of products under the Magna, Echo and Yamo brands among others. We also introduced the number of new products at the show last week for remote controls, wireless speakers, hearing aids and connectivity and reception products. For wireless speakers under the AR brand will be shipping to Costco, U.S. and Canada for the first time ever where we're enjoying their business, both in Canada and the United States simultaneously. We're hoping these programs will help offset the challenges we're all facing. Retail is tough right now. All you have to do is turn on the news to see what's happening. The global economic environment has changed over the past year and we're hopeful of a recovery in the second half of 2023. We're planning as if the status quo will remain and could get worse based on recessionary fears in the U.S. and market environments globally. With that said, we're closely managing inventory and taking conservative approach with our retail partners. We're also working to enhance margins and lower our cost, and when conditions improve, we'll be in a very strong position to drive bottom line returns and continue to increase market share. Lastly, our Biometric segment. While sales were down modestly, we have a number of new programs with various customers under development. There is a lot of activity at EyeLock right now, and we believe we'll begin to see top line increases and improving bottom line performance. Within the financial services and as I discussed on our last conference call, EyeLock won a new program in Axiom Bank last quarter to deploy its banking as a service solution and development should be completed by the end of our fiscal 2024 first quarter. We are receiving NRE payments to cover certain development costs and we'll bill monthly based on reaching product development milestones. Within healthcare, we officially begin what we believe will be the last round of testing with the big healthcare account we've been talking about. Testing will begin the week of January 23rd and we expect results to be delivered by the end of February. We'll have a clearer sense of the program and its impact thereafter. We're also continuing our work with Integra [ph] to develop and roll out EyeLock's Myers logical access solution for big pharma. Within automotive, there was a lot of inbound interest at CES last week and we'll be discussing solutions with two of our larger OEMs in the coming quarters. We have a proof-of-concept being developed for one of the large car rental agencies and this program mirrors the one we have in process with the Miami Auto Mall. With respect to that program, it's progressing and we've completed the access control installation for their parking garages and lots, and we'll be rolling out the system to their other 25 dealership location shortly. This past quarter, EyeLock installed its access control system at four nuclear power plants in the U.S., and conversations are underway to deploy solutions at other plants throughout the country. Momentum is definitely building, and we have a number of other projects in development across several sectors, security, government, industrial and gaming, for example, which we believe will lead to more business for EyeLock in fiscal 2024 with several large global enterprises with strong brand names and reach. Our pipeline is growing. We have lowered expenses significantly, and with the launch of our healthcare and banking solutions, we should see strong growth and drive the segment to profitability. In closing, my comments from last quarter remain, a tough first half with challenges that will persist into the second half of the year, but a profitable second half on the steps we have and continue to take to improve the business. We expect a tough fourth quarter, but to be profitable and we expect improved performance in fiscal 2024 based on fiscal 2023 comparables and due to OEM and Onkyo and Pioneer contributions. We have a lot of good things happening at VOXX in all of our segments. We just need to weather the storm and I am confident that we will. Thanks Pat. Good morning everyone. As Pat provided a thorough review of the Q3 performance drivers, I'll focus my remarks on the P&L and balance sheet. I'll keep my remarks to the third quarter and we can address any year-to-date questions thereafter. Net sales declined by $48.8 million with automotive down $13 million, consumer $35.6 million and biometrics down approximately $100,000. Within automotive OEM product sales grew by $600,000 and as Pat mentioned, supply chain issues our customers faced and resulting production shutdowns in some cases curtailed our growth. We had higher sales at both code and envision and a modest decline in sales at VSM and as Pat mentioned, we're in the process of transitioning production to Mexico and will be fully operational shortly. Aftermarket sales were down $13.6 million with security and satellite radio products accounting for $11.8 million and $1.2 million of decline, respectively, with remain to spread across various categories in some offsets. Within consumer, premium audio product sales declined by $31.4 million. We have lower sales of premium home theater and wireless speakers, which drove the year-over-year decline as retail traffic has been down and retailers are taking in less inventory due to economic concerns and higher borrowing costs. Onkyo and Pioneer related product sales were up $9.4 million for the comparable third quarter periods, which offset the decline in European premium audio product sales of $9.4 million. Premium audio sales are now around pre-pandemic levels, but we do anticipate increases as Onkyo and Pioneer related production ramps and distribution is expanded globally. Additionally, other CE product sales were down $4.2 million and it was really spread out across many categories due primarily to retail environment domestically with international sales essentially flat. Biometric sales were down $100,000, but anticipated to grow in the future quarters given the volume of products now underway and new projects under development. Gross margins of 26% were down 90 basis points with automotive up 80 basis points, consumer down 170 basis points and biometrics down. Throughout the year, we have put in place various programs to address the supply chain issues, higher tariffs, the cost of materials and shipping container and warehousing cost, and have instituted several rounds of price increases to offset higher costs. We began to see a greater positive impact in the third quarter and believe we have room for improvement, especially on the automotive side as certain aftermarket categories increase in volume and OEM production normalizes. We'll also see improvement based on certain OEM production relocated to Mexico where our facility is expected to be fully operational shortly. To put this in better perspective, gross margins in Q3 were up 140 basis points over the first half of the fiscal year, with automotive up 130 basis points and consumer up 160 basis points. Even with the challenges we faced. We reported operating expenses of $34.8 million, down a little over $9 million for the comparable periods with SG&A and engineering and technical support down for the comparable periods. With selling expense -- within selling expenses, which declined by $2.5 million, we had lower commission expense of $1.5 million and approximately a $600,000 decline in salary and bonus expenses. Within G&A expenses, which declined by $3.8 million, salary expense declined by $2.4 million, legal and professional fees declined by $700,000 and we incurred approximately $300,000 of restructuring related expenses related to our new OEM Mexico facility. Bad debt expenses also declined by approximately $300,000 as we had more reserve releases compared to the prior year. Engineering and tactical sport expenses declined by $2.5 million, with $2.2 million related to headcount reductions in the Biometric segment, which took place in the fourth quarter of last fiscal year and lower development expenses and other segments. Lastly, direct labor expense declined by approximately 400,000. As you know from our remarks last quarter, we instituted stringent cost containment and expense reduction programs given the market environment and many of these changes are reflected in our Q3 results with more to materialize in Q4. As for other income, which increased by $38.1 million, this was principally due to the Seaguard arbitration award, which accounted for $38.5 million of the year-over-year variance. Additionally, interest in bank charges increased by $700,000, equity and income of equity investee, which is for our 50-50 joint venture with ASA declined by $200,000 and other net improved by $600,000 and this primarily -- and this is primarily related to net foreign exchange currency gains in fiscal 2023 third quarter compared to net foreign currency losses in the comparable period principally due to the dollar strengthening versus the yen. We recorded an income tax benefit of $4 million compared to a benefit of $600,000 in fiscal 2022 third quarter. This resulted in net income attributable to VOXX of $7.4 million or $0.30 per share compared to a net loss attributable to VOXX of $28.1 million or a loss of $1.16 per share inclusive of the Seaguard accrual. Lastly, EBITDA was $7.7 million and adjusted EBITDA was $9 million as compared to an EBITDA loss of $24.8 million and an adjusted EBITDA of $15.8 million in the comparable fiscal 2022 third quarter. Moving onto the balance sheet and comparing our balance sheet as of November 30th, 2022 to February 28th, 2022, we had cash and cash equivalents of $8.5 million compared to $27.8 million. Total debt was $47.2 million as compared to $13.2 million. The increase in total debt is primarily related to the $37 million outstanding on the domestic credit facility, which was used to fund inventory in quarter three and quarter four, and we'll begin to see this decline as we bring inventory to more normalized levels. The additional variances related to a $400,000 payment reduction in our Florida mortgage and a $700,000 decline in our shareholder loan payable to Sharp as a result of the strengthening U.S. dollar versus the yen. We continue to manage our working capital and expect our balance sheet to improve. We're preparing for a weak global economy and believe we have taken the right steps to stabilize and improve our business going forward. And our first question comes from the line of [Isabella Sung] (ph) with D.A. Davidson. Your line is open. Please go ahead. Hi, this is Isabella Sung from D.A. Davidson. I have one question and one follow up question. So, from a cost and margin standpoint, how should investors think about impact of declining container costs on your result for the remainder of this fiscal year? And can you give your initial thoughts on next year? Yeah. As we see container costs continuing to drop, obviously that's going to attract the landed cost of our merchandise as we bring it in. And we expect to see lower costs due to the lower container costs. Some of them are getting close to pre-pandemic levels. But what we also will have to do is balance that reduction in cost with lowering some of the prices that we offer our product at so that we can remain competitive and make sure that we are maximizing top line revenue as well. So, it's going to be a balance. We do expect that it will allow us to increase margins, at the same time, offering the consumer more competitive prices. Thank you for answering that. So, my follow-up question for you is, as a long time industry participant with VOXX at CES, since the beginning, what were your thoughts on this this year CES and what were the implications for VOXX? As I indicated when I opened this morning, the show was in our estimation well attended. It exceeded the expectations of CTA. I thought that the attendees were quite positive coming into the year. Everybody recognizes the situation we all face with a slowing economy and possibly the Fed slowing further. But I would say the mood was upbeat. We had a number of our OEM customers in, and there were -- with some of the new things that we were showing at the show, we are -- we have generated a good amount of interest with them, and we'll be speaking with them over the next month or two. We will be performing some demonstrations, some proof-of-concepts, especially with one of our newer products that we introduced. And that is a pediatric heat stroke device. We're working with a major OEM on that, on a proof-of-concept. So, these are all the things that develop at the show and that hopefully will turn into some solid business on a go forward basis. But I thought overall the attendance was up, the mood was good, and the meetings that we had were very, very positive. Thank you. And one moment for our next question. And our next question comes from the line of Bruce Olephant with Oppenheimer. Your line is open. Please go ahead. Thank you. I often do channel checks and go to Costco. And starting in November when I was doing my channel checks at Costco, I noticed that the Klipsch product, I couldn't even find. And then when I proceeded to go weeks later, I saw the product there not in abundance. And I asked some salespeople there about the product, and they made a comment that a, the product wasn't selling well, and that whatever was there, if I was just there buying, I should buy it because the product was going to be discontinued. So, I was curious to know, at that stage going into the holiday, it just seemed did we have the Klipsch product available? And really what's the situation with Costco regarding the product? We maintain Costco as a valued customer. And the way the programs work with them, we present new products and different products because it's not like they keep the same product on the shelf all year long. They do offer promotions and things like that. We offered this year we offered Onkyo receivers that we thought met the requirements that we had for the program. Some of the other programs are selling out, and we expect that we'll replace those programs and those products with newer offerings as we move into next year. But Costco remains a good, strong account, but it's not our only account. So, therefore, some of the product that is there, is not -- some of the product that they have is not also some of the product that we offer through specialty premium audio manufacturers or retailers and things like that. So, it's -- we've got another big program coming through as I mentioned with the outdoor speakers that -- this is the first time that we're enjoying both Canadian and U.S. business, and we expect to have a very, very positive program starting probably in February where we start to deliver, but it's really a spring launch. So, our relationship with Costco continues to be strong. Thank you. And one moment for our next question. And our next question comes from the line of Matthew Chen with Apollo. Your line is open. Please go ahead. Hi. I'm actually a private investor. I have a general, and then a specific question concerning the joint venture with Sharp. The general question is, could you please comment on the relative significance, perhaps in percentage terms of the business of the joint venture to the significance to the business of the premium audio company, and then the overall significance of the business of the premium audio company to the overall company? When we look at our relationship with Sharp, Sharp was the primary manufacturer to Onkyo before we were to take them over. And part of the acquisition is that we worked very closely with Sharp and we became partners in the acquisition of the Japanese Onkyo company. And our relationship remains where Sharp manufactures the product. We jointly own the company that develops the product, and PAC, our Premium Audio Company is the arm that markets and sells the products worldwide. They are a key supplier to us. They own as we reported, approximately 24% of the Japanese operation. As far as premium audio, premium audio in our Consumer segment is the largest segment we have. And obviously, I've announced that some of the sales were down from last year, but we do maintain number one market share in premium loudspeakers we have for years. This is just really a result of what's happening in the economy. We expect to maintain number one market share in our speaker business, but we are also increasing market share that we have in receivers under Onkyo and Pioneer. So, an important segment within the entire VOXX operation. Okay. Thanks. And the specific question I think might be for Mike, because in note two of the 10-Q you state that a Gordon growth model is used for expected payments made beyond the last year of projections. So, I'm wondering what's the last year of projections and then for the growth model, what's the discount rate and growth rates assumed in the growth model? Okay. All right. What we'll do is we'll get back to you with that -- with the answer to that question. I'll have Mike contact. Thank you. And I'm showing no further questions at this time. And I'd like to turn the conference back over to Pat for any further remarks. Okay. As I said, based on the economy and what we see happening in the economy, we will adjust, we will remain nimble. Hopefully, the Fed can achieve a soft landing and we can move forward. We do have a number of new automotive OEM awards that will start this year and later into the year. And again, the expansion of Onkyo and Pioneer worldwide will help offset a lot of the decline that we may see in the general overall economy. I want to thank you for joining us this morning, and I thank you for your support of VOXX. Have a great day.
EarningCall_1516
Good afternoon, everybody. I'm Chris Schott from J.P. Morgan. And it's my pleasure to be introducing Amgen today. From the company, we have the Chairman and CEO, Bob Bradway. Obviously, a very eventful year for the company in 2022, and look forward to hearing from Bob as we think about the story going forward. Okay. Thank you, and thank you for your interest in Amgen. We feel we've delivered well in the past and that we're well positioned to deliver in the future. Now, I know that many of you are very familiar with Amgen, but there are a few who are joining this event that are a little bit less familiar with our company. So, I thought I might just take a couple of moments and very quickly orient those of you who are new to Amgen, to our company. I would start by pointing out that these are our 26, 27 brands. What they have in common is that they address serious illnesses and most of these are first-in-class innovative medicines with a large effect size against those serious illnesses. And these 26 or 27 medicines generated about $26-plus billion over the course of the last four quarters, addressing, again, the needs of patients in the following disease areas. You can see, we're active in cancer. We're active in inflammatory diseases, rheumatoid arthritis, for example, severe asthma as well, as a couple of newer indications for us that you see listed here. And in addition, we're very active in the fight against some of society's biggest health challenges, including heart attack, stroke and, of course, we have an obesity franchise that's attracting quite a bit of attention at the moment as well. So, we have a broad-based business, again, characterized by innovative medicines focused on serious disease. Again, perhaps for the benefit of those that are less familiar with Amgen, let me just share a few facts here just to orient you to the scale of our business. And for those that are more familiar with Amgen, let me jump in and give you a sense for how we feel as we kick off the year [2022] (ph). And what I would say is that, in addition to being well prepared for the future, we feel we executed effectively in 2020 and that we are making the progress that we intended to, against our long-term objectives which we discussed with our investors at our Investor Day in February of 2022. Now, the reasons that we feel optimistic about the progress we're making, starts with the performance of our in-line commercial brands. We have a portfolio of leading innovative brands which, through the first three quarters of the year, generated volume growth of about 9%, and that's a reflection of the fact that these are brands that address very large markets like cardiovascular disease, osteoporosis, asthma and, of course, cancer, and these are brands that we expect to continue to grow through the end of the decade. With respect to our pipeline, we accelerated and de-risked a number of important programs in our pipeline in 2022, and I'll talk more about these this afternoon. But there are six programs in particular that I would highlight, which we moved into Phase 3 or into registration-enabling trials in our pipeline. We committed a little more than a decade ago to establish a biosimilar business which, we think, can play a role in helping to create savings and offering choice in the health care system and we are proud today to have an industry-leading biosimilar business. And again, with respect to our long-term objectives for that business area, we were successful in 2022 in completing three Phase 3 clinical trials for what we expect to be our next three biosimilar programs, and those are molecules directed against EYLEA, STELARA and Soliris. We also, of course, feel we're well positioned to be the first in the U.S. to launch a biosimilar molecule for adalimumab with our product known as AMJEVITA. So, we're looking forward to having the opportunity beginning on January 31 to compete in this marketplace. International growth is an important part of our reason for believing we can deliver attractive performance through the end of the decade. And again, through the first three quarters of the year, the volume demand for our products internationally grew by some 17%. So, we're encouraged by what we see in terms of the international demand for what we're doing. And finally, as I've often said at this conference, capital allocation is a forethought at Amgen, not an afterthought. And here again, I think, we maintained our disciplined approach to capital allocation throughout the course of the year, including completing one and announcing a second important acquisition, while increasing our dividend by some 10% during the course of the year and after having completed a buyback program amounting to in excess of $6 billion. Our world is changing fast and we often say that the factors like the Inflation Reduction Act, you either get ahead of it or it runs you over, and I think we feel we got ahead of it in 2022. And again, part of that is a reflection of the fact that we built a portfolio of products that we think is well suited to volume-driven growth in an environment of declining net prices. And I'm sure it's not lost on any of you that net prices have been declining in the U.S. market since 2018. That's a trend that we anticipated and, again, is a fact that I think our product portfolio is well suited to address. Moving to the IRA, or the Inflation Reduction Act. I think you're all aware of the likelihood of this legislation having a chilling effect on innovation in our industry for the long term. And while we think that's true, we think our relative positioning for the Inflation Reduction Act is strong, given our heritage and orientation towards biologic molecules and given our very efficient cost structure and in particular, our world-class, efficient biomanufacturing capabilities. Finally, I would note, in terms of getting ahead of the challenges facing our industry that we think the combination of compressed sector valuations, the rising cost of capital for some of the smaller companies in our industry and the scarcity of funding, will create opportunities for us on the strategic business development front. And again, as you're well aware, we undertook two important transactions in 2022. The first, the acquisition of ChemoCentryx. And the second, the announced acquisition of Horizon. And I'm sure it's not lost on any of you that both of those are well positioned in a world -- or in a U.S. Inflation Reduction Act setting. So, we're excited about the value that we can bring to those acquisitions and what they represent for us as opportunities at Amgen. The details of Horizon, again, are perhaps familiar to you at this point, but we feel very confident that this is a strategically compelling and a financially advantageous transaction for us. This is an acquisition that we think will strengthen our portfolio of first-in-class and best-in-class therapeutics. We think that it will leverage our decades of established leadership in inflammation, in particular, in nephrology, and we think that we have the global scale to capitalize on the growth potential of the Horizon products. We also think that our decades of leadership in biologics research, development and manufacturing will enable us to add value to the Horizon portfolio. And we think, financially, the combined company will be a very strong one, whether measured by cash flows or prospective growth. So, we're excited about what that represents, and I would simply reiterate that we expect the deal to close in the first half of 2023. Deals always look good on paper. Fortunately, the ChemoCentryx deal looks good to us in reality as well, and the integration of that company is proceeding very efficiently, very effectively from our perspective, bringing to us a molecule known as TAVNEOS, which is a first-in-class treatment for a very rare but serious disorder known as ANCA-associated vasculitis. This is an autoimmune disorder that leads to inflammation and can lead to the destruction of small blood vessels with serious consequences for those who are experiencing it. And this is a disorder that is treated by nephrologists and rheumatologists, where, again, we have decades of experience and these are professionals in whose offices we're in and out every day. So, we look forward to being able to build on the potential for TAVNEOS as a result of that acquisition. With respect to our portfolio of commercial products, there are some rookies and some veterans in this list that will be familiar to you. But let me just remind you that we're active in inflammation, oncology and general medicine, and I would just highlight two of the important contributors to the outlook for growth in our inflammation franchise by pointing to Otezla, which, of course, is the oral product that is widely prescribed and has been used now for many years to treat psoriasis and we experienced about 7% volume growth for that medicine through the first three quarters of the year. And then let me just highlight that TEZSPIRE, having now crossed its first-year anniversary, is off to a great start, whether measured by the clinical effect of the medicine or by the broad prescriber base that is reaching for TEZSPIRE. We're really encouraged by the results we see. So, pulmonologists, allergists are prescribing it for patients irrespective of what their eosinophil status is. So, some important questions that some of you had at the time of launch have been answered by the data that we've generated in the first 12 months, and we're excited about inflammation and TEZSPIRE in particular. Shifting to oncology. This portfolio continued to perform well in 2022 with 11% of volume growth, and I'll highlight a couple of the opportunities that we see for further expansion of the opportunity in oncology in a moment. And I also want to touch on our general medicine molecules, starting with Repatha, which generated 52% growth through volume growth, through the first nine months of the year. And I would also point you to one of the things that we expect to be a really important contributor to growth for Repatha in the future, which are the open-label extension data that were reported in the fourth quarter, which demonstrated very encouraging results indeed for those patients who have sustained low levels of LDL throughout in that case, about 8.6 years, demonstrating significant reduction in cardiovascular events and demonstrating that when it comes to LDL, lower is better and the sooner you get lower, also the better. The American College of Cardiology has also changed its prescribing guidelines, again, I think, paving the way for increased growth and demand for Repatha over the balance of the decade. Our bone franchise, which is comprised, for the treatment of osteoporosis, with Prolia and EVENITY, also performed very well during the course of the year, and we continue to be excited about the outlook for growth from those innovative first-in-class molecules that are making a big difference for women at risk of fracture after having transited through menopause. With respect to the pipeline, we have a pipeline of first-in-class medicines, again, focused in inflammation, oncology and general medicine and I'll highlight a number of these in particular. But let me just repeat that six of these molecules transitioned from mid-stage to Phase 3 or registration-enabling studies during the course of the year and I'll give you a sense of that here in a moment. Starting in inflammation with TEZSPIRE. We began a Phase 3 study that was announced recently, but we began that study in November, in eosinophilic esophagitis. So, we now have 2 Phase 3 studies underway for TEZSPIRE, offering lifecycle management expansion opportunities. And then, of course, we have two important Phase 2 trials also studying this first-in-class medicine, which is an antibody directed at TSLP. So, very exciting, looking forward to generating more data for that medicine and seeing what we can do for patients who are suffering from autoimmune disorders. Rocatinlimab is our antibody -- partnered antibody which is directed at patients suffering from atopic dermatitis. That program is actively enrolling patients in the Phase 3 trial. I would remind you again, this is a novel program, an antibody that's directed at OX40, which is expressed on activated T cells. So, it is a molecule that not only eliminates those activated T cells, but also plays a role in preventing the expansion of or the further activation of other pathogenic T cells. So, we're encouraged that, that's rapidly enrolling now. We look forward to generating results there. And then we have two other mid-stage programs in inflammation directed against lupus and ulcerative colitis. Turning to oncology. Let me just point out that we began -- again, last year, we began our Phase 3 study in first-line gastric cancer for bemarituzumab, which is an antibody against FGF -- the FGF receptor 2b and we're excited to be rapidly enrolling that program and also studying it in another -- a number of other tumors that express the fibroblast growth factor. So, quite a bit going on in that program. Tarlatamab is another cancer asset that entered into potentially registration-enabling work during the course of 2022. This is a half-label extended -- or excuse me, half-life extended BiTE directed against the target known as DLL3, which is particularly prevalent in small cell lung cancer patients which, as you know, is a very challenging disease for which there has been very little innovation over a long period of time. So, we're excited about what we've seen in the way of clinical evidence for efficacy with this molecule. And as I said, that rapidly enrolled in a Phase 2 program that has the potential to be registration-enabling. Shifting to BLINCYTO. I want to highlight BLINCYTO as well where we generated, again, very important data in 2022 that we think will play an important role in helping BLINCYTO to become a bigger medicine over the balance of the decade. BLINCYTO was also a BiTE molecule. And the Phase 3 data that I'm referring to were reported at the ASH meeting in the fourth quarter, which demonstrated that BLINCYTO when combined with chemotherapy, generated superior survival outcomes for patients compared to standard of care. So, this represents in first-line ALL patients, a really significant advance, in particular, for patients who were considered to be MRD negative. On the back of clinical data that we've generated with that molecule in a subcutaneous formulation, we're also moving very rapidly forward with that formulation and excited about what new opportunities that might open up for us with BLINCYTO as well. And finally, as you know, our LUMAKRAS, which is a first-in-class molecule directed against KRAS G12C mutations, continues to be performing well and continues to be active across a wide range of different clinical studies. Let me just jump quickly then to our general medicine franchise and repeat what I said earlier about Repatha, which is that, we think the open-label extension data for Repatha which were reported in the fourth quarter, are very important and underscore or provide confidence in our outlook for this business and for the role that it can play in helping to prevent heart attacks and strokes. Olpasiran is our siRNA medicine directed at Lp(a). And here again, we reported Phase 2 data in 2022 that showed we were able to reduce LP(a) levels 95% to 100% in patients who are born with high levels of Lp(a). And off the back of those very strong data, we opened a Phase 3 study that began enrolling in the fourth quarter and I would say there's tremendous demand from clinicians and patients to be included in that study. And then, finally, let me touch on two obesity assets. Notice I said two. AMG 133, of course, attracted quite a bit of attention following our Phase 1 data, which demonstrated an attractive trio of qualities for that molecule, again, in a Phase 1 study. On the back of that, we have begun enrolling patients in a Phase 2 study, so that is underway. And then, in addition, I would offer that we have begun clinical studies for a second obesity molecule known as AMG 786, and we're remaining quiet about the mode of action of that molecule. But I would say that our interest in it was inspired by human genetics and that it operates in a method or a manner that's orthogonal to AMG 133. Furthermore, when it comes to obesity, we have a series of preclinical assets that we're very excited about as well, assets that also work orthogonally to AMG 133. So, our commitment to obesity and the disorders that are related to obesity is a franchise commitment. With respect to our research engine, let me just quickly say that, again, we're really excited about how we have repositioned, restructured, energized our research efforts at Amgen, and we talked in some length in February about the generative biology platform at Amgen as well as our multi-specific platform. And during the course of the year, we made tremendous progress in both of those areas. I'll just give you a couple of quick examples to underscore my enthusiasm. First, with respect to using technology to reduce the cycle time that it takes us to choose the right molecules to advance into the clinic, our antibody lead optimization time lines were shrunk by about half. So, think about that as from two handfuls or many months to something less than one handful of months to choose a lead antibody. So, we're moving at a speed there that wasn't possible a few years ago. And similarly, with respect to our bispecific or multi-specific leads, we've also demonstrated during the course of the year -- past year that we've been able to deploy our technology in a way that enables us to significantly, in this case, reduce by 75%, the time that it takes to -- from design of a molecule to generation of multi-specific leads. So, again, that would -- you think about that in terms of a couple of dozen months to something less than a handful of months. So, we're excited about what we see there. I would note that if you were reading your press -- industry press over the holidays, you may have seen that we entered into two collaborations to bring antibody drug conjugate opportunities to Amgen. We're intrigued by the data that have been generated in this field. And while that was an area that we had a presence in a number of years ago, we withdrew. And in light of changes in the field, we are back in, and those were the subjects of the transactions that we announced with LegoChem and Synaffix. And then, finally, I would just note that we continue to be very active in leveraging our world-leading human genetics capabilities and complementing those genetics capabilities with considerable other efforts in proteomics and other areas of human data in order to inform our choices for which molecules to advance in discovery research and how to design our clinical trials. Our industry-leading biosimilars business, we think will be accretive to long-term growth. As I said earlier, we expect to be the first and only competitor to Humira in the U.S. market beginning on January 31, and we think we'll enjoy that period of exclusivity for some number of months. We are in a position now to be in the first wave of launches for the three other biosimilar molecules that I mentioned earlier. And as we've said in the past, we expect this business to be able to grow considerably during the decade and to be able to do that at attractive margins, given that we have the capabilities that are required in order to establish that performance for our business globally. Capital allocation, as I've already said, is an important part of how we run the business and our commitment to capital allocation is something that we take seriously. We obviously deployed a significant amount of capital this year in making acquisitions and that was on top of the $4-plus billion that we invested in our R&D and that was on top of the $1 billion that we invested in long-term capital projects. And, of course, it came alongside of the 10% dividend increase in the repurchase of more than $6 billion of stock. I think I went -- there we go. With respect to the bottom line, obviously, accountability today is broader than just delivering the bottom line and this is something that, fortunately, at Amgen, we've been focused on for some time. In fact, we were focused on it before we knew what to call it, but we have a number of activities underway to address our responsibilities to the community from an ESG perspective. I'm often asked whether I feel more confident or less about the outlook for Amgen for the balance of the decade now, as compared to where we were in February when we met with our investors and shared our long-term perspectives. And I would say that we feel even more confident about the outlook for our business than we did then. And let me just remind you what we said. We said that we felt we could deliver attractive financial performance, which we define as operating performance, that would reflect mid single-digit revenue growth. Of the back of that mid single-digit revenue growth, on average, we expected earnings per share to be able to grow by high single-digit to low double-digit. We continue to feel very confident about our prospect for delivering that. We also stated that we expected to be able to deliver that performance while continuing to return significant capital to our shareholders. And I think, as you've seen, we've continued on that trend during the course of the year. We said that in order to deliver those results, we would need to expand successfully in our international markets and we have, as I remarked earlier, with volumes growing in the first three quarters by 17% internationally. Biosimilars, as I said, we will need to perform well in our biosimilars business in order to be able to deliver those results for you. But again, we successfully completed our Phase 3 program for three molecules on time, on budget, in 2022. I've already touched on AMJEVITA. And, in total, we'll have 11 biosimilar molecules when we get to the end of the decade. And then, finally, we said we had to advance the innovative pipeline in order to deliver those results. And I would just repeat that we de-risked at least six programs during the course of the last 10 to 12 months by moving six programs from mid-stage to late-stage Phase 3 or registration-enabling trials. So, we're excited about that. In addition, I think we demonstrated the kind of data that we needed to have confidence in the growth of our in-line innovative brands. So, Otezla, obviously, we demonstrated over the course of the last 12 months that the mild to moderate indication will be an important one for us in the U.S. So that -- we've had now 12 months of data to make us feel more confident about the outlook for that. TEZSPIRE, as I mentioned, a year ago, it was still in the first few weeks of its launch. We can now look at the benefit of that molecule with the benefit of a full year and recognize that it's off to a very strong start, making a big difference for patients and then well recognized for that by prescribers and payers. The open-label extension data for Repatha was core to our belief that, that will be a big growth driver for us throughout the course of the decade, and we've now been able to share those data publicly. And then finally, I would just reiterate that our bone health franchise will be an important contributor to growth for us over the decade. And there too, we've demonstrated that EVENITY continues to be a very strong performing molecule now around the world, capitalizing on the strong franchise that we've built already with prescribers for osteoporosis therapies with Prolia. And then, again, a year ago, we didn't know exactly what would happen from Washington, or from a political perspective, but now we do. And the IRA, our Inflation Reduction Act, we've made some assumptions in February about what changes government legislation might have on the business and the Inflation Reduction Act is in line with what we expected at that time. So that was a big unknown, or risk. We now know what the issue is and we can adapt accordingly to deal with it. So, all in all, looking at our business, again, we remain very optimistic about the long term. We remain strongly of the belief that the business development that we're doing is additive to what we think we can achieve organically, and we feel we're in an even better position now to deliver on those long-term objectives. Trying to click that slide forward, it doesn't seem to want to move. Let's -- here we go. Give it one more chance. There we go. Perfect. Thank you. Great. So, maybe just kicking off on the questions. Would love to dive into a few product questions. So, maybe first on Otezla. Can you just talk a little bit about the ramp in mild with the label expansion, how that's been going so far? And how you're seeing the franchise in terms of like what patients are being started on the drug maybe today versus where we were a few years ago? Yes. So, recall that we were waiting for data that would show efficacy in mild to moderate patients which we've received. Then, we've had the benefit of the last 12 months to engage with prescribers. And we felt that there were about 1.5 million incremental patients in the U.S. that we could reach with the benefit of these data in the label. And I think the experience in the last 12 months would suggest that there are indeed a large number of patients that are transitioning from topicals to some therapy and we think Otezla is well suited for those patients based on the years of data and the -- both safety and efficacy data for those patients. And that's what we're seeing. So, so far, so good. I know there have been a lot of questions about the TYK2s but, so far, I would say there's nothing that's happening in the new product category that's surprising to us or different from what we expected. So again, very much in line with what we had expected for the psoriasis patients. Should we expect, as the TYK2 starts to get some kind of better coverage, that there could be some window of time where volume growth could slow as we had some physicians taking patients who are responding as well and kind of explore what that profile could look like? Again, I think we're going to see patients continuing to move from topical to oral. I don't think those patients will go straight to TYK2. I think there's still some prescriber reluctance to embrace a product that doesn't have the established safety and efficacy record of Otezla. So, we think that we will see patients flowing from the mild to moderate community on to Otezla. Patients who aren't responding adequately or feel they need a different therapy, may then move on to TYK2 or move on to another biologic. But fundamentally, I think we feel that the dynamics are in place. Now, with respect to how -- from one quarter through another, how patient volumes will move, I mean, clearly, there are some free drug programs and other things in the market now, that will be disruptive from one quarter to the next. But when we look at the opportunity for Otezla through the remaining years of its patent life, which takes us to the end of the decade, we feel very good towards the end of the decade. We feel very good about the prospects for continuing to serve more and more patients with that medicine. Yes. So, we're kind of right around the corner from the biosimilar Humira launch. So, I'd love just latest thoughts on launch dynamics there as we think about maybe both this year and next year, how that market you see shaping up? Right. Well, again, I would perhaps offer a couple of thoughts. First, we worked hard to have a biosimilar ready approved and ready to go. And as I've said now a couple of times, we expect to launch on January 31. We expect that we'll launch with a parity formulary position in most of the market. And so, we expect that will pave the way for some adoption over time. I would say -- I wouldn't expect the adoption to be anything like what we saw for MVASI or KANJINTI, for example, where we saw very rapid adoption. Those are so-called buy-and-bill products. And so, the market dynamics there are very different from what we're going to see for AMJEVITA as it competes with Humira. So, I think it will be more gradual. But the important thing from our perspective is that we have an opportunity now and we've succeeded so far in that opportunity of being recognized by the formularies of the big payers and so that we will be listed as an alternative to the innovative brand. And I don't think that will be possible for the dozen or whatever it is other adalimumab biosimilars that are seeking to come to the market. So, I think -- our hope is that over the next year or two, we will have established a firm long-term position for AMJEVITA. And we're the leading biosimilar provider outside of the United States and our aspiration, of course, is to be that in the United States as well. Great. And a broader question on the biosimilar business. This is one that I'm sure you get pretty frequently. And I think investors are trying to get their still hands around the attractiveness in the market. It seems like on one hand, there's a huge TAM to go after and there's relatively few players and Amgen being seemingly the best position of them. They have all the pieces in place to be successful. But I guess, on the other hand, it seems like there's been quite a bit of price competition that gets introduced as new players enter the space. So, I guess, how do you think about balancing those as you think about this as one of your kind of core growth drivers over time? Well, I think you're right that the addressable market is large. We think we can provide an appropriate alternative to the innovative brands. We think we can do that reliably with a high-quality biosimilar portfolio and we expect that through time. We'll be able to earn an attractive return for our shareholders by doing that. If we look at what we've established so far, I don't think there's any question in our mind that we're earning a return for our shareholders as well in excess of our cost of capital on the biosimilar program. But that comes from executing on time, on budget. And I would note that not everyone in the biosimilar industry has been able to complete their programs on time. That's part of what we expected. We thought it would prove more difficult than perhaps other observers expected, and that at some point, there would be a shakeout as a result in the number of competitors for any individual molecules. So, there will be price pressure as long as there are more marginal competitors in these markets. But what we've seen in Europe, for example, is that, over time, the number of competitors stabilizes and there continues to be a relatively attractive market for us from a margin or cash flow standpoint. So, again, we're a world leader in biologic development -- biologic process development, biologic manufacturing and we're able to bring those capabilities to bear for the benefit of our biosimilar business. And in addition, we're bringing forward biosimilars that are in therapeutic categories where we have strong existing relationships with payers and prescribers and we're able to use that network for the benefit of our biosimilar brands. So, we think those -- that combination of attributes has enabled us and will enable us to continue to earn an attractive return here. But we'll continue to evaluate each opportunity to make sure that we continue to have that confidence. So far, we think there are 11 medicines that we intend to commercialize through the back end of this decade. Great. Can you talk about TEZSPIRE and the uptick you've seen so far? And maybe also as part of that, what are you most excited about as you think about the additional indications that you're developing? Well, again, TEZSPIRE is a novel first-in-class medicine. And at Amgen, we've been excitedly awaiting the opportunity to serve patients with this medicine. It's Phase 1 data were in the New England Journal of Medicine. Because they were so striking, the Phase 2 data were in the New England Journal. The Phase 3 data were in the New England Journal. And this is a new pathway for inflammatory diseases. It functions higher on the inflammatory cascade than other molecules that have been explored previously. And we think it's turned out that, that has -- that creates some benefits for prescribers and for patients. And again, it's off to a strong start for patients suffering from severe asthma, irrespective of whether they have high or low levels of eosinophils. And for prescribers, both allergists and pulmonologists, it's proving to be an attractive option. So, so far, so good, touch wood, from a safety and efficacy standpoint. And there are four big programs that are underway, two in Phase 3, two in Phase 2 for TEZSPIRE. Obviously, the biggest opportunity there is COPD, but that's still some way off and still perhaps a little bit more speculative and the Phase 3 programs in chronic polyps and in eosinophilic esophagitis or probably near-term opportunities. Obviously, not as big as COPD, but what we see there is a little bit of the pipeline in a product metaphor. Lots of different opportunities to go after inflammatory diseases where the TSLP access may be relevant. Great. On 133, it's obviously generated a lot of excitement over the past few months. I know it's still early in development, but just would love to get your thinking about the obesity market and the role Amgen is going to play in the space? Well, again, we think there is still an unmet need there even after taking into account a couple of molecules that are further along in their development lifecycle than ours. And we've approached this medicine differently from our competitors. We made a decision to try to interdict both GLP-1 and the GIPR receptor and in particular, to antagonize GIPR based on human genetic data that led us to believe that, that was the right way to think about addressing the obesity challenge for these patients. And the data that we showed from the Phase 1 trial were very, very encouraging; encouraging as regards to effect size, encouraging as regards to the dosing intervals that we explored, encouraging as regards to the duration of effect. And even after the medicine and stopped being administered, patients maintain weight loss in some cases up into six-plus months. So, we're encouraged by what we've seen from that Phase 1 program and that's what led us to rapidly enroll the molecule in a Phase 2 study, where we will explore it on a variety of different arms. But there is obviously a massive opportunity to address the public health problem of obesity and its -- and the disorders that are related to obesity. And I think as the biology of adipose tissue becomes better understood and as its contribution -- inflammatory processes that contribute to related diseases becomes better understood, this will be seemed to be an important new way to try to prevent some of the chronic diseases that are such a problem for us in society today. Now, I would say that we have -- as I mentioned in my remarks a moment ago, we have a second asset in the clinic generating data now that -- which works orthogonally to AMG 133 and several preclinical assets which also work orthogonally to AMG 133, which is a way of saying, ultimately, we think we may have to go after obesity and related complications of obesity through a variety of different mechanisms. And right now, we're excited about the leads that we have and the progress that we're making in designing medicines to address them. Okay. Sounds great. Maybe in the last few minutes, I'm just going to take a few questions from the queue related to Horizon. I guess, first, how are you thinking about capital allocation in -- over these next several years as you're delevering post -- some of the acquisition goes forward as you go through this delevering process? Again, I think we'll continue to maintain our disciplined approach to capital allocation. It starts with investing in long-term attractive innovation, so our innovation and external innovation. And we'll remain committed to returning capital to our shareholders. And we've mentioned or we've announced that we expect to be able to bring leverage down to the status quo ante by 2025. So, the combined company will be a very strong, cash flow-generating enterprise and we expect to leverage or to benefit from that strong cash flow to bring down leverage levels in the way that we've already announced. Sure. We're going to continue to look -- we'll continue to look across a range of opportunities to acquire external innovation and also to license external innovation. So, as I said in my remarks earlier, we think the environment now is well suited to business development opportunities and we want to keep the company, and we think we've put the company in a position to capitalize on that and we want to continue to capitalize on that. Great. Maybe one last quick one here, another one coming in from the queue. How do you see the pipeline at Horizon fitting into Amgen's broader R&D efforts? Well, obviously, we'll have more to say about that once the transaction has closed, but there are a number of assets there that we're intrigued by and there are important studies that are running now. We look forward to seeing the data when those -- when they become available. So again, stay tuned. Look forward to have more discussion about that after the deal closes, which we expect to be at some point in the middle of the year.
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Also on the call with us today are Jennifer Bath, Chief Executive Officer; Brad McConn, Chief Financial Officer; Ilse Roodink, Chief Scientific Officer; and Barry Duplantis, Vice President of Client Relations. Before we get started, remember some statements we make today may be considered forward-looking statements for the purposes of applicable United States and Canadian securities laws. IPA cautions that these forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those indicated in the forward-looking statements. Additional information about these risks and uncertainties is included in our SEC filings. IPA undertakes no obligation to update these forward-looking statements except as required by law. On today’s call, non-GAAP financial measures may be used to help investors and analysts understand IPA’s business performance. We refer current and potential investors to the forward-looking information section of its Management’s Discussion and Analysis issued today at www.sedar.com and on EDGAR at www.sec.gov. Thank you, Dennis. Good morning everyone. I’m glad that you are able to join us today. We’re excited to share with you IPA’s second quarter updates and our progress toward achieving our strategic goals for the fiscal year, including the steady growth of our revenue driven by our expanding client relations team, as well as milestone achievements with our in silico platforms from our newest subsidiary, BioStrand. With several goals in mind, the company recently announced its voluntary delisting from the TSX Venture. These goals include creating a central market for its common shares on the NASDAQ, enhancing long-term liquidity and shareholder value, lowering administrative and legal costs, saving time, and harmonizing reporting requirements. Finally, we believe that de-listing from this exchange makes it easier to reach institutional investors who are prohibited by compliance from investing in such exchanges. IPA is considering a shift in its corporate offices as a compliment to its recent delisting from the TSX Venture. While the exact potential location has not yet been selected for shareholder approval at a future special meeting of shareholders, some of the key location characteristics being considered include a U.S. location with access to high-performing workforce with relatively low average wages, a region with expanding technology-based businesses that is complimented by numerous business incentives and easy access to government officials, highly competitive cost of business operations, and a highly educated workforce. This quarter, we look forward to keeping you informed of any developments relating to this particular update. As we approach the end of this calendar year we are focusing on accelerated revenue growth and sales integration of our in silico capabilities. This year we are also reflecting on market conditions and our historical performance as we strive to maximize shareholder value in 2023. This graph compares IPA's year-to-date share price change to that of independently selected competitors as reported by NASDAQ with these figures as of Tuesday, December 13. While we have maintained shareholder value in a difficult market, especially as compared to our peers, we are far from satisfied. With regard to shareholder value and corporate growth we have set immense goals and we are committed to working tirelessly until those are executed. We are not intimidated by the current market conditions, but rather energized and inspired by the opportunity to significantly outperform them. Elaborating on our most recent press release, the emergence of Meta's ESM Fold 2 and DeepMind's AlphaFold AI-driven predictive platform recently opened the door to the world of structures and their impact on drug discovery. Irrespective of their precision, these platforms provided us with a novel visual representation of sequences and their uniqueness. Having fully integrated these two platforms into our end-to-end in silico discovery workflow, we have saved an appreciable amount of development time and cost. The timing of these platforms was fortuitous, having recently launched our structural HYFTs, which will help explore formal and explicit biologically relevant and hidden knowledge drawing upon our HYFT technology, which cannot not only connect sequence to structure and function, but also link those sequences to structure and structure to many types of textual information such as scientific papers and also medical records. These multi-omic, multi structural capabilities are unparalleled and have the potential to greatly speed up drugs discovery. From a commercial perspective, we started integrating BioStrand’s cutting-edge AI technology into our global fee-for-service offerings this quarter, creating unique in silico capabilities to expand our platforms for next-generation antibody discovery and development. These in silico services show quick turnaround times that result in faster revenue recognition, excellent profit margins, and a competitive edge, thanks to our unmatched data outputs. One of the examples in the new in silico offerings is the recent client access to our in silico immunogenicity screening service, which enables clients to quickly and affordably predict which lead candidates may be immunogenic when administered to patients. It offers insights into which patients, specifically based on their genetic background, are most likely to experience an adverse event and determine which lead candidates are most likely to be safe in the majority of the population. In order to prevent unfavorable side effects this information may also help drug sponsors decide which patient population should be selected in a clinical or commercial context for a particular therapy. This and other new AI services have not only been launched, but have also been chosen by select clients as extensions to their current programs and will soon be available for all to view on our updated website. Thank you, Jennifer. This quarter IPA grew its sales team in key geographic areas. I am pleased to report that a new Director of Client Relations started with us shortly before the end of Q2. This new addition is covering CRO service sales in the San Francisco and Pacific Northwest region and brings with her years of experience serving clients from past antibody service sales and project management roles. In addition, IPA has received a signed commitment from an East coast-based Senior Director of Client Relations set to join the team in early calendar year 2023. This individual has an impressive background in antibody discovery, while also possessing firsthand knowledge of client needs and expectations. The San Francisco and Boston regional markets have always offered significant market potential for IPA and we look forward to the impact that these two key hires can bring IPA in the future. Last quarter we spoke of a significant increase in Q-over-Q sales orders. Those sales orders have helped drive a 9.8% increase in revenue of Q2 over last year. They have also yielded record quarters at both IPA Canada and the Utrecht sites. The Canadian site also posted a single monthly revenue record reporting over $844,000 in October, and we’re optimistic for continued growth with strong revenue trends continuing through November. These results are primarily driven by a continued and growing interest in IPA's memory B cell selection workflows, particularly IPA's rabbit B cell platform, while the Utrecht site is beginning to take advantage of their increased capacity following a seamless move to their new facility, which Jennifer will expand on later. We've also recently announced that IPA's BioStrand subsidiary has signed a research collaboration and licensed agreement with the clinical stage bio company, BriaCell. The research collaboration is based on BioStrand's ability to develop clinically relevant antibodies using its multifaceted, in silico HYFT based platform. Due the unique nature of BioStrand’s therapeutic discovery potential, we're happy to announce this is the first non-fee-for-service based discovery program run by a service-based IPA subsidiary. While the fee-for-service models have served IPA's traditional wet-lab services very well, the fiscal benefits of using an in silico discovery workflow, asset ownership retention until certain contractual requirements have been met and the potential backend value of the program make for an incredibly attractive business model available to BioStrand’s technology. Lastly, we would like to turn our attention to the growing market of Wnt proteins where IPA Europe's Utrecht campus is occupying a rapidly growing niche with an exclusive product arrangement in IP protection. An organoid is an in vitro three-dimensional replica of an organ that has been scaled down and simplified to display accurate microanatomy, and they're increasingly valuable model systems for human biology. Wnt surrogate is a protein that is required as an organoid growth factor. IPA has seen an uptick with our Wnt surrogate production and sales at our Utrecht site, which is consistent with our views that the organoids market is rapidly growing and demand for growth factors continues to increase. According to a Vision's research reports, the global organoids market is valued at over US$2 billion in 2021 and is predicted to reach well over US$12 million by 2030, at a CAGR of 21.58% during that timeframe. With UPE’s move to the new accelerator building, the company is well equipped to meet the rapidly growing demand. Yes, thank you, Barry and good morning all. As recently announced, IPA subsidiary Talem Therapeutics entered into a strategic collaboration with Ligand Pharmaceuticals’ new subsidiary OmniAb, expanded the ongoing relationship by further developing three antibody programs with validated immune oncology targets. Under this agreement, Talem will lead to the progression to clinically suitable molecules by combining the expertise with IPA's LENSai in silico technology to advance out-licensing and commercialization of these three human antibody therapeutics. Immuno app and Talem will share certain research costs of each program and are eligible to receive shared downstream economics upon potential out-licensing or commercialization of each program. We believe that the application of our in silico analysis has the potential to greatly enhance the quality and value of these programs as it does for any discovery pre-clinical or clinical program. During our last earnings call, we announce the maintained efficacy of PolyTope, Talem’s first-generation four antibody combination therapy against the SARS-CoV-2 variants, B8.5 and B8.275. We are very delighted that NIAID has agreed to include our product in their regular neutralization screenings of clinical and antibody therapies towards emerging variants. This demonstrates NIAIDs recognition of the exceptional resilience of PolyTope in maintaining effectiveness against variants. To-date, we have also had ongoing conversation with NIAID on clinical trial support through mechanisms facilitated by NIAID. We are pushing for the first patient doses of PolyTope in the spring of calendar year 2023 and accordingly, we have engaged a global clinical trial CRO, named the cells to support us with clinical development of PolyTope, [indiscernible] was selected based on the experience and constructive interactions as well as the results of an independent audit at IPA's request. [Indiscernible] is involved in the finalization of the study protocol to evaluate the performance of PolyTope in humans and will prepare other documents require such as manuals, patient information and patient informed consent. [Indiscernible] will on behalf of us, be responsible for clinical site monitoring, regulatory safety and data management and logistical aspects, transferring the drug product and clinical samples. To-date, we are pleased to state that the production of the final drug substance having completed and the filing of the drug product and placebo are in the final stage. This slide summarizes our part and ongoing task towards regulatory submission for clinical trial approval. With the continuum mutation of SARS-CoV-2 resulting highly politicized dropout authorized therapies. There's a growing need and interest for more sustainable and broadly efficacious product. This unmet need has been recognized by health and regulatory authorities as well. As such, the FDA and EMA organized a joint workshop that takes place a day. IPA was invited along with a handful of leading pharmaceutical companies who previously had effective anti-SARS commercial therapy that have lost regulatory support to join an additional working group leading up to the final workshop. The aim of the working group is to identify alternative strategies to expedite testing of effective antibody therapies, targeting new SARS-CoV-2 variants to align our perspective regarding possible regulatory relaxations for clinical development and to prepare a joint presentation to the EMA and FDA at the workshop. [Indiscernible] readiness of our drug product while others are back in the development phase, as well as very favorable earning potential of infectious disease assets in general put Tyler in a good position for partnering and outlicensing discussions for PolyTope, in particular with human safety data on the horizon. From an intellectual property perspective, we are pleased to share that we have received very promising feedback from the examiner regarding our U.S. national patents for PolyTope and expect that its granting is close. As discussed during the last quarterly update, Talem has combined lead candidates from two oncology programs into a bispecific therapy to create a potential best-in-class T cell engager that has now been proven to recruit and activate T cells in vitro. Of interest, it was noted that T cell activation by our bi-specific candidates differs from that of a chosen benchmark, commercial benchmark. We believe that it's differentiating properties open avenues to develop safer and potentially more effective oncology therapies and underscore the first and best-in-class potential of these candidates. We have filed professional patents for each of these programs, including T cell engagers. Having established priority days for these programs allows us to create more visibility for these assets publicly, greatly benefiting our ongoing partnership discussions. Great. Thank you, Ilse. As a result of meticulous relocation planning, IPA's Utrecht team executed an extremely smooth transition to the new accelerator facility in October and quickly ramped up production to seamlessly serve clients. Lab for floor space has doubled and new equipment and staff additions are in place to support the increase in production capacity afforded by this move. The new facility will also allow the Utrecht team to add new services, including the expansion of offered biophysical characterization assays. In fact, even in the short period of time since the expansion, we have witnessed an appreciable revenue gain from the new facility offerings as will be highlighted next by Brad McConn. Thank you, Jennifer, and good morning everyone. I will provide an overview of our financial results for the second quarter before touching on our financial position as of the end of the period. As a reminder, all numbers I reference are in Canadian dollars unless otherwise noted. Before we dive into commentary on the financial results, I briefly want to touch on a change that we made to the organization of operating expenses on our comprehensive income statement. We've updated the classification of our expenses to be organized by function as opposed to our previous presentation by nature. The four functions you'll see this quarter and moving forward are research and development, sales and marketing, general and administrative and amortization of intangible assets. I want to touch specifically on the research and development function and note that it includes compensation expense related to research, including share-based compensation, research, supplies and materials, service contracts for research projects and allocated depreciation. We feel this organization provides increased visibility into the cost structure of the company and much improved comparability to our publicly listed peers. Turning to the financial results. IPA recorded total revenue of $5.2 million during the second quarter, a 9.8% increase from $4.7 million during the second quarter of fiscal 2022. Barry previously mentioned record quarters at both Victoria and Utrecht, and both achieved greater than 20% revenue growth compared to Q2 of last year. Gross profit for the quarter totaled $2.8 million, an increase of 7.9% compared to the same period last year. Gross profit margin of 54% is a slight decrease from 55% in fiscal 2022. Our increased cost of sales is primarily attributable to increased salaries and benefits and lab supplies allocated to projects to support our increased revenue, along with some small effective inflation on the cost of supplies. Moving to our operating expenses. Research and development costs increased to $4.6 million from $3 million during the same period last year. The majority of research and development costs related to the clinical manufacturing of the PolyTope antibody combination therapy, which totaled $3.7 million during the quarter. Other notable expenses include $0.3 million in compensation expense and $0.1 million in depreciation allocated to R&D. Sales and marketing expense totaled $0.8 million during the quarter, an increase of $0.2 million compared to fiscal 2022. This increase is attributable to additional advertising expenses, compensation expense and consulting costs. General and administrative expense was $4.3 million during the period, compared to $3.1 million in fiscal 2022. Salaries and benefits increased $0.4 million and management fees $0.3 million primarily due to the addition of staff at BioStrand and some routine pay increases. Office and general expenses allocated to G&A increased $0.1 million. Consulting fees increased $0.6 million. Lastly, share based compensation decreased $0.4 million year-over-year. Finally, amortization of intangible assets increased $0.4 million due to intangibles that we recorded for the acquisition of BioStrand. Other income totaled $0.3 million during the second quarter of fiscal 2023 compared to a loss of $0.1 million during the same period last year. The largest variance to note is an increased in unrealized foreign exchange gain of $0.4 million compared to the second quarter of fiscal 2022. All told, IPA recorded a net loss of $7.4 million during the second quarter of fiscal 2023, compared to a net loss of $5 million during the same period last year. As previously highlighted, the major drivers of the increase in net loss include increased investment in research and development activities and increase G&A costs. Moving to the balance sheet. IPA held cash of $15.1 million as of October 31, 2022, compared to $30 million as of April 30, 2022. Cash expenditures totaled $5 million during three months ended October 31, 2022, a reduction from $10.6 million in expenditure during Q1 of fiscal 2023. The cash used in investing activities include $0.8 million in the purchase of equipment and $0.7 million for the first deferred payment for the acquisition of BioStrand. Cash from financing activities includes an outflow of $0.6 million from lease payments offset by inflows of $0.6 million from the issuance of shares due to option exercises. Thank you very much. [Operator Instructions] And your first question will come from the line of RK with H.C. Wainwright. Please go ahead. Thank you. Good morning, Jennifer and team. Thanks for taking questions and congratulations on a very successful quarter. In terms of – I have few questions, so I’ll just go one by one. In terms of the revenue trajectory, which we are saying, it certainly is moving in the right direction, and it’s very encouraging. In terms of the resources that you are adding in Europe, to offer increased quantity and also quality of services, what do you – what are your expectations in terms of the growth in the project revenue from these additions and what percentage of – what percent growth in project revenue would make you and the team comfortable especially going into fiscal year 2024 and beyond? Thank you for your question, RK. So with regard to specifically the growth and added space, we’ve taken on in Europe, and then also with regard to the additional company in Europe, I can touch on that from a couple of different perspectives here. So the first one I’ll start with is the expansion of our space in Utrecht where the majority of the expanded space, it’s actually ROI generating space. And we’re looking for a couple of areas there where we have specifically focused on for increased revenue, not only ability to take on more programs because that site has been at maximum capacity for probably about half of the previous fiscal year. But in addition to that, to be able to take on certain types of programs that we’ve had to decline historically because of needed additional footprint to be able to house some of the equipment that we now have purchased since the move. So some of those include extremely high throughput small scale protein production from some of the large pharmaceutical companies in that region who have a very particular need for that and have inquired specifically about us filling that need. And the other one is exactly the opposite. It’s extremely large scale manufacturing in which we have received numerous requests over the most recent ones here to produce both proteins for outsourcing to a large companies interested in reselling those products for us. So we’re looking forward to the continued growth at that site. It’s already kind of beyond our expectations after just having moved two months ago. And we believe that revenue trend will continue there. As Brad stated, it’s already 20% year-over-year right now. So what would we anticipate or forecast on officially going forward and expect? I would expect that to at least double in size for that particular location with regard to the particular types of activities I just mentioned. With regard to BioStrand as you know, BioStrand is still pre-revenue company. We anticipate that to change relatively quickly, as mentioned, we have put out these offerings for fee-for-service work that’s just been on a face-to-face, one to one offering with clients we’re in communication with. It’s not something that’s been wide scale offered or is available on our website at the moment. These are wet lab capabilities that are still running fee-for-service, but as I mentioned in the call, they are different than our existing wet lab services in the sense that, because they do provide results relatively quickly depending on the offering, anywhere from 12 hours to three days as opposed to several months. We obviously anticipate much faster revenue recognition. The profit margins are also significantly higher than our existing profit margins. We definitely anticipate that site to be revenue generating in the very new future – in near future. What we’re really – what we’d really be happy with that site is to see some of the revenue generation, not just from those fee-for-service programs, but from the de novo in silico program such as the one that was just agreed to with BriaCell. We are anticipating closing several more of those this year, and so ideally, we would see some of those upfront payments rolling in which range anywhere from $500,000 up to several million dollars depending on which company would hit those milestone goals. Thank you very much, Jennifer, for that. Just to follow-up on your last set of comments. At a high level, those offerings within that AI-based product are – is basically to kind of test the market and see not only assessing your ability and successful delivery of whatever the objectives are for the client. But also kind of to tweak your product in such a way that you can offer it to all the current clients and also for to prospective clients. So for that – for you to get to that level, what is the sort of timeline that you’re wanting within your teams to deliver? And also I know it’s very difficult to figure out what sort of growth you’ll attend there, but for people like me who kind of think about numbers, how should we think about that? So if you can comment a little bit on the timing, whatever you can give at least qualitative statements about growth expectations. Absolutely. So with regard to those offerings, which I just mentioned, we actually do include expected timelines in those agreements that have been drafted for those clients. So one thing I’d like to point out is with these groups that we have gone out to specifically, we went to four groups, this is something else that or four different companies, this is something else that we have not offered on our website or been very public about. And with respect to these particular groups, what we offered were four unique packages that we anticipate will become the future standard de novo in silico offerings at Biostrand. And with regard to those, we’ve given very specific timelines for the anticipated output of in silico sequence product. And every one of these packages on our early adopter program, as I mentioned, are slightly different. Some of these groups will be required to make an upfront payment as soon as an in silico product is generated, whereas others are based on actual validation of the product being able to do something most commonly a functional test. The anticipated timeline, I would say, average that’s been given for the in silico work is about four weeks. The anticipated timeline for follow on proof-of-concept work from the actual product produced from the in silico sequences four to six weeks. So for the majority of programs, we would anticipate that we would see some revenue generation somewhere between eight to 10 weeks after starting a program with these groups. And that first initial payment unilaterally becomes what we’re referring to as the upfront payment to actually be able to receive the sequence and the product that’s been tested. Perfect. Thank you very much for that. In terms of the commentary that we heard today on the organoids business and how that could be growing quite rapidly in the R&D, certainly, we’ve seen enough in the literature. But how is that really translating into the Wnt protein sales? Because even though quarterly – on a quarterly basis, it’s certainly growing, but on a yearly basis, it seems like declined a bit. I’m not trying to make a big fuss about it, but I’m just trying to understand, is there some anomaly between last year and this year. And what is – what has changed – what is the expectations for this year and next year? So yes, I’m happy to answer that. That’s very observant on your part for our product sales year-over-year. And so a couple of clarifications on that when we break down and look a little bit more closely at our product sales. So the Wnt protein is actually our best selling off-the-shelf product coming from our Utrecht facility. And as mentioned by Barry, it is something that we have exclusivity to an IP protection around. So Wnt protein is interesting in the sense that our primary buyers for that protein are ones who are seeking to include that in growth media for these organoids and also large scale contracts to be able to turn around and actually resell the Wnt protein. So that needs to, in those particular cases, be bought in bulk, so that they can be sold competitively still on the market. With regard to any sort of decrease in product sales, that’s because when we provide our product sales numbers, we actually do it, just on a consolidated basis across all of our sites across the globe. And we do have a particular product that historically has had a couple of large product sales out of our site in Oss in the Netherlands. And as of this year, the group that routinely places an order for that particular product has not yet placed an order, even though we still anticipate them to do so because they’ve been a regular client. So the dip is actually not something that pertains directly to the Wnt protein. And so going forward, we actually do anticipate that Wnt protein to take over more and more a significant share of the off-the-shelf product. And that’s in part, because what we’re beginning to see is more and more groups wanting to be able to come in and get access to that Wnt protein because of the quality of that protein, the stability of the protein, and the increased activity of that Wnt surrogate protein reported by several different larger technology companies compared to some of the standard Wnt proteins that are otherwise available on the market. Perfect. Thanks. Thanks for breaking down that product sales. What is there in the product sales? So one final question from me before I step down. In terms of the tau [ph] we see, it’s obviously very encouraging to see [indiscernible] able to neutralize even the latest mutant of the virus. How are – if this, how big of a commercial opportunity do you think this is, especially when you would be coming into the market, at least two years down the line, if not more. And with the virus mutating all the time, do you think the structure of your antibody is such that it can capture whatever mutants comes down the pike? So that’s one question. And the other question is on the oncology offerings, are those more for you to out license? Or are these products more for similar to what you’re doing with TATX in the sense at least initiate data, and then, go to the market for out license? Okay. Yes, so starting first of all with the PolyTope program. So I think one of the first things to always cover is the fact that we absolutely don’t see SARS-CoV-2 going anywhere. Just based on the science and what we know about virus evolution and its ability to continue to adapt. With regard to the relevance of our PolyTope, we actually believe that we’re in a better position than we ever could have. We were – so I think specific from the beginning and saying, we are not going to be the first out there. But our intent is obviously to build something that has sustainable efficacy. So that eventually when we predict others will need to go back to the drawing board, because they will lose efficacy, that we will retain that efficacy and eventually take a pole position in the market because we never had to go back and reset our timelines and reset our strategy. And so today, and kind of going back, real quick to one of the things that Ilse mentioned here we are sitting in working groups with these large pharmaceutical companies that did get products out there that did have commercialized products with emergency use authorization. Many of the products that only lasted a couple of months actually in that commercial setting. And then were no longer efficacious due to these mutations. And last, obviously, the regulatory approval. And so had relatively short timeframe with regard to commercial benefits. From our perspective, the probability of our program, of our products staying efficacious and having a much longer-term window in a commercial setting is probable. And the reason why we say that is because we have all of our historical data and based also on the scientific way that we actually constructed PolyTope. It was actually designed to do exactly that. So we are at this point in time, the only first generation therapeutic that has retained efficacy for all of the variants of concern that have emerged. And we’ve retained that efficacy within a relatively small window of potency, while so – while we’ve watched all these commercial products dropped off, we have sustained that efficacy and we have continued to move forward. And it’s that historical data that gives us the confidence that we’re likely to move forward under those same exact conditions because it hasn’t mattered whether it’s a parental, virus variant that continues to pick up mutations or it’s a new virus backbone with many more mutations that has been emerging. Another thing I think for people have to keep in mind when they think about the potential sustainability of PolyTope is it’s not just that historical information we rely on, even though we’ve never had to swap to date any of the products out of that combination therapy to retain efficacy. In part because even if one does reduce in binding or efficacy on its own, we have synergy built into that, that we have demonstrated. And so the other antibodies are retaining that efficacy for us. But we did build in a backup option should we ever actually reduce significantly in efficacy, which are the backup bins that we’ve talked about historically, our plug and play options. Those plug and play options would allow us should we ever significantly decrease an efficacy to slide over in one of the regions where we may have decreased an efficacy with an antibody that has been optimized for binding in that particular region, but avoids an epitope that may have been mutated. And one of the reasons why we have felt some of our conversations with one of the regulatory authorities involved in the process of getting, giving us feedback and making the final approval for this product that has been so encouraging, is that they’ve actually encouraged us to go ahead and consider trying some of those backup antibodies in a clinical setting, which is actually incredibly encouraging. So we have this first line of defense that just hasn’t been broken. We’re the only group with that first line of defense that hasn’t been broken. And then we have a second line of defense that we feel quite confident with. And this, one more thing to mention with regard to how we constructed that, that I think is also really important to keep in mind is that a lot of the new mutations that are occurring are mutations that are cropping up in people who have reduced or inadequate immunity to the virus. So people who might be immunocompromised, people that were not vaccinated that has already been demonstrated to be one of the areas where we see an increase in these mutations occurring. And then those novel variants of concern beginning to spread. And another way that we had another reason we had built in to PolyTope, these different safeguards with having synergy with having Fc function activity. And also, with the four antibodies in the combination therapy is under the premise that we may be able to stop a novel of variant of concern with new mutations in a patient from continuing to replicate and continuing to spread. So it could actually be a novel and efficacious way to actually prevent the spread of new variants of concern and prevent them from emerging in populations in addition to being able to treat patients prophylactically and therapeutically. So that’s where our real confidence in this is coming from. And with these working groups also mentioned, it has been clear to us that we really are in a pole position and the other groups really have had to go back in recent months to redefine and rediscover new molecules. With regard to the oncology programs and your question regarding those. And in particular with our bispecific T-cell engager, we do not anticipate taking those into the clinic. We built these particular programs based on unmet needs in the market, based on really attempting to be best-in-class products in the market. Actually, that particular T-cell engager is probably the hottest asset that we have on our books right now. And it is something that we do intend to out license and then collect additional downstream milestones and royalties form. Hi there. Jennifer, Brad, Ilse and Barry, thanks much for taking my questions and thanks for a really great overview of what's been going on at IPA. I wonder as it relates to the BioStrand offerings and the general sort of in silico offerings that you are rolling out, I wonder if you could provide sort of a high level – your high level thinking on how that offering will be stage gated from being sort of a internal development to early adopter phase rollout to being more available to clients broadly. If you could take – if you could take us through that that process and your thinking that would be great? Yes. Yes, absolutely. So as I mentioned a little bit earlier we started with limiting who we went out to share these opportunities specifically for the de novo in silico programs. And we did so based on wanting to offer these early adopter basically pricing, but in return for an – in return for our ability to collect that information and use that information also in a blinded manner to go out and also show proof of concept of our capability to other companies when we were ready to do so. And so what we really wanted to start with was let's find some of these groups we have very good relationships with already, but we also have insight into what they've been working on for the last multiple years, what's been their pain point, what's been that program they couldn't be successful with historically with other CROs and with other partnered programs. And really demonstrate to them, how we can conquer these challenges that haven't been conquered by more traditional methods. And so with those particular groups, we decided to stop with the outreach with just those for particular groups and not further specifically so that we could continue to optimize our algorithms so that we could adjust if we saw any areas that we felt needed improvement, and so that we could utilize all of the sequence information coming in from those programs to also feed our algorithm as our AI would enable it to continue to collect statistical data and improve. We anticipate that it's probably two to three months before we go out with data. And again, it really depends on how these programs go from a timeline perspective and a quality perspective. But to be able to start using some of that data to go out and, and share with other groups, probably again for several months on a face-to-face, one-on-one offering with various groups. And I would anticipate and again there's caveats there that make it difficult to exactly pinpoint, but not until we've had a total of five or six successful programs through there that we would open this up on mass to larger offerings. That being said, the offerings that we've gone out through but right now for these four groups are two smaller biotech and two very large more like Top 10 pharmaceutical companies. And what we anticipate and what's also been indicated by those larger companies is if we were successful with these programs for them, they would likely be interested in taking on larger target deals to use up the capacity that this available at BioStrand with a larger upfront payment? So whether it's more companies or just more programs, well, we'll have to see. The overall timeline for that if we had to put an estimate on it is probably around eight months. Okay. That's extremely helpful. And I'm glad you provided that detail of two small biotechs and two large biopharmas, I guess. I get, and this is rolled nicely into my next question. We were glad to see that that you were able to publicly announce like the name of your health department that you're working with BriaCell. We recognize that you are partnered with a high quality group of partners through the CRO – the historical CRO business and your other businesses. Do you expect you will be able to announce the names of partners that you work with and in the future this is helpful to understand the pedigree of groups that are attracted to the offerings we have today? Yes. Great question. So right now as a part of the early adopter program, it is actually a requirement that we have written into the four different standard agreement options. So right now we do have approval from those groups and the three remaining groups that if those agreements go through, we would be able to share their name publicly. There is one time consideration for one of those groups who said we are currently working on something that's very important that would suggest that maybe not releasing our name right away would be pertinent, but that timeframe is possibly one to two months out. So if that deal closes prior to that particular significant event changing for them then we would make the announcement without the name and then follow up on the first event with that program with a name. On the contrary if their personal big event for them occurred prior to signing the agreement, we would be able to announce it. So short answer is that yes it's been written in definitely for the 75%, three of the four, the name will be out there in the initial announcement for one it may trail slightly. Fantastic. Well we'll watch the newswire to see those names announce. Thank you very much for taking my questions. I'll hand that. Good morning, Jen and team and thanks for taking my question. I'm delighted to see the progress at BioStrand so far with partnership agreements. I was hoping you could explain what specifically about the technology is resonating the most in discussions and how it might be different differentiated from other offerings out there. Sure, and hi Will. Great to hear from you. But yes, I'd be happy to explain that. So as I mentioned a minute ago, we had offered these to four different companies from smaller well funded biotechs to Top 10 pharma. Participating in this early adopter program and during the due diligence process what really became evident for these companies going into due diligence especially the larger ones was really what was kind of driving their excitement around these particular programs and why they came to us in general. And one of the more common themes here is the potential for LENSai software to analyze and solve these very complex programs that couldn't be achieved with those traditional laboratory settings. And in addition to that, we saw a number of programs that reflected therapies that these groups have been working on for close to a decade that never had a success. Lot of the enthusiasm, which I think is also of note, has been around the concept of the HYFT and the uniqueness of the HYFTs, and as a distinguished and differentiator from our competitors. In fact, the two larger pharma companies that that we’ve been working with have gone into a pretty significant due diligence on that and really wanting to understand, how the HYFTs really drive that differentiation. And has garnered quite a bit of excitement around how the HYFTs drive the algorithm based exploration and their potential to be able to identify these relationships that the traditional AI and ML supported codes being used by other companies don’t have. And so I think that’s actually been where quite a bit of the interest and differentiation has come in, is around the uniqueness of the way that we have a real true discovery backing, the development of these codes and the fact that for them, that’s a concept of a HYFT and how that HYFT relates to what we understand about evolutionary biology is very tangible and very directly related to their experience in biology. Let’s see. Will, I apologize I don’t know, if I answered all of your questions, so please… No, no. That’s super helpful. I guess then I also wanted to ask, just sort of looking back over the course of 2022 multiple members of the management team have bought stock in the open market and pretty consistently throughout the year. So I was curious to just hear from you guys what most excites you about the IPA investment case going forward. Yes, absolutely. So we’re, yes, you know that we are really excited and part of it really is because all along will we have had this really a magnificent vision for IPA. Our strategic goals every fiscal year have been aligned toward that vision. Many of the milestones that we have accomplished in the past couple of years were built specifically toward our vision of fully integrating digital – of being, I’m sorry, a fully integrated digital technology company that’s able to solve the most complex personalized medicine challenges. And I think also importantly on an unprecedented timeline and budget. And so, for years we have emphasized the increase in our discovery program throughput, and then accordingly also, the optimization of antibody sequence outputs from our lab, standardizing those workflows across all of our locations. We focused on high-throughput NGS or next generation sequencing capabilities, but more specifically, we built a digital pipeline to mine large multi-species sequences and structures with amplified functional diversity. And then another, milestone we had built into that was, we coded algorithms to, and this is outside of BioStrand. We coded algorithms to augment our ability to mine and formalize and perform deep sequence analysis while building a repository for all of the data. So our ultimate aim was to apply this information to the right tool when that tool was identified with the ability to continuously learn from an AI or ML perspective, and then to apply the knowledge gained from these collection processes. And that tool is now our LENSai tool that we acquired through BioStrand. So going back more specifically to your question, during the past three to four months, our excitement is definitely possible in particular amongst the, the management team because we’re starting to see very real world examples of how we’re able to process and interpret these informative models to solve real and complicated life science problems. And not only do we see our vision now starting to come to fulfillment, but it’s also being accomplished on a timeframe that accelerates some of our more lofty ambitions around the de novo and silico discovery and development, which is actually the foundation of the application supported by this BriaCell deal that we’ve been discussing, and then some other similar discussions. So in essence, really we see strong concrete signs that our vision is rapidly unfolding, that the pieces of the puzzle that we’ve been strategically constructing over the past couple of years are coming together, and the potential that – it generates is at the root of our enthusiasm and our excitement. So I think going forward, we’re most excited to demonstrate the power of our algorithms to solve these challenges for our partners. And then of course along with the anticipated revenue generation that could result from these accomplishments. Great. It seems like the scientific achievements are really on the verge of producing some pretty exciting financial performance as well. So thanks for that. I think everything else I had has been hit on, so I will drop. Thanks. And at this time there appear to be no further questions. Dr. Bath, would you like to take over for closing remarks? Yes, sure. Thank you. All right. So now first of all, I wanted to start by just talking a little bit about the fact that we have accomplished, a great deal in developing, integrating these new technologies to drive our commercial potential. We’ve also been successful in recruiting and assembling a world-class team which continues to execute on our stated objectives to achieve new heights in terms of our commercial goals. All of this was accomplished also while delivering on our partnerships and signing our first extended revenue potential deal which is the in silico licensing agreement with BriaCell. We are confident and we remain confident in our capacity to continue acquiring new in silico partners and programs this year, as well as our potential to realize revenue through comparable agreement structures through our Talem Therapeutics subsidiary. Prior to closing, I would like to recognize and thank our team for their unwavering commitment and remarkable efforts so far this year. And as you can tell, we are very enthusiastic about the future, and we look forward to communicating with all of you and even meeting some of you next month at JPMorgan. And we appreciate your attention and again, we look forward to speaking with all of you soon.
EarningCall_1518
Good day, ladies and gentlemen, and welcome to the Champions Oncology Second Quarter Fiscal Year 2023 Earnings Call. At this time, all participants have been placed on a listen-only mode and the floor will be opened for you questions and comments after the presentation. It is now my pleasure to turn the floor over to your host, Dr. Ronnie Morris. Sir, the floor is yours. Good afternoon. I am Ronnie Morris, CEO of Champions Oncology. Joining me today is David Miller, our Chief Financial Officer. Thank you for joining us for our quarterly earnings call. Before I begin, I will remind you that we will be making forward-looking statements during today's call and that actual results could differ materially from what is described in those statements. Additional information on factors that could cause results to differ is available in our Forms 10-Q and Form 10-K. A reconciliation of non-GAAP financial measures that may be discussed during the call to GAAP financial measures is available in the earnings release. Overall, we had another good quarter with record revenue in our services business as well as progress in our drug discovery effort. We continue to monitor the current economic environment and for the first time, we have noticed an effect on our business. During this quarter, specifically in September and October, we noticed a slowdown in bookings compared to prior quarters. While the quarter's total bookings remained strong, they were below those obtained in our previous quarter. Our late-stage pipeline continues to be strong, and we feel that in Q2, there was a general delay when it came to finalizing a proposed statement of work from our customer base. We are halfway through Q3 and we are cautiously optimistic that bookings are back on track to Q1 levels. We are confident that our superior TumorBank, high-quality work and expanded services will continue to propel our growth even in these uncertain economic times. With regards to Lumin, which is our multifaceted data platform, we have our software product and our data analytics product. As I discussed on our last quarterly call, Lumin adoption has been slower than anticipated. We still envision our data platform as an asset and part of our overall long-term strategy. However, we determined that we were at a crossroads with regards to our SaaS platform. We either needed to invest more heavily in both sales and marketing and our software support or to reduce some of our costs and refer more opportune time to increase investment. Given the current economic environment and the multiple platforms we are working on to expand our pharmacology offerings, we've decided to reduce our Lumin investment for the time being. While we are still signing up a small number of new users, the short-term focus will be to continue to learn from our active user base and to improve on the product. With regards to our drug development effort, we continue to make good progress. Our lead discovery programs are progressing well through its therapeutic discovery stages. As discussed last quarter, our partnership with Alloy recently reached a milestone with the completed development of a series of lead antibodies, exhibiting favorable biophysical binding and specificity characteristics. A lead candidate was selected from this series and evaluated as a promising antibody drug conjugate. We expect to start preclinical testing shortly. Our lead molecule from our Fannin collaboration is also expected to progress into preclinical testing in the next six months. Both programs are the first of many potential therapeutic programs from our platform. In summary, during the second quarter, we had record revenue, we continue to expand our platform, we are reacting to the current economic environment and we are optimistic on our long-term growth prospects. We anticipate that our target discovery effort will progress into the preclinical phase, marking a significant milestone. Our second quarter financial results were good with record revenue of $14.3 million compared to $11.8 million in the year ago period, an increase of $2.5 million or 21%. We generated operating income of $7,000. And excluding stock-based compensation and depreciation, we recognized adjusted EBITDA of approximately $686,000. Focusing as we do on results, excluding non-cash expenses such as stock comp and depreciation, our total cost of sales was $7.2 million compared to $5.5 million in our second quarter last year, an increase of $1.7 million or 31%. The increase was primarily from compensation and supply expenses as we geared up from an increase in steady volume. Due to the current economic climate, we experienced an uptick in cancellations, limiting our anticipated revenue for the quarter and pressuring margins. Gross margin for our pharmacology services was 51% versus 53% in the year-ago period, while total gross margin was 49% compared to 53% for the same period last year. As Ronnie mentioned, we've decided to reduce our Lumin spend in the coming quarters, which should alleviate some of the total margin pressure. R&D expense was approximately $2.6 million compared to $2.3 million in the year-ago period, an increase of $300,000 or 13%. The increase is in line with guidance provided in the past as we indicated we'll be ramping up our R&D investment, adding data to our TumorBank and investing in our therapeutic target discovery platform. Sales and marketing expense was relatively flat $1.65 million compared to $1.6 million in the year ago period. Our G&A expense was at $2.1 million for the quarter compared to $1.6 million a year ago, a 30% increase. The increase was primarily due to compensation and IT expense as we invest in upgrading our infrastructure to support company growth. Additionally, we increased our bad debt allowance due to the current economic conditions. In total, our cash-based expenses were $13.6 million for the second quarter of fiscal 2023 compared to $11 million in the same period last year, an increase of approximately $2.6 million or 23% with the increase primarily stemming from cost of sales as we built in infrastructure to support higher revenue levels. Now turning to cash. At the end of the quarter, we had $10.8 million of cash on the balance sheet, an increase of $2.8 million from our prior quarter. For the quarter, net cash generated from operating activities was approximately $3.3 million, primarily due to positive cash-based operating results and an increase in accounts payable in the ordinary course of business. Cash used in investing activities of $600,000 was primarily due to equipment purchases for our laboratories. In summary, we had a good financial quarter, hitting a new revenue record of $14.3 million. As discussed, we experienced a slowdown in bookings in the quarter, along with an increase in cancellations. While we're cautiously optimistic that bookings will reaccelerate in the second half of the year, the slowdown in bookings and increase in cancellations will likely impact total revenue for the year. Accordingly, we're expecting our total revenue growth for fiscal 2023 to be in the 10% to 15% range, down from the approximate 20% range provided at the beginning of the year. We're well positioned to weather this revision, and we are excited about the company's overall progression and long-term prospects. We look forward to our next update call in mid-March. Thank you. Ladies and gentlemen, the floor is now open for questions. [Operator Instructions] And the first question is coming from Matt Hewitt with Craig-Hallum. Matt, your line is live. Hi, this is Jack on for Matt. So for the first question is following a choppy Q3 reporting season where some companies spoke of headwinds due to the current weak biotech funding environment, I'm just curious what you're seeing and hearing from your customers. Thanks. Yes. So we're still seeing -- we look at a couple of different key performance indicators. We look at the pipeline, which includes conversations, interest from our pharma customers and then we look at the actual SOW signings. What we're seeing is a robust pipeline, a lot of conversations, a lot of discussions, there's a big need out there. But what we think we've been seeing over the last couple of months or we saw in the middle of Q2 was just more scrutiny, longer time to the signing of those SOWs. And so far in Q3, we seem to be back on track. So it's unclear if -- how things are going to progress the rest of the year. We still think we are well positioned to continue to have growth and -- but there's certainly an aspect out there of tightening of the belt, there's certainly an aspect out there where especially some of the smaller biotechs are maybe either worried about their funding or not getting some funding. So it's definitely having an effect on us. But it's hard to quantitate because we had a couple of months where we saw that and then a couple of months now where we're seeing things seem to be opening up again. Thank you, and good afternoon. I did have a couple of questions. First, with regards to the cancellations, can you talk a little bit about who is canceling? Are these smaller biotech companies? Are these larger companies? Is it earlier-stage work or later-stage work? Any color that you can provide would be helpful. Thanks. Yes, Scott, I think it's a little bit of everything. I think it's a mixture of some smaller biotechs, but certainly, there were some mid and larger biotechs that we prioritize. I think that sometimes the reasons might be different. I think that -- I think everyone over the last, say, six months has been scrutinizing their prioritization of projects. I think some -- we have examples of some of the larger biotechs that cancel some stuff, but then we booked some other stuff. So it's going to have a short-term impact because that stuff won't turn into revenue, but then they turned around and use that allocation to rebook other stuff. And then there's examples of some of the smaller biotechs that just cancel for lack of funding or reprioritization, where they're just doing what they absolutely need to do right now for some short-term results, so they can raise more money. So I think it's a combination across the board. I think that everyone has been looking at their spend, prioritization. And I think that when we think about the value we provide and the services that we provide, I think that puts us in a good place, but when everyone gets a little bit squeezed, I think, we also get squeezed as well. Okay. Shifting gears, the revenue guidance of 10% to 15%, I mean, there's only six months left in the year. So that range looks a little wider given its half the year through. Do you feel comfortable that you are going be one, end of that range? Or are you targeting the middle of it? And as well can you talk about the mix between Q3 and Q4? Sure. So listen, I think that we feel comfortable with that range and it’s a range for that reason. I think that what we've experienced with greater than usual cancellations and some of the weakness in the bookings in Q2 is definitely going to have an effect on the year's revenue. Certainly, the stuff -- most of the stuff that we book now and in Q4, even if it turns out into Q3 and Q4 go back to our normal projections, it's probably not going to have as much of an effect on the total revenue for the year as what happened to us in Q2 in terms of the slowdown in bookings and the greater than expected cancellations. So from that perspective, we think that we're going to take a shorter-term hit on what we expected, and that's why we revised our projections. I think longer-term, we feel pretty comfortable and confident that all the stuff that we continue to do and have done over the last couple of years is going to put us in a good position to be able to weather the storm and continue to grow. So right now, from where it looks, certainly, there was a hiccup based on what we think is economic environment. What we're seeing now is pretty much the last six to seven weeks has come back to normal pace for us. So that is a good sign going into next fiscal year. Okay. And I guess the final question, I completely understand the environment, cutting kind of non-core business expenses. But I'm curious why the discovery target business, you still seem pretty bullish on that category. And as well, maybe if you could just talk about when do you monetize that discovery target processing? Are you just trying to get through preclinical and then out-license? Or do you ever anticipate taking it beyond preclinical? Just trying to get a sense of how much that business costs and what the time line to expense recovery is there. Yes. So again, going back to the thesis we have that our data is a very unique set of data. It's a very, very deep set of data that's unique because of all these PDXs. But not just all the characterization we have on these a couple of thousand patients, but it's also the fact that all of these patients have been treated with multiple drugs, and we have multiple drug treatments against the PDX. So it really gives us a very unique and rich data set with which to do our discovery. And I'll remind you that our bank is characterized on a very deep level, including proteomics, phosphoproteomics, the DNA and the RNA expression. So we really look at all of these treatments, what the effects were from these treatments. And so, it gives us a very unique database. And that was the impetus for us to think that we could take this data and really find unique target. So we're excited about the targets. We're excited about the molecule so far that we've been able to develop against these targets. So we continue to be excited about the results we're getting. We are starting to do preclinical work now very, very soon. So we've been doing a lot of work ex-vivo and in-vitro, but now we're starting to do some preclinical in-vivo work. And the plan is really to do enough work so that we really get more confident, not only in the molecule and the stability and efficacy of the molecule, but also in the efficacy on the PDX models that we have. And then the plan is to go out and try to find a home for it, which includes getting investment or out-licensing and so on and so on. So that's the current plan. We don't plan currently to take these into the clinic, but the goal is to get them ready for the clinic and then find a partner. [Operator Instructions] Okay. We currently have no questions in queue. I'd like to turn the floor back to management for any closing remarks. Thank you. Yes. I just want to thank everybody for joining us for our call. We look forward to continuing to update everybody. We're excited about the growth trajectory that we have at Champions, a lot of exciting assays and a lot of exciting services that are continuing to be developed that are important to the pharma and biotech world. So we look forward to continuing to update everybody on our next call, and thank you for joining the call. Have a good evening. 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_1519
Welcome to the Lee Enterprises 2022 Fourth Quarter Webcast and Conference Call. This call is being recorded and will be available for replay at investors.lee.net. [Operator Instructions] A link to the live webcast can be found at investors.lee.net. Good morning and thank you for joining us. Speaking on this morning's call are Kevin Mowbray, President and Chief Executive Officer; and Tim Millage, Vice President, Chief Financial Officer, and Treasurer. Also with us today and available for questions is Nathan Bekke, Vice President, Audience Strategy. Earlier today, we issued a news release with preliminary results for our fourth fiscal quarter of 2022. It is available at lee.net as well as at major financial websites. Please also refer to our earnings presentation found at investors.lee.net that includes supplemental information. As a reminder, this morning's discussion will include forward-looking statements based on our current expectations. These statements are subject to certain risks, trends and uncertainties that could cause actual results to differ materially. Such factors are described in this morning's news release and also in our SEC filings. During the call, we refer to certain non-GAAP financial measures including adjusted EBITDA and cash costs which are defined in our news release. Reconciliations to the relevant GAAP measures are included in tables accompanying the release. And now to open the discussion is our President and Chief Executive Officer, Kevin Mowbray. Kevin will open the conversation on Slide 3 of the earnings presentation for those following along. Good morning, everyone. I’m pleased you could join us. The Lee team delivered another strong quarter with continued execution on our Three Pillar Digital Growth strategy. And I’m really encouraged at the pace by which we're transforming Lee into a vibrant digitally centric company. Our fourth quarter results exceeded all of our Digital revenue guidance, and we achieved our full year adjusted EBITDA guidance as well. Our ability to exceed expectations and produce industry-leading results demonstrates the success of our strategy resiliency of our business model to support these investment thesis and increases our conviction in achieving our long-term goals. In the fourth quarter, we grew Digital Only subscribers 32%, the 12th consecutive quarter of industry-leading growth. We are also encouraged that we grew average rates for our Digital Only Subscriptions driving fourth quarter digital subscription revenue, up 46% year-over-year. Digital Only Subscription revenue grew 42% for the full year. We exceeded our Digital subscriber guidance with 532,000 digital subscribers at the end of the quarter and revenue outpaced guidance as well. On the advertising side, we exceeded all of our digital revenue guidance metrics, and we achieved industry-leading digital revenue results. Amplified Digital revenue grew 82% in the fourth quarter and 83% for the full year with revenue totaling $76 million for the fiscal year, pacing well ahead of other DMS solutions in the industry and our guidance. I couldn't be more proud of the Lee team for achieving results that lead the industry, exceed our guidance and further transform Lee into a vibrant digitally centric company. Lee is the fastest-growing digital subscription platform with industry-leading digital subscription growth metrics for the last 12 consecutive quarters. With more than 530,000 digital subscribers today, our strong growth is attributed to the attractiveness of our digital product offerings, and we just scratched the surface of our vast addressable market. In addition to growing digital audiences and engagement, we offers a full suite of omnichannel advertising and marketing solutions to local and regional advertisers through Amplified. We created Amplified from scratch several years ago, and we are seeing tremendous industry-leading results. Revenue at Amplified increased 82% in the fourth quarter and totaled $76 million for the fiscal year with growth rates more than 6x the nearest industry peer. Amplified is key to our growth strategy in a significant size of the addressable market. As a result of driving industry-leading digital growth, total digital revenue for the fiscal year was $240 million, up 27% compared to the prior year and accelerating from a 19% compound annual growth rate over the last 2 years. We are rapidly transforming the mix of our revenue, and in the fourth quarter, total digital revenue represented 33% of our total operating revenue. 2022 was a successful year for Lee. I couldn't be more proud of this team for their strategic thinking and operational excellence that has allowed our company to be agile during times of uncertainty. This steadfast commitment toward delivering on our Three Pillar Digital Growth Strategy and the rapid execution of our plans to drive value for our shareholders. Before I go deeper into our strategy later on in the presentation, I will turn the call over to Tim to discuss fourth quarter and fiscal year results in more detail. Thank you, Kevin, and good morning, everyone. To reiterate Kevin's sentiment, we are pleased with our fourth quarter and full year results and the digital transformation at Lee as we exceeded expectations for digital revenue and digital subscriptions. And despite many headwinds, we achieved our adjusted EBITDA guidance as well. In the fourth quarter, total operating revenue was $194 million, flat compared to the prior year as the growth and outperformance of our digital revenue streams offset the decline in our print revenue stream. Total digital revenue increased 31% in the fourth quarter to $65 million, driven by the rapid growth at Amplified and in Digital Only subscription revenue. 33% of our revenue in the fourth quarter was Digital revenue, up from 25% a year ago. Digital Only Subscription revenue increased 46% and totaled $11 million in the fourth quarter, driven by increases in digital subscribers and rates. Digital Advertising and Marketing Services revenue totaled $49 million in the quarter, a 33% increase over the prior year and represented 55% of our total advertising revenue in the quarter. The increase was due to rapid growth at Amplified. Total print revenue was $129 million in the fourth quarter, an 11% decline compared to the same quarter a year ago due to continued secular declines in the demand for print. Operating expenses totaled $199 million and cash costs were down 3%. Decreases in cash costs were attributed to continued business transformation efforts, partially offset by strategic investments in digital talent and technology tied to our growth strategy, increased digital cost of goods sold and general overall rising prices. For the quarter, we reported a net loss of $5.8 million, largely driven by noncash impairments. Adjusted EBITDA totaled $30 million in the quarter, an increase of 17% compared to the prior year. For the full year, total operating revenue was $781 million or down less than 2% compared to the prior year. Total digital revenue for the year increased $27 million to 27% to $240 million. In the fiscal year, 31% of our revenue was digital revenue, up from 24%. Net income totaled $1 million in the fiscal year, and adjusted EBITDA totaled $96 million, achieving our full year guidance. I will now hand it back over to Kevin to discuss our digital transformation and our Three Pillar Digital Growth strategy in more detail. Thank you, Tim. Lee is a digital subscription platform. Our strategy aims to grow digital audiences and engagement by providing compelling local content using best-in-class storytelling across our rich multimedia platforms, while also offering full suite of omnichannel advertising and marketing solutions to local advertisers. Our Three Pillar Digital Growth Strategy is guiding our transformation to a vibrant digitally centric company. The strategy is focused on three pillars: Pillar one expand digital audiences by transforming the presentation of local news and information; Pillar two is about growing our digital subscription base and revenue; and Pillar three is about diversifying and expanding our offerings for local advertisers. Our fiscal year 2022 results demonstrate significant progress in Lee's digital transformation, and there's even more room for growth. We are more than halfway towards our goal of $435 million of recurring sustainable digital revenue by 2026. Slide 9 offers an in-depth look at Pillar one, focused on expanding digital audiences with local journalism as the foundation. This encompasses everything from coverage of breaking news and local business to end up investigative reporting that leads to meaningful change in the communities we serve. Our goal is to expand our audience by providing compelling local content using best-in-class storytelling that reflects an uplift the communities we serve. We've made significant progress in Pillar one by improving the user experience on our digital products and hiring top digital native talent. We've redesigned our digital products using multimedia presentations with an emphasis on video and audio. We recently hired a public service journalism team focused on investigative and watch dog reporting with data analysis and storytelling that comes from the numbers. This type of work can change the conversation in the community and leads to substantial transformation about how we understand or approach the world right outside our door. These talent and technology investments are important in order to enhance our content, enhance our digital products and grow our digital audiences. Pillar two is about accelerating our digital subscription growth. We've made tremendous progress in this area as we have 532,000 digital subscribers more than halfway towards our goal of 900,000 digital subscribers by 2026. We have a huge addressable market of nearly 5 million known users and we are deploying tactics and leveraging cutting-edge data and technology to convert our known users to digital subscribers. Turning to Slide 11. Our third pillar focuses on diversify and expanding our offerings for advertisers through both Amplified and our owned and operated digital products. With advanced data driven ad tech specialized category expertise, scalable custom video content and powerful first-party data access, Amplified has a strong partner for local and regional businesses looking to drive growth. In fiscal year 2022, Amplified achieved full year revenue of $76 million, up 83% over the prior year. While Amplified has the growth engine for top line revenue, our massive owned and operated digital audience fuel high margin digital advertising revenue. Our owned and operated properties attract massive audiences. We are offering more video inventory and branded content opportunities to boost digital advertising revenue. Execution of our Pillar three taxes is expected to drive $310 million of annual digital advertising revenue in 2026. Tim will now take us through our strong track record of sustainable cost management. We faced a number of headwinds in 2022, including dealing with rising prices that are impacting our cost structure. One example of this is newsprint as prices increase 9x during the fiscal year, in total a 30% increase and had a $5 million impact on our cost structure. One way we are addressing the inflationary environment has remained focused on managing the profitability of our print business as we see changes in demand for our print products. As we discussed in previous earnings call, early in the third quarter of '22, we completed a deep dive into all aspects of our print organization optimizing our cost structure and distribution, manufacturing, national content, marketing, finance, IT and other corporate services. This process was used to evaluate our external spending as well as our human capital and was done to better align our cost structure with our long-term strategy. As a result of this review, we executed on expense action that we expect to reduce our cost structure on an annualized basis by $45 million. Execution of these actions began early in the third quarter, and we achieved more than $20 million reduction to our cash cost in the last two quarters of 2022. And we expect the flow-through impact from these reductions to reduce cash costs by $25 million in FY '23. As shown on Slide 12, we expect continued legacy cost reductions as part of our business transformation in fiscal year 2023. While we remain focused on driving efficiencies and reducing cost to improve profitability of our legacy print business, our main priority is to drive long-term sustainable digital revenue growth. With that in mind, we aim to invest in areas that are aligned with our Three Pillar Digital Growth Strategy which include local content, development of our digital products and digital talent to drive results. In the fiscal year, we expect $25 million of incremental investments in our strategy. The investments will have a short-term impact on margin that are expected to drive Lee's digital transformation. In fiscal year '22, we began providing both short-term and long-term metrics to give better transparency and clarity on our digital transformation progress. And we continue that practice on Slide 13, where we summarized our fiscal year '23 outlook. Total digital revenue is expected to be between $280 million and $285 million in the fiscal year. At the low end, 17% growth, we expect to be realized through continued revenue growth at Amplified and through digital subscriber revenue growth. We are guiding to 632 Digital Only subscribers at the end of the fiscal year or a 100,000 increase in subscribers or nearly 20% growth. On the cost side, we expect to reduce cash costs by between 2% and 3% in fiscal year '23 due to continued business transformation efforts, partially offset by incremental digital investments. With the strong digital revenue guidance combined with continued reduction to our cost structure, we are guiding to a full year adjusted EBITDA of between $94 million and $100 million. Moving to Slide 14. The principal amount of debt at the end of the fourth quarter was $463 million, down $113 million since our refinancing. As a reminder, our credit agreement with Berkshire has favorable terms that are incredibly important for us as we execute our strategy. Importantly, the agreement has a fixed interest rate and a 25-year runway. These factors, along with no financial performance covenants and no fixed amortization payments give us the necessary flexibility to make our investments and transform lead. Our pensions are in the aggregate over-funded, so we do not expect any pension contributions in fiscal year 2023. Finally, we continue to identify opportunities to monetize our real estate, which facilitates accelerated debt repayment. We have generated $40 million of proceeds from asset sales over the last 3 years and more opportunities exist to monetize real estate. As a reminder, our goal is to achieve our long-term leverage target of under 2.5x by the end of 2026. Thanks, Tim. Under the guidance and oversight of our Board of Directors and our leadership team continued execution on our growth strategy, sets the stage for significant long-term value creation. We are very pleased with our fourth quarter and full year results and the tremendous progress we are making towards the target in our Three Pillar Digital Growth Strategy. Our Three Pillar Digital Growth Strategy is the foundation of our investment thesis and the execution of that strategy is at the core of creating value for shareholders. Our strategy aims to grow recurring sustainable digital revenue and drive free cash flow, which will fuel debt reduction. A stronger balance sheet and improved operating cash flow combined with multiple expansion fueled by increasing digital revenue creates a strong path to significant long-term value creation for our shareholders. To wrap up, I'd like to thank the entire Lee team for their efforts in driving our transformation. We have the right Board, the right team and the right strategy, and I believe we are better-positioned than ever to create long-term value for our readers, our users, our advertisers and our shareholders. This concludes our remarks. The team will remain on the line for any questions. Operator, please open the line for questions. Thank you. Well, first of all, I want to congratulate you and your team. Great job. Exceeded my expectations, so congratulations. Couple of questions. Your Digital Only subscriptions were strong, obviously, it exceeded my expectations. But I know that you have promotions all the time, but were there any significant changes that may have been more successful in terms of driving digital subscriptions in the quarter, which obviously accelerated from your previous quarters. And I was just wondering if you had any changes in the pay wall or anything like that, that may have accounted for the acceleration of the growth in the quarter. We didn't have any changes in our payroll. But one thing that we are doing more than ever before is using sophisticated data and analytics with our insight time to convert more users once they hit our pay wall, and we are seeing big success using that analytical approach to drive Digital Only subscribers. Got you. And just staying on that theme, in terms of your fiscal '23 guidance, which is in line with my expectations, by the way, you did not provide the guidance for Digital Only Subscription revenue, but yet provided very strong Digital Only subscriber guidance. I was wondering if that was due to the prospect of discounts? Or do you plan to drive rate in 2023? Or will you driving rate, would that be more of a fiscal 2024 strategy? Hey, Mike, this is Tim. I think we’ve been successful at driving unit growth as well as rate growth throughout FY '22 in digital subscribers. In fact, from September to September, we saw a 22% increase in digital subscription rates. And so we've had a lot of success in growing our subscription rates and expect that to carry forward throughout 2023. So we do expect continued significant growth in digital subscription revenue, and that's going to help fuel the targets that we've outlined for total digital revenue that we guided to. Got you. You mentioned that advertising on the print side was down 11% in the quarter. And I was just wondering if you can just talk a little bit about the tone of advertising as we've seen now some rate increases from the Fed, and that might be kind of starting to see some slowing of the economy. Are you anticipating further moderation in the rate of revenue decline in print or what are you seeing in terms of what we are looking at in the fiscal first quarter? Well, let me break that down into a couple of buckets for you. What we are seeing on what we call national advertising or key accounts and that be your Target's, Walmart's of the world is sort of choppiness given what's going on with their business models. Where we are seeing to success though is with the local advertiser, where we've had these really strong relationships for many, many years. We have the right print-digital solutions to really help them grow their business. Got you. And then I was wondering if you can add more color on the strong results you delivered on Amplified. I mean, Amplified grew very strongly in the quarter. Were there specific categories of business that fueled that growth particular regions? I mean, any other additional color that you can add on what's fueling that exceptional growth there? Sure. Well, video is a big driver for Amplified throughout all of fiscal year '22, and it will continue in fiscal year '23. But what I would also characterize the growth too is we sell Amplified Digital services in and outside of Lee, and we have had a lot of success selling our services outside of our markets as well. Got you. And then just a final question. Some companies have indicated there has been some moderation in cost trends from the earlier inflationary impact and things seem to be moderating a little bit. Are you starting to see any moderation in cost, particularly whether it be from newsprint or labor or any other costs that you're seeing in terms of what you see -- what you’ve seen earlier this year and what you're starting to see now? Yes. I think that's what you said is exactly right. We are starting to see moderation. The big factor that we pointed to in our comments related to newsprint, that's been more stable. And actually, we may start to see that come down a little bit. So certainly, that's what you mentioned is what we are seeing as well in some of that start to moderate. And in terms of your guidance in terms of -- because you went through some expense cuts earlier this year, and you're indicating that in fiscal 2023, our $25 million in additional cost savings, would that be then any of those type of moderation trends are not really factored into that $25 million in savings for fiscal 2023, correct? Well, let me clarify. So the $25 million that I mentioned was actions that we took last year that will have an incremental impact on this year as we realize the full year impact. And so that's really what we were talking about the $25 million. Thank you. Ladies and gentlemen, at this time, we have reached the end of our question-and-answer session. This concludes the call.
EarningCall_1520
Greetings and welcome to the Enzo Biochem, Incorporated First Quarter 2023 Earnings Call. At this all participants are in a listen-only mode. [Operator Instructions]. Please note that this conference is being recorded. At this time I will turn the conference over to Brendan Payne [ph] of Investor Relations for Enzo Biochem. Brendan, you may now begin. Thank you, Rob and good afternoon everyone. Joining us today from the company are Hamid Erfanian, Chief Executive Officer and Patricia Eckert, Interim Chief Financial Officer. Enzo issued a press release detailing financial results for the first quarter of fiscal 2023 last night which is now available on the Investor Relations of the Enzo website. Before we begin, I would like to read the company’s Safe Harbor Statement. Except for historical information, the matters discussed in this news release may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended and Section 21E of the Securities Exchange Act of 1934 as amended. Such statements include declarations regarding the intent, belief, or current expectations of the company and its management, including those related to cash flow, gross margins, revenues and expenses, which are dependent on a number of factors outside of the control of the company, including the markets for the company’s products and services, cost of goods and services, other expenses, government regulations, litigation and general business conditions. Please see risk factors in the company’s Form 10-K for the year ended July 31st, 2022. Investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve a number of risks and uncertainties that could materially affect actual results. The company disclaims any obligations to update any forward-looking statement as a result of developments occurring after the date of this conference call. During this conference call, the company may refer to EBITDA, a non-GAAP measure. EBITDA is not and should not be considered an alternative to net income or loss, income loss from operations, or any other measure for determining operating performance. The company has provided a reconciliation of the difference to GAAP on its website, www.enzo.com, and in its press release issued this afternoon. I would now like to turn the call over to Hamid Erfanian, Chief Executive Officer of Enzo Biochem. Hamid, please go ahead. Thank you, Brendon. Good morning and thank you for joining us on our first quarter business and financial update. Last night we issued our first quarter fiscal year 2023 financial and operating results. First quarter revenue was 18.3 million, a decrease of 31% year-over-year compared to Q1 fiscal year 2022. We continue to cycle through some anticipated difficult comparisons driven by historical COVID revenues, which will anniversary in the fourth quarter of this fiscal year. COVID revenues declined from 9.2 million in Q1 fiscal year 2022 to 0.8 million in Q1 fiscal year 2023, which accounted for the full decline in the year-over-year revenues. First quarter revenues without COVID grew in the single-digits. Enzo Life Sciences reached 7.1 million in revenues with revenue growth of 9% year-over-year and 5% on an organic basis when adjusted for negative FX impact. This is an acceleration compared to our organic growth of 2% in Q4 fiscal year 2022. Enzo Clinical Services bridge reached 11.2 million in revenues, a decrease of 43% year-over-year, impacted by the decline in COVID testing revenues. On a sequential basis, the first quarter without COVID testing grew 4%. We anticipate growth in our core testing revenues going forward offset by direct COVID testing declines. The Q1 fiscal year 2023 revenue performance on a COVID adjusted basis was encouraging and a validation of both the significant opportunity in our end markets and progress on our focused return strategy. Let me begin by highlighting some of our progress within each business and the status of their end markets and then wrap up with a summary of our overall strategies. Let's start with our life sciences business. The business operates in a large and healthy $10 billion market that is growing in the upper single digits, driven by significant growth in genomics, molecular biology, and tissue analysis segments. This is an area where our differentiated capabilities in labeling and detection reagents which are fundamental enabling solutions for assays and workflows across technologies for instance, genomics, tissue analysis, and applications such as cancer, immune-oncology, immunology, neuroscience, and stem cell research position Enzo to maximize commercial opportunities. The upper single digit growth we achieved in life sciences in Q1 fiscal year 2023 combined with a double-digit growth over the past two fiscal years demonstrate a consistent ability to grow this business. Within fiscal year 2023, the growth was driven by 10% growth in drug discovery due to several new bulk orders for proteins and enzymes. We experienced 6% growth in immunoassay and antibodies due to larger orders from existing customers. We achieved a healthy growth in the bioprocess Eliza kits business in Asia and the addition of a new distributor in China. We also had 10% growth in libraries and small molecules due to rising demand and new bulk orders. This is evidence of our moving down the drug development pathway where we can experience recurring revenues as well as reliable forecasts from our customers. In addition to solid revenue growth within the quarter in Enzo Life Sciences, we also made strong progress in advancing our growth opportunities for the future. We launched our Powered by LoopRNA product which will allow us to better penetrate the high growth area of spatial biology for drug development. In addition, we have a number of GMP product launches with a focus on small molecule chemistry and antibodies as well as further portfolio expansion around bioprocess and toxicology for immune and biochemical assays. These efforts, combined with our ability to drive strong, consistent product order flow as evidenced by our ninth straight quarter of product orders in excess of an average of $1,000 per order, leave us well positioned to continue to drive strong revenue growth going forward. Now moving to our clinical lab services business. The business is situated in a very large $1.8 billion market in the tri-state area that is growing in the mid-single digits driven by macro drivers of growth in precision medicine from diagnostic testing to segment patients, data richness, patient driven testing, and regenerative medicines. This is an area where our combination of the full range of testing capabilities with the convenience and personalized service of a local, community-based laboratory operation differentiate our service offerings. The Clinical Services business has been impacted by declining COVID revenues as well as the impact of the pandemic on our other types of business testing services. Revenues in this business sector in absence of a strong COVID contribution declined in low single digits on flat volume over the past two years, however, it has begun to rebound. We believe revenue growth in the Clinical Services business is poised to return to consistent and more predictable growth following the anniversary in Q4 fiscal year 2023 of the higher COVID comparable periods. This is due to our focused return strategy with the addition of new specialty clinical menu for core services and molecular diagnostics, our efforts to direct-to-consumer options for molecular diagnostics, and expansion of the salesforce in key geographies that we anticipate growth. We are expanding capabilities in the lab to perform an IPT testing to become a leading reference lab in the region. These exciting new product introductions coupled with the opportunity to add new customers with expanding presence throughout New York State, New Jersey, Massachusetts, and Connecticut markets, as well as reference testing from other hospital networks leaves this business poised to grow at above market rates. Let me now wrap up my comments with a few remarks on our overall strategy. As noted last year, we set out distinct strategies in the following areas; market expansion of the current product portfolio and growing and optimizing the clinical services segment. In addition to the factors noted above, we have made strong progress this quarter on a number of initiatives. Within the product, within the current product portfolio we successfully expanded distribution channels in Asia Pacific and continued to prepare to launch a new Life Sciences service offering, which is targeted for launch in mid fiscal year 2023. Finally, we also advanced our efforts in growing lab services through further advancing our CRO launch initiatives with leading life sciences companies, executing an agreement for staff work for a leading reference laboratory, and adding new novel tests in the rheumatology and oncology testing area. These specific developments achieved this quarter is advancing our strategy combined with the growth drivers noted above position us well to take advantage of the large healthy market, that we compete in and leverage our unique attributes. We are one of the few companies in the world that's able to leverage combined assets from biotechnology, life sciences, and clinical lab services. This allows us to understand our client’s challenges and provide tailored, lower cost solutions to their needs. We continue to leverage each of these segments to the benefit of the other and ensure they're working together in a well-coordinated strategy. In addition to progressing our revenue growth opportunities, we're also focused on improving the efficiency of our operations. Our new website designed to improve the efficiency of our Enzo Life Sciences order taking process is expected to come online in early 2023 calendar year, which should help revenue growth and reduce the cost of transactions. Our consolidation into our new state-of-the-art facilities in Farmingdale with our exit from Ann Arbor, Michigan and our constant focus on improving the efficiencies of the lab are positioning us to continue to reduce our fixed cost infrastructure and thus reduce redundant costs. These efficiencies and cost improvements coupled with a fixed cost leverage from expected volume growth combined with higher margin new products provide us with the opportunity to expand margins while growing the business leading to better profitability. On the business strategy front, as noted in Q3 fiscal year 2022, we have engaged in investment bank to help evaluate strategic alternatives for the company. That process is progressing well with strong support from our banking partner. We will provide details to our investors as process unfolds. In summary, I'm encouraged by the progress we've made in expanding our portfolio, driving commercialization, and leveraging our capabilities across our integrated business. It is important to iterate that our Enzo Life Sciences business continues to grow and our Clinical Services division is growing in non-COVID routine services. The team is very focused on driving our focused strategy forward and we believe that continued strong execution will position us well to take advantage of the large attractive markets that we compete in. I look forward to continuing to provide our investors with updates as we progress through the year. With that, I would like to turn the call over to our Interim CFO, Ms. Patricia Eckert. Patty. Thank you, Hamid. I will now provide a review of the financials for the first quarter of 2023. Starting with revenue, total revenues reached 18.3 million in the first quarter, which was a decrease of 31% compared to 26.5 million in the first quarter of last year and decreased 10% sequentially compared to the fourth quarter of 2022. As Hamid noted in his earlier comments our COVID testing revenues declined from 9.2 million in the first quarter of last year to 0.8 million in the first quarter of this year. Without the impact of COVID testing our consolidated revenues grew in the single digits. On a divisional basis Enzo Life Sciences revenues for the first quarter was 7.1 million, an increase of 9% or 5% taking into account FX compared to 6.8 million in the first quarter of 2022 and a decrease of 10% compared to the fourth quarter of 2022. We had a strong quarter versus last year with growth in most segments including libraries and small molecules, drug discovery, and immunoassays and antibodies. Enzo Clinical Services revenues for the first quarter were 11.2 million, a decrease of 43% compared to the 19.7 million in the first quarter of last year, impacted by the decline in COVID testing revenues. On a sequential basis, our first quarter without COVID testing revenues grew 4% with those accessions increasing by 3%, difficult comparisons for direct COVID testing and in the fourth quarter of this fiscal year. The blended gross margin for the quarter was 20% compared to 42% last year and slightly down versus the 21% blended margin in the fourth quarter of last fiscal year. ELS gross margin declined from 40% to 35% in the first quarter of last year and was near flat versus the fourth quarter of 2022. The October monthly gross margin returned to 50% as better product mix and lower investments increased the margins. Further revenue growth, cost improvements, and new products with higher margins should help drive margins back up overtime. ECL gross margin declined from 43% in the first quarter of last year to 10% in the first quarter of this year with a slight reduction versus the fourth quarter of 2022 due to lower COVID testing. Margin improvement is expected overtime as cost savings, higher margin tests, and higher fixed cost leverage or more testing volumes begin to occur. R&D grew from 0.7 million to 1 million as we continue to invest in the development of new products and services in both businesses. SG&A grew from 11.1 million to an 11.5 million with special charges of 0.9 million pertaining to strategic initiatives, professional services. Legal and other expenses of 1.1 million decreased by 2.2 million year-over-year primarily due to the reduction of outside counsel costs after the addition of an in-house general counsel. Adjusted EBITDA was a loss of 7.4 million in the first quarter of 2023 versus income of 1 million in the first quarter of 2022, driven by the sales declines and lower margins, both of which we expect to improve due to the numerous factors previously outlined. Cash, cash equivalents, and restricted cash were 13.1 million at the end of the first quarter, a decline of 9.5 million versus the fourth quarter of 2022, due to the decline in profitability and slight impact of working capital and capital expenditures. The company's current ratio remains strong with a ratio of close to two times and we currently have minimal debt outstanding on the business. Evaluation of a short-term pre payable credit facility is in process to provide funding as we drive increased profitability and our growth initiatives. I will now turn the call back over to Hamid for his closing remarks. Thank you, Patricia. We continue to make strong progress in advancing our business and positioning the company to take advantage of its capabilities and its attractive end markets. Our focused return strategy continues to gain momentum and I look forward to providing you with further updates as we work our way through 2023. On behalf of the management team, I would like to thank the entire Enzo team for all their hard work and dedication as we continue to work to allow Enzo to fulfill its true potential. Due to our ongoing banking process, we will not have a Q&A period on this call. However, feel free to e-mail any questions you may have to ir@enzo.com. With that, I'm going to go ahead and turn it back to our operator, Rob.
EarningCall_1521
Good day and welcome to Arqit's 2022 Fiscal Year Earnings Conference Call. On today's call, we will be referring to the 20-F and press release filed this morning that details the company's full fiscal year-end 2022 results, which can be downloaded from the company's website at arqit.uk. At the end of the company's prepared remarks, there will be a question-and-answer period for selected equity research analyst. [Operator Instructions] Finally, a recording of the call will be available on the Investors section of the company's website later today. Please note that this webcast includes forward-looking statements, statements about the company's beliefs and expectations containing words such as may, will, could, believe, expect, anticipate, and similar expressions are forward-looking statements and are based on assumptions and beliefs as of today. The company encourages you to review the Safe Harbor statements, risk factors and other disclaimers contained in today's press release, as well as in the company's filings with the Securities and Exchange Commission, which identifies specific risk factors that may cause actual results or events to differ materially from those described in our forward-looking statements. The company does not undertake to publicly update or revise any forward-looking statements after this webcast. The company also notes that on this call, it may be discussing non-IFRS financial information. The company is providing that information as a supplement to information prepared in accordance with International Financial Reporting Standards or IFRS. You can find a reconciliation of these metrics to the company's reported IFRS results in the reconciliation tables provided in today's earnings release. Before discussing Arqit's performance, I would like to reflect for a moment on the recent passing of our Co-Founder, colleague and friend, Andrew Yeomans. Andrew was responsible for early foundational patents of Arqit. He was amount of great intelligence, ethics and warmth and his daily missed. We will honor his life and achievements by seeking to fulfill the promise which he saw in Arqit. Promise is an appropriate word for Arqit's first full fiscal year of commercial operation. For the period ending September 30, 2022 we generated $20 million in revenue and other operating income, compared to $48,000 for the prior fiscal year. However, revenue generation alone does not pay the appropriate picture of the promise, which we see for the business. Arqit has made great strides in our technology, business model and go-to-market strategy, announcing this week three hyperscale channel partners which validate our technology and give us access to large global customer bases. As a result, we believe we have now built a pathway to success. In May of this year, the White House urged all organizations to prepare transitioned to post quantum cryptography. Also in May, the National Security Agency stated that symmetric keys are the recommended solution. We believe the Arqit is the only company in the world that can deliver zero trust cloud fulfilled symmetric key agreement at scale. Customers can now buy our product through three hyperscale channel; AWS, Dell, and Fortinet and other trusted partners. We're ready to deliver the requirements of the White House and others. I stated on Arqit's 2022 half year earnings call, that Arqit was improving its understanding of how customers want to consume the product. I also said, that it's often the ease of implementation that is a major purchasing decision factor. We've learned that end customers largely want to consume our product through products and services that are already part of our technology architecture and therefore easy to implement. Arqit's go-to-market strategy was in the short-term to be focused on direct enterprise license sales to be followed by the launch of a cloud-based platform-as-a-service. And in the fullness of time we expected that we would generate channel strategies and market access through leading global technology partners. The assurance of our security proof by the GCHQ accredited University of Surrey in May, accelerated the interest in our products by those leading technology vendors. As a result, we reoriented most of our finite sales and marketing resources during the year towards developing those relationships. Whilst the shifting resources with to the detriment of realizing potential short-term enterprise license opportunities, we are delighted with the outcome. The integration of our symmetric key agreement software with the products of AWS, Dell, and Fortinet gives access to very significant global sales and marketing resources into very large existing customer bases. Today's announcement of the integration with the Fortinet Fortigate series of firewalls, enables unbreakable quantum safe encrypted connectivity between customer locations, keeping safe both data in transit and at rest. Fortinet has launched the integrated product for all global customers and the joint proposition is to be found on both company's websites. Fortinet has consistently shipped more security appliances than any other vendor for nine consecutive years and as reported to have a greater than 35% market share. For end users, particularly the large existing Fortigate customer base, it makes the Arqit purchasing decision and the implementation of our software easy and seamless. For Fortinet, the integration of our product is a potential sales differentiator, which we hope will help them to further drive unit growth and customer retention. For Arqit, the partnership provides us access to Fortinet's massive installed base and potential new customers. Leverage is Fortinet's global sales organization and is expected to result in annual recurring revenue. Similarly, Arqit and Amazon Web Services announced the integration of QuantumCloud with Amazon S3 a cloud-based object storage service. The integration of QuantumCloud with AWS S3 will allow AWS customers to protect their data against the attacks today and against the future quantum threat. AWS is the largest global cloud service provider with reportedly a market share greater than 30%, that's of an $83 billion global market. The integration of QuantumCloud with S3, presents our products to a very large global customer base, as an easy to purchase and implement upgrade. For us it greatly accelerates potential customer reach and joint marketing initiatives with AWS are beginning. We also this week announced a partnering agreement and a joint sales mission with Dell Technologies to integrate Arqit's product into a range of products available to their U.S. Defense Department and other customers. This solution will be available through the Dell order fulfillment system and made available initially via Dell's federal and technical teams. We're very excited about the immediate opportunity which this partnership presents within the Defense Department and other Federal Department market. We see additional broader opportunities with Dell across its business activities globally. We believe that the prioritization and consummation of these channel partner relationships is potentially transformational for Arqit. We believe that these relationships and others which we are pursuing, represents a significant acceleration of our go-to-market strategy, bringing forward the date by several years the moment where we expect it to be doing business with such fantastic hyperscale companies. Two additional important initiatives gain traction for us in 2022. We recently announced that Arqit has signed a contract with TraxPay, a leader in supply chain financing solutions to deliver quantum safe digital finance instruments enabling supply chain access to conduct business more efficiently and securely. Financial institutions such as Deutsche Bank, DZ Bank, Nord LB, trust TraxPay financing solution and maintain strategic partnerships with that company. Deployed directly into TraxPay's supply chain finance platform which has processed over €65 billion of supply chain finance to date. Arqit's trade secure service users distributed ledger technology, made secure by QuantumCloud to provide customers with referenceable digital promissory notes in digital bills of exchange, which are easier to manage than paper-based alternatives, unique transferable and in variable. What is driving the adoption of digital assets in this market, is the U.K. government's upcoming electronic trade documents bill, which will legalize electronic transferable documents. Other leading trade jurisdictions around the world have also passed or will pass legislation enabling such advancements. This opens up the potential $17 trillion global market, the supply chain finance for digital assets. We believe that Arqit is the only company in the world to comply with the requirements of this legislation, namely that the digital asset must be tamper proof. Only Arqit has published a security proof demonstrating that it is provably secure. Without such proof, no digital asset can be described as tamper proof. We believe that digital transformation in the financial services market is likely to accelerate at scale now, but bank is experimenting with private ledger technology should take note of the importance of quantum security. We're very excited about the opportunity for digital transformation more broadly beyond trade finance. Finally Arqit Software has been selected by prime contractors as part of the potential technology solution for two U.S. government programs of record. The contracts were expected to be signed and built in the fiscal year 2022, but billing slipped into the current fiscal year. There are headwinds in the U.S. government contracting market, as a result of continuing budget resolution and also international operational requirements. But despite those headwinds, we are delighted that months of effort by our commercial and technical teams has been rewarded by these important contracts. Participation in these programs of record is important validation of our technology and represents what we believe to be just the beginnings of the opportunity within the United States and other government defense departments. These contracts in our Dell channel partnership set us up for potential future success in this very important marketplace. In addition to the acceleration of our go-to-market strategy, innovation in our technology is resulting in changes to the financial profile of the company. We announced today under a separate press release that, as a result of additional innovation, Arqit no longer requires satellite delivery of replicated randomness to datacenters as part of the symmetric key agreement process at endpoints. Arqit sometime ago developed a terrestrial method of delivering this replicated randomness to datacenters. The security of encryption keys created on the endpoint using our lightweight software agent is as strong with the terrestrial method as with the satellite method. The security proof work that we published earlier in the year satisfied us of this. Therefore, we concluded that we do not require satellites and associated ground systems in the background of our technology stack. The implications of this are as follows. We've commenced conversations to sell a partial or complete interest in our satellite system under construction with multiple parties. Some government customers for very specific reasons are interested in sovereign on-premises control of key agreement which comes with a concept called eavesdropper detection. We will continue to fund the construction of this asset until the sale is agreed. If the sale becomes unlikely, we would discontinue construction. Arqit will build no further satellite infrastructure beyond this and intends to license its quantum satellite IP to subsequent customers with similar requirements. This will enable those customers to build their own domestic sovereign systems and we are seeing demand for this offering. We expect these changes to our technology strategy, will result in a positive effect on future results with a portion of capitalized satellite costs recouped through the planned sale of the satellite currently under construction. Additional revenues through the licensing of our quantum satellite IP and the elimination of future capital and operating expenditures associated with use of satellites as part of our core product offering. Arqit intends to continue to perform under its satellite construction contract with the European Space Agency and recognize these related projects incomes generated there under. We've recently completed a new security proof, demonstrating that the satellite technology has its own validated security, which has been shared with these new customers under NDA. These are significant changes in our technology infrastructure. We believe that the changes simplify our business model by focusing on selling our symmetric key agreement software platform-as-a-service. The benefits of stepping away from hardware infrastructure, a potentially significant from a financial perspective. The most important takeaway is that, these benefits are achieved with no negative impact on the security of the keys created endpoints by our software. And of course, removes CapEx. It's beyond doubt, now that the world wants and needs stronger and simpler encryption. We believe and leading cryptographic experts and validated that Arqit's symmetric key agreement software delivers just that. The partnerships which we have announced a further validation of our technology. However, our promise is not fulfilled by merely having great technology and people. Our promises fulfilled by getting our product into the hands of customers to secure their data. The acceleration of our go-to-market strategy offers Arqit a faster pathway to [technical difficulty] focused on fulfilling and maximizing the opportunities which these partnerships represent. With that let me turn the call over to Nick Pointon, our CFO for a few remarks on our financials. Nick? We only commenced commercialization and began generating revenues late in the second half of our fiscal year 2021. Therefore, the comparison of our fiscal year 2022 results with the comparable period in fiscal year 2021 may not be meaningful across all financial metrics. For the 12 month period ended September 30, 2022, we generated $20 million in revenue and other operating income from new QuantumCloud contracts and other activities. Our QuantumCloud revenue totaled $7.2 million for the period generated by five contracts. The bulk of the QuantumCloud revenue was generated by contracts with Virgin Orbit and AUCloud. As David noted, the reorientation of much of our sales and marketing effort to realize our announced channel partner relationships, impacted our direct enterprise license sales activity in the second half of our fiscal year. Other operating income for the fiscal year of $12.8 million resulted from Arqit's ongoing project contract with the European Space Agency. Despite the announced shift in technology strategy, we expect to continue to perform going forward under our contract with ESA, realizing future other operating income. Our administrative expenses equates to operating costs for those more familiar with U.S. GAAP. For the period our administrative expenses was $72.2 million versus $14.6 million for fiscal year 2021. The material increase in expenses reflect significant post NASDAQ listing growth in our operating infrastructure costs and personnel. Additionally, $22.9 million of the increase reflects non-cash charge for share-based compensation. Our employee base grew to 145 from 73 at the beginning of the period. Since the end of the fiscal year, we have undertaken a review of budgeted fiscal 2023 headcount and operating cost growth to align it with revenue and focus on our key partner initiatives. As a result, we have provisionally kept fiscal year of 2023 headcount at no more than 195 employees. And have reduced non-employee budgeted cost by 8%. In total, we have reduced budgeted costs for fiscal year 2023 by 18%. In addition, we will accrue benefits from the reallocation of certain employees to support our key partner initiatives and the deferral reduction or elimination of costs from activities, which are not deemed high priority at this time. Operating loss for the fiscal year was $52.1 million versus a loss of $172.6 million for fiscal year 2021. As a reminder, the operating loss for fiscal year 2021 included a $155.5 million reverse acquisition expense associated with our transaction with Centricus. We generated a profit before tax of $65.1 million. However, we've generated an adjusted loss before tax of $52.3 million which in managements' view reflects the underlying business performance once non-cash charge in warrant value is deducted from operating profit before tax -- sorry from profit before tax. During the period, 1,852,736 warrants were exercised with cash proceeds to Arqit of $21.3 million. We ended the period with cash balance of $49 million versus a cash balance of $87 million as of fiscal year-end 2021. Please note that we have filed today a universal shelf registration statement and an ATM prospectus supplement. The filings represent sound fiscal -- sorry financial housekeeping providing the company flexibility in corporate finance matters in the future. The pioneering activities of our incredible team of engineers, innovators and commercial offices in fiscal year 2022 has created a pathway to success. We have assurance that our product delivers as advertised. We better understand how customers want to consume our products. And now we have hyperscale channels through which to reach end user customers. Securing this knowledge, we must now focus on the hard yards of execution in 2023. We're pleased with all that we have achieved in the fiscal year and are optimistic for our future. Hi, good morning guys. Thank you for taking my questions. David, the first one, how should we think about these channel partnerships converting to revenue? Hi, Scott. So the Fortinet project is perhaps the most easy to understand. They are making available our software to the entire global customer base as an upgrade that will cost each individual customer base single digit percentage increases in the unit cost. So it becomes very simple to module price times volume against the penetration of Fortinet's existing and future customer base. And we will be walking you through that in a Capital Markets Day, which we're hoping to host in the near future. AWS is very similar. They have commenced joint marketing with a specific cohort of the larger customers, and again we can start to build a picture of likely penetration rates of those customer bases and the price times volume metrics are quite straightforward. We have, in fact, published our pricing on a British government cloud website. So for trade users of that portal, the Arqit pricing is now out there. So price times volume is becoming much easier to calculate. These organizations have got enormous reach globally and the penetration is likely to be in the 20% to 30% range, in our opinion over the medium to long-term, and this represents a potential to greatly fulfill our business plan without an enormous increase in Arqit direct sales and marketing costs. With customers like Dell, we're focused more on a smaller number of government and defense projects, but each of those projects come with pretty significant tickets. I've already said that, there are two programs of record that we're now working on and those will we hope come with some very significant current year billings. But once the product is certified and accredited by government users one expect to see fairly rapid take up. So those defense customers will continue to have an enterprise license orientation, whereas the things like AWS and Fortinet will have an annual recurring revenue startup business. We are working hard on signing a couple of other hyperscale channel partners to that style of business. Great. That's very helpful. I'm curious, what is the level of product education you've already provided the partners? And how should we think about, how that those sales channels begin to scale? Well, you can see the joint proposition is now on Fortinet's website and it's in their partner portal. We've already been working in the last couple of months in a number of jurisdictions around the world with Fortinet's salespeople directly and there is already a list of customers that we're targeting jointly Similarly, the Dell and AWS teams in various departments have been educated on the product, know what it does, know how to sell it and there are representations of this integration currently being very actively proposed into those customer bases. So there is still more work to do to educate sales teams and distribution channels. But that work has slightly begun in earnest and we're starting to see the prospects coming through the pipeline. That's great. And is there any exclusivity arrangements in any of these partnership contracts that would meaningfully restrict your ability to sign additional channel partners? Okay. Great. And then I wanted to ask a little bit about the work you're doing on the trade finance side and obviously, that's a large market. I'm curious, how far out are we from that becoming a meaningful revenue contributor? We expect to build our first revenues on that project during the current half year. We initially plan to go to full launch around about spring next year based on the passage of legislation going through one particular government, but we've actually begun service planning already, because we encountered one very large global partner, who wants to start using the product before the legislation was even past. We haven't pitched that product to a single potential customers who said no yet. Every single potential customer we pitched into has said, yes. It has some very peculiar advantages, not just in its cyber security. But the way that the product has been created, it improves the cash flow for the vendor of the product and it reduces the risk for the bank that finances the invoice. So it's really a win, win. So we're expecting some billings, certainly in the current financial year. It's a very large global market. So I'm really very optimistic about where we can go with that. But we've also already started talking other styles of financial services organization about using this product in other areas of finance such as insurance for example. I'm actually convinced now. Although, we've seen the blockchain industry has had a rocky road as a result perhaps of experience in the unregulated spaces. But it seems now very clear that the regulated financial services market is adopting digital assets at scale and we're having some very interesting conversations as a result as banks in all areas of financial services transformation realize, that if technologies are not quantum safe, they have no long-term future. Now that makes a ton of sense. And then last one for me, David, any hesitancy you're seeing among potential customers just given kind of the rising level of macro uncertainty? No, I don't see any particular effect of macro uncertainty, other than as I said in the U.S. Defense Department, there is a continuing resolution, which makes it harder for departments to create new budgets and that's affecting everybody a bit. And of course there, are budgets being applied to the east that wouldn't necessarily expect to the year ago. But what we're seeing is, that every organization now knows that, it has to upgrade its encryption. We've recently done some surveys ourselves and all see those that we've spoken to are aware of the need to urgently improve their encryption. So it's not as though we're starting in a mature market, which has been experiencing problems. We're starting almost at zero. It was only in May that the White House demanded all organizations prepare for crypto transformation. So this is a market which is growing from a low base and we are expecting it to accelerate very dramatically. So I don't think macro is a particularly relevant effect for us. [Operator Instructions] Our next question comes from the line of Nihal Choksi with Northland Capital Markets. Your line is now open. Yes. Thank you for taking my call. So how long would Dell, AWS relationship started? And where they part of that $740 million pipeline few months ago? Yes, good question. The relationships in their first iterations definitely began about 18 months ago. So, we definitely had hopes and expectations before we came to market that those projects would come to fruition. I would say, however, that the engagement that we got from those companies did accelerate when we published the security proof in April this year. We were able to generate independent validation that's uniquely amongst all companies in the world, Arqit Software producers keys which are zero trust and probably secure. And of course, that was backed up by the fact that the organization doing that assurance, is a GCHQ accredited Center of Excellence. So it carried quite a lot of providence and our friends at PA Consulting also did their own assessment. So that degree of independent validation placed under NDA into the hands of these customers actually helped us to educate those customers much faster. And so I think those engagements have really accelerated very noticeably since about May or June time when we had those first meetings. Similar things are happening with a small number of other hyperscale vendors, who perhaps may have had six months ago entrenched views or different opinions or simply didn't understand this. But we found that when we place the proof into the hands of their experts and when we deploy experts at Arqit such as Dr. Daniel Shiu, and Dr. Barry Childe very quickly skepticism goes away. So I feel optimistic that, there will as a result be a number of other large corporations signing up to use our products during the current financial year. So yes, those companies were in our pipeline at the beginning, but they've most certainly accelerated in the last six months. All of those companies was certainly on the pipeline of companies that we wish to do business with where we hope and expect to generate revenue. Understood. And is your understanding of what the value of that pipeline for each of those changed since citing that initial 749 -- $740 million pipeline? Yes. It most certainly has. We've been able to engage with those companies over the last few months in a very high level of detail about the nature of the opportunity. So we have very specific pricing. We understand the likely volume of trade that we can imagine we can do with those companies. For example, Fortinet have a very large installed base, we are able to gain access to detailed planning with our partners like Fortinet about which of their customers are likely to want to buy the product, do we know what we'll sell it for. So we're able to now build our own views of price times volume and penetration based on real world facts coming from detailed partnership discussions rather than an extrapolation. So, yes, I think we have a more detailed view of how that's likely to pay out. Given that, I didn't expect that we would sign hyperscale partners until 2024 given that we've already done it, I feel that I've got better visibility of the medium term of this business and as a result I have better confidence. Got it. Breaking down that price times volume equation that you now have greater detail and confidence on what the price times volume is, how has that price change from 13 months ago and volume changed from 15 months ago? Well, if we go back a year and a half or so, we were originally imagining that we were selling enterprise licenses with fixed prices and we weren't at that point, able to produce an annual recurring revenue started price, we just didn't have the information. It's my belief -- I think it's relatively well understood that an ARR style of revenue is to the advantage of a company like Arqit. It's definitely better to have an ARR style of business that have enterprise license. When you set of fixed enterprise license, you tend to be giving away the farm for a modest amount of money. We thought we'd be doing that for a couple of years, because we didn't expect to have success with hyperscale channel vendors. And ARR's style of business with the product being sold into a very, very large customer base in my opinion is likely to generate faster superior financial outcomes as larger revenues in the medium to long-term that an enterprise license style of business. So, this feels like an acceleration of our go-to-market strategy to me and it feels like my confidence is higher as a result. Great. So you had $7 million QuantumCloud for fiscal year 2022, what does it actually to exit ARR for fiscal year of 2022 on the ARR? We haven't published that number. So I don't think I can give you that stat. We'll try and give you some deeper granularity when we do the Capital Markets Day, which we're looking to organize early in the new year. Got it. Okay. And then what's the -- what do you expect Arqit needs to do other than educating these partners sales teams to sell the Arqit Solution in order to drive the customers of Dell, AWS, and Fortinet to adopt Arqit Solution? What Arqit is going to be doing beyond just the education of that sales team? So in some cases, we are involved in direct bids to large organizations in partnership with those companies. And that means visiting those very large organizations perhaps with our own technical experts to educate the end customer. And that's what typically very large contracts. But for the vast majority of the ARR style of business, we have to support the channel. And what that means is and I've been doing that myself, I think I've been in six countries in the last six weeks, visiting customers, doing large events conferences and exhibitions where our partners presenting and educating. Finally, we have to make sure that the all of the distribution channels of these hyperscale vendors are educated. So it's really about supporting the channels with marketing collaterals with white papers, with information and research. Making sure that we have salespeople on the ground that can deal with queries and we do now have sales people employed on the ground in Australia, Singapore, in the Middle-East, in several jurisdictions in Europe and in North America. So, the salespeople are typically supporting the key account managers of those large vendors directly as and when required. But ultimately, certainly for Fortinet and AWS, this is a cloud fulfilled sale. This is customers being able to simply buy product in the marketplace, pick a box make a payments and buy the software. So there is some channel management with sales, account managers having to be educated, but overtime, we expect revenues to be driven by simple online fulfillment. Got it. Okay. A couple more quick questions here. Just going back to the $7 million QuantumCloud. Is that all going to be -- is that all effectively subscription revenue? Or is some of that enterprise licenses were actually a perpetual? Okay. So just to be clear, when you say enterprise license revenue, is that term based or is it a perpetual arrangement? Yes, typically enterprise licenses term based. But also what you find is that an enterprise license with some customers will begin at a tightly bounded range of utilization. So for example, one might say, that the enterprise license grants the license or the rights to use the service in a certain market, in a certain segment for a limited number of endpoint devices and a limited range of keys. And hopefully the customer expanded their activity and needs to buy more. Yes. Got it. And then finally this $50 million ATM that you announced this morning. What's share price range do you expect to be utilizing it? And what is your current cash burn rate? We don't expect to be utilizing anytime soon. I don't think we put any statistics in that document, that was something which our bank when we did our SPAC told us to do the exploration of the first year of trading. So I think it was always planned that was something that was an ordinary course of business thing to do. So, we haven't given any more thought than that. We have no further questions at this time. Now, I will turn the call back over to David Williams for closing remarks. David? Thank you. It's been a really interesting year in which our business model has developed technically and commercially far faster than we imagined. We look forward to speaking with our investors and analysts again in 2023 and we appreciate your interest in the company and your support as fellow shareholders. Thank you.
EarningCall_1522
Good afternoon, everybody. I'm Chris Schott at J.P. Morgan, and it's my pleasure to be hosting this fireside chat with Eli Lilly. Lilly has obviously had a tremendous few years here and very much looking forward to the discussion today. So from Lilly, we have Anat Ashkenazi, the company's CFO, as well as Dan Skovronsky, the Chief Scientific Officer. So Anat and Dan, thanks for joining today. So I guess just to maybe open up with some opening comments about -- as we think about 2023 and Lilly's positioning heading into this year. Maybe just kind of set the stage of how you're thinking about the business? And then we can obviously jump into a lot of different topics. Sure. Thanks. First, thanks everyone for joining us and having an interest in hearing more about the Lilly story. So we're closing out 2022, we've shared our results through the third quarter and shortly in a few weeks we'll share the full year result. But as we shared on our guidance call just a few weeks ago in December, we had a strong growth in 2022, our core business demonstrated robust growth, top line and bottom line. But we've also during this period had very meaningful progress in our pipeline, which then we'll talk about in a little bit as well as new launches. We've launched Olumiant for alopecia areata, and just six months ago, little over six months ago we launched Mounjaro for type 2 diabetes, which is truly an unprecedented launch in the history of pharma. So we are well positioned for further growth in 2023. We're looking at another unprecedented year for Lilly. If we think about the number of launches we have ahead of us, we have the potential to launch four new molecules with dunenumab, pertibrutinib, mirikizumab and lebrikizumab, so truly across our therapeutic areas and then potentially launch a second indication for tirzepatide in obesity, potentially as early as the end of this year or early next year. And we've shared on the call that we will be initiating a rolling submission, which we have, I can confirm we have initiated that rolling submission in 2022, and we'll look to complete that submission assuming we get a positive second [indiscernible] study here early this year. So a strong year ahead of us in terms of potential launches and top line growth. It's a year of investment as well. With the success we've had in our pipeline, we're continuing to make investments in our late stage opportunities, which then will cover but several new opportunities, exciting new molecules that we're going to be investing in. We're also making investments in our team through additional enhanced compensation. And you've heard us talk about the comprehensive agenda we have across our manufacturing facilities, expanding our footprint with two new sites in North Carolina, one that's going to be coming online this year, the second that we broke ground on two new facilities in Indiana and another one in Ireland. So we truly are expanding our footprint to ensure that we can support the demand we're seeing for portfolio over the next decade or so. We're excited about what’s ahead of us. 2023 top line growth for the core business should be in the mid-teens, which is incredibly strong, but we're expecting to see continued top line growth through at least the end of the decade at a rate that's probably at the high end of the industry. And with that and with continued investments in our organization, we do also expect to see margin expansion over time during that period. And maybe Dan a few words about the pipeline. Yeah. Thanks, Anat, and thanks, Chris for hosting us. It's great to be back here in person again. It's really been a truly exciting year for Lilly and I’d mentioned that we've got five launches on tap for this year, which means we essentially had data readouts on all of those last year. So to be clear, it's the tirzepatide obesity launch, the SURMOUNT data took most of the attention probably in terms of data readouts for the year. But we had so many other things behind that. Of course, continued progress with dunenumab, that's at the FDA. Pertibrutinib, we had additional data readouts on our BTK inhibitor and that's at the FDA. Lebrikizumab for atopic derm, which I see is a great option, potentially a first line biologic for atopic derm under review at the FDA. Mirikizumab or IL-23 for ulcerative colitis. That's also under regulatory review. So all of those stand to launch. But the other thing that happened in 2022 is we gained visibility to what's next. So even though we have such a young portfolio with new launches, we already see the next generation of innovation behind that with five more molecules coming behind these big five. So the next five are once weekly insulin, which I think is a really important innovation for patients with diabetes. The next generation Alzheimer's disease drug called Remternetug. We have an oral SERD for breast cancer. I think it's in a Phase III trial in adjuvant breast cancer setting. And then just last month, we announced two more molecules moving into Phase III for diabetes and obesity. That's our oral GLP-1 Orforglipron, and our triple agonist to GGG Retatrutide for obesity. So pretty exciting time to have so many new launches and then also a full pipeline of next gen molecules. Great. A couple of high level questions here. I guess first is on the 2023 guidance. I think we're seeing a fairly significant step up in OpEx supporting some of these growth drivers. Just help me understand a little bit why such a big ramp this year? And then I think some of these -- [indiscernible] some of these launches, it seems like many of them are leveraging infrastructure that's already at Eli Lilly. So just maybe a little bit of color there. Yes. So you're right. Many of the launches we have are using and leveraging the existing infrastructure. We're not expanding our commercial footprint by any meaningful way. The increases we're seeing in SG&A is really coming from two main areas. One is the intense compensation, which is a one-time step up in compensation. The second is investment in marketing efforts behind these new and upcoming launches of preparation for tirzepatide obesity and four other launches that we've mentioned. So as we think about it, we're not increasing the size of our infrastructure and footprint on the commercial side, but we're investing appropriately to be able to be very successful with these drugs. Very different on the R&D side and that's where we're investing behind opportunities, the largest driver of R&D cost is our Phase IIIs. And as we launch these, we tend to see a ramp up and then a decline depends on the length of these studies as these studies accrue. So really that's the driver behind the increasing cost in R&D. And how do we think about the cadence of margin expansion for Lilly as we think over time. I think you've talking about some longer term margin aspirations. Is this going to be fairly linear or is it kind of hockey stick that some of these products start to ramp? So what we've said a little over a year ago when we provided kind of mid-term guidance is that, we do see opportunity to expand margin as the firm grows and that revenue grows significantly. And we said mid to high 30s is probably a reasonable range for us to aspire for in that period, that hasn't changed. When we think about you kind of go into the income statement, where is that growth coming from? In the comps line, we expect to see hover around 80% gross margin give or take a point. What we're seeing is, we exit the COVID antibody business or the impact on gross margin, but we have investments in our new facilities and new products that should stay around 80%. So there are kind of pushes and pulls, but that should stay there. R&D will -- the number for R&D will be dependent on opportunities. If we have great opportunities, if we find the next generation for any one of these disease states that Dan mention, we will pursue them. So that could go up or down depending on the opportunity here. Where the leverage will come from is in the SG&A line. As you've mentioned, because we're not expanding our footprint in any meaningful way and we're leveraging existing infrastructure and we're hyper focused on productivity, then we should see that leverage coming from that SG&A line. Over time, I expect it will not be linear, so it's not -- we can't map a direct line to that number that I've just mentioned. There could be some ups or downs, some years are going to be stronger, some are going to be lower depending on primarily on the opportunities we see within the R&D organization. And Dan, on the R&D front, I think you commented on the guidance call that the late stage pipeline is one of the most promising Lilly's had in recent years. I guess I'm just trying – thinking about the broader R&D organization, what's enabled you to kind of drive these high levels of innovation? Because that's something I think we've seen the industry as a whole really struggle with and it does seem like Lilly has very much differentiated from peers on that front. Yes. Thanks for that comment. And I agree with it. I think we're in a remarkable period of productivity for R&D at Lilly, we're super proud of what we've accomplished, but we're also paranoid about what’s next. So I highlighted the next five into Phase III, but we're still not satisfied and we're still pushing in the early stages to make sure we can have a sustainable growth enterprise here. We don't take that for granted. There's a couple of things that we do at Lilly, I think, to help drive that kind of productivity and sustainability one, and it's sort of an obvious thing, but just to say it allowed us. We have four therapeutic areas and they're all working right now. We're having innovations in diabetes obesity metabolism. We're having innovations in oncology, neuroscience and immunology. We've never been in a position like that before. That's important and we intend to sustain that by continuing to invest in those areas. Oftentimes, with multigenerational themes, like you're seeing with obesity where we have multiple agents, or Alzheimer's where we have multiple agents once we unlock some critical biology as we've done. So I think that's one way that we think about sustainability. But at the same time, as we're focused on those areas, we have to be open to what's new. And it's sort of easy to point at Lilly and say, oh, well, Lilly is in obesity, and Lilly is in Alzheimer's, those are areas that are opening up right now. We were in these areas for decades when they weren't open yet. And so I think at the same time as we're focused on these areas that are working, we're always looking for what's next. What are the areas that are out of favor largely from a pharmaceutical industry where we can break them open and be leaders as we have in these. And then the final piece I add to that is just an openness to different ways of making drugs. For so long, it's been small molecules, in biotechnology large molecules and now we see the dawn of genetic medicines. And so we're investing robustly in that area too to make sure we're leaders in those kinds of medicines. Great. Maybe shifting to some of the products side of things. Obviously, Mounjaro was a big focus for all of us over the last year and a pretty spectacular launch. Can you just talk about the learnings so far from the launch? I guess is there any surprises in terms of either where the patients are coming from or the cannibalization you're seeing elsewhere in the portfolio? Yes. So we launched Mounjaro at the end of May, in June we start promoting the products. So we're still in the learning phase of a new launch. And certainly, this had been a unique launch because I don't think we've seen an uptake of this nature, just such a rapid uptake in other products, not just in diabetes, but in other disease states. So it's certainly a very exciting launch for us and for patients. And what we're hearing, I'm not sure if Mike Mason, who's the head of Lilly Diabetes is here right now, but we're hearing great feedback from patients and from prescribers who are getting experience with this product, both about the efficacy, the ease of use and the tolerability of the product. So that's encouraging. We saw it obviously in our clinical trials, but it's always good to see it in the real world. What surprised us? I think the uptake was incredibly impressive. And we always have a range of scenarios, but it was at the highest end of our range of scenarios as well. I would say the viral nature of kind of the marketing not by us, but by patients of this drug is also something we have at least [indiscernible] experience at the scale where you see patients communicate with each other about the benefit of the drug. So certainly exciting early days, we're probably going to learn more in terms of where patients are coming from. And this is a data point that we shared recent -- late 2022 is that what we saw through the end of the third quarter is that about two thirds of patients had previous diabetes medication on board and about a third did not, which means they're either newly diagnosed or something else. That's what we saw. We have to still accumulate that data and see where we are today. And then in terms of cannibalization, we always assume there'll be some cannibalization of Trulicity or GLPs in general. And what we saw is Trulicity held up really well. Now Trulicity had always been a product that where patients -- when patients got on Trulicity, they stayed on Trulicity, they stayed on Trulicity for a very long time, in many cases, longer than what they would be on an oral medication. So the adherence is one of the best in the industry. We know patients like Trulicity that get the benefit, it's very easy and simple to use. And we've seen that cannibalization be very small. So the data point we shared the latest was about 10%, it's probably a little different now of patients came from Trulicity. So these are patients that were on Trulicity, they're disease progress or they needed more in terms of either weight loss or A1C level control and have shifted to Mounjaro. Patients that are on Trulicity and are doing well and are well controlled will likely stay on Trulicity. I mean, hopefully their disease doesn't progress, but if they do and they need something else we have that product to offer to them. How do I think about kind of coverage of the drug? And I think we're all kind of struggling with how to think about where gross to net and when gross to net normalized. So can you help us a little bit of as we go through this year and into next how to think about that? These things always take a little bit of time because there's lag in coverage versus what's see in the financial results. So we've recently shared that in Q4, we gained about 50% access in the U.S. There is a lag to that, so I would not use if you're thinking gross to net -- 50% as the gross to net ratios by any means. And also important to remember is, we have -- we launched the product with a copay card, a patient assistance program at $25. And patients that are on that copay card are going to be grandfathered through the conclusion of their card, which is mid-2023 or end of 2023, depend on their coverage. So for those patients, obviously, the gross to net looks very different. As we continue to gain access and we shift more patients to their covered program as opposed to copay card, you'll see improved in that gross to net rates and further monetization of scripts. So that's what we're expecting to see overall. We did announce we made a few changes to our copay card program at the back end of 2022. So the effect of this financially we'll see in 2023, we're seeing the impact on NBRx we saw a few weeks ago. But the change in design was the change in the copay card assistant amount to patients who are getting the program. So we've increase that amount. We expect it to see a drop in new prescription as a result of that, which we are, but overall we're not expecting to see a financial impact over time as we're getting more patients into the covered program. Great. And maybe pivoting over to the obesity market as we think about kind of later this year and into next, just high level thoughts of how you see this market building up over time? Is that kind of seems like perceptions have changed about what exactly we need here, kind of what the demand is going to look. So maybe just high level, how do you think about that indication? Let me start and then maybe Dan can make a few comments. So certainly a very large market, over 100 million patients in the U.S. are obese and about 650 million patients globally. So it's a global issue really across almost every market you look at. So there is tremendous opportunity for us to come in with a drug that can offer a long term solution for patients. But how does this -- how do we build this market? There's a product now in the marketplace that offers a solution to patients hopefully by the time we submit and we get to market either at the end of the year or early next year with a new product. And what we're doing is, we're also building kind of the wall of evidence behind this product. We know that there's a benefit of just reducing the weight for someone. There are huge benefit associate with this. We all know the risks associated with being obese, but we're going to also demonstrate beyond just our obesity studies, we're going to demonstrate that in hard outcome studies in multiple indication, including obstructive sleep apnea, heart failure, kidney disease, and additional indications that we're going to be -- that we're studying for Mounjaro, so for tirzepatide. So we're going to have a wall of evidence to share with the medical community and with payers that hopefully will advance this field even further. We know that there's demand out there from everything we're hearing and from our conversations externally. One important piece of legislation to watch for is the [indiscernible] Act, which could open up if this if passed could open up the opportunity for additional patients to get on the drug and get reimbursed. So hopefully that will progress as well. Just to add that we started our rolling submission to the FDA for the obesity indication. We said, we'll complete that when we get [indiscernible], so the next Phase III trial, which should be in the beginning of this year. And then look forward to being able to launch it in obesity. As Anat was saying, we really see this as a chronic medical condition. And so, what we'd like to do over time is generate more and more evidence that obesity is a disease with severe medical consequences and that disease can be treated and those adverse medical consequences can be prevented. And we have a number of outcome trials now designed to prove just that. We'll be at this for a while, but really excited about the benefit we can have for public health by reversing obesity. It seems like this could potentially be a significant cash pay market here. So talk about, I guess, how are you thinking about the cash pay and how does Lilly prepare for that market that may exist until we get some of these outcome studies and reimbursement comes into place? So we still have much to learn in terms of what this market will look like in terms of reimbursement. We obviously are not having these negotiations just yet. We need to file for approval again and then have these conversations with peers. Hopefully, this will get covered and reimbursed. I think there could be interest from large employers to have this available for their employee population. Again, if [indiscernible] passes, that's another step in that direction. So we'll see where patients are going to come from and what we would need to do to make sure the patient can actually get access to this medication. Another question I get often is, how do you think about duration of therapy here? So what's your data suggesting in terms of how long the patients have to be on these drugs? And do you think the paradigm actually evolves over time that maybe different drugs are needed depending on where you are in your kind of weight loss journey? Yes, it could be the latter. I think in terms of duration of therapy, we don't know yet, having not launched it in obesity yet. But I think there's several data points that we can look at that make us feel pretty optimistic here. First is just the patient experience with the injectable device. So that once a week injection is the same type of experience that we've seen with Trulicity and we're seeing with Mounjaro here in type 2 diabetes is very highly tolerated by patients. In fact, for Trulicity where we have more data, this is of all classes of diabetes medications or orals or injectables, this one has the single highest patient adherence. So that speaks to the patient experience. I think that's good for obesity and these are probably going to be a large number of patients that haven't had a previous injectable. So having that good patient experience will be important. The second point here is, this is a chronic disease. It's not going away on its own and we want to manage it like a chronic disease, which means, patients should be educated by their physicians and understand that this is going to be a long duration therapy. And then finally, this is a disease where the patient experience is so integral to the mechanism of action in the treatment. People feel less hunger, people lose weight, which they can readily observe. And our data suggests that like every other medication. When you stop taking it, you stop getting the benefits of the medication. So I think it's natural that people will experiment despite education and efforts to recommend they stay on the drug, people might come off the drug once they've lost some weight. And as they lose the benefit of the drug and they start to feel that appetite, the hunger again, start to see their weight come back. I think that will be a strong incentive to come back on the drug. So we're excited to see what we can get for in terms of length of therapy. On the pipeline assets and you've got an oral GLP that you're moving into Phase III. Just talk a little bit about the profile that you're seeing emerge there? And I guess what role do you kind of see the oral playing versus the injectables? Yes, this is really exciting molecule. It's a true small molecule, so it should have the dosing convenience of really any other small molecule, meaning, no food or fasting restrictions once a day. But on the efficacy side, we think this can deliver similar efficacy to that which can be achieved with really high dose injected GLP-1. So we're getting injectable like efficacy, but in an easy to use pill. It probably won't be quite as good as tirzepatide, which is two types of ingredients, GLP and GIP, but really as good as the GLP-1 monotherapies can get. That's really exciting. I think there'll be some patients who are new to the class and prefer to start with an oral perhaps or even stay on an oral. I think we also just see the magnitude of the challenge in obesity. And I was saying the numbers, 100 million Americans, this is a once a week injectable is tirzepatide. So multiply that by 52, that's 5 billion devices to make. And around the world, we're going to have 1 billion people with obesity. So it's not a market that can -- I think, ever be addressed purely by injectable. So it's really important to have an oral there and super excited to have that go to Phase III. Yes. And then maybe on GGG, I guess one of the questions that I hear is like, what does this, I guess, bring beyond what we already have with [indiscernible]? Is this incremental weight loss kind of needed for as many patients? Or how do you think about that? Yes. And so I think at one level, the first benefit is that we're expecting and we commented on December call is a step change in efficacy from tirzepatide, meaning additional weight loss. Some patients won't need that. For many patients, the efficacy from tirzepatide may be enough to normalize their BMI. But even in our clinical trials, about half of the patients probably didn't achieve their ultimate BMI goal and didn’t get to normal body weight. And so particularly for people who might have longer standing or higher levels of obesity, GGG could be a good alternative. In addition, we're starting to see some other metabolic benefits. We commented on, for example, really profound effects on liver health. So there could be different segments of the obesity population depending on their comorbidities for whom tirzepatide is better or GGG or maybe as I said the oral. Excellent. The other I think the topic we've heard on this conference is just seems like this market is obviously huge. Your competitors want to get in there as well. How do you think about the market spend and I think on the GLP side is mostly a duopoly. Do you envision if we're looking five or 10 years down the road, it's still a duopoly or do you think this ends up being a lot more competitive and that we end up seeing maybe a bit more fragmented market share within some of the newer entrants who are targeting it? I can start from science and then I'll come in on the commercial situation. Look, I think this is natural in the industry that when someone paves the way and shows a breakthrough in a given area, then everyone else wants to follow. I don't think it's a great way to run the business. We try not to do that at Lilly. It's better to be the one who breaks open the science. But at the same time, we don't rest on our laurels, we continue to innovate. So alone, we'll have multiple incretins in the market and probably segmenting for different patients as I commented earlier. But it is a big opportunity. We're talking about changing society and medical practice here and so probably welcome competitors to help us make those changes in society. It's a large market. And just given the numbers that I've just shared and if you look at forecast, these numbers are what they are today and are likely going to be much, much higher by the end of this decade with no other therapy in place. So if there are options for patients, that's probably a good thing. And then a physician can make the decision based on the best option for their patients given their characteristic, I think what Dan had shared is, we're going to have a suite of products potentially available for patients with -- that need chronic weight management, all the way from patients that may need mid-teens weight loss and would prefer to go with an oral through a tirzepatide like efficacy and then a GGG, which is much higher than that. So we're going to cover probably most patients and their needs. But can we share in the $6 million, $7 million, 1 million patients with other companies? There's room for other companies. Now what I will say is, never underestimate the depth of expertise and the relationship we've built over decades in diabetes, not in obesity, but certainly there's overlap in the prescribers. It doesn't mean other companies can’t do it. I'm sure they can. But there is a huge benefit to having the reputation we have even as we're thinking about [indiscernible] clinical trials and working with investigators and weight management centers and prescribers that know and trust our products and our teams. There's huge benefit to that as well. Great. Maybe pivoting over to dunenumab. Maybe just to start the conversation, we'd love just -- as you think about the data we saw at CTAD with lecanumab, just the efficacy kind of you saw from the asset, the hurdle that creates. So just how does that affect your confidence in the development program? Yes, it's really good news. You know, Chris, I've been working on this for a long time. And pretty much the whole time we've been saying for Lilly, like, what matters is removing a lot of plaque and doing it quickly and that will translate to cognitive benefits. And the problem with the previous generation amyloid long drugs is, they didn't hit enough amyloid. So finally, I think we now have a number of data points, starting with dunenumab’s own Phase II, which looked very good. The first successful trial lowered a lot of plaque, slowed cognitive decline. And then now we have lecanumab, which is another very good plaque lowering drug, it lowers a lot of plaque, it slows cognitive decline. And then we got the data point from Roche, of course, we never hope for any drug to fail. But can dunenumab failure, even in that, there's additional scientific evidence they lowered plaque a little bit. They had a little bit of cognitive slowing. So I feel like this theory that we've been talking about and pursuing for decades now, there's enough evidence that we should feel very confident that we're on the right track. That doesn't mean there's no guarantees that our Phase III trial will be successful. We have to be humble in Alzheimer's disease and wait for the data, but I've never been more excited and I can't wait to see that data in the middle of this year. I think the big debates we have is reimbursement and how that's going play out and it just seems like with maybe the first asset that came with [indiscernible], there's just a lot of scar tissue there, maybe leftovers. So how do you envision knock on wood you have successful [indiscernible] study, what that pathway looks like and when could we see reimbursement? It's certainly a frustrating situation. You can sort of understand how it came about. In Alzheimer's disease, there's been no progress for so long. Everybody gave up and there is sort of sense of nihilism came over the field that nothing will ever work. And then came atakinumab and there was all of this controversy and that set us back even further, I think. So we're building now from a deficit of credibility, dunenumab data is going to be helpful. The lecanumab data has been helpful. And of course, we have to encourage CMS here to change their position. I don't think the accelerated approval period here is an important one. But once we have full data and full approval, our expectation should be full reimbursement. This is health insurance for Americans over the age of 65. This is the number one disease they fear. These are the first examples of drugs that have the potential to modify the disease here. This needs to be covered by Medicare. Okay. As you think about the infrastructure that needs to be developed to support this market, what does that look like from Lilly's perspective? Yeah. So -- and of course, it starts with reimbursement if you consider that infrastructure or basic necessity. Beyond that, I think there's probably two aspects. The most important one is diagnosis. We've been working hard there for quite some time as well. Certainly, their PET scans. These are great for diagnosis. But we also have a blood test that we hope to launch about the same time period as the drug. And this all -- it’s really amazing science that we can potentially be able to detect the changes in the brain through a blood sample and then send those patients on to further valuation of therapy. So improving that diagnostic ecosystem is really important. The others -- these are infusion drugs right now, so just making sure there's adequate infusion capacity. And then if I -- I think there's been some debate on the differences between the molecules and especially the dosing and frequency and maybe the duration of dosing. How are you feeling about that in terms of the kind of approach you took versus the approach your competitor took? Yeah, there are differences. Of course, the important thing here in Alzheimer's is not competing with another company for market share. It's building a brand new market for the benefit of patients. So we welcome their presence here. The differences I think are based on molecule properties and our understanding of the science. So our doses administered every four weeks instead of every two weeks, that's the difference. But the bigger difference is that, we took an approach of dosing until the amyloid plaque is done and then patients no longer have to stay on drug. That means a lot of patients will require less than even a year of therapy if that bears out in our Phase III trial. That's pretty exciting and I think that has economic benefits for society. And may be preferable for some patients. The science is still open. I think we'll wait and see our data, but if we can have that kind of dosing paradigm, it could be an important advantage for patients. And maybe the last one on Alzheimer's. Just your thoughts on where this market ends up if you look eight, 10 years down the road. Like, who's getting these drugs? What stages of disease they're getting the drugs? What's your sense? Yes. So I actually think the most important opportunity in Alzheimer's disease is prevention, secondary prevention. So taking patients who are ready have pathologic changes in their brain and correcting those with plaque lowering drugs before they get symptoms. So we're running those trials now and maybe four or five years from now, I hope we'll have positive readouts. Alzheimer's is a really big opportunity given the number of patients, but preventing Alzheimer's is even larger and we think of that in the same way as we do obesity. But this is a major trend that can have a huge benefit on public health then we want to be leaders there too. We've got launches of mirikizumab and lebrikizumab on the horizon as we go into this year. How do you think about Lilly's positioning to compete in immunology. I know this is one of those sectors that they have lots of -- it's a huge category, but the payer side can be tough. Let's talk a little bit about the opportunity there. Yeah. Let me start by saying it's interesting that if we had been having this conversation a decade ago, we had nothing in immunology. Right? So Lilly built some of the things Dan had mentioned about excellence and innovation, focus on first in class or best in class medication. Lilly has built this presence in pipeline with immunology over years. And then we launched with Pulse, obviously, and that products doing well in the marketplace. But now we have an Olumiant and now we have the potential to bring two more market, both mirikizumab and lebrikizumab. Both are going to be launching into markets that we think have opportunity for growth in terms of use of -- additional use of biologics for these disease states. We're preparing for these launches, mirikizumab will come earlier, lebrikizumab will come later in the year just given the timeline, the approval timeline. And we do think there is a potential for a differentiation story here with these products. So we're preparing to launch. The good thing is, this was one of your first questions. We have that infrastructure not in GI necessarily, but certainly in atopic dermatitis or in some of these disease areas with thoughts that we can leverage and we're looking for GI, where do we need to supplement? What do we need to do to be successful in that launch as well? And certainly I think for maybe a different time in Lilly's history or for other companies, these might be the tire focus of the story. But I guess with these products, do you expect that there -- we should expect there could be some time that these will take for reimbursement etcetera that -- to evaluate how the other launch is going to be doing, it might take maybe 2023 is the best year to do that? Or is there opportunities to get – Yes. So we start with lebrikizumab, given we announced in November that we filed for approval. So just start the clock, it will launch at the end of 2023. So don't expect to see major revenue because just the time within the year that we have for that product. Miracizumab will be earlier, but given that it will start with an infusion, it does require [J-code] (ph) that takes a little bit longer to get processed. So that will be impacting what you will see in terms of uptake of launch for that specific product. And we'll work to build excess for both products obviously with payers. Yes. Thanks. So there's a lot to be excited about. I mean, starting with immunology, as you said, probably for many other companies, right, launching two big biologics and immunology in a given year would be the story. And here we get to it like in the few minutes. They're great drugs that doesn't change the potential here to help patients or grow the company with them. And there's more behind that in immunology. So I'm really side about the science our team has led on checkpoint agonist. So this is taking what's worked in oncology to activate the immune system and reversing it and to turn down the immune system. We just presented late last year data, really breakthrough data, I would say, with our PD-1agonist in rheumatoid arthritis, a small proof of concept trial, but really remarkable efficacy and safety looks good so far. So super excited to move that aggressively into Phase IIb and a number of similar mechanisms right behind that other checkpoints that we're reversing to treat immunologic disorders. So that's really great science going on in immunology right now. We haven't talked about oncology at all. We're launching pertabrutinib, our BTK inhibitor hopefully this year. And behind that, a number of really exciting things. I mentioned the oral SERD. We also have a PI3 kinase inhibitor that's in Phase I that I have high hopes for. We'll have to wait and see the data working on KRAS inhibitors and many more things behind that. And maybe just the last question, as I think about the cash flow the company is generating and business development. It just feels like Lilly has made a different position in terms of its needs given this long kind of growth path you have ahead. What's the sweet spot in terms of BD right now in terms of where do you see the most opportunity for the company to look? So the way we look at business development and that has not changed over the year in terms of our overall strategies, we're not looking for a very large merger or acquisition to replace revenue. We don't have that problem, so we don't have that need. But we are looking at where can we supplement our pipeline and bring innovation in house that is best in class or first in class in our core therapeutic areas or new modalities. And it could be very early stage pre-clinical Phase I. Or if we find something that's late phase and it fits right within our portfolio, then we'll bring that in as well. So we're looking across the board for opportunities. The one thing that I would say, we're not compromising on is the level of innovation that we see the potential for in some of these transactions. And Dan you may add on what you're seeing. I guess it’s harder on the late stage side to find opportunity is in that, I would -- it just again seems like others in the space may have more pressing needs those assets than Lilly has. So should we think about skewing more early stage because of that? I would say, think of us skewing more to early stage. On the late stage, it's not that it's more difficult to find opportunities. Obviously, there's a funnel, so you're always going to have fewer Phase IIIs and you're going to have Phase I. But getting to value on these opportunities is even more challenging. The risk has been discharged, the Phase II data. You're now in this Phase III, maybe you're in advanced Phase III, maybe you're prior to submission. So a lot of the risk has been discharged. So actually getting to -- how do I add value as a company? If you have a large commercial footprint, maybe that's where you add value. Our goal is to potentially add value through the -- our development engine and the expertise we've built there. But again, it doesn't mean if we see something late phase that fits right in and leverages our existing portfolio, then it doesn't mean we're not going to look at it. We certainly will evaluate it. But I expect that it would be more heavily weighted towards the earlier phase. I think we feel like we're in a privileged position given the strength of our portfolio that we can afford to be picky and make sure that we're creating value through BD, particularly late stage BD. We don't have a need. We always have a want, though. Great. Well, I think we're just about the time here. Really appreciate the comments and it was an exciting time ahead for the company. So thanks for joining us today.
EarningCall_1523
It's a great honor to have Scott Sheffield from Pioneer. Scott, thank you so much for being here down in Miami. Yes. Pre-COVID. And so, it's great to have you here and to share your perspective on the outlook for the shale, but particularly the focus on the Permian. Scott, I know you're going to walk us through a couple of slides here and we're going to then jump into Q&A. So, we're going to turn the floor over to you, sir. Thank you. Good morning. Obviously, two of my favorite speakers before. It's hard to follow Jeff. I think he's been really one of the best predictors of oil prices since COVID hit. Up until recently, who would have predicted SPR, who would have predicted zero COVID policy and who would have predicted a recession? Maybe one for that, I'm a firm believer and what he's saying is going to happen. And I'll add some fuel to the fire of what's going to happen? Let me advance the slides. The first slide, you all have seen something similar. So I picked a few slides over the Christmas and New Year break, I thought, were interesting. This is reserve replacement, which nobody looks at anymore. We never get asked the question, Neil, about reserve replacement anymore. But it's very, very important to what happens to this industry. This goes all the way back to 1933. And so, you can see it's divided up between the majors and the independents. And you can see what's happening now. It happened back in the early 80s with the collapse of oil prices, and it's happening now. The majors are way below 100%. The independents are now down to about 100% reserve replacement. So that's setting up for a lot of things to happen over the next seven years in regard to whether it's higher oil prices or whether it's, to a lot greater extent, to great M&A activity over the next seven years. Next slide. Again, you've heard this number, we don't have it on here, but it's – you add it all up, we're spending over $1 trillion less than what I'll call the previous cycle. That's 2010 to 2014. So since 2015, about the industry worldwide is spending over a trillion dollars less in investment. This slide, I found going back to 1986, this is essentially all demand on a linear trend. And you can see the effect of what happened with COVID. All it takes, as Jeff was saying earlier, is for China to get back, which is going to happen sometime by the end of 2023 and we're going back on that relationship. I think it's already been stated. There's only a couple of countries left in the world that have the extra supply. And you can see past recessions hadn't really affected oil demand. It always comes back to this relationship. This is an interesting slide from RBC put out over the last two weeks. Since I've been around a long time, even back before this, and looking at oil prices and oil price predictors. This is the oil price, WTI. And those lines that are going forward is the forward strip as of January 1 of that year. And you can see, obviously, we all know that the futures curve, we all try to run our business off of it. We all test at lower cases, we run higher cases. But you can see the prediction ability is terrible. And what's amazing now is that we're probably in a more extreme backward dated than I've ever seen. So Brent today is $80. It averages $75 over the next – $73 to $75 over the next five years. It gets down to $67 in about five to six years. WTI is obviously in that $3 to $5 range less in that. So, we can't really use the strip. But in regard to a lot of people I've talked to, I'm a firm believer that strip is going to stay in backwardation. What Saudi wants is a higher price, whether it's $90 or $100 or higher. They want the strip to stay in backwardation. There's no liquidity in the markets. Banks aren't hedging. There's nobody that's using the product that's hedging anymore. No airlines are hedging. So there's nothing to bring the strip up in my opinion. So I'm a firm believer, if oil goes to $150, the strip is going to be backwarddated to $100 or $90, definitely over the next several years. So, this is definitely what's going to happen. And you just can't use the strip in regard to what the future price of oil is. Now, this is the futures curve as of mid-December, and this is you all's prediction, Neil. I don't know if it's yours or Jeff's or what, but I'm definitely a firm believer. I think we're setting ourselves up. As Jeff has told me over the last two or three years for another – if you go back to this curve, you can see there are certain events in the world over the last 30 years that resets the oil price. So, I'm definitely thinking we're resetting into a base of about $90, with upside up to about $150 between now and 2030 is my firm belief. This is Goldman versus the Brent futures curve, who's going to be right? I think Goldman is going to be closer than the futures curve. You can't use SPR that much more. We're already at a 40 year low on SPR for political reasons. The recession historically has not affected all demand that much. And then we all know China's going to come back and come back strong. Couple quick slides on Pioneer and then I'll stop. Obviously, Pioneer has probably the largest contiguous acreage position in the Permian Basin. We definitely are focused on high returns. We’ve upgrade and simply said, Rich and myself and a couple other executives got more involved in picking every location over the next several years. So with our staff, our top job is capital allocation, improving capital efficiency, and we have over 25,000 locations. Some of the exciting things you will see over the next few years, there are deeper plays that are being discovered, if you haven't followed. Watch out for the Barnett Woodford over the next several years. It's been tested already, looks very positive. Pioneer has several thousand locations there in that regard and also enhanced oil recovery. We know it works. Whether it's wet gas or whether it's CO2, the Permian is going to be here for a long time. And lastly, in summary, Pioneer delivered $7.5 billion to its shareholders, $26 a share. 95% of our free cash flow returned to the investor. Yeah, that's a great way to set the stage for the conversation. So thank you for that, Scott. Let's start on the micro and talk about the key strategic priorities for the organization in 2023. I think you alluded to it in terms of being more selective in terms of which well locations that you pursue and prosecute over the course of the next couple of years. Talk about what shifts you're making within the organization. Yeah. Essentially, what we're doing is just picking the highest. We upped our hurdle rates and pick us the highest return locations. When you have 25,000 locations to pick for, you have an area that's 200 miles north to south, 100 miles east to west. That's simply what we're doing. Our goal is to produce the lowest emissions intensity barrel, and provide it to the world. That's really our key focus, and return most of our free cash flow back to the investor. Yeah. We'll talk a little bit more about the Pioneer specific plan, but the keynotes on the outlook for the Permian. So what is your outlook for the Permian? We're hearing a lot about resource maturity in the basin. We've had an extraordinary 10 year period to get to this point. But how do you think about the growth profile and the next phase of the Permian? We have the Permian – about a year or two ago, I stated it was going to go to about 8 million barrels a day to 2030. The EIA has it at 5.5 million barrels of oil per day. We have lowered that to about 7 million barrels by 2030. The reason we've lowered it is that people – obviously, the effects of moving to what I call stack development in both the Delaware and also in the Midland basin. And that's combining either the Bone Springs or the Spraberry, depending on which basin you're in, the shallower formation look to Wolfcamp zones. It's better to drill four wells or six wells of all at the same time to get the best performance. Also, there are a lot of companies that are moving – they're running out of inventory. They are moving to Tier 2 and Tier 3 inventory. Also, I'll make a point. Chevron made a point recently that they were going to 1.2 million to 1.5 million barrels of oil equivalent per day by 2040. But the first time somebody put out a number that far, there's only three companies in my prediction that will be over 2030 in the Permian Basin over a million barrels of oil equivalent per day, that's Chevron, Conoco and Pioneer. They are the only three that have an inventory that deep, that can take it over a million barrels of oil equivalent per day. Now what's going to happen over time. The gas/oil ratios in the entire Permian Basin will continue to go up. We're seeing that. You'll see the percent oil drop for all those companies, most likely below 50% over the next 10 years. And the gas itself will get up to about 30 BCF. We're going to need a gas pipeline, at least about every 18 months to two years going forward. So the revision from – you said 8.5 million to 7 million, how much of that is a function of gas/oil ratios versus reinvestment rate versus a degradation in productivity? I think one of the words I wanted to focus on is, as a reservoir engineer my entire life, degrading is probably the wrong term to use that the market is using. So when you combine the true degrading from a reservoir engineering standpoint is when you down space a well and you're robbing barrels from the other well. That is what I call a degrading. So, you're drilling your wells too close. Instead of 800 to 1,000 feet, you're drilling at 600 feet. If you're not careful, you're going to be robbing oil from the other. It's going to affect the decline curve of the original offset well. That's true degrading. By combining Spraberry, Bone Springs with Wolfcamp and seeing lower productivity is not degrading, in my view. But it's a combination of – some companies are truly degrading. And some companies are just – it's the best way to develop the resource. So it's a combination of both of those, Neil, is what's happening over the next several years and what's happening now. Right now, we are a pure play. We made two acquisitions that doubled the size of the company. Very good acquisitions at the right time in the cycle. There was nobody else there left in the Midland Basin. There was a couple other privates that have been rumored to sell. One is degrading their inventory significantly, and the other one is not for sale. So really, we see no opportunities long term in the Midland Basin for Pioneer. Do you think the Permian will consolidate over time and these independents will end up in the hands of either the majors or merging with each other? I think because of the some of the slides I showed before in regard to people running out of inventory, reserve replacement, there has to be massive M&A activity. The biggest issue is that people – we had a series of companies in 2020 and 2021 that sold out toward the bottom of the market and sold out a small premium. Nobody wants to sell out at a small premium. Now, eventually, what will happen with a lot of these companies that don't sell out, the multiples will continue to decline as their inventory depletes. So they have a choice to merge with somebody, with another inventory in high grade, or do I just take a lower, lower, lower multiple over time. That's what I predict will happen. So it'll be a combination. Some will choose the merger route, and some will choose just to stay. Now, I'm going to use the vertical drilling program as an example since we drilled the most vertical wells of anybody in the Permian Basin over the last 40 to 50 years. You have to realize the vertical reservoir pressure decline is declining in the Delaware and the Midland Basin. So as we drill more and more wells, reservoir pressure is declining. So, we took the vertical Spraberry, the conventional from 160s to 80s to 40s to 20s. So one of the long pluses of the Permian, once it hits that peak at 8, 7 – call it, 7, whether it's 7.5 or 6.5, it's going to stay flat for about 30 years, in my opinion. So people will continue to down space, oil price will be higher, they'll get more capital efficiency. So never expect the Permian to roll over, in my opinion. It will be flat for a long time once it peaks. That's an out of consensus view, Scott, because there's a perception that the decline rates will start to catch up with the Permian as you get to that plateau level, it's going to be hard to sustain without a step up in capital spend. So maybe you can talk about it from an engineering standpoint. What needs to happen to maintain a plateau without capital efficiency going wrong way? As people flatten the production, obviously, the decline rate will lower for everyone. So instead of growing 5% a year or 10% or 15% or 20%, instead of being in the mid-30s, people will move down into the high 20s, in my opinion, maybe even the mid-20s in the Permian over time. The more gas will actually help in regard to the capital efficiency. I'm definitely a strong believer in higher natural gas prices over time, too, along with oil. And the question is, is how far it has enhanced oil recovery and also these other zones, whether the Barnett Woodford takes out through both the Midland and the Delaware Basin, enhanced oil recovery? The question is, is can we get enough supply of CO2? CO2 will work better than wet gas. We've already proven that wet gas works as a miscible agent. Question is, can we get enough CO2 with Oxy’s project or bring in CO2 from the Gulf Coast long term. We're only getting 6% of the oil out of the ground. So the more enhanced oil recovery works, it will also flatten that decline curve. And small companies aren't going to be able to afford it. It'll be companies with contiguous acreage and large acreage positions. Let's talk more about 2023 in the Permian and some of the constraints that exist in the system, which of them are more transient versus structural? Maybe the first one is talk about the gas takeaway situation in the Permian. Henry Hub has come down, but Waha has been soft over the course of the last six months independently. When do pipes come online and how is Pioneer positioned, given that you have a better takeaway position than most? There's two big expansions coming on by the end of 2023. The next large pipeline coming on by the third quarter of 2024. But that's not going to solve – this has to happen every 18 months to two years. So you've got to think about more stuff – expansion has got to start in 2025, another pipeline in 2026, which hadn't been announced yet. So I think the Waha problem is going to continue off and on for the next decade, in my opinion. So, you're going to see it do exactly what it's doing. 75% of our gas is either going to the Gulf Coast or California. So, right now, a lot of our gas is going to California and collecting $40. So, if you watch the California market, a lot of it's going to the Gulf Coast. Eventually, 25% of our gas will get down to about 5% once these expansions – so it's really partially in double point that didn't have access to long term capacity when we purchased them and we'll be adding them to the expansions into the new pipeline. So Pioneer by the summer of 2024 will be down to 5% Waha. NGL prices have come under pressure as well, Scott. How do you think that changes the economics of whether privates are willing to – with the weakness in local gas and in NGLs and in the softening of the crude curve, at least in this air pocket, are going to attack the 2023 growth plans? If you look at most privates, the two biggest privates, Mewbourne and Endeavor, have been essentially a flat rig count since last summer. One's at 15, one's at 19. If you look at the private percent of the Permian, it's actually going down. So any increases – in fact, I did make the point earlier, Delaware is up about 10% since last summer, mostly in New Mexico, and the Midland basin is flat. So the privates are coming down in the Permian. One of the big reasons is that they don't have takeaway capacity. The pressure on flaring and venting has continued to increase and be there in the Permian. That's going to keep them from – besides inflation – we know inflation is up 10% to 15% in 2022. Most companies are in that 10% to 15% for 2023. Nobody wants to build a new rig because the new rigs are going to cost 30% to 40% and you've got to sign a three-year contract. And so, somebody told me, Patterson made a comment that they're up to 38,000 a day. That's unheard of. The strip is what I said earlier, the next five years is $70. And so, something's got a break in between. And so, I just don't see the rig count really increasing at all in the Permian. If anything, it may decrease a little bit. So, the privates are definitely going to be held back because they don't have takeaway capacity. Also, there's going to be an issue with midstream companies not having the capital. Look at the number of 200 million a day plants we have to build. Target is staying ahead of the game, but the rest of the other midstream processors are not. They're falling further and further behind. So that's going to be an issue in regard to growth in the Permian also on the midstream. And talk about how Pioneer manages the cost inflation dynamic around services companies. Service companies have under earned for many years, their returns on equity. And they're looking at the E&Ps earning solid returns on capital and, understandably, asking for their piece of the pie. No, I don't blame them being in the industry for as long as I've had. I think the best formula is to tie it. I've been surprised how volatile WTI and Brent was in 2022. It's the tightest supply/demand I've seen in my 50 years. And then, we have oil fluctuating from $75 to 125 or $125 down to $75, where Brent went down to $75, WTI went down to $70. It really doesn't make sense. And so, service companies have to have that return. They've got to return capital back to their shareholders. So, to me, I think the best mechanism that I've seen that we've done with all the providers, you've got to tie it to an oil price. And so, when oil prices are high and up, they get a higher price. When they're down, they get a lower price. That's really the only mechanism that I see that will work with the service companies. Let's tie it all together. This is a great perspective on the Permian. If you think about exit to exit, US this year, probably – oil is going to look like 700,000, 800,000 barrels a day, it seems like, based on the monthly. Weekly are a little noisier. How do you think about exit to exit US oil in 2023 versus 2022? Yeah. I look at that 700,000 and it's probably 150,000 that's Gulf of Mexico. And you've got to look at that versus the hurricane. So, I looked at September and October EI monthly. So, I focus on all the oil shale states. And so, basically, they're all flat except Texas and New Mexico. So, Texas is up – if you look at September to September is up 150,000. If you look at October, it's up 200,000. But you've got to share Texas with the Midland Basin, the Texas Delaware and the Eagle Ford. And the Eagle Ford did have some growth. So, long term, those three plays are only – in my opinion, they are tapped out at 150,000 to 200,000, in my opinion, oil. So, that number is going to come down over the next 12 months, in my opinion, based on all the things we've talked about. Now, you look at the two counties in New Mexico, they're up 350,000. So if you go into Inverse and S&P data, there's five companies that run 80% of the rigs in those two companies. If you look at their inventory on high return – I'm talking about high return inventory, it's only about three years. So within three years, that 350,000 growth is definitely going to slow. It's going to drop off significantly after a three-year time period. So New Mexico is going to slow from 350,000. When you put those numbers together, ignoring the Gulf of Mexico, I look at oil shale, I've been saying 500,000 to 600,000 for the last probably 12 to 18 months where the EIA was at a million or higher. I'm saying now probably about 400,000. I'm ignoring the Gulf of Mexico. I don't follow as closely as I used to. But I'm saying about 400,000 for non-Gulf of Mexico. In lower 48, 400,000. And that will continue to decline over the next five years. That's exit 2023 versus 2022 black oil. That's good color. Let's talk about the production plan. And then we want to spend some time on talking about return of capital. And then lastly, we'll spend some time on policy as well, which I know you spend a lot of time on as well. I think there's a lot of confusion around Pioneer, whether on the sell side or the buy side. Is productivity going the wrong way? Was last year not as good of a year for execution as expected relative to peers? And I think what you you've talked to me about is a lot of it is just about timing. And it's not a reflection of anything in the asset base. But I want to give you the forum to talk about how you're seeing that and respond to some of the bear cases that might be out there. Obviously, the data pointed – we should have the best type curve in the Midland Basin. So that starts with 0.1. And so when we started looking at our data, and the data, we ended up drilling, in my opinion, too many delayed wells. Delayed wells, you should not drill a delayed well, whether it's in the Delaware or the Midland. You get a less productive well, if you drill a well six months or two years after the fact on a delayed well. And it was basically experimentation. And so, when we saw our type curve getting to the middle of the pack for the year 2022, among all the players in the Midland Basin, we said we've got to make a change. So we increased our hurdle rate. And as I said earlier, Rich and I got involved in every well, every location, all 500 wells and looked at it well by well. Generally, we are responsible for capital allocation. But a lot of times, you've got to trust your employees, but we got involved in every location. And so, our goal is to be at the top of the Midland Basin in regard to that curve. We can do it significantly for several years. And so, you're going to see an improvement back to 2021 or better for the next several years. And we can do that for easily 15,000 locations for a long time. So that's basically what happened with us. So walk us into the room. So how do you approach that process of looking at the 500 wells and which ones to let? It was simple. By picking the – we raised our hurdle rate, which knocked out, obviously, some locations. The locations, when I say knocked out, they get drilled 8, 10, 15, 20 years from now. And so, it's as simple as that. We have to move our type curve back up. So it's as simple as that. But when you have this massive position that we have, there were wells – we questioned why were you drilling in this area, why are we drilling in this area. And some of them may be leases held by production. Or some of them may have been to protect a lease. And so, there's other ways to solve that problem, basically. Scott, you showed a great chart that showed average 2023 to 2027 type curves relative to the 2022 type curves and the step up in capital efficiency that you anticipate, in productivity that you anticipate. But when do we see it in calendar 2023? Is that a mid-year? The first wells are drilled in first quarter. So we report those second quarter, basically. So, by May, you'll see the first quarter results. Let's talk a little bit about return of capital. As you said, you've put up $26 of dividends in in 2022, at least $26 in dividends, which is a 12% dividend yield. How should we think about, in the current commodity environment, what the dividend could look like in 2023? And you had indicated you're going to be countercyclical from the buybacks. The stock has pulled back and you're still constructive on the commodity as are we. Does it make you want to change the composition a little bit more buyback versus dividends? No. All the shareholders – when we went out to all of our shareholder base, 99% of them preferred dividends over buybacks. And we will continue to go out and talk to people over the next year. But for instance, I've been upfront with people, I collected myself $16 million, $17 million. So, I got more compensation of dividends than I did my total compensation as CEO. So, people don't look at the fact – when you get $26, what do you do with that $26? They make another investment. And so, I notice in stock returns, a lot of people report Pioneer stock return for the year. They don't include the dividends in their analysis, a lot of the analysts. And so, when you talk about $26, it's a big number. And so, we will continue with that policy. It's been positive. Unless our current shareholder base want us to change it. And I always will go back to the shareholder base. With the strip, I've asked myself, the strip stays in backwardation, it gets up to $150 backward dates to $100 and continues that for the next seven years, I probably would have wished I bought back more shares. How do you think about when do you lean into share repurchases? You did $1.5 billion over the course of the last year. Is it when the stock gets dislocated? So far, if you look at the majors, most of their stock purchases are dismal. They bought them at the top of the market. If you go back to each of the majors and look over the last 20 to 25 years, independents historically have never bought back their stock until the last 18 months. But the majors' track record is terrible. Exxon has announced they're buying back $50 billion. They got so much cash flow that they have to buy back the stock. So in my oil price scenario, it's going to look to be a great purchase most likely. But if oil is $60, $70, that spend, that $50 billion may not long term. And so, independents track record, it'll be interesting to see what happens. But you have to have a strong oil price. We will continue to buy opportunistically. I think our average price is $218, close to the current price. So, it's probably better track record than most companies in regard to where to buy back to stock, the independents especially. Let's talk a little bit about the way you're thinking about policy and spend some time on the environmental side, which is important part of the conversation we have with investors as well. What do you think the risks are out of Washington, as we think about energy policy here in 2023? Or do you feel like that there is a supportive enough environment that doesn't affect the way that you approach your business? And then we should talk a little bit about OPEC as well. Sad to say we've seen what's happened with the current administration from the time they came into office two years ago, asking us to drill more. They don't understand the inventory, they don't understand inflation. And so, there's been a big debate about whether or not companies should drill more, obviously. And as I stated in the Financial Times interview recently, it'll bring the industry back to the bottom of the S&P 500. Can you imagine if we would have done what they said over a year and ramped up production and grew production a million barrels a day going into this recession, zero COVID policy. Oil price today would be $50 a barrel. And so, our industry will be back to the bottom of the S&P 500. So it's working. Origin's comment about 5% of the S&P 500, I'm a firm believer, we'll get up to 10% to 15% for the reasons that we've all said. So we can't go back there. This is the first US President – to my knowledge, I haven't found a CEO yet he has talked with. He has not talked to any oil and gas CEOs. And that's the first US President that I know of that has not talked to anybody from our industry. He has other people that's talked, Department of Energy, others. Obviously, if the Republicans can find a speaker, there's a block over the next two years. And it's going to be interesting to see what happens in 2024. So I think we're at a stalemate for our industry for the next two years, nothing else will happen. So I'll leave it there. And if we do get a price spike over the course of the summer as we work through zero COVID and we get into the seasonally stronger period and refining capacity starts to ramp up as well, do you see the risk that the administration does something again, whether it's release more SPR, whether it's implement an export ban? Yes, the only thing the President has the power to do himself is export ban on LNG, our products and oil. So, he can do that with a stroke of the pen. So that's probably the biggest risk. Obviously, [Technical Difficulty] have been done recently and previously to show what the impact that would have on the industry. If you want to import more crude oil from the Middle East, that's the best policy. And it's not going to lower the price of gasoline to the American consumer because it's based on Brent. But that's his most powerful tool. We've seen Australia and Europe go to some type of windfall profits tax. With the House being definitely Republican, I see no risk of that in regard to windfall profits tax. But as you know, if our scenario, whether my scenario or Jeff's scenario, if oil gets to $150, then people are going to look at ways – it's already impacting the North Sea in regard to windfall profits tax on the UK side. And so, it's again not the right message. But you'll see people speak more and more about it. If we get to that scenario where oil is $150, gasoline is again at $7, $8 in the State of California. California will probably do their own windfall profits tax. You may see some states do that possibly. But those are some of the things that could happen. But with the Ways and Means Committee controlled by Republicans, I see no changes. I don't see that happening in the next two years. I just don't see it. They need more production. So why hurt the State of New Mexico, which is pretty much a strong democratic state. They rearranged. Now they have 100% of Congress is democratic from the State of New Mexico, which affects obviously the Delaware. People don't realize, one-third of the revenues in the state of New Mexico comes from oil and gas. Scott, you spent a lot of time with OPEC as well. You've spoken at OPEC over the years. Talk about the dialogue that you're having with OPEC participants as well. And what do you think – it's a question we asked Jeff as well. How do you think about their calculus over the next couple of years? No, I agree. Saudi is not going to let Brent stay around $75. $75 average or even $73 average for the next five years, it won't happen from the standpoint of ABS and MBS. Their breakeven budget is over $80 a barrel. You've seen what MBS is doing with the country, with neon and other things that are going on in the country. They need oil to be at $100 a barrel or higher in my opinion. OPEC ministers are frustrated over the recent price fall. It's understood. I think is going to change. If it stays too low, it wouldn't surprise me if they have another cut. But they've got to wait till February 5 to watch the product ban on Russia. They've got to see what happens with the COVID policy being 100% reversed in China. And then, we'll see what happens in the next 90 days. So you've laid out a very constructive oil view. You said you're also constructive on natural gas when it's 80 degrees across America. It's hard to be bullish at this moment. But you look out a couple of years, there is an interesting bull case. Talk about how you're thinking about the potential supply air pocket that we might have for the next couple of years, relative to the structural demand side of the equation. Obviously, we're going from about 12, 13 BCF exports, we'll probably get up to 20 BCF. It wouldn't surprise me if we get closer to 25 BCF. We will be the largest exporter in the world. The gas over the last few quarters, call it, two to three years, is trading at 17, 18 to 1. So if you look at my bull price in oil, there's no way gas is going to stay at $4. So, if you had $100 oil, divide by 17, I'm probably more of a long term $6 gas person, long term. There's plenty of gas there. The gas people have learned not to over drill also, not to put too much gas and get it trapped again. I think they've learned their lesson as the oil people have to, trying to get returns back to their shareholders. And eventually hope that there's a world price on gas. And long term, we talked a lot of the people. I think they'll eventually be a world price on natural gas. How do you get closer to JKM or TPS? And, of course, again, right now those prices have moderated, but they're still trading at five to six times relative to the US Henry Hub price. How can you get your barrels to market into those international markets to get a better gas price realization? You have to end up signing 15-year long term contracts with the LNG players. A couple of the independents have done that. We've continued to look at. We eventually think it'll equalize. So whatever the world price is, back off the liquefaction and the transportation cost, they're just like Brent, WTI. I think eventually it'll equalize. Yeah, so why commit to a 15 year contract is our question. So you're going to have spikes like we've seen. You're always not going to have Russia do what they did and see that spike go up as high as it did. So, it's hard to make that investment to play that market. But eventually, I'm a firm believer, it'll equalize like Brent, WTI has historically, is that JKM and TTF will equalize with Henry Hub long term. Some model specific questions. As we make the turn into 2023, talk about capital budget. Where we were in 2022? What are some of the moving pieces that investors should keep in mind as they're modeling out 2023 spend? Long term, we are really – we did not grow 5% in 2022. We grow 0% to 1%. When you model what happened in our acquisitions in 2021, we grew in that 0% to 1% range. We're really focused on long term growing closer to 5%. So I think in 2023, 2024 2025, 2026, we will try to hit closer to 5% growth. You'll see that as a change. And then you'll see us beginning to – continue to test enhanced oil recovery and you'll see us, as we've been public about, drilling a series of deep wells in the Barnett Woodford, maybe test shallower zones and other zones over the next five years. We have another probably eight zones we haven't tested, things are getting very positive. Basically, the big surprise to me, we thought the Barnett Woodford was going to be condensate. Oxy has announced four great wells in just – near Midland. We're surrounding them. The gravity was 43 degree gravity. That was the big surprise to me. And so, you're going to see other zones being tested, like that. And so, you'll see us do that in 2023 and on. So those are the some of the upsides that I see. But I think you'll see us try to move closer to that 5% production growth. You asked about capital, I think we've been up – we're going to add, continue to add about 2 rigs per year, and capital will be up about 10%. How do you think about – it's early to talk about 2024 and beyond. But when you talk about the 5%, you're talking oil growth specifically? If we all go to this service cost and we all sign contracts with WTI and Brent fluctuating, we're all going to have to figure out how to build that into our budget. Okay? So, that's one of the hardest things. Companies are going to have to give wider ranges, in my opinion. So, if 50% to 75% – service companies don't want to do a fixed cost. We've tried that for 40 years. It's almost impossible to do a fix cost for a two or three year timeframe. So we all go to this oil price fluctuation. We're all going to have to build that into our budget range that we give. So, if oil is $70, our budget could easily come $200 million. If oil was $100, our budget could go up $200 million. So that's one of the big issues we're all going to have to deal with if we get the right formula for the service companies. The 5% number is a longer term CAGR? 2023, it sounds like it could be a little bit lower as you work through this. As it relates to service cost inflation, you have a unique relationship with ProPetro. How's that timing of pressure pumping contracts affect the potential inflation that you're seeing? You're seeing us diversify among the various frac companies. You're seeing us move more toward and trying E&G fleets, using a combination of CNG, LNG, using gas from our wellheads to run it and eventually electricity. And so, the grid has to change significantly in the Permian Basin. It will. It'll be slower. But that's the – eventually, most wells – by 2030, I would say most wells will be on E fleets and using the grid, whether it's at Pioneer and the larger companies for sure. How do you get credit for your inventory depth? It's something that we talk a lot about as it relates to the majors. Or even companies that have a lot of inventory that can be prosecuted in 2035 or 2040 and they pull forward that value. Does it make sense to monetize some packages? We've been asked that for years. As you know, there's a lack of capital. People don't pay much for that. And so, the best way we found is using private equity money. And so, they put up the capital. And after somewhere between 12% and 15%, return, we back in for the rest of it. And so, you'll see some of our programs start kicking in 2023, 2024 and 2025. But the market is not there. There's nobody out there paying $10,000, $15,000, $20,000, $30,000 per acre. And that's what it's really worth. And so, there's no way to monetize inventory. So to get credit – if you look at the longer inventory companies, I think we should trade a higher multiple, all companies with long inventory. We're only trading 0.5 to 1 term above companies with shorter multiples. But eventually, my opinion is, as I said, the company with shorter multiples have to continue to make, to me, dilutive acquisitions that hurt their inventory. So that's what's going on now. It will dilute their current inventory. Companies will have to do that. And eventually, the market will recognize that in my opinion, and there'll be a bigger spread. Either, they will go down, our multiple stay where it is. Or if we do get up to 15% of the S&P 500, the multiples will expand for longer life inventory companies. And that's the pushback we get on our positive Pioneer view. Many look at your free cash flow yield or even EBITDA and say that you trade at a premium multiple relative to peers, but it sounds like your counter is you've got more inventory depth. And we got higher – our free cash flow margins – returning 95% of our free cash flow back to the investor. Those are also things that beat our competition. Last question around balance sheet. You effectively have no debt on the business or very low leverage levels. Do you have the optimal capital structure or does it make sense if you go into air pocket around commodity prices to be more aggressive around returning capital and taking a little bit more debt on to the business in order to fund it? Our debt to EBITDA is down at 0.3. Longer term, I personally would like to get down to zero. I think that's the better balance sheet in a fluctuating commodity price long term. So, what you want to do is be able to – when you look at what happened in 2020, when our stock got down to $50, you want several billion have firepower to be able to go in there and buy the stock really cheap. And there was not one oil and gas company including the majors that bought their stock in the bottom of the COVID market. And that's when you really want the firepower to go in there and buy the shares. We know our business, we know it's going to come back. And so, that's the reason you want the balance sheet to zero debt.
EarningCall_1524
Hello, everyone. Let's get started here. I'm Robbie Marcus, the Medtech Analyst at JPMorgan. Really excited to introduce our next company, Intuitive Surgical. I'm going to bring up CEO, Gary Guthart for some presentation. Then we'll turn to Q&A. Gary? Thanks, Robbie. All right. Good morning. Delighted to be here with you today. I'll go ahead and jump right in and look forward to the Q&A as well. We do have some forward-looking statements. I do recommend that you look at our SEC filings on our website to look at risks and uncertainties and look forward to a robust conversation. Our mission and our vision for those of you who are new to the company, we believe minimally invasive care is life changing. It has been our mission since our start in December of 1995. I'm standing up here in a booth that is actually a surgery that is 5 weeks old. It was not going to – maybe 6 or we talk about the real value of these things. For the company, we think there's opportunity to be profoundly better that outcomes can be not a little better, not 5% better, but a ton. And the more you look, the more you double click on these things and look at the experience that patients actually have, look at the variance of surgeon populations and the variance of patient populations, the more opportunity there is, it's actually quite shocking as we look at it. That has driven us to new places over the last 25 years. We're starting to move, kind of up the care continuum into diagnostics because if we think if you can find it sooner, you can do a lot better. So, waiting until it's late doesn't help and we think we have some capabilities there. And we're moving into some opportunities, post-surgery too, and most of those around understanding and really being deep in surgical science, and I want to talk to you about that today. Just some stats to kind of center us where are we in the world. In the last year, physicians using our products performed just under 1.9. Our finance team thankfully is being conservative at 1.8. It came in just under 1.9 procedures in the year. I always ask, is that bigger, was that small? How do I think about that number? And we'll put that in context in a couple of slides, bigger than we've been and smaller than the ultimate opportunity. We are a highly studied company. I think that's great. I think it's natural. There are about 3,000 peer-reviewed publications on our products and technologies in the year. The problem with the database isn't that it's too small. The database is so big. It's hard to sort. The vast majority of those over 90% are fully independently conducted and funded from Intuitive. We do some funding, but a lot of people study us without that. We put another 1,200 da Vinci systems in the world. Total experience about 11 million procedures in the total experience for Intuitive database now over 35,000 peer-reviewed articles and over 7,500 da Vinci systems in clinical use. This is a habit of ours. What did we say we were going to do last year what things did not go well or what we would be challenged by and what were the areas of strength. We wanted to move through the back-end of the pandemic well, support our customers. These are things like making sure that quality of supply is there that they could depend on us. We wanted to make sure that our existing and new platforms. We're launching the way we wanted them to. We wanted to get additional indications and drive our launches. We wanted to diversify our growth. Outside of the United States, outside of urology. We had a good experience in urology in the year, but we wanted also to see growth outside of that specialty and general surgery has been a growth driver in the United States. We wanted to see that continue. The year was not without its challenges. Supply chain disruption was significant in the year. It's gone up and down. It's abated a little in some places, but it's not all the way gone. Inflation in costs, inflation in supply chains continues. I don't think we're through that, yet you've all seen foreign exchange impacts on revenue. Staffing constraints in some hospitals in some countries have put pressure on surgery. I think actually, staffing constraints are both a challenge to an Intuitive – to Intuitive. It's also an opportunity. We actually are helpful with regard to diminishing the staffing requirements of hospitals both in the OR and post-surgery. So, if staff and constraints are acute for our customers, it can diminish the amount of surgery they do. If they are not acute, if they're pressured, we actually help solve it for them, which is interesting. COVID waves continue. We saw it in the fourth quarter in China. We saw a relatively significant decline in surgical procedures performed in Q4. How long that lasts, we don't know. I think all of us have been through COVID waves now and we know that they abide and then they end, when it ends we'll see. But when it ends, we know there will be a backlog of patients and people who need surgery. We had areas of strength in the year, benign general surgery growth in the United States was really strong. I'll show you a little more about that. Our diversification outside of urology. Urology was great. I don't mean to imply urology wasn't good, but we diversified beyond urology outside the United States. That's a result of investment and focus. It’s been great. Our flexible robotics platform is Ion. First indication is looking for suspicious nodules in the lungs. That has been adopting nicely. I'm going to share that with you shortly. We have a suite of digital technologies. I'll try to introduce them to you in a little bit of a concrete way. I’m an applied mathematician by training. Whenever I hear people talk about digital, it makes me nuts because it's so high level as to be meaningless. I try really hard not to do that. It's hard in the short setting, I'll do my best. Customer acceptance has strengthened for us in the year and that's important. So, we like to look at how we do. It's better to ask our customers how they think we do and that has been strong for us. Procedure trends, we had 18% growth in 2022. The compound annual growth rate through the pandemic was 15%. The growth rate entering the pandemic was, I think, Jamie, 18% to 19%. So, we've kind of bounced back in 2022. I'm happy about that. Our anticipated growth range going into 2023 12% to 16%. That low end is really anchored on what happens in China what's the uncertainty there. The high-end is really mostly gated by how fast we can do things like training or our world and the staff. I think we are the constraint on the top end, not the end market. So, we can talk more about that in the Q&A. On capital, if you look on that left side, that’s system placements, the dark bar underneath, that is additional capacity into the field. So that's people who are building capacity. And the light bar trade-ins of older systems generally Gen 3. We're on Generation 4, X and XR Generation 4 product. We're at the end of the trade-in cycle for Gen 3. So, you see the light blue starting to compress. That's because we've traded out with our customers most of those Gen 3s, but actually you see a dip in 2020, the beginning of the pandemic in and folks installing additional capacity. And then it recovers, it recovers in 2021 and it recovered in 2022. That's encouraging, right? That says, hey, people got a little bit hesitant, a little bit cautious at the beginning of the pandemic, and we're unsure as to how it was going to unfold. That's not a shock, and then it's recovered. So, anyway, that's what's happening in capital. If you look at the installed base, clinical installed base that are out there doing procedures, you see that we've grown 11% through the pandemic as a CAGR and 12% in this last quarter – I'm sorry, in this last year in 2022. So, it's kind of interesting that the drivers, why don't we start this way? The drivers of the business are, how often do people want to use our products? That's procedures. Then are they willing to acquire the capital required to go do that either by buying it or by leasing it or by renting it or whatever we provide for them. And that's been pretty healthy. The difference between those two, 18% procedure growth, 12% install based growth is efficiency gain. How frequently do they use the systems they already have? And I love efficiency gain. I would drive it as hard as we can. It's hard to move. Because it's a lot of workflow within the hospital. It's an indicator of how they run their programs, a little bit of indicator of how we design our products, but we've had roughly 4% annual compound growth on utilization. Utilization is fantastic for our customer. It may suppress future capital sales. Don't freak out about that. I don't. What you really care about is, are they using the products they want to use and we'll talk a little bit about recurring revenue. So, the goal of the business is not to put as many capital systems out as the world wants to buy. The goal of this company is to make sure we support the procedures that need to be supported. If we have very high utilization, it's a great return for our customers. It's a great economic situation for us. It all works great. So, capital is important because it sets up the set of technical capabilities and clinical capabilities that the customer needs, but it is not the primary driver. So, revenue trend, what does that look like? Here's how we've been. 12% compound annual growth through the pandemic. The dark blue bar is now moved to the sources of recurring revenue, the things we have to earn every day. So, that's instruments and accessories that are used as part of every case. It's the service contracts on our capital equipment. It's rental and leasing revenue. Things that are not capital sales. And you've seen over time that it's grown to about 80%. We have to earn about 80% of our revenue annually. It's more predictable. I like this setup. I think it's very healthy for the company. And the reason is, it keeps us really focused on the leading indicator of the health of the business. Procedure growth drivers, I told you it was 18% in the year, some things that were accretive, things that drove growth. We said one of our priorities was to drive diversification beyond urology outside the United States. That was 25% growth in the year. Fantastic. We said that U.S. general surgery has been important. That's a procedure domain that is adopting. It's in the middle innings of a lot of these different procedures from bariatric surgery to cholecystectomy. That's healthy for us, 22% growth and then all other, which is more the legacy side of our business, urology and some of the gynecology, will also grow through the period. So not bad. Where are we in the opportunity? This is kind of a framework we shared with you last year. If you just look at the systems we have in the market and this is da Vinci and our da Vinci SP, and the countries in which we operate for the clearances, for the indications we already have, we think there's about 6 million that ought to be done this way. And I just said, we came in at about 1.9 million. So, for the products that we have, we think we're less than a third penetrated, but the things we're working on, additional indications, Ion and its growth, new ideas for SP are not yet in that 6 million. We think that opportunity gets a lot bigger, up to 20 million over time. And Jamie will correct me. I think Ion is not in this slide just yet. That's true. So, we're not done. I think there's decades of opportunity in doing technology-enabled ecosystems to address acute care, which is how we think of ourselves. I want to talk to you about things that may be obvious to you, but if you've been with us for a while, probably worth calling out. We are now supporting the standard of care in several surgical disciplines in many countries. And that means that we're supporting procedures at an industrial scale. If tomorrow we had to go out, if we were at the FAA, if the FAA comes out and says, hey, our systems went down, you can't use them tomorrow, the majority of prostate cancer surgeries in the United States wouldn't be conducted. A large fraction of the gynecologic surgeries in the United States wouldn't be conducted. Majority of long resection surgeries in the United States wouldn't be done. There's an industrial scale component of this that I think is requiring attention and investment from us. I think it is a fantastic thing. It's an honor and a privilege to do it. Done well, it builds I think long-term value in the company. And I want us to get better at it. We have an innovation engine and the innovation engine has built the company. And so now it's a left hand, right hand thing. We want to make sure that we maintain our innovation edge and drive it, and also take advantage of and perform at a very highest levels at some of the industrial scale opportunities that we have. We start with the end in mind. We now do work. What this little graphic shows is preoperatively from the point of view is assessment and training and helping understand patient selection. We do work, of course, [intraoperatively] [ph]. It doesn't matter if it doesn't matter in the operating rooms. We want to make sure it works in the operating room. And we do a lot of work postoperatively, in post-procedure analytics, and the capabilities that we call surgical science. And I think that our group is helping to lead an analytic understanding of Surgical Science, and I want to talk more about that in the talk. So, getting there really working across this, of course, requires engaging the customer all the way through this set of life cycles. That has been one of the missions of the company in the last years and we've gotten stronger at it. It's not enough to have some products in that space. There are attempts out there to go acquire all these little things. And they become [Frankenstein] [ph]. I had a foot surgery. I look like Frankenstein. It ain't good. You definitely want these things to work as a [piece] [ph]. So, I think integration matters a lot, and I think dependability matters a lot. If you want to be underpinning or supporting the standard of care, it's got to work routinely, virtually all the time. So, we focused the company on this and I think it has been to our benefit. We're seeing a change in the market. We're seeing a change in the way our customers engage us. And that is that we have built evidence now that this is a 4-way win. It's a win for the patients in terms of better outcomes and their experience. It's a win for the care teams. In terms of their experience, and the amount of work they have to do. It's a win for the hospitals and providers. And we are seeing in our data that is a win for the payers, lower total cost to treat per patient episode. It's actually win across the floor, and we have evidence that that's true. And you'd say, okay. Well, Gary, that's nice. It's a nice chart. This is true. We just show – show me some evidence right. Well, let's talk about what people have actually done. That the top chart are integrated delivery networks, so corporate ownership of providers that own more than 20 – 20 or more systems inside their institution and it has been growing sequentially. Every quarter, it grew. 16% it's grown all the way through the pandemic. So corporate ownership, these are sophisticated human beings. So, they can go look, is it really better for our contribution or margin or not? Is it really getting us better outcomes or not? They can use their electronic health record data to validate. About hospitals, single institution, single building that has more than 7, 7 or more. If you had asked me a decade ago, how to predict that? I don't know how to have predicted, but it's grown 48% year-over-year in the fourth quarter. Hospitals that have now have them lined up. And when they've lined them up, they're not talking about experimentation. They are talking about standard of care. And so this issue of industrialization of this side of the business, I think, is evident in the data. So, you will see from us a set of investments. Why do I tell you all that? Why would we talk about our investments? And why we think the investments are important? That's why. We're investing to operate consistently at industrial scale to engage the globe. We have a systematic process for identifying which countries we think we can invest in and do really well. So, we review that annually or quite disciplined about it. We're in 69 countries now. So, we want both, strong innovation and industrial scale capability. I talked about four wins. Quadruple aim is of course not our language. It's our customer's language. The four wins are just that. Can you demonstrate better outcomes through their own data, through clinical studies, and through real world evidence, better care team experience, better patient experience, lower total cost of care? I think the answer to that is, yes. What's happening now is that we're being invited into policy conversations with governments around the world that say, we believe the quad aim. We see that. We see the data. Now, let's talk about improved patient access. I think we've earned a seat at a policy table that the company didn't have five years ago or six years ago. And it's not because we're articulate, it's because the data shows that it works. And so now one of the opportunities we get are, okay, if it really is a quad aim improvement, can you open access to more people and more places? Can you make sure that people get it? That's something we'll be driving in the next couple of years. So, where do we go from here? What does that look like? We want to raise surgical capabilities in hardcore ways inside the operating room so we can start driving and continue to drive standard of care. Even today standard of care is not good enough, there's just no question about it. We know there's massive variation between surgical skill and care team skill, there's population variance in surgery, and we want to do something about that. I think we can be one of the leading partners and companies in the world that make that better. We want to make sure that we can gain efficiencies for our hospitals. Healthcare staffing is not going to get easier anytime soon. It may be a durable problem in many aging societies. And so, dealing with that in terms of staffing efficiencies and costs, I think we're a part of the solution, not a part of the problem. And that last point I made to you is, we do think there's an opportunity to open access and to grow the capabilities of the company over time. For those of you who haven't seen it, we'll just touch on product. Our flexible robotics program Ion, this first indication is in the lung. Meter long catheter fully sensed – shape sensing, fully sensed along its full length using this fiber optic system that's pretty awesome. Clinical outcomes for this in our precise trials have been great. Adoption has followed suit. And so, this has been a demand. We have a single indication for Ion at this time and that is for biopsy in the peripheral lung or in the lung itself. Indications for lung cancer are high. You see it on the left. We're currently available in the U.S. That's the market we're operating in. We were granted green channels, so local channel access to the regulatory pathway in China. So, we're pursuing that. I think that's a good sign and it's an indication of the trust that the Chinese healthcare system has in our joint venture with Fosun. We are submitted to our program for European MDR, so we expect to make progress there. Installed base has grown nicely, Procedures have grown nicely, we're seeing a nice traditional adoption here. Safety profile has been very good. Safety profile is as good as CT guided needle biopsy in the clinical data that we see, and the efficacy has been good as well. So far so good. On our single port program, so this is narrow access surgery going into the body through something about the size of a quarter. We're seeing really nice growth. In Korea, it is very strong. In the U.S., it's gated by indications. We are working with clinical trial sites and the FDA to expand those indications. Platform is performing very well. I'm actually quite enthused. SP should give us pathways to new indications and those new indications should introduce us to surgeons we've not met before and procedure categories and segments we've not participated in. And I think that's quite exciting. 38% SP procedure growth, despite no additional indications in the year. We have a colorectal IDE ongoing, a thoracic IDE ongoing, and working on additional geographic clearances. We just got a broad clearance in Japan that launch has just started. So, we're excited and we will continue to drive this. Stay tuned. I talked a little bit for a minute about digital and data. What are we trying to do in digital? We want to make sure that we support clinical workflow and decision-making. That's an integration of what we get. The data we get out of operating rooms and integration with hospitals, electronic medical records. We want to accelerate learning. I talked a lot about variance in care teams. I think Intuitive is an opportunity to show with data what that variance really is and to use machine learning techniques to be able to identify the sources of clinically relevant variation. There's a lot of variations, something that doesn't matter. So, the real question is, what variations clinically relevant? I think that we have the datasets, the sensing, and the infrastructure, the back-end to be able to help our customers identify that. And then when you have those two sets of data, you can start driving program optimization. We can do things that help our hospitals, our customers save money, save costs. In the environment we're in. I think this is powerful for them and strong for us. That actually looks like different products. That's the point. I won't take you through every one of these things, but these are the products that flow through, preoperative 3D modeling, we call it IRIS. Real time access to case reports, think of that as [fit-bit] [ph] for the surgeon available on their phone right after they stand up from the case. They can look at their history, they can look at what just happened. We have integrated Intuitive learning in portals that allow them to do that. We talk about personalized learning using machine learning techniques, that's the connection. We have integrated telepresence into our computing and the operating room. We have our Intuitive hub. Intuitive hub is an edge computing platform. It's a smart screen that sits cloud connected in the OR, or it can be locally connected depending what the surgeon wants to do. That allows data for them and data for us. We're going to talk about a computational observer. I had mentioned that too maybe last year or the year before, the ability to have computational capabilities sitting over the surgeon's shoulder and giving them some insights we call that procedure review, I'm going to touch on that in a minute. All of this goes through a single integrated entry point into the surgeon's hands and allows them to do things like order and maintain their relationship with us multi-platform aligned. So, that's what they do if you ever go out to one of the trade shows and walk through it, you'll see these various products. This is the point. This is what we're trying to achieve. Just to give you a little sense of is it actually happening? Again kind of trying to keep it real. Virtual reality training is a routine part of robotic assisted surgery training on da Vinci. It happens everywhere all the time. It grew 25% year-over-year last year. We've put our smart technology or edge computing into operating rooms that had 200% growth in procedures captured on da Vinci in the last year. People are appreciating it, gives them fast access to the data and the video that they just had. It's extremely easy to use, quite powerful. And the use and registration of our My Intuitive App, the mobile portal grew almost 600% in the year. So, these things are real. They're showing up in the hands of our customers and they're adopting it. I have talked to you about computational observer. I just want to talk about it. This will – we're now in about a dozen research, academic research institutions, working closely with clinicians on meaningful surgical science. If we have all this data, what can we do with it? We have some other data sensors coming too. So, the kinds of things that they're interested in doing are looking at how they're performing against expert surgeons, having correlation-based analysis that determines where they're doing something differently, connecting that to the electronic health record over a large data set. So that they can tell, was that clinically meaningful or is that a style difference? And then feeding it back to say, okay, if this is where you're struggling, this is who you ought to go talk to, perhaps in proctoring. This is what you might practice in virtual reality. Here's a way to connect the loop. Is it all validated yet? No. Does it work? I think it works. Have we done all the academic validations? That is to be done. That's why we're working with multiple academic medical centers to help us with it. It's a multiyear journey. The promise is quite high. The demand is off the charts. The rate limiting step is really how fast we can learn and how fast we can deploy. I don't think this will be a huge revenue driver. I don't want to leave you with that impression. I think what it is, is the core science that allows us to innovate with our customers going forward. So, our goal is not to perfect this and then charge an arm and a leg for it. I think what it is, it's a partnered effort with customers to generate insights that will drive surgery in a better direction. And I think with our products and services that will open opportunity and we will pursue it. In terms of Net Promoter Score, this is done blinded. It's a J.D. Power based survey. It's not ours. They go out and survey our customers, compare us to competitors and other things. We grew again in the year. Customers are appreciating our efforts and our approach. We're told world-class is above 70. We're running at 79. Why do they do it? What do we think is happening here? I think databased engagements with them, quadruple aim, demonstration world-wide evidence builds, belief, dependability of our systems and dependability of our staff is very high. The learning innovation and excellence, the investments in surgical science are highly appreciated. Our team has been very good and flexible to capital acquisition models. We've allowed them to reduce their costs while maintaining a strong economic performance for Intuitive. I think that's appreciated. And we're able to bring them analytics insights that are hard for them to generate themselves. I'm shocked, because they have very large data investments in electronic health records. And yet we still are able to routinely share with them opportunity. So, in closing, what are we driving this year? We want continue to increase utilization and penetration in the target procedures we think are important. Those are by country, by specialty and we have strong tactical plans and investments to support those efforts. On our innovation fronts, we're expanding indications and launching our new platforms, SP, Ion. A focus on quality of supply and reliability of supply as we emerge from pandemic stresses remains important. Our supply chain and logistics are not fully settled yet. We have an opportunity as we move to industrial scale to be more efficient inside our company and to drive both better quality out of our organization at lower cost and we're going to do that. So, we're making some automation investments inside the company, whether it's factory automation or workforce automation, some things that can help us. Well, great. Given the nature of your business and your global span, I thought we could kick it off with your views on the health of the capital equipment environment, what you're seeing around the world and any color U.S. versus OUS? Yes, I'll frame first with reflecting on 2022. So, if you just look at 2022, system placements were down 6%. We have to kind of double click. So, if you look at trade-ins, we saw about 510 trade-ins in 2021, that was down to 345 in 2022. And that really reflects the kind of decline in the installed base of SIs in the field. If you look at where we are at the end of 2022, it’s about 134 SIs left in the U.S. U.S. has been driving our trade-in volumes. So, trade-ins in the year in 2022 were down by about a third. If you look at incremental placements, greenfield accounts, the say net new, they grew 10% in 2022. If you look back to earlier in the year, what we described at the end of Q1, we saw it into Q2 was kind of an elongation of our capital pipeline. It really reflected given pressures, customers were under with staffing, with increased interest rates, et cetera. We saw customers start to take a close look at their capital budgets and reprioritize. And so that took some time. Come to the end of Q3, what we saw as customers resolve that process start to establish what their priorities are. And more recently, what we've seen on the capital front is, where customers have healthy growth in robotic procedures, da Vinci is a relative priority in their capital budgets. And so, we saw them then invest in Q3 and Q4 and you see that kind of reflected in the results. As you talk to customers from a capital perspective, they are clearly still cautious. I think staffing pressures are better today than what they were earlier in the year, but labor costs are still higher than, let's say, pre-pandemic levels, vacancy rates are still higher than pre-pandemic levels even though they're a little better. And of course, those customers they have to have higher interest rate expenses, et cetera. Supply chain and inflation is having an impact on everybody, including customers. I characterize the capital environment as cautious. When you look at, let's say, 2023, what our customers do with their capital budgets, I don't think we have yet any particular highlights that I would, kind of comment on. I would just say that customers are cautious. There's still a number of risks and uncertainties in the macro. The question of whether there'll be recessions, we'll see. So, I'd characterize it as cautious. If we look at the pre-announced numbers and guidance for today, fourth quarter procedures up 18%. Maybe you could give us a little more color on how that trended geographically and China has been a difficult environment. We see on the news, how that impacted. And then while you're at it, maybe also talk on the 2023 procedure growth of 12% to 16%. Gary, you touched briefly on what's included at the low and the high-end, but usually give a little more robust color. Any additional commentary there would be great. Sure. So, why don't I start off on procedure guidance first. So, procedure guidance for us for 2023 is 12% to 16%. At the low end of the range, it assumes ongoing choppiness with COVID hospitalizations and also staff and pressure at hospitals throughout the year. In addition to, as Gary has noted and in your question as well, assumes just significant ongoing challenges with China, right? You really can't predict what's going to happen there throughout 2023 in addition to just uncertainty with timing around the quota for capital. At the high-end of the range, it assumes no real significant impact from COVID throughout the year In addition to, say, ongoing growth in general surgery in the U.S. and diversified growth outside of the U.S., beyond urology, again similar to what Gary had presented. In that range, it does not reflect significant material supply chain disruption throughout the year or any hospital capacity constraints similar to what we had seen at the beginning of the pandemic. I don't know – with respect to maybe Q4 procedure trends, actually, what you saw was the U.S. and OUS procedure growth were both the same at 18%, I believe. And that 18% OUS growth is normally above the U.S., impacted by what we saw in China. We started to see, kind of a slow or moderate impact to procedures in China at the beginning of November. That accelerated through the remainder of the quarter. Last two weeks procedure impact in China from COVID as cases rose and as they kind of eliminated their zero COVID policy was a significant reduction in procedures in the last couple of weeks, and so that will continue into Q1. Obviously, I don't know how long that will persist. Our historical experience as Gary referenced was that at some point that recovers as you accumulate backlog of patients and as COVID pressures ease. Robbie, I overran my time. We're going to do lightning around now though. So, we get your questions. We'll keep them pithy on our side. No. Just a few more. Two, I really want to get to. Spending. We've seen Intuitive Surgical materially increase its spending over the past few years. You've added a lot of headcount at the business, a lot to R&D. You've also talked about in the last earnings call how you're going to moderate your level of spend year-over-year growth will be less in 2023 versus in 2022. So, two parts here. Maybe directionally, how do we think about how much you're moderating spend? And then second, where is the spending priorities and what are you investing in at the company? Just maybe quickly on some framing. If you look at Q3 year to date, we haven't released our Q4 results yet. OpEx as a percent of sales was about 34%. Just as a comparator pre-COVID 2019, OpEx was about 32% of sales, so about 2 percentage point difference. That increases predominantly in our newer earlier areas, Ion, SP, our digital investments, there's a little bit of higher regulatory costs given changes in requirements in the regulatory environment. And we've been investing in our infrastructure for the industrial scale that Gary just described. If you look at our operating expenses as we reported on a pro forma basis, we're actually at the lower-end as a percentage of sales relative to our medtech peers largely because our SG&A rates are pretty low. If you look at 2023, what we've said is, our operating expense growth will be below what we saw in 2022. 2022 we guided plus 21% to 23%. That reflects some leveraging and enabling functions and the sequencing of certain investments. For R&D and SG&A at this point for 2023, obviously we'll talk about it more in the earnings call. I'd expect them actually to grow at similar rates next year. There's obviously some mixes in there in SG&A. We're investing overseas given the growth opportunities there. We're leveraging some of the G&A functions. It will net to about - for SG&A as similar growth rate to R&D. Maybe two comments on my side. If you just kind of do a double click on hiring, what have we hired? Highest category is manufacturing, folks put the product together. In some places we've in-sourced some technologies that we think are either important from a supply chain robustness point-of-view or cost for the customer point-of-view has driven some manufacturing headcount. I think it makes tons of sense. Second category was commercial. Got to go reach out and touch all your customers. I think that's been really good. Third category has been engineering. So, we're not spending too much on R&D. I am not struggling with the level of investment in R&D. I think it's healthy, I think it's justified. Some things have been taking longer than they were historically. A couple of things are behind that. Supply chain disruption has made it hard for some developers. And the second part of that has been regulatory environments globally have changed data requirements. That [aggravates] [ph] me and I'd like to see us increase cadence, but that cadence is interacting with the environment we're going to have to work on. Maybe the last question ties in a little bit with your spending priorities, at least the way I'll ask, it is competition. You've spent billions of dollars over the years, 20 cumulative years of experience. You had a huge number of institutions with 7 plus systems. And as you said, this is more a proven idea versus experimentation. So, right now it's pretty much monopoly around the world. You have some new competitors coming in. How are you treating the competition? And what are you doing to make sure that it basically remains a near monopoly? Yes, I'll reject the framing of [monopoly in your monopoly] [ph]. So, [let's just stop that] [ph]. What do we look at and what do we think. At first, customers appreciate choice and they have it. There are systems being sold by competitive companies all over the world in Korea, local competition in Japan, local competition in Europe and in additional – there's actually competitors in the U.S. and there'll be more. So, how do we look at that? I think first of all, there's the validation of the space that technology-enabled ecosystems matter to customers is not just a robot. First of all, robots aren't commodities. A robot is not – they're not there yet. It's not that you walk up to one of these things. They all do the same thing. They all work the same way. Technology is not at that point. It may become that over time, but it's not there. That's one, but it's not enough. You want the entirety of the instruments and accessories, the imaging systems, the data that wraps it, and you need the dependability. We think if we do that well, customers will evaluate other options. I encourage them to do so. My thing is, you know, try before you buy, make sure you know what you're buying, but remember, you're going to live with this thing. And that has gone well for us. And as other companies have put more salespeople out into the market, we've seen total market growth grow and we've competed well with them. So, we want to be first choice of customers for the right reasons and so far so good.
EarningCall_1525
Good morning. My name is Emily, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Fourth Quarter PPG 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. I would now like to turn the conference over to John Bruno, Vice President of Investor Relations. Please go ahead, sir. Thank you, Emily, and good morning, everyone. Once again, this is John Bruno. We appreciate your continued interest in PPG and welcome you to our fourth quarter and full year 2022 financial results conference call. Joining me on the call from PPG are Tim Knavish, President and Chief Executive Officer; and Vince Morales, Senior Vice President and Chief Financial Officer. Our comments relate to the financial information released after U.S. equity markets closed on Thursday, January 19, 2023. We have posted detailed commentary and accompanying presentation slides on the Investor Center of our website at ppg.com. The slides are also available on the webcast site for this call provide additional support to the brief opening comments Tim will make shortly. Following management's perspective on the Company's results for the quarter, we will move to a Q&A session. Both the prepared commentary and discussion during this call may contain forward-looking statements, reflecting the Company's current view of future events and their potential effect on PPG’s operating and financial performance. These statements involve uncertainties and risks, which may cause actual results to differ. The Company's is under no obligation to provide subsequent updates to these forward-looking statements. This presentation also contains certain non-GAAP financial measures. The Company has provided, in the appendix of the presentation materials, which are available on our website, reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures. For additional information, please refer to PPG's filings with the SEC. Thank you, John, and good morning, everyone. I'd like to welcome you to our fourth quarter 2022 earnings call and my first earnings call as CEO. I'll keep my comments brief to provide a few highlights on the recent quarter, the year 2022 and our outlook. Let me start with the fourth quarter. Our fourth quarter sales of $4.2 billion were near the record levels achieved in 2021 despite significant unfavorable foreign currency translation. Sales were aided by our strong U.S. automotive refinish volume growth as supply chain disruptions started to moderate, and our order books remain robust. In 2022, our automotive refinish coatings business delivered over 2,000 net new body shop wins as customers continue to value the product technology and industry-leading services and capabilities that this business delivers every day, including what we believe is the best-in-class body shop full repair product [Indiscernible]. Also aiding our sales were record results in our PPG Comex business in Mexico as our team continued their strong execution and delivered another record quarter of sales and earnings. PPG Comex sales are now more than $1 billion on annual sales basis, another record year for this business. Our aerospace business continued to recover, delivering organic sales growth of more than 20% on a year-over-year basis, even with continued supply chain challenges. With an initial reopening in China, strong global order book, increased military related growth and PPG's advantaged technology products we expect this business to continue to grow in 2023 and beyond. Our adjusted earnings per diluted share from continuing operations were $1.22, above the midpoint of $1.13 from the guidance we provided in October. This included more than 20% year-over-year segment earnings improvement driven by selling price realization and strong cost management. On a two-year stack, selling prices were up about 19%. We achieved this segment earnings improvement despite the significant and unpredictable shutdowns in China from COVID-19 that were worse than what we had anticipated going into the quarter and these have continued into the first quarter. In Europe, despite demand remaining soft, earnings were similar to prior year due to strong selling price realization and cost management. We also continue to execute our previously announced restructuring programs and realization of acquisition synergies and delivered about $20 million of savings in the quarter. Now a few comments on the full year 2022. The challenges were many, including unprecedented cost inflation, unexpected geopolitical issues in Europe, disruptive and unpredictable shutdowns in China, strong appreciation of the U.S. dollar and rapid escalation in interest rates in the United States. Though all of these factors impacted our sales and margin performance, the PPG team responded to these challenges, including rapidly implementing real-time selling price increases that, by early 2023, will offset all cumulative cost inflation incurred since early 2021. Given the more difficult macro backdrop, we also announced, and are quickly executing new cost savings initiatives with particular focus on Europe. In 2022, we also made good progress on key strategic initiatives, including strengthening our relationship with the Home Depot, as evidenced by the launch of our new U.S. architectural Pro program, and winning more shelf space with our Glidden Max-Flex spray paint. In addition, we were honored to be awarded Home Depot's 2022 Overall Innovation Award, which was the first time that a paint supplier has achieved this distinction. Our partnership with the Home Depot continues to be a great opportunity for significant growth in the coming years. The PPG team continued the integration of our recent acquisitions, including timely execution of acquisition-related synergies. These businesses are all executing well and will provide the Company with increased organic growth prospects in the next few years. We made some smaller, but strategically important powder coating acquisitions, which adds needed manufacturing capacity and greatly aids our technological capabilities in this fast-growing product category. In 2022, we once again lowered our SG&A as a percent of sales, decreasing by about 100 basis points, including the delivery of about $65 million in restructuring savings in the year. While working capital remains higher than we would like, we made solid progress in the second half 2022 to lower our inventories on a sequential basis. We expect cash conversion to return to our historical levels in 2023 and have exited 2022 with a strong and flexible balance sheet. Throughout 2022, we took actions to bolster our ESG program, including announcing our commitment to the science-based targets initiative, issuing our first-ever diversity report, and finally obtaining shareholder approval to declassify our Board and remove supermajority voting requirements. In 2023, I expect our team to continue their strong progress by introducing additional sustainable products for our customers and unveiling our new 2030 sustainability goals. In summary, for 2022, we did not meet our own earnings expectations. But through the resiliency of the global PPG team, we did deliver record sales of $17.7 billion and set the foundation for many accretive growth initiatives. Now moving to our outlook. As we outlined in our press release, we expect the Q1 demand environment to remain similar to the fourth quarter. However, as the year progresses, we are more confident that we have several catalysts that will enable PPG to drive earnings growth, including improvements in the supply chain, which will further moderate raw material costs, and we expect to see this flow through our P&L more prominently starting in the second quarter. Also, our strong position in China that will benefit us as the COVID reopening progresses. With respect to Europe, we expect coatings demand stabilization beginning in the second quarter, resulting in higher year-over-year earnings. In the U.S., we will benefit from the continued recovery of the aerospace and automotive refinish businesses and the current strength of our order books in both of those businesses. Also in the U.S., our recent share gains in the architectural business will help buffer lower demand from a softer U.S. housing market. As a reminder, our overall exposure to the U.S. new home construction market is relatively small, only about 1% of our global revenues. As we said last quarter, we believe our global portfolio mix will prove more resilient in the coming quarters if we experience a broader global economic decline. As normal course of business, we will be highly focused on controlling the controllables, including managing our costs and optimizing working capital. In summary, while economic conditions are challenging in the near term, I expect segment margin recovery to continue in the first quarter and remain confident about the future earnings capabilities of PPG, and we certainly see a path to return to prior peak operating margins with opportunities to exceed it. As I begin my tenure as CEO, the PPG team is laser focused on delivering improved financial results, including recovering our historical margin profile, and executing on all levers to return our portfolio to mid- to high-teen percentage segment margins. At a high level, you can expect me and the PPG team to elevate our collaboration with our customers, bringing them innovative, sustainable and differentiated products and solutions, which will enable our customers to improve their productivity and growth and allow us to improve our own organic growth performance. We'll simplify and optimize our manufacturing and supply chain efficiencies to reduce complexity and deliver productivity for both PPG and our customers. And we will preserve our legacy of prudent management of our balance sheet, continuing to prioritize cash deployment for shareholder value creation. I plan to share more details on our key initiatives as the year progresses. In closing, I am looking forward to leading this great team, 50,000 employees around the world, as we continue to partner with our customers to create mutual value. This year marks PPG's 140th year anniversary, and I strongly believe that our best days are ahead thanks to our people, industry-leading products, innovative technologies and great customers. Thank you for your continued confidence in PPG. Tim, for the full year, consensus was around $7 per share, which will imply a pretty big ramp up from the Q1 levels. Is that a number that you think you can -- that can be achieved or get close to as year progresses? Yes. Right now, David, just because of all the uncertainty in many different avenues of our business, we're focused on Q1. And clearly, Q1 has some hangover elements from Q4, particularly around China. We do believe, as I said in my comments, that there are the shopping list of multiple potential earnings growth catalyst for 2023, including China, including aero, including refinish, including Comex, EVs, THD, literally a shopping list of potential earnings catalyst, but we'll get through this hangover of Q1 and then reassess and communicate more as we move forward. Tim, I think your outlook for the first quarter is down mid-single digits for volumes. Can you walk us through what the volume outlook is from your less cyclical markets and your more cyclical markets to give us a gauge of kind of where those are at for the first quarter? Sure, Mike. I mean the biggest impact is again China. Typically, in China, March is a very big month for us, okay. And our assumption for China in Q1 is that they'll see a second wave to some degree after Chinese New Year. And so our base case is that we won't really see significant China recovery until starting in Q2. Additionally, on the architectural side, particularly in Europe, we would normally, in Q1, see a fairly robust stock up ahead of paint season. And because of everything that's happening in Europe that we see some buildup, but not nearly what we would see in a normal year. And then finally, one of our top-performing businesses, PPG Comex, typically has a very strong Q4, and it had an even stronger-than-expected Q4 in 2022. So there's a little bit of just timing there, even though we expect another great year from that business, there is timing issue in Q1. So those are the three main factors, I would say. Mike, this is Vince. Just [Indiscernible] the other businesses. We're not seeing any tone change in the businesses sequentially again, good strong pace of recovery in aerospace, a solid, consistent growth in refinish, auto OEM, consistent -- generally consistent quarter-over-quarter, starting to recover in Europe. So again, we're not seeing any significant changes in some of the other key businesses either. Just a real quick question on pricing. Can you just comment on the current pricing environment just given the macro movement in, let's say, raw materials and then also several management changes across the sector. Are you still seeing the ability to sustain price throughout the year? Just any commentary would be incredibly helpful. Yes. Sure. Thanks for the question, Chris. You saw on the print that we put up 11% for Q4, 19% on a two-year stack, sequentially it was 18% on a two-year stack in Q3. So we still have pricing momentum. We will have additional price in Q1 targeted by business. We've got some carryover impact in Q1 as well. As for what's happening out there in the world besides PPG, all the coatings companies are facing the same inflation inputs that we are, be it raw materials, which we focus a lot on but there's also significant inflation outside of raw materials that we are all experiencing. So, we see a continuation of positive pricing as we enter the year. And beyond that, a lot of it depends what happens on the inflationary environment, but that's our view at this point in the year, Chris. Hi, guys, good morning. As it relates to the U.S. architectural, I mean, obviously, there's bifurcation so far between yourself and some of the professional markets. How do you sort of see that evolving over time as the year unfolds? And then for European architectural, just given the extent of the volume weakness in the markets, can you just give us a sense as to how competitive the pricing backdrop is in the industry, just given the volume weakness? Sure. Thanks, Ghansham. So let me start with the U.S. environment. I'll start at a high level from a macro standpoint. Clearly, DIY is down partly because of what's happening with consumer confidence, but also a bit a holdover from the COVID piece of DIY. And clearly, new housing construction going down, again, only 1% of our sales, but those two segments are down. Fortunately, for us, we're much stronger in commercial and maintenance. And there, we still see backlogs with our customers. I think you know we do a survey every quarter with our professional customers here in the United States. And their backlogs are still floating in that 12- to 13-week range. So we still see some good demand there. And then as we move forward, we expect to continue to see growth from our Home Depot Pro program moving forward. Now going over to Europe, the volume started to really deteriorate after the invasion last Q1, and was down double digits throughout all of 2022. The professional painter business down not nearly as much more in the single digits, but as we enter 2022, we'll see particularly for Q1 -- I'm sorry, 2023, for Q1, we've got a little bit of a comp issue where we're still comping part of the quarter to the pre-war era. But then once we get to Q2, we start to have, frankly, some positive comps because our total business in Q2 in Europe was down about 10% double digits, low double digits. So we do see it more or less kind of bouncing off the bottom, if you will, as we end Q1 and then comping better as we get into Q2. Tim, you spoke in your prepared remarks about the target of mid- to high-teens margins for PPG going forward. Is it a function of just raw materials getting back to normal and kind of having that catch-up kind of finally been made? Or do you see a lot of manufacturing efficiency improvements that may have uncovered themselves through some of the supply chain problems, what have you? And if so, if it's the latter, can you help us to understand what some of those levers might be? John, this is Vince. I'm going to start, and I'll let Tim add some color here, but really three levers. One, we've been chasing, which is the raw material price, or total inflation price gap, which, again, we think will be kind of on that in early 2023. We call it weeks not uneven months. But the second, which I think is important is and you hit on it, John, we haven't had a strong manufacturing couple of years here due to disruptions, due to supply disruptions, due to customer disruptions, COVID disruptions, due to churn in the workforce that many companies are seeing. So we do -- that is not a significant number for us from a manufacturing perspective. But the third, which is very important, though, is we're still down about 10% versus pre-COVID levels in terms of volumes spread throughout our portfolio. So, those are the three big levers and Tim can add color here. Yes, you really hit the Phase 3, but particularly to the volume, we've got aero still down significantly. We've got auto, auto has been at recession levels for three years now. There's pent-up demand across the planet for cars. Refinish is still down 10%-ish from 2019. In addition to what Vince mentioned, we have done a good bit of cost out during this period as well and restructuring. So we'll get levered from that. We're not completely finished with our acquisition synergy realization. So, as I said, I used the term shopping list. We've got a shopping list of items that are contributed to our margin in public. Yes. Thank you. Tim, you made a comment a few minutes ago about inflation outside of raws. And I just wanted to drill into this near-term outlook of yours of low-single-digit inflation in the first quarter. Is that a comment on broadly cost of goods? Or is it just raws? And are you also seeing it in labor and freight and so forth? And maybe just on the raw side of that, for first quarter, when would you say that flowing through cost of goods is based on? What month would be the midpoint of your purchases that would flow through cost of goods in the first quarter versus your purchases of those raws today, what would you say that would reflect in terms of maybe second quarter raw material costs? Sure, Steve. I think the numbers you were quoting at the beginning of your question were raw material, okay? So Q4, we were up mid-single digits year-over-year, down low single digits sequentially. In Q1, we expect to see modest down year-over-year and another sequential step down. The reality of flow-through is, we're really flowing through inventory that we have on hand now pretty much and that will flow through throughout Q1. So, we're expecting the positive benefits of that on the P&L to really not show itself significantly until Q2. Okay. And then on the other inflation, that's going to be, at least for now, that's going to be pretty constant as we move from Q1 into Q2 around labor inflation and some of the other installations. Yes. And, Steve, just going back to what Tim said earlier in the call. That's why we're doing targeted pricing in -- across our portfolio to compensate for this other inflation that's going to be higher year-over-year, primarily labor. I'm not seeing as much freight as you pointed out. It's not been an inflationary factor the last couple of quarters. Question just around price. So, as you ended last year, if you just anniversary the price that you had at that point, how much would that move up price this year just from an accounting standpoint as we roll through? And two, I'd imagine you've gone out with a lot of your price increases already. So if you average that across the Company kind of what's the ask on price that you've sent out to customers so far this year? Yes. Duffy, I'll handle the first part of the question. The carryover pricing -- we do have every quarter, our price off of our sales base so that you can do the math. You come up with several hundreds of millions of dollars of price carryover in 2023 and from our 2022 pricing initiatives. Again, if you just do the math, you can easily come up with that. It's certainly north of $300 million and will be carried over. Yes. And Duffy thanks for the question. It's Tim here. On the new pricing, if you will, it will be more targeted just based on where each of the segments are on their catch-up and on offsetting total inflation and new inflation. We've already gone out for additional price in a couple of businesses. We're having discussions with customers in a few other businesses, and we'll prefer to have those discussions with the customers first and -- but we'll have more visibility on that as we move forward. But we will have positive price when you net all of that here as we move through '23. Tim, in your focus areas, you mentioned simplification and optimization of supply chain and manufacturing. I was wondering if you could talk a little bit about this and maybe size the opportunity on costs and working capital, and other areas where you think you need to rationalize the footprint based on a structurally lower demand environment for instance in Europe? Yes. Thanks, Laurent. If you look at our journey over the last decade and we've got a lot of acquisitions, we've acquired a lot of manufacturing [indiscernible]. We've also acquired a lot of product portfolios, and we've captured a lot of synergies along the way. As we look at where we are today and some of the things we've learned through some of the supply shortages, et cetera, of the crisis, we believe there's fairly significant opportunities for us to really simplify, not only our footprint, but our processes, simplify and standardize some of what we've acquired, simplify some of the portfolios that we've required are. So, we do believe that there's some significant upside for us there as we move forward. And as you can imagine, that's not as quick a realization as, say, procurement synergies when you first close the deal, but we feel pretty confident that in the medium and long term that we can deliver value there. Tim, a question on your U.S. architectural business, if we look at most of the macro indicators for housing and construction, they're slowing markedly in recent months. On the other hand, you have some company-specific tailwinds in the form of a ramp of your Pro paint program at Home Depot. I think you also referenced increased shelf space at Glidden. So can you frame that out in terms of what you're anticipating maybe volumetrically as 2023 progresses in that vertical? Yes, Kevin, this is Vince. Let me just start on the macro. Again, what we're seeing, which I think has been pretty chronicled is new housing starts and leading indicators, certainly pointing down. We really have to bifurcate that. Single-family housing starts are significant, significantly down. Multifamily, we expect to turn down, and they're starting to turn out, but there's still going to be growth. Multifamily completions, again, paints at the end of the cycle here, there's still completions that will carry us well into the year. Tim mentioned earlier on the commercial side, commercial new build, again, for the -- sorry, for the first half of the year should be some constant, if not longer. And then commercial repaint is solid right now. And there's a backlog on that. So, those are the macro signs and we do have some PPG-specific items that Tim's can talk about. Yes. Yes, the PPG specifics, you know well about the THD Home Depot Pro program, and we expect double digits from that program again this year after strong double digits last year. The other one, we've got a nice additional retail win. Our customer is going to announce it first, but you should hear in weeks, possibly months here of what that is, that will help offset some of the other things that Vince mentioned. And then the spray paint win for us with that innovation award at the Home Depot is -- we're excited about opportunity to not only leverage that specific product, but expand that offering either further. But when you put it all together, Kevin, we are expecting net-net for volumes in that space to be down, but of course sales to be up with the price offsetting the difference. First, I want to extend my sympathies to the PPG's family on the passing of Bill Hernandez. He really was a great, great guy. Tim, I appreciate your answer on the full year EPS question, for sure, given all the uncertainties. But you already indicated that you expect European earnings will be up year-over-year in the second quarter. And you also mentioned that your folks on the ground in China are expecting China to really pick up come April. And so I'm wondering, is part of your calculus that we will likely see higher year-over-year EPS in the second quarter? Well, again, Frank, first of all, thanks for the call out to Bill Hernando, a loved PPG partnered here for many years. and just a world-class CFO and great human being and been a tragic and sudden loss this past weekend. So thank you for calling that out. Frank, at the end of the day, the uncertainty at this point with what's happening with China and when and what's happening with Europe and to what degree, and what's happening to raw material pricing and the specificity of that raw material pricing, as you know, can change our earnings profile fairly significantly. We're just not in a position right now to put out a statement on Q2 EPS. That said, as I said earlier, I believe we've got a hangover in Q1, but a number of those, let's call them, earnings levers start to come due in Q2. Yes, Frank, this is Vince. We do give this up. If you look at our profile of countries, China is one of our largest countries for sure. So there's still uncertainty there as we pointed out, and Tim pointed out in the opening remarks about the timing of the opening. Right now, we certainly hope March aerospace a strong month. Definitely April too hard to predict April, which is Q2 is typically a very good quarter in China. So, we're not in position at this point to provide any real line on that at this point. I just have a couple of follow-ups here. First, do you think you can achieve the low end of your margin targets this year in 2023 on average? And second, if you could comment on your ability to hold prices across the businesses as we move through this year? And any comments there versus why this might be different versus prior cycles? Yes. Josh, one lever to help us improve earnings, again, we're not trying to give full year guidance on margins, and that's even harder pass than top line. So, we'll defer that till a little bit later into the year. Your question on pricing, I'm going to let Tim answer it. Yes, Josh, I'm confident in our team's ability to hold price similar to prior cycles. And with this cycle, possibly even more because of other inflation that is more persistent than we've had in other cycles. So that's -- we're confident in that. I think you commented in the prepared remarks that you've got auto builds flat in 1Q, and I think the consultants are still calling for it to be up about 2.25%. So is that just something you're seeing in your own book? Or are you anticipating those consultant numbers to come lower? And just, in addition to that, could you talk about how you anticipate the mix of auto builds this year? Is there going to be any different than last year, and would that be a plus or minus for you? Yes. Thanks, Vincent. Well, first of all, historically, I don't want to brag, but historically, we've actually nailed it pretty well compared to some of the external consultants on the builds because we got so many people in the plants every day. We have visibility to operating schedules, and we talk to those folks. So, the difference for us in Q1 specifically is China. Because our base case is that there will be, to some degree, a second wave after Chinese New Year of infections, and we saw what that did on the first wave to assembly plants and other suppliers. So that's our base case, and that may explain the difference between us and some of the consulting houses out there. But beyond that, we're expecting modest growth for the year, low single digits. And that's an area where there potentially could be upside, but our base case is low single digits. Yes, just to give you some examples specifically of what happened on the ground in China, and why we are a bit cautious on the post-Chinese New Year. When things opened up in mid China -- I'm sorry, mid-December in China, we've got 19 PPG manufacturing sites across the country. And we went from near zero absenteeism very quickly to above 50% absenteeism across that whole network. And that has returned very rapidly to near zero in a period of about 2.5 to 3 weeks. And we saw that same in some of our other suppliers, assembly plants, you name it. So we've lived it, we've seen the data, and we believe that as people travel to the families that more travel than the last three years across China for Chinese New Year, as they travel to some of the more remote villages to visit their families in return, we do believe there will be a short, but acute second wave. And so that's why we're a bit more cautious. And as Vince mentioned, March is a huge month normally for our China business. I just wanted to clarify your raw materials commentary from earlier. It sounds like you are currently destocking sort of earlier raw materials purchases and will begin to purchase more perhaps in the second quarter. So, there could be more of a step down in the cost. Is that the right way to think about it? Yes. Aleksey, let me provide some -- maybe some clarity here. So we did see, as Tim mentioned, some modest sequential raw material deflation Q3 to Q4. We expect a -- we expect a further incremental deflation in Q4 to Q1. We were still up Q4 year-over-year. And we have to work that deflation through our inventory, which will take us likely through the first quarter before we see that impact on our P&L. And so that's, I think what we were trying to articulate. We do have -- as Tim mentioned, we do have efforts underway to optimize our working capital, primarily our inventory. We ended July or June with exceedingly high inventory levels. We worked in the second half of the year to work those down, and we're still working those down as we get into the first quarter of 2023. So, they're still above what we want to be our target range. So, we're still going through various destocking depending on the region, depending on the product. So, we will have print raw material purchases in Q1 and likely some crimped on material purchases in Q2 as well. Good morning, Tim, Vince, and John. I just wanted to ask a question about auto refinish. You won 2,000 new body shops in 2022. Was that concentrated anywhere regionally? Or was there something else common to those shops that switched? And when you talk about 15% higher productivity, is that relative to the prior supplier to those shops? Or how are you defining that since you're leading competitors also talking about having productivity higher than the competition? Yes. Thanks, John. To your first question, our net wins on body shops are positive in all the major regions, U.S., Canada, Europe, Australia, New Zealand and China. It's just proportion to our business that the vast majority of those are in the U.S. and Europe. Relative to the whole productivity question, the way we look at it is change is only as strong as its weakest link. And so every link on the refinish body shop throughput has to be strong in order to really drive what's most important to the body shop owner, and that's what they call key to key time. From the time you take the vehicle owner's keys until the time you hand those keys back to the vehicle owner. That is the one and only metric that that is present. So if you are incrementally faster in one of those steps, but slower in several others such that your key to key time is 15% lower, than you're simply not as productive in the eyes of that -- in that body shop over. And so we focus on that end-to-end with things like the digitized color match, our linked digital system that really encompasses the whole body shop, the visualizer, optimized mixing to improve speed, eliminate waste. And another thing that's really important to the body shop owners right now that PPG's value proposition delivers and some of our competitors don't, is you're actually simplifying some of those steps with things like moon walk and the visualizer so that the constrained flavor of the professional painter doesn't always have to be the one to do that. You open it up to other labor that can do that and that adds additional productivity of the body shops. So again, the most important thing is that key to key time, and that's where we have the 15% advantage. Yes, good morning. Tim, clearly, the housing market is slowing down, whether you look at new homes or existing home sales. Have you seen a slowdown in the contractor business? The contractor business was robust. Last couple of summers, they had a huge backlog that they were working from COVID. As that backlog is worked down, do you expect some slowing in the contractor business? Yes, P.J. Yes, we have already seen a slowdown in contractors that are primarily focused on new housing. That's a brutal reality that we all have to face. But again, that's a small portion of our business. Our backlogs for where we're strong, which is commercial and maintenance, literally have moved only incrementally, 13 weeks average backlog in Q3 to 12 weeks average backlog in Q4. So, that's what's been the margin of error of four survey. So that's holding up much better than the new build. I believe part of that, if you think about a lot of commercial work and maintenance work and light industrial work, a lot of that work was near zero during COVID, while the DIY and res repaint was offsetting it. So there's still a lot of pent-up demand there. So I don't -- as I said earlier, the total volume is still going to be incrementally down. So I don't want to oversell that. But that's why some of our Pro business is holding up better. I just had a bit of a follow-up on the raw material basket. Can you just help us with how you think about that evolving broadly over the course of this year? I guess, with 1Q demand being pretty benign or restock volume was down five-ish-percent or so, why do you think input costs aren't coming down faster? And if China does recover in 2Q and beyond pretty quickly, how do you think about what that does to your raw material cost? So, Mike, I'll start and let Vince fill in some color. I think there were some actual artificial demands in the second half of '22 that has maybe delayed some of the basic supply-demand economics, because you'll recall that for most of '21 and the first half of '22, raw material availability was our number one issue and a lot of our coatings peers' number one issue. So as that availability improves, we all stocked up and got safety stock and, at the same time, demand started to collapse. So if things were kind in -- when I say collapse, I mean, particularly on the DIY and eco side, but big driver to the overall raw material change. So, I think a lot of companies, and you've seen that in what companies have said, ended the year with more inventory than they would like. So, there was a bit of artificial demand that delayed what would be a normal supply demand curve. Yes, Mike, let me just add some color here. So as we enter 2023, again, we're destocking. We know from a public commentary, a lot of our peers have excess inventory and are destocking. I do think there is this type of war with the supplier base typically Q1 and Q2 are peak volume orders for coatings raw material purchases. I don't think that's going to materialize in the same manner this year. So, we'll have a lower buy -- PPG will have a lower by in Q1. We have suppliers in virtually every week or every day for the past couple of weeks, indicating to us to have excess supply to give to us. And so, we're going to maximize that to the benefit of our shareholders. And we'll negotiate our Q1 and Q2 pricing accordingly. We do believe, as we said for the last couple of quarters, there's ample supply in our supply base. This is Silke for Jeff. I was wondering whether you can discuss your volumes and your price and your U.S. architectural stores. And secondly, I was wondering whether you can talk about what's happening in the packaging business? Sure. So, the stores pricing, we've raised price there multiple times, and we held that price throughout the year. And 2023, it will depend on what happens from an inflation standpoint, but that's one of the businesses where we moved fairly quickly to keep up with cost inputs. On packaging, we did have strong margin recovery in that business throughout '22, and we expect that to continue in 2023. We do see some softness there in pockets around the world, driven by -- in China, it's the lockdown. And in Europe, it's just consumer confidence in beverage spending. So, we have seen some softness in volume, but strong margin recovery. And we also continue to convert to our Innovel Pro BPA-free content material, and we've had some nice wins in that beverage space, that will be launched as we move through this year. But overall, at a high level, good margin recovery, some softness in demand around the world. I guess my question is about some framework you've provided in the past. If we go back maybe a year, 1.5 years ago, you were discussing maybe $9 of earnings for 2023. Do you see that as still maybe a possibility a couple of years out that would imply another $400 million, $500 million of EBIT on top of where you are, so what's the framework to get back there? Is it kind of that high teens EBIT margin and maybe the recovery of the volume? Or would you need more than that to get back? And is that still maybe again available in a couple of years' time? Yes. Arun, I've said before, I believe that the $9 EPS is when, not if, and I stand behind that. And that's because the fundamentals are there. We have portfolio that has earnings power that has yet to be released. And I won't give you my entire 10-point plan that will get us there, but you've still got recovery in some of our better businesses, aerospace, auto, refinish. Let me talk about auto for a second without going too far off topic here. But if you take a six-year run rate of global builds before COVID, compared to the -- I'm sorry, 2021, '22, there's 40 million fewer cars that were built during that three-year period compared to the six year before. So, everybody has their guess as to how much of that 40 million will be made up over time, but it's not zero. And so that business has a lot of volume recovery to go. We've got the price/cost momentum. You've heard about our restructuring, acquisition synergies, some of the technology innovation, productivity, sustainable products that will drive share growth. And then just broader volume recovery, we feel confident that the $9 is a when not yet. And just Peru, just a couple of comments it's actually a little more near term. So if you look at 2022, we have to remind -- Tim mentioned this earlier, but it's a good reminder. We really saw Europe fall really the back half of March. So, we're going to come up against some recession type volumes here in a couple of weeks. We remind everybody that, in Q2, China was shut down, industrial-wise, for almost two months. So again, we don't think 2022 was representative in China of a traditional -- even a compressed run rate on GDP growth. So, those two outside of aerospace, outside of refinish, we think have some opportunities to contribute. And again, as Tim mentioned earlier, we expect very good leverage above historical average leverage as volumes return in any business. It's Dan Razon on for Lawrence. Just in terms of the backlog you mentioned, I think you said commercial backlog was 13 to 14 weeks. And then I think in the comments, you said a $200 million backlog in aerospace. I was just for comparison purposes. How -- what does that mean like versus what, I guess, historically it's been? Yes. Dan, historically, that 12- to 13-week or U.S. PRO paint is actually still high. So that will offset some of the negative volume in some of the other segments. I can tell you that in my short 35.5 years of with PPG, I don't remember the aerospace backlogs ever being this strong. And that will take us -- that's pent-up demand for the foreseeable future. Refinish, our refinish backlogs are still, particularly here in the U.S., probably 5x what they were pre-COVID. And it's not only a matter of us getting product out or getting raw materials in, our refinish customers' backlogs are high. I hope you haven't had any minor fender benders lazy, but if you have and you've taken a car to a body shop, they're likely to tell you it's six to eight weeks before you're going to get that car serviced and taken care of. So the backlogs across all of those spaces are high, and in some cases, historically high. Yes. I'll answer the color, Dan, to the aerospace figures here. So we said before, aerospace is circa $1 billion business for us. This $200 million backlog is typically a small fraction of that. So this is almost another two months of activity. If we can get it done this year, we're still facing some supply challenges that are governing what we can do in a particular month or quarter, but it is a significant backlog relative to historic terms. Yes. And I'm going to grab that back one more or one more comment. The demand in aerospace is actually growing as we progress through the months and quarters. So you've got kind of the underlying demand is growing, which means that $200 million backlog is going to be there even longer. And recall that China, international travel only opened on January 8, so that's going to be another stimulus for aerospace demand. In the auto OEM business, a question on electric vehicles that hit 10% of global car sales last year, I was hoping that you could give us an update on some of the key products that you're providing for electric vehicles. Any recent wins or other metrics you can share on that portion of the auto OEM business? Yes, Mike, we're really excited about EV because we are winning where the EVs are winning, okay? We're winning where the EVs are gaining the most and that giant. You probably saw the journal article here not that long ago. It's something like 65% or so of the EVs sold last year wherein in China, and that's where we're having the most success. In fact, we're growing significantly with the largest EV producer in China. The way we're approaching is, it's not only about new technologies, it's about picking the winners on the EVs and selling, let's say, more conventional corrosion protection and beautification products to those customers. So it's a combined effort of selling our new and differentiated products like our battery fire protection, and our dielectric coatings products to those customers, but also targeting and winning with the EV winners in the market. [Audio Gap] partly because of the crazy raw material inflation you've seen. Now as raw materials tail off, are you not getting pushed back from your customers when you're trying to do these targeted pricing, especially in a demand environment, which has at least changed and has slowed? That's my first question. And the second question really is on protective. Could you just tell us like what's the backlog in marine and protective these days? Jaideep, I'm sorry, the beginning of your first question kind of -- I apologize, but if maybe you could repeat your first question for us, please. Yes. So, Jaideep, I'll take it and then Vic, you can jump in. On pricing, you got to remember that the pricing that we've achieved over the last couple of years was to offset what's happened in inflation in the last couple of years. And our customers have visibility to what's happened to our net margins. And so, they have optics on where we are on a margin recovery standpoint and they also know when we have these discussions with them that we're not back to peak margins. And so it's not like we're going, in most cases, above and beyond that. So, as we move forward, we'll continue to be competitive, and we'll continue to price to offset non-raw material inflation. Before Tim answers the protective question, Jaideep, I think we have discussions with our customers and almost every business. And they want us to be a healthy supplier that continues to innovate and they understand that and again, get paid a fair price for innovative technology that typically helps them. And we're coming into a period of time, given the inflation and base and salary where our customers really value functional attributes of our coatings products. And again, they're pushing us -- not so much on products, they're pushing us to help them with their productivity right now, which is a much bigger cost pull for them, cost opportunity for them than the price on coatings. So again, we're in a lot of discussions with our customers about how to improve their productivity, which again is a key attribute for them. Yes. On your protective question, our protective and marine business actually had a very strong year last year. Even though there was volume degradation in Q4, that volume degradation was China because whether its marine new builds or large petrochemical protective projects, a lot of those are done in China. So, that will -- some of that will follow the China closing and then reopening curve. But beyond that, a couple of things are happening in protective. There is significant investment in LNG, all aspects of LNG, and that's that area uses a lot of our advantaged protective products. There's an infrastructure investment certainly coming in the U.S. and other countries that leads to future growth for the protective business. And then, finally, on a PPG-specific protective opportunity, we had a fantastic distribution network in Mexico, over 5,000 store locations that has historically been very heavily architectural and deco focused. Well, we're now leveraging more and more of that network to grow our protective business, which is how we're successful in that business in other countries, like the U.S. and Canada. So, that's a really great growth opportunity in the protective area that differentiates PPG.
EarningCall_1526
Good evening and good morning, ladies and gentlemen, and thank you for standing by for 17EdTech's Third Quarter 2022 Earnings Conference Call. Well, at this time, all participants are in a listen-only mode. After management's prepared remarks, there will be question-and-answer session. As a reminder today's conference call is being recorded. I'll now turn the meeting over to your host for today's call, Ms. Lara Zhao, 17EdTech's Investor Relations Manager. Please proceed, Lara. Thank you, operator. Hello, everyone, and thank you for joining us today. Our earnings release was distributed earlier today and is available on our IR website. Joining us today are Mr. Andy Liu, Founder, Chairman and Chief Executive Officer; and Mr. Michael Du, Director and Chief Financial Officer. Andy will walk you through our latest business performance and strategies, followed by Michael, who will discuss our financial performance and guidance. They will be available to answer your questions during the Q&A session after their prepared remarks. Before we begin, I'd like to remind you that this conference call contains forward-looking statements as defined in Section 21E of the Securities Exchange Act of 1934 and the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements are based upon management's current expectations and current market and operating conditions, and relates to events that involve known and unknown risks, uncertainties and other factors, all of which are difficult to predict and many of which are beyond the company's control. These risks may cause the company's actual results, performance or achievements to differ materially. Further information regarding these or other factors -- uncertainties or factors is included in the company's filings with the U.S. SEC. The company does not undertake any obligation to update any forward-looking statements as a result of new information, future events or otherwise, except as required under applicable law. I will now turn the call over to our Chairman and Chief Executive Officer to review some of our business developments and strategic direction. Andy, please go ahead. Before we begin, I would like to mention that the financial information and non-GAAP numbers in this release are presented on a continuing operation basis, and all numbers are based on the RMB, unless otherwise stated. We managed to deliver resilient performance in the third quarter. Before we go into the details, let me update you with some quick highlights. Firstly, we recorded RMB124.6 million of net revenues in the third quarter of 2022, contributed by our new business despite the uncertainty and economic impact associated with recent COVID-19 outbreaks. This represents an increase of 549% compared with the revenue of RMB19.2 million excluding the legacy of online K-12 tutoring services in the third quarter of 2021. Secondly, we are able to continue narrowing net loss on GAAP basis through efficient cost and expenses management, allowing us to achieve net profitability on a non-GAAP basis for the fourth consecutive quarter. Thirdly, we continued to develop and upgrade our teaching and learning SaaS offerings together with our clients and to explore personalized self-directed learning products and better satisfy customer needs. Now, let me go into some details. Let's start with our in-school teaching and learning SaaS-based business. The third quarter of 2022 saw a few milestone progresses in our in-school business in Shanghai Minhang District. Our services now achieves full coverage from primary to high schools. There are 128 schools with 156 campuses that are now using our precision teaching and adaptive learning system to assist the day-to-day teaching. The accumulated number of students using the tool for homework also exceeded [40 million] (ph) as of now. We introduced intelligent dot matrix pen in September and launched a trial with 20 schools to advance digital transformation of teaching and learning intelligent dot matrix pen facilities, curriculum development and tutors to different demands of schools. We have been awarded the intelligent in class and homework SaaS service contract at Shanghai Chongming District during the reporting period. Our precision teaching and adaptive learning system were used to promote digitalization of teaching and learning with virtualized data to facilitate school management and student development. This is a milestone product illustrating growing demand and market acceptance for SaaS services and recurring SaaS billing model. Strategic cooperation and pilot school programs in relation to digitalized homework and teaching platform are also being launched across different districts in Shanghai and other cities, such as Songjiang District. Likewise, we were also awarded two contracts by Beijing Xicheng District to help build online integrated student evaluation platform and an integrated student learning performance evaluation platform. These two systems make full use of live streaming tools of existing digital school platform to create a closed loop from question bank, design assignment, collection, traction, analysis, feedback, research, management during whole teaching and learning process. It allows conducting key scenario through online setting. We have also attended a number of education exhibition and forums, receiving positive feedback on our product and services from teachers and education experts. In the third quarter, we have also entered into a strategic partnership with a local partner to joining construct a digitalized education platform for our city with more than 2,000 schools and the 1.5 million primary and secondary schools. From a product and a service offerings perspective, we are integrating an increasing level of artificial intelligence and IoT technologies application to fully enhance user experience and achieve a closed loop teaching and learning measurement for schools, without disrupting transitional teaching and learning habits. In the aspect of a self-directed learning products, we continued our efforts in exploring developing self-learning products that caters to various kinds of demands of our customers based on the educational content and data-driven insights we have accumulated during last decades serving students in school. We continue to see positive feedbacks from students on our products, being helpful to supplement their in-school studies, satisfying students‘ diversified learning demands, and provide them with targeted customized learning content in line with the government regulation and assists to form an integral self-directed learning experience and to improve their learning efficiency in a personalized way. We continue to see revenue contributions from such products and with the great potentials in the segment evolving with the regulatory environment and the students’ needs and form into a major new compliant market in the education sector. We would like to note to our shareholders that the impact of the recent outbreaks COVID-19 across different regions in China. It has caused these delays and uncertainties in various biddings and contracting process associated with government procurement. The overall economic environment has also led to uncertainty and concerns around household income and municipal budgets. We are closely observing the trend, adopting prudent strategies to minimize impacts from such uncertainties and concerns, allowing us to be flexible under certain environment. Now, I will turn the call over to Michael, our CFO, to walk you through our latest financial performance. Thank you. I will now walk you through our financial and operating results. Please note that all financial data I talk about will be presented in RMB terms. I would again like to remind you that the quarterly results we present here should be taken with care, and reference to our potential future performance are subject to potential impacts from seasonality and one-off events as a result of the series of regulation introduced in 2021 and a corresponding adjustment to our business model, organization and workforce. The third quarter of 2022 is the fourth quarter of operation after we officially seized our online K-12 tutoring businesses and generated revenue purely from our continuing businesses. Our new business strategy has shown continued momentum in the third quarter amidst the complex external challenges and uncertainties posed by the COVID-19 pandemic, and posted record revenue growth when compared with the same period last year. We have achieved profitability on an objective basis for the fourth consecutive quarter, which serves as a testament to our resilient operational efficiency and opportunities from our new businesses. Net revenues were RMB124.6 million, representing a year-over-year decrease of 74.9% from RMB496.8 million in the third quarter of 2021. The decrease was mainly due to the cessation of our online K-12 tutoring services by the end of 2021 to be in compliance with the latest PRC regulations, which prohibits the provision of tutoring services relating to academic subjects to K-12 students. However, when compared with the net revenues excluding those from online K-12 tutoring services, our net revenues increased significantly from RMB19.2 million to RMB124 million during the same period. Cost of revenues for the third quarter of 2022 was RMB31.7 million, representing a year-over-year decrease of 87.4% from RMB251.4 million in the third quarter of 2021, which was again largely in line with the decrease in net revenues due to the cessation of online K-12 tutoring services and there's a new regulatory and business environment. Gross profit was RMB92.9 million, representing a year-over-year decrease of 62.2% from RMB245.4 million in the third quarter of 2021. Gross margin for the third quarter of 2022 was 74.5% compared with 49.4% in the third quarter of 2021. The increase was mainly attributable to the company's more stringent and efficient cost management. Moving over to the expense side. Total operating expenses for the third quarter of 2022 were RMB120.5 million, including RMB31.8 million of share-based compensation expenses, representing a year-over-year decrease of 83.8% from RMB743.7 million in the third quarter of 2021. Sales and marketing expenses for the third quarter of 2022 were RMB27.9 million, including RMB4.7 million of share-based compensation expenses, representing a year-over-year decrease of 92.8% from RMB388.6 million in the third quarter of 2021. This was mainly due to the decrease in promotional cost expenses and advertising expenditure as a result of the change in regulatory environment, as well as staff optimization in line with the business adjustment. R&D expenses for the third quarter of 2022 were RMB50.9 million, including RMB6.9 million of share-based compensation expenses, representing a year-over-year decrease of 74.7% from RMB201.2 million in the third quarter of 2021. The decrease was primarily attributable to staff optimization in line with business adjustment. G&A expenses for the third quarter of 2022 were RMB41.7 million, including RMB20.2 million of share-based compensation expenses, representing a year-over-year decrease of 66.1% from RMB123.1 million in the third quarter of 2021. The decrease was primarily due to staff optimization in line with business adjustment. Loss from operations was RMB27.6 million compared with RMB498.3 million in the third quarter of 2021. Loss from operations as a percentage of net revenues for the third quarter of 2022 was negative 22.2%, improving from negative 100.3% in the third quarter of 2021. Net loss for the third quarter of 2022 was RMB23.5 million compared with net loss of RMB489.9 million in the third quarter of 2021. Net lost as a percentage of net revenues was a negative 18.9% in the third quarter of 2022 compared with negative 98.6% in the third quarter of 2021. Adjusting net income on non-GAAP basis for the third quarter of 2022 was positive RMB8.3 million compared with adjusted net loss of RMB456.6 million in the third quarter of 2021. Adjusted net income on non-GAAP basis as a percentage of net revenue was 6.7% in the third quarter of 2022, improving from the negative 91.9% in the third quarter of 2021. Now, turning on to our business outlook. The COVID-19 outbreaks across China have led to uncertainties and potential delays in the government procurement process and unpredictable timetables in relation to project delivery, which thus impacted our revenue recognition. It also brought uncertainties to consumer sentiment and local government budgeting. This situation has significantly affected the company's ability to provide accurate business forecast, especially when our new businesses are still in the early stage of development. The company has hence decided not to provide revenue guidance going forward. With that, that concludes our prepared remarks. Thank you. Operator, we are now ready to begin to the Q&A session. Thank you. Thank you. [Operator Instructions] Thank you. I am showing no questions. So, I’ll now turn the conference back to the management team for closing remarks. In closing, on behalf of 17EdTech's management team, we'd like to thank you for your participation on today's call. If you require any further information, please feel free to reach out to us directly.
EarningCall_1527
Good day. Thank you for standing by. Welcome to FactSet First Fiscal Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. I would like to hand the conference over to your host today, Kendra Brown, Senior Vice President, Investor Relations. Please go ahead. Thank you, and good morning, everyone. Welcome to FactSet’s first fiscal quarter 2023 earnings call. Before we begin, I would like to point out that the slides we will reference during this presentation can be accessed via the webcast on the Investor Relations section of our website at factset.com. The slides will be posted on our website at the conclusion of this call. A replay of today's call will be available via phone and on our website. After our prepared remarks, we will open the call to questions from investors. To be fair to everyone, please limit yourself to one question plus one follow-up. Before we discuss our results, I encourage all listeners to review the legal notice on Slide 2, which explains the risks of forward-looking statements and the use of non-GAAP financial measures. Additionally, please refer to our Forms 10-K and 10-Q for a discussion of risk factors that could cause actual results to differ materially from these forward-looking statements. Our slide presentation and discussions on this call will include certain non-GAAP financial measures. For such measures, reconciliation to the most directly comparable GAAP measures are in the appendix to the presentation and in our earnings release issued earlier today. Thank you, Kendra, and good morning everyone. Thanks for joining us today. I am pleased to share our first quarter results. We grew organic ASV plus Professional Services by 8.8% year-over-year achieving adjusted diluted EPS of $3.99 and an adjusted operating margin of 38.3%. These results demonstrate our continued momentum coming out of fiscal 2022 and lay a solid foundation for executing on our full year targets. Last year's Q1 ASV growth was a record for us and this quarter's performance is a strong result for what is usually our seasonally lowest revenue quarter. The biggest contributors to this quarter's growth came from banking, asset owners and private equity and venture capital clients, all of which exhibited double digit growth rates. Small and medium sized deals across client types drove ASV growth this quarter. Our investments in content and technology including deep sector private markets, APIs and analytics solutions continue to support client retention rates and expansion. It's important to acknowledge the continued uncertainty in global markets. While conditions have been supportive, we are starting to see a more challenging environment for our clients and we are closely watching for signs indicating a prolonged change in conditions. These signs could include reduced client budgets, elongated sales cycles, material layoffs, and a reduction in new firm creation. However, FactSet has a proven history of stability and growth in volatile markets and we remain confident that our strategy and ability to execute will position us well even in a choppy economic cycle. As we look ahead, we remain focused on building the leading open content and analytics platform, reinforcing our position as an anchor partner for clients, allowing us to grow our share of the addressable market. At the foundation of our strategy is our commitment to further scaling our content refinery. We continue to grow and invest in critical content. For example, within our content and technology solutions business, our cloud-based real-time solutions are gaining traction with the launch of ticker plants in Europe and Asia, and our recently announced relationship with BMLL for enhanced tick history. The connectivity of our data powers hyper-personalized solutions that puts key information and analytical tools in the hands of investment professionals, enabling them to generate alpha across all market conditions. FactSet is an essential partner for our clients as they advance their digital transformations to increase efficiency and be more competitive. These transformations are critical and clients are prioritizing investments in technology and data to drive performance, giving us further confidence in the resilient nature of our business. Turning to our performance for the quarter, we continue to see strength in ASV growth across all our regions. The Americas remains the biggest contributor with organic ASV growth of 8.5% and growth was diverse across firm types, driven primarily by higher retention in banking. Private equity and venture capital clients also drove growth with Cobalt, our leading portfolio monitoring solution, plus the workstation securing client wins. Organic ASV growth accelerated to 8.8% in EMEA marking the region's strongest Q1 in recent history and the seventh quarter of increasing LTM growth. Performance was driven by higher retention among asset managers, asset owners and banking. Asset managers also saw a higher expansion across the product portfolio, and we also continued to see healthy demand for our wealth solutions with Advisor Dashboard driving key wins. Finally, in Asia Pacific, we delivered organic ASV growth of 11.1%, driven primarily by expansion among asset managers and new business wins with asset owners. However, we also experienced headwinds in the region from macro factors including regional COVID policies, which resulted in slower decision making among clients. In summary, I'm pleased with our first quarter results. We recognize the uncertainty in the market and are closely monitoring the macro environment for any signs of weakness. As we head into the start of calendar 2023, we expect to get a clearer picture of our second half as client budgets are finalized. Using our downturn playbook as a guide, we are focused on disciplined expense management and later in the call Linda will share the actions we've proactively taken. FactSet maintains a long-term view of our strategy and we will continue investing to sustain growth. We have a healthy pipeline of opportunities and as such we are reaffirming our guidance. Thanks, Phil and hello to everyone on the call. As you've seen from our press release this morning, we reported high single digit organic ASV growth and double digit year-over-year growth in revenue and adjusted diluted EPS. I'll now share more details on our first quarter performance. Consistent with our definition of organic revenues in ASV, we exclude any revenue in ASV associated with CUSIP Global Services when reporting organic related metrics for the 12 months following the acquisition date. We will, however, provide some specifics on CGS, so you can continue to understand its performance as part of FactSet. Beginning March 1, 2023, the first anniversary of the CGS acquisition, it will be included in our organic results as a component of our CGS business. As Kendra noted, a reconciliation of our adjusted metrics to comparable GAAP figures is included at the end of our press release. We grew organic ASV plus Professional Services by 8.8%. As Phil stated earlier, this is a strong start to our fiscal year as compared to our typically lower revenue first quarter. Our performance reflects increased demand for our content and solutions, higher retention and continued expansion. We saw strength in the workstation for banking, key client wins with our Enterprise solutions and our subscription-based ASV continued to support value-based pricing. GAAP revenue increased by 18.9% to $505 million for the first quarter. Organic revenue, which excludes any impact from foreign exchange and acquisitions, increased 8.3% to $460 million. Growth was driven primarily by CGS and our Analytics & Trading and Research & Advisory solutions. All regions saw notable growth. From our geographic segments on an organic basis revenue growth for the Americas was at 7.6%. EMEA grew at 7.2% and Asia Pacific came in at 14.9%. All regions primarily benefited from increases in Analytics & Trading and Research & Advisory solutions. GAAP operating expenses grew 10% in the first quarter to $333 million. Let me now review our expenses based on our primary cost buckets. Starting with people, our expenses grew 4% year-over-year, primarily due to increased salary expenses for existing employees and higher stock based compensation expense. As a percentage of revenue this was 572 basis points lower year-over-year, demonstrating our continued focus on achieving a sustainable balance of investment in our talent and productivity. Next, real estate costs decreased by 21% year-over-year, driven by the right-sizing exercise we performed in fiscal 2022. As a percentage of revenue this was 181 basis points lower year-over-year. Third, technology expenses increased this quarter by 11%, driven by increased cloud spending. As a percentage of revenue growth was 51 basis points lower year-over-year. And finally third party direct content costs decreased by more than 12% year-over-year, driven by our continued focus on financial discipline and data governance. As a percentage of revenue growth was 156 basis points lower year-over-year. While this is a good result for the first quarter, we expect the annual rate to grow at 5% to 6% in line with the outlook we gave at our April 2022 Investor Day. Compared to the previous year, our GAAP operating margin increased by 517 basis points to 34.1% and our adjusted operating margin increased by 471 basis points to 38.3%. Improvement was driven by higher revenue, lower personnel costs as compared to revenue and lower content and real estate costs. These expenses were offset by higher technology expenses and costs related to the integration of CGS. Regarding our first quarter margin, I want to remind everyone that our first quarter margins tend to be seasonally higher than in subsequent quarters. While we've had a strong first quarter margin performance on both a GAAP and adjusted operating basis, we remain committed to balancing investment in our business with returning value to shareholders. As such, we continue to anticipate 50 to 75 basis points of margin expansion for the full fiscal year 2023. Further, we expect our fiscal 2023 adjusted operating margin to be between 34 and 35%. This means we anticipate that margins will likely be lower in the subsequent quarters of fiscal 2023. You'll find an expense block from revenue to adjusted operating income in the appendix of today's earnings presentation. As a percentage of revenue, our cost of sales was 380 basis points lower than last year on a GAAP basis and 450 basis points lower on an adjusted basis. On a GAAP basis, SG&A was 140 basis points lower year-over-year as a percentage of revenues and 20 basis points lower on an adjusted basis. Moving on, our tax rate for the quarter was 13.4% compared to last year's rate of 10.2%. Our higher rates primarily due to higher pre-tax income and an increase in the UK statutory tax rate from 19% to 25%, which will continue for the foreseeable future. GAAP EPS increased 26.2% to $3.52 this quarter versus $2.79 in the prior year. Adjusted diluted EPS grew 22.8% to $3.99. Both EPS figures were driven by higher revenue and margin expansion and were partially offset by increased interest expense and a higher tax rate. As noted in our press release, adjusted EBITDA increased to $200 million, up 38.2% from the same period in fiscal 2022. And finally, free cash flow, which we defined as cash generated from operations less capital spending, was about $89 million for the quarter, an increase of 37.8% over the same period last year. This was due to higher net income, partially offset by increased capitalization costs related to internal use software. Before moving on, I want to provide additional financial housekeeping items to help with modeling. First CGS continued to perform well, adding $3 million in incremental ASV for the quarter. We expect it to grow in the mid-to-high single digits. As a reminder, we will update guidance next quarter to include CGS. Once it is included as part of our organic results, we will no longer report on CGS separately. Next, interest expense for the quarter was $16 million. For the full year, we expect to end fiscal 2023 with interest expense of about $66 million. As a reminder, we paused share repurchases to prioritize debt repayment following the CGS acquisition. As such, no additional shares have been purchased since the first quarter of 2022. As of the end of November, 2022, our weighted average diluted share count was 39 million shares. Moving on to the bonus accrual, given our performance so far, we expect the bonus pool for fiscal 2023 to be about $100 million. Our operating income benefited from the strength of the U.S. dollar versus major currencies we hedge. However, we expect exchange rates to be volatile throughout the year, so the impact will fluctuate. As a reminder, 95% of our revenue and most of our expenses are denominated in U.S. dollars. Next, we ended the fiscal quarter with capital expenditures of about $18 million up $9 million from the prior year period. This was driven by increases in capitalization as well as technology expenditures. As we discussed on our last earnings call, we expect an increase in CapEx this fiscal year to be about $68 million at the midpoint as we move to our hybrid cloud strategy, increased focus on capitalization and consolidate our offices in Paris as part of our real estate strategy. And finally, we expect our dividend program to continue delivering value to shareholders. Fiscal 2022 March 23 consecutive years of growth and we paid a quarterly dividend of $0.89 on December 15. Our ASV retention for the first quarter remained greater than 95%. We grew the total number of clients by 13% compared to the prior year, driven by corporate wealth and private equity and venture capital clients. Our client retention remains at 92% year-over-year reflecting the stickiness of our Content and Digital platform. Turning now to our balance sheet, we continue to pay down the term loan related to the acquisition of CGS. In the first fiscal quarter, we made another planned prepayment of 125 million, bringing our gross leverage ratio down to 2.7 times from the initial 3.9 times level when we financed the CGS acquisition. Following our next planned prepayment of $125 million in the second fiscal quarter, we expect to be within our target leverage ratio of 2 to 2.5 times. The strength of our net income and adjusted EBITDA has allowed us to move faster than expected to reach this target. As a reminder, while we may make minor share repurchases to offset the dilutive impact of stock option grants during this time, we do not intend to resume our share repurchase program until at least the third fiscal quarter. Next, I'd like to discuss our downturn playbook. As Phil mentioned, we are still experiencing supported [ph] end markets and FactSet has historically fared well during periods of volatility. Should anything change, our downturn playbook gives us levers to reduce our operating expenses by 2% to 3% or $24 million to $36 million. Given market uncertainty, we have proactively implemented parts of our downturn playbook to protect margins and prioritize investment. Actions taken to date include limiting travel to client engagements and essential business needs, revisiting our real estate footprint and focusing on the continued reduction of third party content costs. In addition, we are also monitoring our open positions to ensure focus on roles that are essential to our business. Finally, we've restructured our cloud budget as part of our hybrid cloud strategy, which will use both cloud and on-premise computing to run our core platforms. This change will save more than $20 million over the next five years, including $7 million this fiscal year. In closing, we are confident in our ability to navigate the changing market conditions. While it's still early in the fiscal year, we have confidence in our pipeline as we look ahead and as stated before, we are reaffirming our guidance for 2023. Thank you. [Operator Instructions] And our first question comes from the line of Manav Patnaik with Barclays. Your line is open. Please go ahead. Thank you. Good morning. Linda, you gave us kind of the, what to expect from margins. I guess looking forward, I was just wondering, was there, is there any cadence for ASV throughout the year based on what you see in the pipeline or is there any seasonality to pricing perhaps that we should keep in mind? Sure, Manav. Let me talk a little bit about margin and our expectations and then I'll let Phil go back on ASV and pricing, if that's okay. So to set the stage on margin for the first quarter, we had 570 basis points of margin expansion on, excuse me, 470 basis points of margin expansion as compared to last year, and about half of that has come from CUSIP. In looking forward, as we get past March 1st we will have lapsed CUSIP, so we won't have that additive margin increase from CUSIP. The rest of the margin increase came from the organic business which is great, and it is performing well. If we look at our cost buckets Manav, a couple of things that we note here. Our third party data costs are doing very nicely and in fact have moved down. Our real estate costs have moved down as well. Our tech costs are up, but we've had a good re-planning of our cloud strategy, which will result in $7 million of savings this year. So the big bucket to watch here is our people expenses. So we've got to keep a close eye on headcount and on compensation. So we will look forward to staying within our adjusted operating margin guidance of 34% to 35% for the year. But as we said in the script, we expect that margins might be lower for the next three quarters of this year, than they've been for the first quarter. So I hope that answers the margin question. Sorry to go a bit backward, but Phil can now handle ASV and price. Great. Hey Manav, thanks for the question. Yes, so for the rest of the year at least what we're looking at today, we're still looking more positive for Q2 and Q3 and Q4 than we were this time last year. Some of that is definitely supported by price. As we, as I indicated on the last call we said we were going to go out at more than a 4% price increase and conversations are going well with clients. Clearly they're all going through their own introspection about trying to figure out what's happening in the markets and budgets and I believe are getting finalized now. So we'll have more visibility, but it's hard to argue, frankly, with the amount of investment FactSet has put into our platform over the last few years. So we've got great relationships with clients. Conversations are going well. We do believe that we'll be successful in executing on the price increase. And there's a lot going on in the markets right now. I'm cautiously optimistic. Our strategy is a good one and we'll get more information, particularly as we head into January in terms of what the rest of the year looks like. We have better visibility on Q2 and Q3 and as you know, Q4 is such a big quarter for us. We need a bit more information in terms of how that's going to play out. Got it. And if I could just follow up, Phil, just quickly on the sell side, I mean, you guys have been doing really well there. Obviously the narrative there seems to be changing, but you guys are a little bit more enterprise and SICOM focused. I was just helping, I was just hoping, sorry, that you could help us kind of filter through the noise we would anticipate and a lot more layoffs versus maybe how secure your contracts are on the sell side. Sure, yes. So the sell side continues to accelerate. That may surprise some of you, but we're really healthy there. So we're not as exposed to capital markets as some other companies. And most of our users, as you know, are in investment banking. And in the conversations I've been having, it doesn't feel like the banks are laying off massive amounts of staff in investment banking. Maybe they're hoping for a soft landing here and within like the next six months or so, M&A activity will pick up. But I'm, again, I'm optimistic there that we'll be able to hang in particularly in that part of the banks. And as you pointed out, we've begun to diversify our solutions for the sell side. So I just took a look at this for the next six months, and it looks like we have a very good CTS pipeline on the sell side. So we're now going in and being able to take out the value that we create and integrate it into client systems for their back and middle offices. And this is a theme I would say across most client types is that the data that our clients want to see, they want to see consistency, right, in terms of the workstations they're using, whatever interfaces and the data that's going through the systems, and we're beginning to benefit from that particularly on the sell side. Thank you and one moment for our next question. And our next question comes from the line of Toni Kaplan with Morgan Stanley. Your line is open. Please go ahead. Thanks so much. I also wanted to ask one on sell side really, really strong over the last six quarters, and I know last quarter you had called out upsell, and so I wanted to see if there were any sort of solutions that were particularly in demand. I know you just called out the CTS pipeline, but just anything that is just different now that you're able to upsell to sell side versus historically or things that they're demanding more than normal? Most of it seats Toni. So I think what you're seeing there is the investment that we've made in deep sector and private markets. So those new or newer content sets for FactSet that are getting expanded out are allowing us to get into maybe different parts of the bank, more users than we might have historically and just give us a good competitive advantage. So that's really helping with renewals and it's helping us gain new users of the banks. Yep. Okay, great. And, and Phil, you mentioned a couple times the uncertain environment and starting to see this more challenging environment for clients. Is it the hiring that's sort of driving your comments there or is it this like slower to pull the trigger slower sales cycle? I guess what are the things that are really going on there? Yes, a bit of both. So we're going to I imagine see less hiring on the buy side. We're also within institutional asset management, I should say, and for the larger transformations clients are going through, we're not, we're not seeing a lot of this yet, but I imagine that some of them may be deciding to pause some of these transformations that they're going to go through. I don't think it's negotiable with them. They have to go through these transformations, so we're confident that the solutions we're providing are the right ones. But it could be as they're trying to figure out their own futures they may be pausing on some of these larger deals. Thank you and one moment for our next question. And our next question comes from the line of Andrew Nicholas with William Blair. Your line is open, please go ahead. Hi, good morning. Thanks for taking my questions. I first wanted to just follow up on Toni's question and just ask if you're seeing any difference in terms of kind of end market health on a regional basis. There was obviously some disparate growth between the different regions, but just curious if your comments are pretty uniform across geographies or if there's anything to call out on a region by region basis? I think they're pretty uniform Andrew. Europe did have an exceptionally strong quarter this quarter, but as I look out into the next six months, there are different puts and takes there by region. Asia looks a little bit stronger frankly, for the next six months maybe than the Americas and EMEA, but I wouldn't say that there's any one region that's dramatically different than others. In terms of where we might see more effects from recession, I would imagine that Europe just generally might get hit harder than other regions. But we haven't, we don't see a lot of impact from that yet. Got it. Thank you. And then for my follow up, I wanted to ask about the digital strategy, if, you know I know you hired a new CTO, Kate Stepp half the year ago, wondering if there are any major takeaways from her involvement with the strategy. Sounds like you're restructuring the cloud budget and that's going to result in some cost savings. Any more color on what's happening under the hood there that would be great. Thank you. Yes. First of all, Andrew, Kate has been with the company for quite a number of years, so she has changed position, but she's not a new hire. What we did was we sat down and we looked at the cloud budget and we concluded that not everything needs to be on the cloud. So we have kicked up our CapEx, as I said in the housekeeping and we are looking to move a few items back into data centers. We've had to buy some new servers, things like that. But we think the long-term balance for the company is better with some on-premises computing core capability as well as cloud capability. So we've rebalanced that over the next five years we'll save $20 million. With that change, we'll save $7 million this year, which is very helpful. But again, it's just a rebalancing of what we're doing with the cloud versus on-premise computing. And Kate has been very helpful as we've thought through what we want to do with the technology budget. So hope that helps you. Thank you, and one moment for our next question and our next question. And our next question comes from the line of Ashish Sabadra with RBC Capital Markets. Your line is open. Please go ahead. Hi, this is John filling for Ashish. Thanks for taking my question. Maybe just quickly on the people cost, it seems like head count is up around 7% over the last 12 months, really focusing Content & Analytics, Trading & Sales, could you maybe talk about any potential benefits you're seeing on just hiring technology talent as well as just the people bucket as a whole? Thanks, Yes, I'll start and I'm sure Linda will have some comments. So this is a great market for talent, frankly and we've been very successful at hiring who we wanted to hire over the last few months and attrition has come down. So Linda and I am watching this day to day. We want to be careful that we're not running hot here, but it -- but we do have an opportunity here to continue to upgrade our talent and lean in and continue to invest. So we're hopeful, right, that we don't have to kind of slam on the brakes too hard here from a talent standpoint. But as we've done in previous cycles, if you're able to keep investing and not go through too much pain on the people side, it definitely helps you in the long run. Yes, as Phil said John, we're watching headcount day by day. It's very important that we get that right and not run too hot. As Phil said, our attrition has come down very nicely. Some of that is the result of the market being a little bit more employer friendly and some of the moves we made in our compensation last year to make sure that we're rewarding our people and our high performers appropriately. So we got that right. You're right, we have increased headcount quarter-over-quarter for the first quarter. About 65% of that headcount is in centers of excellence, so our lower cost locations. And we've been very careful about bringing on that headcount largely to support our deep sector effort, which we've talked about before, to help with the sales effort and to assist with analytics and trading. So, so far so good, but the trends are attrition down and hiring has to be sized accordingly to make sure we don't get out over our skis. But we are seeing a much healthier retention picture than we did at this time last year which is a really nice thing. So hope that gives you a bit more clarity. Yes, that's great color, thank you. And maybe quickly, could you just talk about the wealth pipeline and maybe if there's been any change in tone around client conversations as well as the sales cycle? Yes, the wealth pipeline continues to be healthy. We have a good mix of larger deals that we continue to work. And now in terms of markets, that's one of the markets where we just feel like in the long run we've got just such a great opportunity and more tailwinds. Thank you, and one moment for our next question. And our next question comes from the line of Alex Kramm with UBS. Your line is open. Please go ahead. Yes, hey. Hello everyone. Just coming back to what you're seeing in different client segments or regional, can you also expand your comments on the pricing side, is it pretty uniform? Any sort of pushback you're getting? One of the things that we've heard, for example, is in Europe with all the FX changes year-over-year asking them for more in dollar terms, when the currency has devalued so much over the last year is increasingly harder. So just curious if there's anything you would call on, on pricing by customer set or region? Thanks. Yes, nothing I'd call out yet, Alex. So similar to last year, not a lot of conversations have reached my desk, which is a good sign in terms of how the conversations are going. And as I've said it's very hard for clients to argue with the value that FactSet has put into the product. So my sense is that clients are understanding this. Everyone is seeing it everywhere in terms of inflation and we're coming in, I believe, at a very moderate place relative to what clients may be seeing from other providers, which gives us a great opportunity to capture more market share. We've certainly gotten some inbound opportunities as a result of that for sure. Oh, that's helpful, thank you. And then maybe just one follow up on the wealth side, and this may be too much in the weeds, but you called out in your press release Model Center launch, which I think was at the beginning of November. Sounds to me like when I look at what you're describing here, that this is something very much like a shelf, like something like an investment does -- has for example. So my question is a, can you talk about the revenue model in that business? Again, it's obviously very early days, but then is this a sign of you really expanding the scope of the workflows you want to order -- offer the wealth segment versus just obviously repurposing facts at terminal or other services to wealth, but really getting deeper into that end market? And then maybe talk about some of the things you envision yourself doing that you're not doing today. Yes, it is absolutely a sign of that Alex and consistent across the other firm types that we're servicing. So FactSet is continuing to push beyond being just a workstation company. We've gone way beyond that already. But we're giving a lot of thought to within each client type what adjacencies can we get into and as we open up the platform and work with other partners, what more can we do for clients? Wealth, wealth is a relatively newer firm type for us, so there's a lot more, I think, room for us to expand than some other firm types where we're more well established. That's probably a good follow-up with Kendra later in terms of the detail on the Model. There's probably a little too much detail for this call and if you want to have a follow-up with our wealth team, I’m sure they’d be very happy to talk to you about what they’re doing there. Thank you. One moment for our next question. Our next question comes from the line of George Tong with Goldman Sachs. Your line is open. Please go ahead. Hi, thanks. Good morning. You noticed that clients are pausing on larger deals. Are there any large deals coming up for renewal this fiscal year or any competitive large RFPs that you’re involved in? There are, I mean, hey George, thanks for the question. There are deals like that every year. So I think this year and Kendra can or Linda can get into this later if we need to. But I believe there are less large renewals this year than we might have seen in previous years. So there are definitely a couple. And there are a couple of very interesting deals that we’re working on that are larger in Q2 and Q3 and Q4 for this year, some sell-side related, some partner deals. Got it. And secondly, you mentioned you’re seeing longer sales cycles, a little bit slower hiring. Can you talk a bit about what you’re seeing with overall client enterprise budgets, the direction that those are moving in? Yes. So I said these are things that we’re watching out for. We’re not seeing a lot of them yet, right? So there are indications that it may be happening. And again, we’re -- I don’t know if you saw that Financial Times article, which was a good one, that came out a few weeks ago, but it was an article I think it was idle asset managers pull a money into technology platforms and really speaks to the investment that a lot of the -- a lot of asset managers are having to make to be competitive. And this plays really well into FactSet’s hands in terms of all the work that we’ve done on the PLC, all the work we’ve done to open the platform, all the work that we’re doing with partners in the space, some of which we’ve been public about, some of which we haven’t. So these transformations are not going to stop. Then clients are not going to completely cancel these. It’s just a question of the pace at which they go. But overall, I’m very optimistic about our position in the marketplace for these deals and our ability to execute. Thank you and one moment for our next question. And our next question comes from the line of Craig Huber with Huber Research. Your line is open. Please go ahead. Yes, good morning. First question, can you just comment some more on the marketplace, the traditional buy-side out there? Just talk a little more specifically about the pressure points maybe that might be building there for the longer potential sales cycles? Just what’s going on with that traditional part of your legacy business? I’ll start there. Yes. So overall, it’s pretty healthy, Craig. So we -- there’s less hiring than there was last year, but I don’t believe it’s down significantly. The buy-side number that you see in our press release has a lot of components to it. So maybe it’s helpful to sort of go through that so everyone understands what we’re looking at. The two firm types where we’re seeing the most headwinds now and less revenue than last year are corporates. So we did add a number of corporates this year. They make up a good part of the new firm creation for the quarter, but it’s a lot less than it was in the prior year. And we had a really lumpy quarter with partners. So that’s some of what -- that’s what’s in the buy-side number that you’re seeing. Above that, I would say that institutional asset management, hedge funds and wealth are all kind of a little bit less than last year or on par with last year in terms of what we’re seeing in the environment. And on the plus side, asset owners are doing exceptionally well. So asset owners typically have a much longer view, and we’re crushing it in asset owners versus last year. That’s very encouraging in terms of the work that we’re doing there on the PLC and working with partners. And we’re seeing great adoption of multi-asset class solutions from the asset owners, and we’re seeing positive signs on the fixed income side. So -- but hopefully, that’s helpful in terms of thinking about the overall buy-side number that we give you. Okay. And then, Linda, if I could ask on the cost side of things, I’m scratching my head a little bit here. Your fiscal fourth quarter costs were meaningfully higher than the third quarter costs or the quarter. You guys just finished here by roughly $30 million if you take out the various onetime items and stuff. I know you’ve called out last time we spoke on this at about, say an extra $6 million or so was incentive compensation in August quarter versus the May quarter, but then the total cost here in the November quarter in a good way fell back down to the May levels and stuff from last year and stuff. The lumpiness here of the cost, maybe you could just talk about that, maybe just a little more specific about how we should think model out the costs for the rest of the year versus this lower number in the first quarter? Thank you. Yes. Thanks for that, Craig. And your observations are correct. In the fourth quarter, we really worked hard to ensure that we had compensation right. So you saw a couple of things. You saw a merit pool, which was stronger than usual to deal with inflationary adjustments in a number of countries and the U.S. You also saw bonuses, which were quite fulsome because we had a very strong FY 2022. And then you saw that we also worked harder on equity, and equity-based compensation moved up as well in FY 2022. So the goal there while we were running strong, was to make sure we had a compensation picture correct for our employees coming off the great resignation. So as we move forward into this year, we’re watching our costs very carefully. The entire situation has shifted, Craig, to one of conservatism around costs. I talked about our three buckets that are going well and are nicely controlled. I think the place where we watch here very closely is our people bucket, which includes both headcount and compensation costs. So we’re watching those very, very carefully, as Phil said. A couple of things to notice on the revenue side for the first quarter. Last year, we had a record ASV level in Q1 that was about $17 million. This year, we’re running at about half of that. So the timing change matters to us in terms of how the revenue comes through later in the year. So that makes my job just that much more exciting to make sure that we’re managing correctly for the margin. So we’re doing that. The other thing, Craig, to take a look at is the dollar had been very strong. Recently, the dollar has been retracing about one-third of that strength. So we have to be careful on the impacts of the later ASV, on timing and the conversion to revenue. And then we also have to be careful on what’s happening with FX, which has been unusually bouncy as we have moved through the last couple of quarters. So hope that helps, but we’ve got an eagle eye on those cost buckets and we did pretty nicely managing them in the first quarter. I’m happy to have the 38.3% margin in the bank, and that will help us as we move through the rest of the year. So prudence is the name of the game here. Hope that helps. Thank you. And one moment for our next question. And our next question comes from the line of Faiza Alwy with Deutsche Bank. Your line is open. Please… Yes, hi. Good morning. So I wanted to ask about the competitive environment. Over the last several years, my perception is that you’ve gained share as some of your competitors have been busy integrating deals, and you’ve been investing. But it looks like there’s now, new products that they’re rolling out. So I’m curious as we head into a potentially more challenging environment, how would you characterize your competitive positioning across your various products? Hi Faiza, thanks for the question. I’d characterize it as being exceptionally strong. If you just start with the FactSet workstation, all of the investments we’ve made in content are in there as well as we’ve really upgraded a lot of the applications that our clients use in terms of ease of use, searchability, alerting clients. So you see that reflected, frankly, in our workstation numbers across a number of firm types, and that’s grown significantly over the last five years. On the analytics front, we continue to do great things with the portfolio life cycle and work with asset servicers and other partners in the space to go in and really be the core of -- or anchor partner for our clients in terms of what they want to achieve from the back, middle to front offices. So that -- there’s a lot of runway for that, frankly. The market is looking for accretive solutions. They’re looking for companies that are ahead in terms of technology and innovation, and FactSet checks all those boxes. And on the CTS front, we’ve done a lot to expand that product suite. One of the things we’re very excited about is real time. That’s a pretty small piece of CTS today, but there’s billions of dollars of market share out there on the real-time space. You might have seen that we made a recent investment in BMLL, which is a very good tick history product, which you need to do -- you need to complement real time. So this is an area of great opportunities. So there’s just more and more ways we can help our clients. And the investment we’ve made over the last three years and continue to invest really put us in good stead. And I’d be remiss not to sort of mention the FactSet relationships that we have with our clients. Many of our clients are trusted partners. They’ve been with us for a long time. And this is the type of environment, frankly, where they need help. And we’ve been there for them in the past, and we’ll be there for them in the future. So I feel as good, frankly, is about our competitive position as I have in almost my entire 10-year at FactSet. Great, thanks for that. And then just as a follow-up, I wanted to ask about capital allocation and the interest expense guide that you provided, Linda. Just want to confirm, are you assuming sort of no further debt pay down? Because I think you raised the interest expense guide, and I understand that rates are a little bit higher, but I feel like you’ve also been paying down debt, so I just wanted to clarify sort of any assumptions behind that guide? Yes. Faiza, I think we've mentioned this a bit in the script. So let’s talk about our leverage levels and go back and think about that. So when we purchased CUSIP, our gross leverage level went up to 3.9 times. We’ve made a number of pay downs of $125 million basically per quarter. Now our gross leverage ratio is 2.7 times. We’re looking to get back within what would be considered typical for our level of investment grade rating, which is 2.5 times to 2 times. So we have one more payment to make, which is what is anticipated to get inside that leverage level. And then we may not continue at the exact same pace of pay down prepayment on that term loan as we had done before. At that point, we’re going to speak to the rating agencies, be clear to resume our share buybacks and we’ll think about what we want to do with that. The remaining Board authorization, I want to be crystal clear here, authorization is $181 million. That doesn’t mean that’s what we’re going to spend. That means that’s what the authorization is, so you can note that. And we’re going to think about what we want to do with this after we have those conversations. So the interest expense presumes all those things that I had mentioned. And if we do get back into the share repurchase market, please note that’s going to be back-end loaded and it won’t move the average share count all that much for FY 2023 as a whole. It will be helpful as we move into FY 2024. So hope that, that gives you all the detail that you need, Faiza. Thank you. And one moment for our next question. And our next question comes from the line of Kevin McVeigh with Credit Suisse. Your line is open. Please go ahead. Great, thanks so much. I just want to circle back. On the downturn playbook you were very helpful. Of the $24 million to $36 million, can you tell us how much you’ve implemented? Like is it one-third? And then the $7 million this year is obviously incremental that, Linda. Is that right? I just want to make sure -- I think you are clear, I just want to make sure I heard the comment right. Yes. I think it’d be good, Kevin, to think about sort of the midpoint of that amount. And I think it’d be fair to say we’ve probably implemented about one-third. We’re taking a close look at what we want to do with T&E because, obviously, the top line is paramount here, and we’ve got to get that right. So we’re looking at some of the other things that we need to do mostly around people. We’re being extremely cautious on new hires, as we had said and we’ll see what happens with the bonus line. It’s too hard -- too difficult to tell at the end of the first quarter how that will lay out. Just to be clear, the bonus line, we are expecting, as I had said in the housekeeping section, about $100 million. We have booked about 24 for the first quarter. Generally, that number is ramped up a bit as we move through the year. So maybe you go from 24 to 26 in the fourth quarter if things play out the way that they have in previous years. That’s a question mark. So we’ll think about what happens with that. If we don’t do as well as we expect and the center point of our guidance matches what our bonus targets are, there’s -- it’s all very clear cut. If we come in light, perhaps our bonus line comes down by $10 million, which would save about another one-third. But it’s way too early to talk about that right now. So the solution is to make sure we’ve got it right in terms of the pace of hiring, keep that focus on the technology budget. And we’re going to take another pass through our real estate footprint, probably as we get towards the fourth quarter. Any change we make in that real estate footprint, though, the expense saves will be something we’ll see in FY 2024. For the most part, it will come in later in fiscal year 2023, so not going to be of too much help to us in that bucket. But as I said before, eagle eye on all these buckets, and we’ve got to support growing the top line. Our second and third quarter pipelines look even better than last year, as Phil had said. Just want to reemphasize that. So mainly, we’ve had a bit of a timing shift. So we’re dealing with that and making sure we’re matching the costs accordingly. So I hope that’s helpful, Kevin. Very, very helpful. And then just a quick follow-up. I know you talked about the centers of excellence. Is there any way to think about how the kind of the current employee footprint is today and where you think that can get to over time? Yes. So the last few years have been very interesting, right, from a talent standpoint. We’ve learned a lot. We’ve taken the approach of having a hybrid work environment, which is why Linda is talking to you about real estate expense. So we do have more options globally. We have very good centers of excellence in India and the Philippines. Those continue to crank. But as we move forward, we want to make sure that we’re -- we have the very best talent we can globally and that we’re exploring all of our opportunities there. So we’ve made some moves actually to make it possible for us to hire employees in more locations if we needed to and that’s a piece of work that we’re in the middle of right now. Thank you. And one moment for our next question. And our next question comes from the line of Stephanie Moore with Jefferies. Your line is open. Please go ahead. Hi, this is Hans Hoffman on for Stephanie. So for my first question, given you guys sort of noted sort of a more challenging environment, could you just update us on what you’re seeing in terms of client cancellation trends? Well, so far it’s been okay and we’re just being cautious as we go into the year, and clients are finalizing their budgets. You can see in the press release that we’re net positive on users, and we’re net positive on funds. So we’re continuing to grow our business. The numbers are down from last year in terms of absolute numbers, but we’re not seeing, like a lot of panic out there in the client base, and we’re seeing that we’re very competitive. So we’re -- I want to emphasize that these are signs we’re looking for. We’re managing our business well, but we’re – we feel really good about our ability to execute no matter what the market environment is and FactSet has a strong history of that as you well know. Got it, that’s helpful. And then just for my follow-up, could you just talk a bit about where you sort of see the biggest opportunity in the sort of next stage of investment in technology and content? There’s a great opportunity given that we’ve opened up the platform. So we’ve done some press releases about partnerships we have, but really taking all of the components of FactSet and going in and being the anchor partner for the very largest firms is a big opportunity. When you look at the buy-side institutional asset management, we’re doing very well in what we call our premier book. So our premier book also extends to the sell-side, but it’s close to our top 100 clients. And that client base is doing actually very well on a relative basis to last year. So some of the weakness that we might see has to do more with smaller firms in the middle markets, and I think less small firms getting created or potentially some firms going out of business. But overall, within the clients that are much larger where we have a big percentage of our ASV and a big percentage of our opportunity, we’re seeing very positive signs there. No one has asked us about the CUSIP business to this point in the call, and I want to make sure that we’re clear that we also see opportunity coming from the CUSIP business. It’s not technology exactly as the last questioner had asked. But let me just point out some interesting points on CUSIP. So we’re very happy with the acquisition. We’re very happy with the team and we’re very happy with our relationship with the American Bankers Association, which is going great. We were just down to see them a few weeks ago. So CUSIP’s growth of $48 million contributed in revenue in Q1, about $42 million of that from subscriptions and the rest from the issuance business, about $6 million, which is a little bit slower, but still really good growth in the things you don’t think about like municipal bond issuances and also certificates of deposits, which have grown very dramatically as interest rates continue to grow on those types of investments for individuals. o done very well with that. Overall, 7.6% growth, and we’re very pleased with that. We see more growth opportunities coming from CUSIP. The retention grew about -- contributed about two-thirds of that growth and new logos, about one-third of that growth. Now we – as we’ve said before, we see very good opportunities in a couple of areas: one is expanding CUSIP to the private markets; second would be expanding CUSIP to the leveraged markets; and third, potentially as different packages of the ESG, for example, carbon credits are traded, we see growth there. So CUSIP has done a really good job for us. We will lap it, as we said, the 1st of March. We come off our technical services agreement. The only blip there with CUSIP is the days sales outstanding. That has extended a bit. And as we move into the lapping on March 1, we are going to tighten up on those days sales outstanding. So hope that’s helpful to everyone, our biggest acquisition to date and we’re pleased with its performance. We have one more quarter where we will give you the details on CUSIP. After that it is subsumed in the CTS business, as we said. One moment for our next question. And our next question is from Shlomo Rosenbaum with Stifel. Your line is open. Please go ahead. Thank you. Yes, Linda, you absolutely did front-run the AR DSO question. I was going to ask you about that coming back up again. But I want to shift to just a little bit. Historically, the sell-side has been a lot more volatile in downturns than the buy-side. Is there any difference in the combination or the composition of what’s in the sell-side right now that would lead you to believe that the case would not be the same if we end up in some of the banks just decide not to hang on to people the same way? Is there some way that you would think that we wouldn’t start to go – or start to see there be more of a drag on the growth as opposed to being a positive for the growth? If there are large layoffs Shlomo, in investment banking, that certainly would affect us, but the – as I mentioned earlier, right, the CTS business, we’re beginning to sell more than just workstations to the banks. So that’s a very positive sign that there’s other things we can sell them in terms of workflows and other departments we can go into. And again, the investment that we’ve made in content for deep sector and private markets just put us in a much stronger position and potentially open up new users for us. The other thing that I haven’t spoken about that’s in the sell-side number is our private equity and venture capital firm type. So that’s not massive, but it is growing very quickly. And over time, I expect it to be a meaningful contributor. So that is definitely something to keep an eye on. We called it out this quarter as being one of the drivers of the quarter. And as I look out into the next six months, it’s private equity, venture capital firms, the sell side and asset owners that look the strongest. So I think the PEVC and the CTS piece, in particular, are just a couple of things that will be hedged if those – if big layoffs do occur in investment banking. Shlomo, just a couple of things to note. The M&A pipeline is still very strong. So there might be some interest to making sure headcounts stay pretty fulsome at the investment banks. Also, some of the trimming you’re seeing now, those firms have not engaged in that what would be more normal trimming through the pandemic. So it’s been a couple of years since they did that, and you’re seeing some of that happen. And again, there’s the question of headcount versus compensation for them. So we’ll see what happens next. But analyst classes look to be about the same size. The lesson learned through the pandemic is that those more junior employees are important. They have to be brought on and trained. So just a few more points there that might help you. Okay, thank you. And then just, I’m trying to make sure I understand the tone, which sounds more conservative with some of the comments that you’ve made about the strong pipelines. Is the cost actions that you took to implement some of the downturn strategy, just looking at the world around you versus what you’re actually seeing happening with your pipeline and with your sales cycles, is that what’s going on? Because it seems like the sales seem to be going pretty well, at least that’s what the narrative sounds like. Well, one is we’re just taking a long-term view here to sustainable margin expansion. So Linda has I think, come in and really put in a good framework for us. Some of that is just sort of a multiyear effort to make sure that we expand our margin on a reasonable basis. Attrition has come way down because of all of the great actions we took through the year. And people expense is our biggest expense. So I think that’s – the thing we’re keeping an eye on the closest is just making sure that our headcount expense is moving ahead at the right pace. And yes, there’s so much news out there right now about possible recession and layoffs and cost cutting. We’re just – we’re positioned well relative to a lot of other companies just in terms of our business model and our investment, but we just want to make sure that we’re being conservative enough as we get into January when clients will be printing their budgets. We still don’t have great visibility on what the budgets of our clients are going to look like. So that’s the thing that I think will give us a lot more confidence in terms of the numbers that we can project. Thank you. And one moment for our next question. And our next question comes from the line of Keith Housum with Northcoast Research. Your line is open Please go ahead. Thank you. Good morning, Phil and Linda, I appreciate it. In terms of just trying to understand, and I guess going forward, if we do hit more of a downturn, where the risk is greatest for FactSet in terms of customers closing? I noted that PE and VC firms. If I would think we most likely would like to close, you guys are doing very healthy now. So where do you see the business risks of losing customers as we do go into this year downturn? Well, I think yes, firms that are not being competitive, the smaller firms, there’s risk of firm closure. Hedge funds could be one example. So for hedge funds, I’d sort of put them in the medium middle of the pack here for us in terms of the next six months. The hedge funds seem to be doing okay. That’s another firm type where we’re doing well from a CTS standpoint. And I -- it’s unusual that FactSet loses completely a large asset manager or a bank that’s out there. We have some footprint. So really, for us to win -- and what we’re focused on is just taking market share within those firms. So firm closure doesn’t worry me so much. More of our -- but it’s hard to control that, frankly. More of our focus has to be on the largest accounts that have the largest amount of opportunity for us moving forward. Great. I appreciate that. And then in terms of your revenue stream, remind me – I know most of it is being reoccurring, but what portion of your revenue is nonrecurring? And how did that do in the quarter versus, I guess, obviously, recurring part? It’s a very small percentage of our revenue. I mean I think it’s probably less than 2%. It’s something we’re taking a closer look at. And if that would be more helpful to break out, that’s something we’re certainly going to consider moving forward. I think it’d have been a little down. Typically, it’s going to trend with ASV, right? So -- and very much trends with the analytics business. So most of the professional services comes out of the analytics implementations. Thank you. And one moment for our next question. And our last question comes from the line of Owen Lau with Oppenheimer. Your line is open. Please go ahead. Thank you for taking my questions. Could you please give us an update on your ESG initiatives? How should we think about the impact of your ESG initiatives to your revenue and expense this fiscal year? Thank you. Hey, Owen. So FactSet’s overall, our overarching ESG strategy is just to be an agnostic agent in the ecosystem for our clients. ESG is so fragmented. There’s different focuses region by region globally. And we probably have the best selection of ESG in the market. And we integrate so many other providers. In fact, that adds its value in terms of concording that data so that firms that are creating their own ESG composites don’t have to go through all the pain of managing the data. So building applications on top of that to provide clients their own tools to create their own view, that's primarily what we’re focused on. It’s not a meaningful contributor to ASV today. I think some of it probably doesn’t show up directly as ASV as its own product, but there’s a lot of value that we’ve put into the workstation. So I believe most users that subscribe to a workstation can access whatever ESG products they’re subscribing to in the market. So that’s really where our primary focus is right now. You, too. Yes. So thank you all for joining us today. We’re off to a good start in fiscal 2023. While economic uncertainty persists, we are constantly talking to our clients and are really well prepared to respond to any market environment. I’m confident in our ability to drive continued sustainable growth, and FactSet is a consistent performer with a proven history of successfully navigating volatility. We have a resilient business with an innovative product mix, differentiated content and diverse end markets. And we are only further strengthening our offerings as we continue to invest in our products to enhance our competitive position and the value we deliver to clients. Before wrapping up, I really want to thank all FactSetters globally for their continued high level of execution and engagement and hopefully, everyone at the firm is having fun. I know I am. I think most FactSetters are. We’ve invested, and we have a great culture. So it’s a good place to be right now. Please be well this holiday season. We look forward to speaking with you again next quarter. And in the meantime, feel free to contact Kendra Brown with any additional questions. Operator, this ends today’s call.
EarningCall_1528
Ladies and gentlemen, good day, and welcome to Dr. Reddy's Laboratories Limited Q3 FY 2023 Earnings Conference Call. As a reminder, all participant lines will be in the listen-only mode and there will be an opportunity for you to ask questions after the presentation concludes. [Operator Instructions] Please note that this conference is being recorded. Thank you. A very good morning and good evening to all of you and thank you for joining us today for the Dr. Reddy's earnings conference call for the quarter ended December 31, 2022. Earlier during the day, we have released our results and the same are also posted on our website. This call is being recorded and the playback and transcript shall be made available on our website soon. All the discussion and analysis of this call will be based on the IFRS consolidated financial statements. To discuss the business performance and outlook, we have the leadership team of Dr. Reddy's comprising Mr. Erez Israeli, our CEO; Mr. Parag Agarwal, our CFO; and the Investor Relations team. Please note that today's call is a copyrighted material of Dr. Reddy's and cannot be rebroadcasted or attributed in press or media outlets without the company's express written consent. Before I proceed with the call, I would like to remind everyone that the Safe Harbor contained in today's press release also pertains to this conference call. Thank you, Richa, and greetings to all and wishing you call a very happy new year. I'm pleased to take you through our financial performance for the quarter. For this section, all the amounts are translated into US dollar at a convenience translation rate of INR82.72 which is the rate as of December 30th, 2022. This is yet another quarter with a strong all-down financial performance reflected in higher server sales and profits and strong free cash flow. Consolidated revenue for the quarter stood at INR6,770 crores that is $880 million and grew by 27% year-on-year basis and by 7% on a sequential quarter basis. The performance was supported by healthy growth across our businesses, with contributions from both base business and new product launches. Consolidated gross profit margin for this quarter stood at 59.2%, an increase of 545 basis points over previous year and 15 basis points sequentially. On year-on-year basis the gross margins were mainly aided by an increase in contributions from new products and favorable product mix. Gross margin for the global generics and the PSAI business were at 64.6% and 18.2% respectively for the quarter. In line with our expectations, PSAI gross margins have rebounded compared to the last quarter. The SG&A spend for the quarter is INR1,798 crores that is $217 [ph] million, an increase of 17% year-on-year and 9% quarter-on-quarter. The expense in the current quarter reflects an increase in investment, certain one-off expenses, and an impact of the ForEx rate. As a percentage to sales, our SG&A has been at 26.6%, which is lower by 240 basis points year-on-year and marginally higher by 30 basis points sequentially. The R&D spend for the quarter is INR482 crores that is $58 million and is at 7.1% of sales. We have been making good progress on our R&D pipeline in line with our business strategy. We continue to drive productivity across our businesses, while also making investments to strengthen the product pipeline and capability development in marketing, digitalization, and people including for Horizon 2 initiatives. The next finance expense for the quarter is INR14 crore that is $2 million. The EBITDA for the quarter is INR1,966 crores that is $238 million and the EBITDA margin is strong at 29%. Our profit before tax stood at INR1,635 crores that is $198 million, which is a growth of 68% year-on-year and a growth of 1% quarter-on-quarter. Effective tax rate for the quarter has been at 23.7%. We expect our normal ETR to be in the range of 25% to 26%. Profit after tax for the quarter stood at INR1,247 crores that is $151 million. Before this, EPS for the quarter is INR74.95. Operating working capital decreased by INR490 crores, which is $59 million against that on September 30th, 2022. The decrease is majorly due to higher collection of receivables and some increase in payables. Our capital investment during the quarter stood at INR292 crores, which is $35 million. We generated healthy free cash flow during the quarter of INR1,975 crores, which is $239 million. Consequently, we had a net cash surplus of INR3,401 crores that is $411 million as at the end of the quarter. As of 31st December, 2022, foreign currency cash flow hedges in the form of derivatives for the US dollar are approximately $51 million, largely heads around the range of INR80.3 to INR83.3 to the dollar; RUB2,975 million at the rate of rupees 0.9661 to the ruble; AUD1.8 million at the rate of rupees 56.20 to Australian dollar; and ZAR34 million at the rate of rupees 4.812 to South African rand maturing in the next 12 months. Thank you, Parag. Good morning and good evening to everyone. I hope you and your loved ones are keeping well. I'm glad to report that we continue to disclose [ph] financial performance in the current quarter as well as with record sales, profit, and cash flow generation. We made good progress in our productivity journey, which allow us to remain competitive and grow in our markets. We have been able to identify several new business opportunities which refer to as Horizon 2 business and have started building this. We have also made good progress against most of our ESG goals. Let me share with you some of the key highlights of the current quarter. One, strong revenue growth driven by continued traction US and Russia markets; second, high cash generation leading to net cash surplus of more than $400 million at the end of the quarter. Three, significant progress made for biosimilars, completion Phase III clinical study with rituximab, and completion of Phase I clinical studies for tocilizumab. Let me cover a business-wise key highlights in a bit more details. Please note that all references to the number in this sections are in representative local currencies. Our North America generics business recorded sales of $375 million for the quarter with a strong growth of 51% year-over-year and 7% on sequential basis. Sequentially, the sales continue to grow in the US market with a positive traction seen in both base business and recent launches including sorafenib, [Indiscernible] Contributions from [Indiscernible] capsules may fluctuate from quarter-to-quarter, we expect it to remain meaningful over the next few quarters. In this quarter, we launched five new products and expect the launch momentum to continue during balance of the year. Our euro business recorded sales of €51 million this quarter with year-on-year growth of 8% and sequential quarter decline of 2%. During the quarter, we launched 11 new products across various countries within Europe. We expect to continue with the gross momentum in the rest of FY 2023. Our emerging market business recorded sales of INR1,310 crores with the year-on-year growth of 14% and sequential growth of 7%. Within the emerging market segment, Russia business grew by 29% on a year-to-year basis and 8% to quarter-to-quarter basis in constant currency. This strong growth was supported by higher sales of biosimilar products in Russia. During the quarter, we launched 29 products across various countries of the emerging markets. We expect these businesses to continue the growth momentum during the balance of the year. Our India business recorded sales of INR1,127 crores with the year-over-year growth of 10% and sequential decline of 2%. During the quarter, we launched two new products in the Indian markets. We are creating several growth engine for India business for Horizon 1 and Horizon 2, which includes ramping up internal portfolio, collaborations, innovation, and inorganic opportunities. Our PSAI business recorded sales of 95 million with the innovative decline of 2%, however strong growth of 18% on sequential quarter basis, contribute by an improvement of the volume pick up. This business is starting to show signs of recovery and we expect this momentum to continue in the coming quarters as well. We are progressing well on our pipeline products. The number of filings in several of our key markets have been improving. The ANDA and drug master filings are expected to significantly improve during Q4. We are evaluating several inorganic opportunities across businesses in line with our strategy. We believe all of these will lead to several growth opportunity for us both in the short-term, as well as in the long-term. I'm confident that we'll be able to continue the growth momentum supported by our strong cash position, focused management team, and robust governance and processes. Yes, good evening, and congratulations for the great set of numbers. So, the first question on REVLIMID, I think I missed your comment, while you said the REVLIMID revenue could kind of fluctuate on a quarter-to-quarter basis. But is there any kind of outlook that you are providing for let's say, quarter four and FY 2024 in terms of the quantum -- relative quantum vis-à-vis quarter two and quarter three, what we are seeing? So, we cannot share as a part of the agreements that we have. But that's what I said, it's -- what will determine the size of the opportunities, of course, the timing of the orders that will come from the customers that may vary from month-to-month or quarter-to-quarter. But overall the product will continue to be meaningfully contributing to our business and we are very confident about it. We cannot share guidance in this respect because it's part of the agreement. That's why I'm sharing what I'm able to share at this stage. Sure. And second question on [Indiscernible] while we have shared that our capital deployment priority is kind of India followed by the branded market and likewise, but I think we are generating significant cash flow and we are not seeing any activity on that front. So, is there a basic timeline, which you are looking at to deploy this cash or elsewhere considering any other option to know about returning this to shareholders? We engaging in the multiple business opportunities and actually we'll be able to share that when we'll sign the deals. Like we discussed in the past, we knew that this is coming and we knew the type of capital that we are going to create. So, for us, it's well within our plans -- our strategic plans. The priorities will continue to be similar to what we have discussed in the past. We want to engage it in this development, which is not a shopping spree or big deals, but rather complimentary deals that will enable our strategy and create capability or brands that we don't have, or areas in which we can create more meaningful contribution to our -- all stakeholders, customers, shareholders et cetera. The second is to continue to invest in both Horizon 1 and Horizon 2 and CapEx and R&D. That we use of the money. We believe that we will have a good support [ph]. Hi, thank you for the opportunity. My question is in India business. So, although on year-on basis, you have seen good growth, healthy growth, but sequentially it has declined. And what we have seen in some market databases that Dr. Reddy's growth has been lagging against the broader market growth. So, how should we see growth outlook for your India piece, given it's the most important segment for you and what will be key growth drivers from here on? The main growth will come from investment in differentiated product and the specialty products and collaborations that we are working. So, we are planning to introduce a lot of innovation in India, and we are building it. In addition to that, we will continue to focus on the brands that we believe can contribute in short-term, but much more in the long-term. And we will continue also to invest in the capabilities to market within the most productive manner using all the relevant digital tools and the ability to maximize the return on the investment. We are going to see also in India continue divestiture of the brands that we are not planning to invest behind. If we believe that the returns that will come from those divestitures will be more than what we will get if we continue to market it. So, in that respect, we are well within our strategy. And maybe the results here and there will fluctuate because of brands, but overall I'm very confident that will be top five as per the targets that we shared with you [Indiscernible]. Sure. And in the [Indiscernible] portfolio, which you have done some time back, are the results in line with your initial expectation, or do you think you have further headroom to see better sales for some of the top brands? The [Indiscernible] product sales, they're not serving us very well. I'm very happy with these acquisitions there. It's already exceeded expectations. My last question is on Russia, [Indiscernible] besides a very strong quarter which you mentioned there were biosimilars, which contributed, so do we assumed it to be sustainable sales or this is driven by someone one-time pick up and we might see moderation from here on? Russia will continue to be strong for us. Quarter wise, it will fluctuate. This quarter it’s a timing of the bits with the government on biosimilars for example. So, unlikely that we will see that in the other quarter. So, it will fluctuate, but overall we are going to see in the local currency growth and as related to the protection the ruble, I think we have very lucky for this year. We're very good the protection on the ruble itself. So, we are -- I am optimistic from both -- from even with the scenarios that there will be a significant devaluation of the ruble. Yes, thank you, sir. Thanks for the great set of numbers. Just on the REVLIMID side, if you could say something more on the kind of visibility in terms of -- like -- it seems that first two quarters -- or in the last two quarters, whatever number that we would have generated, it seems that we have already achieved around 5% odd mid-single-digit kind of volume set in the product opportunity. So, considering that, is it fair to think that fourth quarter and first quarter possibly could be a relatively low number that we could see from REVLIMID? Okay. But could you give some sense about let's say, in terms of the volume set, whatever that is fixed for the first year, how different the volume share number would be for second year? Ballpark indicate--. Again, it's not because I would love to share, but I can't. We have an agreement and I have to honor the agreement. So, please bear with me on that. Okay, sure sir. Then sir the extended question relating to this that see the cash flow generation what we are witnessing. So, considering that, so, the near-term priorities -- could you share the near-term priorities that you would be having? Because, what I have seen that you have already indicated that and you are likely to be -- or you're likely to remain active in terms of inorganic growth as well as the R&D spend also, rate, if I see, it has just moved on, along with the kind of ramp up in the revenues. So, considering these two things, what priorities that would be there for us in the next 12 to 15 months or 18 months' period going ahead? So, as we discussed in the past, our priority is productivity in the short-term. So, it needs to grow what we call Horizon 1 which is meaning the current business that we have, including investment in those productivity investment in our portfolio, in the ability to get some of those complex genetic faster to the market, some of those biosimilars faster to the market. As well in Horizon 2 building those new businesses that will give us the growth in the future. As we showed in the past, we assume that we will be able to generate enough cash and enough profit to finance for those activities and so far it is going well for us. The extra cash that we will have, we will use for business development and for investment in capabilities in the business, especially digital and mechanization, automation, and artificial intelligence. The -- and in line of what we have discussed, so I say the old guidance remain the same, we are comfortable on the long-term basis with the 25% EBITDA and 25% ROCE, double-digit growth and no debt. This continue to be the guidance that from time-to-time will be above it like this; from time to time, we'll be below it like some couple quarters ago. But overall, I think it's allow us to both to be very healthy company and to grow very, very well and we have potential upside even to exceed these numbers. But so far, we are very much into that, that makes up for the quarter, but if you see record for the last few years, we are very much where we said we are going to be. Sure sir. So, then the revenue -- US revenue excluding REVLIMID, if you consider, we have seen this year as a kind of we all know we maintained the revenue run rate excluding REVLIMID. But there were challenges and a couple of our key products also witnessed competition from others largely from Indian players only. So, for this revenue piece, could you give some sense that okay next year, what is the visibility that you are having? Are you likely to see the sustained competition and all that impacting the business or some sense about growth that you can indicate for the US business excluding REVLIMID? Next -- in FY 2024, we are planning to launch at least 30 products give or take. And we are planning to continue the growth that we saw in the last couple of years. So, we indicated that we believe that the baseline of 6% -- not 6%, that single-digit growth, 6% was the past. Single-digit growth will likely to happen and maybe more than that. And from time-to-time, we'll have a product or products that will create much better growth. And that like I said to us in the last couple of months, and those products at a certain point in time also will go down with [Indiscernible]. So, overall, the trend is growing. In addition to that, we believe that once Horizon 2 will kick-in also the US will go in double-digit, but this is in a later stage towards five, six, seven years from now. So, now, it may fluctuate because of pressure. Usually come to predict the market share, it's hard to predict. So, unfortunately, I cannot -- I don't know what will be quarter-on-quarter, but absolutely, we are planning to growth in United States. Okay. And is it fair to believe so, the next year, we will see a kind of a meaningful ramp of in the kind of spend towards Horizon 2 plans -- growth plans versus current year? We don't like to ramp up spend, we are planning to spend in accordance -- in a very disciplined manner in accordance to our growth. At the time, we indicated that we are going to have more expenses both on the SG&A as well as the R&D, but within the range of profitability that I mentioned in the past, so we will be able with our growth and our cash to finance the investment, it will not be extra, and -- because of the profit [ph]. Yeah hi. Thanks for the opportunity. Good evening. Just wanted to understand one is the industry level question. So, we've been seeing a lot of USFDA issues going to the next level and we've been hearing that there's a volume distribution that is happening to the large Indian and global players in the US generic side, are we seeing that happening to us also? We are getting some volumes for our base business, would that be correct understanding? We too have a growth in volumes. I cannot attribute necessarily for that in the growth at least we are facing is from activities that were initiated primarily. Naturally, we are watching carefully all the results of all the inspections that are happening in India and outside of India. So far for us, knock on wood, all of our plans are operating in full compliance. Okay, okay. And with that kind of volume gain, et cetera, do you think there is some improvement in pricing on base business or it still remains mid to high single-digit for the base portfolio? I'm not aware of any, let's say, special phenomena that can indicate both on price or quantities as related to that. Okay, okay. Fair enough. So, would it be fair to say that the incremental growth, you had some approvals and launches for sure. But with the price erosion, it nets off and the incremental sales momentum is coming from this product itself? Okay, okay. And last one on the capital allocation, we've seen some companies being successful in late-stage innovator led programs, are we thinking about it? Or in the past, we had done 505(b)(2), and then we move to self-sustaining and selling those assets. So, what is the plan for both these -- I mean, if there's any plan on both these strategies? We are not planning to come back to the 505(b)(2), we worked hard to get out. Horizon 2 contains activities that are differentiated by design. So, we are talking about the 11 spaces in India and a couple of spaces outside of India, in Aussie market, Europe, as well as United States. We do have NCE as part of our origin discovery, especially in the area of cancer. We do have activities in cell gene therapy, in therapeutic management, in [Indiscernible], in pharmaceuticals, as well as in other innovation in go-to-market, this is part of the Horizon tool that we have, but not 505(b)(2). Thank you very much and good evening, everyone. The first question is on government grant looks like in 3Q, you did INR43 crores in first half, some INR240 crore odd. So, I guess your product mix is not changing that much. So, what's driving this? So, the grants are -- obviously, we file the applications as for the government's scheme, Sameer, and it depends on the eligibility of the products and the scales that we are making. So, depending on the underlying numbers, the grant is recognized. So, it's obviously something that will continue but will fluctuate from one quarter to another. Okay, no fair enough, I get that. But is the product mix changed so much? The products which were eligible, you didn't do those sales in three-- Okay, okay. Cool. And the second question is on biosimilars, you clearly are focused on that, but if I look at your pipeline, I mean, first of all, good job on Rituxan for Phase III. But to succeed in this market, you need good five, 10 products, of fairly vibrant pipeline, several products in Phase III type of situation. So, can you talk a bit about it, how will you make a mark in this space? If you recall, we decided at the time to skip the products that will be a with the product expiration until 2027 because we felt that we'll be late to the market. And we have a [Indiscernible] portfolio for the pattern click that is after that, even larger number of what you've just said. We kept rituximab as it was already there. We already -- we're already selling in 27 countries. And by having the USFDA approved, it will allow us to sell it in many more countries and we have also agreement with the third-party in the US market. Rituximab also will be the USFDA and we will be able to prove the relevant facts from a GMP point of view. So, to your question, we are committed. We are committed to a larger number of molecules than that and other times we are going to sit and in accordance to the relevant data that we need to launch the product. And -- but we absolutely are going to play biosimilars to be a significant player, especially in emerging markets. Okay, got it. And one final one is on [Indiscernible], it's been some time that we are stable at 14%, 15% market share. So, what's the outlook on this? And we'll continue to try our best to gain as much market share as possible. It's fluctuated in according to decisions of the customer. Yes, thank you for the follow-up. So, I think on the biosimilar products that we are -- whenever we have got the good trial data et cetera, do we have the existing capacity which can support let's say fair market share in this product or would we need to invest more? And if yes, would it be the same facility where we would seek expansion or it could be a greenfield facility? We are investing in capacity for the last five years and continue to invest, likely to see our facilities investment growing every year. Yes, we have enough capacity to capture market share globally. And what would be our current biologics capacity -- reactor capacity in total, in terms of kilo-liters? And the gross block related to? And in terms of our cost structure, would you have benchmarked that cost of production versus let's say, Korean and Chinese player? And where we stand there versus NIM? We believe that we're very competitive in terms of the cost structure, part of it is because the technology we are using, part of it is the calculation that we have on the product and part of it is the fact that we are in India, and leveraging the economy of India. Yes, hi, thanks for taking my question. My question is only PSAI business. So, we've seen recovery here, is it fair to assume that the disruption in this business is behind us? And there is -- this will continue to normalize as we go forward? And the second question is on the gross margin side, again, this used to be mid-20 percentage gross margin business in the past, can it still get to those levels, or would it settle a bit lower? I believe that it should go there and we are in the right direction to be done. And I also believe that the challenges that we faced in the last 18 months or so are behind us. And like I mentioned, we do see very good signs of recovery, and there is still room for improvement on that side, which I believe that we will achieve. Yes. Thanks and good evening. Erez can you update us on China filing and how the business is doing? And when do you expect meaningful traction in revenues? So, we continue with the process. It's going well, Amit [ph] can help me, but I think we are talking about 14 or 15 products-- Every year now, Saion we are started filing more than double-digit -- double-digits filings have started. As we speak, we have about 20 filings pending approval and in the next few years. So, going by this run rate, obviously, there will be 40, 50 filings over the next three four years. So, typically, after filing, it takes 18 to 24 months for a product to get approved. So, last year, we got like approval for four products. This year, we expect similar run rate and going forward, even it to become better and better. So, all I think statistics are working as we are expected and the sales also should start picking up faster. So, we are already growing in double-digit, but that can start growing faster, maybe somewhere second half of 2024, 2025 onwards. Okay. And is this also on the Russia I mean how -- I mean I know this quarter is good, you had biosimilar contract, but in general, the market dynamics are you seeing more traction for Indian companies in terms of procurement by the government, or market demand in general? I'm just looking at how should we think about constant currency growth in Russia from a slightly longer term perspective maybe for the next couple of years? I don't see anything special as related to company or country in the -- everybody just expect to my opinion are waiting to see how events will fold in the country. And to the best of my analysis, if people did not leave the market as of yet and so it's not a growth that's coming because other than -- it's real growth that’s coming from the consumption of [Indiscernible]. So, the way we are looking at it as part of our products, our OTC which have seasonality to them and the biologics -- different seasonality that are related to the timing the government is fulfilling it and they are exposed that very much the same demand over the years. So, so far is behaving very normal to what we see and the growth is attribute primarily to our productivity and not to external elements. Okay. And one last question, if I can for India, adjusted for the acquisitions, Cidmus, et cetera, can you share how the organic growth has been? And I think couple of quarters back, you indicated Cidmus to be a big drag on your gross margins, now with the patent of how should we think about the situation on that product? So, this product will be profitable for us, the cost structure will be better in the future and the brand is well accepted by the community is actually number one in the future as we speak. And we are going to continue to see growth in India, in all the places in which we are focusing. So, the -- like we indicate, I'm expecting India to continue to be double-digit growth also in the future and on top of it, we will see both inorganic move, investment in collaborations and divergence. So, all of these movements will happen in India also in the near future as well as the longer term. Okay. And can you share the growth number adjusted for acquisition and divestments just to understand the organic growth in India this quarter? Saion we look at the entire business as a portfolio. So, we don't analyze including and excluding acquisitions. I think overall, we reported a growth of 10%. And as Erez said, we are confident that we'll be able to continue to drive growth in India given the growth levers. Thank you for the opportunity. Is AMITIZA still meaningful opportunity for us as sales are declining and few companies have already discontinued the product? Yes, so we have launched this product in US I think in quarter one. I think there are significant number of players if I'm not wrong, about eight to 10 players have launched. And with price erosion I think has been fairly decent, so we are having a decent pace, but it's not a very large product for us. Yes, just a quick follow-up just trying to understand the smaller strengths where we had exclusivity, when is the competition expected to come for REVLIMID? Yes, I'm just trying to understand when are we expecting competition on the smallest trends for REVLIMID, where we have exclusivity? Okay. And would that be decent -- a meaningful contributor to the run rate -- whatever run rate we are doing on REVLIMID sales? Or these are the small shares? A cannot share the information that SKU. Like I mentioned before, indeed exclusivity will go in that period of time and the for that will continue to be meaningful to us. Sorry that I cannot share, I understand. Yes. Hi. Sir, can you provide an update to with respect to some of these complex US generic assets, which you had disclosed during your analyst meet last year. So, when do we expect launches for these complex assets to begin for us in the US market? Given one of your peers recently indicated that market formation has begun for a product regarding [Indiscernible]? Yes, Rahul, so, we also have approval of this product. So, I think it is linked to the IP. So, as it allows us, we have a settlement also with the innovator. So, as per the settlement terms, we will be able to launch. And for your border questions, we are very much on track of what we share then also we are planning to launch complex products that was not shared on the investor meeting. So, the pipeline of complex product is robust and getting better. Sure sir. So, any timelines which you can share in terms of products like Octreotide or liraglutide or teriparatide, when do you expect these launches to begin? So, would these launches be over the next 12 to 18-month period or beyond that? No, so specific timelines, we're not sharing Rahul. So, some of these products, we have filed, some of these products are under development. And obviously, the launch is linked to both IP scenario as well as we being able to secure the approval. So, while some of these should start coming to the market may be FY 2025, FY 2026 onwards, but that is what we believe. We do not have any firm timeline because all these are linked to both approval and IP. Okay, sir. And this mid-single-digit growth, which you're talking about the US portfolio on an ex-REVLIMID basis. So, that essentially will be driven by these 25, 30 launches, which we are talking about? Again, I know you you're putting with and without the product, we are not looking at in this way. By the time that the price of origins will come to this product, which will be naturally part of today's. So, we are not looking at the market with and without. And absolutely these products that we mentioned will be part of the [Indiscernible] the growth in the United States and from time-to-time because of the nature of such a product we will see blinks that will be much more than the single-digit which we discussed. So, we are reiterating that we will see growth on the continuous basis, and from time-to-time we will see upside. Yes, thank you for taking my question. Just the first one is on this recent launch by Amazon in the US for this RX pass. Right. So, they have started a subscription based in a $5 per month for the most common like 60 odd generic medicines. I know, it was launched only yesterday across the entire United States. But it isn't team any early thoughts on you know, how the supply chain could potentially change? Given that if they start making meaningful progress is that -- is the uninsured or the out-of-pocket population? Is it significant? You think, because it seemed doesn't seem to include Medicaid, Medicare. So that's one your initial thoughts just on the industry development. So, initial, it's definitely at the channel that was not there before and then there will be -- and it will be impactful, I believe. And all the time, whatever is not covered, I believe will be covered. So, it supposes it's likely to have and it will make the retail more competitive. And it will be dealt with opportunities as well as trips to [Indiscernible] for the industry. And so, we also saw this kind of stuff that is happening in other countries. But let's say as initial so primarily, I see it as another channel that we can use. Got it. So, I now know that -- we now know that Amazon doesn't directly deal with manufacturers, they probably go through the existing supply chain. But it is do you foresee or have you seen examples globally, where you know, somebody like that directly deals with manufacturer, so you think those kinds of business models can't evolve? Got it. Thank you. And my second question just on some of the commentary around the SG&A. In your press release, you've talked about one of expenses in the SG&A both I think sequentially and y-or-y so what are these? And is it -- if you could quantify or qualify please? Thank you. The SG&A is used for Israel supporting our brands or supporting our capabilities, especially in us related to technology, digital, et cetera. As well as the ability to launch a new product. The SG&A will grow as related to both version one and version two. But there will be more growth that will come from the sales as it will support it. So, I see -- that's why I kind of say that it's all about the mountains. And we that's why we're still committed to the same mountains that we committed. And I was just referring to referring to just the one-off expenses, just a one-off expenses, is what I'm wondering what it is? Yes, approximately, it would be it would be less than 100 basis points of sales approximately. And what is it for? I don't think we can disclose the nature of this. This is something normal person the business but it's not likely to recur. Yes. Thanks for the follow-up. Just one clarification as on the commentary on the US business when you talk about single-digit growth. What I understand is you've been talking about this even without REVLIMID before so let's say before REVLIMID kicked in, you were doing let's say $250 million a quarter, a $1 billion a year. So, is that the base we should take for next three, four years to see single-digit growth and there will be volatility at around that due to REVLIMID. Is that what you meant? Or you're saying that on this larger base that you have used, you can grow single-digit in the US? Okay. And just to follow-up on you talking about 30 odd product launches. How many of them you think would be complex? And is there any improved visibility over the past a year or so based on your FDA interaction, that you're more clarity on these launches next year? And basically, if you can give some color on the quality of launches versus the CRU [ph], is it going to improve remain the same if you can give some color on that? If I'm not taking into account [Indiscernible] the quality of the launches will be better. And some of them will be bigger quarter, some of them smaller. In terms of pipeline of complex products or products that can be very big, this pipeline is going up as we speak and we are working very hard on it. I believe that we'll have a very, very interesting pipeline in the next few years of complex. I don't know exactly what will be the onset of which one of them, but it's a very interesting portfolio. Thank you, everyone, for joining us today. If you have any follow-up questions, please reach out to the Investor Relations team. Thank you. Thank you very much. On behalf of Dr. Reddy's Laboratories Limited that concludes this conference. Thank you for joining us. You may now disconnect your lines. Thank you.
EarningCall_1529
Good morning, ladies and gentlemen. Welcome to the Goodfood First Quarter of Fiscal Year 2023 Financial Results Conference Call. At this time, all participants are in a 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. Please note that questions will be taken from the financial analysts only. [Operator Instructions] I would like to remind everyone that this conference call is being recorded today, Tuesday, January 17, 2023, at 8:00 a.m. Eastern Standard Time. Furthermore, I would like to remind you that today's presentation may contain forward-looking statements about Goodfood's current and future plans, expectations and intentions, results, level of activity, performance, goals or achievements or other future events or developments. As such, please take a moment to read the disclaimer on forward-looking statements on slide two of the presentation. I would now like to turn the meeting over to your host for today, Jonathan Ferrari, Goodfood Chief Executive Officer. Mr. Ferrari you may go ahead, sir. Thank you. [Foreign Language] Good morning, everyone, and welcome to this call for Goodfood Market Corp. to present our financial results for the first quarter of fiscal 2023 ended December 3, 2022. I'm happy to be joined on the call today by Neil Cuggy, Good Food's President and COO; and Jonathan Roiter, Chief Financial Officer. Our press release reporting our first quarter results was published earlier this morning. It could be found on our website at makegoodfood.ca and on SEDAR. Please be aware that we will refer to certain metrics and non IFRS measures. Where possible, these measures are identified and reconciled to the most comparable IFRS measures in our MD&A. Finally, let me remind you that all figures expressed on today's call are in Canadian unless otherwise stated. I will now turn to Slide three, which reviews Goodfood's recent strategic developments. During the first quarter and in recent weeks, we have taken multiple key steps in our march towards profitability and growing positive cash flows. Through key strategic initiatives, we have made big strides towards achieving that goal. With the improvement in cost structure well underway, our attention will begin to turn towards generating top line growth, underpinned by our improved profitability. We are very pleased with the progress made on our two key pillars of cost structure improvement, which are: one, consistent gross margin enhancement; and two, SG&A and footprint streamlining. Together, they have combined to substantial gross margin and adjusted EBITDA improvements this quarter. Zooming in on the two pillars. First, we have reached record gross margin this quarter. Standing at 35.5% or 36.9% when adjusted for inventory write offs related to the discontinuation of on-demand. Gross margin has benefited from the substantial simplification of our operations and our price adjustments to match recent inflationary pressures. With our most recent price increase having been passed through in early January, we are confident that we have reached a level of pricing and operational, labor and source efficiency that will help drive profitability in the coming quarters. The second pillar is our continued SG&A and assets streamlining. This quarter, we have rigorously and consistently cut costs to improve profitability and cash flows. With additional headcount reductions and contract renegotiations, combined with lease exits this quarter and in recent weeks we reduced our SG&A from $35 million in the first quarter last year to $22 million in the first quarter of this year. While our teams continue to work tremendously hard to reduce our SG&A further and implement efficiencies, we are nearing the cost structure that provides the spring board for adjusted EBITDA profitability as demonstrated by our 14% adjusted EBITDA margin improvement year-over-year. Looking forward to the remaining quarters of fiscal 2023, having now mostly completed the consolidation of all of our operations into two facilities located in Montreal and Calgary, we expect strength in our gross margin, as well as reduced labor and other SG&A expenses and improved cash conversion to materialize throughout 2023. As a result, we are glad to reaffirm expected positive adjusted EBITDA in the second quarter of fiscal 2023. The improvement in profitability can be further amplified by new marketing initiatives we are implementing to spur growth. We have recently launched a series of delicious meals in collaboration with Aloette, a Toronto based restaurant that was one of the first restaurants in Canada to receive a Michelin star last fall. In the coming weeks, we will also be launching a new VIP customer program, cementing our focus on acquiring and retaining customers with strong order profiles and a partnership with a Montreal based Canadian athlete as an ambassador of our brand. Together, these initiatives will focus on taking our customer experience to the next level and increasing customer lifetime values, while conveying our core purpose through a differentiated meal experience. Overall, we are excited with the consistent progress we have made to return to profitability and the marketing plans we have put in place to take our customer excitement about our core purpose and our meal-kit offerings to the next level. Thank you, Jonathan, and good morning, everyone. I will now turn to slide four, which provides details on our top line performance. Quarterly active customers during the first quarter were 148,000 compared to 254,000 in the same quarter of fiscal 2022, and 157,000 in the previous quarter with the majority of the sequential quarterly decline stemming from the exit of Goodfood on-demand offering. Net sales were $47 million for the quarter, a 6% decline compared to last quarter. This quarter as we continue on executing Project Blue Ocean, our focus on achieving profitable growth in the near term led us to continue focusing on our most profitable customer segments and product lines. As such, during the first quarter we discontinued our on-demand offering, impacting our active customer counts and net sales. We also streamlined our grocery and meal solution product offering, which also had an impact on net sales. Despite that, we are pleased to have kept net sales per active customer stable despite the smaller product offering. With our teams focused now solely on weekly subscription delivery method, returning to top line growth is a key component of the next steps of our strategy. And our initial focus will continue to be on our highest value existing customers. Please now turn to Slide five, which looks at our profitability levels. We are pleased to report record gross margins this quarter, reaching 35.5% or 36.9% when adjusted for non-recurring inventory write offs related to the discontinuation of products sold through our on-demand channel. 1,160 basis point improvement compared to the same quarter last year, underscores the momental effort made by our operations team to simplify operations and enhance sourcing and fulfillment. Combined with price adjustments and reduced credit incentives, we believe these improvements are structural in nature and provide a strong platform to reach profitability and positive cash flows. The improvement in gross margin was also driven in part by discontinuing our on-demand footprint during the quarter, which also allowed for further reductions in SG&A. These improvements and cost reductions resulted in $13 million adjusted EBITDA improvement year-over-year or a 1,380 basis point adjusted EBITDA margin estimate versus the same quarter last year, demonstrating our commitment to profitability. It is based on this progress that we continue to feel confident that we can achieve positive adjusted EBITDA in the second quarter of fiscal 2023. I will now move to Slide six, review of cash flows and capital expenditures. Cash flows used in operating activities after considering the $2 million spent on reorg and related costs came in at $4 million, a $15 million improvement compared to the same quarter last year. A lower net loss was the main driver of the cash flow improvement. Capital expenditures came in at less than $1 million, [indiscernible] payments of completed projects and tech investments. This continues our consistent reduction of capital intensity when compared to last year's first quarter CapEx of $12 million. We will continue to improve our cash flows from our operations and look to reduce capital expenditures in the coming quarters to drive further cash flow improvement and are now expecting our full year fiscal 2023 CapEx to be in the $4 million to $6 million range versus the previously communicated $5 million to $8 million range mentioned last quarter. As outlined on the bottom of the slide, our cash use defined here as the addition of cash flows from operating activities, cash flows from investing activities and lease payments has decreased from $32 million in the fourth quarter of fiscal '21 to $6 million this quarter, an improvement of $26 million. This positive performance has been a result of growing profitability as well as lower capital investment. As we look forward through fiscal 2023, we are expecting continued reduction in our cash use and based on realized first quarter results and our expected positive adjusted EBITDA in the second quarters, we are approaching positive quarterly cash flows. In addition, in recent weeks, we've continued working with landlords of the buildings that are no longer in use and are pleased with the progress we've been made in finding mutual satisfactory solutions that are allowing us to terminate our long term liabilities. These terminations sometimes carry relatively small termination costs well below the value of our lease liabilities. With these costs appearing in cash flow from operations and are viewed as reorganization related costs. With these efforts, we have reduced annual lease payments by over $6 million. Lastly, we ended the quarter with cash and cash equivalents of $29 million, which we believe provides balance sheet flexibility to execute our cost reduction strategy and return profitable growth and positive cash flows. Turning to Slide seven, you'll find a summary of our performance this quarter. Overall, we are encouraged with the progress made on our key focus this quarter, the improvement in profitability metrics. All profitability indicators have shown marked improvement in the first quarter, demonstrating our unrelenting work to return to positive adjusted EBITDA and cash flows. The record gross margin with the further streamlined SG&A have positioned us very well to achieve positive adjusted EBITDA in the second quarter. Hence we turn our focus to growing our top line, to achieving profitable growth in the coming quarters. Thank you. I will now turn to Slide eight to review our outlook. Our near term outlook continues to be dictated by four key drivers: first, the turbulence we experienced last year has led us to recenter ourselves around Goodfood's core purpose. Our mission is to spark joy by making, cooking and eating a fun, exciting and enjoyable experience to help Canadians live longer by achieving a balanced and healthy diet and to enable our community to enjoy a healthier planet by offering planet conscious products that are sourced, packaged and delivered sustainably. With our recent collaborations with the top restaurant in Toronto, as well as the onboarding of ambassadors that align closely with our core values and purpose, we are proud to be translating our purpose into a concrete message and actions. We are bringing our customer experience to the next level and look forward to generating growth from these initiatives. Moreover, with our cost structure and gross margin now significantly improved, we believe we have achieved and will continue to achieve the improvement in unit economics, enabling us to scale up our growth initiatives further. Second, the initiatives we have completed and continue to execute on are expected to generate EBITDA profitability in the near term and drive positive cash flows. As we discussed, we have already seen great improvements in gross margin, reaching record levels and have improved our adjusted EBITDA margin by nearly 14% year-over-year. We continue to face operating and market challenges where our progress in reaching profitability and positive cash flows continues. Third, our balance sheet has been our key focus this past quarter. Following the previously announced tolerance entered into with our lenders, we are pleased to have reached an updated credit facility that is adapted to our current needs. We appreciate the support our banking partners have shown as we continue to right size our cost structure to our current business model and scale. Beyond our credit facilities, we announced last quarter that our plan is to operate our business out of two main facilities in Montreal and Calgary. As such, we have exited the majority of our leased facilities and are actively looking to exit remaining leases and renegotiate commitments that would help simplify our balance sheet and further improve cash flows. These negotiations are crucial to enable Goodfood to thrive in the coming quarters and years, and I am very pleased with the progress our teams have made. Finally, we expect all our team's hard work and these initiatives to lead to continued improvements and financial performance in the upcoming quarter of fiscal 2023. We are pleased to confirm our expectation of positive adjusted EBITDA in the second quarter. And with these results, we are confident that we can expect to generate profitable growth and positive cash flows in the very near term. Thank you, sir. Ladies and gentlemen, we will now begin the question-and-answer session [Operator Instructions] Your first question is going to come from Luke Hannan of Canaccord Genuity. Please go ahead. Yes, thanks and good morning everyone. I wanted to dig a little bit deeper if we can into the VIP program. Can you give any color on what exactly that entails? What potentially that could mean in terms of growth to your overall business as well? Hey, good morning. Thanks for the question. So as we've been discussing over the past few quarters, the intent is to focus on engaging, retaining and growing our highest value customer segments. Our VIP program is specifically targeting customers that are spending somewhere between $5,000 and $10,000 per year with Goodfood. And the intent is, it's still early days in terms of iterating on the program and really understanding what generates the most value for our customers. But so far what we've seen success with is dedicated customer service lines for those VIP customers. We've tested out and created some live events for these customers where they can cook with our heads chef, Jordana, and build a community around the customer experience and the products. So those are a few examples of what we've tested out so far and what's resonated well with those customers. But again, it's still early days and the program will evolve over the coming year. Got it. That's helpful. And then the second question I have is, now with this slim down footprint, I'm trying to sort of ascertain what would be a realistic revenue capacity that this newer slip down footprint could support going forward? Yes. Thanks, Luke. If you rewind to 2019 and 2020 pre-COVID, the footprint will look pretty much the same as that as we described, so our Alberta facility plus our Montreal facility. And with that, we were approaching the $500 million to $600 million of revenue in peak COVID. So that kind of revenue is well within the capacity of the system. And with the other growth initiatives that we have, we can grow pretty substantially from where we're at today without any new CapEx in major facilities. Okay, thanks. Last one for me and then I'll pass the line is, there was commentary in the press release now there is more SG&A rationalization done towards the end of the first quarter and I imagine that's probably what gives you confidence that you're still on track to achieve positive adjusted EBITDA in Q2, but I'm curious to know if you can provide any sort of direction on the overall magnitude of what those cost cuts are, a dollar amount would be great, but otherwise any color there would be helpful. And then if I can also for the balance of the year. I know you'll be largely done Project Blue Ocean in short order here, but curious to think about how you're scoping in future cost rationalization moving forward. Hey, Luke. Thanks. It's Jonathan Roiter. Good question. Look, when we -- in the first quarter, there were ongoing SG&A reductions. It comes really from two -- well, two big levers. One, as we exited Goodfood on-demand, it allows to continue to modify our workforce. And those elements took place late in the quarter. In addition, as we're exiting leases, there's all the -- the ancillary costs associated with leases, that also disappear. And those as we described we’re exiting progressively through the quarter and into Q2. So when you look into the second quarter, what we could expect is, for our gross margin, we said we're going to be EBITDA positive, adjusted EBITDA positive. And so if we had an adjusted gross margin of close to 37% it would ultimately mean that our SG&A in the second quarter would have to be below that 37% to 36% [indiscernible] of net sales with those continued elements coming out. So that's from a percentage perspective. And another way of looking at it is, our SG&A for calculations of adjusted EBITDA went from around $16 million in Q4 to $19 million in Q1. And what we said in Q4 is that, we had a onetime benefit as we cleaned up at the end of the year. And so we were expecting an increase in SG&A in Q1. But ultimately that bump is temporary in nature. So the numbers that you saw towards the end of Q4 would be a number that we would try to strive for as we head into Q2 and Q3. Hi, good morning. I would like to touch on your customer base and I’m trying to understand at what point do you think the erosion of your customer base abate and then that your customer count stabilizes? Good morning, Martin. So the -- most of the decline in the quarterly active users in Q1 was related to the discontinuation of Goodfood on-demand. And so, if we look at our weekly meal subscription customer base, that was fairly stable in the first quarter, and we expect to see growth in the coming quarters in terms of that quarterly active customer base. And the most important piece for us is to make sure that we're focused on growing profitably, both in terms of EBITDA and cash flow. And so really, the key focus has been to ensure that the business can be EBITDA positive and cash flow positive at the current size. And as we look into the back half of the year, the new initiatives, including our VIP program, some of the restaurant partnerships that we've launched and we have in the works and some of our brand ambassadors are going to help us grow profitably from there. Okay. And I was wondering if you could touch on the promotional environment right now. I've received a voucher on the mail with a rebate of all the way up to $200, which -- from Goodfood, which I thought was pretty high. Can you talk a little bit about the promotional environment right now, how it is? And how is your customer acquisition strategy going? Sure. So in terms of promotions, what we've been testing out over the past few months is, declining value of the coupon per basket. So rather than either offering the whole discount upfront, on the first basket or offering the same discount across two or three baskets. We're starting to offer higher on the first basket to optimize for our conversion rate and then declining the value of the offer on subsequent baskets that the customer orders in order to help build the habit of ordering from Goodfood while reducing the incentives on the basket going forward and improving the ultimate lifetime value of our customer base. So we've been quite successful in seeing improvements in our unit economics through that strategy. If we look at the competitive environment, December tends to be a slow month in the meal-kit industry, and so we did experience normal seasonality during the month of December, particularly in the second half of December. And so acquisition and offers and order rates typically slow at that point. And then we've seen a rebound in January, both in terms of order rate and new customers being acquired. And I would say if you look at the unit economics on a year-over-year basis. I would say they compare favorably to last year. Customer acquisition costs are a little bit higher on a year-over-year basis. But we've also made improvements on lifetime value retention and gross margin. And so I would say the economics are healthy versus historical comparables. Okay. And my last question, you've had a sizable margin -- gross margin expansion this quarter. I was wondering if it would be possible to bridge and quantify some of the drivers of that increase? Look, in terms of detailed numbers, we can obviously circle back with you. But the -- there's three big pieces associated with the increase. The first one is by exiting the Goodfood on-demand that provided the largest benefit because the -- there was a difference in margins between our weekly subscription and Goodfood on-demand. The second piece has been now that we're focusing solely on our weekly subscription, the [office] (ph) team has done a tremendous amount of work around simplifying the operation, simplifying the amount of ingredients that we're using, now the suppliers that we're working with. And ultimately, that drives a lot of efficiencies inside our facilities, whether it be around labor efficiency, but then also around waste and products that we're not using on a weekly basis. And the last is, we have benefited as we took price earlier in the year. And that price was aligned with bringing our products to where our competitors stood. So those would be the three big buckets. And I guess, lastly, as John has laid out C&I, so our credits and incentives has declined as well. From a credit perspective, if you can tie that back to improved execution within our facilities, again, greater focus, less issues and therefore, less credit. And then from an incentive perspective, John laid out -- Jon Ferrari laid out how we're very focused on acquiring the right customers as opposed to just acquiring customers. And so, we're being very thoughtful in terms of our incentive programs as we go forward -- looking back in Q1 going forward throughout 2023. Yes, sure. Sorry. Yes, so that was not a Q1 event, right? So that was back in Q4. And I think the contribution probably was around 3%, maybe 2% to 3%. It's about a 300 basis points improvement in the gross margin based on the price increase that we put here. Thanks. Good morning. Just wanted to ask on the path to being cash flow positive with CapEx already being reduced significantly, is the cash flow positive goal highly dependent on not only being EBITDA positive, but meaningfully growing that EBITDA. So if you could maybe comment just on the levers to getting you to cash flow positive? And I'm guessing it also includes the working capital. Any thoughts on those elements would be helpful. Hi. Good morning, Fred. Very good question. I mean, you've answered the question for me, but you've hit on the elements. Look, if we take ultimate cash use in our business, why don't we distill it to kind of four big levers, right? So obviously, the first lever and to be sustainable from a cash flow position you need to have a positive adjusted EBITDA, right? So we are -- I think we're very clear our perspective on when that's happening, and we're in that period right now. Second piece that we have is working capital. The business traditionally benefits from negative working capital as we collect from our customers earlier than we have to pay our suppliers with regards to our meal-kits, raw ingredients. And so, as we transition back to our weekly subscription business, there's no reason why that will not eventually return to the business to have negative working capital. The third piece is use of cash in investment. And you saw from our CapEx in Q1, the marked decrease of the historical business. Look, when you're down to ultimately two facilities that have lease costs in the $200,000 range per month. There's not a significant amount of CapEx that we put in the business, and that's why we brought down our thoughts for the year. And I think we'll work to be on the low end of that range, possibly even provide an updated review when we speak next in April. So CapEx has fallen very materially, and we're working to be on that low end of the range and maybe even update that number as we go through a few more periods. And then the last big use of cash for our business historically was leases, lease payments that you saw in cash flow from Investec, that financing, excuse me. And as we laid out in our prepared remarks, we've exited a significant amount of our leases. We're in the process of talking to a handful of landlords currently. We're -- we feel confident that we'll be in a position where we'll be down to, as Neil laid out in one of the answers, two facilities that we are only operating in two facilities, but we think we could be only making rent payments on two facilities in short order. And that means I gave you what that number would be. So we have a very clear path on those four levers to get back to a positive cash generating business. It begins with EBITDA, which we said it this quarter, working capital structurally we should benefit from investing. There really isn't a significant amount of CapEx and leases we've -- the team has done a very strong job of working with our landlords and finding mutually acceptable solution to bring down the amount of monthly cash that goes out. So those are the four big pieces. That's helpful. Thank you. Just maybe a follow-up on that last point. Any way for you to maybe quantify sort of the cost of the leases that are remaining right now. Like how incrementally positive would it be for you guys to successfully exit those leases as we think about future cash flow generation? Sure. Look, we're still in discussions with some critical landlords. So I think it's important to be thoughtful on there. But ultimately, we're very pleased with what I'll say, like the payback of the cost to exit. And so, you're seeing that in -- those costs you'll start seeing, there's a little bit of cost in CFO in Q1, I think it was about $150,000 of cost in CFO in Q1. You will see an increase of those costs in Q2, right? And those are like temporary in nature. So we'll obviously let you know what those costs are in the second quarter. But our goal would be to have essentially all of those costs out of the way in Q2, and we'll be able to walk you through what those costs are when we do a bridge of our cash use in the second quarter. Okay. Great. Last question for me. Just curious to how -- generally how you think about price points in the current challenging economic environment. I know in the past, you had a, call it, discount brand for meal-kits. Is that something that maybe not in the same form, or is that something that you're thinking about in terms of lower price point items? I know maybe it sounds contrary to what you're trying to do with maybe the VIP program, but just maybe your thoughts on potentially having different price points. Yes. So currently, the focus is on maintaining all of our products under the Goodfood brand. So we did have the Yum! discount brand in the past. I think where the decision is today, we want to stay laser-focused on operational excellence, cost structure reduction and profitable growth. And so launching a new brand is not something that we want to be doing right now in terms of focus and discipline. Our key focus really has been in demonstrating the value of our meal-kits and meal solutions versus restaurants and takeout options and so as the cost of restaurant delivery, restaurant meals takeout has skyrocketed in the past 12 month to 18 months. I think the customer segment that we're targeting sees a lot of value in our meal solutions at our current price points. So the key focus is on increasing value to the customer rather than trying to reduce our prices to the customer segment. And I think we've been successful in demonstrating that value to our customers, finding new ways to make some of our products more convenient like our easy prep products that have precut ingredients. We also launched at the beginning of January, keto and paleo recipes on our Clean 15 plan, so making it easy for customers to eat healthy, follow certain dietary preferences, whether they're full-time keto and paleo or part-time diners on those plans. And so what we've seen is, despite the inflationary pressures, customers are seeing value in some of the new products that we're launching. And even our restaurant partnerships like with [Alo] (ph), certainly the value that you can get from cooking at Michelin star restaurant at home is a very high value perception for those customers. So that's been our approach so far, and we really want to maintain focus and discipline around our profitable growth and cost structure. There are no more questions at this time. I would like to turn the conference back to Mr. Ferrari for any closing remarks. Thank you for joining us on this call. We look forward to speaking with you again next quarter. See you soon. Thank you. Ladies and gentlemen, this does conclude your conference call for this morning. We would like to thank everyone for participating and I ask you to kindly disconnect your lines.
EarningCall_1530
Good morning, and welcome to the First Quarter 2023 Earnings Conference Call for D.R. Horton, America’s Builder, the largest builder in the United States. There will be an opportunity to ask questions on today’s call. [Operator Instructions] During today’s Q&A, we ask that participants limit themselves to one question and one follow-up. Thank you, Paul, and good morning. Welcome to our call to discuss our results for the first quarter and fiscal 2023. Before we get started, today’s call includes forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Although D.R. Horton believes any such statements are based on reasonable assumptions, there is no assurance that actual outcomes will not be materially different. All forward-looking statements are based upon information available to D.R. Horton on the date of this conference call and D.R Horton does not undertake any obligation to publicly update or revise any forward-looking statements. Additional information about factors that could lead to material changes in performance is contained in D.R. Horton’s Annual Report on Form 10-K, which is filled with the Securities and Exchange Commission. This morning’s earnings release can be found on our website at investor.drhorton.com, and we plan to file our 10-Q tomorrow. After this call, we will post updated investor and supplementary data presentations to our Investor Relations site on the Presentations section under News and Events for your reference. Thank you, Jessica, and good morning. I am pleased to also be joined on this call by Mike Murray and Paul Romanowski, our Executive Vice Presidents and Co-Chief Operating Officers; and Bill Wheat, our Executive Vice President and Chief Financial Officer. The D.R. Horton team delivered a solid first quarter, highlighted by earnings of $2.76 per diluted share. Our consolidated pre-tax income was $1.3 billion, on a 3% increase in revenue with a pre-tax profit margin of 17.5%. Our homebuilding return on inventory for the trailing 12 months ended December 31 was 39.5% and our consolidated return on equity for the same period was 31.5%. Beginning in June 2022 and continuing through today, we have seen a moderation in housing demand due to affordability challenges caused by the significant rise in mortgage rates, coupled with high inflation and general economic uncertainty. Despite these pressures, we still closed over 17,000 homes and sold more than 13,000 homes in what is typically the seasonally slowest quarter of the year. We have seen increased sales activity in the first few weeks of January. While higher mortgage rates and economic uncertainty may persist for some time, the supply of both new and resale homes at a portable price points remains limited, and the demographics supporting housing demand remained favorable. We are well-positioned to navigate the current challenging market conditions with our experienced operators, affordable product offerings, flexible lot supply and great creative supplier relationships. Our strong balance sheet, liquidity and low leverage provide us with significant financial flexibility. We will continue to focus on turning our inventory and managing our product offerings, incentives, home pricing, sales pace and inventory levels to meet market, optimize returns, consolidate market share and generate increased cash flow from our homebuilding operations. Mike? Earnings for the first quarter of fiscal 2023 decreased 13% to $2.76 per diluted share compared to $3.17 per share in the prior year quarter. Net income for the quarter decreased 16% to $958.7 million, on a 3% increase in consolidated revenues to $7.3 billion. Our first quarter home sales revenues were $6.7 billion, on 17,340 homes closed compared to $6.7 billion on 18,396 homes closed in the prior year. Our average closing price for the quarter was $386,900, up 7% from the prior year quarter and down 4% sequentially. Paul? During the quarter, we continued to sell homes later in the construction cycle to better ensure the certainty of the home close date and mortgage rate for our home buyers with almost no sales occurring prior to start of home construction. Our cancellation rate for the first quarter was 27%, down from 32% sequentially, but still elevated from our typical levels. Our net sales orders in the first quarter decreased 38% to 13,382 homes, and our order value decreased 40% from the prior year to $4.9 million. Our average number of active selling communities increased 4% from the prior year quarter and was down 1% sequentially. The average sales price of net sales orders in the first quarter was $367,900, down 4% from the prior year quarter. We are continuing to offer mortgage interest rate locks and buy-downs and other incentives to drive traffic to our communities, and we are reducing home prices where necessary to optimize the returns on our inventory investments. Our second quarter sales volume will depend on the strength of its spring selling season, and we currently expect significantly higher levels of net sales orders in the second quarter as compared to the first quarter based on historical seasonal trends, current market conditions and our inventory of completed homes available for sale. Bill? Our gross profit margin on home sales revenues in the first quarter was 23.9%, down 440 basis points sequentially from the September quarter. On a per square foot basis, home sales revenues were down 4% sequentially, stick-and-brick cost per square foot increased 2% and lock costs were flat. The decrease in our gross margin from September to December was in line with our expectations and reflects the increased construction costs we incurred during 2022, along with higher sales incentives and home price reductions. We expect both our average sales price and home sales gross margin to decrease further in our second quarter for fiscal 2023. We are continuing to work with our trade partners and suppliers to reduce our construction costs on new home starts. We are making progress in these efforts, but we do not expect to see much benefit from lower costs on homes closed in fiscal 2023. Jessica? In the first quarter, our homebuilding SG&A expenses increased by 6% from last year and homebuilding SG&A expense as a percentage of revenues was 7.8%, up 30 basis points from the same quarter in the prior year. We are controlling our SG&A during this market transition while ensuring our platform adequately supports our business. Paul? We slightly increased our home starts from the last quarter to 13,900 homes and ended the quarter with 43,200 homes in inventory, down 21% from a year-ago and down 7% sequentially. 27,800 of our homes at December 31 were unsold, of which 7,100 were completed. We are focused on improving our housing inventory turnover. With more completed homes not available for sale, we expect our mix of homes sold and closed in the same quarter to increase back towards our normal historical levels. For homes we closed this quarter, our construction cycle time fully increased by a few days compared to fourth quarter, which reflects lingering supply chain issues. However, we are seeing some stabilization in cycle times on homes that we have recently started and we expect the cycle times to improve during fiscal 2023. We will continue to evaluate demand and adjust our homes and inventory and start pace based on current market conditions. Mike? Our home building lot position at December 31st consisted of approximately 551,000 lots, of which 25% were owned and 75% were controlled through purchase contracts. Our total homebuilding lot position decreased by 22,000 lots from September to December. 32% of our total owned lots are finished and 53% of our controlled lots are or will be finished when we purchase them. Our capital efficient and flexible lot portfolio is a key to our strong competitive position. We continually underwrite all of our lot and land purchases based on future expected home prices and cost. We are actively managing our investments in lots, land, and development based on current market conditions. During the quarter, our Homebuilding segment incurred $4.8 million of inventory impairments and wrote off $19.4 million of option deposits and due diligence costs related to land and lot purchase contracts. We expect our level of option cost write-offs remain elevated in fiscal 2023 as we manage our lot portfolio. Our first quarter home building investments in lots, land, and development totaled $1.7 billion, down 21% from the prior year quarter and up 16% sequentially. Our current quarter investments consisted of $900 million for finished lots, $690 million for land development, and $130 million to acquire land. Bill? Financial services pre-tax income in the first quarter was $18.2 million on $137 million of revenues with a pre-tax profit conversion of 13.3%. The lower profitability of our financial services business this quarter was primarily due to lower gains on sales and mortgages, increased competitive conditions, and a lower volume of interest rate lots by homebuyers during the December quarter. We expect our financial services to pre-tax profit margin for fiscal 2023 to be higher than the first quarter, but lower than the full year of fiscal 2022. During the first quarter, 99% from mortgage company's loan originations related to homes closed to buyer home building operations and our mortgage company handled the financing for 77% of our homebuyers. FHA and VA loans are accounted for 45% of the mortgage company's volume. Borrowers originating loans with DHI Mortgage this quarter had an average FICO score of 7.2 and an average loan-to-value ratio of 88%. First-time home buyers represented 55% of the closings handled by our mortgage company this quarter. Mike? Our rental operations generated $328 million of revenues during the first quarter from the sale of 694 single-family rental homes and 300 multi-family rental units, earning pre-tax income of $110 million. Our rental property inventory at December 31st was $2.9 billion, which included approximately $1.9 billion of single-family rental properties and $1 billion of multi-family rental properties. We expect our rental operations to generate significant increases in both revenues and profits in fiscal 2023 as our platform matures and expands across more markets. For the second quarter, we currently expect no multifamily rental sales and to close fewer single-family rental homes than in the first quarter. Forestar, our majority-owned residential lot development company reported total revenues of $216.7 million on 2,263 lots sold and pre-tax income of $27.9 million for the first quarter. Forestar's owned and controlled lot position at December 31st was 82,300 lots. 57% of Forestar's owned lots are under contract with or subject to a right of first offer to D.R. Horton. $190 million of our finished lots purchased in the first quarter were from Forestar. Forestar is separately capitalized from D.R. Horton and had more than $580 million of liquidity at quarter end with a net debt-to-capital ratio of 28.7%. Forestar is well-positioned to meet the current challenging market conditions with its strong capitalization, lot supply and relationship with D.R. Horton. Bill? Our balanced capital approach focuses on being disciplined, flexible and opportunistic. We are committed to maintaining a strong balance sheet with low leverage and significant liquidity to provide a firm foundation for our operated platforms during changes in market conditions and to support our ability to provide consistent returns to our shareholders. During the first three months of the year, our cash provided by homebuilding operations was $313.9 million, and our consolidated cash provided by operations was $829.1 million. At December 31st, we had $4 billion of homebuilding liquidity, consisting of $2 billion of unrestricted homebuilding cash and $2 billion of available capacity on our homebuilding revolving credit facility. Our liquidity provides significant flexibility to adjust to changing market conditions. Our homebuilding leverage was 12.8% at the end of December, and homebuilding leverage net of cash was 4.4%. Our consolidated leverage at December 31st was 22% and consolidated leverage net of cash was 13.3%. At December 31st, our stockholders' equity was $20.2 billion and book value per share was $58.71, up 33% from a year ago. For the trailing 12 months ended December, our return on equity was 31.5%. During the quarter, we paid cash dividends of $86.1 million and our Board has declared a quarterly dividend at the same level as last quarter to be paid in February. During the quarter, we repurchased 1.4 million shares of common stock for $118.1 million. Jessica? As we look forward, we expect challenging market conditions to persist with continued uncertainty regarding mortgage rates, the capital markets and general economic conditions that may significantly impact our business. We are providing detailed guidance for the second quarter as is our standard practice, but it is still too early to know what housing market conditions will be during the height of the spring selling season, so we are not providing specific guidance for the full year yet. We currently expect to generate consolidated revenues in our March quarter of $6.3 billion to $6.7 billion and homes closed by our homebuilding operations to be in the range of 16,000 to 17,000 homes. We expect our home sales gross margin in the second quarter to be approximately 20% to 21% and homebuilding SG&A as a percentage of revenues in the second quarter to be approximately 8% to 8.3%. We anticipate a financial services pre-tax profit margin of around 20%, and we expect our income tax rate to be approximately 23.5% to 24% in the second quarter. We are well positioned to aggregate market share in both our homebuilding and rental operations. Our goal remains to generate consolidated revenues in fiscal 2023 or slightly higher than fiscal 2022. However, it is realistic to expect that our full year revenues will decline year-over-year, given the environment and pricing actions we are taking. The low end of our current range of expectations includes consolidated revenues down from fiscal 2022 by a mid-teens percentage, which is unchanged from last quarter. 24%. We expect to generate increased cash flow from our homebuilding operations and on a consolidated basis in fiscal 2023 compared to fiscal 2022. We also plan to repurchase shares at a similar dollar amount as last year to reduce our share count during this year with the volume of our repurchases dependent on cash flow, liquidity, market conditions and our investment opportunities. We have $700 million of senior notes that matured during the remainder of fiscal 2023, which we are currently preparing to repay from cash. We plan to continue to balance our cash flow utilization priorities among our core homebuilding operations, our rental operations, maintaining conservative homebuilding leverage and strong liquidity, paying an increased dividend and consistently repurchasing shares. David? In closing, our results and positions reflect our experienced teams, industry-leading market share, broad geographic footprint and diverse product offerings. Our strong balance sheet, liquidity and low leverage provide us with significant financial flexibility to effectively operate in changing economic conditions and continue aggregating market share. We plan to maintain our disciplined approach to investing capital to enhance the long-term value of the company, which includes returning capital to our shareholders through both dividends and share repurchases on a consistent basis. Thank you to the entire D.R. Horton team for your focus and hard work. We are incredibly well positioned to continue improving our operations in providing homeownership opportunities to more American families. Thank you. The floor is now open for questions. [Operator Instructions] And the first question is coming from Carl Reichardt from BTIG. Carl, your line is live. You may go ahead. Thanks. Good morning, everybody. I just want to ask about inventory, unsold inventory. So about two-thirds of the inventory that you've got now is unsold. I think normally, it's about half when I went back and looked, so I just want to make sure, should we be optimistic because you've got product ready to go for the spring or in the supply chain perhaps is normalizing a little which is allowing you to get that ready or should we be more pessimistic because you haven't necessarily price that inventory to move yet? That's my first question. Well, Carl, as you know, I'm always optimistic. We feel very good about our inventory position. And you know, through the last three, four quarters, we limited sales to better align inventory cost demand and our ability to deliver. We are now positioned more in what I would consider a normalized inventory position and again, feel very good about our position and where we're heading into this quarter. Normally coming into the spring selling season, we'd be a little heavier than our normal 50% spec ratio. But feel really good about what we have in front of us right now for demand. Okay. And then -- I was looking at the market count now we're about 109 markets and say four years ago, I think you were about 80 or so, that's a lot. And obviously, you all benefited post-COVID by entering a lot of smaller markets that saw a fair amount of demand, post the pandemic. Now that that wave is potentially crested, can you talk about how some of the new, especially, the smaller what I call the tertiary city markets are performing over the course of the last six months? Are they better than some of the major markets less competitors, or is that growth beginning to wane now that we've seen a little more return to office back to the large cities? Thanks, guys. Carl, we've seen these newer markets and secondary markets performing well for us due to limited competition in those markets. We certainly saw a strong push to all the secondary markets with a pandemic moving people making them more mobile that we've been happy with the progression in the secondary markets and glad that we entered them. You know, Carl, even before the pandemic, we did very well in the small markets. And ultimately, it comes back to SG&A and control and the ability to deliver houses incrementally add a competitive advantage to what anybody else out there is able to do. So, that - that's been a part of our program and I think you're going to see continue to be a part of our program. Morning everyone. Thank you for taking the questions. Want to ask about the construction cost environment, I think I heard you say at the top that you were making some progress, but I'm paraphrasing but perhaps not expecting to see as much benefit on the construction cost side on homes close through fiscal 2023? Obviously, some of your peers have sort of quantified, some of the benefits they might already be seeing on the construction cost side. So, just curious if you can parse that out a little bit as you guys sort of aggregate market share as we think about your ability to press on costs here? Thank you. We've been really successful working with a lot of our trade partners in lowering our cost. And we've gotten a little bit of tailwind from certainly from the lumber price reductions that have occurred, but it just takes a while for those cost changes on the front end to actually show up in the closing, especially with the more recently prolonged build times. So, it's just a function of the calendar working those new cost structures through the pipeline. So, the deliveries we see in 2023 were largely, first half of the year especially started in fiscal 2022 in a different cost environment. And typically, lumber prices go up as we move throughout the spring. So although we're seeing a benefit from lumber today, if typical seasonality holds, lumber would actually be a headwind against the cost reductions that we are seeing on those new home starts that Mike just alluded to. Okay. Gotcha. Thank you for that color. And then second one, just kind of following up around the pricing environment. As you've seen sort of some of your peers enacted, I guess, different strategies around pricing versus pace here. And perhaps as we get into the spring, we might expect to see some builders on the ground react more aggressively on the pricing side versus -- I would argue you guys have been leading that first, I guess. So as we get into the spring, sort of, what are your expectations or perhaps what are you seeing on the ground right now around your competition and price reductions and would you expect to see another leg lower on the pricing and margin side through all that? Thank you. We have still addressed our incentives with a balance of rate buy-downs, financial incentives, along with adjusting price community by community to drive the returns that we're looking for. As we enter into the spring selling season, we're seeing some seasonality that we're happy with as the market starts to lead and we'll continue to adjust to drive the absorptions by community. Good morning, guys, and thanks for taking my questions. The first one is you mentioned the first few weeks of January saw increased activity, can you maybe just elaborate a little bit on that and maybe frame it sequentially or year-over-year? And how were incentives in the first few weeks of January relative to December? Yeah. So we talked about on the call that we do expect to see normal seasonality in terms of the move from Q1 to Q2 sales. And so what we saw in terms of the increased sales activity in the first few weeks of January was a positive early indicator. It is still too early to ultimately say what's going to happen this spring, but it gave us the confidence to say that we could see normal seasonality, which typically would be about 50% up from Q1 to Q2 in terms of net sales orders. We also did see a slight improvement, it’s only a few weeks, which doesn't make a quarter, but we've seen a slight improvement in our cancellation rate in January as well, which also helps give us the confidence to say an increased level of net sales orders in Q2 versus Q1. Got it. That's helpful. And then maybe could we talk just about cash flow expectations. It seems like it's going to be pretty robust here. I mean you're buying back stock, paying dividends, paying down $700 million in debt. So maybe just your expectations for cash flow and what the expectation for rental investment might be? Yeah, we still expect increased cash flow from our homebuilding operations in fiscal 2023 versus fiscal 2022. We saw our inventory step down slightly this quarter. We will be increasing our start pace as we move into the spring and then adjusting that to what we see in market demand. So we may not continue to see the same pace of cash generation as we did in our first quarter, but we do still expect to see robust cash. And then we're going to continue to take our balanced approach to deploying that first foremost of the homebuilding business next to the rental business. We will still see a substantial increase in our assets in the rental business this year, we're not guiding to a specific growth number there quite yet for fiscal 2023 because we're still evaluating the market and evaluating investments as we move through the year, but we do expect that level of inventory to increase while we see a significant increase in revenues in that business. And then past that, we will continue to pay dividends and continue to repurchase shares. We expect to repurchase shares at a similar dollar volume as last year, which would indicate greater than $1 billion of share repurchases for fiscal 2023. And then finally, on the balance sheet front, while we're very pleased with our leverage level, we do have $700 million of senior notes that mature in fiscal 2023, 300 million in February, 400 million in August. And currently, just given the overall environment and our cash flow expectations, we're preparing to pay those debt to maturities off with from cash. But obviously, we'll evaluate capital markets along the way to determine whether we want to refinance or not. But right now, preparing to pay those from cash. Great. Thanks very much, guys. Lots of good information. I wanted to follow up on, I think, Matt's question regarding the cost negotiations, though. I think last quarter, you had suggested that you could see the benefit starting to certainly from repositioning your product at least to benefit you by your fiscal third quarter I was just wondering whether or not that process is maybe taking a little longer or if that was sort of separate from your comments on the – the labor and product negotiations. And then in your answer to him, I think you also sort of mentioned or volunteered that you were sort of assuming lumber costs were going to increase. And I just wanted to get a sense, how much of an assumption or -- how much of an increase are you assuming you might see in lumber? Are you sort of just conservatively modeling it might go like halfway back to where it was last year. Just give us a sense for what you're incorporating in your outlook for lumber, knowing that you don't know yet, obviously. Most importantly, we don't know. And we're taking probably a conservative stance in looking at the fact that seasonally in a normal seasonal environment, we do see lumber cost increase through the spring -- and if we do -- are seeing some normalized demand coming back with the spring selling season, seasonality, would expect that to drive lumber prices higher, which would offset some of the efforts we've made on like-for-like cost reductions. We have been able to get new product starts out, new home starts out that are more reflected to today's environment, smaller homes, more affordable homes that should help -- but in terms of a like-for-like cost benefit increase, it's going to take a little while for that product to move through the system in a material way. I didn't hear a number there. I think I was getting ready to write a number down. I didn't hear a number. You want to give us a sense or sort of like how much of the way back just sort of thinking lumber might increase. Yes. We don't have a sense for a number, Steve, I'm sorry. We're not that good at predicting. We're just taking a conservative approach that seasonally lumber tends to go up in the spring. And that's probably going to have an impact on our cost and our deliveries later in the year. It does feel Stephen, like there is some normalcy returning to the market. And so you go back pre-pandemic and you look at what happened – costs get inflated during the last year, 18 months? Yes. Are we fighting get that back? Yes. our commodity price like lumber may go up, may go down, may stay the same. But are we going to be conservative in our guidance? Absolutely, we are. No complaints here. And I'll say that if lumber goes up because of normalization, I think we'll take it. In regards to your lot count, I noticed that your owned lot count in numbers -- numbers of lots went up a little bit. I think quarter-on-quarter, it had declined, I believe, in the last two quarters preceding that. So, I'm curious, are you -- or at least in the last -- sorry, the last two quarters preceding that, are you -- do you feel like your lot cost -- sorry, your lots owned will increase from here, or do you think we might actually see a further reduction in your actual number of owned lots? Just try to give us a sense for what that number might be, not in year supply but more like in absolute units? Yes, Stephen. We have worked hard for the lot position that we have and the relationships that we've built and with those developer relationships, we're continuing to -- it's still hard to get a lot on the graph. And so our lot count as a percentage of owned and total numbers, we expect to continue to increase -- and some of that will depend on what we see with the spring selling season and through the rest of fiscal 2023. But we don't expect that to go down and we expect to see potentially our owned lot supply as a percent increase marginally through this market. And as a reference, again, our owned lots finished percentage is only 32%, which is roughly 43,000 lots. So, we're by no means oversupplied from a finished lot perspective, which is what we're trying to continue to position ourselves forward community-by-community. Thanks. Good morning everyone. Thanks for taking my questions. I just wanted to circle back to your more recent trend and demand comments. Obviously, you mentioned that the first few weeks of January, saw some increased activity and that you could see a typical 50% improvement in orders in 2Q versus 1Q. That would imply if we're to take that just on a straightforward basis an order decline of only roughly 20% down year-over-year. So, I'm curious around if that's kind of -- and I know you haven't given hard guidance or a range. But directionally, if that's how we should be thinking about things? And also to this point around the improvement that you saw in January, I was curious also if you could kind of give any color around trends intra-quarter during the past first quarter, if that improvement in January was a continuation of perhaps a change in trend that you saw during your December quarter? I would say during the December quarter, as we mentioned on the call, as you know, Mike, is the seasonally slowest quarter of the year. So, we generally don't extrapolate anything that happens in October, November, and December, and we don't generally give a whole lot of monthly color, but we felt like based on current market conditions that warranted talking about the first few weeks of January, and that's what we're pleased with is we've seen what we would typically expect to see as we move through these first few weeks. In terms of the math that you laid out. If we do see that normal seasonality, yes, it still would result in net sales down year-over-year, but up very nicely sequentially. Right. And secondly, I know there's been a couple of questions around the construction costs and the impact there. I think that's been covered pretty well. Obviously, another big part is the gross margin guidance for the second quarter, and you're expecting further declines. I wanted to also focus though on pricing trends in the market. And if you could give us a sense of on a total basis, how much net pricing has come down from June of last year to today? And how much of that has occurred in the last month or two? In terms of just pricing, really, our net sales orders in the quarter and the average sales price on that is the best indication. Our net sales order price this quarter is around 367,000, I believe. And, of course, we peaked last year, a little over 400,000. So you're already looking at roughly a 10% decline in our net sales orders. And as then we look at our margin guide going forward, we're taking recent pricing into effect. We're hopeful that if we see some normal seasonality and normal demand during the spring that further significant pricing reductions would not be necessary, but we're going to assess that week-to-week and month-to-month as we go through the spring. But our gross margin guide takes into account recent pricing along with the cost trends that we've already been discussing. Just to add, it is very hard to put a lot on the ground. It's very hard to build houses. And the overall market is still undersupplied. So long-term, I think we've got a great outlook what happens in the next quarter. We're going to deal with the market as it comes. Hey good morning, everyone. Thanks for taking my questions. So first, has the land market started to capitulate at all on takedown pricing with your alls, ASPs down kind of 8% quarter-over-quarter. Are you actually starting to see the land market correct at all with more meaningful price declines, or is it still just too early to tell? I think generally, it's still a little too early Truman. Land is typically one of the stickier parts of the process. And as David and Paul both mentioned earlier in the call, it is increasingly difficult to get a lot entitled and on the ground. And so that is something that has held up pretty well. But anecdotally, there are situations where we're able to make some progress on the land residual with some of our land sellers. But not broad trends yet, for sure. Okay, okay. Thanks for that. And then you all made a recent acquisition in Arkansas. Could you all just, kind of, walk through the drivers of that purchase? And are you seeing more small privates, their willingness to sell at a relatively attractive valuation pop-up given the market slowdown? Yeah. The acquisition of Riggins in Northwest Arkansas gave us -- not I want to say, an entrance into the market. We were in there with a couple of communities, but gave us a solid position in a market that has remained strong with good employment growth and limited housing supply again to the earlier question of the secondary markets, a solid market that we are happy to be in. It was a good acquisition and tuck-in for us with a well-established community with a great lot of supply. And so gave us immediate inventory and homes in progress, well-respected builder in the market that we're happy to as part of the family. As far as other acquisitions, we continue to look at those -- and where we have tuck-in opportunities similar to this, we had things that we would explore but no broad-based change in how we look at builders and margin. Good morning. Two things. First of all, the 40% reduction in starts, I'm curious if there's -- what the discipline or logic is in what you're not starting if there's buckets of this. You mentioned trying to change the product a bit to fit a price point. But curious if there's something to learn from how you're making those decisions of where you're reducing starts. A lot of our starts decisions are made within the quarter on the basis of what the sales trends are occurring at that point in time. And certainly, through late summer and into the fall, our first quarter, mortgage rates spiking up, cancellations increasing, looking at our current inventory positions neighborhood by neighborhood relative to recent sales paces, certainly led us to slow down our starts. Coming into this fiscal – this calendar year into the second quarter, seeing some improvement in our cycle time and supply chain issues unsnarling, and we feel like we'll be able to start homes and complete them in a more timely fashion this year. So we did -- we are trying to meter our starts out a little bit to more closely match our sales demand right now. And Eric I think its just – I think it's just indicative of the entire industry and lessons learned in the last downturn. I mean I do believe that there is a discipline around the industry, and it's not just short-term, chase every market every day. So it's -- we're trying to do a lot in inventory levels with demand. And it ultimately comes back to if you look at the long-term position of the industry, there aren't enough lots for houses for the population and demand that we see taking place over the next three to five years. Okay. And then related to this, the inventory per community number, it looks like it's up. And I guess the follow-on would be the path forward with starts from here is down 40 a pace you maintain for another quarter and then lift your heads up, or how do you think about the pace of managing the supply path going forward? I think we saw the starts kind of align with our sales pace in the quarter, and I think we're going to look to try to maintain that relationship through this time of the year as we're seeing good sales demand in the early spring selling season, we'll be replacing those homes with new starts to continue having inventory in the shelf available to sell. We are certainly seeing more homes selling later in the construction process, certainty of delivery date, certainty of mortgage rate and payment are big important factors for our buyers. And we're also focusing very heavily on recovering our housing inventory turnover metrics and getting more efficient with those inventory dollars. Got to get our returns back up on our housing inventory. And so as with everything, our starts are managed community by community, market by market by our local operators to focus on not piling up excess completed homes that have been sitting there for an extended period of time. Good morning. Can you talk about the tenure of buyers who canceled this quarter? Were those contracts that were signed in fiscal 4Q or maybe even earlier? Is there a larger cohort of buyers who may be placed orders in the fall, but are still at risk of cancellation with rates rising? Just wondering if you can give any color around kind of cancellation trends there? I think as you've seen, our cancellation trend moderate and cancellation rate moderate, we have younger backlog that have signed contracts more recently. As Mike spoke to, certainty of home close date and mortgage rate is very important. So, as we have cycled through and we're improving our housing inventory turns, I think that's where you're seeing our reduction in cancellation rate. Okay, that's helpful. And then just in terms of renegotiating prices for homes in backlog, has that sort of normalized or died down now that rates have stopped rising and to your point, cancellations have come down? Hey, thanks. Good morning guys. I wonder if I could dive in a little bit more on the incentives that are out there, the tools that you're using out in the field, it sounds like a lot of builders are having some success with a mortgage rate buy-down program. where you're buying down or fixing the mortgage rate below market for sounds like for the life of the loan, it seems to be popular out there. I'm wondering if you could maybe elaborate on -- are you using mortgage rate buy-downs? How does that mechanically work? And kind of what does that cost you in terms of upfront margin hit or as a percentage of sales? Yes, Buck, we do, as an ordinary course use mortgage rate buy-downs and many of those are for the life of the loan. That's been a program we've had in quite place for quite some time. The costs do vary from time to time, depending on market conditions and timing of when you tie up those positions. But that's something that we try to make sure that we have in the toolbox for our salespeople is to be able to offer an attractive mortgage rates to buyers who come in. Okay. Would you say that that's the most effective sales tool at the moment is a buy-down or are you using some other level of incentives? It's going to vary community-by-community and over time as to what the most attractive incentive is, and we try to put a lot of tools in our division operators' hands to make the best decisions about what's going to motivate and drive their realtor and buyer traffic in their communities and excite our sales agents with a reason to call and a reason to drive some traffic this week. So, it might be a little bit of a pricing adjustment on a few homes. It might be the rate buy-down, some mortgage financing incentives have been very popular, very heavily utilized. And it might be that supply chain is working back out that we're back to a washer-dryer Wednesdays. I mean there's plenty of incentives out there that we're going to use to drive a pace to hit a return we need to hit at every given neighborhood. Okay. Thank you. And one quick separate topic on single-family rentals and the -- it sounds like the guidance quarter-over-quarter is slightly lower in terms of projected sales of single-family rental homes. I'm wondering if that's strategic to hold back the pace of those sales. And just curious what the demand is like in the marketplace for and/or the pricing for stabilized SFR homes these days? It's just timing of projects and when they'll be ready -- completed and ready and through a sale process. We'll just have fewer this quarter ready to close than we had this past quarter. The first quarter benefited from a few projects that were lined up to close in the fourth quarter of fiscal 2022 had some storm impact and delayed some timing of a few closings there. So that 1Q number was probably a little higher than the original production sales schedule is set up for. And you're starting to see some level of closings each and every quarter, but it is still choppy here in the earlier stages, and we would expect that to become more consistent over time as we get further along with the lots and the houses we have under construction. Hey guys, good morning. Thanks for taking my questions. First, I was hoping maybe you could just help me a little bit reconciling the closings results versus the orders. The closings for this quarter came in well above your guidance. The orders were a bit lighter versus what you signaled in mid-November. And I thought I heard you say that cycle times have been relatively stable, maybe even ticked up a little bit. So how did you drive the upside to closings without stronger order activity? Was it just that much of a greater mix of completed sales versus homes that were a month or two out from completion than you were anticipating? And I'm sure that ties into the 2Q guidance as well with your delivery guidance above your beginning backlog. So I'm just maybe looking for a little bit more color to understand what's going on there? Yeah. As we see marginal improvement in our inventory turns and home construction times, you're starting to see and you see that in our numbers, a larger percentage of our inventory homes on the completed side, which allows us to meet the market, which quite frankly is available to us today, which is shorter-term close. And so we're seeing more homes sell and close in the quarter, getting back more towards historical norms, and we expect to see that on a go-forward basis with the maturity of the home inventory that we have. Got it. Okay. That's helpful. Second question, kind of, related, but tying in maybe the margin conversation as well. So when you look at your 7,000 completed specs, are you able to provide a little bit more detail on how many of those are maybe less than 30 days completed? What's more than 30? And how is your pricing strategy differ on completed specs as it hits certain threshold? Is there a level or a point where you get more aggressive on price adjustments, or do you just look at it more holistically? So generally, we talk about a completed spec, we have a pretty aggressive definition of what's completed, it's when it gets into the final flooring stage. So typically, from a home hitting that completion milestone for us, normal conditions, it's probably going to take between two weeks to four weeks for that home actually to be moving ready and more likely to the four-week side of that. So if we look at how many houses we have out there that are aging in the buckets, we have about 190 houses that have been passed our completion date by more than six months or more. So we still feel very comfortable about the freshness of that spec inventory, and this is the exact right time of the year to have that inventory, especially with the backdrop of very low existing home sale inventory available in the marketplace. And that's something we manage very closely. Obviously, we've been building specs for a very long time. We have a lot of discipline around that. And so we do watch those completed specs as they start to age. And they get longer if they get longer than 90 days, then yes, we will start to step up the efforts to ensure that we move them. But right now, we still have a very fresh – fresh batch of completed specs out there for springs selling season. Great. Thanks for taking my question. So the first one, just to follow up on the margin discussion. I understand there's not a lot of forward guidance you're going to get beyond this next quarter and a level of uncertainty. I'm wondering just as you see it today, if you look at your current orders, as you look at what you're expecting to sell in the quarter versus kind of the timing of some backlog still coming through in that gross margin that will be reported in fiscal 2Q. How should we be thinking about the likely cadence of margin beyond 2Q? Is it still barring some quick improvement in the market, going to be lower as you cycle off your backlog and into the recent sales as you get into fiscal 3Q, or any color on that? Mike, we're only guiding to Q2 margin. And the reason we're only guiding to Q2 margin is we don't know what margins or what the environment will be beyond Q2. The spring selling season, obviously, we've got some early encouraging signs So we have visibility to where our margins and our sales and our backlog and our pricing and our costs are today heading into the quarter but even Q2 had some level of uncertainty to it. We would expect to sell and close 40% of our closings in the same quarter in the coming quarters. So while we believe that there's some possibility of some stability in the market with mortgage rates stable that could change this afternoon. And so right now, we're giving you what we get -- what we have. So our guidance for margins of 20% to 21% is what we can see today for Q2. There is some risk, both upside and downside there. I would say it's possible we could beat that range. But it's certainly possible that we might not. But past Q2, we simply don't have visibility right now. We're going to continue to meet the market and do what we need to do to maximize returns community by community. Okay. Fair enough. And then my second question, there's been a lot in the press around Arizona, in particular, tightening up on some of the water rights and kind of permitting or lack of issuing permits in certain parts of the Phoenix, Metro area given some of the requirements around water usage. You guys obviously had your Vidler acquisition last year. I think they do have some projects in Arizona. Can you give us a sense of if the counties or municipalities are just outright refusing to issue permits to certain areas, does your – does your ownership of Vidler and the projects in those regions exempt you from that? Are you able to still get permits for your planned projects, or any color on what you're seeing there would be, I think, interesting in light of some of the press that's been out there? Well, yes, I think there has been a lot in the press on water and water is and will continue to be a headwind throughout the West, not just in Arizona. And certainly, our acquisition and integration of Vidler has helped our positioning and that's really some benefit to the short-term, but mostly a long-term strategic decision on our part, knowing that we're going to head these -- facing these headwinds for the foreseeable future. I don't think there's been a significant change on a local basis. It's still difficult to get lots on the ground to get entitlements through the process and to get those permits. It has been for a while, and that continues. So, we feel good about our position -- the lot positions we have in the Phoenix market and we've got a great team on board there that continues to navigate through that environment. Hey, good morning everyone. So, Bill going back to what you talked about looking to close 40 -- or so and closed 40% of the 2Q closings. I guess, how in, say, pre-COVID times, what would that percentage have been in normal Q2? Sure, Jay. Our typical percentage, we're in just pretty consistently up until the last year or two in the 35% to 40% range. A quarter ago, we were in the high teens. A year ago, it was even lower than that. And this quarter, we were roughly 34%. So, when we talk about reverting to normal, we started to see that reversion in the first quarter, but we expect that to continue to tick up. So, whether it's actually 40% or closer to the 35%, 36%, we don't know. But typically, 35% to 40% would be a pretty consistent range for us. Okay. And then the second question I had, assuming you pay down the $1 billion in debt like you've talked about. Any idea of what benefit that might be to gross margin since it's going to be less amortized interest or interest being amortized? Yes, Jay, we have $700 million of homebuilding notes that mature this year and right now we plan to do to pay those off with cash. That's out of just under $3 billion of homebuilding debt. So, roughly 25% of the balance would be paid down that if we do not replace that debt, that would reduce our interest carry in time. That benefit would really primarily be probably noticed in fiscal 2024 and beyond because it takes time for the interest to be capitalized and move their inventory. But it would take our interest carry down probably 20, 30 basis points as a percentage of margin over time -- longer term benefit. Thank you. And in the interest of time today, the last question will be coming from Rafe Jadrosich from Bank of America. Rafe, your line is live. Hi, good morning. Thanks for taking the question. I just wanted to ask on the rental side. What are you seeing in terms of demand? And margins have been really strong last year and obviously this quarter. Just do you anticipate any type of normalization going forward, or do you think you'll have to hold those properties longer if demand comes down? I think we're still seeing demand for the properties. I think the pricing and the margins we realized on our early project sales benefited from construction and lower construction cost environments coupled with a very attractive rate environment when we sold those and that continued to some degree into our first quarter deliveries, we would expect to see some kind of a more normalized reversion to demand to a mean. And I think we'll see our margins come back in line to be closer to slightly above on what we're seeing on for sale side, the traditional core sales side. But our business model is to develop the communities and sell them into the marketplace. That's what we do best, finding the land, building the homes and bringing people to those communities is what we've been very successful with so far. So still learning, still going to get better, but we do like that business. And then just one more on the -- in terms of the improvement in demand that you're seeing in the quarter and quarter outlook for orders in the second quarter relative to the first quarter. Can you talk about what you think is driving the stronger demand? Is it the fact that mortgage rates have come down a little bit? Is there anything happening with consumer confidence what's giving you that confidence in supporting the view that we're going to get back to normal seasonality after what's been a very tough housing market at the end of 2022? I do think the credit markets have stabilized somewhat, consumer confidence improved a little bit. Job growth continues to be very good. So overall, if you look at product demand at just a generalized economy becoming less bad, very good signs for housing. And we monitor our sales; we monitor cancellations week to week to week to week. And so when we see that trend returning to more of a normalized market, it's hard not to be optimistic that we're going to good spring. And that's the way we're positioned and we'll get up every day and respond to what happens out there in the field. Yeah, specific to Horton, those are other industry reasons, right? Specific to Horton, our inventory position puts us in a more confident place to be able to say we're going to see that pick up with the level of completed homes we have and the stage of construction, the homes behind those are at, because what we're seeing the most success in today is buyers who do want a home quickly because they can get that certainty of not only close date, but most importantly, interest rate. And so that is the majority of our buyers today, and that's why we feel very confident and are very happy with our inventory position right now. Thank you, Paul. We appreciate everyone's time on the call today, and look forward to speaking with you again to share our second quarter results in April. And finally, congratulations to the entire D.R. Horton team. We're producing a solid first quarter while navigating changing market conditions, go compete and continue to win every day. Thank you. Thank you. This does conclude today's conference. You may disconnect your lines at this time, and have a wonderful day. Thank you for your participation.
EarningCall_1531
Good morning and welcome to State Street Corporation’s Fourth Quarter and Full Year 2022 Earnings Conference Call and Webcast. Today’s discussion is being broadcasted live on State Street’s Web site at investors.statestreet.com. This conference call is also being recorded for replay. State Street’s conference call is copyrighted and all rights are reserved. This call may not be recorded for rebroadcast or distribution in whole or in part without the expressed written authorization from State Street Corporation. The only authorized broadcast of this call will be housed on the State Street Web site. Now I would like to introduce Ilene Fiszel Bieler, Global Head of Investor Relations at State Street. Good morning and thank you all for joining us. On our call today, our CEO, Ron O’Hanley, will speak first. Then Eric Aboaf, our CFO, will take you through our fourth quarter and full year 2022 earnings slide presentation, which is available for download in the Investor Relations section of our Web site, investors.statestreet.com. Afterwards, we’ll be happy to take questions. During the Q&A, please limit yourself to two questions and then requeue. Before we get started, I would like to remind you that today’s presentation will include results presented on a basis that excludes or adjusts one or more items from GAAP. Reconciliations of these non-GAAP measures to the most directly comparable GAAP or regulatory measure are available in the appendix to our slide presentation, also available in the IR section of our Website. In addition, today’s presentation will contain forward-looking statements. Actual results may differ materially from those statements due to a variety of important factors such as those factors referenced in our discussion today and in our SEC filings, including the risk factors in our Form 10-K. Our forward-looking statements speak only as of today, and we disclaim any obligation to update them even if our views change. Now, let me turn it over to Ron. Thank you Ilene and good morning everyone. 2022 was an unpredictable year for many of the world’s investors and the people they serve. Despite a market rebound in the fourth quarter, 2022 was the worst year for financial markets since the global financial crisis. Both fixed income and equity markets impacted by the war in Ukraine and several macroeconomic headwinds including bulk of supply chains, price and wage inflations, dramatically higher global interest rates, U.S. dollar strength, and heightened fears of global economic recession which remain today. The uncertainty created by these factors contributed to a meaningful year-over-year decline in global financial markets as well as increased market volatility impacting flows. Despite these difficult macro conditions, State Street performed well. As a result, we continued to progress in 2022 towards achieving our medium term targets. Our durable 4Q and full year 2022 results were driven by a strategy underpinned by our relentless focus on innovation, the power of our distinct value proposition, and State Street’s diversified products and services, all of which continue to resonate with clients as demonstrated by yet another year of strong, organic net new servicing wins. As we continue to execute against our strategic agenda, we achieved a great deal in 2022. Slide 3 of our investor presentation shows our full year highlights and the progress we made towards achieving our strategic goals in 2022. In a challenging operating environment and compared to what was a very strong year for our business in 2021, we again delivered positive total operating leverage, pretax margin expansion, and a higher return on equity as you can see on the left of the slide. We drove continued business momentum, including 1.9 trillion of total new asset servicing wins, delivered total revenue growth, and demonstrated ongoing expense discipline in the face of inflationary pressures and our continued investment in the resiliency and capabilities of our businesses, as you can see on the right and bottom of the slide. While weaker average market levels created fee revenue headwinds for our investment servicing and asset management businesses in 2022, our balance sheet businesses combined with higher interest rates and our deposit strategy produced materially higher net interest income as compared to 2021. In addition, our foreign exchange trading services and front office software and data businesses produced double-digit year-over-year fee growth, manifesting the desired results of our investments in these businesses and demonstrating the revenue diversification of our business model. Turning to Slide 4 of our presentation, I will review our fourth quarter highlights. Business momentum was solid in the fourth quarter with new AUC/A asset servicing wins amounting to 434 billion driven by broad based wins across client segments. We reported two new alpha mandates in the quarter and expanded 12 existing alpha relationships, seven of which added additional back and middle office offerings. Helped by this sales performance our AUC/A installation backlog was 3.6 trillion at quarter end. At Global Advisors quarter end assets under management totaled 3.5 trillion, supported by another good quarter of ETF inflows. Turning to our fourth quarter financial performance, 4Q 2022 EPS was 1.91 or 2.07 excluding notable items, up 7% year-over-year or 4% higher year-over-year excluding notable items. The year-over-year EPS growth in a challenging market environment was supported by the resumption of common share repurchases in the fourth quarter as we focused on returning capital to our shareholders. Even in a year marked by economic and political disruptions, total revenue for the fourth quarter was the highest on record, increasing 3% year-over-year as lower total fee revenue was offset by very strong NII result which increased 63% relative to the year ago, primarily driven by higher global interest rates plus our balance sheet positioning and effective execution of our deposit management strategy. As we meaningfully invested in our people and business, we remain focused on expense discipline in the fourth quarter with total expenses down 3% year-over-year or flat year-over-year, excluding notable items, in part supported by the stronger U.S. dollar. This was achieved by our relentless and ongoing focus on operational productivity, simplification and automation. Turning to our balance sheet and capital, our CET1 capital ratio increased to a strong 13.6% at year end. Recognizing the importance of capital return to our shareholders and having already announced a 10% per share increase to our common stock dividend earlier in 2022, we resumed share repurchases in the fourth quarter, buying back a total of 1.5 billion of State Street's common stock. For 2023, it is our intention to return up to 200% of earnings in the form of common stock dividends and share repurchases, subject to market conditions and other factors. We expect our business mix, balance sheet strategy, and earnings momentum will enable us to do so while maintaining prudent capital ratios within our target range. Accordingly, as we announced this morning, our Board of Directors has authorized a new common stock purchase program of up to 4.5 billion through the end of 2023. To conclude my opening remarks, I am pleased to be reporting the third year in a row of pretax margin expansion and higher return on equity, which demonstrates the successful progress we have made towards achieving our financial goals. Now, let me hand the call over to Eric, who will take you through the quarter in more detail before I discuss our strategic priorities for 2023. Thank you, Ron and good morning everyone. Before I begin my review of our fourth quarter and full year 2022 results, let me briefly discuss some of the notable items we recognized in the quarter outlined on Slide 5. First, we recognize acquisition and restructuring costs, including wind down expenses related to the Brown Brothers Investor Services acquisition transaction, which we are no longer pursuing. Second, we recognize 70 million of repositioning costs consisting of an employee severance charge of 50 million to eliminate approximately 200 middle and senior manager positions, largely related to our investment services business as we continue to streamline our organizational structure. We also recognized 20 million of occupancy charge in the quarter to help us further shrink our occupancy costs. We expect these actions to generate a total run rate savings of roughly $100 million. Lastly, we recognize the benefit of 23 million in the quarter related to the settlement proceeds from a 2018 FX benchmark litigation resolution, which is reflected in the FX trading services GAAP revenue line. Taken together, we recognize notable items of $78 million pretax, or $0.16 a share. Now, turning to Slide 6, I'll begin my review of both our fourth quarter 2022 and full year 2022 results. As you can see on the top left of the table, despite the dynamic and challenging operating environment, the diversity and durability of our business model allowed us to finish the fourth quarter with solid results. Total revenue for the quarter increased 3% year-over-year or 5% year-over-year, excluding notable items, as lower fee revenue was more than offset by robust NII growth of 63%, which I'll spend more time discussing later in today's presentation. We also continued to demonstrate prudent expense management, which enabled us to deliver positive operating leverage in the quarter and pretax margin is up more than four percentage points year-on-year, while ROE is up more than a percentage point this quarter as well. On the right side of the slide, we show our full year 2022 performance. Notwithstanding the challenging operating environment, we saw in 2022 for the year, I am quite pleased that we again delivered positive operating leverage and nearly a percentage point improvement in pretax margin. As Ron mentioned, it has been three consecutive years of margin expansion and ROE improvement. Turning to Slide 7, during the quarter we saw period end AUC/A decrease by 16% on a year-on-year basis, but increased 3% sequentially. Year-on-year the decrease in AUC/A was largely driven by continued lower period end market levels across both equity and fixed income markets globally, a previously disclosed client transition, and the negative impact of currency translation, partially offset by net new business installations. Quarter-on-quarter AUC/A increased as a result of higher quarter end equity market levels and the positive impact of currency translation. At Global Advisors, we saw similar dynamics play out. Period end AUM decreased 16% year-on-year and increased 7% sequentially. The year-on-year decline in AUM was largely driven by lower period end market levels, some institutional net outflows, and the negative impact of currency translation, which was partially offset by 22 billion of net inflows in our SPDR ETF business. Quarter-on-quarter, the increase in AUM was primarily due to higher quarter end market levels, ETF net inflows, and the positive impact of currency translation, partially offset by cash net outflows. Turning to Slide 8, on the left side of the page, you'll see fourth quarter total servicing fees down 13% year-on-year, largely driven by lower average market levels, lower client activity adjustments and flows, normal pricing headwinds, and the negative impact of currency translation, partially offset by net new business. Excluding the impact of the currency translation, servicing fees were down 10% year-on-year. Sequentially, total servicing fees were down 1%, primarily as a result of the client activity adjustments and flows. On the bottom panel of this page, we've included some sales performance indicators which highlights the good business momentum we again saw in the quarter. As you can see, AUC/A wins in the fourth quarter totaled a solid 434 billion driven by strong broad based traditional wins across client segments and regions, including expanding relationships with existing alpha clients. At quarter-end AUC/A won but yet to be installed totaled $3.6 trillion, with alpha representing a healthy portion, which again reflects the unique value proposition of our strategy. Turning to Slide 9, fourth quarter management fees were 457 million down 14% year-on-year, primarily reflecting lower average market levels and the negative impact of currency translation, which represented about two percentage point headwind. Quarter-on-quarter management fees were down 3%, largely due to equity and fixed income market headwinds. As you can see on the bottom right of the slide, notwithstanding the difficult and uncertain macroeconomic backdrop in the year, our franchise remains well positioned as evidenced by our continued strong business momentum. In ETFs we saw solid full year net inflows in the U.S. with continued momentum and market share gains in the SPDR low cost equity and fixed income segments. In our institutional business, there's a continued momentum and defined contribution with 48 billion of inflows in the full year, including target date franchise net inflows of 21 billion, offset by industry wide outflows in Institutional Index products. In our cash franchise, we still gained 60 basis points of market share in money market funds in 2022, even though first half inflows reversed in fourth quarter. On Slide 10, you see the strength of our diverse revenue growth engines with both FX trading services and software and processing up double-digit teens year-on-year in a difficult year. Relative to the period a year ago, fourth quarter FX trading services revenue ex-notables was up 15%, primarily reflecting higher FX spreads partially offset by lower FX volumes. Our global FX franchise was able to effectively monetize the less liquid market environment which was driven by sharp moves in the U.S. dollar. Sequentially FX trading services revenue ex-notables was up 8%, mainly due to higher direct and indirect revenue. Securities finance performance in the fourth quarter was more muted with revenues up 1% year-on-year. Sequentially revenues were down 6%, mainly reflecting downward pressure on spreads due to lower special activity and year-end risk of activity by clients. Fourth quarter software and processing fees were up 16% year-on-year and 17% sequentially, primarily driven by higher front office software and data revenues associated with CRD, which were up 28% year-on-year and 25% sequentially. Lending fees for the quarter were down 10% year-on-year, primarily due to changes in product mix and flat quarter-on-quarter. Finally, other fee revenue of 18 million in the fourth quarter was flattish year-on-year and up 23 million quarter-on-quarter, largely due to the absence of negative market related adjustments. Moving to Slide 11, on the left panel you'll see fourth quarter front office software and data revenue increased 28% year-on-year, primarily driven by multiple on-premise renewals and continued growth in software enabled revenue associated with new client implementations and client conversions to our cloud based SaaS platform environment. Turning to some of the front office and Alpha business metrics on the right panel, the 21 million of new bookings in the quarter was once again well diversified across client segments, including asset owners, wealth and private markets as well as across asset classes, particularly in fixed income. Front office revenue, backlog and pipeline remains healthy, giving us confidence in the future growth of this business. As for Alpha, we are pleased to report to two new Alpha mandate wins this quarter in the insurance and asset owner of client segments. Now turning to Slide 12, fourth quarter NII increased 63% year-on-year and 20% sequentially to 791 million. The year-on-year increase was largely due to higher short and long term market interest rates and proactive balance sheet positioning, partially offset by lower deposits. We have a well-constructed balance sheet including both U.S. and foreign client deposits, a scale of sponsored repo franchise, and high quality loan and investment portfolio that was consciously configured to benefit from rising global rates. Sequentially, the increase in NII performance was primarily driven by higher global market rates working through our balance sheet. On the right of this slide, we show our average balance sheet during the fourth quarter. Year-on-year average assets declined 6% and increased 3% sequentially, primarily due to deposit levels as well as currency translation impacts. The U.S. client’s deposit beta, excluding some new deposit initiatives was about 65% to 70% during the fourth quarter. Foreign deposit betas for the quarter were much lower in the 20% to 50% range depending on currency. Our international footprint continues to be an advantage. Total average deposits were up sequentially. We saw sequential quarter reduction in non-interest bearing deposits of 5% which was more than offset by higher NII accretive interest bearing deposits that will help support high quality client loan growth and selective expansion of the investment portfolio. Turning the Slide 13, fourth quarter expenses excluding notable items were once again proactively managed in light of a tough fee revenue environment and flat year-on-year or up approximately 3% adjusted for currency translation. We have been carefully executing on our continued productivity and optimization savings efforts which generated approximately 90 million in year-on-year growth savings for the quarter or approximately 320 million for 2022, achieving near the top end of our full year expense optimization guidance of 3% to 4%. These savings enabled us to drive positive operating leverage and pretax margin expansion, which while partially offsetting continued wage inflation headwinds and continued investments in strategic parts of the company, including alpha, private markets, technology, and operations automation. On a line by line basis compared to 4Q 2021 compensation employee benefits were down 1% as the impact of currency translation and lower incentive compensation was partially offset by higher salary increases associated with nearly 6% wage inflation and higher headcount. Headcount increased 9%, primarily in our global hubs as we added operations personnel to support growth areas such as alpha and private markets, invested in technology talent, and in sourced certain functions. There was also a portion of the headcount increase associated with some hiring catch up post COVID. We expect headcount to increase more modestly in 2023. Information systems and communications expenses were down 5% due to benefits from our insourcing efforts and continued vendor pricing optimization, partially offset by technology and infrastructure investments. Transaction processing was up 1%, mainly reflecting higher broker fees and market data costs, partially offset by lower sub custody costs related to lower equity market levels. Occupancy was down 17% largely due to an episodic lease back real estate transaction associated with the sale of our data centers which was worth approximately 12 million. And other expenses were up 12%, primarily reflecting higher professional fees and travel costs. Moving to Slide 14, on the left side of the slide we show the evolution of our CET1 and Tier 1 leverage ratios followed by our capital trends on the right of the slide. As you can see, we continue to navigate the operating environment with strong capital levels relative to our requirements. At quarter end, standardized CET1 ratio of 13.6% increased 40 basis points quarter-on-quarter, primarily driven by episodically lower RWA, partially offset by the resumption of share repurchases in the quarter. With respect to RWA's, it's worth noting that we saw unusually low RWA this quarter worth about $10 billion, largely driven by our markets, businesses and some specific currency factors. We would anticipate a similar amount of normalization of RWA in the 10th $15 billion range going into first quarter. Our Tier 1 leverage ratio of 6% at quarter end, was down 40 basis points quarter-on-quarter, mainly due to the resumption of share repurchases in fourth quarter. We were quite pleased to return $1.7 billion to shareholders in the quarter, consisting of a 1.5 billion of common share repurchases and 220 million in common stock dividends. Lastly, as Ron mentioned earlier, we announced this morning that our Board of Directors has authorized a new common stock repurchase program of up to 4.5 billion through the end of 2023. And as I said in December, we expect to execute this buyback at pace and get back to our target ranges for both CET1 and Tier 1 leverage market conditions and other factors dependent. Turning the Slide 15, let me cover our full year 2023 outlook as well as provide some thoughts on the first quarter, both of which have significant potential for variability given the macro environment we're operating in. In terms of our current macro expectations, as we stand here today, we expect some point to point growth in global equity markets in 2023, which equates to global equity markets being down about 2 percentage points year-on-year on a full year average basis. Our rate outlook for 2023 largely aligned with the forward curve, which I would note is moving continuously. However, we currently expect to reach peak rates of 5% per Fed funds, 3.25 at the ECB, and 4.5 at the Bank of England. As for currency translation, we expect the U.S. dollar to be modestly stronger than the major currencies on average, but less than what we saw last year. As such, currency translations like to have 0.5 point or less impact on both revenues and expenses. In light of the macro factors I just laid out, we currently expect that full year total fee revenue will be flat to up 1% ex-notable items with servicing fees likely flattish and management fees down a bit, largely due to a modest reclassification of revenue, other fees, and NII. Regarding the first quarter of 2023, we currently expect fee revenue to be down 1% to 2% ex-notable items on a sequential quarter basis, given some normalization of foreign exchange market volatility that impacts our trading business with servicing fees expected to be up 1% to 2% and management fees expect to be down 1% to 2%. We expect full year 2023 NII to be up about 20% on a year-over-year basis after a very strong 2022. This is dependent of course on the outcome of rate hikes and deposit mix and levels. After a significant step up in fourth quarter 2022 NII, we expect first quarter 2023 to be flattish. And after the first quarter of 2023, we expect to see a slide 1% to 2% of sequentially quarterly attenuation of NII throughout the remainder of 2023, then with the stabilization expected in 2024. Turning to expenses, as you can see in the walk, we expect expenses ex-notables will be up 3.5% to 4% on a nominal basis in 2023, driven partially by wage and inflationary pressures and continued investment in the business and our people, while still driving positive operating leverage. You can also see on the walk that for a full year 2023, we expect growth saves of approximately 3%, which will help offset inflationary pressures and variable costs and ongoing investments in areas like private markets and alpha and further automation. Regarding the first quarter of 2023, on a year-over-year basis, we expect expenses ex-notable items to be up about 2%. Finally, taxes should be in the 19% to 20% range for 2023. This outlook would deliver a fourth consecutive year of margin expansion and advances us towards our medium term target goal of 30%, as well as deliver positive operating leverage and strong EPS growth for our shareholders. And with that, let me hand the call back to Ron. Thanks, Eric. As we enter 2023, we see an uncertain environment. On the positive side, many supply chains have been repaired, the outlook for energy supply is better than anticipated, particularly in Europe, and developed world inflation may have peaked. We proceed continued rising interest rates in the short term, but at a slower pace. The most significant known risks are geopolitical, including the Russia Ukraine War, China from an economic performance and policy perspective, and the United States as it approaches its debt ceiling. Turning to Slide 17, even with another year of economic and geopolitical uncertainty ahead of us, we continue to be very clear in our strategic priorities for 2023 focusing on what we can control. We plan to deliver further growth, drive innovation, and continue to enhance shareholder value as we further progress State Street towards its medium term targets. First, we are targeting further improvements in our business growth and profitability by leveraging State Street’s alpha value proposition and enhancing its private markets capabilities. As we aim to become the leading investment service or platform and enterprise outsource solutions provider in the industry, we intend to maintain and extend our leadership positions in a number of key businesses. In global markets, we aim to expand wallet share as a leading provider of liquidity, financing, and research solutions to investment professionals. At Global Advisors, we aim to build on our strengths in areas such as ETFs and cash, while organically accelerating growth efforts in fast growing segments where we can win. Second, as we have over the past several years, we must continue to transform the way we work by driving increased productivity and efficiency throughout our organization as we build out a simplified, scalable, configurable end-to-end operating model. As we lead with client service excellence, productivity will become a core differentiator of our value proposition. Third, we must continue to build a higher performing organization. We are strengthening execution skills and increasing accountability, thereby fostering an even more results oriented culture required for future growth. Our fourth priority is supported by and the intended outcome of the first three priorities and is aimed at achieving our financial goals, meaning another year of positive operating leverage, margin expansion, and higher returns. To conclude, supported by our distinctive value proposition and diversified offerings, as well as our ability to manage State Street through challenging environments, I believe that we will be able to execute on each of these strategic priorities in 2023 as we advance towards achieving our financial goals, all while being an essential partner to the world's investors and the people they serve. And with that operator, we can now open the call for questions. Hi, thank you very much. I like the NII outlook, I want to ask you a question on that. You've been a big beneficiary of higher rates. I'm curious on the deposit side, down almost 10% year-on-year in the quarter, but actually up a drop sequentially. I wanted to think about or could you tell us what you're thinking about that you have stable outlook for 2023 for deposits, we've seen a lot of fear in the banks in deposit runoff and betas and attrition and so curious what gives you that confidence for the flat deposits for the year, thanks? Glenn, it's Eric. We've navigated through interest rate cycles before, right, and so we have a fair amount of internal data. And we also have, I think, an engagement with our clients that really understands the multiple avenues for them of putting their cash. Clients broadly with us have $1 trillion of cash, some of that's in deposits, some of that's in our sponsor repo program. Some of that's in our global advisers, money market complex, some of it's in our suite products in our State Street Global Link franchise. And so what we're seeing is that clients are shifting gently their deposits between different categories. But they also need an outlet for that cash. They need an outlook for that cash at a reasonable price, at a reasonable ability to move it and use it as necessary. So with that as a context, I think we continue to see some expected rotation out of noninterest-bearing into interest-bearing, that's been happening, I think, at a reasonable pace and kind of in line more or less with what we've seen before, and we expect that to continue for the next few quarters. At the same time, clients do have cash, especially given the risk-off environment but in general, they all sit on cash as part of their investment planning. And we found that they're engaged with us to leave cash in our balance sheet. They like the flexibility. They like some of the pricing. And obviously, some cash comes in at noninterest-bearing, some at lower rates when it's very transactional, some at rates that are closer to market levels. And so it's an ongoing engagement with them and the visibility we have is reasonably good. It can always change. But deposits as a result, seem to be in the zone now after couple of quarters in the first half of the year of coming down a bit, seem to be flattening out. I won't say that we won't see a little bit of seasonality occasionally in January until February, we see a downtick. And then March folks prepare for tax payments is up and then April is down. So we'll see some of that kind of movement. But on average, we expect deposits to be flattish from -- going forward into next year and through the bulk of the year. I appreciate that color. That's good. You mentioned repo, so maybe I'll just have my follow-up question. In the slides, I noticed you created this inventory platform for peer-to-peer repo, I would love a minute to go on what it is for, who is it for, and how you get -- how that -- you will get paid for that? Thanks. Sure. This is part of the, I think, innovation heritage that we have here at State Street across the franchise, but inclusive of the global markets area. We -- our sponsored repo program, which is now $100 billion in size, was started in I'm sorry, in 2005, I think, if I go back to the history books. And there's now a $100 billion franchise, right, as an example. And we do this in FX, we do this in sec lending. Venturi is a repo offering that instead of working through our balance sheet or one of the clearing corporations, which is how we do repo today actually directly connects lenders and borrowers of securities and cash. And so it's just another platform, so to speak, another venue that clients seem to want to engage with. A big part of it early on is working with the asset owners, those who are -- have long booked securities and cash. And what we find is sometimes when they may want to make margin calls for -- or have margin calls, they want to raise cash without selling securities, right. And so a natural question of well, where do I repo, do I repo through a bank structure, or do I repo with someone who's on the other side of that trade, right, who actually wants to lend against securities. And so we find that there are counterparties on the other side of that trade, who would be interested in doing that. And what a Venturi does is it actually connects borrowers and lenders with direct access to one another. So they have both the underlying collateral as the stabilizing force. And then they have the counterparty rating. And with different counterparties, you get slightly different pricing and sometimes that flow-through is actually positive and quite appealing both to the lenders and borrowers. So that's a little bit of it in a nutshell. We like to grow it to some amount during the course of the year, early returns are positive. But it's -- I'll put it in a bucket of innovation and how to connect folks in the capital markets, but connect folks who our core clients and provide additional services for them. Okay, one follow-up question on NII and then a question on expenses. Just a follow-up question on NII Eric, I just wanted to make sure I understood the cadence, the pace that you are suggesting NII should follow. I know you used the word attenuate, but we had a debate over here as to which way attenuate was going to traject, so sorry to ask the ticky-tacky, but appreciate it? That's all right. But we want to be transparent and sometimes language always matters, as you say. Our perspective is we've got a very nice step-off point from fourth quarter NII. We said we'd be roughly flattish into the first quarter. And then we expect it to trend downwards, so attenuate downward, let's say, 1% to 2% for the next few quarters. Just as you see you see a tailwind of interest rates creating a positive but you see that continued rotation out of net interest bearing deposits being a headwind. And the net of that is down NII we think 1% to 2% for a couple of quarters. And then towards the end of the year and into 2024, we see rough stabilization probably because we've kind of burned out on the noninterest-bearing rotation, and then we get to a more stabilized area. But all in, we expect full year NII to be up about 20% year-over-year, and we'll take it from there. Got it. Yes. No, that's helpful. And then on the expense side, I know you mentioned that the benefit of the actions you've taken, am I right, $100 million run rate. I just wanted to understand when that comes into the 2023, is that immediate in 1Q, or is that something that comes in over time, just that would be helpful? Thanks. Yes. Roughly about half of that comes in, in 2023. The payback on most of these actions is about five quarters so roughly half comes in on a fiscal 2023 basis. And then we'll hit the run rate, I think, within quarters, whatever, sixish or something after these actions, most of these actions are in the next few let's call it the next quarter. The run rate then builds to $100 million. So good payback and the kind of actions we want to keep taking in this kind of environment. Yes. So your point, that was my final follow-up, which was, do you feel this is the extent or if for whatever reason, top line disappoints based on macro not working out or what have you, is there more that you would consider doing going forward? Betsy, it's Ron. Maybe I'll take that. I mean, we've obviously got a pattern of investments that we're intending to execute. We've also got an ongoing program in place that we've really had running now since 2019. So we certainly -- if the environment were to change materially, we would think about those investments. We would also think about being more aggressive. I mean, we have more or less in the background, continued to take a lot of gross expense out of the system every year. We see an ongoing ability to do that, but we also want to keep investing in the business. So there is a balance there. But to the extent to which things started to go south in an unanticipated way, I mean we do have levers. Thanks, good morning. I was wondering if we -- if you had any kind of just -- well, post-game thoughts -- post the BBH decision and within that, just you acknowledged and put forth this $4.5 billion capital plan. Just how will we think about just your commitment to that now as opposed to whatever thoughts you might have about acquisitions going forward? Thank you. Ken, I mean, as we've always said, we've got a very clear strategy and M&A is not a strategy. M&A is a way to help execute a strategy, to move it faster, to enable it to get further than was anticipated. But it's not a strategy by itself. We are very comfortable with our organic strategy. BBH was a scale enhancing acquisition that we would have liked to have done, but it doesn't materially change. In fact, it doesn't change at all our strategy. So at this point, where we sit, we have a strategy that we like. We have a strategy that we're executing against. There are some big milestones that we're confident we're going to be delivering on in 2023. And therefore, we are committed to that share buyback. Okay, great. And then on servicing fees, can you help us understand in your flat to plus one, what's the impact of the BlackRock ETF deconversion, where are we in that process, and how much, if any, has already been recognized of that expected revenue attrition at this point? Thank you. Yes, I think maybe just to answer that in the various components. I think you saw the BlackRock transition begin at the end of last year was $10 million in the quarter, sort of call it, a $40 million run rate. That continues to transition out in 2023 and in 2024, there's obviously just a natural schedule that you expect that we've worked closely with them on. And so it'll impact our servicing fees during 2023, during 2024, and into 2025, just when you think about the year-on-year comparison basis. I think if you want to model it out broadly, we've said in our last regulatory filing, we said it was worth about two percentage of fees as of the December 31 pointer we just crossed. It's now about 1.7% of fees. And I'll let you sort of build it from there. But it's included in our forecast. It will continue to be included in our forecast. We think about net new business, right, we've got to sell. We always have a bit of attrition, and we'll -- we want to continue to be net ahead. And as you've seen us in the last couple of years, we've been net positive with net organic growth broadly. And then with BlackRock, specifically, they continue to be a very important client of ours. We have continued and kept a good amount of business that we do with them. We're strong providers for them in alternatives, which is growing quickly. And we've also been awarded new business over the last year. And so that will just -- I think it will just be part of the outlook that I give you as we go forward. Hi, good morning. Thanks for the question. Maybe just to follow-up on Ken's last point around servicing fees. I guess if you take your run rate servicing fees at the end of the year, it still implies a pretty wide gap versus where you guys expect to end for 2023. So maybe just provide a little bit more granularity where the ramp is going to come from. So I know equity market is one thing, and you guys are assuming, I think, 10-ish-percent growth in global equity, so that certainly helps. But off of the kind of $4.8-ish billion run rate that you exited that to get to, I don't know, $5.1 billion, that's a 6% growth that's still wider than we've seen in the past. So I'm just curious whether it's new business or something else that you see on the horizon that will help you bridge that gap? Yes. Alex, if you -- I think I tend to spend a little more time on the full year to full year kind of servicing fees, it sounds like you're modeling the last four quarters and then the next four quarters, which obviously model as well, and we have in our budget. It's really a combination of factors, right. So there is -- on a -- if you start with fourth quarter of 2022 and then work forward, we expect some appreciation in equity markets. We'll see if that plays out, and we'll obviously stay in touch with you all. We think that will be a tailwind. We think client flows and activity, in particular, should not be a headwind like it was in 2022, maybe neutral, maybe a positive just as clients have adapted to this new environment. And so we see the new year -- this new year as a time when they're going to be trading, investing, building positions. So we'll see if that plays out, that will be part of it. Then we have net new business. And so we do have a good pipeline both in the traditional servicing and Alpha area. And I think as part of that, we continue to mine our existing client base because the share of wallet growth can be positive there. And then finally, there's always some amount of normal pricing headwinds, but that's factored in. But you kind of have to go through those four areas. And remember, we're assuming some growth in equity markets on a point-to-point basis but we'll see if that plays out. I got you. Alright, that's helpful. Maybe just a follow-up around the balance sheet strategy. I heard the NII guidance, the deposit commentary all makes sense. When it comes to the tailwinds from sort of repricing the fixed portfolio, the fixed securities portfolio, can you help us frame what the roll-on, roll-off dynamic looks like today? And also whether or not there are some more opportunistic actions you guys might take liqutine [ph] with both RFBK [ph] and Northern over the last month or so. With respect to just maybe reaccelerate some of the lower-yielding securities roll off into something that might be a little more attractive here. Yes. Let me describe it as follows. The investment portfolio has an average duration of a bit over two and half years, so call it average maturity of five years. And so you go through the math, and that means about 20% of it rolls on, rolls off in a typical year. It will move around a bit. I think what we found, and that's invested across the curve, it's invested in various currencies, so there's a mix. So you tend to get as you have rolled-off, rolled-on somewhere between 1%, 1.5% to sometimes 2.5% tailwind for that particular quarter of the amounts that are rolling off and rolling on. And so that's what's actually been one of the factors that's in billing the yields and the yield improvement on the profile and both how it was designed and what we're pleased to see. So that will be a gentle tailwind assuming five-year rates stay more or less where they are and European rates continue to float up. And so we'll just have to -- that will be one of the tailwinds that we see. In terms of more dramatic action, we obviously always think about what we might do. What we've noticed is that if you have high risk-weighted asset positions in your risk-weighted asset-intensive positions in your portfolio, then what happens, you could take the loss, you reinvest, and it helps accelerate a buyback, right. That's why I think a number of players are doing that. Doing the -- just the -- for vanilla instruments, treasuries, agencies, government-guaranteed securities, there's -- I think the benefits are a little closer to a push. We could take some losses through the P&L. They're already in the equity accounts through AOCI, you put on NII in the future. I think that's just moving around of the financials, and we just don't find that that's a particularly compelling trade to do. We'll always evaluate well. So we see if we have specific positions that might need some adjustment. But we don't see that as particularly compelling. It's not really compelling economically. And the financial benefits you guys can kind of model out either way. And so we -- I think we're pleased with the ability to continue to manage the portfolio in line with our current processes, and they've been numerous. The NII is up significantly this past year and up another 20% next year, and we've got a tailwind and it -- I think it bodes well for where we are and where we're going. Great, thanks, good morning folks. Actually on net interest revenue outlook for 2023, Eric, can you talk a little bit about what you view as sensitivity to say if we had rate cuts in the back half of the year, I don't think that's assumed in your outlook, but just if you can talk about that dynamic and whether you think that would just be offset by reducing the deposit beta? And then also on the foreign deposit beta that you talked about, which is much better than U.S. Do you expect that to continue or do you see incremental foreign deposit betas moving higher from here? Yes, let me do it in reverse order. The U.S. versus foreign currency betas in our experience, this cycle, prior cycles, do tend to run at different levels, partly because the U.S. has the structure of noninterest-bearing versus interest-bearing deposits. So the client deposit betas are in a subset of the total and partly because the international markets just operate a bit differently, how we're paid and how that -- those expectations have been set over, I'll call it, decades for the industry, operate differently. So I think for the -- as we look into the next few quarters, we think the U.S. client deposit betas ex any new money that we bring in on an initiative basis is going to be in that 65% to 70% and the international betas, we think will continue in the 20% to 50% range when you look at Euros, Pound Sterling, Canadian Dollars, Aussie Dollars and some of the other currencies. So we think they're kind of in the -- they're going to be in this zone and that gives us some ability to continue to take advantage of the interest rate increases. If I then work through the other part of your question, what happens with rate cuts, that's in our expectations, that's in the forward curves, especially for the U.S., that there could be a December cut. There's some probability there could be a cut before that. I think it doesn't dramatically affect because they are late in the year. The rate cuts don't dramatically affect the NII forecast, so we'll kind of take it as it goes. I do think you're -- as you're intimating, there's a bit of this offset, which is if the Fed's cutting rates, and there's probably going to be even more cash that clients keep on hand and deposits in the system, there'll probably be some offsetting impact. And obviously, with the U.S. betas higher, conveniently rate cuts actually at some point help with the NII as well. So I think there's a fair amount of -- there's a range of scenarios, let's call it, in the second half of next year. And so my guess is, Brian, we're going to be having this conversation often with you. And we'll certainly keep you posted as we see some of those scenarios develop or there's more variability. That's super helpful. And then just maybe on asset servicing, just maybe an update on how you're seeing the pricing headwinds fold out for this year and also obviously, you typically do get a pricing headwind just from a mix shift towards ETFs, but maybe if you could talk about whether you think that might be set offset by some of the growth in alternatives? And then I know I think there is an expense offset too or I should say, I believe the margin is the same on ETFs versus say, mutual funds, so you again an expense offset, so maybe if you just want to confirm that? Yes, Brian, I think the pricing experience that we're seeing in the industry has been stable and consistent over the last few years, and we expect it to be consistent into next year and beyond. We just have the standard because our contracts are tied to equity markets, when they roll over every four, five, six years, typically, folks are thinking whether they expect equity markets to be. They know we're going to get paid, they're going to pay us more in the coming years, and they want to share some of that. And so there's a partial pricing offset. But it's in the 2% headwind per year on servicing fees and been relatively consistent. Yes. Brian, it's Ron. The mutual fund to ETF shift, the -- I mean there's been some high-profile conversions of mutual funds to ETFs. But that's -- there's not a lot of that going on. More typically, what you're seeing is ETFs being added to lines. And yes, the economics are different, the revenues fees are lower, but also particularly when you're at scale like us, the expenses are much lower. So it's not meaningful in this overall revenue kind of guide that we're giving you. Good morning, thanks for taking my questions. So I'd like to start on capital. So the buyback sends a strong message. Ron, very encouraging to hear about your comments on M&A. But I wanted to clarify that the buyback is up to $4.5 billion. So does the upper end of the range there assume that you're going to see some AOCI accretion and is the quarterly range of $120 million to $200 million still the right way to think about it, if rates are stable? Brennan, it's Eric. The answer is yes and yes, right? If you think about it, we forecasted just you guys just as you have earnings and coming through the P&L, AOCI in that range, $120 million to $200 million a quarter, it bounces around a little bit and it may with movements in rates. But the pull apart has been good to us and will be a nice tailwind. There's some normalization of RWAs, which I mentioned into the first quarter, then there is some RWA growth in our plans because we want to continue to lend more to clients and support more with their foreign exchange or hedging activity so we'll continue to do that. And then there's the buyback. And our plan is just to at pace, get back into our range and that authorization comfortably gets us there. Okay, excellent. And then a couple folks have touched on it before, but maybe if we think about the fee revenue, can you please update us on the impact of market moves to fee revenues and whether or not there also a corresponding impact on the expense side to I'd assume there's at least some degree of impact there? Thanks. Yes, let me do it this way. I think as we've -- we have been relatively consistent here and I think the guidance will hold a 10% average change in let's call it, an increase in equity markets, right, will typically lead to about a 3% increase in servicing fees, if you have both of those on average. So that's the kind of gearing we have. It's higher on management fees, 10% higher equity and markets tend to be closer to a 5% increase in management fees. On the expense side, if I -- it moves around a bit, but I think it's a 10% average increase in equity markets. Probably close to let’s say around -- the range around a percentage point increase in expenses could be a little bit less, it kind of depends. But our subcustodian costs are -- have a gearing towards equity markets and fixed income markets, market data, in some cases, does as well. So it could be half a point, could be a point, and that's part of the what we have in the expense walk and outlook that we have given and in some ways I think we are actually pleased to see that particular expense increase because that particular expense increase comes with a real revenue growth and that’s – and that delivers EBIT and earnings growth when you bring it all together. Hi, good morning. So Eric, I actually have a two part if you'll indulge me just on some of the NII guidance. First, I was hoping you could provide just some guardrails on your assumptions for NIB outflow given you're relatively close to the trough that we saw last cycle? And the -- for the second part, just since you alluded to NII stabilizing beyond 2023, even as NID remixing pressures abate and reinvestment tailwinds start to work through the balance sheet, was curious why NII isn't actually growing beyond 2023, is that a function of rate cuts, international mix, any perspective would be really helpful? Alright, well the -- crystal balling into 2024, I got to tell you, we've got a lot of variability playing out right now, whether it's economic, whether it's central banks. And I think I know there's a lot of talk about what's happening in NII, where do we go to, and then does it -- what happens after we get to a peak. So, I was just trying in 2024 to kind of level set that we see stability. There's a scenario where you see growth. There are scenarios where we may not. But it's hard, it's -- you're getting far out on our forecasting and predictions to be honest. So let's come back to that maybe in the middle of the year, that will be a good conversation. In terms of noninterest bearing, you saw noninterest-bearing on average was about $44 billion this quarter. This quarter, meaning fourth quarter, it was down 5% sequentially. It's bounced around quarterly but we see -- I don't know, you could have off the $44 billion, you could have a $4 billion rotation out next quarter. You could see that again into the next quarter. Then it starts to -- or it could be $3 billion and then $2 billion and so on and so forth. So we're -- I think we're at this level where we've seen some amount of rotation. We think it's going to continue roughly at the pace that it's been going. So it could be anywhere between $2 billion, $3 billion and $4 billion a quarter, but you could have some changes to that. What we do think is that we'll continue to see some of it in the first half of the year, and then it just starts to slow down into the second half. And what we've done is to use that kind of base case into our modeling. And it's all factored into the 20% increase in NII that we expect for next year. That's great. And my defense, Eric, since you did talk about stabilization, I felt like I had to take advantage of that window of opportunity, to look forward to talking about it a little bit more in the middle of the year. Just one more for me on capital management, I was hoping you could just speak to or give us some insight into the cadence. Should we expect that buyback to be executed ratably or be a little bit more front-loaded here? And just given the commitment or at least early like a strong effort to optimize your capital levels, how are you scenario planning for the Basel IV proposal or update that we should be getting from the Fed early in 2023? Yes. All fair and it's a kind of discussion we have internally. We want to front-load the buyback. You saw us start particularly strong this past quarter. And we want some amount of front loading. On the other hand, it's actually quite stabilizing to the stock to have buybacks on a consistent basis. So, I think we're -- we don't want to front load at an extreme, and we don't want to be ratably flat through the year at the extreme either because it gives, I think, it's a good kind of market practice to have some I'll call it, front loading, but reasonable consistency in the buyback as well. I think then the goal is to get into our target range at pace. And then we'd love to operate in the middle of our range over time. That's kind of how a range is set up. But I think what we always have to do is look out on the horizon is are the economic conditions worsening, right? And so then you may be want to run close to the upper end of the range to insulate and prepare or are they particularly benign and they're particularly good uses of capital, and you might want to be at the lower end. Similarly, I think we'll learn more about Basel III and some of the changes in capital rules, maybe that comes with other changes in capital rules, we don't know. And I think later this year, we'll evaluate and that's another reason to either run towards in different areas of the range as well. So, it all factors in, but I think we're quite comfortable with the direction where we want to go and then like you will -- we'll think about what's on the horizon and plan for that. Good afternoon guys. Eric, as a follow-up on the stock repurchase commentary, did you guys -- and especially in the sense you referenced it would be more front-end loaded, did you guys consider an accelerated share repurchase program? Gerard, we did. And I think what the accelerated share repurchase program typically does is operate in such a way that the stock buyback is accelerated within the course of the quarter, right, within the three-month period. There are typically some benefits of that. You tend to add $0.01 or around that EPS. It's actually interesting in a high interest rate environment, you also lose the NII benefit of the capital. So we've actually found that the ASRs tend to be a push roughly. And so we're -- we often do a more typical buyback within the available trading days in the quarter in a way that's fairly market practice as a way to return the cash and the capital to all of you. Very good. And then I know you pointed to the RWA benefit you had this quarter for the CET1 ratio. And I think you said in your slides, you're targeted range is 10% to 11%, which, of course, you're above at this time. Do you have any guidance on when you think you may reach your targeted 10% to 11% CET1 range? It will depend on -- let me say it this way, we want to return the capital at pace and I've given some bookends as to what that means. And that's, I think, a forecast you guys can build off of. And we want to get to our target range, we don't want to wait until, I don't know, next Christmas. That's not the -- that would not be at pace in my nomenclature. At the same time, there's just a range of what will move. If RWAs lighten again, it'll take a little longer. If they go back and we fully utilize our limits in our various businesses and areas, then it might be a little more quickly. So it's hard to pin it down, but as I said, we'd like to get to -- we'd like to execute the buyback at pace. We'd like to get back to a range -- into a range at pace and we're going to -- we're driving that direction. Hi, Well thanks for all the answers on the cyclical factors. I wanted to ask about the structural end game, a strategic end game post Brown Brothers. And the reason I ask, I count five restructurings in the last 20 years. They seem to come around like the softness the Olympics. The fourth quarter is yet one more quarter with notable items, account notable items in 18 of the last 20 quarters. And I do get some of it. Like you have incredible headwinds, mutual funds, markets, technical debt. You've been reinventing yourself front-to-back, straight reprocessing, serving clients, more agile tech. And I also recognize what you said at the start that the ROE and the margin improved for a couple of years in a row. But when I look at fee expenses, that has gone the other way and it seems like maybe one route issue is fixed cost. So really, the question is a concrete question, what percent of your expenses are fixed, how does that compare to the past, I'm assuming they've come down and where would you like to take that? And then more broadly, what is the end game strategy after Brown Brothers? Thanks. Yes. Let me start on that, [indiscernible] there's a lot in there. A comment on -- I'm not going to comment on past restructurings, I'll comment on this one, right. We've made some changes to the way we organize ourselves. We talked about that back in the middle of the year. And there's some benefits we can take out of that in terms of simplifying the management structure, having a smaller number of senior managers, we're going to take advantage of that. It's consistent with simplifying our business. It creates accountability and we stand by the need have done that restructuring. In terms of where do we take this business going forward, it's -- it has a lot of benefits to it. It's very tied to investment markets over time. Investment markets grow, they don't shrink. So the actual, if you will, unit pricing while the unit pricing may go down, overall pricing actually -- overall revenue is actually more times than not have the tailwind. We like that business. It's also one that is changing fundamentally from being a kind of a back office, show me the lowest price kind of thing to much more of an enterprise outsourcing business. We are very new in that. We're very early in that transition. And we think by far, we are the best positioned to take advantage of that in terms of the technical capabilities that we have, the people capabilities that we have, the position we have in the marketplace. We've made initial in roads and wins in that, but there's development that we talked about that will be delivered in 2023 and beyond, but a lot of it in 2023 that will only help strengthen our position. So we see the end game here in terms of the core investment servicing business as being one which is much more akin to an outsourcing services business, much less susceptible to kind of these instantaneous, I'm going to put it to RFP. And it's just a stickier business. And we are very respectful and wary of our competitors because having an edge and a lead can be easily caught up on. But we -- right now, we believe we have that edge and lead, we're going to capitalize on it. In the investment management business, again, similar kinds of changes there. We're seeing an increased desire for the kinds of things that we do, systematic and otherwise. Asset allocation, which we are very, very good at is now an area that everybody is talking about after literally decades of reliance on the 60-40 model, and guess what, it didn't work or it doesn't work at all time. It will lead to a lot of thinking and demand for that. So we like our businesses. We like where we are strategically. In terms of what's going to happen, will there be other Brown Brothers out there. What I do think that you will see over time is an increasing number of competitors where this may not be their core business saying enough is enough. The capital requirements are -- in terms of the investment capital requirements are much too high, mostly above the technology. If it really does continue into an outsourcing kind of environment like we believe it will, it's going to put more demand to invest in the business. And if this is business 42 of your 80 business structure, you might decide you don't want to be in this business. So that's how we see it going forward. That was expansive, thank you. And the fixed cost part of the question, you don't report it that way, but just in rough terms, I guess. So in asset servicing, less RFPs, lowest price, this enterprise outsourcing, okay, investment management, more holistic instead of the real old model. But still as you transition, you have a certain degree of fixed costs that are tough to manage. I mean it's not quite like a brokerage firm where you reduced bonuses. So is there any way just to ballpark how much of your expenses are fixed costs and I think they've come down from the past, you're probably trying to floor them more? Mike, it's Eric. All good questions. I think that this section in the industry, which used to be variable cost intensive, right, it was very manual, and when you add a new piece of business, you actually have to hire fund accountants. We're working on ledger paper first and then on the Excel sheets next. And so it's quite manually intensive and variable in nature. It's actually as we've automated, think about the data centers, you've talked about the movement to the cloud, the developers that we have, this business has really evolved to a fixed and semi-fixed cost oriented business in truth. And that means that for certain types of business, we bring on custody business, core custody. Those are kind of the most automated and the most the oldest part of what sits in our franchise, that comes in, you plug it in, and the computers just process a few more times, not overnight, but literally in nanoseconds. And so this has become a more fixed cost business. And so what we need to do is think about how do we want to manage those fixed costs, how are they deployed, the development dollars and technology, how do we shape that each year because we can -- if we do that right, we'll add feature functionality and that will bring in new business over time, that will help retention and that will help growth. And so this is more of a fixed cost business and semi-fixed costs. Where is it? It's more 80-20 fixed and semi-fixed than 20-80. And I think it actually has evolved. And so what's important for us to do is to make sure that we have the products and the offerings and the client coverage to support that and to add new business, add the right type of new business. And then where there are variable cost components, we've talked about some of the more manual and complex areas. Servicing for private, for example, is still quite manual, it's complicated. They are not standard systems. Typically, in the industry, there are no -- there's very little in third-party software that one could avail oneself of, those are the variable areas where we need to continue to find ways to automate and streamline and that's part of what we're doing with the ongoing investment program that we have underway. Hi guys. AUC/A wins in the fourth quarter were pretty good. And Eric, you called out a strong pipeline there. What level of new business wins are you expecting in 2023? And do you see those coming from any specific client category, cohort, service area, anything like that? As we have said, the pipeline remains strong. I think we're pleased with wins this year. Wins were about $1.9 trillion for the full year. What I have said is and I think we feel good about this target or line in the sand as we've said, to drive the kind of organic growth that we'd like we want to win about $1.5 trillion per year of new business. We did that this past year, we did it in space closer to double that in 2021. And so -- and that's our expectation. We expect and we think that's par for 2023 as well. Obviously, we want to sell more than that. We want to bring in new -- more new clients or further deepen relationships with existing clients. I think what we feel good about here is both the new business this year, the $1.9 trillion that has come in has come in at good fee rates. The fee rates of the new wins are actually in line with our overall fee rate this year. And so that means that as it on-boards it will be neutral or even accretive to the fee rate. So that's important and that's an important part of the program. In terms of segments, it's been broad-based. I mean this past quarter, for example, was broad-based across regions, literally, I think it was a third, a third, a third and we saw particularly strong growth this past year in Asia. We'd like to repeat that again. I think we got -- we have an intensity on Europe and North America as well. So there's not -- I'd say it's not one particular segment or one particular region. It's fairly broad. But it's a good pipeline overall. Got it. And then you also mentioned some higher renewals in the Alpha business. Wondering if you could talk about the retention rate there, how is the retention among front-to-back clients compared to your more traditional back or middle office only clients? Yes, Rob, I mean in terms of fully installed Alpha clients, the retention rate is 100%. And you wouldn't expect it to be much less than that simply because it's still relatively new. I think that there's a real commitment that's made on both sides of the house when you enter into these things. First of all, to actually rewire the firm around -- for the client to rewire around front to back. There's a lot of effort on their part. And while there's a lot of commonality across these clients, there's a lot on our part that we need to do to install it. So contracts are longer. But the reality is that the switching costs have also gone up dramatically in these front-to-back things. So we would expect more. But we also recognize that we've got to earn that. I mean we've got -- right now, there's a -- when that happens, there's a huge dependency on the part of the client and us delivering every day. And so we take that responsibility quite seriously. Thank you. Just a couple of little details for you, Eric. You mentioned RWA came down by about $10 billion and you expect to see another decline $10 billion to $15 billion. Any color on what you did there and does it sustainable post 1Q? Yes. Let me just clarify. RWA was lower than expected in the fourth quarter by about $10 billion. And in first quarter, we expect it to reverse, in other words, to move back up by $10 billion, $12 billion, $15 billion. And it's just driven by some of the underlying volatility in our business. For example, overdrafts were lighter than expected this quarter. They moved around by a few billion dollars, and that moves RWA by a few billion dollars each quarter. In the FX book, we run a very sort of a typical forward book 2 weeks, 4 weeks, 6 weeks forward. And as you have U.S. dollar appreciation or depreciation, you can get you can get $5 billion moves in RWA relatively easily. So that's just the volatility that we saw. We tend to be quite careful to stay within our RWA internal limits. That's why we tend not to have upswings in RWA, but we tend to have these beneficial quarters now and then. And we'll just note them to you so you can model out our capital ratio trends. Great. Second, another little detail for you, your software processing and data, could you parse that into data versus CRD since that's not combined. So you got this big growth rate there? What's going on underneath? How much is data? How much is...? Sure. It's a combination. I mean, the bulk of that is really around Charles River and the franchise that we purchased back in 2018, which has really given us the kind of growth that we had expected. So you can go back and compare the size of the franchise, I think at the last disclosure. I think we probably showed it a year ago and compare it to that software and data line and get a kind of an adjustment. But it's the large majority, I'll say, of that line. Data to us is though a very appealing offering that supplements what's in -- sometimes sold with the Charles River offering sometimes with Alpha and the middle office, sometimes sold as supplemental to just custody and accounting because it's such a high-value and informative kind of window, sometimes for risk management purposes, sometimes for client transparency purposes for our asset manager or asset owner clients. And so it's actually one of the faster growing areas of that area. And that's why we've put it together because it's actually a software type sale, but an important one. Yes Vivek, it's Ron. Let me just add to that because we've done a lot of innovation in this area of new product development, and we do expect that to continue to grow as Eric said, because what -- everybody is interested in simplifying their operations, simplifying and getting control of their tech depth and innovating on the technology side. But in addition, there's a data management, data control in some parts of the world with some investors, it's also location of data. Where does the data actually both move and rest. So this is sitting increasingly -- this is a growth area. It goes beyond asset managers, large asset owners in particular very interested in this. So we see it as a way to extend what we're doing broadly in the Alpha arena. And just to clarify on CRD, Eric, to your comment earlier, when you previously talked about it was growing in sort of the low double-digit range. This was a year or two ago when you were when it was broken out. Is that still the pace at which is just continuing to grow or is that as it matures, slowing down a little bit or is it accelerating any granularity or any color on that? Yes. It continues through odd pace. I'd say it moves around depending on some of the on-premise renewals that still flow through the P&L, high single digits, low double-digits. And what we've done is continued to -- the team continues to drive kind of the core CRD offerings, the -- start with an equity product. It's moved to equity and fixed income, which are now industry, I think, industry at peer levels, in some cases, industry-leading. And then what we've done is supplemented that. For example, we purchased a small company called Markidis [ph], which was kind of a front-end portion of a Charles River type offering. And so we've added a kind of private market area to what I'll call the broader Charles River Complex. So this is an area that I think will continue to grow probably twice the rate of State Street -- it will help lead us forward but also as the tip of the spear of how we engage with clients, new clients, existing clients in broader ways. And that's why the core software, I think, is an important product. And what I think I've been pleased with, especially this year, which has been all over the place economically and politically, right, even with the equity markets up and down, software and software growth, core Charles River, data, private software for private continues to grow in this double-digit range. Low double-digit range through thick and thin, and that helps balance out, I think, the growth dynamic of the company. Thank you. 1That will be for our last question. I'll be turning the call over back to Mr. Ron O'Hanley for closing remarks. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a lovely day.
EarningCall_1532
Greetings, and welcome to the Jabil First Quarter of Fiscal Year 2023 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the call over to Adam Berry, Vice President of Investor Relations. Thank you. You may begin. Good morning, and welcome to Jabil's first quarter of fiscal 2023 earnings call. Joining me on today's call is Chairman and Chief Executive Officer, Mark Mondello; and Chief Financial Officer, Mike Dastoor. Please note that today's call is being webcast live, and during our prepared remarks, we will be referencing slides. To follow along with the slides, please visit jabil.com within our Investor Relations section. At the conclusion of today's call, the entirety will be posted for audio playback on our website. I'd now like to ask that you follow our earnings presentation with slides on the website, beginning with the forward-looking statement. During this conference call, we will be making forward-looking statements, including, among other things, those regarding the anticipated outlook for our business, such as our currently expected second quarter and fiscal year net revenue and earnings. These statements are based on current expectations, forecasts and assumptions involving risks and uncertainties that could cause actual outcomes and results to differ materially. An extensive list of these risks and uncertainties are identified on our annual report on Form 10-K for the fiscal year ended August 31, 2022, and other filings. Jabil disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. With that, I'd now like to shift our focus to our solid quarter. To kick off the fiscal year, the team delivered approximately $9.6 billion in revenue, well ahead of our forecast and at the top end of our guidance range, driven by even better-than-expected revenue in automotive, healthcare and industrial. All other end markets largely performed consistent to our expectations from 90 days ago. When you put all of this together, at the enterprise level, revenue grew by 12% year-over-year and 7% sequentially. Core operating income during the quarter was $461 million, an increase of 15% year-over-year, representing a core operating margin of 4.8%. This is up 10 basis points over the prior year and in line with expectations. From a GAAP perspective, operating income was $362 million, and our GAAP diluted earnings per share was $1.61. Net interest expense in the quarter came in higher than expectations at $66 million as the combination of higher interest rates and better-than-expected demand drove our working capital needs higher during the quarter. During the quarter, we also repurchased 2.6 million shares for $161 million. Core diluted earnings per share was $2.31, a 20% improvement over the prior year quarter and at the higher end of our range as core operating income grew much faster than net interest expense. Now turning to the segments. Revenue for the DMS segment was $5.1 billion, an increase of 8% on a year-over-year basis and ahead of our plan from September, while core operating margin for the segment came in at 5.2%, slightly below expectations as upside strength in automotive and healthcare was offset by operational inefficiencies associated with mobility in China. Revenue for our EMS segment came in at $4.5 billion, an increase of 18% on a year-over-year basis, while core margins for the segment was 4.3%, up 50 basis points year-over-year, reflecting solid operational execution on strong revenue growth. So in summary, another strong quarter is in the books for Jabil. And I know the team here is extremely proud of the strides we've made to not only improve our business over the last 10 years but also make it stronger and more resilient. In a moment, I'll turn the call over to Mark and Mike to provide some additional thoughts on our performance in the quarter and update our outlook for fiscal '23. And I think you'll see there's still so much opportunity as we move into fiscal '23 and beyond. Thanks for your time today. It's now my pleasure to turn the call over to Mike. Thanks, Adam. As Adam just detailed, our performance in Q1 was quite strong. I continue to be extremely pleased with the strength of our business, which delivered double-digit growth in revenue, core operating income and core diluted earnings per share in the quarter. Our diversified portfolio and continued participation in end markets with long-term secular trends was once again reflected in our Q1 performance. I'd now like to walk you through our balance sheet and cash flow performance in the quarter. In Q1, cash flow from operations was $166 million and net capital expenditures totaled $164 million. As a reminder, our customers routinely co-invest in plant, property and equipment with us as part of our ongoing business model. We often pay for these co-investments upfront, which are then later reimbursed to us by customers. Due to the high dollar value of these co-investments from our customers and how they are reflected on our cash flow statement, it is important to net the two line items shown on the slide to reflect the true CapEx number and what we refer to as net capital expenditures. For the quarter, inventory days came in at 78, down 1 day sequentially on improved working capital management by the team. As a reminder, we offset a portion of our inventory levels with inventory deposits from our customers. Net of these deposits, inventory days were 61 in Q1, also down 1 day from Q4. We continue to be fully focused on bringing this metric down further in FY '23 as some of the supply chain constraints continue to improve. Turning now to our second quarter guidance on the next slide. We expect total company revenue in the second quarter of fiscal '23 to be in the range of $7.8 billion to $8.4 billion. At the midpoint, this anticipates DMS and EMS revenue to be $4.1 billion and $4 billion, respectively. Core operating income is estimated to be in the range of $347 million to $407 million. GAAP operating income is expected to be in the range of $319 million to $379 million. Core diluted earnings per share is estimated to be in the range of $1.64 to $2.04. GAAP diluted earnings per share is expected to be in the range of $1.44 to $1.84. Interest expense in the second quarter is estimated to be approximately $67 million and for the year to be in the range of $265 million to $270 million, which is higher than we forecasted in September due to more conservative interest rate and working capital assumptions. The tax rate on core earnings in the second quarter is estimated to be approximately 19%. Moving to the next slide, where I'll offer an update on the end market demand assumptions that we noted in September. As a reminder, our FY '23 guidance assumed a moderate economic slowdown and some moderation in growth in the second half of our fiscal year. Based on what we know today, our assumptions from a demand perspective remain largely consistent. Across many of our end markets, demand has been extremely resilient, particularly in areas that continue to benefit from strong secular tailwinds like electric vehicles, healthcare, renewable energy infrastructure 5G and cloud. We continue to expect these secular markets to expand in the pace of an economic slowdown. At the same time, we also continue to expect some consumer-centric end markets to underperform year-on-year consistent with our thoughts in September. All together, we still expect good growth in FY '23, as you'll see detailed on the next slide. Starting with our automotive business, which continues to outperform despite global supply chain issues as the transition to EV accelerates. We've seen this rapid acceleration manifest in FY '23 automotive revenue growth expected to be in excess of 40% year-on-year. We're also expecting double-digit year-over-year growth in our healthcare business, which continues to benefit from an outsourcing of manufacturing trend and has historically been recession resistant with long product life cycles accretive margins and stable cash flows. Further, our industrial business is also expected to expand by double digits this year, fueled by growth in clean and smart energy infrastructure as government legislation, such as the Inflation Reduction Act in the U.S. accelerates investment in the space. And in 5G wireless, we continue to expect solid year-on-year growth. Infrastructure rollouts are accelerating, and our localized manufacturing capabilities are leading to growth in other geos such as India. We expect these rollouts to play out over the next several years regardless of near-term economic conditions. Within our cloud business in September, we detailed our plan to shift certain components we procure and integrate from a purchase and resale model to a customer control consignment service model. This transition, in fact, began in November, which is earlier than our expectations 90 days ago. As a result, revenue would be lower than previously expected as an incremental $300 million of components was shipped to the new model. This is in addition to the $500 million of consignment impact we announced in September. Adjusting for this shift, we expect continued robust unit growth in the cloud space in FY '23 and beyond. In summary, we feel the outlook for our business is solid and expect demand across many of our end markets to remain strong with year-over-year revenue growth at an enterprise level to be approximately 3% for FY '23 despite an assumed economic slowdown in the second half of the fiscal year. Now turning to the next slide. We have intentionally structured our business with the aim of delivering core operating margin expansion, sustainable earnings growth, strong predictable cash flows and shareholder returns. With that in mind, while we continue to expect growth in our business despite recessionary headwinds, we have identified certain cost savings mainly in our SG&A and support organization for the second half of our fiscal year as we continue to look at doing more with less. And noncore expenses associated with our optimization activities will be approximately $45 million, with the benefits expected in the back half of the fiscal year. We anticipate these costs will result in a net benefit to core earnings per share of approximately $0.10 in FY '23 and $0.20 in FY '24. This benefit has been considered in our updated core EPS outlook for FY '23 of $8.40. We expect the cash outlay associated with our optimization efforts to be incurred over the next two quarters, and we continue to expect free cash flow of more than $900 million in the fiscal year. We expect the momentum underway across our business to continue even in a subdued economic environment and feel the steps we've taken to optimize our business are appropriate and make us stronger. I would like to wish everyone a safe and happy holiday. Thank you for your time today, and thank you for your interest in Jabil. I'll now turn the call over to Mark. Thanks, Mike. Good morning. I appreciate everyone taking time to join our call today. I'll begin by saying thanks to our team here at Jabil. Thank you for your attention to detail, and thank you for the way you care for and accept one another. Your attitude is amazing, and your dedication is incredible. With that, let's move to our next slide. It's staggering when I think about what our team has built and tailored over the past five to six years. A large-scale portfolio of business sectors, eight discrete yet interwoven sectors, which offer Jabil a high degree of resiliency during times of macro and geopolitical disruption as well as gearing times when we simply welcome the ongoing demands placed on us by our customers. IN looking at this slide, I think about a world where countless products and a massive number of supply chains need to be created, redesigned or modified, therefore placing Jabil deep in the heart of essential end markets. Before moving to our next slide, it's worth revisiting the topic that we addressed during our Investor Day event back in September, the topic being the intentional output of the portfolio you see in front of you with the intention being that no single product contributes more than 5% to Jabil's overall earnings. This result is a good thing. It's a really good thing, especially when we think about dependability and sustainability. It also shines a bright light on the strategic importance of diversification and scale and the clear impact it has when operating our business. In recognizing our Q1 results, along with our 2Q guide as detailed by Adam and Mike, combined with a watchful eye on the back half of the year, we find ourselves with an updated financial plan for FY '23, an outlook which has us increasing core earnings per share to $8.40, an increase of $0.25 from our forecast roughly 90 days ago. In addition, we believe that core operating margin will hold at 4.8% for the year on revenue of roughly $34.5 billion, while free cash flow remains north of $900 million. Integral to this outlook is the fact that our team is doing an exceptional job of proactively managing costs and controlling what they can control in today's environment. Moving to our next slide. I'll share thoughts on our path forward. Shown here are fundamental catalysts, which are key to favorable results and future outcomes for Jabil: The unique combination of our approach, structure and experience, our ability to execute, combined with our engineering expertise, financial plans that are grounded in rational assumptions and our commitment to returning capital to shareholders. And rounding on our path forward, maybe it makes sense to step back a bit and think about the past few years. The data suggests that what we're doing is working, a testament of just how well our team is managing the business I'd now like to transition from our path to our purpose. Here at Jabil, we're never confused about our obligation to deliver a fair return to shareholders. With this obligation well understood, and considering the upcoming holiday season, we're taking a little extra time to heighten our focus on ensuring a meaningful purpose in all we do. We're encouraging our employees to take a deep breath and a short pause, creating a little time for reflection, reflect on our team, reflect on their personal lives and reflect on giving back to those in need. And speaking a reflection, when it comes to helping those in need, I'm proud to report that our employees around the world just surpassed 1 million hours of personal volunteer time for calendar 2022. What a positive difference created for so many around the world, so many who need it most. Our team's effort was extraordinary. And in multiple ways, their effort was life-changing. Here at Jabil, we fully embraced the meaning and importance of carrying a purpose, both at home and in the workplace. And we do so with exceptional conduct and care. I'm just so honored to serve such a strong and steady team. Their approach is responsible and reliable. They value the relationships we have with all of those that we serve. Each day, we welcome the challenges put forth by our customers. And in doing so, Jabil is making the world just a little bit better. In closing, to all of you here at Jabil, please know that you can be your true self without anxiety or fear recourse each day when you come to work. And to everyone on the call today, I wish you a safe and peaceful holiday season. Two questions, if I could, please. First, on inventories, Mike. A little bit of improvement there quarter-over-quarter and it looks like you were able to get more components on the auto side. I wonder how close we are to just sort of calling spring in terms of normalizing inventories during the course of the next 12 months. And then I had a follow-up. Hey, Steve. Yes, so the inventory days that we just printed 61 days, down 1 day from Q4. A normalized run rate, Steve, would be around that 55, 57. That's what I expect. Not anytime soon, but that is the ultimate sort of aim. I do expect that 61 days to continue to go down to that 58, 59 level. There will be quarterly nuances, timing nuances, et cetera. But overall, the trend would be in the downward direction, particularly with the supply chain constraints easing, as you mentioned. That's helpful. And then as a follow-up, I was wondering if you could talk a little bit more of some of the stuff you're doing on the energy infrastructure side. It seems to be supporting some good growth in industrial from the standpoint of how the new program backlog looks, what your right to play in those markets, whether it's increasing and where you're seeing production interest. Steve, that's an area of our business. As you know, it's embedded in our industrial business. We don't tend to break out all the individual products. But in terms of overall energy management, clean energy, et cetera, that's an area where, if you take a look at our overall industrial growth, I would say that the growth rate of that component of our industrial business is greater than most of the other industrial business. So whether it be solar, whether it be off-grid battery storage, whether it be new efficiency of off-grid power generation, mobile power generation, it's an area that's, from a strategy standpoint, very important in the next three to four years of the overall industrial business. I'd equate it -- I don't know that the growth will be as secular as maybe EVs. But five, six years ago, when we made decisions to go hard into the EV market and move a lot of our resources that way, you could think of it a bit the same in terms of our overall industrial business. That part of our industrial business is getting a lot of attention. Yes. You're welcome. I guess I'd make a general statement and a specific statement. I think one of the interesting characteristics of Jabil is to be really effective in this business over the long term, I think scale matters. And then in one of the slides that we just indexed through, if you look at the overall portfolio today that make up the $34 billion, $35 billion of revenue, the balance of the portfolio is substantial. And so again, coming back to your specific question, when I think about the markets that you're referring to, A, we've got a whole set of engineering staff that are, let's just say, expert in that area. But much like all of our businesses, they also have a vast pool of engineering resources in other sectors that they also get to confer with and talk to and think about being creative in terms of overall solutions in the industrial space. And I think that makes a big difference. You mentioned a little bit of manufacturing challenges with the DMS segment. I assume that has to do with the COVID closures and things. Can you just update us as we sit here now around December 15? Have those kind of been back to normalized? Are there still inefficiencies going on? Or any changes in how we should think about those efficiencies and inefficiencies? Hey, Jim. I think for the quarter, so if we backward look to September, October, November with the kind of zero COVID policy, everything that was in the media around China and then kind of our exposure to that and our experience with that, in very round numbers, I would say that the kind of overall China COVID activities probably impacted Q1 by about $10 million, give or take. As you've seen recently, and maybe you're referring to this with some recent changes around the zero COVID policy, we'll continue to manage that in much the same way, being very careful, practical, thoughtful in terms of managing China coming out of a zero COVID policy. We've been doing that around the world since January of 2020. I think our protocols around the world and in China are kind of best-in-class. And I think protocols and processes aside, Jim, I give a huge amount of credit to our leadership team and our supervisors on the ground in China. We have a fabulous relationship with our people and our employees, and that in and of itself makes a huge difference. So anyway, that's our intent. And then as a follow-up on a different topic, you mentioned some more consigning. That was kind of the same customer? Or is it expanding more or the relationship getting deeper? Or is it kind of getting broader for the consignment? I'm just kind of curious, it seems like to me, I should think about the consignment as a good thing for like more sticky business and sticky relationships. Yes. I'm not going to get into customer-specific. I think when it comes to parts of our cloud business, Jim, we've been very, very consistent. And I don't know the first time we came out on a call and started talking about our entry into the cloud business based on our right to play and the solutions that our team wanted to bring forward. But what we talked about maybe back in 2018 and through 2019 and even through 2020 and COVID and on and on and on, we've been extremely consistent with the fact that our value proposition in that area of our business is very geocentric and very asset-light. And said differently, we do a very good job of aligning variable costs with the puts and takes of the revenue. This is nothing more than that continuing. And the team has done an absolutely fantastic job of growing that business. I think on one of the slides again that we showed, you can see our cloud business or let's just say, cloud and 5G is now $6 billion, give or take. So I think that's a proxy for how successful they've been. And again, we'll continue, and our intent is to continue to run that an asset-light way. And Jim, if I could just add, I think when we gave guidance in September, our assumption was that the consignment would start sometime in March. We actually managed to get it done far earlier in November. So you're seeing an earlier impact of this consignment piece showing up in our -- a little bit in Q1 but mainly in Q2. I wanted to understand a little bit more about the decision to reduce costs. I understand there's continued productivity improvements that you can do. But I'm wondering sort of what you saw out there that led you to do this? And how much of it is proactive versus changes you've already seen in customer behavior? And then I have a follow-up. I think it's a natural decision. We -- the world is, I don't know if I use the word difficult, but let's just, for lack of a better word, things are a bit choppy right now, a little bit difficult. And whether it's running our business in each sector of our business, in a different way based on what customers need, whether it's our execution, whether it's overall cost management, I think when we sat here in August, September, and we're taking a hard look at the year. Our belief is that we should be maybe a bit more cautious to the back half of the year as we sit today. So Mike and I got together with our leadership team, and I'm really pleased with the outcome. And by the way, this was a hard press by the overall team. We're just being proactive in terms of largely in terms of overhead costs and maybe costs that sit on top of the factories. I think that Mike said in his prepared remarks. And I think one thing I think it's worth differentiating, being proactive in the methods in the way we're being proactive in terms of cost management is, to me, way different than say writing off or writing down assets. It's really about taking a look at the business, being aggressive and proactive and then being sure that shareholders get a very fair return on that in short order. And I think Mike in his prepared remarks somewhere said on our cost management and the charge we took in the quarter, investors will get about a dime back at the back half of this year. But more importantly is, is I think the payback for '24 and into perpetuity will be $0.20, $0.25. So I think it's good use of our effort and nice returns for shareholders. And Shannon, our business assumptions continue to be extremely robust. I think I highlighted some of the secular trends that we're actually participating in. All of those continue to show very decent growth. And then just one other question. How -- when you talk to your customers, how are they thinking about geographic distribution of manufacturing these days? Given the challenges in China, I know it's starting to open up again, but obviously, it comes and goes, I'm wondering how much of a discussion customers are having about Eastern Europe and India. And obviously, you're pretty well positioned to help them as they move production around. Thank you and happy holidays to all of you as well. Thank you. Happy holidays to you too. I don't know that there's a general theme. I think we have 400-plus customers, and I think our customers' thoughts are all over the map, and they're doing the best for their business based on their products. Everything -- and this will give you a little bit of a feel for the complexity of it. And by the way, it's why our structure is so efficient and so optimal in terms of customer solutions. Here at Jabil, we don't run our business on a factory basis. We run it customer by customer, line item by line item. And the reason we do that is let's just take a product that, let's say, the unit cost is x, but the ability to move that product around the world in terms of distributing the product is very expensive. Well, that would suggest maybe we build it in-region. We have other products that cost y and moving that product around the world is very small relative to the cost of the product, and we might consolidate that to a single spot in the world. Then you add to it, all the different geopolitical issues, the very unfortunate issue that continues to wane on in the Ukraine. So it's hard for me to go, geez, this is kind of the herd mentality of our customers because the business just doesn't act that way. Also, I would suggest that when you look at our portfolio, and you look at the eight sectors that we define and then you think about all the subsectors of the business, Again, one of the things I think is a huge strength at Jabil is the diversification. And with that diversification becomes endless amounts of solutions. And again, I take you back to our approach and our structure. We kind of work with each customer in a very unique way, accommodating their needs. With that being said, I would say that you'll probably see us do some expansion in Eastern Europe. You'll probably see us continue to expand in Mexico. I think we feel pretty good about our footprint in China. And you'll probably see some expansion over the next couple of years in India. I have a question, Mark, regarding your updated revenue guidance for FY '23. You're raising the outlook for auto and healthcare. Is that related to just better supply conditions or demand related? Why taking that number up -- taking those numbers up? We're taking them up because we can. I mean, as we sit here today, one could look at it and go, why would you guys take the numbers up, if you're somewhat cautious about the back half of the year or gosh knows what's going to happen in '23 based on what the U.S. Fed is doing in the markets, et cetera, et cetera. But I think we use very good judgment. Again, a real good charm about Jabil is we break our business up into really, really, really small pieces. And it gives us really good acuity, high resolution of all elements of our business. So in a more general sense, I think the -- again, referring back to one of the slides that one of us spoke to is we're -- as we sit today, we're going to -- we think we'll see double-digit growth in the areas of auto and transportation largely driven by EVs. Healthcare, I think we showed on the slide would be maybe north of 10%, and then same with our industrial semi cap business largely being led on the industrial side. And the growth in all three of those areas, A, supply chain is getting better and getting better faster. One caveat there is, is legacy semiconductors in the EV space are still tight. But supply chain is getting markedly better. Our ability to gather parts relative to others is very strong. And then in certain aspects of those, based on certain trends, demand is holding reasonably well. And then a question, Mike, regarding the incremental consignment revenue that you talked about. So total $800 million in revenue going to consignment for your cloud customer. Does that move the needle on gross margin at all? Is there any change in terms of the operating margin or operating income on that business? So yes, it does move the needle a little bit on margin, but there's been some offsets. I think Adam highlighted some inefficiencies that we had on the mobility side in China, particularly in Q1. We've made some assumptions around further COVID, et cetera, as well in parts of the world, and that does have a little bit of an impact on margin. But you're right, on the consigned side, it has a small margin improvement impact. And that's one of the reasons we pursue this with -- along with the customer. If I could add to that, here's a real simple way to think about it in very round numbers. Two years ago, the overall op margin for the company was 4.2%. Last year, it was 4.6%. This year, at the beginning of the year, we suggested that the op margin for the year will be 4.8%. We're holding to that 4.8%, which we're proud of. So there's a 20 bps expansion between '22 and '23. About half of that is based on our cost management for the back half of the year as well as continuing to advance our asset-light nature of our cloud business and the other half of that is the lack of a better word, the core business. But what's interesting is, I don't even like differentiating that because for me, all of this activity goes hand in hand with running a good business. So -- but in terms of your modeling and the way to think about it, I think that's a reasonable way to think about it. My first question is on the DMS segment. Mark, you're seeing strong growth in automotive and healthcare, and you've taken up those two segments combined by $600 million for the full year. Like you said, the consumer-facing end markets in that segment are weaker, and you're taking that down by 200 basis points. Net when I look at operating margin, it's down 10 bps. So my question to you is if the consumer-facing end markets get weaker, can you talk us through your thoughts on margin risk in DMS? I mean, how -- do you think margins can go lower in that segment? Or what offsets do you have -- and typically, the reason I'm asking this is because typically one would think automotive and healthcare to be higher-margin end markets. So if you're seeing a mix shift into that, what's driving the 10 basis points lower? And how do you see risk to that if the consumer-facing markets go lower? Ruplu, that's a little bit of an open-ended question because I don't know if you mean it this way, but I'll answer it how I understand it, which is if the bottom falls out of all consumer-facing products, could the overall DMS margins go down further? Maybe. As we sit today, I think we've done a reasonably good job of for what we know, handicapping the back half of the year. And you -- the way you stated it is largely correct. We've really kind of haircut and handicap any consumer-facing products. And again, the reciprocal of that is we feel good about industrial, automotive and healthcare. If you -- as you're putting your model together for the year, we just reported first quarter -- we just gave you a hard guide on 2Q. As I think about Q3 and Q4, our DMS margins, as you start putting numbers together and do your after calls and whatnot, I think what you'll find is doing the math is to have our DMS business end up being at 5% or 5.1% margin. Whatever it ends up being, Q4 is going to end up being a pretty strong quarter. And I think that's reflective of exactly what you said, which is some of the higher margins in auto and healthcare. I would also -- why we're on the topic of the year is, let's not be -- let's be sure it's not lost on us, the hard work and the complementary work that our EMS team is doing in terms of their business and margins for the year as well. When we went into 1Q, on the EMS side, we thought margins would be in the 4%, 4.1% range, that came in 4.3%. If you take a look at our guide and do your math on that, you'll see the strong margins returns in 2Q. And then if you think about the year on the EMS side, last year, I don't remember the exact number, but EMS was 4.2%, 4.3%. Beginning of the year, we thought EMS would be -- for the year, EMS would be around 4.4%, 4.5%. And I think EMS is going to come in closer to 4.6%, 4.7%. So again, let's step back and just have an appreciation for the fact that the business is kind of an entire portfolio. And I say that respectfully I understand your question was around DMS. I hope that helps. For my second question, if I can ask, Mike, 4.8% operating margin total for the company. Can you help us quantify the inflation pass-through impact on that? I'm assuming like other EMS companies as component costs have gone up, you're passing that through. I'm not sure if it's a dollar for dollar, but if it is, then your revenue should be hurting -- but sorry, your margin should be hurting because of that. And so what would that 4.8% have been if there was no inflation pass-through? And when we think about modeling margins, if we look back, the Slide 13 that you have, you've kind of shown us the last five years and how the margins have progressed since fiscal '19, very strong performance. But I mean, as we model out going forward, what are the puts and takes here? Like I mean you're going to get a benefit as inflation goes down. That should help margins. But what are the other things that can drive margins? And any guidance you can give to -- how do you think about what the target margins can be in the long term? Ruplu, I'll intercept that one for a minute. Wow, that was a lot. Let me bring you back to what I think was the first part of the question, which is, yes, you're correct. In the first quarter, at an enterprise level, margins were 4.8%. I kind of think you answered your own question, which is 1Q of last year, margins were 4.7%. We thought that the first quarter would come in back in August, September, we were guiding and anticipating the margins for Q1 would be 4.8%. They came in right on top of the 4.8%. Again, I'll bring you back to DMS margins were down about 20 basis points. EMS margins were up 20 basis points, again, indication of the size, scale, but again, the wonderful diversification we have. If we didn't have good understandings with our customers in terms of equitable sharing when variable costs go up and down, we wouldn't have delivered the 4.8%. So I don't say that to drive a concern. I say that much in an opposite way, which is the way we have our business set up, the way we have our customer relationship set up are very satisfactory to our leadership team. In terms of what else could have impacts on the overall margins for the year, it could be anything. On the downside, it could be that -- the macro gets worse on the -- so what do I worry about? Yes, the macro could collapse is that in the other, but then that instability will be there for everybody. What I don't worry about is, I don't worry about our team's ability to execute. I don't worry about our team in and of itself. I love the portfolio that we have. I don't worry about the size of the market. I don't worry about our ability to continue to gain share. And maybe you wrap all that up I think our team, both at a factory level and above factory does a really, really nice job of controlling what we can control. Got it. I mean I really appreciate all those details. And wondering, maybe now if I can sneak one more quick one in. I know you've announced Kenny Wilson to be the new CEO effective May 1, and you're going to take on more of a strategy, corporate development role. So can you just talk about from now until then, what are some of the handover activities you're going to do? And should we think of any change in direction to the company? Or how should we think about this transition? Congrats again on the quarter. Well, that's an interesting question. I've been at this a long time, and I'd make this comment not directly around my relationship with Kenny. Whether my relationships with Kenny or Borges or Dastoor or McCoy or JJ or all the folks that you've met, we have a significantly tight-knit group. We've all been at this a long time. Sometimes that becomes problematic because it feels sometimes like we've complete each other's sentences. So we've got to continue to challenge ourselves so we don't have a group think. But Kenny has been with us a long time, so has the balance of the team. I don't envision any of this being revolutionary. I think it will be evolutionary. We also added some other new leadership to the team recently with LaShawne and Kristine in legal. So I think we'll carry on. With that being said, as I continue to move more and more throughout the year into an active Chairman role, and you're right, I'll have my hands firmly involved with investors and our foundation and strategy and other stuff, I hope the team takes my 10 or 11 years and is disruptive in a positive sense. I think one of the things that this team has done over and over and over and over, and time and time again over 30 years is I think we're proactive. I think we change when we need to change. We don't change for the sake of changing. And I'd say, Kenny and some of the expanded leadership team is probably, in some sense, a little bit more edgy than I can be. And I think that's a good thing. So I think there'll be I think there'll be some good changes. You can think of them as evolutionary, not revolutionary changes because the foundation we've built for this business has never been stronger. And I'm really, really, really looking forward to the next two, three, four years to see how things shake out. So just on cash flow, you've typically seen more cash investments in 1Q, but you actually squeezed out some free cash flow this quarter. So is this more about timing or maybe less need for working capital investments kind of given elevated build last year? And any comments there in the kind of the shape of free cash flow for the year? And then also on guidance, it remains unchanged. So how are you kind of offsetting the increase in interest expense and kind of cash outlays on optimization? Or was that kind of included in your projections last quarter? Yes. So the free cash flow assumptions that we have today that reflect everything reflect they reflect the sort of charge that we've taken, the cash outlay associated with that. Don't forget that the savings on the other side of that as well. So there is definitely everything that's out there is reflected in the free cash flow. From a Q1 standpoint, I think it's more timing. We've talked about our CapEx being in that 2.5% range. Not much changes from that 2.5% guidance that we provided in September. You'll always have timing differences. You'll have nuances. From a shape of the year perspective, I sort of -- I’d just use shapes from previous years. I think it will be very similar to that. Obviously, timing moves things here and there a little bit. But overall, we still feel committed to our $900 million free cash flow number for the year as well. Got you. And then just a follow-up on op margins, seem very kind of good progression here over the last two years, some nice benefits from cloud consignment. But can you expand on the drivers to get to that 5% mark and kind of the pace beyond fiscal year '23? You're doing some cost optimization here, but will it be more a function of mix kind of efficiencies or even scale as you guys are approaching $10 billion in quarterly revenue run rate now. I would suggest all of you about, Paul, I think it's definitely a mix, operational efficiency, something we always execute on. We've always invested in the past around automation, robotics, et cetera. So we feel good about that as well. And overall, the margin, does it go beyond 5%, 5.5% as well. We're not stopping at 4.8%, and we're definitely not stopping it at 5% either. So it's something we're actively engaged in and feel very strongly about. I have a big picture macro question on sort of demand. And you talked about your demand characteristics being relatively consistent with 90 days ago. But I'm trying to square it with your commentary being a little bit more cautious as we move through the back half of this year. I guess my question is when you think about what's happening in the marketplace, we're seeing some intensity drop from a capital spend in telcos and cloud. How much of your demand visibility or your revenue visibility has to do with elevated backlogs because supply chain has been sort of elevated for quite some time versus the in-period demand that you're seeing today from your customers? And then I have another question. David, well first off, welcome to the group. I think you just started coverage on us, and we look forward to spending more time with you so you can better understand the business. In terms of your questions, there's pent-up demand, but I would caveat answering your question similar to a prior question, which is I don't want to make a blanket statement because, as an example, let's take networking or, say, legacy telco. That part of our business today is about $3 billion on a $35 billion base. So in terms of what type of backlog we see from the telco folks or the networking folks, I guess it's relevant. But in terms of our overall corporate results, I'm not sure how impactful that might be. I think a 100% we have seen pent-up demand and backlog across almost every single area of our business where supply chain constraints existed. If I could paint it with a broad brush and take this with a degree of inaccuracy, I guess, because I'm trying to paint it with a broad brush across a large-scale portfolio, I think that most of the pent-up demand and the backlog, in general, will probably be alleviated by late 1Q of '23 or into the second quarter of '23, to say the first half of '23. So I think most of the pockets of backlog clear and normalized as we get back -- as we get to the back half of calendar '23. Again, I don't know if that's helpful or not, but that's kind of a general statement as we look across the business. No, that's helpful. What we're trying to kind of understand is sort of the normal cadence of sort of order trajectory of the business, stripping aside what we've kind of lived through the last couple of years. So that's helpful. We appreciate it. And then maybe just a final question on cash flow and capital priorities. You've done a great job in terms of returning shareholder capital and managing cash flow over the last couple of years. Does your commentary about the second half or maybe some of the cash used for the restructuring change any of your priorities in the balance of this year. I wouldn't think so, but just wanted to just confirm with you. No, there's no change to our capital allocation. We've talked about in September, we have another $1.1 billion left of our authorization. We continue to use it. We use quite a bit of that in Q1, and we'll be doing in the range of 150, 200-plus type of buybacks every quarter. So nothing that happens in the second half for -- also that, that actually be an opportunity to do some more in fact, if things start going south. We have reached the end of our question-and-answer session. With that, this does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day, and happy holidays.
EarningCall_1533
Great. Good morning and thank you for attending J.P. Morgan's 21st Annual Semiconductor Technology and Automotive Forum here at the Consumer Electronics Show. My name is Harlan Sur, I'm the semiconductor and semiconductor capital equipment analyst for the firm. I'm very pleased to have Mark Murphy, Chief Financial Officer; and Sumit Sadana, Executive Vice President and Chief Business Officer at Micron herewith us today. I've asked Mark to briefly summarize the company's November quarter results and outlook, which they reported just two weeks ago, and then we'll dive into the Q&A. Okay. Thank you, Harlan and thank you all for joining us today. I'll start with the Safe Harbor. We will be making forward-looking statements. Those statements have risks and uncertainties associated with them. I refer you to our risk factors, which you can find in our public filings. As Harlan mentioned, we did just recently report on December 21st, our November quarter, which was our first fiscal quarter. The quarter was characterized or impacted, I should say, by lower pricing trends through the quarter than we had anticipated and as a result, we ended up printing results at the lower end of our range. And it reflects the market conditions remain challenging, customers continue to adjust inventory levels, certain end markets are weak, especially consumer, and just the overall macro environment is weighing on the market conditions. We've taken decisive action in a number of ways. We've got additional enterprise-wide cost reductions that are underway, and you heard those details on the call if you had an opportunity to listen to the call. Furthermore, on the supply side, we have reduced utilization, 20% from our peak levels in order to help achieve supply/demand balance in the industry. And also, we've reduced CapEx further. We now have -- our view on WFE for fiscal year, is down over 50% versus last year. So, as difficult as the market conditions are, we do see bits having bottomed in the November quarter and we see volume strengthening through the year as customer inventories improve, and they've begun to replenish their inventory levels. We would expect customer inventories to be in a better place by the second calendar quarter. The second half revenue, we do expect to be stronger than the first half fiscal revenue and that would lead to just, again, the strengthening volume -- driven by the strengthening volume. However, given the market conditions and also some of the cost effects of the underutilization, margins will be challenged in the second half relative to the first half. Micron's navigating these difficult -- in this difficult environment with technology leadership and product leadership and world-class operations and a very strong balance sheet. Over the long-term, we're fortunate that we're serving markets that are supported by strong secular growth drivers and expect that growth and a better supply/demand balance in the industry to yield strong profitability and cash flows in the future. Great. Perfect. I'll kick it off with the first few questions and turn it over to the audience. So, what is the team monitoring or seeing from customers that gives the team confidence on supply side that upstream inventories are trending the right way? And then on the demand side, what are your assumptions for end market dynamics that are going to help further drive the inventory normalization and subsequent revenue inflection, right? In other words, what are your expectations for PC, smartphone, data center, and embedded market trends in a weaker global macro environment for this year? I'll take that, Harlan. So, in terms of the overall dynamic, of course, all of us can see that the macroeconomic environment is challenging and quite uncertain and we have taken some prudent reductions in our estimates for forward-looking growth in calendar year 2023 due to the macro environment. But I will state that the environment continues to be not easy to predict as all of you have seen over the course of several quarters. So, our approach is that we are very transparent with our assumptions with all of you and you can assess and judge whether our own assumptions for end markets are reasonable compared to your own assessments. But as we look at modeling of 2023 demand and talk to customers, talk to different players in the ecosystem and use many different data points to create our view, our assessment is that the PC units will decline in2023 calendar year from 2022 in that around mid-single-digit levels, get it down closer to where the PC units worldwide were in 2019, so pre-COVID. So, all of that increase that happened in 2020 and 2021 would have been unbound through that 2022 and 2023 decline in PC units. Of course, the decline in 2022 has been much more significant compared to this assumption in 2023. In terms of smartphones, there is obviously a lot of uncertainty there as well, particularly in terms of determining the trajectory of consumer demand. We have modeled flat to slightly up smartphone unit demand and a continuing increase of 5G penetration in terms of units as a percent of the total smartphone volume, but obviously, this requires second half demand in smartphones in the calendar year 2023 to be stronger and some benefit coming from the reopening of the economy that we have been expecting in China. So, when we originally made this assessment way back internally in November and early December and then communicated to all of you, since then, obviously, certain things have transpired in China that all of you have seen a lot of the rollback of COVID restrictions and the country is going through a tough time right now because of all of that, but our expectation and hope is that the country will come out of it, China will come out of it, just like the rest of the world has over the next few months and second half of the calendar year with government incentives and stimulus, et cetera, should do better and that is the basis of our smartphone forecast. Now, on the data center side, yes, there is definitely continued changes happening under the covers with new server platforms being deployed in 2023, DDR5 being deployed in 2023, but there is also considerable things on the macroeconomic front that our customers are dealing with there. So, there has been a reduction in the growth in data center for 2023 due to some of these end market challenges. And I think whereas segments like PCs and smartphones have entered the inventory correction earlier in calendar 2022, data center has been relatively late in entering that inventory correction. So, in terms of purchased DRAM and NAND bits in 2023 calendar year, there is a pretty significant impact coming in the data center due to a fairly high level of inventory of DRAM and NAND in data center customers entering 2023 calendar year. And that's the part that's weighing on the demand and offsetting some of the underlying demand that otherwise would be there. Now having said that, I will point out that the underlying demand itself is weaker than it has been in the past and we have been cautious about the trajectory of that demand for some time now, as you have heard from our public comments and some of that concern is coming to fruition with data center demand weakening combined with the higher inventory entering that year. So, that's all part of the mix as to why we have felt that yes, the inventory will improve, your first part of the question. We are seeing customer demand and purchases of DRAM and NAND fall further below their consumption levels and their ship out levels and so we have a feeling that we have a reason to believe that the inventory at customers is on a trend to improve. It's not perhaps improving as fast as we would have liked, mainly because customers have had LTAs. They are under a lot of pressure to minimize the gap to LTAs or reduce some of the gap versus what they had originally planned to take. So, -- and then, of course, the pricing is pretty attractive. So, they are also using the pricing to perhaps purchase more than they would have otherwise purchased given their inventory levels. So, that's stretching out some of the timeline of the normalization of inventory at customers. But we do think that by middle of calendar 2023, by that June-ish timeframe, we should have an environment where customer inventories are in much better shape than they are now and -- than they have been in the past few months and that's our base view. The team is reacting exactly as we would have expected from a supply discipline cutting utilizations, cutting WFE spend, holding back bit shipments on current output, and slowing the pace of technology migration, your industry assumption on supply and overall supply/demand normalization assumes that all of the major memory competitors act in a similar fashion, right? And talking with investors, there are concerns that one of your large competitors may or may not be acting in a disciplined fashion. Obviously, your visibility as to what your competitors are doing is somewhat limited. But you are monitoring aggregate excess inventories at customers across various end markets and the slope of the drawdown should be reflective of what you and your competitors are doing to a certain degree. So, based on the metrics that you monitor in real time in your end markets and with your large customers, are you seeing broad supply discipline by competitors? And any differences between the DRAM and NAND segments of the market? Yes, I would say that definitely, the NAND segment has more challenges in terms of supply/demand imbalance compared to DRAM and part of it is driven by -- there are more suppliers in NAND as well compared to DRAM. And then I think I can't speak to other competitors' plans, but definitely, there is no doubt that part of the reason that we have articulated in our earnings a couple of weeks ago that we expect a challenging 2023 calendar year is because -- even though, as Mark said, we do expect bit growth to happen is because of the supply/demand imbalance that we think needs to be improved. Micron has taken extremely decisive steps. As you have heard from us over the last months to reduce our investment in CapEx to curtail our bit growth, we think our DRAM bit growth is going to be negative on a year-over-year percent growth basis in calendar 2023 versus 2022. And we think that DRAM bit growth needs to shrink year-on-year in order to improve the industry environment and we continue to watch for signs of what's happening with the industry's supply/demand balance, continue work with our customers. But that's what we think is necessary to accelerate the improvement in the health of the industry and we have definitely taken decisive action to do our part. The team has cut wafer starts by 20% versus the beginning of last year. You mentioned your intention to continue to keep utilizations low potentially into fiscal 2024. From a financial impact perspective, underutilization charges forecasted to be $460 million in the second half of the fiscal year with more of that weighting towards Q3, more weighting towards Q4. By our estimate, that's like a 4% gross margin impact in Q3, 6%, 7% impact in fiscal Q4. And then I believe you mentioned you still have another $400 million or so of these charges that will be recognized in fiscal 2024. So, if you do maintain utilizations below your capacity potential beyond fiscal 2023, how do we think about utilization charges extending into not just fiscal 2024, but calendar year 2024? Yes. So, we've not provided any additional comments on the duration of the underutilization period. As we strive to deal with supply and demand imbalance, we'll continuously reassess that. As you said, our current plans addressing this fiscal year, we will have higher cost inventories that more than half of that will pass through the income statement in the third and fourth quarter. So, as mentioned, that will weigh on margins, as you said, in the back half. And then less than half of the higher cost inventories related to FY 2023 underutilization will pass through the first half of fiscal 2024. Now, if volumes are stronger than our current forecast, then more of those underutilization cost will be pulled into the back half of fiscal 2023. If volumes are less than we think, then more of those costs will be passed through to fiscal 2024. If we do -- if the supply/demand balance does not improve, and we have a more prolonged period of underutilization, then, of course, we'll have higher cost inventories, which then will affect FY 2024 and potentially as you mentioned, depending on how long that inventory has to clear, and it could -- it will just be a function of how long and then how long it takes that inventory to clear. Longer term, the team talked about a slowing of technology migration cadence in both DRAM and NAND, given lower assumptions around DRAM and NAND bit demand growth. And so the first question is, if you slow tech migration cadence, doesn't this slow your cost per bit profile and your ability to drive through cycle profitability improvements? And secondly, what are the demand assumptions that caused you to revise a long-term bit demand profiles lower because it doesn't really seem like assumptions pre-COVID-19 have changed all that much in terms of content growth and unit TAM growth in your various end markets? Yes. So, addressing the second part first. Yes, I mean the pre-COVID 2019 timeframe, now we are in 2023, so, a lot has changed in the world and part of what had transpired over the last few years was a view that the PC volumes are going to sustainably be higher than pre-COVID levels where those volumes ultimately settle remains to be seen. They'll be at some point, some kind of an upgrade cycle for all the PCs that we bought. But typically, those things are stretched out for several years in terms of upgrade cycle. So we'll see when that happens. But certainly, as I mentioned earlier, the PC volumes have come down, and we have lowered our views of PC volumes as well as smartphone volumes in the longer term view because the upgrade cycle in smartphones has continued to stretch every year, for the last few years, the upgrade cycle has continued to elongate and so have appropriately modeled that in our forward-looking views. And the cloud is substantially bigger than what it was back in 2019 in the pre-COVID days and so we have somewhat moderated longer term cloud growth rates based on that as well. So, those are some of the factors driving the lower long-term growth rate assumptions for both DRAM and NAND bits. With regard to cost reductions, yes, absolutely, when tech transitions move out in terms of longer guidance, cost reductions do become more shallow because of that. But we believe, number one, it's an industry-wide phenomenon. It's not a Micron-specific issue. And there is a strong linkage between cost reductions, time of technology transitions, CapEx investments, and pricing and margins, as you know very well. So, our view is that if cost reductions industry-wide become shallower, then pricing will consequently also become similarly impacted in the same way. So, if cost reductions are shallower, pricing declines will be shallower over time. And that in itself should not cause any changes to the margin expectations of the industry. Really, it's a matter of the supply/demand balance and the supply discipline in the industry at an industry level and that ought to be the primary determinant of longer term sustained margins. The team has had a very strong technology leadership position in both DRAM and NAND, right? First-to-market with 1-beta DRAM, first-to-market with 200-plus layer NAND. But in response to the supply/demand challenges that we just talked about, you are slowing the ramp of 1-beta. You are slowing the ramp of 232-layer NAND, and it's pushing out some of the future roadmaps. Bears [ph] would argue that competitors will use this down cycle as an opportunity to close the technology gap with Micron. So, how does the team retain its technology leadership given the near-term slowing of tech migrations? Do you start to focus on more product differentiation, system-level differentiation, higher value add, or -- what are the things that you're going to do to maintain this technology edge? Yes, great question. And I'll just point out that a couple of things. Number one, we have been very focused as a company on both tech -- process technology leadership as well as product portfolio leadership. So, you have seen a fairly substantial transformation in the Micron product portfolio over the last five years, even as we have gone through the technology innovation curve and taken a leadership position on the technology side. For example, we lead the industry in QLC penetration on NAND. We are the first to the market with 176-layerdata center SSDs and already have several qualifications completed, many more in process of being completed over the course of the next several months. And best number one share in the industry in DDR5, world's fastest graphics memory. I mean there's a lot of data points that we can go through that demonstrate our leadership on the product side, while we have taken technology leadership in both DRAM and NAND in the industry and lead the industry by several quarters and ramping volume in both of the leading-edge nodes in DRAM and NAND. So, that has been a consistent strategy that will continue. But in terms of this whole cadence, I again want to emphasize that a lot of that is driven by our expectations of demand bit growth. And every new node of technology creates a certain amount of increase in gigabits or gigabytes per wafer as the case maybe between DRAM and NAND. And if you use a model of a certain amount of demand bit growth in the industry, then it almost dictates for a given amount of bit growth per wafer in going from one techno to the other, that the cadence has to be aligned to the demand bit growth that you're trying to satisfy in order to keep demand and supply balance. So, that's why we strongly believe this is an industry-wide phenomena and our relaxation of slowing down on the cadence of technology needs to really be something that we believe ultimately will happen in the industry just because the laws of physics and math work the same way in every company. Before I jump into some of the product and end market segments, I just want to see if anybody has any questions. So, let's talk about the data center segment of your business. The team's view on cloud datacenter dynamics, as you mentioned in your opening remarks was probably one of the end markets where the memory demand dynamics changed pretty meaningfully relative to your prior views, right? It seems like the level of inventories of cloud and data center value chain is carrying was much higher versus your expectation. Obviously, cloud demand has moderated from the high growth rates in the past couple of years, but CapEx spend on -- by the cloud guys is still growing 6% to 8% forecasted for this year. You've got new server processor ramps. There's still strong spending on accelerated compute initiatives like AI and data analytics and these clusters like suck up a ton of memory. So, is more of the inventory issue your customers wanting to just maintain a leaner inventory profile or is it really more a change in their compute and memory infrastructure sort of deployment plans? I think there are a couple of factors that I'll just very briefly touch upon. One is that definitely from expectations of six months ago, the demand environment for data center customers has deteriorated for 2023, and that is partly reflected in our overall view of what will happen in this segment in 2023 calendar year. The other aspect is, yes, indeed, I mean, the inventory ending calendar 2022 or as the customers started planning for calendar 2023 has been substantially higher in DRAM and NAND than what was our view as well as what was broadly communicated by our customers to suppliers. That view changed quite a bit over the course of the last several months, both as a combination of what they were buying in 2022 as well as their view of demand. There is no doubt that there are a lot of good demand drivers in the data center that long-term will be very positive for demand for memory, both DRAM and NAND. These include, obviously, these DDR5 platforms that are certainly more expensive platforms to deploy. They'll take more dollars. Of course, there is increased content because these newer CPUs and GPUs have a lot more cores and bandwidth per core is an important driver of system-level performance and a lot of the workloads are memory bound rather than compute-bound alone. So, increasing a lot of capability on the CPU or GPU side without increasing the amount of memory that's connected is not going to be terribly beneficial to system-level performance. And so the underlying demand trends are really solid long-term. That's also the reason why CXL ultimately will connect to a lot more memory than what the DDR channels are able to connect to today, and it will increase system-level average memory per server quite substantially over time. And so all of those things are great positive. They will play out over time. CXL is in its super early stages will take time to deploy, but we are talking really about 2023 calendar year where we still have to go through the inventory adjustment and all the other factors I mentioned. So, once we get through that, looking ahead, 2024, 2025, 2026, et cetera, things should continue to improve from a demand trajectory perspective in the data center for sure. In terms of technology enablement, you guys have been -- I think there's a misconception in the market that EUV is new for Micron. I know the team has been working on EUV for many, many years. Now, in fact, you've had an EUV system in your Boise R&D Fab for quite some time. You're getting ready to launch EUV into your next gen 1-gamma technology that's targeted around 2025. There's always a learning curve with new technology adoption. So, has the EUV process, the module, the architecture have been fixed? Is the team still optimizing it? If you are still optimizing, what are the big challenges? Is it uptime, liability, throughput? Would be great to get an update from the team here. Sure. Yes. So, in terms of EUV, like you said, Harlan, we have had EUV in our R&D for many years and we have really great improving performance of those tools compared to prior generation tools that existed. So, that tool is performing well. We continue to make great progress and the capability of the EUV tools has substantially improved over the last couple of years compared to what it used to be. So, we feel really good about the timing of the introduction of EUV into our roadmap. We are super glad that we didn't rush to introduce this any sooner than we are because that would not have been a very cost-effective way to do so. And so of course, for something that's going to be introduced into volume manufacturing in 2025, we are just starting in 2023 now. So, there is a considerable amount of development still to come. But we continue to make progress with EUV as we have been needing to and wanting to. We have definitely areas focused on lithography, where we talk about look at engineering resources focused on patent fidelity, leading-edge features and the consistency of those leading-edge features when we ramp a particular product into volume. Those are all kinds of things that are very natural for this stage of the development of a new technology node and a lot of those issues have to continue to be worked on right up to the point we get to mature yields and mature levels of defectivity. So, that is an ongoing business as usual kind of thing we do. But yes, I mean, EUV continues to be on track to support that 2025 deployment. We're just about out of time, but I want to ask one last question, shifting to the cross cycle financial model that you guys laid out at your Analyst Day in May. From a profitability perspective, op margins, 30%; EBITDA margins, low 50%; free cash flow margins of greater than 10%. With the current memory downturn in full force and a revision of the longer term sort of bit demand profile for certain of your end markets, what is the confidence level by the team at achieving these cross-cycle targets? Well, we think that the updated market view of volume growth does not change our revenue outlook. As mentioned earlier, the slower volume growth does in part result in less price revision. So, that helps offset, so no change there. And then we do expect when supply/demand balance improves that through cycle, we can deliver the strong profitability and free cash flow that we've outlined in our model. Good. Look forward to monitoring the progress and execution of the team this year. Thanks, Sumit. Thanks, Mark. I appreciate your participation.
EarningCall_1534
Good morning, and welcome to the Opsens Incorporated First Quarter 2023 Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note that this event is being recorded. All right. Thank you very much and thank you all for joining us today for the Opsens first quarter fiscal year 2023 conference call for the period ending November 30, 2022. With us on the call representing the company today are Louis Laflamme, Opsens' President and Chief Executive Officer; and Brad Davis, Chief Commercial Officer. At the conclusion of today's prepared remarks, we will open the call for a question-and-answer session. Before we begin with prepared remarks just a couple of comments. Today's call will contain forward-looking statements that are based on current assumptions and subject to risks and uncertainties that could cause actual results to differ materially from those projected and the company undertakes no obligation to update these statements, except as required by law. Information about these risks and uncertainties are included in the company’s filings, as well as periodic filings with regulators in Canada and the United States, which you can find on SEDAR and Opsens' website. Today’s discussion will include adjusted financial measures, which are non-IFRS measures. These should be considered as a supplement to and not as a substitute for IFRS financial measures. Finally, today's event is being recorded and will be available for replay through both the webcast and conference call dial-in information provided in the press release. With that said, let me turn the call over to Louis Laflamme, President and Chief Executive Officer for Opsens. Louie, please proceed. Thank you, Robert, and good morning to all of you. We are excited to speak with you today following another strong quarter of growth across all of our business lines. Let me also take a minute to greet the French speaking audience. [Foreign Language] On a financial perspective, we are pleased with the strong growth we achieved across our entire operating platform this quarter with $10.2 million in sales, a new record for the company, which was up 26% compared to the year ago first quarter and up 12% sequentially. Beyond the quarterly financial performance, I could not be more pleased with where we are as a business and the opportunity for the future of our assets. On the structural heart side of the business, we are highly encouraged about our sensor guided TAVR initial commercialization business, SavvyWire is more than a wire. It is the world first and only sensor guided TAVR solution, it provides a three-in-one solution for stable aortic valve delivery and positioning, continuous accurate hemodynamic measurement during the procedure and reliable left ventricular pacing without the need for adjunct devices or venous access. I have asked Brad Davis, our Chief Commercial Officer to join us this quarter to share his thought on the success of the launch and why we believe this is truly a game changing product. For coronary artery disease, performance has been strong across nearly every geography besides Japan, which we will chat about in a moment. Our OptoWire is a pressure guidewire design for contemporary clinical practice, allowing navigation through complex anatomy, delivery of a stent without guidewire exchange. Choices among different [indiscernible] resting, and this is to assess coronary physiology and confirmation of treatment with easy and reliable post-PCI measurements. Geographically, U.S. OptoWire sales were up 38% compared to the year ago quarter, a new U.S. record quarter. Growing the U.S. has been a key focal point for us with OptoWire and of course, our new SavvyWire and will be a key theme as I think you will see through our operation in fiscal 2023. I will expand more on this in a moment. Importantly, the commercial synergy between OptoWire and SavvyWire has already been seen in Canada and U.S. We also expect to have positive effect in EMEA and Japan down the road. As we look longer term, our R&D activities are working on various complementary technologies through the OptoWire and SavvyWire that we believe will support further market penetration for our products. Within our business partnership divisions, we are becoming increasingly excited about our performance and perspectives. Our customers are growing and we are growing with them. Sales were up 42% to $3.4 million, a new record for this division. Based on our conversation with our current customers we think this elevated level of sales can be sustainable going forward. In addition, we have a large pool of existing customers and pipeline that will generate further growth. Our second generation fiber optic sensing technology is high demand due to its accuracy, small size, and reliability. Our Industrial business exceeded our short term expectations. Similar to past discussion on Industrial, we remain cautious on future quarters as most of the current Industrial revenues are nonrecurring. Meanwhile, we continue to see this business unit revolution and doing a revolution in the world of fuel monitoring for aeronautics, which may provide that recurring revenue component. But clearly, the most exciting growth opportunity we have as a company is SavvyWire, our new innovative guidewire for TAVR within the structural heart market. As we've discussed during our year end call, we are ahead of our original expectations for the commercialization strategy originally outlined. We started with a limited market release in Canada and U.S. and have recently moved to a bit more of an [expanded] (ph), but still controlled market release. We are taking a similar strategy that many other companies have successfully taken with recently [created] (ph) device by moving very systematically in the early commercialization process to ensure complete success by the physicians. Brad Davis leads our global commercial team and has a strong track record of launching new medical device products into the market that have ultimately achieved market share leadership. We believe our playbook is sound and based on the initial positive feedback from physician, we have an absolute winner on our end with SavvyWire. Thank you, Louis, and good morning, everyone. I'm excited to expand upon Louis' comments regarding the SavvyWire launch and share some early insights. As you know, we achieved both regulatory approval from Health Canada and clearance from the FDA ahead of our guidance. Prior to our early regulatory success, we had developed a robust commercialization plan to ensure long term commercial success. The key aspect of the plan was to double the size of the U.S. sales organization to capitalize on the large market opportunity, which we have now done. We also completed the limited market releases in both Canada and the U.S. ahead of schedule which are now being followed by controlled market releases in each country and we will then progress to full market release in the second half of fiscal 2023. The speed at which we completed the limited market releases is one thing, yet the excitement from the physician community has been another. Importantly, customer feedback from the limited market release has validated that SavvyWire has demonstrated excellent performance over their current TAVR guidewire, while reducing the number of device exchanges and improving procedural workflows. We have refined our account launch process for the controlled market release, including device and procedure training, monitor installation and procedure rooms, software upgrades and coordination with administration to ultimately achieve maximum penetration in each account. So what does the controlled market release really mean? We will work with an account to schedule 10 to 20 cases over a one month span, we in service and train both physicians and staff ahead of their first SavvyWire cases, then partner with them during dedicated TAVR days where we are in the procedure room for cases to reinforce best practices. We gain valuable lab access from these dedicated TAVR days at each account which allows us to reinforce the benefits and also roll through educating the various teams of technicians and nurses that are supporting the cases. Our goal is to get the hospital TAVR team fully functional and independent to conduct the cases successfully themselves. This allows our field team to then partner with their next target customer to repeat the same in-depth launch process to ensure a clinical and commercial success at each account. As you know, getting new products approved in the current healthcare environment with the value analysis committees at hospitals can be lengthy and challenging. Based on our value proposition of creating sensor guided TAVR category with SavvyWire being more than a wire, we have been successful in driving premium pricing by demonstrating the value to the overall TAVR procedure. We are confident we will continue to achieve price premiums over standard TAVR guidewires that do not provide rapid pacing or efficient standardized invasive hemodynamics. Our strategy is to also go deep at each account and become their primary provider of TAVR guidewires. Another key enabler to our go deep strategy is that our same OptoMonitor now supports both OptoWire and SavvyWire cases. This allows us to leverage the efficiency of our field footprint and capital deployment to improve the decision making process for installation and adoption, which is exactly in line with the strategy that's been shared over the years. This supports our long term commercialization vision to sell multiple products to the same customer group and it's part of the reason we have made investments recently into our sales and marketing efforts. At the end of the quarter, we also successfully completed the first TAVR procedures using SavvyWire in New Zealand, which represents the third commercial market for Savvy after the U.S. and Canada, which are covered by our direct sales force. We consider entry into New Zealand to be of strategic importance as this territory provides the optimal combination of condition they will help us validate our commercial distribution model, which we will look to replicate in EMEA and parts of Asia, while also providing an initial entry into the rapidly growing Pacific region. Clinically, we continue to make good progress with our European SAFE-TAVI study focused on SavvyWire for left ventricular pacing and TAVR procedures. This study is important because it supports our pre CE Mark clinical strategy that will lead to the commercialization of SavvyWire in Europe. It will also build on our medical evidence for reliable, rapid pacing, which is necessary to decrease pressures and stabilize the heart during most TAVR procedures. The SAFE-TAVI study will enroll 118 patients at up to eight hospitals in Spain and Canada. And to date, we have enrolled 32 patients in four hospitals. We're also planning to conduct various post market studies in North America to further advance the medical evidence supporting SavvyWire benefits. In summary, we are very pleased with overall SavvyWire performance and are out of the gate extremely strong and ahead of expectations. We are approaching 500 total SavvyWire cases across four countries and we have launched in over 20 hospitals in North America. I would like to thank our talented global commercial team for their passion, commitment and launch execution for this game changing technology. Thank you, Brad, for that overview. Clearly, one of the biggest questions we all have is, how quick the ramp up will be? Based on the feedback of physician and the broader medical opportunity we think this will be a big opportunity for us, but we need to make sure we don't have any initial operational hiccups that prevent the widespread adoption we are expecting. It is the reason why we are in a controlled market release and being so involved with each of the accounts in the early stages. We are following the playbook of many other medical device companies, moving systematically from a limited market release to a controlled release and then to a full market release. At this point, we are projecting to enter full market release mode in the second half of fiscal year 2023. This most recent quarter with just over a marked of U.S. limited market release and our Canadian controlled market release, we had sales of about $400,000 which was ahead of our internal expectations. Going forward, we are expecting to see continuous growth each quarter as we look to expand adoption, but also make sure that we are achieving complete success along the way. Again, our goal is to avoid any major unforeseen hiccups in the rollout. Once we enter full market release, we certainly expect sales to ramp rather significantly. So on the one hand, we are purposely throttling growth in fiscal year 2023. On the other hand, we are making sure we have complete success in the marketplace from physicians that will lead to SavvyWire becoming the gold standard guidewire option for patients undergoing TAVR procedures. We think this is the best strategy for long term commercial success. Transitioning, let me circle back on our OptoWire solution. As mentioned, we had a very strong quarter in the U.S. with sales up 38% as we continue to add a strategic focus to increase sales in the country through both direct sales and group purchasing agreements. Further, the coupling of SavvyWire with OptoWire in the future will lead to continued growth as well. In EMEA, sales were up 13% year-over-year and up 15% sequentially as we continue to see our distribution partners in the region highlight the benefit of OptoWire. You may recall that we made a concerted effort about a year ago to retrain our partners, which have certainly paid us. In Canada, we were basically flat sequentially and down 6% compared to the year ago first quarter. We continue to benefit from a multiyear contract we received where we were selected as the main coronary pressure guidewire for the eastern part of the province of Quebec, which has now been in place for over a year. The weak spot for OptoWire is clearly Japan, where sales were down 31% compared to the first quarter of 2022 due to increased inventory level with the distributor following a large shipment in the third quarter of fiscal 2022, coupled with slower demand than expected. As a whole, excluding Japan, OptoWire sales were up 15% year over year, which we feel good about. But clearly, we need to improve our performance in Japan. As I started off with in our partnership segment, we had record performance during the quarter with sales up $3.4 million compared to $2.4 million in the year ago quarter, driven mostly by a step up in our deliveries to Abiomed to supply sensors into their Impella heart pump. With the recent announced acquisition of Abiomed by Johnson & Johnson, an expectation for growth in this area, we believe this will hopefully be a new sustained level going forward. For those not familiar, recall that we have a multiyear relationship to supply sensors into Abiomed Impella heart pump including a four year extension of the recent signing of a critical supply agreement that runs through April 2028. All told, we are very pleased with our start to fiscal 2023. Before I turn it over to your question, let me hit on a few other key items. First, as you all aware, with Robin Villeneuve [indiscernible] in mid-December, we are continuing with our comprehensive search for a new CFO. A mandate has been given to an executive search firm to ensure recruitment of a new CFO that will support Opsens future growth. In the interim, we have a strong finance team in place that has afforded us stability in our internal controls and reporting structure. We hope to be able to make an announcement in the coming months. Since the CFO normally would get on a few of the pertinent items on the income statement and balance sheet, let me fill in this quarter and touch on a few areas. As I mentioned, the first quarter was highlighted by record revenue of $10.2 million, an increase of 26% compared to the year ago quarter. Growth from our Optical Medical Products segment coupled with the addition of TAVR sales were key drivers. As we look to the second quarter, we continue to make strong progress in a number of our key geographies. We look forward to building on the trend of this most recent quarter with second quarter growth expecting to be up more than 20% compared to the year ago quarter. On gross margin, first, the gross margin was 57.6%, an increase of 670 basis points compared to 50.9% during the prior year period. The increase was driven by more direct sales compared to distribution sales, better product mix and strong industrial business. On a midterm basis, as we see more sales coming from areas where we sell direct, such as the U.S. and Canada and as we see growth in SavvyWire, we expect to see gross margin continue to rise. We are also benefiting from critical mass in the factory, which is driving operational improvements. That said, we are making certain investments in our manufacturing facilities going forward to improve the manufacturability of our devices going forward and to meet higher demand from our customers. From an operating expenses standpoint, overall our operating expenses were $9.7 million compared to $6 million in the first quarter of 2022. Breaking this down, sales and marketing was $4.6 million versus $2.1 million, R&D was $2.5 million versus $1.8 million and G&A was $2.6 million versus $2.1 million. So the $3.7 million increase was primarily due to an increased sales and marketing activity, including an increase in our direct U.S. sales force in advance of the launch of SavvyWire, an increase in nonrecurring administrative expenses coupled with an increase in R&D due to structural heart and coronary artery disease projects. Looking forward, we think that sales and marketing will be pretty similar to the most recent quarter and likely increase slightly due to the increased commission expenses on sales growth as we make continued investment to capitalize on the opportunities to accelerate growth of our OptoWire and SavvyWire. For administrative expenses it should be lower in the remaining quarters of fiscal year 2023. For R&D, it will be similar for the remaining quarters of fiscal year 2023, we will continue to be a company that is innovating. One key opportunity we see as a possible next stage of growth, will be generating value added information and data using artificial intelligence in future products and technologies. We are investing in products that will likely be coming to market in the next 24 months. I hope to be able to share more with you in the future on this topic. Additionally, Opsens has been invited by key physician and leading life science company to participate in clinical studies to access the SavvyWire for actionable TAVR procedures. We believe these studies could open new market opportunities for the company. On the balance sheet, we ended the quarter with $17.5 million in cash, subsequent to the end of the quarter we raised $11.5 million growth and above deal financing. Based on our outlook and guidance it is our belief that we have sufficient capital to reach breakeven unless we are presented with new opportunities for growth. So to wrap things up, we are extremely pleased with the progress made during the first quarter on nearly all fronts. First half revenues were a new quarterly record. We had strong operational performance with record OptoWire sales in our key U.S. market. We are seeing a step up in our optical medical product division, which we believe will be sustainable in the future. We achieve or surpass every operational metric we had in the approval and early commercialization plans for SavvyWire with very strong end market response. Our gross margin increased by 670 basis points as we are capturing synergy in our operation and the benefits of the investments we are making in sales and marketing. We commence our SAFE-TAVI on the SavvyWire in Europe, which is part of our pre CE Mark clinical strategy. In New Zealand, we successfully completed the first TAVR procedure using the SavvyWire, presenting a third commercial market and the first one being covered by [indiscernible]. We completed $11.5 million bought-deal, which should bring us to breakeven and our outlook for the Q2 2023 shows growth across various operating areas. As always, I want to thank all our employees for their hard work and dedication. We have accomplished important milestone and developments with many more opportunities ahead. We will now begin the question. [Operator Instructions] Thank you. Our next question comes from Rahul Sarugaser from Raymond James. Rahul, please go ahead. And congratulations on the strong revenue this quarter. So speaking of that, clearly you have a lot of initiatives and a very strong commercial push, particularly in Brad's comments. And so, many investors, of course, will be looking for the revenue trajectory. We are, of course, want to be able to predict this. And other than the revenue trajectory over the next few quarters, what are the catalyst particularly data, particularly any conferences that could be looked to sort of get the leading indicators off the adoption? Well, in terms of leading indicators, I would say, us internally we are looking at a number of accounts, reorder from accounts. Also as a catalyst down the road in 2023, we do expect to obtain CE Mark approval on SavvyWire, which would lead to a national path of growth. Down the road, we may share a little bit more about those information. But right now, it's still so early that we feel it's probably better to retain on that. But clearly, when we think about the SavvyWire initial commercialization phase, we are glad about the number of accounts that we had -- we have right now, more than 20 accounts in North America. We are also really glad about the feedback that we are getting from our customer. That is somehow validating the value proposition for this product. So in summary, to your question, because I talk mostly about [indiscernible] my answer. You can think about also -- I mean, in the business partnership division for our OEM customers, you can expect to as a catalyst or as an indicator of growth just the number of procedure fully recovering from COVID, this should help. And for the coronary artery disease business, we have -- the management is looking exclusively at the market share that we have in U.S. Because as Brad mentioned in the call, we see great opportunity for us to combine, to bundle SavvyWire and OptoWire to really increase the market share of both Savvy and Opto in direct markets. Terrific. Thank you for that, and we'll certainly be watching for all of that closely. So maybe looking a little bit further ahead, you had indicated, of course, that there continues to be further product development. There had been some discussion about potentially expanding SavvyWire use into other indications within valve replacement, what sort of modifications to the current SavvyWire would be required? And what's the timeline would be looking at expanding its potential applications? I mean, we -- it's a really good question. And for us, it's an opportunity because SavvyWire has been built for the aortic valve replacement procedure. Some doctors are seeing and it has been mentioned in conference are seeing the opportunity to use the Savvy in other type of procedure, and [indiscernible] valve procedure may be an example of that. We -- the team right now is gathering additional data to better understand multiplication that could be required on the product to have an optimal product for different application. This being said, we think in general those application would be minor. And in that context, we could bring something in the market in fiscal year 2024 or 2025. On top of that, I would say, part of the R&D is dedicated to single use device, like OptoWire, SavvyWire and sensors. There is also a good amount of energy that is invested into taking the data that we are producing and transforming this into more meaningful information for physicians and customers and doctors. And we think there is also another path of growth for Opsens in that area. Perfect. Thank you. And then just one last quick question. Given the relatively rapid growth in the OEM business, and now with Abiomed’a acquisition by Johnson & Johnson, are you getting any sense from -- as Johnson & Johnson doubles down in this space, whether there should be potentially higher demand for your optical sensors for the Impella and/or other applications within Johnson & Johnson's portfolio? Yes. So what I can say and it has been publicly mentioned by Johnson & Johnson is that, clearly, they made the acquisition of Abiomed, because they are seeing additional potential for growth. So as we mentioned and this is applicable for Abiomed or any of our customers in the OEM business, we are growing with them. And we feel that providing them the best optical pressure sensing technology in the world and medical application is giving them an advantage that is helping them to grow faster. So that we are pleased with the result that we got in Q1, 2023 and we are confident that we can either maintain or continue to grow that figure in the next quarters. Perfect. Well, thank you again for taking our questions. Congratulations on the quarter again and I'll get back in the queue. Thank you. Good morning, Louis. My question just has to do with -- we've now had 400 or 500 procedures done with the SavvyWire. And I'm just curious as to the observations that the doctors or surgeons may be providing you with or are there any positive observations or any issues or tweaking that you need to do as you complete the rollout and you go into the full component of what you expect to do in the second half of fiscal '23? Yes, that's a good question. I would say on the positive side, it's clearly around the fact that when they use SavvyWire they can eliminate different steps. As example, they don't need to do another insertion, to use another device for right ventricular pacing. And this is positive in their procedure because, obviously, with that they have the potential to save time. Also some doctors depending on their practice, I mean -- and the type of valve they are using having the real time a more dynamic information is really important, is helping them to be really efficient in their workflow and again eliminate some unnecessary steps. And for the rapid pacing, that's also an area where doctors were, again, in the workflows some could react [indiscernible] different things that can happen in the procedure. So overall, I mean, the value proposition of having a wire that is performing, that is providing good meaningful pressure information and yet that can be rapid pacing. This has been positively validated by our customers. Where we felt there was some adjustment or improvement that we could do and those are normal. There were different minor things that could be adjusted on the software side, so adding doctors using the software, the display they identified opportunities for this product to be even more useful for them. And we have been doing some release of new version of the software. And we are also seeing some additional improvement coming down the road. Yes. Excellent. And then when you think about bottlenecks for the rollout, would you say that the device and procedure training that are required as part of the process and given the limited number of people that you have on board that can help with that, will that be the bottleneck or do you see the bottleneck in terms of rollout somewhere else? No, I think we discussed even during the last call where product depending of the market. And if we take the example of the U.S. market, it's not a market today where less ventricular pacing provided by SavvyWire is frequently used. A good number of doctors are using a right ventricular phasing. So on that area there is some kind of transition education that can be done in collaboration with our customers. So that's an area where we are spending time. We -- I mean, we have the team in place to be capable to do that in a really efficient way with the doctors. But still, we have to be -- to take some care of that there. So I think that's an example. So I would say at high level training and properly convey the information and the way to use our product to customers is key. Also learning, again, about using the software is another element that is important. So to say that those are bottleneck, I would say, bottleneck maybe a strong word, because it's part of our job, it's part of our knowledge. The team build by Brad is well able to do that, but that's an area that is important. And the good thing behind this answer is that, if I take the example of the OptoWire initial phase, manufacturing was a challenge. The ramp up, I mean, the company was younger, the team was younger, the experience and ramping up production was not as present as what we have to be. Because on the production side right now the team is doing an excellent job, we already have safety stock and so on. So we can operate normally and following the speed that the commercial team is selecting to act. On the strong gross margins in the quarter, 58%, that was much higher than what we were expecting at around 51%. I know there was comments on the product mix, but was there anything unusual or one time in nature for that strength? And what's a good gross margin number to use going forward? I mean, first, we were also glad of the gross margin that we got during the quarter. I mean, moving from, as you know, in Q4 2022, we had 48%. So to get 58% is a good improvement in just one quarter. And the drivers behind this, you have the fact where the percentage of direct sales in Canada and U.S. has been more important in the quarter and this is not a surprise because, obviously, we are selling the SavvyWire right now only in direct market, except really minor sales in New Zealand. On top of that, I mean, adding more critical mass higher revenues is also helping us to get good gross margin. So we are confident that even when we look at mid-term targets, we will even do better than this 58%. To say that 58% will be repeated in Q2, maybe, let's say, positive at this time. We are expecting to do slightly less in Q2. But to your question, was there anything non-recurring? Well, you have the line other in the financial statement, so $300,000 that were kind of revenues more related to development milestone with some of our customers. So those may be really high margin revenues that would not be repeated, but somehow this will not materially affect our performance. So if I would summarize my answer is that, I mean, gross margin is trending in the direction we want. We are really pleased with Q1, but there is still in our mind opportunity to do better than that. Understood. Thank you for the thorough answer. And then within the press release, there was mention of the SavvyWire launch having, obviously, good feedback, but also commentary on premium pricing. So is the pricing you're receiving or anticipated to receive better than what you were expecting? And is that the same in all the markets where the SavvyWire is being launched? Okay. Well, right now, we are getting premium pricing on the SavvyWire in all of the markets where we are. So we are pleased about that. It's above our initial expectation. Even if we knew that the value proposition of this product was really strong. So I would say we are pleased with that. The second part of your question was, I was going to say something -- Can you repeat? I think I missed one component of your question. Well, if the pricing has been better than expected, which it sounds like it is and then if there's any differences in the markets you serve, for example, the U.S. versus Canada? Sure. I mean, the economics of TAVR in Canada or U.S. or Europe or Asia is different. So we don't expect to get necessarily the same pricing for our product in all of the geographies. And clearly, I mean, in U.S. the TAVR procedure is growing rapidly. The market is large. For hospitals, they are facing some shortage in personal. So all of those factors are pushing them to have product that can make them saving time or being more efficient. And that's where SavvyWire is falling. So we think the U.S. market is probably the area where we can secure the best average sales price. Thank you. And then just a clarification question. I believe you mentioned the SavvyWire being in 20 accounts, which I interpreted as cath labs. If that's correct, and I think that compares to 10 accounts, if I'm correct, last quarter. Yeah. I mean, we -- the number of accounts is a driver. We are glad about the number of accounts we have today. We expect to continue to grow. But again, we want to be -- we are still in the early phase of commercialization and we want to be sure to make things properly in terms of training and knowledge transfer to our customers. Good morning, gentlemen, and again congrats on the quarter. On the TAVR revenues, you mentioned in the release, I think about $400,000 in sales, which in the first quarter after approval is pretty nice. I was just wondering if you had any comments around how much of this is kind of initial inventory build from some of the new accounts versus kind of ongoing usage? Could this be a bit of an early bump as those early sites are getting their initial SavvyWire orders in kind of as we look to the next kind of quarter or two? Yes. Well, I would say that our -- the information that we have is that the inventory is really, really low in our customers, because we've been attending to a good number of those cases. So I would say that the revenues that you are seeing right now are reflecting the usage of our product. That's great. And on your own balance sheet, I noticed there's a pretty big kind of increase in inventory as well kind of quarter over quarter. I imagine that's building up that inventory for TAVR and -- or for Savvy and OptoWire. Is that kind of done for 2023? Do you expect kind of another relatively large increase in inventory over the year? Or are you kind of now set for the rest of that commercial launch? Yes. Well, I think most of the investment is done right now. We do still expect to continue to grow inventories for both SavvyWire and OptoWire. And this is an investment that is made in the context where, as Brad mentioned, we are anticipating to see growth with those two products. So we -- I’m really comfortable with the investment we are doing in inventory and we feel that we have the funnel, the pipeline of accounts from customers to justify this. But most of the investment has been done, I would say, in the last few months, while we were preparing for this commercialization of the SavvyWire. Yes, that definitely makes sense. And as you look to kind of that full market release in the second half of the fiscal year, do you have a kind of target goal for the number of centers that you want to hit? As you mentioned before, about 20 in North America right now -- goal and the number you want to hit before you transition into that full market release? No, there is no specific goal that will trigger that we will move them to a full market release. I would say it's more about having the full understanding of users of SavvyWire by customer to make sure that we can be really efficient and powerful when we convey this technology at large in markets. So it's not driven by number of accounts. It's more about the moment where we will feel that we have seen everything. Got it. And just lastly from me, in terms of procedure volumes, either for OptoWire or SavvyWire, are you seeing kind of any ongoing issues from staffing or kind of COVID or any of that or have things kind of gotten back to relative normal? I would say from -- in general there is various market research that went out on this. The market right now is coming close to what we could consider normal in term of procedure. But I would say there is still substantial challenges for [indiscernible] having the staff available to execute this. So I would say they get this done, but it's not easy. And we see this as an opportunity where both SavvyWire and OptoWire are really efficient product to be used in procedures. Hi, Louis. How are you? I just had a quick question pertaining to the Industrial segment. Moving forward, do you see [Avionics] (ph) being a binary outcome? Or do you have some better sort of line of sight for us to benchmark? It's difficult to give really specific figure and timeline on the aeronautic application. Now what I would say there and we had various discussion with customers, with potential partners. And clearly, let's say, if we take the example of the application for measuring fuel, this is going to move to fiber optic. And we have the most, what we think, the most efficient technology to achieve that in those type of applications. So we see this as an application that can drive good value for shoulders. We are careful with time. We've been working on this since many years, so it's not like if we are starting. The good thing is that, we can achieve this substantial development activities within a context where the Opsens solution business, so the industrial business that we have is operating in a profitable manner. So we feel from a strategic standpoint for Opsens, it's making a great sense where this -- the same optical technology is being used in medical and industrial. We are applying and helping our customers to be either efficient or to optimize their operation in the Industrial business with various sales and various application. And on top of that, we have a project that can a real value driver for us. Awesome. Thanks. And just another question related to something you mentioned on the call. You're saying the data insights and machine learning, where do you see that moving forward? Do you hire many new people, a few new people, do you have those people on board? Sort of what's -- what do you think about that? Yeah. The team is already in place. They have been working on various interesting execution from a customer sales standpoint. They also have worked on some application of artificial intelligence that can have an impact on our production. So we see benefit of this knowledge this team has having an impact for us on both on the revenue side and on the cost side down the road. Perfect. And I guess, lastly, just Japan. What sort of is your game plan fully moving forward? Are you going to increase sales teams there? Are you going to slowly exit? Is it loss of customer to attrition just over time? How is that sort of unfolding? Yes, the high level plan for Japan, I mean, on one side we are working in collaboration with our partner, our distributor for the OptoWire in Japan. On the other side, we will find also another partner for SavvyWire. And such partner may also be able to provide additional coverage for OptoWire. So let's say on a short term basis, what we can -- what we would like to deliver to the market somewhere in the calendar year 2023 is a really strong partner for SavvyWire. And this should potentially help us in the other areas. And this concludes our question-and answer-session. I would like to turn the conference back over to management for closing remarks. Thanks. Okay. Well, many thanks to everyone for participating on today's call. We look forward to hopefully speaking with all of you again shortly.
EarningCall_1535
Good afternoon, and welcome to Zedge's Earnings Conference Call for the First Fiscal 2023 Quarterly Results. During management's prepared remarks, all participants will be in a listen-only mode. [Operator Instructions] After today's presentation by Zedge's management, there will be an opportunity to ask questions. [Operator Instructions] Thank you, operator. In today's presentation, Jonathan Reich, Zedge's Chief Executive Officer; and Yi Tsai, Zedge's Chief Financial Officer, will discuss Zedge's financial and operational results for its first fiscal quarter 2023 ended October 31, 2022. Any forward-looking statements made during this conference call during the prepared remarks or in the question-and-answer session, whether general or specific in nature, are subject to risks and uncertainties that may cause actual results in the future to differ materially from those discussed on today's call. These risks and uncertainties include, but are not limited to, specific risks and uncertainties disclosed in the reports that Zedge periodically files with the SEC. Zedge assumes no obligation to update any forward-looking statements or to update the factors that may cause actual results to differ materially from those that they forecast. Please note that our earnings release is available on the Investor Relations page of the Zedge website. The earnings release has also been filed on Form 8-K with the SEC. Good afternoon. Thank you, Brian. And thank you all for joining us today. I’m going to start by briefly reviewing our first quarter results, which were generally in line with our expectations, as Q1 has historically been seasonally weaker ahead of the holidays. Q1 revenue increased 15% from last year. The most significant driver is attributable to the addition of GuruShots. However, the combination of global economic uncertainty, geo-political risk, inflation and rising interest rates resulted in lighter advertising spend when compared to years past. Aside from that, there was also an anomaly in our Q1, as some advertisers tried optimizing their user acquisition campaigns by testing new usage attributes, ultimately resulting in lower ad spend in the Zedge App. The good news is that spending trends improved at the end of the quarter but were too late to offset the earlier declines. As discussed previously, we are reinvesting our profits into GuruShots and other new growth initiatives while still aiming to remain profitable and cash flow positive. Specific to GuruShots, we have been diversifying paid user acquisition by adding new platforms to the mix and optimizing performance across each platform. The expansion to new platforms relates to the challenges associated with Apple making it more difficult for app developers to gain detailed information about their user attributes and harder to track performance for marketing and advertising purposes. On a consolidated basis we reported operating, GAAP net, and per share losses in Q1. For those new to Zedge, I’d like to start with a brief discussion of our business and strategy. Zedge sits at the intersection of two major growth trends in consumer tech, casual gaming and the creator economy. To capitalize on this, Zedge is building a strategic flywheel that leverages synergies across our portfolio; and engages communities through our content marketplace that provides value across a multitude of online and mobile platforms, including social networks, messaging, and gaming. This approach connects creators with friendly competition, community and commerce. Our leading products are the GuruShots photography game and Zedge’s digital content marketplace, which today offers mobile phone wallpapers, video wallpapers, ringtones, and notification sounds through a freemium model, subscriptions and in-app purchases. In total, our products served roughly 40 million users in October. Today, most smartphone users have become amateur content creators, sharing their photos, illustrations, memes, and videos. Technology like DALL-E spurs people’s creative needs and now enables consumers to simply type a description of something that they envision and create an excellent image rendition. This bespoke content allows people to express themselves and gain social validation. In addition, they value friendly competition and garner popularity and recognition from their online community. Many of these creators are talented enough to attract a significant following and monetize their content. This is known as the “creator economy,” a market that has grown massively over the last five years. Before acquiring GuruShots, our core offering was the Zedge marketplace which served 32 million monthly active users in October 2022. We monetize these customers with advertising, subscriptions, and in-app purchases of Zedge tokens, our virtual currency. Despite being a more mature product, we still see significant opportunities to drive long-term growth and profits. One potential growth opportunity lies in allowing artists to sell their content directly to our 32 million users. To this end, about a year-ago, we introduced ‘NFTs Made Easy’, which provides non-crypto experts with an easy-to-use, eco-friendly platform to tokenize and sell their art to our customers for Zedge tokens. This enhancement has helped drive higher gross transaction value, or GTV, while also contributing to higher ARPMAU. Although the industry is grappling with the effects of a ‘crypto-winter,’ we still believe there is a fundamental need for the benefits of limited edition digital goods this technology innovation brings to the table. We will continue to proceed cautiously as to how we execute in this domain. Bottom line, ‘NFTs Made Easy’ is built for the mainstream and provides for provenance, which is a win for both creators and consumers. In the coming quarters, we see several opportunities to grow GTV. These include adding new content verticals and expanding ‘NFTs Made Easy’ by offering auctions, payments in cryptocurrency and trading directly within the Zedge app. In addition, and as announced on Monday, we just started realizing one of the synergies we identified when we acquired GuruShots, mainly the ability for GuruShots players to sell their photographs in the Zedge App. We also believe we can drive MAU growth in the Zedge App. Marketing is crucial, and I will discuss our plans in more detail in a few minutes. Making it easy to find and create new, relevant content is another way to drive user growth. Earlier this month, we introduced pAInt, an AI image generator in the Zedge App. Users can now make exceptionally high-quality images simply by typing descriptive phrases and the AI algorithm generates art based on those phrases. We believe this feature has significant potential to drive user growth, ARPMAU, and overall engagement in the Zedge app. We are encouraged by the early interest, as over the first weeks following its release, users generated over 150,000 images with pAInt. Initially, we limited the rollout to a subset of developed countries, but we anticipate opening it up further over time. Our goal is to use pAInt to both grow our user base and improve engagement. Moving to GuruShots, a category killer that fuses photography with gaming, enabling amateur photographers essentially anyone with a smartphone to compete in a wide variety of contests across iOS, Android, and the web, that showcases their photos. The game mechanics include progressively more difficult competitions, with successful players mastering their skills and then continuing to the next level until ultimately earning the coveted 'Guru' title. Players can compete individually or join together as a team. The game includes community features, leaderboards, and chat functionality, which create a sense of belonging, inspiration, and competition. The penetration rates leave much room for growth, as we estimate 30 to 40 million photo enthusiasts regularly use their smartphones to take and publicly share high-quality photos and who would be interested in participating in photo contests every month. From a product perspective, we have several promising developments that are being scaled up. The first relates to customer onboarding. Over the past several months, we revamped the onboarding process to better convert new players into paying players. As a result, our new onboarding ramp yielded a more than 35% rise in converting installs to first-time paying players in the Android app, which is a key gauge of measuring return on ad spend, or ‘ROAS.’ Next, we recently introduced ’Learn,‘ which offers users TikTok-style, short-form instructional videos to improve their photographic technique. When surveying our users, nearly 70% said they would engage with this content regularly. We are evaluating the different ways we can monetize ‘Learn,’ including introducing a subscription-based offering. Finally, we're still testing 'Battles,' which offers a quick way for newbies to start competing in simplified photo competitions that are short, limited in size, and built on a coin-based economy. We expect that ’Battles‘ will allow us to convert more users into players early on, increase engagement, advance our game economy and ultimately drive more revenue. Turning to Emojipedia, we now support 19 different languages. Going forward, we will focus on optimizing the ad stack and expanding the product offering, potentially with a native mobile app version. We are very excited about the changes we’ve made over the past year and believe they can drive high double-digit, low triple-digit growth rates, with very high gross margins, in fiscal 2023. Looking across all our properties, we have committed meaningful dollars to marketing, a new focus for our company, to drive user and player growth and improve engagement. We are investing in paid user acquisition and customer re-engagement campaigns and building all the infrastructure needed to do this profitably. The additions to our data team are already bearing fruit, not only with respect to marketing but across the entire organization. Finally, we are down the road in evaluating the viability of new content products in addition to the ones we’ve discussed today. pAInt was an example of this. Stay tuned for more information on this in the coming quarters. Before handing it off to Yi, I would like to thank our investors, Board members, partners, and employees for your continued support. 2022 has been a momentous year with a marked increase in geo-political, economic and industry-specific risk. However, it has also opened our business to new and exciting opportunities. We are and will continue doing our best to build long-term, sustainable value and effectively address the challenges that we are facing. I wish each of you a peaceful, healthy, and safe holiday season. Moving to our first quarter results. MAU, defined as the number of unique users that opened our Zedge app during the last 30 days of the period, decreased 7% to 32 million. MAU in well-developed markets was down 16% and emerging markets nearly 4%. Europe, which contributes to both metrics, was hit especially hard by the Russian invasion of Ukraine and the energy crisis, which continued to play a significant role in this quarter’s MAU decline. Total revenue in the first quarter was $6.9 million, a 14.5% increase from last year. The temporary decline in ad buying that Jonathan discussed, combined with lower MAU led to a decrease in year-over-year advertising revenue for the first time since Q1 2021. Gaming revenue came in at $1.3 million. Similar to Q4 of fiscal 2022, GuruShots’ revenue was negatively impacted by the situation in Europe. Since this business is still in its investment mode, we believe that the new features, marketing and advertising strategies will ultimately drive solid growth in our gaming revenue. Subscription revenue was down 7%; however we are working on improving the value of the offering in order to return to growth in the quarters to come. Other revenue, which mainly consists of Emojipedia, Zedge Premium and the amortization of AppLovin’s integration bonus, increased by 45%. Zedge Premium's GTV decreased 5% to $310,000, reflecting lower volume and ASPs for NFTs. Again, while we are impacted by the crypto winter, we believe our strategy somewhat insulates us from the broader NFT market challenges, while also providing us with a differentiated offering that we believe will return to growth. Active subscriptions were down 12% versus last year, as new subscription sales did not offset churn. Despite the decreases in other metrics, ARPMAU was $0.54 an increase of 1% year-over-year. Operating expense increased significantly related to the both the investment in GuruShots and a $150,000 decrease in the fair value of contingent consideration related to its acquisition, leading to an operating loss of $201,000. Net loss was $169,000 and reported diluted loss per share was $0.01, share count was 14.3 million. Adjusted EBITDA was $1 million for Q1 2023, versus $3.3 million in the prior year period, and our adjusted EBITDA margin was 14% in Q1 2023 versus 55% a year-ago period. From a liquidity standpoint, we remain in a strong net cash position with over $18 million in cash and cash equivalents. As we mentioned on our last call, we gained access to an $11 million credit line and had to draw down a $2 million term loan, which showed up on our balance sheet this quarter. Moving to our stock repurchase program, between September 23, 2022, when we started buyback activity, and December 9, 2022, we repurchased 261,000 shares of our Class B common stock. Thank you for listening to our first quarter earnings call, and I look forward to speaking with you again on the next call. Thank you. We will now begin the question-and-answer session. [Operator Instructions] Your first question is coming from Allen Klee. Allen your line is live. Yes. Good afternoon. First question is on monthly active users. From a sequential basis going forward, what will be the key elements that will cause this to just potentially stabilize and start growing? Hey, Allen. How are you? Yes. So there are a couple of initiatives that are contributing to that. First of all, from quarter-to-quarter on a sequential basis, our monthly active user count was basically flat. There is obviously some variation in terms of the various geographies, whether it's well developed or emerging market. But in all, it was in aggregate, I'm saying it was basically flat. Having said that, several different contributors. One is, as we've talked about for the last couple of quarters, features that will drive users to download and install the app and to reengage with the app. So most recently, we rolled out pAInt, which is our AI wallpaper generator. And as you know from following the press, there's been a tremendous amount of pent-up demand for tools like this. My Zedge, where we've added social and community features that contribute to users coming back more regularly in order to see what either their friends or artists or fans and so on and so forth are adding to the app. Those would be two examples of features that will drive that. Secondly is marketing efforts, and that includes paid user acquisition, where we have been scaling up over the course of the last, give or take six to 12 months. And then that is coupled with reengagement campaigns, where we market to users that have the Zedge app installed on their phone to drive them back into the app because of content or features that we have added to the app accordingly. Okay. Excellent. And then on, Jon, the kind of your advertising revenues, you were able to – the statistic for that of the – I'm forgetting average revenue per monthly active user. That held up year-over-year it seemed like despite what you mentioned of some advertisers going away, but you feel like that could kind of I guess, come back potentially next quarter? Do you think it would more normalize? Or how do you think about that? Yes. So it's difficult to provide clarity there. And the complication here is that depending on what one reads in the trade press. There is certainly some downward pressure on advertising budgets and the like, but there are also pockets of growth. More recently, I think I came across an article yesterday saying that mobile advertising spend in calendar year 2023 will decline compared to years past, where CAGR over the course of the last five years or so has been, if I recall correctly, north of 15% a year. But with the economic uncertainty in the overall market, analysts are expecting that, that will decline. As you know, we invest a tremendous amount in optimizing our inventory, and we will continue to do that. But I can't say with certainty whether or not that industry-wide trend will be something that has a material impact on our business. Too early in the fiscal year for me to answer that with clarity. Yes. I mean, in my model, I'm assuming that your average monthly advertising revenue per user is going to decline over 10% year-over-year. So hopefully, I factor that in, but we'll see. Nobody knows. So then – so with pAInt, it sounded like the initial reception of pAInt has been exceptionally strong. This is a – just so I understand, it's a free product today, but the net benefit to you is more engagement? Or how do you think about how that evolves? Sure. So the product is a free product insofar as users do not have to make an in-app purchase in order to create AI art. They do need a balance of an in-app currency called a Bolt or Bolts and they can acquire those either through rewarded ad experiences or through in-app purchases or through subscribing to the Zedge app. So it's not necessary that they make an in-app purchase. But if they don't make an in-app purchase, the only way that they can accumulate more art is through watching rewarded ads and securing the benefits associated with those ads. And we've only rolled this out in Tier-1 or well-developed markets. We're planning on rolling it out in other markets in the not-too-distant future. And we are viewing this as both a growth driver for new users as well as a re-engagement tool for existing Zedge customers with an associated revenue benefit. We're going to have to take a look at the data and how this evolves over time to determine whether we focus more heavily on growth initially or more heavily on revenue and the like. And we've got the infrastructure in place to test, analyze results and then react quickly based upon the various tests that we undertake. And over time, we may prioritize different goals based upon region. Okay. Great. I had a question related to GuruShots generators of photos shifting them to your marketplace to try to sell them. I think you just announced setting that up. I don't know if it's too early to talk about what's been happening there. But if you have any commentary on that yet? And maybe a theoretical or philosophical thing, but to what degree do you think that the issue is supply versus the issue of enough people interested in buying things? Like is it an issue if you create more supply, there will be more demand? Or would you have to create the demand? Or how do you think about those things? As you know, we just announced the availability for GuruShots players to market and sell their content in the Zedge app yesterday. So it's obviously very early. And we will continue to improve upon that process to minimize friction and enable those GuruShots players with an income stream with the least amount of hurdles. Having said that, as with any marketplace, there always needs to be a healthy balance between supply and demand. And we think that the addition of this new content, if you will, is something that will contribute to achieving that overall goal. We also have said in the previous earnings call that one of the areas that we are very focused on is in building out our data team and its capabilities. And theoretically speaking, that will mean that we will be able to segment users more efficiently than where we are today and avail the best content to those various user segments in a fashion which really optimizes our marketing and product marketing inventory in order to improve the contribution of Zedge Premium to the overall revenue pie that we have in our business. That's great. So one of your initiatives this year is to increase your paid marketing spend, a lot of that getting targeted to GuruShots. Is it too early or any commentary on what kind of returns you've preliminarily seen from those marketing dollars? Yes, it's too early. What I can say is if you rewind the clock to 2020 to 2021, there was a lot less effort needed in order to grow user base. You just would go into platform, defined a lookalike audience and so to speak, begin to scale from there. Of course, I'm simplifying things. When Apple came in and sort of changed the rules of the game in order to limit what data is available, that process has become more complicated and has resulted in our case, in our beginning to test a wider array of acquisition platforms and use the benefits of data in order to optimize those user acquisition campaigns. I think it's important to conceptualize that with user acquisition as one expands into new platforms, it is really so to speak, a search type of experience. One doesn't know what will optimize best on that platform. One doesn't know if that platform will work out. So inherently, one has to allocate a portion of their budget for that research and development, if you will. And then based upon the data that comes back, one will find certain campaigns, certain creatives, certain approaches in terms of what one is optimizing against that can scale. And then it's a question of, well, by how much can it scale? So that's another piece of this. I will comment as well. There have been some changes that Apple has undertaken in terms of expanding the window of time in which one can collect data. And my suspicion is that Apple has opened up that window slightly because they had underestimated what the impact would be to the overall market in terms of their very limited launch or policy with respect to understanding what is happening from a user acquisition perspective. So we're just hard at work. We’re doing our best to unearth the right platforms, the right campaigns, making sure that we've got the right data pipes and good data that we can ultimately use in order to optimize the spend over the mid to longer-term accordingly. Thank you. So you said your Zedge is testing a wider array of acquisition platforms. Can you just clarify what you mean by acquisition platforms? Does that mean Android versus Apple? Or do you mean something else? And then how long do you think it would be until you have enough data that you could report back to us on how the marketing plans are doing? Acquisition platforms would be third-party platforms like Facebook or Instagram or Google or Apple search ads. So these platforms – and those are just some illustrations, but these platforms are selling their inventory to acquirers like Zedge, and we bid on certain attributes. These platforms have, in many instances, machine learning capabilities in order to unearth and identify the attributes that an advertiser is looking for. And as we get data, we analyze it, and then we try to improve upon that for campaigns that seem to have promise with respect to various KPIs that we consider in making our buying decisions. In terms of the period of time where we can more properly report back. I would say that if you roll back in time, when we acquired GuruShots, we said that, give or take, we would need around 24 months to bring the business to being breakeven. And that is the process that we're undertaking right now. So incrementally, on a quarterly basis, we are becoming more attuned to all of the ingredients that contribute to this return on ad spend. And that is what we're doing on a day-in and day-out basis. So I think that we're still holding to that 24-month time period in aggregate to get us to profitability with the goal of closing that gap on an incremental basis quarter-by-quarter. Great. My last question, for now, is if you could comment a little on your prior guidance and how you made a little comment about it in the text, but just how you feel about your ability to continue to grow your revenue and have profitable cash flow positive in fiscal 2023, while investing given just the give and takes, given the first quarter, how you feel about? Has anything changed and how you feel about your outlook for the year fiscal year? Yes. Our goal continues to be to meet that threshold of being cash flow positive. And as I've said in quarters past, that we see some incredible growth opportunity, which would require us to have a loss, we would go to the Board and explain to them why we think that opportunity is something that we should pursue. But barring that, we really are going to do everything within our power to achieve that goal. And our philosophy generally is if we're profitable, then we've got runway. And runway is one of the most important assets that one can have in terms of maintaining and scaling the business over the long-term. Thank you, Allen. [Operator Instructions] Okay. This concludes our question-and-answer session and conference call. Thank you for attending today's presentation. You may now disconnect.
EarningCall_1536
Good morning. This is Josh Weinstein. Welcome to our Fourth Quarter 2022 Business Update Conference Call. I’m joined today by our Chair, Micky Arison; our Chief Financial Officer, David Bernstein; and our Senior Vice President of Investor Relations, Beth Roberts. Before I begin, please note that some of our remarks on this call will be forward-looking. Therefore, I must refer you to the cautionary statement in today’s press release. Our business continues to accelerate on an upward trajectory as we rapidly close the gap to 2019. In fact, we are already exceeding 2019 revenue per diem, and we’re gaining momentum on our return to strong profitability. Taking a step back, this year, we’ve completed a monumental 18-month journey, and with our scale, what we believe to be the world’s largest start-up, returning 90 ships to service, re-boarding over 100,000 team members, and restarting our unmatched portfolio of 8 private islands and port destinations, plus our unrivaled land-based footprint in Alaska and the Yukon, all while welcoming back nearly 9 million guests. For that, I sincerely thank our global teams around the world for the ingenuity and sheer determination it took to see that through to completion. Throughout 2022, we have aggressively built occupancy from a 50-point gap in the first quarter to less than 20 points in the fourth quarter. We achieved this on growing capacity as we returned another 35% of our fleet to service in 2022, reaching 99% of our 2019 capacity levels during the fourth quarter. And on top of this, our constant dollar revenue per passenger cruise day was 2% higher than 2019’s record levels for the full year and 4% higher in the fourth quarter, overcoming the dilutive effect of future cruise credits. Without this impact, each would have been two points higher, and in the process we sustained record breaking onboard revenue per diem significantly higher than 2019. We’re also not losing sight of our cost base as we’ve worked through our restart and continue to absorb and mitigate the impacts of the high inflationary environment we’ve all been living in. We’ve reduced the increase in adjusted cruise costs, excluding fuel per ALBD in constant currency from up 25% in Q1 to up 11% in Q4. We’ve also significantly ramped up our advertising and sales support to drive future demand. Thanks to this, and the hard work of our amazing trade partners, our percentage of first time guests has continued to sequentially improve, closing the gap to 2019 levels. And we’ve been working smarter with our shoreside teams’ headcount already having been significantly reduced from 2019 levels for some time now. We delivered stunning new flagships for five of our brands, including Carnival Celebration, AIDAcosma, Costa Toscana, and Discovery Princess, as well as our first luxury expedition ship, the finest in the world, Seabourn Venture. All of these ships were purpose-built to generate higher returns. We broke ground on a new exclusive destination, Grand Bahama port, which will be a game changer for Carnival Cruise Line, while at the same time benefiting more than ever from our existing private islands and unique port destinations, which captured 6 million visits from our guests and all while working to minimize our environmental impact, with a 7% reduction in carbon intensity, a 30% reduction in food waste, and 290 million less single use items compared to our baseline. Most importantly, we are back to doing what we do best, delivering millions of unforgettable and much needed vacation experiences to our guests. And we are truly a global company with 45% of those guests who are outside of North America in 2019. In fact, we practically carried more people outside the U.S. than any of our peers carried in total. We believe that having the number one or two brands in each of the largest cruise markets such as North America, the UK, Germany, Australia, Italy, France, and Spain, is the foundation of our portfolio strategy and allows us to tailor our experiences and offerings to those specific source markets, enabling us to generate stronger brand loyalty and gain greater penetration and profit. In this current environment though, there are two factors that have had an outsized impact on our results: an uneven reopening of cruise travel around the world in the aftermath of COVID; and the more direct impact the war in the Ukraine has had on European countries. While all of our brands are on an upward trajectory, the pace of the recovery has trailed for those brands most heavily exposed to these factors. In 2019, one-third of our non-North American guests, 2 million people came from Australia, Asia, and the Baltics. The vast majority of these guests were sourced through Costa and Princess, representing 40% of Costa’s guests and 25% of Princess’ guests. At this point in time, Australia’s reopening is where North America was a year ago, and Japan is closer to two years behind. The lagging reopening of these markets has triggered multiple changes in deployment and guest sourcing approaches as we anticipate the impacts will continue to be felt, particularly for the first half of 2023. Of course, China also has yet to reopen, given Costa’s significant presence in Asia with five ships planned to operate there year round pre-pause, we’ve taken actions to right size the Costa brand with the removal of another two smaller, less efficient ships from the Costa fleet. This is in addition to the previously announced three ships transferring to our highly successful Carnival Cruise Line brand. This positions Costa well with a competitive fleet with closer to home deployments focused on its core markets in continental Europe. We have already been encouraged by the recent strength in booking volumes for the Costa brand. In fact, last month Costa’s booking volumes in these core markets were above 2019 levels for the fourth quarter of 2022 and the first quarter of 2023 as they navigate a closer-in booking curve. The war in the Ukraine remains concerning for us all, and especially those in the affected regions. Given the closer proximity for both Costa and our German brand, AIDA, the war and associated impacts have weighed heavily on consumer confidence in those regions, resulting in greater uncertainty and closer-in booking patterns. To help manage, we’ve made strategic deployment decisions, leaning into more itineraries that homeport where the guests originate, as well as shorter duration cruises helping us to reduce the friction of air travel, lower the overall cost, and facilitate a closer in booking environment. We believe this positions us well to attract more new to cruise guests and make us even more of a value proposition versus land based alternatives by bringing our ships closer to where our guests live. We have furthered our fleet optimization efforts again this quarter, bringing the cumulative number of ship disposition since the pause 26 when coupled with a delivery of larger, more efficient ships, including the successful introduction of Carnival Celebration last month, and the addition of Arvia for P&O Cruises just last week. This will result in nearly a quarter of our fleet consisting of new capacity. This fleet transformation results in an 8 percentage-point increase in balcony cabins, along with a tremendous increase in available real estate onboard to deliver even more differentiated onboard experiences and generate associated revenues contributing to durable revenue growth going forward. We will also benefit from lower ship level unit costs that help to mitigate inflation with 9 percentage points higher fuel efficiency, and 6 percentage points greater efficiency in remaining operating costs. Our revenue generation will also benefit from the launch of Carnival Venezia’s Fun Italian Style in New York. The program is off to a great start, having been met with strong demand and high prices, building confidence in prospects for this creative initiative. Overall, in 2023, we’ll have just 3% capacity growth compared to 2019, while still retaining the excitement and demand from 12 fantastic ships delivered -- 2020. And thanks to portfolio optimization effort, our capacity growth is weighted toward three of the highest returning brands: Carnival Cruise Line, AIDA, and P&O Cruises UK. There is no doubt 30-year assets will hold dividends along our path to strong profitability as we build demand and generate higher revenue yields over time. Having said that, brand by brand, there is high-capacity growth that we are managing in 2023. In this transition year, P&O Cruises is absorbing 40% more capacity than 2019, thanks to Iona and Arvia. AIDA has 20% more capacity at the start of the year. Costa will have significantly more capacity in its core markets versus 2019 as the full benefits of our fleet optimization program won’t be completely felt until 2024. And Princess will source more heavily than ever before from North America, given its source market disruptions. As I mentioned on the previous call, to help support this growth and to drive overall revenue generation, I’ve actively been working with each brand on their strategies and roadmaps. As a result, I have authorized our brands to take a significant step up in advertising activities, including a nearly 20% increase in our investment this past quarter over 2019, to elevate awareness and consideration and to drive demand for both, the near and the longer term. This should be particularly impactful with those new to cruise where we draw about one third of our guests as we position to take share from land-based alternatives. We are capitalizing on the 25% to 50% value gap to land-based alternatives that frankly should not exist with new marketing campaigns to communicate our significant value advantage to land-based alternatives, including newly launched digital creatives from several brands. We plan to continue these increased investments in advertising as we head into next year to promote a strong wave season where we capture disproportionately higher bookings for the year, particularly our important summer season. Having been in pause status for the better part of two years, we are also rebuilding top of funnel demand to the army of advocates coming off our ships every day, recommending our cruise vacations, a renewed focus on our trade relationships and a growing sales force. On the revenue management side, we are ensuring that each brand is utilizing pricing philosophies to maximize revenue from launch to sailing and sharing best practices across brands. Our teams are focused on higher value add from bundle packages supported by a market to fill approach and consistently capturing incremental revenue streams from many initiatives such as more robust cabin upgrade programs. While building back demand and enhancing our yield management tools and strategies, we are optimizing the combination of occupancy, ticket and onboard to deliver revenue to the bottom line in the near-term while maintaining price integrity for the long-term. Given the close-in nature of the booking curve from the disruption caused by the Omicron variant earlier this year, and the friction from protocols in effect through the bulk of the year, most brands have leaned heavily into opaque distribution channels, like our friends and family rates, which allow us to achieve higher occupancy and resultant onboard revenue while still preserving pricing power over time as they are rates that are not offered in the general marketplace. These channels are beneficial in reaching higher occupancy levels and higher onboard revenues, particularly for our North American brands. Booking volumes have already strengthened following the relaxation in protocols. Cancellation trends are improving globally and we have seen a measurable lengthening in the booking curve. This applies across the board. Since the start of the year, our EA brands have pushed the booking curve out and narrowed the gap by more than a month, while our North American brands have pushed the curve out and narrowed that gap by two months, now nearing 2019 lead times. We enjoyed a strong response to our recent Black Friday and Cyber Monday activities, and the momentum has continued into December, building our base occupancy and marking an early start to a strong wave season ahead. It is important to recognize much of the first half of 2023 was booked prior to the relaxation in protocols. And in actuality, many of these first half cruises are still implementing certain more restricted protocols given the itinerary profiles consist of lengthier exotic deployment, including our long-awaited return to world cruises and long winter deployments for our European brands operating from colder climates. And much of this relies heavily on long haul flights, which are not conducive to a closer-in booking environment. Nonetheless, we expect our first quarter occupancy gap to 2019 to be reduced even further and on higher net per diems, on our way to historical occupancies in the summer. This bodes well for 2023 overall, as we expect more markets to open for cruise travel, protocols to continue to relax, our closer to home itineraries play out, and our brands continue to hone all aspects of their revenue generating activities. And as we continue to invest to build demand, we are positioned to pull back on promotions and opaque channels to drive meaningful ticket price improvement over time. On a complementary basis, our industry leading operating costs and fuel consumption for ALBD set us up to effectively deliver more of this revenue to the bottom line. Normalizing for 2019 fuel price and currency changes, which provides a better sense of the strength of the underlying fundamentals of the business and our progress, we expect adjusted EBITDA per ALBD to reach 50% of 2019 levels in the first quarter of 2023 with sequential quarterly improvement as we progress through 2023 that should rival 2019 levels by the end of the year. Turning to capital expenditures, we actively managed down our spend by over $500 million during 2022, and we’ve taken a hard look at 2023 and beyond and reshaped investment spending by $300 million annually for a cumulative reduction of $1.7 billion. We have reprioritized project lists and hurdle rates to reflect the current environment while absolutely maintaining our commitments to excellence in compliance, protecting the environment, and the safety and wellbeing of our guests, team members and communities we serve. Going forward, we are committed to using our expected cash flow strength to repair the balance sheet over time and will be disciplined and rigorous in making new build decisions accordingly. We have just four ships on order through 2025 plus our second incredible Seabourn luxury expedition ship to be delivered in 2023. This is our lowest order book in decades. We don’t expect any new ships in 2026 and anticipate just one or two new builds each year for several years thereafter. Turning back to our operating performance, we are effectively addressing near term challenges in the post pause transition with higher first quarter net per diems expected and have been reshaping our portfolio to drive revenue growth as we return to historically high occupancy levels and delivering measurable pricing improvements over time. We are fast tracking our momentum by investing in marketing and sales support to effectively communicate the amazing vacation experiences we deliver day in and day out, offering an unparalleled level of convenience and personalized service and at way too good of a relative value to land-based alternatives at every price point from mass contemporary to ultra luxury. Overall, we remain focused on driving revenue growth that hits the bottom line and accelerating our return to strong profitability. And over time, this revenue generation, our industry-leading cost base, and our more focused capital expenditure profile will support significant free cash flow and propel us on the path to deleveraging investment grade credit ratings and higher ROIC. This has been a truly remarkable year, and we have come a long way in incredibly short amount of time. These efforts highlight what we’ve always known, our people are our greatest asset, and now they are armed with an even greater skill set built up over the last few years, creativity, agility, and perseverance that will help push us forward. We’re looking forward to 2023 and are positioning for our first strong wave season in four years, enabling us to deliver a strong summer period where we generate the bulk of our operating profit for the year. Thank you, Josh. I’ll start today with a recap of our cumulative book position and our financial position. Then I’ll provide some color on 2023. Turning to our cumulative book position. Marking an early start to wave season, we ended the year with multiple brands breaking records on very strong Black Friday and Cyber Monday booking volume. Our full year 2023 cumulative advanced book position is at higher prices and constant currency normalized for FCCs when compared to strong 2019 pricing and is higher than the historical average book position. The second, third, and fourth quarters all have a book position that are above the historical average, while the first quarter 2023 book position was impacted by heightened protocols during its prime booking period, which have since been responsibly relaxed. As a result of the relaxation of the protocols, booking volumes for first quarter 2023 along with all future sailings have increased. Therefore, we expect to continue reducing our occupancy GAAP in first quarter 2023 to 2019 by nearly 5 percentage points from fourth quarter 2022. The strong cumulative book position has resulted in total customer deposits hitting a fourth quarter record of $5.1 billion as of November 30, 2022, surpassing the previous record of $4.9 billion as of November 30, 2019. Next, let’s talk about our financial position. During 2022, we continue to take refinancing risk off the table by addressing our 2023 debt maturities and getting ahead of our 2024 maturities. As a result of this, we ended the fourth quarter of 2022 with $8.6 billion of liquidity. Looking forward, we expect to turn free cash flow positive in the back half of 2023 and continue to be free cash flow positive in 2024 and beyond. We anticipate utilizing this free cash flow to delever our balance sheet on our path back to an investment grade credit rating. Now, I’ll finish up with some color on 2023. For first quarter 2023, we expect capacity growth to be 3.7%, when compared to first quarter 2019 and 3.3% for the full year 2023 as compared to the full year 2019. During 2023, we expect to continue to close the gap on occupancy to 2019 levels. Occupancy for first quarter 2023 is expected to be 90% or slightly higher just a 14 percentage-point gap or better. As I said before, this would be nearly a 5 percentage-point improvement from the fourth quarter 2022 gap, but that is not enough. We are working hard and expect to close the GAAP to 2019 with occupancy returning to historical levels in the summer of 2023. On the pricing front, first quarter 2023, we expect net per diems to be a 5.5% to 6.5% in constant currency, and 3% to 4% in current dollars as compared to first quarter 2019, a great accomplishment as we start the New Year. However, net per diems for first quarter 2023 are expected to benefit from brand mix when compared with first quarter 2019. During 2023, while our European brands expect onboard and other revenue per diems to be up significantly versus 2019 as they were in 2022 and as has been the case with our North American brands, absolute onboard spending on our European brands is less than that on our North American brands. Our European brand guests tend to drink a little more, but gamble a lot less. As the European brands catch up on occupancy with our North American brands during the second and third quarters and fill their ships, they will make up a larger percentage of the total changing the per passenger average. And with their historically lower onboard revenue per diems, we will no longer benefit from the brand mix. Also for 2023, we do anticipate returning to non-GAAP financial measures to report revenue performance and use net per diems as opposed to revenue per passenger cruise day we used in 2022. For 2023, we once again expect the onboard and other revenue per diems to be up significantly versus 2019, helping to drive the net per diems up. However, as I indicated in the past, as we change the bundled package offerings, we reevaluate the revenue accounting allocations. As a result, in 2023, more of the revenue will be left in ticket and less allocated to onboard, impacting the onboard in other revenue per diem comparisons to both 2022 and 2019. Just another reason to add to the list of reasons why the best way to judge our revenue performance is by reference to our total cruise revenue metrics, such as net per diems. Now turning to cost. Off the base of our industry-leading cost structure, adjusted cruise costs without fuel per ALBD for the full-year 2023 versus 2019 are expected to be up 5% to 6% in current dollars and 7.5 to 8.5 in constant currency. For the first quarter 2023, the ranges are up one point less driven by lower dry dock cost per ALBD versus first quarter 2019, but first quarter 2023 does include an over 30% increase in advertising to further accelerate demand. There are three main drivers of the cost increase. First, our forecast is for an average mid-teen level of inflation across all our cost categories globally. Second, our decision to further invest in advertising to drive demand in pricing in 2023 and beyond is expected to add 1 to 2 percentage points the cost per ALBD. And third deployment optimization and other small investments are likely to add 1 percentage point. Significantly mitigating these increases are our fleet optimization program that is expected to drive a 6 percentage point improvement in ship operating costs per ALBD, that is worth 4.5 points of adjusted cruise costs without fuel per ALBD, and the creativity resourcefulness and hard work by our global teams producing, sourcing and productivity savings of approximately 4 percentage points, a great accomplishment. I would like to say thank you to all the team members who contributed to this effort. The details of depreciation and amortization, interest expense and fuel expense can be found in the business update press release we issued earlier this morning in the section titled Selected Forecast Information. So, I will not walk you through all the numbers. However, for those of you modeling our fuel expense, please note that we expect MGO to represent about 40% of fuel consumption for 2023. However, that percentage may be slightly higher during the early part of the year. While we’re on the subject of fuel consumption, I would like to recognize everyone on our global team who contributed to the expected 15% reduction in both, fuel consumption per ALBD and carbon emissions per ALBD for the full year 2023, both as compared to 2019. We are working aggressively to drive down our carbon footprint, fuel consumption and costs through technology upgrades being rolled out like the Air Lubrication Systems mentioned in this morning’s business update along with investing in port and destination projects, and even more focused on itinerary optimization across our portfolio of brands, while realizing the benefits of our fleet optimization efforts, so that everyone can fully understand the underlying strength of our business. I did want to point out that for 2023 versus 2019 at current fuel prices and FX rates, we did expect a negative impact from fuel price, fuel mix and currency of approximately $150 million for first quarter and an impact that is multiple times that for the full year, including a full year currency impact of over $70 million. Putting all these factors together, we expect $250 million to $350 million of adjusted EBITDA for the first quarter 2023 and sequential improvement compared to 2019 in each quarter of 2023 as we continue to close the gap. However, given the significance of the wave season ahead of us, we will be in a much better position to provide full year guidance for net per diems, occupancy and EBITDA early next year. We plan on providing that guidance during our first quarter business update in March. Good morning, Josh and David. So, I guess, the first question would be around the marketing spend for 2023. And I guess, we were thinking that marketing would be accelerated throughout the fourth quarter of ‘22 and then into the first quarter of ‘23 and then start to fall off some. But it sounds like you guys might be keeping marketing spend pretty high throughout the entire 2023 year. And guess -- the question is maybe why are you keeping it so high for the full year? And is there any way to understand maybe what that cost cadence will look like throughout next year? Just wondering if there are any quarters that were -- spend levels for marketing or other costs might be higher or lower? I hope that all makes sense. So with respect to the advertising in 2023, if you saw the materials that have been put on the website, we’ve been ratcheting up across -- across all of 2022. And we are very excited about the momentum that we’ve got. We’ve already started the wave season incredibly strong with our Black Friday, Cyber Monday and really just the whole book position that’s moved nicely in the month of November. And we think that advertising has a good amount to do with that to really reach first timers, generate awareness, generate consideration and doing so in a really meaningful way. And I think it’s -- we’ve got great brands. I mean we’ve got tremendous brands, but we need to do a better job getting the voice out. And this is a good way to do it. And it helps not just us, it helps our trade partners. It helps the bookings across the board. So, as far as how we’ll look at it across 2023, we’ve given you the guidance specifically for the first quarter. The great thing about advertising is we can dial up, dial down across the board where it’s working and where we don’t think it’s having as much of an impact. But right now, the activities that we’re doing, both in the mainstream media side and then the digital and performance marketing, it’s really starting to hit our stride. So, we’re pretty pleased with the results. Yes. Steve, the only other additional color that I’d add to that is, remember, I’ve said historically, the best way to judge our cost structure is the full year, and I gave you the guidance there of 1 to 2-point increase. The problem with the seasonality is as we go along, we make decisions that are most appropriate and we remain agile and flexible. But with that said, I will say that the advertising is likely on a quarterly basis to be the highest in the first quarter and the lowest in the third quarter. But the third quarter traditionally has always been a low quarter in terms of advertising. So, that’s probably the best guidance we can give you at this point. And to follow up on that, I guess, as we kind of think a little bit further down the road, I mean if you guys kind of get back to those normalized load factors and demand still looks pretty solid through the majority of ‘23. Would you expect as we get to ‘24 that you would be able to pull back a good bit on that marketing spend? Yes. I mean, it’s certainly within our control. Ultimately, we’re not just trying to get back to occupancy levels that are historical. We’re trying to really drive the unit pricing as well. And so advertising is a big component of that. So, we’re -- I hope we’re having that conversation in six months, Steve. Okay, great. And then just one quick housekeeping, if possible. David, the 2 ships that are leaving Costa, were they sold, or are they just going to be scrapped? No. So, we announced 3 ships in total and 2 of them, we actually have a contract for at the moment and one we’re working on -- a contract for sale. There were a couple of kind of really key things that I just -- I wonder if you could clarify for us. First, the comment on ‘23 price -- that it’s higher, I think you say adjusted for FCC. So, including the impact of that discount, which probably would only be 1% or 2% at this point, is your price on the books in ‘23 in constant currency higher than ‘19, including that? And then, I’m just -- I guess I’m a little surprised that there’s no yield guidance for Q1 because you gave a lot of detail to get to the EBITDA line, including occupancy, and I haven’t been able to do all the math since the release is only out for a few minutes before the call. But it seems like you have a yield in mind for Q1, and it would be sort of 80% plus book by now. So, I just wonder if you could help us with the sort of a range of what might get to the EBITDA that you’re talking about just to help us check our math? And then lastly, the comment on EBITDA, it’s like -- so the guidance for Q1, up $250 million to $350 million and then up sequentially each quarter after that. It is -- I wonder if you could just help us with a floor like on a full year basis, can we -- you’re comfortable that you would be higher than $3 billion in EBITDA for the full year. Like in other words, that sort of up sequentially each quarter, could still get to sort of quite a low EBITDA number for the full year? And I just wonder if you could help give us a floor. Thank you. Hey Robin, how are you doing? That was a lot of questions. So, let me start backwards because I can remember the first -- the last one. So, with respect to EBITDA, what we tried to convey is on a performance basis, on a unit performing basis, when you strip out the noise of fuel and currency, what’s our trajectory and how are we looking at things? And so, we said on that basis, we’d get back to 50% of 2019 levels in Q1 and sequentially throughout the year, continue to close that gap to 2019. I am certainly hopeful in pushing that we’re going to exceed 2019 levels by the time we get to Q4, but we’ve got a lot of work to do to be able to do that. With respect to your question about yield guidance, just to make sure we’re not -- so do you want to do that? Yes. Robin, I guess -- maybe you missed the part in my notes where I did talk about this. I said specifically that we expect net per diems to be up 5.5% to 6.5% in constant currency. And that does translate to 3% to 4% in constant dollars. Now, we gave per diems, but of course, we also gave the occupancy of 90% or slightly higher in the press release. So, you can calculate the revenue associated with that. And as far as the booking trends are concerned, you’re right. We did indicate that the FCCs would be less than 1 point for the year. And the book -- the pricing would still be up even if we didn’t add back the FCCs. We’re still at higher prices. I think that covers all of your questions. Any follow-up? I just wanted to sort of follow up and build on the occupancy ramp. If we look just from 3Q to 4Q, 10 points of improvement, if we look at sort of what you guys are expecting in 1Q, it sort of 5-ish percent. So, can you just sort of walk us through what’s driving that lower sequential improvement relative to the 2019 levels? And maybe how we should think about that in the context of the expectation that you guys are going to be back to sort of full occupancy over the summer? Sure. Sure, Fred. So one thing to think about when you think about our Q1 deployment profile, it is very different from what we typically have the rest of the year. We’ve got actually 9 ships in Q1 on World Cruises, another 4 ships on 70-plus night Grand Voyages and then a host of ships that are doing longer exotic voyages, 35-nighters, 28-nighters. And so, with that profile, those are longer lead time type of itineraries, some bucket list types of things. And so, it is progressing for Q1 exactly where we thought it would be with respect to closing the occupancy gap given the dynamic of that itinerary profile. And as we get into Q2, those have stopped or wind down and we get back to the cadence that we expect. Understood. That makes sense. And just on the booking momentum, there was a comment in the release just talking about November booking volumes exceeding 2019 levels. Also a comment about momentum continuing into December. Are December bookings still above 2019 levels, or did those sort of tail off after some of the promos in November? No. They’ve continued very strong, and they’ve continued well above the 2019 level. So, we’re very pleased with the overall position and the bookings that are coming in to date. Two quick ones. I think in the past, you’ve referenced getting back to 10% ROIC. If you could just talk about the path there and the puts and takes on what has to happen for that to occur? And then second, with respect to the advertising, do you have any sort of measurements or metrics that you -- that are shareable that demonstrate or confirm some of the productivity around that? And that’s it for me. Thanks. Thanks, David. With respect to the advertising, our brands -- without wanting to give away competitive positions, our brands are tracking with respect to awareness and consideration, which has a correlation to booking. They track lead generations, they track conversion -- track conversions on websites, they track via performance tied deals in the marketplace, and we actually know exactly what the impact is from the activities that we are taking. So, we do have them across the board, and we follow them and we discuss them with the brands, and that’s how we make decisions with them about where it is effective and where it might not be effective. And what’s great about us having 9 brands sharing amongst themselves, what’s working and what’s not working, so we can learn from each other. With respect to the ROIC, it’s revenue. I mean revenue is the thing that’s going to drive us back to double-digit ROIC. David mentioned our industry-leading cost base. That will continue to be a focus, of course. But really, it’s going to be the revenue and that’s where our brands are focused. And one thing, David, I’d like to add on the advertising front. One thing we’ve been tracking is we take a look at our book position for 2023. And in the last 6 months, since we have increased the advertising, we have seen a shift and a lot more new to brands. In fact, it’s an 8-percentage-point improvement. So at this point in time, what we’re seeing for the 2023 book position is that it’s roughly half of the guests are repeat royal guests and the other half are new to brand. Unfortunately, these people have an old sail. So, I don’t know whether they’re new to cruise or they’re brand switchers, we’ll find that out shortly as they sail. But the fact is -- we’re getting a lot of great demand and we’re seeing it in the booking volumes. And that’s an indication also of the growing health of our trade partners because they are a huge piece of our ability to drive first timers on board. So, a shout out to them as well. In the prepared remarks, there was a comment on reprioritizing project list. Is there anything noteworthy to update us on maybe what you guys are shifting focus on or shifting focus away from, anything sizable there? So, there’s -- I think a lot of the stuff is timing. From a big perspective, if you look at the change in the CapEx, a lot of that had to do with the fact that 26 ships have left their fleet, they were smaller, less efficient ships. And therefore, we don’t necessarily need the overall CapEx number as high as we had previously. But when it comes time to prioritizing it, it’s also a timing issue and doing the things that are most important first. And that’s some of the reason why you saw the CapEx come down in 2022. The only noticeable thing that where really -- as far as our office space, clearly, with the new ways of working in today’s environment, we’re significantly reducing the amount of CapEx that we’ll probably need to expand our offices as we continue to grow. Yes. We -- I can give you an example of where we would and where we wouldn’t prioritize. So, we talk in the press release and some of our prepared remarks about the impact we’re making on are carbon footprint and the fuel consumption that drives that. That’s going to continue full steam ahead. We see, a, great returns in that; and b, doing our part on the sustainability front, which is critical to our long-term success as well. There could be things that when it comes to making a decision about the speed at which we want to introduce new venues on board of a particular brand, we can pace those out differently. We can take a little bit less risk on trial and error of creating new experiences. So, it’s all a question of what we think the appropriate return could be, where we want to take risk and where we just want to be more focused on managing the cash balance. Okay. And then I know there’s been a lot of discussion on marketing spend. And I’m not sure if you guys have directionally elaborated on maybe the ROI of marketing spend, there seems to be a pretty decent push to sourcing more North American consumers across the cruise operator landscape. And so, I’m wondering if the marketing spend is as productive as it has been historically or if you expect that to be maybe temporarily depressed before you can prune that back? Thanks. Well, I can repeat what we said, which is we are spending more, and we are very happy with the results, and we’ll keep monitoring it and adjusting as appropriate. But we feel real good about our brands to strengthen the market and our ability to champion them with additional advertising. So Josh, I want to dig into the opportunity a little bit more on the marketing front as well. If you were to try and isolate how much of the opaque channel mix shift you’re doing now versus ‘19, that additional mix to that channel and trying to isolate the upside to that -- those per diems just from taking off the additional sort of, again, opaque channel promo activity. Is there a way to sort of give us that level of magnitude for that opportunity when you are able to remove the rest of that? I’d love to give you a straight answer, but I got to be honest. So I’m not sure that I could in a way that I feel comfortable will make sense in a short amount of time. So Brandt, I know that’s like another way of asking us what is our yield guidance for the rest of the year. The one thing I do want to point out, which I said in my prepared remarks is that we will -- and wave season is important, and we will give guidance for the net per diems and occupancy and EBITDA for the balance of the year. However, we did give the net per diem guidance for the first quarter, as I reiterated before, when Robin asked the question. And one thing I do want to point out is that I also mentioned that the first quarter benefited by brand mix. And that brand mix was worth about 2 points, and so as you think through the balance of the year, there will be positives as what you’re just describing. But as you think through that, please take that into consideration as we forecast the year, the per diem now. And I guess I could say looking backwards and you look at our trajectory from Q3 to Q4, we are pulling back, right, and that’s helping improve our per diems. And we’ll -- I mean, the great thing is it’s pretty easy to turn on and turn off. And so far, as we get into this wave season, the momentum is good. It gives us -- it gives us a lot of excitement about being able to pull that further as we get into 2023. Okay. That was really helpful. The second question I have is related to China. You guys -- it looks like the 2 ships that we didn’t know where they were going to go are now being removed. And so that means that there’s no near or maybe even medium-term plans to return to China. Do you guys consider China still a medium to longer-term opportunity for you? And are you watching that market closely to potentially go back eventually to alleviate supply pressures in other markets, or how are you thinking about that market now? Yes. I mean, look, the great thing about our assets, they’re mobile and we’ve moved them to optimize our demand and our revenue generation. If and when China opens up again and opens up not just to domestic cruising, but really opens up, we’ll certainly look at that, but we’re not relying on it. We’re not counting on it. We have -- we are the number 1 or 2 brand in all the major cruise markets today, and we like that position, and we’re going to push hard on increasing our penetration there. So, there was a comment in the prepared remarks about discounting through opaque booking channels. That seems like an important comment. I know criticism by at least one of your competitors is that you guys have been discounting in such a way that it’s going to be difficult to recover from that anytime soon. It seems like you disagree with that criticism. But also, it seems like, if I look at the big difference between 3Q and 4Q, it’s sort of the turnaround in those per diems, which is obviously a focus for you guys. So maybe speak to that strategy and your level of confidence that it’s ultimately going to pay off? Sure. So, I’ll speak for ourselves. I won’t speak for anybody else. We are a global company. We have a different profile than our competitors. With respect to how our brands are optimizing revenue, which is price, it is occupancy and onboard spending. They are all using different levers and different mechanisms, including opaque channels, which, as you just referenced, we’ve been able to pull back over time without much of a problem. We focus on the revenue that is going to get to the bottom line, and that’s our focus, not just driving revenue but driving revenue that doesn’t get caught up in the cost and not hit our EBITDA or not hit our operating income, and that’s where we’re focused. Got it. That’s helpful. And then my second question -- obviously, there’s been a lot in the news and if anybody has any kids in school right now, half the class has something, right? Flu, COVID, RSV, this whole idea of a tripledemic, which you got to hand it to the media for their ability to brand diseases at this point. But, I guess, I’m curious if you’re seeing anything in any of the metrics and booking statistics that you look at that would suggest that that’s having an impact on your business at this point? Or is the consumer largely over it as we think about how viruses and diseases are going to impact their willingness to book a cruise? Yes. We -- look, I mean, having come through two years of COVID, I think pretty much across the board, what we see is people are -- people are happy to get on with their lives. Now obviously, I’m not trying to belittle what you said because there could be some folks that are dealing with some things that are pretty tough on them and their family right now. But what we see is trends that are going back to normal about how people are thinking about those types of illnesses. And we always knew this point would come, right, when all of the masking and staying away from each other would go away and some things that we didn’t experience would come back with a little bit of a fury in the world, not on our ships. And that’s what’s going on, and we’re taking it in stride, and it doesn’t seem to be a problem. How should we read into your comments regarding pricing for next year? Certainly, semantic theory. Previously you said higher, now it’s slightly above. I mean, technically, they could mean the same thing, but a little more color on that, please. Thank you. Well, I think you gave my answer, which is the language change, but it’s really not a significant change in our book position. Half one, we are really trying hard to close that occupancy gap. We are using the opaque channels where we think it makes sense and where we’re going to lean harder and we plan to keep pulling that back as we get through a great wave season. And regardless, we anticipate very strong onboard spending to supplement our ticket prices. So. for us, pun intended, it’s full steam ahead. Okay. Thank you. Then one or two more questions here quickly. Can you just give us an update on what the book direct trends have been in the most recent quarter versus say the comparable quarter in 2019 versus booking through a travel agency? What are you seeing there? Thank you. What we’ve been saying all along is that the direct business held up relatively well throughout the pandemic and the trade had to build itself back up, and we’ve been trying to support them to do just that. And the great thing is, as we’ve referenced in some of the other questions, the trade has been doing great lately. They’re as excited about our advertising as we are because it helps them, too, and they’ve really started to push on the volumes. And so, we couldn’t be happier with how they’re progressing. Okay. And then just lastly, if I caught it correctly, you talked about 15% reduction in fuel for ALBD next year? I think the previous number had been 10%. How much is that being driven by the reduction, it sounds like some of the older legacy fleet and what else may be driving that? Thank you. That’s it. Yes. So, the combination of the removal of the smaller, less efficient ships with the new ships that were delivered, make up 9% of the 15%, and then, the other 6% has to do with all of the itinerary optimization as well as the investment in fuel reduction technology, things like the Air Lubrication System, which I mentioned in my notes and was also in the press release. Just real quickly here, I wanted to get your kind of big picture perspective on the path for margins potentially for the business. And -- it sounds like there’s some real fuel efficiencies to be had on the consumption side. Obviously, you’re dealing with higher fuel prices, but also your operating cost outlook was pretty strong. And then, when you layer in your view for a return to historical occupancy, coupled with pretty decent price position for ‘23. Like, when you put all that together as -- I don’t know, maybe you’re even exiting ‘23, going into ‘24, do you foresee margins getting back close to historical levels, ahead of historical levels? Kind of what are you targeting kind of over the long run? Well, because we’re not giving guidance, I think the best I can tell you is how we’re thinking about that EBITDA on a per unit basis. And when you get rid of the noise from currency and the fuel prices, operationally, what we’re really trying to do is exceeds 2019 levels by the time we get to the end of the year, and that’s where we’re focused. As far as the longer term, maybe we can have more of a conversation on that in March when we’re going to be talking more wholly about our full year guidance. But it’s fair to say, there’s a lot of potential relating to the revenues, all of the advertising that we’re doing, which should bode well for the return on invested capital, which we expect to increase considerably over time as we move through the next year or two. Thank you. So, to everybody on the call, thank you very much for joining us and happy holidays. And I’d encourage you to go to our website for our presentation materials and some supplemental schedules. Thank you all very much.
EarningCall_1537
Greetings ladies and gentlemen, and welcome to the Hooker Furnishings quarterly investor conference call reporting its operating results for its fiscal 2023 third quarter. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Paul Huckfeldt, Senior Vice President and Chief Financial Officer for Hooker Furnishings Corporation. Thank you Michelle. Good morning and welcome to our quarterly conference call to review earnings financial results for the fiscal 2023 third quarter, which began August 1, 2022 and ended on October 30, 2022. Joining me this morning is Jeremy Hoff, our Chief Executive Officer. We appreciate your participation today. During our call, we may make forward-looking statements which are subject to risks and uncertainties. A discussion of factors that could cause our actual results to differ materially from management’s expectations is contained in our press release and SEC filings announcing our fiscal 2023 third quarter results. Any forward-looking statement speaks only as of today and we undertake no obligation to update or revise any forward-looking statement to reflect events or circumstances after today’s call. This morning, we reported consolidated net sales of $152 million, an increase of $18 million or 13.6% compared to last year’s third quarter. The increase was attributable to the addition of Sunset West results as well as sales increases across all the other domestic upholstery divisions and higher sales of Home Meridian compared to last year, when container direct business was severely impacted by the temporary COVID-related lockdowns in Vietnam and Malaysia. The higher consolidated revenue was slightly offset by a $1.3 million or 2.4% sales decrease at Hooker Branded when comparing to record sales in the third quarter of last year. The company reported net income of $4.8 million or $0.42 per diluted share compared to a net loss of $1.2 million or $0.10 per diluted share a year ago. For the fiscal 2023 nine-month period, consolidated net sales decreased by $7 million or 1.5% compared to last year’s same period due to decreases in net sales in the Home Meridian and Hooker Branded segment, partially offset by higher sales in the Domestic Upholstery segment and in our H Contract business. Hooker Branded sales volumes decreased due to inventory unavailability primarily in the first quarter this year. Home Meridian's sales decrease was attributable to the absence of sales from the unprofitable Clubs channel, which we exited at the end of last year, as well as lower sales in the e-commerce channel and lower sales with some retailers who are delaying shipments to help rationalize inventory levels. We reported net income of $13.6 million or $1.14 per diluted share for the nine-month period compared to $15.7 million and $1.30 in the prior period. Despite macroeconomic uncertainties and a challenging retail inventory environment, we were grateful that many of the obstacles we faced last year were behind us and we were able to report revenue and earnings which both exceeded the prior year third quarter. Steady order backlog fulfillment, full production capacity, healthier inventory levels and operational improvements fueled these gains, which we expect to build and improve upon next quarter. Year over year profitability gains for the quarter were driven by sales growth and successful mitigation of supply chain bottlenecks that have impacted us for over the last two years. Improving our operational costs and exiting unprofitable businesses at HMI is beginning to show up in our margins and will continue to help improve profitability; however, economic indicators are mixed and there are potential headwinds, including rising interest rates, declining home sales, and consumer confidence. On a positive note, the recent fall High Point Market was the best attended market since the pandemic and gave us a real momentum boost. The Market attendance exceeded October 2019 by 12%. We found retailers to be upbeat and receptive to new products they can now expect to receive within several months of order for the first time in a couple of years. HMI debuted a remodeled 100,000 square foot showroom, including a 10,000 square foot area showcasing the new portfolio program featuring a breadth of in-stock styles of bedroom, dining, occasional and upholstery across HMI brands, which was very well received. The portfolio’s launch was a successful first step in expanding and diversifying HMI’s customer base to include interior designers and a greater number of independent furniture retailers. At Hooker Casegoods, we debuted the Charleston collection. The updated traditional styling and finishes were met with enthusiasm from retailers, who believe there is a void for timeless designs in the marketplace, a furnishing style that’s sought after by a significant set of younger consumers in their prime furniture buying years. This collection will be shipped before the next High Point Market in spring 2023, when we look forward to the grand opening of our new Hooker Legacy showroom encompassing an entire floor of the Showplace building in High Point. At Hooker Branded, net sales decreased by $1.3 million or 2.4% compared to the same period last year. The lower sales were driven by temporary inventory mix issues. Some vendor factory shipments were received in our warehouses as incomplete collections with missing items and retailers delayed receipt of orders until collections and groups get shipped completely. This issue has been resolved and we’re shipping more of our backlog now. Our Asian suppliers are improving their lead times and Hooker Branded inventories are now about $44 million higher than they were at the end of last year’s third quarter, positioning us well for the holiday selling season. Gross profit increased by about 100 basis points for the quarter, which partially offset that slight sales decline and higher SG&A expenses, which were up due to higher salary and benefits costs and higher commission rates, among other things. Hooker Branded reported $5.2 million in operating income and a 9.5% operating margin for the quarter. Incoming orders in Hooker Branded decreased as compared to the prior year quarter as the market is gradually returning to more typical levels of demand. The quarter-end backlog was lower than the prior year-end quarter but was still about three times higher than pre-pandemic levels in calendar 2019. Moving to Home Meridian, segment net sales increased by about $4.4 million or 9.4% as compared to the abnormally low volume in the prior year third quarter when container business was severely impacted by the temporary COVID-related factory shutdowns in Vietnam and Malaysia. In addition, the hospitality division reported strong sales as that sector continues to recover from COVID-related downturns. The sales increases were largely offset by the absence of the unprofitable clubs channel sales and decreased ecommerce sales. The exit from the clubs channel resulted in significant improvement in returns and allowances and gross margin. Ecommerce sales decreased mostly due to the normalization of post-COVID consumer demand. Gross profit and margin improved significantly due to the absence of excess charge-backs in the clubs channel and order cancellation costs when we exited the ready-to-assemble furniture category last year; however, HMI shipments were lower than expected due to mass merchant retailers with high inventories delaying some shipments. Due to deflated sales from delayed shipments and higher than expected transition and labor costs related to our new Georgia distribution center, HMI reported an operating loss of $3.2 million, a $7 million improvement from the operating loss in the prior year quarter. As expected, incoming orders and quarter-end backlog decreased significantly due to the absence of Club channel orders as well as decreased orders from our retail customers, who are delaying orders to rationalize inventories with current demand. In the Domestic Upholstery segment, we were pleased to report the seventh consecutive quarter of double-digit sales growth. Net sales increased by $14.1 million or 48% compared to the prior year third quarter. The increase was driven by the addition of Sunset West results as well as organic sales growth at each of the domestically produced factory divisions: Bradington Young, Sam Moore, and Shenandoah, which all delivered double-digit net sales gains for the quarterly and nine-month periods. Gross profit and margin increased due to the inclusion of Sunset West results, favorable sales variances, better overhead absorption on higher sales volumes, and near full operating capacity. These improvements were partially offset by increased raw material costs such as leather, foam and upholstery materials. For the third quarter, the segment generated operating income of $3.8 million and reported an operating margin of 8.8%. Incoming orders decreased compared to the prior year quarter due to current demand, long lead times, and high backlog, but year-to-date orders were about on the same level as calendar 2019. Quarter end backlog was lower than the prior year quarter end and fiscal 2022 year end, when demand was exceptionally strong and production capacity was constrained. Comparing to calendar 2019, backlog was more than three times higher than pre-pandemic levels. Turning now to our cash inventory and debt position, cash and cash equivalents stood at $6.5 million at the fiscal 2023 quarter end, down $62.9 million from the balance at fiscal 2022 year end due primarily to a $58.9 million increase in inventories as well as almost $10 million of share repurchases. During the fiscal 2023 nine-month period, we purchased and retired 598,000 shares of our common stock under the $20 million share repurchase authorization approved by our board of directors earlier this year. Through December 7, we’ve purchased 705,000 shares at a total cost of $11.2 million, and even while spending $11 million on share repurchases to date, we’ve been generating cash since last quarter. With lead times shortening as much as they have, we’re aiming to reduce inventories by $25 million by roughly this time next year, which will further enhance our cash position. To improve liquidity, we’ve also implemented some targeted promotions on certain products. On December 5, 2022, our Board of Directors declared a quarterly cash dividend of $0.22 per share, which will be paid on December 30 to shareholders of record on December 16. This 10% increase in the dividend is the seventh consecutive year in which we’ve been able to increase our annual dividend. We believe it demonstrates our continued confidence in our strategy and business model, and we believe our relatively stable balance sheet and variable cost business model will allow us to adapt to economic downturns that may be on the horizon. Other capital allocation priorities including rebuilding our cash reserves, fulfilling the remainder of our share repurchase authorization, and capital investments in our soon to be implemented ERP upgrade and other capital expenditures to improve our competitive position, such as outfitting the new Hooker Legacy brand showroom for its opening in April 2023. Current economic indicators are mixed and we are closely monitoring potential disruptors, including rising interest rates, consumer confidence, and a slowing housing market. At the same time, we see reasons for optimism as the U.S. enjoys healthy employment levels, rising household incomes, and continuing strength in consumer spending. Our backlogs on the legacy side are still much higher than pre-pandemic levels and our recent entry into outdoor furniture with Sunset West is performing above expectations. We believe the environment in the home furnishings industry is shifting from a reliance on historic demand to a dependence on market share, and we believe that many of our initiatives will help us gain market share, including the launch of portfolio and our new showroom next spring. Strategically, we believe we are well positioned to capitalize on this change. Despite our relative optimism, we are paying close attention to economic indicators and retail trends to ensure that our inventory planning and cost structure are appropriate to the short to midterm conditions, while continuing to invest in our longer term strategies. Typically our earnings calls focus on financial highlights; however, we are grateful as an organization to be in the position to support charitable organizations throughout the communities we live and work and where great needs exist. Most recently, we had the opportunity to partner with two key retailers in Florida to send over 1,200 beds and supplies to help with relief efforts for Hurricane Ian. This spirit of giving back is embedded in our culture and has been for almost 100 years. Our employees take this part of our culture seriously and dedicate a significant amount of their own time and resources to many of these efforts. We believe this is a key differentiator for us as a company, which is why I wanted to mention this in our call today. This ends the formal part of our discussion, and at this time I will turn the call back over to our Operator, Michelle, for questions. First on Hooker Branded, just wanted to get a better sense as far as the inventory mix issues. Any way that you guys could quantify what the impact was, and I know you said you’re shipping better in 4Q, so do you expect to get most of that back in 4Q, whatever you lost because of these mix issues, or do you think that will spill over into the first quarter of next year? I think we’ll get a lot of it back. We’re shipping considerably better than we were through most of the quarter. Jeremy? As far as quantifying, I think it’s a little tough to do, although I know that, for example, the category of furniture on hold due to waiting on other orders to ship, I believe was somewhere in the $5 million to $7 million neighborhood, so that’s kind of--that would probably be one number we could somewhat quantify. And yes, we’ve actually been in--it’s a weekly process at this point, and we feel like we’ve managed through it and we feel like we will get that back in the fourth quarter. Then I know you guys talked about the backlog being up overall versus pre-pandemic. Any way you guys could quantify what the consolidated backlog was at the end of the quarter, and how does that compare to the third quarter from calendar ’19? Then for Home Meridian, you said that some customers are delaying shipments. Obviously we all know that there’s a lot of inventory out there in the retail channel, so do you think these are mostly firm orders or could some of these get cancelled, and I guess what’s your view as to when you think that inventory levels at the retail partners that you’re dealing with--I mean, when do you think those will be more normal? First of all, the first part of the question, we do believe those are firm orders. We feel like we went through the process of rationalizing our backlog with all of our major retailers, and what we have left is solid, so that’s how we feel on that question. Secondly, a lot of that is starting, because there is a fairly decent retail environment going on out there. You can’t feel it on the order side because of what’s going on with inventories, but we are hearing that the inventories are starting to correct themselves to the level that it’s going to finally break through. We don’t really know, but we feel like it’s definitely getting better, kind of on a weekly basis. Okay, that’s good to hear. Then as far as the distribution center in Georgia, I know you talked about some labor costs and some inefficiencies there. When would you expect that facility to be operational as far as just the--from an efficiency standpoint, when should that be fully efficient to your standards? We feel like we’ll make significant steps at the end of the first and into the second quarter, and I think we’ll make more significant steps actually into the third quarter too because as we rationalize our inventory more and more on that side of the business, we’re going to be able to reduce our costs pretty significantly. Yes, we’ve already seen some improvement there. We’re not incurring a lot of excess freight charges for goods that haven’t been on time and stuff like that, so we’re starting to see that progress, and we just need to see continued efficiencies first. Then a couple more questions, if I could. As far as on the cost side, ocean freight costs have certainly normalized. As far as the other costs across the business, what are you seeing there, whether it’s labor or domestic transportation? Can you just talk about what you’re seeing there? I think the environment now is what I would call much more stable. Before, you were getting daily increases, whether it be foam, whether it be plywood, whether it be whatever you’re talking about, and now there’s a much more stable environment. To your point, obviously the freight--the ocean freight particularly is coming way down. Now as we’ve said, I think before, it’s difficult to quickly take advantage of that due to the fact we have the contracts in place and we’ve renegotiated a lot of our contracts, but that’s a continuous push from our side to realize the benefits of that lower ocean freight, on top of the fact that everything you shipped into your warehouse still had a lot of the higher cost. Then as far as your ability to gain market share, you talked about benefiting from portfolio, you’re moving to a new showroom next year in High Point. What are some of the other things that you think will enable you to gain market share? And also one of your competitors, Lane Furniture, just abruptly shut down. Just wondering if you think that could be an opportunity for you to also gain share from that. I’m going to start with the last part of that. Absolutely that category, there’s definitely a hole in the marketplace for what they were doing, and so yes, I think once--there’s a lot of product out there from them exiting overseas and factories and whatnot, that will be interesting getting through a little bit of a bottleneck in that, what they have going on over there. But after that, I believe there is an opportunity. As far as where we think we’re going to really take advantage of our growth opportunities, Sunset West is one big part of that. We acquired that company because we see this huge opportunity to put our operational scale on their business and be able to drive that east of the Mississippi - they were pretty west coast-centric, so we’ve been able to already expand that throughout the country. Also with Savannah, they’ll have a distribution model that’s freight-friendly, if you will, on that part of the country as well, so there’s a lot of opportunity in the outdoor category. Portfolio, you know, it’s going to take time, but we already had a really good High Point Market that we believe is going to turn into some pretty significant revenue on the HMI side and diversifying that customer base as well. Moving into Showplace, usually you say, well, you’re just moving into another showroom, but we’re moving into a showroom that’s going to give us a significant multiplier of audience that we haven’t had before. It’s easy to get in the mindset that, well you know, we’re a fairly large furniture company and all these customers know who we are, but being on the 10th floor in Commerce, where we were, did not enable us to--our visibility just wasn’t where we wanted it to be, so this is a real opportunity for us to really show a whole new audience who we are, which is a great opportunity and we believe it’s a great revenue growth opportunity. Then lastly, speed, we’re working on the time we get an order to how fast we can ship it and being in stock, and all the things that matter as far as getting turns, and we believe that’s going to have a significant impact to our revenues as well. [Operator Instructions] There are no further questions. I'd like to turn the call back over to Jeremy Hoff for any closing remarks. I would like to thank everyone on the call for their interest in Hooker Furnishings. We look forward to sharing our fiscal ’23 full year results in April next year. I hope everyone has a wonderful holiday season. Take care.
EarningCall_1538
Today’s opening remarks will be delivered by Rania Llewellyn, President and CEO, and the review of the fourth quarter financial results will be presented by Yvan Deschamps, Executive Vice President and Chief Financial Officer, after which we will invite questions from the phone. Also joining us for the question period are several members of the Bank’s executive leadership team: Liam Mason, Chief Risk Officer; Éric Provost, Head of Commercial Banking; Karine Abgrall-Teslyk, Head of Personal Banking; and Kelsey Gunderson, Head of Capital Markets. I would like to remind you that during this conference call, forward-looking statements may be made and it is possible that actual results may differ materially from those projected in such statements. For the complete cautionary note regarding forward-looking statements, please refer to our press release or to Slide 2 of the presentation. I would also like to remind listeners that the bank assesses its performance on a reported and adjusted basis and considers both to be useful in assessing underlying business performance. Rania and Yvan will be referring to adjusted resulted in their remarks unless otherwise noted, as reported. Earlier this morning, we released our fourth quarter and annual results for 2022, bringing an end to the first year of our three-year strategy. I’m extremely pleased to announce that we have exceeded all four of our financial targets for the year. We executed on our plan with a laser-like focus across the entire organization, which is evidenced by the strong results we issued today. We did this in a period of economic uncertainty and we are confident in our ability to deliver against any backdrop. We have a lot to be proud of as an organization, and on behalf of the management team, I would like to thank everyone at the bank for their ongoing dedication. We had strong net income growth this year, up 12% to $237 million. Top line revenue of $1.03 billion was driven by continued loan growth in commercial banking and complemented by cost discipline and our pivot to finding operational efficiencies across the enterprise. PTPP income was up 9% to $347 million compared to $319 million a year ago. On a full year basis, we exceeded our financial targets. Earnings per share were $5.19, up 14% year-over-year and above our target of greater than 5%. ROE was 9.3%, up 100 basis points from last year, exceeding our target of 8.5%. The bank’s efficiency ratio was 66.5%, down 170 basis points compared to 2021 and better than our target of 68%, and we delivered positive operating leverage of 2.6% while making foundational investments in our strategic priorities. This year also saw record deposit growth of 18%, which outpaced loan growth at 12%, exceeding a key objective to grow deposits in line with loans on a relative basis. We maintained our CET 1 ratio at 9.1% while supporting strong organic growth. Before I recap the year, there are a few highlights from the fourth quarter that I would like to share. First, as part of our strategy to leverage partnerships to deliver products to customers quicker, I’m excited to announce that within just one year, we have launched our newly re-imagined credit card experience. This meets a key objective of reducing the time to approval from 25 days to minutes and provides immediate access to a virtual card that can be added to your mobile wallet. We are launching this initiative to our employees first, followed by a phased customer rollout in the first half of the year. This is similar to the approach we used for digital account openings and allows us to gather feedback and ensure a seamless customer experience. Second, as part of our commitment to make a positive impact for our customers, investors, employees and communities, we published our inaugural sustainable bond framework. The framework was validated by Sustainalytics, a global leader in ESG ratings which found it credible, impactful, and aligned with international standards. Third, as part of our strategic plan, we have now subleased 50% of our corporate office space. This is a particularly significant achievement and highlights the ability of our team to execute in challenging market conditions. Turning now to our achievements over the past year, our year of execution, we kicked off our Investor Day last December identifying culture as our driving force. Guided by our new purpose and core values, we are a very different bank today than we were two years ago. We have adopted a work-from-home-first approach, introduced an employee recognition program, expanded mental health and wellness resources, and provided employees with new tools to work even more efficiently. Our employees are also feeling the positive momentum, as reflected in our reduced turnover rate and in the employee engagement score from our annual survey, which is up three points to 77%, surpassing our target of 75%. At our Investor Day, we said that commercial banking would be our growth engine. This year, we have seen tremendous commercial loan growth of $4.1 billion across our specializations, up 29% year-over-year. The strong growth in inventory financing led us to exceed our medium-term geographic diversification target, moving from 14% of commercial assets in the U.S. last year to 24% today. As part of our diversification strategy, we have also expanded into new industries such as agriculture and technology, where we have grown our dealer base by 27% and 210%, respectively, over the last year. This has all been underpinned by our continued commitment to deliver an excellent customer experience, as evidenced by improving our already excellent net promoter score in commercial banking. In December of last year, we said that our capital markets business offers a focused and aligned offering. Since then, we have been aligning our capital markets activities with core commercial lending capabilities. As a result, capital markets reached its target of 75% coverage of top tier commercial clients, which also led to year-over-year growth in our FX business, ending with a record quarter in Q4. In support of our strategic pillar, Make the Better Choice, we also participated in 100% of green and social bond issuances by our core clients. Personal banking continues to reposition for growth by closing key foundational gaps. This year, we met our objective of reducing time to yes for a mortgage from more than eight days in 2021 to less than three days. We did this by eliminating redundant processes and introducing new digital capabilities like e-signatures. In addition, we launched our renewed brand with a modernized look and feel and closed the top five digital pain points as identified by our customers. This includes our new mobile app, which was delivered in just seven months, tap-on debit, digital account on-boarding, self-service password reset, and a refreshed public website. We now continue to build on that momentum with our new credit card experience. To support our path to improved efficiency, we continued with our focus on cost discipline while also turning to net new cost optimization opportunities. In addition to the reduction of our corporate office space, a few other examples include: reducing excess data storage and associated costs, decommissioning redundant technology applications, and leveraging contract renewals to streamline the number of vendors and professional services providers. We also said that our strategy would be underpinned by a commitment to integrating ESG across the organization. In 2022, we launched the bank’s first ESG and TCFD reports, achieved our objective of moving to a low-risk ESG rating from Sustainalytics, and as I mentioned earlier published our inaugural sustainable bond framework. Each of these on its own is a tremendous accomplishment. To have completed all of this within one year is a testament to the skills and engagement of our teams and successfully closes our year of execution. Now as we enter 2023 with momentum on our side, our focus shifts to initiatives that will stimulate future growth. We intend on concentrating our efforts in three priority areas. First, delivering excellent customer service - we will leverage data from our NPS program to improve the customer experience and reduce pain points. Second, growing deposits - coming off a record year in deposit growth and having closed our top five digital gaps, we are well positioned to grow deposits by deepening our relationships with existing customers and targeting new ones. Third, driving efficiencies through simplification - while not always a straight line as we invest in growth initiatives, we will continue to drive down our adjusted efficiency ratio below 65% over the medium term by further streamlining our internal processes and operations. Notwithstanding an uncertain economic environment, I am confident that we have the right plan and the right team in place to continue to drive results and shareholder value. Merci Rania, et bonjour à tous. I would like to begin by turning to Slide 18, which highlights the bank’s financial performance for 2022. As Rania mentioned, total revenue for the year was $1.03 billion, an increase of 3% compared to last year. On a reported basis, net income and EPS were $227 million and $4.95 respectively. Adjusting items for the year amount to $10.5 million or $0.24 per share and are related to the amortization of acquisition-related intangible assets and charges related to our strategic review. Details of these items are shown on Slide 34. On a quarterly basis, as seen on Slide 19, total revenue was up 3% year-over-year mainly due to higher interest income stemming from commercial loan growth. EPS was $1.31 and ROE was 9%, up 24% and 150 basis points respectively compared to last year and up 6% and 30 basis points respectively compared to last quarter. Slide 20 shows the increase of net interest income by 6% year-over-year and a decline of 2% on a sequential basis. Net interest margin declined by six basis points compared to last quarter and 10 basis points compared to the second quarter, mostly for the following two reasons. First, as outlined on Slide 21, the speed and magnitude of the central bank’s rate increases have caused a temporary loan re-pricing lag of 10 basis points on our NIM since Q2; second, interest rate increases have cooled down the housing market, which along with the efforts of our customer loyalty team have reduced mortgage prepayment penalties. The reduction has negatively impacted NIM by four basis points since the second quarter, which has been offset by favorable changes in our business mix. The re-pricing lag headwind is expected to gradually bounce back when central banks stabilize rates. Slide 22 presents other income, which decreased by 5% compared to last year mainly as a result of volatile conditions unfavorably impacting financial markets-related revenues, including fees and securities brokerage commissions and income from mutual funds. On a sequential basis, other income was up by 3% fueled by a better performance in fees and securities brokerage commissions as well as card service revenues, partly offset by lower income from financial instruments. As a result of strategic investments to close key foundational gaps and support growth, non-interest expenses as shown on Slide 23 increased by 4% compared to last year. This was in line with our previous guidance that investments to close foundational gaps, as well as increased business development and advertising activities would continue in the second half of 2022 as we execute on our strategic plan. Compared to last quarter, salaries and benefits were lower due to a one-time $2.9 million subsidy related to our U.S. operations, a favorable seasonal reversal related to vacation accruals, lower employee benefits as well as lower performance-based compensation. Slide 24 outlines our diversified sources of funding. Total deposits grew by 18% year-over-year, driven by our personal banking segment and was higher than the 12% growth of our loan portfolio, exceeding our objective of deposit and loan growth being in line. Sequentially, deposits were up by 2%. As you can see on Slide 25, we maintained our capital position at 9.1%, which was the same as last quarter, supporting our strong organic growth and in line with our stated objective of managing CET-1 around 9% considering the uncertain economic environment. Slide 26 highlights our commercial loan portfolio, which was up by over $800 million quarter over quarter with contributions from our specialized sectors and includes about $300 million in FX adjustments. When it comes to our commercial real estate portfolio, we deal with established tier one and tier two real estate developers with good track records. Rental construction is centered in major urban centers where demand remains solid and immigration levels are high. The LTV on our uninsured multi-residential mortgage portfolio and term loan portfolio remained low at 55% and 58% respectively. While the pipeline is still strong, we are starting to see a general slowdown of growth in this space and we remain confident in the quality of this portfolio. Slide 27 presents the bank’s residential mortgage portfolio. Residential mortgage loans were up 2% year-over-year as well as on a sequential basis. We maintain prudent underwriting standards and are confident in the quality of our portfolio, as evidenced by the high proportion of our insured mortgages at 56% and low LTV of 48% on the uninsured portion. Allowances for credit losses on Slide 28 totaled $201 million, a sequential increase of $8 million mainly due to commercial portfolio loan growth and a less favorable macroeconomic outlook. Turning to Slide 29, the provisions for credit losses was $17.8 million, decreasing by $7.1 million from a year ago and was up $1.2 million sequentially. The year-over-year decrease was mostly due to lower provisions on performing loans as the bank had recorded a provision in the fourth quarter of 2021 as part of its strategic review. Sequentially, the increase was a result of higher provisions on impaired loans partly offset by lower provisions on performing loans. Slide 30 highlights the improving trends in gross impaired loans, which decreased by $93.2 million year-over-year mainly due to favorable repayments and write-offs of previously provisioned accounts in the commercial loan portfolio. Sequentially, the decrease was $1.3 million. We continue to manage our risk with a prudent and disciplined approach and remain adequately provisioned. For the year ahead, we are maintaining our medium term financial objectives; however, I would note the 2023 outlook on the following measures. We expect the temporary NIM re-pricing lag to gradually rebound once interest rates stabilize, all other things being equal. Our efficiency ratio will be higher in the first half of the year as a result of the continued pressure on our NIM and investments in key growth areas as part of our strategic plan, particularly as we launch our digital account opening solution and re-imagined Visa experience to customers. We expect to end the year equal to or less than 68% but are maintaining our medium term target of less than 65%. We dynamically manage our capital and resources to grow our business and support our customers, and as a result are targeting to remain close to or above 9% CET-1 ratio in 2021. Given the change in our business mix as we grow commercial banking, PCLs are expected to trend up in line with what we said at our investor day. In addition, in light of the weaker economic outlook, we expect PCLs to be in the high teens to low 20s for the year. We expect loan growth to temper next year as economic conditions continue to impact business and consumer spending. Overall loan growth of the bank in 2023 is expected to be in the low single digits. As a reminder, an LRCN interest payment is due next quarter which has an impact of approximately $0.06 on EPS. On a final note, I would like to thank everyone at Laurentian Bank for a great start and continued focus on executing against our strategic plan. On the capital side, what does that imply for RWA growth? I know we’ve seen quite a significant slowdown in sequential RWA growth for Laurentian Bank, and I’m wondering what the outlook is for 2023 from that perspective. Yes, so Meny, maybe I can take it from asset growth and then you can derive RWA, it’s theoretically a straight line. In 2022, we definitely experienced a year of exceptional growth, but we now have a level in terms of utilization rate at NCF in inventory financing which is roughly back to where it was pre-pandemic, and we also, as I mentioned a few minutes ago, see some signs of a slowdown in real estate. So the last point I would add on this is we have economists now guiding to about no growth in terms of GDP for 2023, both in Canada as well as in the U.S. So this year, considering the continued uncertainty, that’s why that we’re leading to low single-digit asset growth for the overall bank, so that still means probably low single-digit growth for the commercial banking, remaining prudent in the current environment as well. In 2023, we will continue to balance the growth with the profitability, but also remaining prudent in terms of capital, so the growth I just gave you, you can probably relate that in terms of RWA. Okay, thanks so much. And then just sticking to capital, can you just remind us the impact that the CAR 2023 requirements, what that will do for capital at Laurentian? Yes, it’s a good question, Meny. So we’re still working on it because it’s pretty complex in terms of revisions and changes and assessments that we need to do, but what I can give you is the following. There is in fact two things that we’ll need to manage over the next two quarters, and maybe I can provide some guidance for capital related to those. So the first one is it’s an industry-wide adjustment in Q1 for the transitional ACL treatment that has been put in place by OSFI at the start of COVID, so the last 25% adjustment is factored in fact in Q1, so we expect probably six or seven bps of capital related to that. But just to go back to your Basel III reform question for the second quarter, at this point, as I mentioned, we’re still computing the impacts, but based on the asset mix that we have, we do anticipate a slight negative reduction in terms of capital, but overall we remain confident with our guidance that we want to remain around 9% for 2023 despite potential quarterly variations. What’s driving that potential negative impact? Certainly, we know there is pluses and minuses, but what specifically is likely to impact the bank? Yes, it’s a good question, Meny. If I keep it really, really high level and simple, it relates to the commitments and our asset mix in terms of real estate assets, so we have a good portfolio and a strong portfolio in that segment, but it definitely is slightly negative in terms of the new CAR. Got it. And then just one last one for me, just in terms of the tax rate, it came in lower than what we’ve typically seen, so just wondering about what we should think about for the tax rate in ’23. Yes, the tax rate in terms of this quarter came in roughly in line with last quarter, pretty close to last quarter. What I would guide you for 2023 is probably stay in the same waters, so 15% to 16% in terms of tax rate would be what we’re looking at right now. I have a couple of questions related to deposit growth, and I think a couple observations here. First off is noticed strong growth in demand and noticed deposits for Laurentian, I think, up 7% Q-over-Q while term deposits were actually down 1% Q-over-Q, and that would mean effectively the opposite of what we observed with the bigger banks. So maybe you can talk us through why better growth in demand and noticed deposits, which is obviously a positive but just wondering what’s driving that. Yes, it’s a good question, Paul. And we’re really, really pleased with the performance that we had in terms of deposits in 2022. And as you can see, we’ve been growing deposits by 18%, the loans grew by 12%, and half of that growth was in demand deposits and the other half in term deposits. So the growth in terms of demand deposits came from a few things. So we did do a lot of efforts in our retail network to go and grab additional customers. We got good traction of that in terms of term deposits. We’re also rebuilding and building and launching to the customer the on-boarding, the digital on-boarding checking account that we’re going to launch over the first half. That will also help us continue on that trend of getting checking account, deposit account, demand deposits from a customer perspective. The other big factor is that I mentioned a few times in the last few quarters, we did put a lot of emphasis in building new and enhancing deposit relationships that we’re having, and that did generate a lot of growth on the demand deposits. So tribute to the team that’s been managing all of this because it’s been a great accomplishment for the year. Okay. And then if I think about the last part of that answer, I’m assuming that implies growth through the broker channel. What kind of assumptions should I make regarding those demand deposits, just from a cost perspective, maybe cost more on interest expense versus demand deposits from the branch, but lower cost versus term? Is that fair? It’s a fair assessment, but I’d just like to add a few comments, right? It’s not like the broker term deposit, it’s really relationships that we put in place with partners and it’s mid-term to long-term relationships that we’re putting in place. So it’s not like demand deposits that will come in and go out the next day, it’s really things that we envision that we’re going to keep in place for the years to come, so it’s really stable funding that we went and grabbed out of those relationships, and we thank the partners to trust Laurentian Bank and we’re looking after additional ones in 2023. Yes, so Paul, just to add - it’s Rania, good morning. So just in terms of what Yvan was saying, we’ve been leveraging our entire network, our various relationships, our vendor relationships and our various partnerships to drive a lot of those deposits. And so, we’re delighted by the success of that and that’s going to continue to be a core part of our deposit gathering strategy, while now we’ve filled in all of our foundational gaps in the personal bank and are repositioned for growth. So really well positioned for continued growth. Final question for me, another observation sort of related to NIM, if I look at the breakdown of interest expense for the quarter, there is this other category there and it came in at $40 million this quarter versus $5 million last quarter, and I think sort of a typical run rate looks more like one to two, so just wondering what explains the significant jump this quarter. Paul, I’ll be transparent - I don’t have the explanation upfront, so what I’ll do, I’ll do a follow-up with you after the call, just to make sure I give you the right information. Hi, good morning. First question on the lag between the loan and deposit re-pricing, can you maybe put some numbers around the duration of loans and how that differs from deposits, just to better understand that lag? Yes, thank you for that question, Gabriel, because I think we definitely need to provide more explanation around this to give you the comfort that we have in seeing that coming back to us. The first thing I would start by saying, we finished the year at 184% in terms of NIM and we had guided a year ago 185, so we’re pleased with the performance for the overall year. That did happen despite many rapid and sharp rate increases in second half of the year, and that did generate what we identify as temporary loan re-pricing lags. We added a graph in the presentation - I’m sure you probably saw that, where the 10 BPs really stand out, and what I’d like is just to explain a few examples--in fact, divide that in two categories and you’re going to see our comfort of why we expect it to come back. Both explanations probably are roughly half of the 10 BPs, so the first one is the industry-wide prime and CDOR spread, and that one has been discussed over the last week, but we all know that CDOR moves on anticipation of the rate increases while the prime waits for the actual increase by Bank of Canada, so as we see rates stabilize, we should see the prime catching up to the CDOR and we should revert back closer to near historical levels. If I give you data, which is pretty interesting because if you look at prime to CDOR one month, the first half had an average spread of 191% while the second half of the year at 165%, so that’s quite a big gap. Historically we would expect to be at around 1.9% plus or minus 10, so definitely the second half has been pretty much impacted by this. The second portion is also very important to understand, is that we do have some products where the rate increase on variable loans are passed to the customer the next month of the rate increase or the following payment of the rate increase, so this one is pretty much automatic. As the rates will stabilize, we’re going to see that catching up, it’s just that over the last six months, we’ve seen so many rate increases that we couldn’t catch up the increases yet. But as you see from what the market expectations are and pretty much based on the comments we got from Bank of Canada, it seems that we’re going towards rate stabilization, and that will allow us to get that back. What’s interesting to really understand of that 10 BPs is we don’t need to pass additional spreads or re-paper agreements with the customers. Those will come back by the fact that the rates will stabilize, and if we’re able to pass the spread to the customers, that will in fact be an additional increase and improvement on the NIM. We’re not betting on that, we’re just at this point telling what we expect in terms of that 10 BPs to come back once the rates stabilize. On the capital front, I just want to get maybe an understanding as to why the RWA inflation was so low this quarter - I mean, we had nearly 30% year-over-year growth in commercial loans and over the past year, RWA inflation has been 40 to 60 basis points a quarter and this quarter it was half of the low end of that, so 20. Was there any mechanical reason for that? Just if you can help me out there. Yes, in fact I can take it from again from a capital focus and give you as well some guidance and explanation. We’re pleased with the current capital level that we have. We constantly manage the capital on an ongoing basis, so we’re pleased with the capital management this quarter. It’s really shown that we can manage capital while still growing the bank, so I think that’s a clear message and something we’re really proud of. One element that did not necessarily impact RWA but did impact capital this quarter is about $300 million of the commercial growth and the inventory financing growth came from FX translation from the U.S. to Canada. Since we acquired NCS many years ago, give years ago, we’ve been hedging the capital impact of FX, so when the FX goes up or the U.S. dollar is strengthening, like we’d seen last quarter, there is no impact on that capital. That also explains how we’ve been able to manage this despite the strong growth in terms of capital, so Gabriel, that gives you some color. Okay, and then last one, the expense item, that $2.9 billion benefit there in the U.S. as well, I guess, just to confirm, that was not backed out of adjusted EPS? I’m wondering if that’s the case, why not? The first thing is that it’s a program related to the fact we sustained employment levels during the pandemic in the U.S., so we had access to a program and we took advantage of it. We kept it in core results because when the employees sustained the employment in 2020, we didn’t adjust the results either, so we took the expense and incurred the expense in the core expenses of the bank, so as we got this subsidy, we just used the same treatment while we did sustain the salaries in 2020 and ’21. Hi, thanks. Good morning. Just wanted to go back to that question on demand and notice deposits. If I look at one of your slides on medium term objectives for new bank account openings in the personal banking space, just wondering how you see that strategy helping with gathering sort of the lower cost deposits as we look ahead, and if there was anything this year that drove the result, I guess, in terms of not meeting that target this year. Thanks. Thank you very much for the question. Well, you saw that we had a record year in terms of deposit growth, so really appreciative about the 18%. It’s been extremely deliberate about growing the deposits. As we closed the top five digital gaps, we’re really well positioned to grow the deposits and deepen relationships with our existing and targeting new customers. The digital on-boarding will also have a strong value proposition [indiscernible] simplified product shelf which is going to support our deposit growth, and we have to remember that half of our customers only have one product with us, which is going to be a tremendous opportunity as we keep on growing. As you referenced the KPIs, we are proud to have been able to open more accounts this year than all of fiscal ’21. Our target was definitely ambitious and predicated on our digital solution being in place, and with digital on-boarding being in place for the next fiscal year, our medium-term target remains achievable. Thank you, good morning. I wanted to turn to your interest rate sensitivity disclosure. I noticed there for a 100 basis point increase in rates, the expected benefit is about $3 million to net interest income. Now, that implies margin expansion about two to three basis points, and this quarter end we’ve already had a 50 basis point increase by the Bank of Canada, so is that the right way to think about it, that we should expect a few basis points of margin expansion from here on out, based on that disclosure? Yes, thank you for your question, Nigel. Maybe I can just recap on that stress test but give you more guidance in terms of what we would expect from a NIM perspective at this point. As you said, the stress test tells us that for a rate increase, we’re going to see a benefit, and we remain positioned to take advantage of it. But that stress test is really at one point in time, and it does assume a parallel shift of the rate curve which is definitely not what we’ve seen over the last year and not what I would expect over the coming quarters. I think it’s probably good that I just recap a bit on the NIM side. As I mentioned previously, we’ve seen sharp and rapid increases that led to what I discussed with Gabriel a few minutes ago, the temporary loan re-pricing lag of 10 BPs, so other things being equal, as we will see the central bank stabilize the rates, we will see that coming back, so I think this is going to be probably the key factor to watch in 2023. We got good insights from the Bank of Canada recently and market expectations, expecting that to come back. We do remain prudent for the first portion of the year, though, because the markets are extremely volatile. If we look at last week versus this week, it seems to change on a daily basis, so we remain really, I would say, prudent for the first six months, but we should see in 2023 gradually bouncing back that famous temporary loan re-pricing lag. So just to clarify that point, since we’ve already had a 50 basis point increase, do you still expect despite the recent rate increase to fully recover the 10 basis points, or could you size how much of the 10 basis points in re-pricing lag do you expect to recover by the end of 2023? Yes, so at this point it’s tough to say because, as I mentioned, the markets are still volatile, but as the rates stabilize, which we would at this point, based on the comments of the Bank of Canada and the markets, we should see that in second half of the year. We should expect most of the 10 BPs coming back in that period. We just remain prudent for the first half because there is still a lot of volatility out there. Okay, so then just switching to credit loss provisions, just trying to get a sense of provisions for performing loans. I understand you have that provision build in the quarter last year. I would think that that was just a true-up of provisioning at that point in time and since then you’ve had revisions to your forward-looking indicators, and this quarter you had a pretty substantial negative provision, especially just to the GDP outlook, so just trying to get a sense of why did that provision you took last year offset the provisions this quarter? I thought that would be a buffer against provisions in the proceeding quarters this year. What was it particularly about this quarter that created that offset? Maybe just to be clear on our side, Nigel, do you mean any text that you’ve seen in the MD&A, because there is not really an offset of the provision we took last year - it did not really impact the results this quarter, so if you could just be precise. Okay, sorry. I thought--okay, maybe I misread some of your comments. Maybe I’ll just phrase it differently. What led to lower provision this quarter versus the last quarter, because there was a pretty substantial downward revision in your real GDP outlook, so was there some sort of management overlay offset that lower provision, given that FLIs were unfavorably revised, both higher unemployment and lower GDP? Sure Nigel, maybe I’ll start. First off, it’s very important to note that we were one of the banks that was very prudent, given the macroeconomic expectations, and we maintained provisions, and as you rightly point out, we’ve been disciplined over the past few quarters in establishing those provisions. Because we were prudent and positioned accordingly with our reserves, we were able to continue that discipline this quarter. I would say yes, the macroeconomic outlook is slightly more unfavorable compared to previous quarters, but our portfolio is holding up quite strong and the real driver behind our ACL increase is really the strength of our commercial growth, so I remain very comfortable with our provisions at this time. We continue to maintain that disciplined approach, and we’ll continue to do so. Okay. I noticed in your stage 2, there was an increase in the high risk category for commercial loans in stage 2. Any comments on what that increase was related to? Yes, I would note that, first of all, the overall portfolio remains solid, and we’re very disciplined around how we manage watch lists and migration. There is some migration, as expected, given the macroeconomic conditions, no specific sector is really driving it, and it’s really about maintaining our disciplined portfolio management approach. We tend to be preemptive with regards to watch lists and to get on top of the portfolio quickly, but as I said, I’m overall very comfortable with our portfolio at this time and the adequacy of our reserves. Hi, thank you. I wanted to touch a little bit upon the deposit strategy going into next year. I apologize for doing a little bit of math here, but I will take you to your annual report and if I look at Table 7 - this is on Page 34 of your annual report, I can see the change in rates for your deposits and, I think, calculate a blended rate for your demand and notice and your term deposits to sort of see what has happened year-over-year, and unfortunately I can only do this year-over-year with all of the big six banks’ data. When I do it for Laurentian Bank, your deposit costs on a blended basis, so blending the two together, basically was up about 29 basis points year-over-year. That is exceptionally good relative to what I see at the other banks - TD is 48 basis points, for reference, National is 52. I can look at CIBC - 75, and even BMO was 40, so. The reason why I’m doing this math is if you do look at that table carefully, the math also shows that the very big increase in rates that occurred for you in the deposit side was actually the demand and notice, and that’s without having the digital solution in place to gather up deposits in the new year, and you’re looking at 30 times more account openings and I’m envisioning a situation here where you have a lot of account openings and you have promotional rates and so on, so is there some level of NIM suppression that we should assume because: A, you have all these account openings coming; B, you may need to compete against these other Canadian banks that may be offering high deposit rates, so maybe if you can just walk me through a couple of those thoughts as we think about an aggressive deposit gathering campaign in 2023. Thank you for your question, Darko, and happy that our deposit performance pleased you. I will take that as just a general comment. But if I just go back to our strategy for ’23, but in fact I should start with ’22, so I mentioned a few minutes ago that we’re really pleased with the performance we had, not in terms of just numbers but in terms of the relationships that we’ve been putting in place, and that one factor that you did not specifically mention is that it did allow us to replace broker term deposits with demand deposits and long and stable at lower rates, so definitely that plays out in terms of the deposit rate that we’ve been paying overall. That strategy has been working extremely well in 2022 and we’re really exceptionally pleased with that result. In terms of 2023, we intend to go out with the new digital on-boarding feature to the customers. First, that will allow us to go and grab customers outside the province of Quebec, where we have retail branches, and if you want to open an account right now, that’s where you need to go - you need to go to a branch, so that will allow us to grab additional customers outside Quebec. We’re not going out with a strategy of very high rates, we’re going out with getting great products, great features for checking accounts, savings accounts, so we expect those accounts to not have an exceptionally high rate, so we will intend to continue the discipline we have on the deposit side and we intend to continue growing the demand deposits at lower rates, based on the new features that we’re putting in place. As we build out on the relationships that I just mentioned a few times on the call, that will continue to allow us to reduce dependence on the higher rate broker term deposits. Okay, thank you very much. I do look forward to seeing the strategy in play, and perhaps we can take this offline, I’d like to discuss maybe a few other small technical aspects of that. Thank you very much. Thank you, that’s all the time we have for questions today. I would now like to turn the meeting over back to Rania. Thank you all for your questions today. In closing, we have had a tremendous year executing against our plan, and I’m extremely pleased that we exceeded all of our financial targets in this first year of our three-year strategic plan. Our solid results speak to the strength of our underlying business, our ongoing focus on cost discipline, our prudent approach to credit, and our continued efforts in executing against our plans. We remain focused on maintaining our healthy liquidity and capital levels. I would once again like to thank all Laurentian Bank team members for embracing our new purpose and living our core values as one winning team as we enter 2023 with momentum on our side. I would like to wish everyone a happy holiday season, and we will talk to you again in the new year. Ladies and gentlemen, this concludes your conference call for today. We thank you for joining and ask that you please disconnect your lines. Thank you.
EarningCall_1539
Ladies and gentlemen, thank you for standing by, and welcome to the RH Third Quarter Fiscal 2022 Earnings Conference Call. I would now like to turn the call over to Allison Malkin of ICR. Allison Malkin, please go ahead. Thank you. Good afternoon, everyone. Thank you for joining us for our third quarter earnings conference call. Joining me today are Gary Friedman, Chairman and Chief Executive Officer; and Jack Preston, Chief Financial Officer. Before we start, I would like to remind you of our legal disclaimer that we will make certain statements today that are forward-looking within the meaning of the federal securities laws, including statements about the outlook of our business and other matters referenced in our press release issued today. These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially. Please refer to our SEC filings as well as our press release issued today or a more detailed description of the risk factors that may affect our results. Please also note that these forward-looking statements reflect our opinion only as of the date of this call. And we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events. Also, during this call, we may discuss non-GAAP financial measures, which adjust our GAAP results to eliminate the impact of certain items. You will find additional information regarding these non-GAAP financial measures and a reconciliation of these non-GAAP to GAAP measures in today's financial results press release. A live broadcast of this call is also available on the Investor Relations section of our website at ir.rh.com. Great. Thank you, Allison, and thank you, everyone, for joining us today. I will start with our prepared remarks from our shareholder letter to our people, partners and shareholders. We're pleased to report better-than-expected results for the third quarter with net revenues of $869 million versus $1.006 billion a year ago and up 28% versus third quarter 2019 net revenues of $678 million. Gross margin contracted 50 basis points in the third quarter, primarily due to fixed occupancy deleverage, partially offset by an increase in product margins as we continue to resist promoting the business. As previously mentioned, widespread discounting continues across our industry. And while it's been almost two years since we've deployed a promotional e-mail, we've been receiving two sale e-mails per day for many home furnishings retailers. Although the stark contrast in strategy may lead to a short-term risk of market share loss, we believe there is certain long-term risk of brand erosion and model destruction for those who choose the promotional path. It’s that discipline and long-term thinking that has enabled us to set new standards for financial performance in the home furnishings industry and our results now reflect those of luxury brands as we delivered 20.8% adjusted operating margin in the third quarter, also exceeding our outlook despite the dramatic slowdown in the housing market. Our results are inclusive of investments related to the launch of RH Contemporary, the opening of our first RH Guesthouse, the development of RH International and the rollout of RH In-Your-Home, which led to approximately 200 of the 640 basis points of adjusted SG&A deleverage in the quarter. Additionally, we experienced adjusted SG&A deleverage due to lower revenues versus a year ago. Our business generated $102 million of adjusted free cash flow in Q3, ending the quarter with $12.5 billion in cash on our balance sheet -- $2.15 billion in cash on our balance sheet, total net debt of $375 million, and trailing 12 months adjusted EBITDA of $1 billion. Fiscal 2022 outlook. As noted in our previous shareholder letter, we expect our business trends will continue to deteriorate as a result of accelerating weakness in the housing market over the next several quarters and possibly longer due to the Federal Reserve's anticipated monetary policy and the cycling of record COVID-driven sales and backlog reductions. Based on our current trends, we now expect fiscal 2022 revenue growth of negative 3.5% to negative 4.5% versus our prior outlook of negative 3.5% to negative 5.5%, and adjusted operating margin in the range of 21.5% to 22% versus our prior outlook of 21% to 21.5%. While we expect the next several quarters to pose a short-term challenge as we cycle the extraordinary growth from the COVID-driven spending shift and shed less valuable market share, we believe our long-term investments will enable us to continue driving industry-leading results. RH business vision and ecosystem, the long view. We believe, there are those with taste and no scale, and those with scale and no taste, and the idea of scaling taste is large and far reaching. Our goal to position RH as the arbiter of taste for the home has proven to be both disruptive and lucrative, as we continue our quest to build the most admired brand in the world. Our brand attracts the leading designers, artisans and manufacturers, scaling and rendering their work more valuable across our integrated platform, enabling RH to curate the most compelling collection of luxury home products on the planet. Our efforts to elevate and expand our collection will continue with the introductions of RH Couture, RH Bespoke, RH Color, RH Antiques & Artifacts, RH Atelier and other new collections scheduled to launch over the next decade. Our plan to open immersive Design Galleries in every major market will unlock the value of our vast assortment, generating revenues of $5 billion to $6 billion in North America and $20 billion to $25 billion globally. Our strategy is to move the brand beyond curating and selling product to conceptualizing and selling spaces, by building an ecosystem of Products, Places, Services and Spaces that establishes the RH brand as a global thought leader, taste and place maker. Our products are elevated and rendered more valuable by our architecturally inspiring Galleries, which are further elevated and rendered more valuable by our interior design services and seamlessly integrated hospitality experience. Our hospitality efforts will continue to elevate the RH brand as we extend beyond the four walls of our Galleries into RH Guesthouses, where our goal is to create a new market for travelers seeking privacy and luxury in the $200 billion North American hotel industry. Additionally, we are creating bespoke experiences like RH Yountville, an integration of Food, Wine, Art & Design in the Napa Valley, RH1 and RH2, our private jets, and RH3, our luxury yacht that is available for charter in the Caribbean and Mediterranean where the wealthy and affluent visit and vacation. These immersive experiences expose new and existing customers to our evolving authority in architecture, interior design and landscape architecture. This leads to our long-term strategy of building the world's first consumer-facing architecture, interior design and landscape architecture services platform inside our Galleries, elevating the RH brand and amplifying our core business by adding new revenue streams while disrupting and redefining multiple industries. Our strategy comes full circle as we begin to conceptualize and sell spaces, moving beyond the $170 billion home furnishings market into the $1.7 trillion North American housing market with the launch of RH Residences – fully furnished luxury homes, condominiums and apartments with integrated services, that deliver taste and time value to discerning time-starved consumers. The entirety of our strategy comes to life digitally with The World of RH, an online portal where customers can explore and be inspired by the depth and dimension of our brand. Our authority as an arbiter of taste will be further amplified when we introduce RH Media, a content platform that will celebrate the most innovative and influential leaders who are shaping the world of architecture and design. Our plan to expand the RH ecosystem globally multiplies the market opportunity to $7 trillion to $10 trillion, one of the largest and most valuable addressed by any brand in the world today. A 1% share of the global market represents a $70 billion to $100 billion opportunity. Our ecosystem of Products, Places, Services and Spaces inspires customers to dream, design, dine, travel and live in a world thoughtfully curated by RH, creating an emotional connection unlike any other brand in the world. Taste can be elusive, and we believe no one is better positioned than RH to create an ecosystem that makes taste inclusive and, by doing so, elevating and rendering our way of life more valuable. Climbing the luxury mountain and building a brand with no peer. Every luxury brand, from Chanel to Cartier, Louis Vuitton to Loro Piana, Harry Winston to Hermès, was born at the top of the luxury mountain. Never before has a brand attempted to make the climb to the top, nor do the other brands want you to. We are not from their neighborhood, nor invited to their parties. We do have a deep understanding that our work has to be so extraordinary that it creates a forced reconsideration of who we are and what we are capable of, requiring those at the top of the mountain to tip their hat in respect. We also appreciate that this climb is not for the faint of heart, and as we continue our ascent the air gets thin and the odds become slim. We believe the level of work we have introduced this year, inclusive of RH Contemporary, The World of RH, RH San Francisco, RH 1, 2, and 3, as well as the opening of our first RH Guesthouse in New York begins to demonstrate the imagination, determination, creativity and courage of this team, and our relentless pursuit of our dream. I mentioned at the start of this year that, in over two decades leading RH, I’ve never been more excited about our future and I’ve never been more uncertain about the present. Although my uncertainty regarding the short-term has expanded due to a complete collapse of the luxury housing market, my excitement for our long-term opportunity has grown exponentially as I believe the investments we are making to elevate and expand our product and platform will once again be transformative. As we look forward to 2023, we will introduce the largest collection of new product in our history across RH Interiors, Modern, Contemporary, Outdoor, Beach & Ski House, Baby & Child, and Teen. To amplify this historic launch, we will once again unveil a revolutionary new Gallery design, as well as redesign and remodel all of our current Galleries. We will be introducing RH to the UK and the rest of Europe this Spring/Summer in the most inspiring and unforgettable fashion with the introduction of RH England, The Gallery at the Historic Aynho Park, a 16th-century, 73-acre estate that will feature three restaurants; The Orangery, The Conservatory, and The Terrace plus The Aynho Architectural Library and The Deer Park, inclusive of the largest herd of White Deer in Europe with viewing from the Grand Lawn. We are also under construction on RH Paris, The Gallery on the Champs-Élysées, scheduled to open in 2024, and RH London, The Gallery in Mayfair scheduled to open in 2024, 2025. We have also secured locations in Milan, Madrid, Munich, Dusseldorf and Brussels, some of which will also open in 2024 and 2025. RH also announced today the following acquisitions and hires to accelerate the brand’s transformation and climb up the luxury mountain. The acquisition of Dmitriy & Co, a To-the-Trade custom upholstery atelier, and the hiring of Dmitriy founders, Donna and David Feldman, to create RH Couture Upholstery. The acquisition of the business of Jeup, Inc., a To-the-Trade custom bespoke furniture workroom, and the hiring of Joseph Jeup to create RH Bespoke Furniture. The hiring of Margaret Russell, former Editor in Chief of Architectural Digest and Elle Decor, to create RH Media, an editorial-content platform that will celebrate the most innovative and influential people and ideas that are shaping the world of architecture and design. Today’s announcements, plus our previous acquisition of Waterworks, firmly plant four RH flags at the very top of the luxury mountain, and clearly state our intention of establishing RH as an arbiter of taste and design. These brands and businesses, thoughtfully integrated and amplified on what we believe will be the world’s most innovative and dynamic global design platform, will begin to fundamentally change the landscape of the luxury home furnishings market and the To-the-Trade design industry. As we approach the holidays and New Year, I would like to express our gratitude to all of our people and partners around the world for your contributions and commitment to our cause, and for bringing our vision and values to life. It’s not easy striving to become the most inspiring brand in the world, and it’s surely not for the faint of heart. It takes courage to lead rather than follow. It takes collaboration to build a brand that can break through the clutter in this world. It takes teamwork to reach the top of a mountain no one else has attempted to climb. 20 years ago we began this journey with a vision of transforming a nearly bankrupt business with a $20 million market cap and a box of Oxydol laundry detergent on the cover of the catalog into the leading luxury home brand in the world. The lessons and learnings, the passion and persistence, the courage required, and the scar tissue developed by getting knocked down ten times and getting up eleven leads to the development of the mental and moral strength that builds character in individuals and forms cultures in organizations. Lessons that can’t be learned in a classroom, or by managing a business, lessons that must be earned by building one. Or, by reaching the top of the mountain. Happy Holidays Team RH, Carpe Diem. The floor is now open for your questions. [Operator Instructions] Our first question comes from the line of Simeon Gutman from Morgan Stanley. Please proceed. Hey, good afternoon, everyone. I wanted to ask a question about written orders in the third quarter. I don't know if you'll comment, but if you use that run rate as a proxy for the business, does that get worse? And then my question is that we now -- since you beat in the third quarter, we have a slightly steeper slope to the fourth quarter. Is that less backlog? Is it more macro risk? What's changing from third down to fourth? Maybe starting with the second part, Simeon. Look, in the beat in Q3, I think most of that I would characterize as just timing of sales from Q4 to Q3 not necessarily -- some of that is obviously relieving backlog faster than expected, but we had expected to relieve that backlog and continue to do so throughout the year. So look, I think on the year, we're still talking about $3.6 billion in sales. I don't think our sort of numbers changed materially in terms of that outlook, slightly steeper sure, but it's not kind of rounding error in a sense with all due respect. But I think it's pretty consistent with what we talked about before and simply just Q3 had some pull forward of sales from Q4 and a little bit of faster backlog belief. Okay. And then as a follow-up, maybe more for Gary, knowing that you're going to continue to invest for the future and still be somewhat responsible here for the near-term. Question is what -- are you looking at prioritizing things differently? Does anything get sacrificed, love to hear how you think about this, especially as the year keeps evolving with the Fed still tightening? Yes, we're communicating what we're doing. We believe everything we do is responsible. So I don't quite know how to answer that. Well, maybe this as the second part, which is, is anything getting sacrificed meaning or some of your longer-term investments putting on pause or no, and that's maybe that's just the right way to look at it. We're not putting any longer-term investments on pause. I mean, we're playing for the long-term. So we're not doing irresponsible things that other people are doing like promoting their business and selling. Sending, I don't know, 30 e-mails to a customer a week with sales time. So that, I think, might be irresponsible. But I guess it depends on your strategy. If your strategy is to stand for price, then maybe that's an okay strategy. Our strategy is to stand for design and quality and innovation. So it's positioned the company around product, not price. So I think we've been really consistent with our strategy. And as you think about priorities, we reprioritize all the time here. We like to say, you've kind of got to get going, get to know are we strategically right? Are we directionally right? We believe we're strategically and directionally right. We believe as we make the right long-term investments and build this business for the long-term, we'll become one of the few brands in the world that exist over a long-term period of time. So that's unusual in our industry. Most people build a concept and then they roll out 300 or 500 stores. And at the end of 10 years, it's an old concept. So we would like not to get old, and we like to continue to reinvent the business. And whatever the cycles are, if you look at it for us, if you look back at history, since I joined in 2001, there was a recession at that time, and we elevated the product and kind of transformed the brand. We did the same thing in 2008 and 2009, the financial crisis. We went through another cycle again in 2015, 2016, 2017, when we made the move to membership and rearchitect the back end. We also introduced Modern and continue to evolve and make the brand relevant and make sure we're leading the industry. And we think the work that has begun with the introduction of RH Contemporary, which will triple in size next year from an assorted midpoint of view. And the introductions we're going to make across the entire portfolio, but the new gallery design that we're going to unveil, and we'll go through and remodel and redesign all of our current Galleries and refresh all of those, as well as the platform we're building globally for the brand is going to once again transform RH and then put us in a position where we create massive strategic separation. So we're kind of comfortable being the others and going the other way. So a lot of people are hunkering down right now and slowing down. We're kind of speeding up. We're more excited, less fearful. I think we saw this coming. This is not a game that's the first time we've seen it. It's just different. But our moves over the last 22 years have been very consistent. I think we're pretty disciplined in the things we do. They're unusual. When we were opening 50,000 to 60,000 square foot stores, the rest of the industry was closing stores and shrinking footprints and trying to move all their business online. Now everybody is opening stores. And I don't know, maybe we're just a little bit ahead of everybody else. Great. Good afternoon. Thanks for taking my question. I wanted to focus on RH Guesthouse. The last time you're on the call, you talked about some of the initial interest. How has that performed the first three months that it's been open? What are some of the early learnings for the hotel? And do you see opportunity to open more of these concepts going forward? Yes. I mean we just opened. We think it's extraordinary. The feedback we're getting from our guests is incredible. The feedback we're getting on the restaurant has been incredible. And so we're just in early learning period. We're not -- I missed the first time we've ever done this. So far, we're really excited. We're going to be opening our Champagne & Caviar Bar soon. We've got our feet underneath on our new live-fire restaurant. And so we couldn't be more excited about it. I mean, the feedback from our guests is -- a lot of people are saying, gosh, how am I going to be able to get in long-term because it's just not that many rooms. But we're excited -- it's going to be learnings here that will help us evolve and make ad spend better and yes, so on and so forth. So, this is just very early, big test. It's kind of a small thing in a very big organization that if it becomes a big thing long-term, great. But right now, it's really positioned to be something that helps redefine the brand and have people look at us differently. So, I think it demonstrates the kind of creativity and passion and attention to detail to do something extraordinary. People from the hospitality industry have come and seen it and toured it. Luxury CEOs that have come and toured it, said they haven't seen anything like it anywhere in the world. So, we just let it kind of unfold here. Okay, great. Very helpful. The other question I had was on gross margin. So, the first quarter of the business has seen a decline, obviously, on occupancy deleverage. But as we look forward is that the likelihood that you probably see gross margin decline again in the fourth quarter? How should we think about the trajectory from here? Yes, I think, look, when you look at the sequential just change in our absolute sales. So, when we went from revenue in Q2 of $992 million and gross margin of 52.8% million and going to $869 million in Q3 and 49.7%. As Gary mentioned, a lot of that is occupancy deleverage. So, -- and if you think about Q4, there's a further sequential decline, right? Q4 is a smaller quarter for us. So, at the midpoint of the guide, we're at $789 million. So, if you do -- if you just -- we were not guiding gross margin, but if you do sort of like similar sort of math and transposition of numbers going from Q3 to Q4, as you did from Q2 to Q3, you'd naturally see a gross margin decline built into that because, again, the absolute sales are lower than Q3. So, it's just math. I mean, directionally, probably 100 basis points-ish, but again, we're not officially guiding gross margin. It's just a correctional number. Yes, I would just say, look, if you look at the housing industry and track the housing industry and if you track the performance of home furnishings retailers against past housing downturns, that would tell you things are going to get worse before they get better here. The housing industry is in a free fall. I think the National Association of Realtors just reported that housing demand was down 37% in October. We've never -- at least in my lifetime, I've never seen interest rates rise so quickly. I don't think anybody on the phone has either and the impact on the housing market, especially when you look at it versus the housing market that was overinflated and run up by COVID, you're going to have some wild swings here. And it's happening first to the luxury market. If you look at the numbers and if you track the last, yes, nine months or the reporting on Redfin, I think it started -- the luxury housing market started going down in the Q4 last year. And the luxury housing market went up faster and higher, and the luxury housing market is going to go down faster and lower. And that's just an outcome. And so the question is, there's going to be people that rode it up and they're going to try to stay up and they're going to promote their business, and I think they're going to break their models. And next thing you know, you got to send out 1,000 e-mails to let next year, too, and you're just going to what I call the downward spiral. We're in the dish. And so we've kind of expected from the beginning that this COVID lift wasn't anything that we manufactured. And generally, when that happens, those kind of things go up and then they go down. And you try to stay focused on the long-term. But we're not going to try to break our model to try to and promote the business in a period. I mean, we -- we have people that are in our industry right now that has some pretty good sales. Their whole website is 30% to 40% off. If I put our whole website, 30% to 40% off, we changed the sales trend by 50 points. Problem is you're just going to have a much less productive business, because doing more volume and lower margins and all that volume also creates costs that are inefficient through a model. I've already run companies like that. So yes, we have a different model. Someone asked me the other day, 'Hey, what if you're wrong on your long-term view? What if the market is not $25 billion? Right? Okay. What if it's not? What if it's half that? What if it's $12.5 billion? And we have 30% EBITDA. I don't know that directionally looks like some other people like Hermès, and people like that, like, I mean, their EBITDA is higher than that. But we've been a ZIP code where this company would be worth a lot of money. And so whether we become $12 billion or $25 billion, it's not really what's most relevant is do we get there. And do we become really the first integrated luxury home brand in the world. And that's just going to be a different path than anybody's taking, because no one's ever done it. So there's going to be some ups and downs here. But the housing market has been a free fall, and it's going to get worse before it gets better. So far, we've been more right than wrong about that because we don't really try to lead our business based on hope. We try to run our business the best we can based on back facts and math and logic and patterns. And so I may not sound really optimistic right now short-term. I'm not. I'm super optimistic long-term. So if you want to play a short-term stock, don't play ours. Do you want to invest for the long-term, this is a good place to put your money. Great. Thanks a lot. So the way that you're seeing your margins play out over the past couple of quarters with upside, both 2Q and 3Q, does that give you more confidence in keeping at least 20% EBIT margins next year if the environment remains challenging? And then just more broadly, how are you thinking about the durability and margin power of the business today given some of the moves that you've made recently? It depends on our -- that always going to depend on your investment and your investment timing. Our underlying core business -- if we wanted to, yeah, we can crank it all back and stay at 20%. I'm not sure that's a long-term priority. I don't know how bad this market is going to get. And we don't want to promote the business over the short-term to try to create some short-term outcome that's going to be a relevant two quarters after that. So there's going to be a lot of decisions to make, really difficult environment for those of us in the home industry. And especially if you're at the higher end, it's more challenging. And for some people, it's not intuitive. But you've got to think about it. With the greatest migration of people moving from cities to suburbs in the history of America during COVID and to second home markets. The people that did that could afford to do that. The people that move the most and bought the most homes were the luxury customers that have the capability to do that. That's why the luxury market went up so high and the housing market, the luxury housing market benefited the most, and we're going to have a flip side here. So look, we didn't -- all that extra money we made during COVID, we didn't waste it. And on the flip side, if we have a bigger give back, that's okay. If you look at every home furnishings retailer and look at where their operating margins were in 2019 when they entered COVID and where they exited in 2021, we had the highest operating margins going into COVID, amongst all of the furnishings retailers, and we exited with even higher margins than anybody else. We picked up more margin than we hit more strategic separation. So -- and I believe, as we should, our consumer move more, our consumer had more urgency. And in some cases, where other people promote it, maybe they got a little bit more top line than us but we just didn't promote. But it's like trying to act like, oh, this is a surprise. Now like -- I mean, the Fed pumped so much money into the economy. They created inflation. They held interest rates at such low levels, they made it easy for people to buy homes. Now we're on the other side of that. Quantitative easing, interest rates are up. We've got inflation. Who's seen this game before? Anybody on this phone, not unless you were in the market in 1975 to 1982. This is a whole new ball game that no one's even seen. We're trying to just look at the patterns and look ahead and say, what's the best way to play this, where we come out and we really are positioned for the next five to 10 years, not the next two to three quarters or even the next five or six quarters. That's not relevant long-term. Relevant long-term is what's the next five to 10 years is going to look like? And what are the decisions we're making today that are going to -- that are going to impact that vector, right, that helps us slightly more up and over the long-term makes a big, big difference. So that's how we're focused. We're not managing this business. We're leading this business, somewhere bigger and brighter and our journey is going to be a little longer. It's going to take a little longer. So there's going to be people that have patience and there's kind of people that don't have patience. We have patience. You need patience if you really want to be extraordinary in this world. Got it. It's really helpful. And then can you just separately speak to the customer reception to Contemporary. How is that going compared to your expectations? And then just any updates on the time line of the rollout to other galleries? Yes. We're very happy with the initial response. We wish we could get more product faster. It's two things, a lot of it got impacted by the supply chain backup, which are now just kind of all coming unlock. But also almost all of the new products is really new product that has never been made at scale before. So one of the things that is going to happen to us during cycles. This happened to us in 2008, 2009 when we kind of transformed the assortment in the business. It happened us in 2015, 2016 when we moved the Modern, and it's happened to us now. When we make these big moves and they're generally every seven or eight years because those are kind of the big cycles in our business. I mean trends can last 10 to 15, but there's generally -- I think every -- every brand needs a major refresh every seven or eight years. And so our just having to be timed to economic downturns. And a lot of that coincidental, quite frankly. In 2015, 2016, it wasn't really an economic downturn. We created somewhat of a downturn when we moved to membership because that was a kind of a year transition to do that. But when you bring in this much new product that the world hasn't seen before that no one's ever scaled Travertine furniture or Burl wood at scale, you can see pieces out there. Antique stores or some retailers have a piece or two, a couple of pieces. They don't have collections with 130 SKUs. And no one's out there making that stuff at scale. So we are going to constantly for the rest of time have to continue to build the supply chain capability that enables us to invent. I mean if you're going to invent something new and scale something new, it means it hasn't been done before. So, it can take longer, it's going to be bumpier. And it's the difference between leading a business, managing a business, invention and innovation versus duplication. So, -- and so I think we're going to go through the same thing with temporary. It's taken longer to scale this stuff. I mean we just got back from the quarries in Italy, meeting some of the best families and quarry owners and building partnerships for stone. And so we can make stone furniture at scale and we can have better economics and a better supply chain. We -- I mean, I don't know, two weeks ago, we went around the world for 10 days. I think we were in seven countries or something like that and -- in the factories and meeting with the factory owners and talking about scaling not only what they're scaling up now, but what's coming next, which is -- I mean, you've just seen the first little introduction of Contemporary. When you see what happens next year, it's extraordinary and revolutionary. I mean I think it's going to be -- we're going to own this entire kind of esthetic and look and be no different than how we approach 2008, 2009, when we took kind of the European Belgian kind of aesthetic and we went out there and owned it and did it at scale. And it became kind of the RH Look in the industry. And then we didn't just dabble and modern. We launched with a 450-page book or something like that. 545-page book, yes, 545-page book. And you have bumpiness on getting the supply chain up on both of those, by the way, but we wind up building a $1 billion business at a Modern. I think Contemporary is going to be the most extraordinary thing we do. So, you've seen like the first kind of -- the first course of the meal. There's, call it, a four-course meal. And next year, there'll be two more big courses and there'll be another big course in 2024. And by 2024, I think we'll have it rounded out. But it's going to be -- I think it's going to be the most extraordinary thing we've ever done. So, we're really excited about it. I wish we had more goods right now, which we could roll it out to more galleries right now. But so far, every dollar we put it in, there's been really good response, and we're really excited about getting into more galleries. Great. Thanks very much for taking. So, maybe kind of one longer term question then a quick model one. So, first, Gary, I'd love to talk about the acquisitions and kind of how much the step-up you're high in trade and interior design business for us kind of a little less than a no and how big an opportunity from a revenue perspective, you could see? And then just as a follow-up, I just wanted to clarify that comment, kind of loosely made about 20% margin next year if you pull back investments, maybe I misheard, but just if you could clarify what you were talking about there? Yes, I think -- yes, as you think about the high-end design and trade, how big is the revenue opportunity. The people at the very top of the mountain own the most homes, not only do they own the most homes, the homes are more expensive. On average, someone spends about 10% of the home costs on furnishings, decor and art, right? So when they buy nicer homes, they buy nicer furniture. They furnished the whole house. They have multiple houses. And so that's the most lucrative part of the business. It will be the most profitable part of the business. It has the most leverage. You make the most money there. So we think it's really important strategically. And we went out and met who we believed had the best reputation and quality and design in upholstery and the same in kind of case goods and furniture. And they're big believers of trying to scale this level of quality and design. And so we're really excited about it. It's going to take a while. We've got to get it up and going and test it and see how it goes. We've got to figure out exactly how it's integrated. But the long term -- yes, I would just say probably today right now, there's a bunch of people in the high-end trade industry that just kind of said, WTF. And then like now what is going to happen. And this is a big move for us strategically. But we've got to build capability. There could be other acquisitions to build capability here. And you think about the investments we're making, building a media platform and a content editorial platform that will position the brand as an authority in the industry. I'm not speaking about ourselves, speaking about the people who are really shaping the world of architecture and design. We want to become an authority and a voice in that. So you don't really do that by talking about yourself. You do that by talking about other people. And so we're just going to taking a different path and to build a different market. We're going to continue to evolve and change. I mean not too different. If you think about Apple, right? I mean, Apple, I mean, they started pretty high up with a $400 phone or something we started out. And what's the latest Apple phone like $1,100 or something, $1,200? Yes, I mean, they kind of created a high-end market for phones. But I think the average phone back then was like $69 in Motorola Razr or something. So I think we're -- one, we're not just going after a market and how big is the revenue opportunity there. We're also going to create a market because that product at that level of the market is not accessible. You can't go into those showrooms. The goods aren't priced. You're kind of blind and you have to go through a middle person to even to have quality of -- that quality and that design. So we think it's going to be a big unlock just starting to make that level of quality and design available. We think we will grow the market. We think it will be a big, big plus to our brand to get us into those customers' main rooms. I think today, we mostly play in the family room, the second bedroom. I don't know we get that customer's living room, master bedroom, main house. I think it's just going to open up a lot of opportunity. But lot to test, lot to learn, lot to figure out. We thought about it for a long time. We've worked on this for a long time. Today, we decided to tell you officially that we're doing it before everybody knows. We're super excited about the talent. It's also -- what I'd say is the talent acquisition, too. I mean these people are just incredible culturally, creatively, entrepreneurially just incredible, incredible talent. We've all, in the short time we've been together. We've learned from each other and they've rendered us more valuable. I think we've rendered them more valuable. So it's kind of an upward spiral. Yeah, for sure, some really impressive resumes there. And then just going to the follow-up question, Gary, just a comment you made about could have 20% margins if you pulled back or something like that, I may have misheard, but I just wanted to clarify that? Yeah, the underlying model, I think we've already said it can withstand a 20% down and probably hold the margins around 20%. So that doesn't necessarily mean that's what we're going to do, that we're going to pull back investments when we should be investing. So right now, again, I don't think the idea here -- I don't think it's strategic to go, hey, let's have 20% operating margins in 2023. I don't think a lot of people get up in the morning and go to work and fight for 20% operating margins. They get up and they go fight to do incredible inspiring work that they think is going to create great long-term opportunity. And if we didn't have a whole lot of things to do, we didn't have a lot of great ideas that we're pursuing right now. Yeah, am I say, hey, you know what we don't have anything that's really that big worth investing in. So like let's, here we go, let's hit 20% operating margin. Let's make that the goal, but we have some incredible stuff what we're working on. The most exciting stuff we've ever worked on by far. And the kind of stuff that you're so excited, you don't -- you can't sleep, you can't even go home, you're just so excited. And we have groups of people that are here have been through all kinds of hours, like figuring stuff out because the work is really that special. So we're investing in that work as we think that work will change the vector and will change everything and will create massive strategic separation. So we're not really looking at. I wouldn't say if you said, hey, Gary, is your focus on financial outcome in 2023? Not really. Our focus is on creating a leapfrog in 2023 and 2024 that when we come out of this cycle, that people look around and go, where did they go? That we've just made such a leapfrog that we're so much farther ahead of everybody else on every level. And that will create big returns. And we know how to create big returns. We built the best model in the industry. So we're going to do things that make the model better. But you can't do that by not investing and go, okay, we're 20, let's hang on, let's do less. That's the downward spiral. That's the long-term death spiral. And that's not the game we play. Great. Good afternoon and thanks for taking my question. Gary, you mentioned 2023 will mark the largest introduction of new products in company history. So how should we be thinking about your Source Book strategy next year? How are you thinking about mailings relative to maybe this past year, given all the new product launching? And should we be planning for elevated Source Book costs, that's my first question. Thanks. Yes, you should. And probably a big advertising campaign that I think it's the best work we've ever done. So we're going to shout from the rooftops. Got you. And then my follow-up question on supply chain. Can you help us understand the cadence of how supply chain cost tailwinds may flow into gross margin next year? The reason I ask is, I think 70% of your cost of goods sold is sourced from Asia. So how should we be thinking about the timing once we're on the other side of elevated inbound container rates next year? Any color there would be helpful. Thanks. Hi, Jon, so we're kind of getting some of that already. If you think about the ocean-freight contracts, they reset roughly June 1. So that's where we saw the initial burden of those much higher rates, as we've talked about in various calls. But I would say every month since then, we have actualized a number lower than contracted. And the way you achieve that, obviously, you're not always going to contract at the spot rates lower. So you're going out in the spot market, and those rates have been coming down, there is excess availability, especially along certain Asia Pacific routes. And so while we initially saw margin pressure from the higher rates in, I would say, the first four, five months, we're at a point now where we -- like this last month, we're lower than we were for the sort of contracted rates for the prior year. So and if you think about our turn, call it, two, three times depending on the product category and a lot of our business is special order so there's an immediate impact on that. But the part of stock, I mean, we felt pressure and we're kind of now getting into the -- some of the initial tailwinds and that's reflected in our guidance obviously. But that we expect, honestly, as we look at it and we think about what's happening with the supply chain, I think there's probably more to come there, more opportunities. And so those are starting, and we'll continue to see that in the next year, we believe. Good evening. This is Atul Maheshwari on for Michael Lasser. Thanks a lot for taking our questions. Gary, your stock buybacks slowed quite a bit this quarter. The question is, why did you go slow on buybacks so much? Was it because of the M&A or has anything fundamentally changed about how you view buybacks in the current landscape given you still have over $2 billion of cash in the balance sheet? Yes. Look, I think that -- the housing market has collapsed. And it's went down pretty viciously as interest rates have went up. And so I think Simeon's first question was about being responsible. So, we're not going to necessarily change the world through a buyback strategy. And when you're going into kind of a storm that you haven't seen before, you don't want to sail -- or let's say, you're not in a sailboat, but you're in a boat -- you don't want to spend all your fuel before you can see the shore and run out and be floating around out there. So, there's lots of examples of people who went out and spent a lot of money on buybacks and went bankrupt. And Bed Bath & Beyond will probably be the next one that does. They're pretty famous for how much stock they bought back. So, I don't know exactly how this housing market is going to play out. I don't know if the housing market is going to -- almost always, the housing market is in a recession. I mean if somebody doesn't think that, I'd love to just to zoom and put our numbers up for you. But the luxury housing market has trailed down since last September, right, it is down 8%, down 16%, down 17%, down 16%, down 12% in January, down 13% in February, down 15% in March, down 18% in April, down 18% again in May, down 21% in June, down 24% in July, down 28% in August. And the new numbers will come out for the next quarter, and we'll never know how far it's go down. But the odds are it could be down 35%, it could be down 40%. So, when we start seeing trends like that, I don't know how it comes all apart. Did anyone see 2008 coming because the way the market reacted, it didn't seem like it, right? And nobody sees the big implosions. And we're not greedy. Again, we're not going to accomplish our goals here based on a buyback. So we're spending our -- we'd rather just go, look, like where is the world going right now? We've never pumped this many trillions of dollars into the economy. Now interest rates have never raised -- accelerated this fast. Inflation hit numbers that we haven't seen in 40 years. It seems like Powell kind of sounds relatively confident when he's up there, but he's the guy that raised interest rates way too slow. He's the guy that didn't start easing. I mean, he should have raised interest rates and not let the housing bubble happen. Housing prices went up from 2020 to 2022 by 45%. That's never happened except in the 1970s. The two-year period, housing going up 45%. And so I don't want to sit here and have all kinds of debt and not have any clarity of what it looks like out there. So let the storm, become clear. Let's make sure we can see the shore. Does that mean, oh, maybe the stock runs a little bit, and we buy a little less. It's not -- we're not here spending all our time trying to figure out how to optimize the buyback. We think our stock is under valued today. Could it get worse? I think business will get worse before it gets better. Will our stock get worse before it gets better? I don't know. But I haven't been here for 22 years. I spend all my time thinking about that. We got much more exciting things to focus on. When we have a better view of the shore, that we'll make the right decisions. Got it. That's fair, Gary. Thank you for that. And as a related follow-up, at this point, how much visibility do you have on some of the planned gallery openings in Europe and even the US over the next 12 to 18 months? And if the macro does turn further worse, would you look to maybe delay some of the openings until when the macro stabilizes so as to get the most customer attention to some of the great work that you and your team have been doing. Yes. It's a little tough to do that, because when you're in construction, if you stop, you're just going to make a gallery cost twice as much. And you're still paying rents. And you're still have cost. So I mean, I don't think we've ever opened a gallery that doesn't make money. So our new galleries, I anticipate will do well. I mean, business goes down 30%, 70% of the people still buy. All our galleries are really productive in the company today. So again, so we opened a little slower and then it just means when we come out of this, those galleries have big comps. So we don't try to time things like that. I mean we're not -- if we were a company that had like 5% to 8% operating margin or even 10% or 12% operating margin, and you hit a downturn like this, that could be sustainable and it pulls you down and you might have a cash flow problem, yeah, then you're going to make decisions like that. We're not going to have a cash flow problem. So why would we stop building stores that we know are strategic and they're going to make a lot of money. So that doesn't make sense to me. Maybe other people have to do it because they have the cash flow problem. We're not going to let ourselves have a cash flow problem. That's why we haven't deployed $2 billion buying our stock back yet, because I don't know. Does Powell and his team knows to do? Are they just tinkering around? They haven't seen this before? And is someone going to make some calls here and we go into a ditch? It's not going to be a sub-prime thing, but it could be something else. Nobody saw -- nobody has seen any of these big things coming except for one or two people. The guy in the big short, he got it. Maybe a few others. The most people don't get it right. And right now, I’ve never seen more confusion. You read the headlines of the top papers in the world. And I mean who's saying what. Who thinks -- I mean, the KPMG Consulting Group, they think housing prices are going to drop 20% next year. Goldman Sachs thinks housing prices are going to drop 7.5% next year. The Natural Association of Realtors think housing is going to go up 1.2%. Prices are going to go up 1.2% next year. Generally, people speak from a place of self-consideration. Like if you're a realtor, you need to sell houses to make money. So you're going to have the rosiest outlook. If you're a banker, you don't want transactions to stop. You don't want the banking industry to slow down, right? And if you're a consultant, you don't mind telling everybody the bad news because people hire you when they're all screwed up and panicky. So maybe they're the ones that going to tell you the worst case, I don't know. But that's a big spread. Don't you think? Housing prices are going to go up 20%, go down 20% or they're going to go up 1%. That sounds like everybody is on the same page. So it's just a lot of uncertainty right now. But one thing I'm certain of the housing market is collapsing at a level I haven't seen since 2008. I haven't seen this kind of drop since 2008. So go look at how far housing dropped in 2008 and 2009, because these numbers look just like that. Thanks for taking my question. First, Gary, I'm sorry, I jumped on late but if you already addressed this. But we noticed in some of your work that you're partially rolling back some price increases on select products. We've also seen a higher level of clearance on your website. Can you characterize that relative to your pricing and brand strategy? Sure, sure. Well, the -- as Jack mentioned, freight costs are coming down. Raw material costs are coming down. Pricing is coming down. And we're not going to not want to have a good value in the marketplace. So of course, we'll adjust pricing as our pricing comes down. And sales are down. So did we plan for sales to be down this far. No. Did we think that housing market was going to collapse this fast? No. Did we think interest rates are going to go up this fast? No. So do we have more inventory than we'd like? Yes. Should we be accelerating the things that we don't want to have in our assortment long-term that we're clearing out because we have new product coming in? Of course. Will we have more than normal? Of course, we will. That shouldn't surprise anyone. It's the retail business. You have new products coming in, you've got to get rid of old products. So you mark it down. If your sales are down, you've got more old products. So you're going to mark it down a little faster. Otherwise, your DC can't process it. So yes, that's all that's happening. And if prices go up, raw materials go up, shipping goes up like everything that happens in COVID. You're going to take your pricing up. The customer -- consumers going to understand it. It's well now, but they're also going to understand when things come down. And so our whole business, you look at everything through a lens of design, quality and value in that order. If the design is not beautiful and inspiring, nobody buys it. if the design is great, then they get closer to the product and they assess the quality. If they love the design and they believe it's really good quality, it's great quality then they look at the price. And then the consumer makes the decision for that design and that quality. Is this a good value and do I buy it? We try to guess where that best point is. Sometimes we're right, sometimes we're wrong. So we adjust pricing all the time. We're never going to price anything exactly –and we're never going to buy it exactly right. As it relates to your clearance strategy, Gary, is the primary channel of clearance through your full-price stores and website as opposed to your outlets? Yes. Yes. You want -- like we've got way more galleries with way more people coming into them, right? And so -- and we have a website, our full-price website is where we have the most traffic. So you don't want to move product out of that channel right away. Like we have -- yes, we would -- you just back up inventory really fast. I mean this isn't the luxury apparel business where they just throw it in a dumpster and burn it. This is furniture. We're never going to run it exactly like the luxury apparel people or the luxury jewelry people and stuff like that. I mean, our business, we can't throw away the product, and it's just got a different thing. We're going to have a different kind of outlet clearance model all the time. Something comes back as a return, you can't take it back at the store, can't put it back on the shelf. I mean once it goes on a truck and it's out of the box, you got to take it somewhere, so you have outlets because customer doesn't like it or it's got a tiny scratch or that you can't fix or something is wrong, you've got to figure out what to do with it. But when you have plans to say, okay, here's the collections, there's things that are going to be going out that you're going to be marking down and your demand falls pretty rapidly. That's going to change your pricing strategy. It has to because you've got inventory that's on order that's coming in. Bulky goods like ours, you better keep that inventory moving because Fernando is sitting here, if we don't move the inventory, he will figure out -- he'll have to figure out where to put it, and we might not like what he does with it. Okay. Lastly, if I may, a point of clarification. Did you say earlier that you could do 20% operating margins next year if you pulled back on a lot of investments? So, with this tough macro environment, should we think of 20% as sort of the high watermark for next year? Well, I think it all depends where demand goes, what happens to the housing market. What's going to happen with interest rates, inflation in the housing market? And are we in -- how long of a downturn are we in? Is this downturn get worse? If housing falls off at a greater rate, just demand is going to go down. Our business is tied to the housing market because if you look at our business, it's tied to events. Someone bought a new home, they're remodeling a home or they are redecorating their home. The core of our business is not like the person that goes, yes, I need some new bedding. That's -- our business is tied to those three things. So, if people are not buying homes, if people are not remodeling home. And by the way, when people remodel a home, they're generally buying a home to live in, our customer is while they're remodeling. So, that's actually kind of good for our business. But if the real estate activity stops, it hurts our business. So, if you have a 20% downfall in the housing market, two out of 10 people didn't buy a home. If it's 30%, three out of 10 people didn't buy a home. And then -- or didn't move or are not remodeling it. Activities -- I mean what is it, mortgage applications were down 47% in October. That's just the number. I'm not the doomsday guy. That's just the number. And we look at these numbers. So, mortgage applications down 47%. Isn't good for the outlook of our industry. It's the highest print yet. So next year, it's like a month and a half away. That slowdown -- like that -- they don't buy a house and they buy the furniture the next day. So, there's a whole tale to all this stuff. And so how it cycles through, I just don't know where it's going yet. I don't think anybody does. I think anybody tells you they think know where the housing market is going. I don't know who's been right yet. This is not -- by the way, for the housing point of view, there is no soft landing. We're way beyond the soft landing. This is a really hard landing or a crash landing, and it's looking more like a crash landing in the housing market. It's looking like 2008, 2009. And that sounds like whatever Eri [ph] said like I'm a pessimist or whatever. Yes, ominous or whatever. Okay. Okay. Maybe I'm a truth teller, and I'm not a BSer. But sometimes the truth isn't what everybody wants to hear. But it's just the truth, the fact. You guys can read out, yes, so. Great. Thank you, everyone. Well, as we said in our letter, we really want to thank all the people and partners, all the world that contribute to our cause, our shareholders for believing in us. And we just wish everybody, happy, happy holiday, and we look forward to speaking with you in the New Year. Thank you.
EarningCall_1540
Good morning and welcome to the CrossFirst Bankshares' Fourth Quarter and Full Year 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. Good morning, and welcome to CrossFirst Bankshares fourth quarter and full year 2022 earnings conference call. I’m Heather Worley, Managing Director, Investor Relations. Before we begin, please be aware this call will include forward-looking statements, including statements about our business plans, the impact of the acquisition of Central, expansion in growth opportunities and our future financial performance. These comments are based on our current expectations and assumptions and are subject to risks and uncertainties that could cause actual results to differ materially from these statements. Our forward-looking statements are as of the date of this call, and we do not assume any obligation to update or revise them, except as required by law. Statements made on this call should be considered together with the risk factors identified in today's earnings release and our other filings with the SEC. We may also refer to adjusted or non-GAAP financial measures. A reconciliation of non-GAAP financial measures to GAAP financial measures can be found in our earnings release. These non-GAAP financial measures are not meant to be a substitute for or superior to financial measures prepared in accordance with GAAP. This presentation will include remarks regarding the fourth quarter and full year results from Mike Maddox, President and CEO of CrossFirst Bankshares; Randy Rapp, President of CrossFirst Bank; and Ben Clouse, CFO of CrossFirst Bankshares. At the conclusion of our prepared remarks, our operator Andrea will facilitate a Q&A session. At this time, I would like to turn the call over to Mike, who will begin on Slide 4 of the presentation. Mike? Thank you, Heather. Good morning, everyone, and thank you for joining us to discuss CrossFirst fourth quarter and full year 2022 operating results. 2022 was our best year on record by a number of different measures. As we turn to 2023, we are well positioned to build on our success and optimize our investments that we've made in 2022 that will shape our future growth and expansion. We reported 17.9 million in adjusted net income for the quarter and 68.6 million in adjusted net income for the year. This equates to an adjusted earnings per share of $1.37 for the year. CrossFirst had an incredible quarter with the closing of our acquisition of Central, launching our new digital banking platform and tremendously strong organic balance sheet growth. We grew loans by 26% for the year was 17% of that growth being organic. From the time of our initial public offering in August of 2019 until today, we have operated through unprecedented times. We've all lived through a pandemic, supply chain challenges and the largest rise in inflation for decades. Despite the unique operating environment, we have made dramatic improvements as a company. We have grown our balance sheet by $1.7 billion or over 33%. This is even after we strategically shrank our balance sheet in 2021 to improve our core funding and reduce our dependence on wholesale funding. Demand deposits have grown from 13% to 25% of total deposits. And our NIM has improved from 3.32% for 2019 to 3.50% for full year 2022. We've had a tremendous loan growth across our markets. But most importantly, credit quality has substantially improved with NPAs declining from 0.97% in 2019 to 0.2% as of the end of 2022. Operating revenue has grown to 210 million in 2022. That was an increase of 60 million or more than 40% from our total operating revenue in 2019. That increase has contributed to more than 100% improvement in earnings per share and taking our ROE from 5.38% to 11.11%. We have worked hard to deploy the capital we raised during the IPO through organic balance sheet growth, buybacks and now a successful acquisition. Our business model has also significantly expanded and become more diverse. We have entered high growth metro markets such as Frisco, Phoenix, Denver and Colorado Springs, and we added expanded industry verticals including family office, financial institutions, SBA, residential mortgage and franchise finance. Lastly, we have a young and talented management team that I believe has the capability to achieve our plans for the future to become a $10 billion plus institution. In short, we are better positioned today than we were when we went public. And I'm very proud of our team and very optimistic for our future. Turning to the most recent quarter, we have had several significant accomplishments and we continue to make investments in the development of our people, our processes and the technology necessary to help meet the banking needs of our clients and our communities. We are very excited to welcome all of the team members from Central with the closing of our acquisition in November. I'm extremely appreciative of the entire team for their dedication and commitment to completing this successful partnership. The culture fit we identified as a differentiator for success with this experienced team has proven to be a key driver of our ability to operate together seamlessly. We've already experienced growth in new markets as a result of delivering more capabilities that come with size and scale. We've also deployed the enhanced SBA and mortgage capabilities across our legacy markets. This transaction is immediately accretive for our shareholders, and Ben will cover more details of the transaction shortly. Not only did we complete a successful acquisition, but we also launched our new digital banking platform in the fourth quarter, providing enhanced online tools and resources for our clients. This marks the culmination of an initiative we started last year to evaluate our technology partnerships and drive to a best-in-class client experience. As I reflect on what defines CrossFirst, it starts with our people. As we previously discussed during 2022, we enhanced the leadership structure of our organization to position the bank for future growth. We have continued to invest in talent and feel strongly that we have the people in place to sustain strong organic growth, and at the same time deliver a great experience for our clients. This is only possible if we maintain and build on our culture. We were once again recognized as the best place to work by the Kansas City Business Journal, and received exemplary scores on our annual Gallup Q12 employee engagement survey. As we turn to 2023, we will continue to be opportunistic about the growth opportunities available to us. Having said that, we remain cognizant of the economic uncertainty as the Fed pursues their goal of reining in inflation. Maintaining great asset quality remains our number one priority, and it will not be compromised to facilitate growth. At CrossFirst we operate as one team regardless of location or function. With increased pressure on talent, it is important for us to invest in the well being of our people. Maintaining our world class culture means ensuring we are not just recruiting but retaining our top talent. We strive to position ourselves not just for annual growth, but for the next decade of growth and performance improvement. That's where optimizing our operations and efficiency becomes so important as does deepening our community relationships. I'm excited about 2023 and the future of our company. Thanks, Mike, and good morning, everyone. During Q4, we continued making enhancements to our leadership team with the promotion of Matt Mayer to President of our Kansas City Market, the hiring of Cody Kiser to serve as President of our Fort Worth expansion, the hiring of Mike Dombroski [ph] to lead our energy team and strategy and the addition of Scott Page and his leadership team in Colorado and New Mexico with the Central Bank acquisition. As we executed on our growth strategy, we added 27 net new producers in the quarter with 25 being from the Central acquisition, including SBA and residential mortgage. We believe the leadership and revenue generator additions position our company well to continue to attract top talent and clients for future growth and expansion. We maintained our focus on and investing in technology to enhance our client experience and drive efficiency throughout our business. In November, we successfully completed phase one of our digital banking conversion, migrating over 90% of our users. We are placing all new clients on the new platform and plan to convert the remaining 10% of legacy system users in Q1 of this year. We have made significant investments over the past several years and have a focus in 2023 of optimizing utilization of these systems, and actively monitoring advancements that will benefit our clients or processes. Turning to Q4 highlights, we reported loan growth of 306 million, excluding the 389 million in loans acquired from Central. Organic loan growth on an annualized basis was 26% for the fourth quarter and 17% for the full year. Total loan growth for the year, including the Central acquisition, was 1.1 billion or 26%. Loan growth in Q4 continued to be balanced between C&I and commercial real estate and also geographically diversified, with the majority of the growth coming from our larger markets in Texas, Arizona, Kansas, and Missouri. Our community markets also reported increased loan activity. Total loans increased despite $106 million decrease in the energy portfolio in 2022, which ended the year at 173 million. It is important to note that the majority of our growth in 2022 was with existing clients and sponsors or borrowers with significant history with bankers and leaders we have hired. During 2022 and especially during the last half of the year, we were presented with many lending opportunities with more favorable structure and pricing than we had seen in recent periods, which contributed to our significant growth in Q4. During the quarter, average C&I line utilization was 45% consistent with the prior quarter and portfolio churn increased slightly and remains above the historical average level. Our loan portfolio remains diversified with a 42% concentration in commercial real estate and 47% concentration in C&I and owner-occupied real estate. Energy exposure now represents 3% of the total loan portfolio. The addition of the Central loan portfolio did not significantly change the composition of the combined loan portfolios. There also remains good diversity within each of those portfolios with the highest CRE property type accounting for 16% of total CRE exposure, and the largest industry segment in C&I being manufacturing at 11%. We continue to manage concentrations at the transaction level and adhere strictly to our underwriting standards to reflect the higher level of economic and interest rate uncertainty that exists in the markets today. For the quarter, average deposits increased 7% to 5.3 billion, up 116 million from the previous quarter, excluding the Central acquisition. Over the past year, average total deposits have increased 746 million or 16%, including 570 million from the Central acquisition. Average non-interest bearing deposits increased slightly during the quarter to 1.1 billion and represent 25% of total deposits, up from 22% at the end of Q3. As discussed above, in Q4, we believe our new digital banking technology will enhance our deposit growth strategy. We remain highly focused on deposit generation and are launching a new DDA growth incentive program in Q1. Moving to credit highlights. For Q4, we reported a drop in non-performing assets of 5 million to 13.2 million resulting in a non-performing asset to total asset ratio of 0.2%. The decrease was due primarily to paydowns in the energy portfolio. This ratio is down from 0.31% in Q3 and 0.58% at year end 2021. Classified assets to capital plus combined reserves ended 2022 at 10%, down from 11.2% in Q3 and 10.8% at the end of 2021. For the quarter, we reported net recoveries of 300,000 and net charge-offs of 3.8 million for the year, resulting in a charge-off rate of 8 basis points. As you will recall, we converted to CECL on January 1, 2022 and have completed our first year using this reserve methodology. At 12/31/22, we reported on allowance for credit loss to total loan ratio of 1.15% and combined allowance for credit loss and reserve for unfunded commitments of 1.31%. We remain focused on strong portfolio monitoring and understand the importance of maintaining good credit metrics moving forward. We continue to have active dialogue with our clients and prospects about the impact of higher interest rates, inflation and economic uncertainty on their businesses, and are closely monitoring our local U.S. and global economies. Our portfolio has minimal consumer and direct consumer exposure, and we're fortunate to operate in many markets and states, continuing to show positive job creation and population migration. We believe the bank is well positioned for continued profitable loan and deposit growth. Thanks, Randy, and good morning, everyone. As Mike indicated, adjusted net income expanded this quarter to $17.9 million or $0.36 per diluted share with GAAP net income of $11.9 million or $0.24 per diluted share, which included several costs related to the acquisition that we closed on November 22. For the year, we earned 61.6 million on a GAAP basis or 68.6 million on an adjusted basis. I'd like to spend a few minutes on the purchase accounting impact for the deal before I review financial results. Starting with the opening balance sheet, as Randy outlined, we purchased 399 million in loans and 570 million in deposits from Central. The acquisition also provided 225 million of the total deposit growth in non-interest bearing. The transaction resulted in 13 million of goodwill and 16.5 million in core deposit intangibles that will be amortized through non-interest expense over 10 years using some of the years’ digits. As part of the purchase accounting adjustments, we recorded a discount on non-PCD loans of 6.7 million, which will be accreted into interest income over the expected life of those loans. We maintained some of the existing FHLB borrowings added from the deal and liquidated the investment portfolio. Turning to the P&L, the day one provision impact, including PCD accounting, was an additional 4.4 million of provision expense. Our non-interest expenses related to the deal were 3.6 million. Net of the tax impact, transaction-related costs, including the provision, reduced GAAP earnings by $5.9 million. I'll frame the rest of my comments around results adjusted to remove the purchase accounting impacts where applicable, which we believe is reflective of our core operating performance. We are on track to achieve our cost savings target and earnings accretion as we anticipated with the deal. Quarterly adjusted return on average assets was 1.15% and adjusted return on average equity was 12.03%. These ratios were the result of improved core performance driven by balance sheet growth and expanding margin while continuing to invest for the future. We are executing our strategy to grow our balance sheet, improve performance and gain leverage in our operations as we have now surpassed 6 billion and are well on our way to 7 billion in assets. We provisioned 2.3 million this quarter, excluding the purchase accounting, with loan growth being the primary driver. Our interest income in the fourth quarter increased by 26% from the prior quarter to 82.4 million. This was driven by rate increases and significant loan growth in the quarter. As a reminder, interest income for the third quarter included a $1 million pickup from a loan returning to accrual status, which is masking an additional $1 million of improvement to the run rate in the fourth quarter. Our average loan balances were up 8% quarter-over-quarter and average loan yield was up 85 basis points. Interest expense was up 12.5 million for the quarter as we increased deposit rates to drive funding deployed for loan growth. As Randy noted, our percentage of demand deposits increased to 25% this quarter, with some being related to the added liquidity of the acquisition in addition to organic growth. Our cost of funds was 2.05% for the quarter. Our total deposit beta against the FOMC increases this year remained about 50 through fourth quarter, in line with our expectations. We will target a beta of 50 in 2023 with the assumption that rates will move upward this year by 50 to 75 basis points and remain elevated in the near term. Net interest margin was up to 3.61% on a fully tax equivalent basis. We expect margin to remain in the range of 3.55% to 3.65% for the start of 2023 with an assumed slowdown in the trajectory of interest rate increases. We anticipate that competition for deposits will continue into '23 as clients seek higher yields. Our balance sheet has moderate sensitivity with 70% of our loans repricing or maturing over the next 12 months, with much of that being in the first 90 days. Turning to non-interest income, which was 4.4 million for the quarter. It increased 15% due primarily to higher service charge income and some gains on bond sales. Credit card income was steady this quarter, and we remain focused on increasing credit card transaction volume. Adjusted non-interest expenses for the quarter were 32.9 million, and increased 4.5 million from Q3. About half of that increase related to additional volume from the acquisition with more employees, a larger footprint and more client accounts. The remainder of the increase was driven by higher incentives, some modest headcount growth and increased loan related costs. We anticipate non-interest expense to be in a range of 37 million to 38 million for the first quarter. We will continue to manage our cost base to be well within our amount of revenue expansion to promote continued earnings growth and operating leverage. We will have some amount of elevated costs through the first quarter as we continue to integrate people and systems. Our adjusted efficiency ratio was 55% for the quarter, as we closed our acquisition and continued to invest in new markets and technology. We expect to manage that into the lower 50s through 2023 as we finish the integration of Central and scale our investments in new markets and verticals that Mike outlined. Our tax rate was 21.9% for the quarter, being a little elevated due to certain non-deductible merger costs and a higher mix of taxable income this quarter, with tax exempt income being flat while overall operating revenue was up over 9% from Q3. We expect the tax rate to remain in a range of 20% to 22% for 2023. Our capital ratios came down due to the transaction as planned, driving a portion of the improvement in our ROE. We remain well capitalized and expect strong earnings to further bolster our position. Unrealized losses declined 20 million in the quarter as longer term interest rates came down. We repurchased 358,000 shares in the fourth quarter for 4.8 million, and we will be opportunistic about the share buyback. Even with robust organic loan growth this quarter, our loan to deposit ratio increased slightly to 95%, which was helped by the acquisition, liquidity and deposit base. We are very focused on driving deposit growth for 2023 and are augmenting our incentives, as Randy mentioned. We also remain well below historical levels for wholesale funding and we have significant capacity for borrowing or wholesale, if needed. In summary, we had a successful fourth quarter and a very strong year with our operating revenue and assets at all-time highs and credit quality being at its best since our IPO. We will now begin the question-and-answer session. [Operator Instructions]. And our first question will come from Brady Gailey of KBW. Please go ahead. I wanted to start out -- I know Central closed kind of intra-quarter. But was there a material level of accretable yield that was realized in the fourth quarter and any sort of comments on your forecast for accretable yield in 2023? Good morning, Brady. It's Ben. The answer in short is no, there wasn't any significant impact for the year. They do have a little bit better NIM than we have historically, but not enough to move the needle certainly in a month. Okay. And then any sort of forecast for accretable yield in 2023 or do you think that will still be minimal? Okay. And then another great loan growth quarter. Even excluding the acquisition, I think loan growth was in the mid 20% range annualized, so very strong. How are you guys thinking about loan growth as we look to 2023? Yes, Brady, obviously we're trying to figure out what's going to happen with the economy. But we believe that we have another opportunity to have another good year of growth. I don't know that it's going to be at the levels that we saw in '22. But we expect loan growth to be high single digits to low double digit loan growth this year. We're still pretty bullish on the markets that we're in and the economies in those markets still seem to be pretty strong. So we made a lot of investments in '22 that we're still scaling, in Fort Worth and in Phoenix and in a couple of verticals. The other thing is, in 2022, we grew those numbers even though we shrank our energy portfolio by over 100 million. So we overcame that and had the growth. We don't anticipate that to be the case in 2023. And we're pretty excited about the energy space and the opportunity to have some moderate growth there. Brady, it's Ben. I was just going to clarify. I think we have this all in the details of the release, but 26% loan growth for the year, 17% without the acquisition for the quarter. Coincidentally, it's 26% organic without the acquisition. Yes. Okay. And then finally for me, you guys repurchased almost 5% of the company last year. You've used up some of your excess capital in the buybacks and Central used up some of it. How should we -- I think the stock is still notably cheap here. So should buybacks continue in 2023? The stock is ridiculously undervalued in our opinion, and you should expect that we'll continue to be active buying our stock back if it continues to trade it with values we don't believe fairly represent the value. So, yes, we will continue to be active in the buyback area. Hi. Just a question here on margin and yield. I'm just curious what was the blended yield on what was added in the quarter? And it looks like you had some good growth in non-interest bearing but also in CDs. I'm curious where are those CDs coming on and what's the term on those [indiscernible] assets and liabilities here? Sure. Good morning, Andrew. It's Ben. We're not a big CD shop. We're, of course, looking at what everybody else is doing and making sure we're competitive. I would say the rates we're offering have really been focused in the 12 to 18-month range. We haven't really been seeking money longer than that because of our view on rates potentially coming down at some point, although -- but we think that's likely after the next 18 months. And in regard to your other question, we're probably most competitive in money market for our client base, and that's really where we compete the most on price day-to-day and where we raise the most funds. Okay, yes. New loans I have here in front of me, give me a second to find it. Rates have come up a lot. We're well into the 6s at this point for new loans, upper 6s. Our loan base, the entire base in the upper 5s, which of course we have in the presentation. Got you. And then just a question on the timing from the cost saves on the deal. Looks like expenses might be a little bit elevated here in the first quarter and then come down after that. So I'm just curious when do you think the full cost saves will be in the run rate? Yes, I think by second quarter, we anticipate those will be in the run rate. The biggest driver of that is our systems conversion, which we expect to happen at the end of first quarter in March. So we have some transition people and some, of course, manual processes ongoing until then. And at that point, we believe we'll have reached the full cost saves for expense outlook. For the year, as I mentioned in my comments, 37 million to 38 million non-interest expense going into the first quarter and I anticipate that to be relatively consistent through the year as we will add some staff later in the year after we realize those savings at the beginning. Back on the loan growth, Michael, I think you said high single, low double digits. You're in a handful of newer verticals and some newer markets. Any loan categories or geography do you think will be the main drivers of that growth this year? Well, we've continued to see really strong growth out of Kansas City, Phoenix, Texas. And I think energy has an opportunity to have some reasonable growth. But we've really seen steady growth out of all of our markets. And so we're just in some dynamic markets that are providing some opportunity. Randy, you may want to talk about segments. Yes. Hi, Matt. It's Randy. As Mike said, we are seeing good growth across the platform. And you referenced earlier, we've made investments in markets, you referenced Frisco, Fort Worth that are just really starting to get going. And you look at Arizona and they've had outsized growth and been very successful in that market. And we are excited to be in the Denver and Colorado Springs markets and think those also provide growth. Our sponsor finance group has reported good growth and has a very robust pipeline. He talked about energy. We're seeing really nice opportunities in the energy space with some of the best structure and pricing that we've seen in recent period. And we continue to grow our real estate portfolio, but being very selective in that space. But again, in our higher growth markets, they’re still presenting some very nice real estate opportunities. Okay, sounds good. Appreciate that color. And then going back to the margin, I think you gave us the guidance range for 1Q, the 3.55%-3.65%. I guess the question is, if deposit competition remains intense, I'm curious if you expect weakness below that beyond the first quarter? Matt, absolutely. That's a big factor. The range I gave you, 3.55% to 3.65% is pretty consistent with where we sit today. So we're not anticipating a lot of change in that for 2023 as we see it so far. If we get a couple of rate increases, we do expect a couple basis points of potential margin expansion, balance sheet being equal and as you noted, the headwind to that is can we maintain our deposit mix. As Randy and I mentioned in our comments, we're very much focused on that and we will have our people focused on that through incentives for this year. Matt, I'm really proud of the way the team maintained our mix in 2022. We lived through a rapidly rising rate environment in '22. And we actually with the acquisition ended up growing DDA as a percentage of our deposits. And we're able to keep our deposit beta within I think a fairly reasonable range. So we're going to keep fighting in '23 and really, really focused on DDA growth, as I know, everybody is, and we're doing some things from an incentive standpoint and strategy standpoint to continue to really grow DDA. Okay. Thanks for the commentary. And then lastly on capital, I think coming into last year, I think one of your goals was to deploy a chunk of the excess capital. It looks like you accomplished that with a buyback, with the growth, organic and inorganic. I guess I'm thinking about the capital of 2023 if you're assuming the loan growth high single to low double digit loan growth, do you expect to accrete capital ratios from here? I'm just trying to appreciate it if there could be a need for external capital. We do, Michael, expect to accrete them from here through earnings. I'm sorry, Matt. We do expect it to accrete through earnings. And as we've modeled out the year, we believe our earnings growth will outpace our balance sheet growth as we built our model. Matt, we don't have any sub debt today. We've got some different levers that we could pull if we needed to go get some additional capital to support our growth. I figured that was the case. Well, most of my questions have been asked and answered. But, obviously, I think one of the positive stories here has been on credit. The reserve is sitting here at 115 of loans. Non-performers have really worked their way down. I assume criticized and classifieds have trended in the right direction as well. But I think what I hear from some investors is there's some verticals out there that maybe could cause some concern, whether it be real estate, I think, is what we hear most often. And then I think what I hear about you guys is kind of an untested loan portfolio and a lot of growth over the past couple of years, both organic and inorganic. What would you say to those that maybe kind of doubt the performance? And how can you help us get more comfortable with just credit in general? Thanks. Yes. Hi, Michael. It's Randy. Good question. We're very comfortable with our portfolio and our credit metrics. We've seen significant improvement in those metrics over the last three years. And one thing you said, there is a portion of our portfolio that has been through COVID and some unique economic times and performed well. I think of lodging and how our sponsors stepped in and supported projects through that. And today, that portfolio has nothing criticized or classified. And so we feel good about the credit quality. We're closely monitoring the portfolio. We've had very successful third party loan reviews and regulatory exams recently, which confirmed our grading accuracy and reserve levels. So we do have third parties also looking at those portfolios closely. At the reserve level, in our conversion to CECL, we did complete our first year. And like the other institutions, we've been making sure we learn how CECL acts in different environments. But when we close the year, our total reserve is a 1.31. We feel very adequately reserved at that level. And where we saw some of the increase in reserves in CECL was in the reserve for unfunded commitments area. And we don't think that will continue to increase at that same pace. And so again, we look at our non-performings at 20 basis points, our classified to capital at 10 and our reserve level of 131, we think the portfolio is really well positioned for future growth and also for some economic uncertainty. We spent quite a bit of time stress testing the portfolio, not only the real estate, but also the C&I portfolio, as we continue to run those tests, and the portfolio holds up well, even with additional rate increases. So we're adhering to our underwriting standards and think we're being very conservative in our underwriting. So overall, again, just feel good about the quality of the portfolio, although we're closely monitoring it. Michael, I'd just add. Randy and the team have done a great job on the credit side. We've been telling investors and analysts that we feel good about our credit quality for three years now. And it's proving out that our credit quality is performing and our portfolio is performing. We went through an energy crisis, and that was something they looked at. And our energy portfolio, although we had a lot of great migration, we had very little loss, and that portfolio has come back and is performing very well. We told everybody we would get our energy concentration down from where it was to that 5% to 7% range. It's at 3% today and we think there's room there for us to grow. People talk about the hospitality. Our hospitality portfolio performed very well. And it's not very big. I think we only have 16 credits or so in the hospitality space. There was strong sponsors, there were professional operators and that portfolio, we have higher average daily rates than we had and better occupancy, and actually those properties overall are performing at better levels than they were pre-pandemic. So we spend a lot of time looking at our portfolio and stress testing it and studying it, and we try to be really proactive in our credit management. And we will continue to do that. And as Randy said, we've had lots of external eyes on our portfolio over the last six months. And to an exam, they've come back and they validated what we're doing and very complementary of the team and the job they're doing. So to your question, Michael, what can we say to them? All we can do is perform, and we're going to continue to perform and we're going to really, really work hard to keep that quality and keep improving it. I appreciate it. Maybe just one follow up, separate topic, just on fee income. It looks like ATM and credit interchange income has come down a little bit. Any explanation for that? And then looking forward, it looks like Central will add a little bit to the mix. But can you just remind us maybe some of the strategies you have in place to grow fee income and maybe what your intermediate to kind of longer term revenue mix would be? Thanks. Sure, Michael. As a reminder, one headwind we've had on fee income particular to credit card is one large client with a very significant concentration who had a very big spike in their business related to COVID. And they have seen that come down all year. We're finally at the point where they're near right sized and the growth in our credit card portfolio is beginning to fulfill that concentration, decline and overcome it. We've moved to an in-house platform and are at the tail end of converting all of our clients and believe that will be an additional contributor to our growth there. So we are adding net clients to our credit card portfolio. And as I mentioned in my comments driving additional transaction volume, so we think there is opportunity there for that to begin to turn now that we've worked our way through most of that concentration. Particular to the Central deal, probably the most significant impact we'll see for 2023 is some fee income from their SBA business and to a lesser extent mortgage which of course is pretty low volume right now. They used a model where they sold all of those loans and harvested gains on them almost exclusively without holding anything on the balance sheet. We will do the same to the extent it makes sense at the current moment like today. The gain on SBA sales is a little bit depressed. And so we likely will hold some of those loans on our balance sheet in the near term, because we can. The yields are very attractive, near double digits on many of those in particular in the guaranteed portfolio. And we'll simply make a cost benefit decision as we think about what the gain looks like in the future, which we expect will come back from its current depressed levels. But when that changes, there'll be significant opportunity for fee income increases for us over our base. This concludes our question-and-answer session. I would like to turn the conference back over to Mike Maddox for any closing remarks. I want to thank everybody for joining us today. And I'm really proud of the team. And we're going to continue our focus on really driving long-term shareholder value. Very proud of our 26% growth in '22. We've added some great new markets. We've enhanced our technology platform. And we've really, really continued to improve and strengthen credit quality. I just believe we're so well positioned for 2023 and the opportunities it will provide and we've got a great team in place and very excited to see what the future holds. Thank you all for joining us.
EarningCall_1541
Okay. Well, good morning, and welcome to Citi's 2023 Communications, Media & Entertainment Conference. For those of you, I have not had an opportunity to meet, I'm Mike Rollins and I cover communication services and infrastructure for Citi. Never know. Before we get started, I'd like to mention that we have disclosures available at the registration desk and on the city velocity page from which we're streaming the audio. It's a real pleasure to welcome back to Tom Bartlett, President and CEO of American Tower. Thank you so much for being with us today. It is. And looking forward to, you know, hearing what's new with American Tower. Before we get started though, I do want to just share a couple of thoughts. We're going to look to incorporate all of our audience's questions into today's discussion. So, for those of us around the table that have microphones, if you light it up with a button, we'll try to get you included into this discussion live. If you're streaming the connection, there should be a question box the page for you to ask questions. And continuing on this tradition of using live surveys, they're completely anonymous. By the way, we are not tracking who you are. We're just aggregating responses. It could be accessed through these QR codes that are here on the table, also, on the streaming portion of the site, and you can use your connected devices, whether it's here or online, to enter in your responses. So, with all of that out of the way, Tom, it's a real pleasure to have an opportunity to just delve in and maybe start with an update on the strategic and operating priorities for American Tower this year and how they might be a little bit different than where we were at this time last year. Fair question, Mike. I think that, you know, just kind of stepping back a moment. We're really looking to build on the successes in the strategy that we have been able to execute over the last several years. You know, if you just kind of take a step back, you look over the last 2 to 3 years, and we built, you know, just under 20,000 sites globally. We've acquired probably in the 35,000 to 40,000 sites globally. And we've built out a significant presence in Europe, which is really a new beachfront, really for us to be able to further develop. Even over the last couple of years, we've entered into or amended, close to 75 master lease agreements with our customers around the world. We've clearly built-out a new class of infrastructure in the United States and the data center business with CoreSite. We've built on our management team that we have in place over the last couple of years, built on our strong culture, so it's really building on, you know, the successes that we have been able to initiate over the last several years. And I think we're in a really good spot, you know, given the beginning of 2023, in terms of being able to do that. The broadest category that we're looking to do is continue to scale the core. And those are common words within the American Tower family. And we're doing that through organic growth, want to take advantage of everything that's going on in the 4G and 5G world, you know, our customers are, in our markets going to be probably spending north of $60 billion on their networks, now they've spent over $150 billion on spectrum. So, they want to put, you know, that spectrum to use. And so, we really want to position ourselves and be able to take advantage that on the organic side. Inorganically, we want to continue with our build program, you know, through kind of life to date on our build program, we probably are generating upwards of $700 million to $800 million of revenue, generates a significant Day 1 yield for us. In 2022, we're coming off building, you know, [6,000 to 6,500] [ph] sites. And so, you know, I've got my sights on building, you know, [40,000 to 50,000] [ph] sites over the next several years. And, and we do that – we don't do that on spec. Now, you know, we do that underneath a formal master lease agreement program with our carriers, and as more and more spectrum gets deployed, and as higher and higher bands of spectrum gets deployed, we're going to see that need for further densification and colocation in our marketplace. So, that's the number one is being able to take advantage of the organic world, being able to build out our sites around the world. And then lastly, within kind of scale, the core is to make ourselves more efficient. You know, we're a really good international business, we're not yet a global business. And while we have capability and assets in 27 markets around the world, you know, I think that the opportunity for us is to be able to provide that global value proposition, particularly as the edge for more fully gets developed. And so, I think we would be able to take advantage of that value proposition, particularly with the cloud players. Nobody around the world has the kind of coverage, the kind of scope that we have, and the kinds of markets that we're in with the types of customers that we have. And so, I think that that's a real opportunity for us, and one that we really need to get after, and take advantage of. And we’ll continue to, you know, further operationalize our business, make ourselves more efficient, drive more margin performance, and those types of things. So, that's everything I kind of talk about when I say scale the core. The second major initiative for us is what we call platform extensions. And we really have two platforms now, within our business that clearly the tower platform, which is the principal platform within our business, and we really want to extend the capabilities that we're providing at the site level. We’re just talking a few minutes ago, you know, the fundamental competitive advantage, we have in our business is our exclusive pieces of real estate, you know, we've got a longitude and latitude on every one of those pieces of real estate. And they're strategically positioned within all of the markets that we're in to be able to support our customer base. In essence, we have a [moat] [ph], really around it. And so for us, it's to drive as much activity as we can in that site and to produce as much activity from within that site. And so, you think of things like power and fuel, which in many of our markets is a critical element to the service we provide, particularly in markets in Africa, India, even to certain extent down in Latin America. And I think it's going to become even more important here within in the United States. And we've invested probably $300 million to $400 million over the last several years in terms of really developing our power and fuel capability. So, it's not just those things that are really behind the meter, which are the things that we're doing within the site that aren't metered that we provide for our customers and pass-through to our customers. But it's also things that are looking in front of the [meter] [ph], and what other opportunities might be there for us. It's not only that the right thing to do for our customers, it's the right thing to do for us, but it's clearly the right thing to do for the environment itself. And the edge also fits within, and I know we'll, I'm sure talk a bit more about the edge and how that fits into our overall plans. But that also gets encompassed within the platform extension as kind of the strategic initiative that we have. I tend the third one is really becoming more strategic with our customers. As I mentioned, we've entered into, you know, 75 kind of new or improved master lease agreements around the world and we want to become closer and closer to them in terms of being able to help them. They've spent an awful lot on Spectrum as I mentioned. They're committed to an awful lot of capital in our markets. And I think that's a real opportunity for us to be able to provide higher levels of service for them. As part and parcel to that are kind of the holistic arrangements that we've entered into in the United States with the big carriers. You know, those are ways for us to become more strategically aligned with them so that we're not, you know, bickering about, okay, what's going to be the cost to go on this particular site. And that's really played out really well for us. So, we kind of led the market in terms of deploying those kinds of pricing schemes. And we've really been able to, I think, take it to the next level and I think our customers have really appreciated that, particularly when time to market is so important for them. Getting on air is so important for them. And to the extent you can take out that, kind of the bickering on pricing as a typical landlord does. You know, it really does help the overall relationship, if you will. And the other elements I think of what we're trying to really focus on is continue to develop our team. We're getting into some new lines of business. We want to make sure that we've got the capabilities and the skill sets within the business to be able to extend the, kind of leadership position that we have. And foundational to that is our culture. And really building on that kind of that leading ESG platform that we have, making our business really purposeful. And I've found that over the years that I've been in business is that to the extent that our employee body can really find purpose in what they're doing, the ownership and the accountability and the drive to provide higher levels of customer service, and it just comes together so much better. And not that compensation and all the other elements and opportunities for growth aren't important because they are, but finding purpose in what they're doing on individual basis is incredibly important. So, those are kind of the broad categories. There's nothing significantly new in there, as I said, in terms of kind of building on the successes that we've had over the last 2 years to 3 years, but it's more of an emphasis and acceleration. And we're continually looking at driving a strong dividend growth, which is what we've done over the past several years. We're looking to define ways to continue to de-lever within our business. We're kind of hit the 5.5x. We're looking to get down to the 5x level. I think that's probably more appropriate place for us. We're continually looking at – and these are all tactical. We’re continually looking at other forms of capital. We've over the last two years with some of the transactions that we've done that brought in third party capital just worked really well for us, particularly in Europe, as well as now in the United States. So, we continue to try to uncover other forms of capital that we can continue to look at and deploy. And we'll also look at even some of the markets that we're in that are of less scale, if you're within the markets. Whether those markets make sense or whether there is capital there that we might look to monetize and deploy in other areas. And that's not different. We've done that for our – over the last dozen years, we've gotten out of some business certain asset classes here in the United States, as well as internationally, but we'll continue to look at different areas of our business and then are there more optimal ways of being able to utilize that capital? Great. This gives us a lot to drill into. Okay. And, but first, we'll tease out the first survey question and get people involved. And the first question that we're going to throw up to our audience, and you can use the QR codes to log in here at the table is, what is the biggest risk to future consensus AFFO per share growth for American Tower? And the choices are not concerned. Customer consolidation or rationalization, including T-Mobile churn, rising rates, currencies, slower domestic growth, and slower international growth. And we'll see what the audience comes back with. But before we get to that, you know, maybe starting in the domestic business, you talked about the MLA progression that you've been making and you had an announcement this past year as well in regards to those holistic deals. Where does American Tower sit today in terms of that visibility? You've given that long-term trajectory of average organic growth. I believe it's 5%, including T-Mobile churn, 6% without T-Mobile churn. Where are you on that visibility path? And what are the things that are not in these agreements that could add some potential upside or downside to, you know, the aspirations of American Tower? Well, yeah, first of all, I mean, our business and I think what I like and I think what investors have always liked is, kind of the predictability of our revenue streams. We’re into long-term leasing arrangements with our customers, with escalators, some fixed internationally as you all know based upon the, kind of CPI. So that gives a good baseline of revenue. On top of that, there's a layer of the pricing mechanisms that you were just referring to with all of the major carriers. Here in the United States, we have these long-term holistic comprehensive type of pricing schemes, which are the ones that I was talking about before in terms of our ability to work even more closely with our customers. You know, they have a pricing scheme, which they can budget more appropriately, and they can then come back and amend the sites that are part of that agreement, which gives them some predictability in terms of their own budgeting and gives us them predictability in terms of what that revenue growth will look like, right? Because they are committed just to paying us at those levels. And in the United States, it's probably 70% to 80% of our revenue growth is tied to one of those revenue schemes. So that gives us good comfort in terms of what that growth is and I think that's why we can come out and say with certainty that we're at the 5% without [indiscernible] and we're with the 6% with it. And we have that visibility going forward because those pricing schemes that we put in place are multi-year. And with the arrangement that then we just negotiated with Verizon, that kind of, you know, put the bow around, okay, all of the carriers now in the United States that major carriers are under that, kind of pricing scheme. So, then we have the other 20%. Now, keep in mind that we do probably have 1,500 customers in the United States. Now the big carriers probably represents, you know, 80% of that, but there are a number of customers that make up that 20%. And we have good visibility in terms of where they are in their own life cycles, what kinds of renewals we would expect. We have that on a side-by-side customer-by-customer basis. And so, as I said, we have I think really good visibility and comfort into that underlying U.S. growth rate. Now, what could change that? Well, in the big carriers, you know, the way those schemes, I don't get into the particulars on each one of them, but they're largely based on space on the tower. And they're largely in place for amendment type of activity. So, to the extent that 5G continues to take off and evolve, and there's more of a need for further densification. There could be an opportunity for more colocation going on within the business. And that generally is not an element of that because we're really talking about coming back to an existing site given a certain space that the customer has available to them and filling out that space. You know, what we found out early on when we put the first holistic in place back with a carrier was that, [candidly] [ph], the underestimated the amount of space that was going to be required. And so that we actually were able to enjoy growth over and above, kind of that holistic arrangement. Not certain whether that's going to happen now. My guess is that further along in the 5G cycle, it has a higher potential for that as more densification is then required and so you might see that. In terms of the other 20%, again, it comes back to 5G demand, what their own used cases would look like and what their own underlying requirements might be? But I think the 80% that we have that kind of real good visibility into, I think gives us comfort that that kind of a 5% is really a baseline of revenue growth going forward. On top of that, if you start to think about some of the other players that might come into the marketplace, you start to take a look at some of the cable players, whether they might be looking. For them, it's math-based, you know, at a certain customer level that they might be enjoying at an MVNO level. Where does it make sense for them to [when you start to] [ph] build out some of their own networks, if you will. As I say, we're really comfortable with that U.S. growth rate. And particularly over the last couple of years, coming-off of a 1%, kind of growth rate with the Sprint churn, it's nice to get back into these kinds of levels. And candidly, I would expect the colo/amendment activity to really start to increase even further than we enjoyed in 2022. And that's not – just not a phenomenon in the United States, it's a phenomenon that I would expect to see globally. So, we feel good about that U. S. growth. So, I was going to ask you about that because, you know, we're getting through this mid-band spectrum build cycle where the focus by the national carriers in the U.S., particularly, was just as you're describing, using more space on the tower and putting up more antennas and radios and things of that nature. You know, in your pipeline and in the search rings that you get, are you starting to see more densification requests and interest to, kind of on top of the amendment type of activity you've enjoyed, start to see more colo? A bit. You know, a bit. I think we're still a little bit early for that. And, you know, kind of going back to the 3G life cycle and the 4G life cycle, really didn't start to see that, kind of colocation requirement until, kind of the middle. And they were using, at the time, kind of, more lower band spectrum, right? And so, I would expect as more of the C-band spectrum starts to get deployed, we should start to see that a little bit more quickly. So, as I said, haven't necessarily seen it yet, Mike, but I would expect to see that going forward. One of the interesting phenomenon is with the, kind of the 5G cycle is even the carrier success that they're having with fixed wireless. And, you know, that could also be another element of growth that 3 or 4 years ago when I was starting to think about the, kind of the 5G opportunity that I didn't consider that perhaps there is an opportunity at – on that fixed wireless side that the customers are enjoying, that will largely fall on the site. I mean, there can be smaller sites that that you might find to be able to support that kind of activity going forward, but right now, the carriers are really supporting that fixed wireless component element value proposition with additional infrastructure on our sites. And maybe I'll turn to the survey. And again, if you want to ask a question by the way, just turn the light on your microphone. And let's see what investors are thinking about in terms of the risk to the future AFFO per share. So, 2%, sorry, 12% not concerned, 12% customer consolidation or rationalization, 41% rising rates, 18% slower domestic growth, an 18% slower international growth. So, you know, you've laid out this, the multi-year AFFO target is, I believe the average over the next number of years is 10% plus, is the goal that that you've laid out. As you think… And so, how do you think about some of these issues that kind of came back, the rising rates, risk of carrier consolidation, slower international growth? Like, what are the things that investors should be mindful of in 2023 as they think about the opportunity for American Tower to continue to grow that AFFO per share? Well, I mean, those risks are real. You know, and we deal with them. That's what we do. I mean, we deal with them each and every day. On the carrier consolidation, we've had carrier consolidation back, you know, over the last 20 years. The most significant one being the Sprint and T-Mobile carrier consolidation, but we've had it in Latin America. We'll continue to have it in Latin America. We've had it in Africa, particularly in South Africa. So that's, the way to be able to deal with that is to enter into long-term relationships, to be able to enter into markets where there's a good rule of law. Where you're able to monetize those relationships. And if that carrier leaves the market that you're able to – be able to have some type of this settlement, to be able to take advantage of that as that carrier does get in consolidated, that that customer that is being consolidated into. Again, has the wherewithal and the ability to satisfy the obligation that that underlying customer may have. So, we've been dealing with carrier consolidation from Day 1 Mike. And sure it does bring in relative levels of risk within the business. We do a significant market scan to be able to look at that. Before we even get into a market. Diversification, I think, has been very helpful. There are certain markets that we might be suffering a little bit from a carrier consolidation, but with diversification and other markets been able to step up. In those cycles, happen [year-in and year-out] [ph]. So, I think from a carrier consolidation perspective, we've been able to manage that risk exposure. From a number of perspectives pretty well. I think in terms of the growth that you also had in survey, if I remember the survey questions, we've talked about the U.S. growth. We haven't really talked about the international top line growth, but we're bullish on that growth. And again, it comes back to building out the 4G and the 5G technology and using multiple spectrum bands to be able to do that. That always works well for a tower company when companies are using multiple bands of spectrum. Because it's still very difficult to integrate multiple bands. And generally when you're doing that, you're bringing it down to the lowest common denominator. So, it's going to require further densification going forward. And if you – I think you guys also produce these – the growth rates for broadband data going forward and slowing down. And the used cases for 5G have really yet to be developed? You know, that we haven't been able to even see the benefits of 5G. We've seen speed, some latency benefits, but the used cases haven't even really been developed, and so I think that's going to drive that incremental demand. And so, we see growth over prior years in terms of new colocation and amendment activity. So, I'm not concerned at all about the growth rate. I think it's there. And I think we're well-positioned to be able to realize it. Who [won nuance] [ph], particularly over the last several months going in this year, our interest rates. And that's a fact. I mean, you could take a look at our balance sheet. You can see what their – that side of the balance sheet looks like and we have a sizable amount of floating rate debt out there in terms of our overall fixed floating types of relationships. We've got a fair amount of fixed that needs to be refinanced over the next 12 months, [3 billion worth] [ph]. So, that absolutely is going to provide some headwinds, if you will, in terms of our overall AFFO per share growth. Obviously not at the revenue or the EBITDA line. I think we're going to see strong growth there and the business model being intact, I think we're going to be able to see that support. And so, that's, you know, I'm not sure what the percentage was relative to picking that one, but that's probably the single largest headwind that we have in front of us. Let me turn up our second survey question, and this will be a preview where we're going in a few minutes. When will AMT begin to recognize material synergies and financial benefits from its data centers? It already has. We generated $700 million to $800 million of revenue last past year, so I'd say we already have. I think if you're thinking about the opportunity to edge, I still think that's a few years away. You know, when we think about the data center business or why, first of all, I think it's just a great infrastructure class. I mean, I had a fair amount of experience being on the board of a very large data center company. And so, I had that visibility in terms of what kind of margin performance, what kind of growth could be for a certain type of data center company, which both Equinix and CoreSite are. You know, we're really looking to leverage the, kind of that interconnection capability to really drive more value at that tower site that I talked about before that we have that exclusive right to be able to utilize. In the meantime, we're able to enjoy the, kind of that interconnection cloud on [rich marketplace] [ph]. And in CoreSite, you know, those we talked about this on the third call, you know, they set record levels of growth of sales in 2022, and I expect to grow on that in 2023. And so, you know, their model is selling to the cloud, selling to the enterprise, as well as sending to the MNOs. And they're doing a terrific job in terms of being able to accomplish that. They have a core set of assets that are really premier in the marketplace and they're very tactical in terms of looking at where are those next opportunities for growth? And so, what we've been able to enjoy over the last 12 months is while those, kind of edge applications are in the formation stage. You know, the relationships that we've been able to build out with cloud players over the last 12 months has been significant. We have an edge advisory board that are made up of industry experts. We have a lab that we've set up to be able to trial new types of applications and work with different entities to be able to explore what the opportunities would look like out at the edge. I mean, [indiscernible] in a couple of weeks, we have, you know, the significant number of meetings with cloud players. And so, those conversations, if there's a synergy, you know, those conversations would not have existed without having CoreSite as a base. And so, as CoreSite continues to move its capabilities from the core NFL cities out, we’re continually looking at what are those [1,000] [ph] sites that we have where we can bring in a megawatt of power. And so, I would expect to see those types of those synergies, if you will, develop over the next several years. But I couldn't be more excited about the opportunity of bringing these two asset classes together to really build something very unique and something that I think will have a significant amount of say, in terms of how that network architecture gets developed. Right. And that's – and for the survey, that's exactly what we were asking in terms of when that edge might come through and be a synergy? And we ask, is it going to be 2023, 2024. 2025 or unlikely to happen in the next 3 to 5 years. And it was very mixed in terms of results 17% 2023, 17% 2024, and then a third 2025, and a third unlikely to happen in the next 3 to 5 years. So, it sounds like your time frame is still over the next few years for these edge synergies to really emerge? Moving over to the macro side. So, can you take us through the regions and help us understand how inflation can impact your escalators and your revenue growth in 2023? How it impacts the cost of your real estate. And I think what investors are trying to figure out is, does American Tower benefit from inflation? Does some of this inflation you might be able to get some of your markets drop to the bottom line or should investors think about this really as kind of a net neutral activity or zero calorie, you know, cash flow benefit relative to the revenue? Yes. I think it probably – the headline is probably zero calorie, but if you look at the markets themselves, when you look at the U.S. market, you know, we have – 95% of our contracts have a 3% kind of escalator, right? And so, and we also have a 3% escalator on our largest cost, which is our land. So, they're pretty well insulated from zero calorie perspective as you kind of looked at. Internationally, it's a bit different because we are triple net, and we do have a significant amount of pass-through. And so, broadly speaking, our inflation or our escalators are a function of inflation in the marketplace. And we underwrote those contracts based upon that, but what – and so we'll enjoy that on the top line. But what's interesting on the bottom line or at the EBITDA level, again, our land costs are significant piece, as well as our fuel costs. And so while you'll increase those costs as a result of inflation, we pass-through those costs to the [tune of about] [ph] 70% or 80%. And so by our ability to pass those costs through, even though they've gotten more expensive, we don't necessarily feel the brunt of it. Now, the reason I say zero calorie is that, I don't like inflation. You know, I don't think inflation is good for anything. And so, from a consumer level, from a customer level, inflation is not a good thing. You know, we need to be able to get that in track. But from an operational perspective, I think we are very well protected in terms of the impacts of that, kind of an event and we have been, Mike. We take a look at some of the growth rates that we've had and over the last several years where we've had more inflationary driven economies, whether it's Brazil, whether it's certain markets in Africa, you know we've seen our ability to capture that type of impact. And keep in mind that largely the rationale for those CPI-based escalators was really to look at the impact of FX. And trying to look at the correlation between, you know, FX exposure and rising currency was how can we mitigate that? And the escalator helps us to mitigate that in a pretty significant way. In our next few minutes, just give a preview of where we're going, I'm going to just get our last survey question out there and we'll come back to this topic, which is capital allocation. And before we hit that, maybe just jumping into a couple of the market specific details. So, the survey question that we're going to ask our audience is, what is the best priority for capital allocation after internal development and the [build to suits] [ph] that you have over the next 12 months to 24 months? And we're going to offer the responses of repurchasing shares, accretive acquisitions measured by AFFO per share or acquisitions measured by tower gross profit, capital recycling, and net debt leverage reductions. And we'll see what our audience comes back with. But before we get there, maybe in some of the markets, can you talk to us just a little bit about India? Like where you are in terms of collections and how that market evolves from a financial contribution perspective in 2023? Well, I mean, we're right where we said we were going to be. In the second half of the year, our customer Vodafone said that they are only going to be able to pay a $0.60 on the dollar for what was contractually committed. And that's what they've done. And they've said that at the beginning of 2023 they're going to start coming back at the 100%. We'll see. Don't know that for certain yet. I do know that they paid us $0.60 on the dollar. And, and they're in the process of trying to figure out exactly how the government is going to, kind of influence the growth of their business and is, as you well know, the government had agreed to pay, take a piece of, kind of the interest on some of the tax levies that they’ve been imposed on them, and convert them to equity. And that is yet to happen. And so, I think the lynchpin for Vodafone Idea is for that to happen. And so, I think that they're all working on making that a reality. I can't say for certain that that's going to happen or not or what the timing might be, but that's going to be a critical element, I think in terms of their ongoing success. So, we'll, you know, continue to monitor closely as we've been doing, and see where that – how that lands in the first quarter in the next month or so. In the meantime, you know, they continue to do as much as they possibly can with the capital that they have. Airtel and [indiscernible] are formidable competitors who are well-capitalized, they're investing in 5G, collectively. The carriers spent about $20 billion on 5G spectrum, just last year. So, they're all trying to monetize that in a significant way. India is a very unique market, you know, we've been there for over a decade. They're just about ready to, I think, take over China in terms of total population. Significant commitment from the government in terms of becoming more digital. The government, I think, has done a fair amount over the last 12 to 18 months in terms of positioning them in the marketplace from a regulatory perspective so that the customers there can be successful. They've, you know, continue to reiterate, it's a three player market. And so, I think that's one of the [impetuses] [ph] for them to be able to want to support Vodafone, as you know, is they being one of those players. So, time will tell. This kind of comes into the play of, you know, we're very diversified portfolio. This was a market that, you know, for the first seven, eight years of our ownership was, kind of high-single-digit, double-digit growth, and has had a number of headwinds over the last several years in terms of consolidation, in terms of tax levies, and have tried to manage their way through this as best they possibly – best we can. We have a terrific management team in place, and we spend a significant amount of time with them in terms of trying to figure this through. And so, more to come on kind of their payment schemes for 2020 theory, but we haven't heard different from them paying at [$0.100 on the dollar] [ph]. And before we get to capital allocation, which is probably our last topic, any international markets that you think investors may under appreciate the growth potential in 2023? Are there things that you're seeing in certain international markets where, you know maybe you're incrementally excited? Well, I'll change that to the global market. [Indiscernible] I don't think people appreciate the investors understand the U.S. market. You know, and so maybe that's an underappreciated market. I think Europe is probably an underappreciated market. I get it, we're new into and really into the marketplace. And, you know, with the long-term relationships that we have with companies like Telefonica, and even Vodafone, in Orange, now, with 101, you know, we're really excited about the opportunity for growth. It's built on the fundamental escalators that we see in the marketplace. I think there's certain markets in Africa that we will probably be able to enjoy, kind of outsized growth. I think Latin America is going to be the one where we do have some incremental churn. So, it comes back to the carrier consolidation risk churn that we need to, to manage through in Latin America, where we've enjoyed some high-single-digit growth rates, it's probably in the lower-single-digit, kind of growth rate category in 2023, but we'll get through that to be able to, you know, hopefully get back to enjoying some of those higher rates of growth going forward. And then the subject to capital allocation. So, I'll share with you the results. And then we'll get into you maybe how American Tower is going to approach capital allocation this year and next year. So, 16% repurchase shares was the best priority, 5% accretive acquisitions by AFFO, zero acquisitions that are accretive on Tower gross profit, 16% on capital recycling, and 63% on net debt leverage reductions. How is American Tower approaching capital allocation potentially differently in 2023 and 2024, and how are you thinking about the current environment? Well, I think versus 2021 and 2022, in more so 2021, I think on the M&A front, you know we've been pretty vocal about saying there's a significant dislocation between public and private valuations out there. And so, that's probably not an area of high priority. We'll always be around the hoop to the extent that there's some opportunities there that should, kind of fall into our lap, to the extent that they make sense for us, we'll take advantage of it. But I think you had zero down on the survey there. My sense is, it's going to be probably pretty low. There could be a couple of portfolios, smaller portfolios. We're always rumored to be part of the huge portfolio and that's just because of our size. And so, that shouldn't spook investors. You know, as I said, we're always around the hoop, but because of the dislocation, I wouldn't expect that to be a significant place where we'll be allocating capital. I think the other areas that you have on in the survey there, I think are fair. I think de-levering, you know, is [indiscernible] the rising interest rates where they are. We're at around 5.5x. Our sweet spot is in the 4x to 5x. And so, you know, we'll be looking to de-lever to the extent that we will. And we've also have commitments to the rating agencies. As a result of the deals that we've done over the last few years, our leverage got up a bit like it had done back in the 14x, 15x timeframe when we acquired the GTP portfolios, you may recall and the Verizon portfolio. So, we're clearly committed to being able to de-lever and to get that element of our balance sheet down and lower those costs. And buying back equity. We have a – we talked about that on the third party – the third quarter call. And I think our equity is, I guess, any CEO could sit, but I think our equity is undervalued. You know, I look at the long-term value of our business. And so that to me is a pretty attractive place to be able to invest, but it also needs to be in concert with being able to de-lever, right? And so, there's no 100% here or 100% there. It's a bit of a mix, I think. But underlying that is the ability to invest in those discretionary parts of our business, like you identified, that was kind of a given, I think, in the survey question, to be able to generate a good solid growth for us going forward and really be able to position ourselves to be able to drive that [40,000 or 50,000] [ph] build-to-suit capability over the next several years. And just one quick follow-up. So, on the earnings call, I think you were describing that there was like a window timeframe where you were anticipating getting back to that 5x or less net debt leverage target, can you remind us like what the period or year is that you want to get to that point so we could think about the flexibility over that horizon? I think we've said, what, 18 months to 24 months? Couple of years. Yeah. Couple of years. Hopefully, we can accelerate that, Mike. But that's what we're committed to.
EarningCall_1542
Good morning, and welcome to United Airlines Holdings Earnings Conference Call for the Fourth Quarter and Full Year 2022. My name is Candice, and I’ll be your conference facilitator today. Following the initial remarks from management, we will open the lines for questions. [Operator Instructions] This call is being recorded and is copyrighted. Please note that no portion of the call may be recorded, transcribed, or rebroadcast without the Company’s permission. Your participation implies your consent to our recording of this call. If you do not agree with these terms, simply drop off the line. I will now turn the presentation over to your host for today’s call, Kristina Munoz, Director of Investor Relations. Please go ahead. Thank you, Candice. Good morning, everyone, and welcome to United’s fourth quarter and full year 2022 earnings conference call. Yesterday, we issued our earnings release, which is available on our website at ir.united.com. Information in yesterday’s release and the remarks made during the conference call may contain forward-looking statements, which represent the Company’s current expectations or beliefs concerning future events and financial performance. All forward-looking statements are based upon information currently available to the Company. A number of factors could cause actual results to differ materially from our current expectations. Please refer to our earnings release, Form 10-K and 10-Q and other reports filed with the SEC by United Airlines Holdings and United Airlines for a more thorough description of these factors. Unless otherwise noted, we will be discussing our financial metrics on a non-GAAP basis on this call. Please refer to related definitions and reconciliations in our press release. For reconciliation of these non-GAAP measures to most directly comparable GAAP measures, please refer to the tables at the end of our earnings release. Joining us on the call today to discuss our results and outlook are our Chief Executive Officer, Scott Kirby; Executive Vice President and Chief Operations Officer, Toby Enqvist; Executive Vice President and Chief Commercial Officer, Andrew Nocella; and Executive Vice President and Chief Financial Officer, Gerry Laderman. In addition, we have other members of the executive team on the line to assist with Q&A. Before we do our normal [Technical Difficulty] walk you through a short deck that explains the intellectual rationale of what we’re[Technical Difficulty] and where we think the industry is headed over a longer term horizon. In short, we think there’s ample evidence that there really have been structural changes in the airline industry that set the entire industry up for higher margins than we had pre-pandemic. First, while the specific to the demand environment will be different, we expect it to return to at least [Technical Difficulty] it could go higher. Second, we believe cost convergence among all airlines as well as supply challenges may drive structurally higher industry margins. And finally, United has been pretty accurate about the macro outlooks, impact of COVID, and what the recovery would look like going all the way back to February 29, 2020. And based on that, United really did take a different and unique approach to the recovery. At the onset of the pandemic, we acted first, and we acted more aggressively than anyone else to protect our airline and the jobs of the people who work at United. At the time, in fact, some said that we were overreacting and that the pandemic wouldn’t be so bad. But by confronting that reality and acting quickly, our leadership team was able to be the first airline to move forward turning crisis into opportunity and began making plans for big investments in United’s futures, while others frankly were still in crisis response mode. It clearly had a head start and planning for the recovery, and you’re already seeing it in both our absolute results as we’ve achieved our 9% adjusted pre-tax margin ahead of schedule, and in our relative margin results compared to the rest of the industry. On this next slide, you can see what industry revenues look like as a percentage of GDP over time. A few interesting points: The industry still has about 15% domestic revenue growth left to go just to get back to 2019 levels here in 2023. Our base case 9% and 14% margin targets assume that we just get back to the 0.49% ratio. In the 1990s and 2000s however, revenue to GDP was even higher. As you’ll see in the next few slides, we think that cost convergence may drive revenues higher than 0.49%. And for what it’s worth, every single basis point of domestic increase translates into about 1 point of margin for United. On slides 5 and 6, I’ll address what I think is the most significant structural change to happen to the industry in a long time. For a host of reasons, we believe the industry capacity aspirations for 2023 and beyond are simply unachievable. But, just like 2022, when the industry capacity was 7 points lower than initial guidance, and we believe that same thing will happen this year for the same reasons. We’ve talked a lot about the pilot shortage, which is just one of multiple constraints. We, along with Delta, American and Southwest alone are planning to hire about 8,000 pilots this year, compared to historical supply in the 6,000 to 7,000 range. Pilots are and will remain a significant constraint on capacity. Post COVID, all companies including airlines and the FAA need to staff at higher levels, lower experience levels combined with sick rates that are elevated because of COVID, and new state legislation that makes it a lot easier to call in sick. We believe any airline that tries to run at the same stepping levels that it had pre-pandemic is bound to fail and likely to tip over to meltdown anytime there are weather or air traffic control stress in the system. OEMs are behind on aircraft, on engines, on parts. Across the board, there are supply chain constraints that limit the ability of airlines to grow. Finally, the FAA and most airlines with the exception of the network carriers have outgrown their technology infrastructure and simply cannot operate reliably in this more challenging environment. Taking all of the above into the consideration, we think at United, we need to carry at least 5% more pilots per block hour than pre-pandemic. In addition to that, air traffic control challenges mean our taxi and in-route flight times are elevated and growing. So, the same number of block hours probably produces 4% to 5% fewer ASMs. Put it together, we need 10% more pilots and 5% more aircraft to produce the same number of pre-pandemic ASMs. Like it or not, that’s just the new reality and the new math for all airlines. I think, however, we may be the only airline that’s actually figured this out and likely the only airline that has included this in our 2023 CASM-ex guidance already. And to be clear, all of these issues also impact United. The reality is that the airline industry is probably the most complex operational industry with by far the highest safety and regulatory standards of any industry in the country. And COVID hit our industry harder than others. All of us, airlines and the FAA, lost experienced employees and most didn’t invest in the future. That means the system simply can’t handle the volume today, much less the anticipated growth. At United, we also missed our capacity target for 2022. We had our own challenges over a year ago during Christmas of ‘21. Omicron hit us all hard. But it had also shown a spotlight on other strains in the system. We responded by proactively pulling down capacity. It was the only choice. You can’t change the engines on an airplane when it’s flying. We flew a lot less last year than we’d have liked to fly, but we did it intentionally, because it gave us the breathing room to make even further investments in our technology and infrastructure, and increase our staffing levels. And we had a huge start -- head start compared to most airlines, because we started with much better technology and infrastructure. But also importantly, we got to acceptance quickly and didn’t spend much time in denial about the structural changes. We accepted that the structural changes were real and moved quickly to what to do about it. On that point, I also fully recognize that most or perhaps all of our competitors will get on their calls next week and tell you one time event, no big deal, no change to our capacity plans. If so, I think they are just wrong. It’s intellectually hard and takes time to get through the denial phase. What happened over the holidays wasn’t a onetime event caused by the weather and it wasn’t just at one airline. One airline got the bulk of the media coverage, but the weather was the straw that broke the camel’s back for several. This keeps happening, over and over again. And you can see that despite good weather, ULCC still hadn’t recovered even as we entered the New Year. The operational difficulties are just the latest among numerous data points proving the systemic challenges that are going to limit the growth in flight. As you can see on the data on slide 6, United’s hub locations mean that we pretty much always have the worst weather. In spite of this, we are able to lead the industry, because we are doing a lot of things differently than we did historically. We made significant additional investments in technology and infrastructure. We are running with 5% to 10% staffing buffers. That means, we need more pilots, gate agents, flight attendants, rampers, et cetera to fly the same schedule. We are running with about 25% more spare aircraft than we did pre-pandemic, and we are flying lower aircraft utilization. All of those obviously cost money, but it’s clearly the right thing to do for our customers and most -- among the most important things we can do to win their loyalty. And it’s turning out these buffers are much less expensive than the cost of avoiding the otherwise inevitable operational meltdowns. In their forward guidance other airlines are likely to talk about returning to 2019 utilization, efficiency, et cetera, but we believe that’s just wrong. Our industry has been changed profoundly by the pandemic, and you can’t run your airline like it’s 2019 or you will fail. But don’t take my word for it, watch the data. United will always have the toughest operating environment. Any airline that’s operating meaningfully worse than United is out over their skis and is simply outgrown their technology, infrastructure and resources. Slide 7 transitions to the unique setup on the international front. This is one of the most stark examples of what United did differently than our competitors. Over the pandemic, we bet international would return strong post-pandemic. And because we were the only airline around the world with that view of the recovery, we were also the only airline to make two important strategic decisions. We didn’t retire widebody aircraft, and we were the only airline in the world that negotiated a deal with our pilot union to keep pilots in place and in position. That allowed us to quickly bounce back. The decisions that our competitors around the globe made to retire aircraft and downgrade pilots take years to reverse. And because of that, they simply can’t grow, and you already see that in this summer’s capacity data. On slide 8, I’ve already hit on the theme, so I’ll try not to belabor it here, but United had a conscious strategy to use the pandemic to invest in the future. Our large aircraft orders were just the latest example of this. New planes are big ticket items to get lots of attention. But other investments we’ve made in technology, infrastructure, and people haven’t drawn big headlines, even though they too are essential to our success. The point here is that we really were unique. It wasn’t just one thing and it wasn’t just aircraft. It started with the fact that we always believed in a full recovery. And as a result, we invested and invested early. On slide 9, everything about this deck hopefully gives investors some comfort on why we have confidence in our margin targets. But I think there’s potential for margins to go even higher, making slide 9 the money slide for this entire deck for me, at least. You can have whatever view you want about capacity. But what really matters is cost convergence. It’s already happening and I’m pretty sure it’s going to continue. I believe a world where ULCCs pay their pilots significantly less than us, yet, they can still hire and retain pilots, and they can somehow operate with previous staffing and utilization levels is just the null set. It’s not a realistic scenario. And with cost convergence, if I were a betting man, and actually I am, I’d bet that the revenue to GDP ratio is going back to the mid 5s. We’ll see. And again, we expect to hit our margin targets even at the 0.49% level. But if it is true, I believe industry margins will go even higher. That’s not our official guidance, to be clear, but it’s certainly possible. And so, to conclude, I think the pandemic led to a structural change in the industry. The supply-demand dynamics are different than they’ve ever been in my career. I realize there’s a lot of investor skepticism on that. But every data point, keeps demonstrating it over and over again. And because United saw this ahead of everyone else, we were able to invest and prepare to take advantage of it. To be clear, I think margins across the board are going to be higher in the airline industry. But because of the unique steps we took to prepare for exactly this kind of recovery, you’re also already seeing United’s relative performance is strong and I expect that lead to just expand. A huge thanks to the entire United team. You’re really doing an amazing job and you are making United the biggest and the best airline in the history of aviation. And with that, I’ll hand it off to Toby, who’ll explain some of these critical investments, why they were important to the success for operation through the most difficult holiday operating environment in my career. Toby? Thanks, Scott, and hello to everyone tuning in today. I first want to thank our employees for their exceptional performance over the holidays. We faced a really challenging operating environment that included some of the busiest days of the year and historical cold weather across most of our hubs and line station. While you wouldn’t know it from the holiday travel headlines, United was actually the most impacted airline from a weather perspective. 36% of all our flights were exposed [Technical Difficulty] 21st, and 26th, more than any other airline in the country. And even though our load factor was already high, we accommodated thousands of additional customers on short notice when their travel on other airlines was disrupted. Despite these headwinds over the holidays, our team connected 90% of our customers within four hours of their planned arrival and served more than 8 million people, 1 million more than we did last year. And our operation performed very well, especially because there were these tough conditions. United was among the airlines with the fewest cancellations during the holidays and we were number one in completion in Denver, San Francisco, Houston and Washington, and Dallas. And we practically eliminated all crew related challenges and cancellations compared to the 2021 holiday period. So, how did we do this? The answer lies in all the planning and investment we made during the depths of the pandemic. Instead of just trying to run the airline like we did in 2019, we worked over the last three years to prepare for a different, more complex operating environment and a sudden surge in travel demand. To prepare specifically for the 2022 holiday period, we’ve purposely built some slack in the schedule and reduced how often we fly during peak times. We accelerated our hiring and added staffing buffers in key locations. We built firewalls to prevent individual weather events from spilling over into broader network. And finally, we beefed up our training in every department, including clearing out the pilot training backlog to be resource ready for the peak travel demand season. Again, as Scott said, our work to prepare goes back even further. Over the last three years, United invested in systems, training, tools and technology that would empower our employees and benefit our customers [Technical Difficulty] a modernized crew scheduling system with 800% improvement in performance, capacity and security versus 2019, a smart schedule and operations coordination to build a reliable and operable schedules, additional spare aircraft in our fleet, updated technology infrastructure supporting our network, operations, airport operations and [Technical Difficulty]. Together with our industry leading customer facing technologies like ConnectionSaver and Agent on Demand, both of which now are integrated in our mobile app. Some of these investments are obviously more marketable than others, but they all make a difference in our performance. Finally, I want to point out the biggest difference maker for United this holiday season, our frontline teams. They worked as one team, they volunteered to pick up extra trips and work overtime and again record setting cold temperature. It was the combination of their dedication and the proactive investment in technology and infrastructure that led to our success. TRASM for the fourth quarter finished up 25.8% and PRASM up 24.6% versus the same period in 2019, a 9.5% less capacity, which was similar performance to United’s third quarter results and above the high end of our TRASM guidance for the quarter. TRASM growth for non-passenger revenue continued to outpace PRASM and Q4, although that will reverse in 2023. The reversal is due to cargo revenue decline in year-over-year to new post pandemic run rate that remained well above 2019 and co-brand credit card revenue growing slower relative to our rate of ASM growth for the year. PRASM in Q4 was strong across all parts of the network versus ‘19 with domestic results up 23%, Latin up 30%, Europe 11% and Pacific up 42%. International capacity in the quarter was down 12% and domestic was down 8%. Looking back at our revenue performance for all of 2022, our overall TRASM performance comparing to ‘19 was up 19.5%, about 6 points better than our expectation for the rest of the industry on average at this point and 3 points better than our network competitors during the same time period. To meet our overall 2023 outlook, we are expecting flattish TRASM for the year versus 2022. The impact of cargo and other revenues on TRASM in ‘23 is a negative 2 to 3 points year-over-year, implying PRASM up about 2 to 3 points in our outlook. As we think about the revenue outlook for 2023, we are bullish about global long-haul. We expect industry capacity across both the Atlantic and Pacific. The United is the largest carrier to be flattish versus 2019, which provides for an easy setup and positive RASM year-over-year. International demand remains incredibly strong, and we are looking at the potential for record profits and margins across our global network. Asia has traditionally been a margin drag on our global flying, but we’ve worked diligently to rebuild the network and close this gap. And we think 2023 will validate that we accomplish that goal. Asia is also close to being fully opened, allowing United to reestablish the bulk of the specific flying outside of China. It’s worth noting that restrictions on the use of Russian airspace will constrain United from flying both of our China network in 2023. This same restriction will also limit our ability to fly to India. While I would not normally provide revenue details about the months within a quarter, I think it’s important to share what we are seeing in Q1. Our unit revenue outlook for February and March is largely consistent with the levels we’ve seen in the past three quarters at roughly 25% higher than ‘19. We believe January is a negative outlier in Q1 with unit revenues compared to 2019 softer than the months after it. We think this is primarily due to holiday timing with less demand for incremental weekend trips, enabled by hybrid work schedules, so soon after the year-end holidays. But, we expect the second half of February and March to be back on trend with booked revenue already 30% to 40% above the same period in 2019, and I think this validates our excitement for 2023. Overall, we expect our Q1 TRASM to be up approximately 25% year-over-year. Another positive catalyst for 2022 revenues is the continued but slow recovery of traditional large corporate business travel. While November and December were low relative to October, it’s great to see that January is materially better by about 5 points versus the average for Q4. January represents the start of a new budget year for most, so it’s a great way to start the year. And we’ve heard often that budgets in 2022 were exhausted early as to why November and December travel were a bit disappointing for large corporate travel. I talked about the great setup we see in global long-haul earlier. We also see a nice setup for our domestic operations as constraints across the industry are everywhere, creating a favorable supply-demand environment. United is also now quickly executing on United Next plans focused on gauge, premium seating, revenue segmentation, signature interiors and most importantly, restoring and building connectivity, which suffered during the pandemic. We’re opening 17 new mainline gates in Newark and 20 in Denver in 2023, which will enhance our customer experience and improve reliability. In Denver, the new gates will allow us to grow our most profitable hub. And in Newark, the new gates will allow us to transition more flights to mainline from Express, consistent with our United Next plans. In addition to gates, we opened more United Club space. In Newark, we have 69% more club space and Denver will be up 180% versus 2019. We also have expanded club space in Chicago by 40% with a new club that opened last week and in Dallas by 43%. Most of these club projects will soon be online and were planned during or prior to the pandemic. Importantly, there are more projects on the way in the years to come. Looking beyond 2023, we continue to implement our United Next plans. We’ve adjusted our upward -- our long-term gauge plan so that by 2026, our North American gauge will be up 25% versus 2022 and 40% versus 2019. United continues to be undersized in gauge as we await delivery of our large narrowbody planes that are largely absent from our current schedule, creating a margin gap versus our potential and versus others that have a significant fleet size in this category. Activity suffered in 2022 due to a reduction in RJ flying capabilities and delays from Boeing. Pilot staffing at our regional operators has stabilized since pay changes went into effect essentially matching one of our competitors combined with our AVA program that provides a 4-year transition plan for pilots from an express job to a United Mainline career. Regional jet utilization is showing signs of improvement, but we still have a long way to go, and it will be until about 2025 or beyond to get to normal. We have also signed a new agreement with Mesa to expand our large RJ flying in 2023 and associated small community service, while our relationship with Air Wisconsin comes through a natural end. With this change, the number of regional partnerships is reduced from 6 to 5 and will eliminate approximately 40 single-class 50 RJs that were not part of our long-term plans in exchange for adding dual-class 70 CRJs, a clear win for United, small communities and our customers. Rebuilding connectivity will be a key focus in 2023 and 2024, and will be significantly additive to RASMs as it was in 2018 and ‘19, giving us confidence as we do it with optimal gauge this time around. Thanks to the entire United team. Thanks, Andrew, and thank you to the whole United team for closing out the year strong. With adjusted pretax income of $1.1 billion, we came in ahead of our fourth quarter expectations and not only returned to pre-pandemic levels of profitability, but actually exceeded the fourth quarter of 2019 on both an operating and pretax margin basis. Even more encouraging in the second half of 2022, we achieved an adjusted pretax margin of 9%, which matches our margin target for 2023 and puts us well on our way for that same success this year. Turning to costs. Our CASM ex performance in the second half of 2022 meaningfully improved versus the start of the year. As I mentioned last quarter, a big driver of this success is the return of the grounded 777 to flying and further improvement in our operational reliability. As we know, a well-run operation is a more cost-efficient operation. Looking ahead, we expect first quarter 2023 CASM-ex to be down between 3% and 4% with capacity up 20% versus the first quarter of 2022. On a full year basis, we expect 2023 CASM-ex to be about flat with capacity up high-teens versus 2022. This full year cost outlook is inclusive of investments in the system that support operational reliability, our current expectations for new labor increases, representing about 4.5 points of CASM-ex, excluding any possible signing bonuses, and a higher inflation outlook for all parts of the business. On the first point, one lesson learned during the pandemic recovery is that it is both economical and profit maximizing to provide cushion to our aircraft utilization. Instead of pushing utilization to its theoretical limit, we are focused on protecting our reliable operation. This minimizes delays and cancellations, which would otherwise drive higher costs such as overtime and customer accommodation costs. Turning to our expectation on profitability. As Andrew mentioned, demand remains healthy. As a result, and using the January 10 forward curve for fuel prices, we expect our first quarter 2023 adjusted pretax margin to be around 3%, resulting in an adjusted diluted earnings per share between $0.50 and $1. Additionally, building on a successful second half of 2022 and with industry dynamics Scott described at the start of the call, we feel even more confident about achieving our United Next 2023 adjusted pretax margin target of 9% and expected adjusted diluted earnings per share between $10 and $12 for the full year. On aircraft, we currently expect to take delivery of 92 Boeing 737 MAXs, 2 Boeing 787s, and 4 Airbus A321neo aircraft in 2023. Assuming all these aircraft are delivered, we now expect full year 2023 total adjusted capital expenditures to be around $8.5 billion. Even with this elevated level of CapEx, based on the capacity, revenue and cost guidance we’ve outlined, we expect adjusted free cash flow to be positive for the full year. Looking beyond 2023, last month, we announced an aircraft order with Boeing that included 100 firm 787 aircraft, which will address much of our widebody replacement needs through 2032. We also received options for up to 100 additional 787s that can be used for growth if there are margin accretive opportunities to do so. Additionally, the order included 100 incremental 737 aircraft to both, meet planned United Next targets and start preparing for narrowbody replacements in 2027 and beyond. Our aircraft order book is one of our key assets as it provides us with both, cost-saving replacement aircraft and the ability to take advantage of profit-enhancing growth opportunity. The cost of the flexibility built into the order book, we can also adjust the delivery time line as the macro economy dictates. Moving to the balance sheet. We ended the year with liquidity of $18 billion and reduced our adjusted net debt by $3.3 billion versus year-end 2021. We continue to balance liquidity levels with deleveraging activity and financing opportunities as we expect to end the year having met our 2023 target of adjusted net debt to EBITDAR of less than 3 times. We’re entering 2023 with a strong foundation, and I want to recognize all of the hard work that has gone into running this great airline. We look forward to delivering to our customers, employees and investors in 2023. Thank you, Gerry. We will now take questions from the analyst community. Please limit yourself to one question and if needed, one follow-up question. Candice, please describe the procedure to ask the question. There’s been some pushback just on the 2023 jet fuel guide and just trying to get comfortable with the link between cost and revenue. So, RASM is the highest it’s basically ever been. And even with the capacity constraints out there, industry capacity is now being added. So, what gives you the confidence that you might pass along additional cost headwinds on to customers in the current environment? Hey. Conor, let me provide a little bit of color on that and maybe Andrew will as well. But first of all, we -- when we provide our fuel guidance, we did this quarter, what we always do, which is we look at the forward curve about a week ahead of the release. So last week -- those numbers, as you know, can change daily. In fact, if we had run it more recently, we would have put out fuel numbers potentially $0.10 to $0.15 higher. All things being equal, that would represent about 1 point of margin, but we are -- we continue to remain confident that there is the correlation between revenue and fuel that we’ve seen historically. For the first quarter, near term, we don’t have quite the same ability that we would have during the full year. But even for the first quarter, we still have February, March and fuel will change daily. And for the full year, we’re still comfortable that there is this correlation. And in fact, had we put a higher fuel number -- and there probably would have been a different revenue number. But let me just give you an example that gives me some comfort. But keep in mind that for the back half of 2022, where we achieved 9% margin, fuel was $3.68. So, we do have a lot of cushion. And I don’t know if Andrew has any additional color. No, I think you covered it really well, Gerry. The -- we absolutely still do believe and have seen constantly over time that fuel is a pass-through on both, the up and the down. And the other thing I can tell you is, as we look at our advanced booking particularly starting in the mid-February time period out well beyond that and into Q2 we’re in a really good, strong supply-demand equation that’s allowing our RM systems to actively work to do what they do best. So, I feel really confident about the outlook. Okay. And then just on the United Next plan. So when you guys talked about that originally, it was all about leading on costs, and I realize the environment has changed a lot since then. But, as you start to look at the cost structure that includes labor and so on, is your expectation that this -- like that United becomes a cost story again going forward -- in the post-2023 world, going forward. Thank you. Well, Conor, there’s no question there’s been an industry reset on costs, and I think Scott did a nice job sort of describing that and the cost convergence ahead. For us, if you just look at our guidance we put out about six months ago for 2023, there’s been movement. There’s no question, probably about 9 points. 3 points of that is just the capacity difference between what we thought 6 months ago versus what we’re thinking today. Another 3 points in the labor numbers we put in, the rest is inflation and buffers. But what’s important for the United Next plan is the relative cost story, which remains very intact. So, whether it’s the mainline gauge benefit we’re seeing -- we will see from all the additional aircraft or less reliance on single-class 50-seat aircraft that have come out and will continue to come out of the operation. We’re very comfortable in the United Next cost story as it’s been adjusted for the industry cost impact. Maybe just coming at the revenue question a little differently, maybe for Scott or whoever else wants to answer. How do you think about getting back to airline revenue as a percentage of GDP? I think that makes a lot of sense conceptually. But, do you think the industry gets there on pricing if volume versus GDP is lower given the capacity constraints we talked about? Well, I mean, if you go back and look at history, while load factors have gone up a little, I wouldn’t expect a lot of change in load factor. And if you went back a few years, pricing in real terms was higher [Indiscernible] it remains a great value. I mean, air travel prices are probably 50% lower than they were about 30 years ago in real terms. And you can still frequently pay more for your Uber to the airport than you do for your airline ticket to Florida. And so, I think -- but I think that what this means is the era of $4 prices from Los Angeles to Cabo and $7 from New York to Florida or $9 from Houston to Central America are probably a thing of the past. And cost convergence -- it’s up to other airlines to decide how to price the product. But I’m pretty sure it’s not upto them what’s happening to their cost structure. And as that is changing, we see it happening already. It is what happened last year. It’s what changed last year. We see that continuing, to Andrew’s earlier point, too, I look at the data as well and following our revenue management team is doing a great job. But the yield curve for February is higher than January. The yield curve for March is higher than February. And the yield curve for the second quarter is higher than March. And by the way, bookings are ahead in all periods. So, I think it’s a structural reset. I think it is the investor store or aviation, I think it’s good for everyone. I think it’s particularly good for airlines like United that have the sophistication, the technology, the infrastructure to operate in this more challenging environment. But it’s good for everyone. And it’s just a structural reset that’s reversing what happened over the past couple of decades, at least a possibility of it. I think it’s likely, but we’ll see it at least a possibility. Thanks so much for that color. And live in New York, can definitely confirm on the Uber versus the airfare of late, so somewhere there. And obviously, a lot has changed, as we just talked about since the original United Next plan, particularly how the capacity bottlenecks we’ve been talking about have played out. How should we think about capacity growth over the next couple of years? Are you still targeting to be about 40% bigger in 2026 based on that 4% to 6% CAGR or help us reset the bar? Thanks so much. I’ll try that. I don’t think we’re going to reset the bar here. Obviously, this is really dynamic. And the OEM delivery delays, both on engines and aircraft have been really unprecedented. So, we’re not going to reguide today to what 2026 looks like, other than we’re plotting our course in very bumpy skies when it comes to the availability of aircraft. And there’s not a quarter that goes by where I don’t get an update with obviously disappointing results from what our outlook looks like for aircraft deliveries. So, we’ll continue to monitor that. And at the appropriate point in time, we’ll update the guidance. I think, the important point is we have real confidence in achieving our 14% margin under sort of all the plausible scenarios for aircraft deliveries. Gerry, a question on the labor cost assumptions, the pilots in the 4.5-point headwind. Do you expect the pilot economics to be backdated to January 1st, or are you using some other date? And also related to this, the EPS guide, do you also consider Delta’s profit-sharing formula to be market? Jamie, nice question, but neither one of those we’re going to be able to talk about on the call. You’re asking for too much information regarding potential negotiations. Okay. Second question for Scott then. On the topic of cost convergence, I think you said that the ability for discounters to maintain a significant wage arbitrage is narrowing or impaired. I didn’t quite get your language. But if we look at the Spirit and JetBlue TAs, yes, they’re incrementally expensive, but the resulting wage advantage to, let’s just go with Delta here. It’s still pretty much the same. So, were you implying that the arbitrage has to narrow even more, or did I misunderstand? I’m saying, not implying, that I don’t think a world where they pay meaningfully less and still hire and successfully fly and complete their schedules. I think that’s an offset. I don’t think they can do it. And one of the other ULCCs has really been struggling this year with a completion factor, which at least had us internally wondering if they had pilot shortage issues because system’s been really pretty good. There was a one-day FAA outage, but the weather has been good, and they’ve been consistently having problems. And then 8 or 9 days ago, they put out a $50,000 signing bonus for pilots. And look, however you want to calculate it, however you want to look at it. And if you’re interested, I can give you some more real-time facts, like I’ve watched the data closely. And it’s not happening. I mean what happened over the holidays wasn’t just at one airline. And at all the airlines that had challenges, you can look at our data that we put out. And if you want data for what’s happening right now, I can tell you some more stuff. But, there are a number of airlines who cannot fly their schedules. The customers are paying the price. They’re canceling a lot of flights. But they simply can’t fly the schedules today. Maybe it’s pilots, maybe it’s something else, maybe it’s technology, maybe it’s infrastructure, but what I’m confident of the big three -- and by the way, I think JetBlue has invested in this, the big three and JetBlue are operating at a different level than everyone else for whatever the reasons are. Scott, thanks for that kind of early intro to the call, pretty extraordinary set of kind of facts, an argument you laid out there. What does this mean for the industry kind of longer term? Kind of it’s really unusual to see an industry, to your point, try to grow in the face of the restrictions that they have like this? I mean, how does this end? I mean, do you think there’s going to be like regulatory scrutiny on kind of airlines trying to grow when they can’t, and that’s hurting service, or what happens next here? Well, I think what it’s going to lead to one way or another is less capacity. You just -- it’s not mathematically possible for all the airlines to achieve their aspirations. And now, I’ll just give you the data. I’m not trying to pick on these two airlines. But, like this seems so blindingly obvious to me. And we talked about it a year ago, we were right all this year with capacity coming in 7 points lower, and I feel even more confident that we’re right today. And the data I’ll give you is snowstorm started -- pretty big sandstorm started in Denver yesterday afternoon and it continued through this morning, 11 inches of snow. So, that’s a tough operating environment. There are 3 large airlines -- there’s 3 airlines, so 2 in addition to United have big operations there. Yesterday in Denver and our mainline, we had a 100% completion factor, so no cancellation. [Technical Difficulty] canceled 12% of their flights, the other one canceled 27% of their flights. Starting off today, we’ve canceled a little less than 1%. Each of them have canceled 33% of their flights, like this isn’t new. And there’s like a dozen of the Wall Street analysts that breathlessly publish a weekly report on industry scheduled capacity. You guys are looking at the wrong data. If you want a forward indicator of what’s going to happen with capacity, you should watch completion factor. One of you should start looking at completion factor because airlines that are running like that, it means they can’t fly their schedule, and they’re going to have to adjust one way or another. That’s my thesis. That’s what happened last year, is what I think is going to happen next year. And all of the structural issues are multiyear -- I mean all of them are 3 years at best to address. And you put all of them together, this is a long-term structural issue. And I think, it challenges us too, but we just did more to invest for that future, saw coming earlier than others [Technical Difficulty] and are better prepared to deal with than everyone else. But it does challenge us too. But really like don’t take my word for it, don’t take the others word for it, just watch the data. That’s what’s happening with completion factors, and that’s going to tell you whether we’re right again this year or everyone else is right when they say they’re going to achieve the aspirations. Great. Thanks, Scott. I think, you can be a good sell-side analyst when you decide to do something else at some point in the future. Just maybe one follow-up. I think the point on corporates running out of budgets towards the end of last year was an interesting point. Do you guys have much data on kind of what ‘23 corporate budgets look like to avoid a similar situation this year? Thank you. I don’t. What I’ll tell you is that the reset looks very good as we head into January, obviously. So, we’re really pleased with those numbers. October was a really good month for corporate and January is tracking at that or above that. And so, we’ll see where we go from here. But, I’ll tell you, this is an important number for United. We monitor it a lot and it’s moving in the right direction. And we’re highly confident, particularly for long-haul global that we’re going to get back to full strength, and that’s an enormous tailwind, I think, for at least airlines that rely a lot on corporate travel. Just on the interrelation between fleet and CASM, if we just back up in time, you announced a big fleet order in June of 2021. I think that’s when you unveiled United Next. And your target for this year was down 4% relative to ‘19 on CASM-ex. You updated those views. Obviously, we had less capacity, inflation, et cetera. So you went from down 4% to up 5%, another big fleet order in December and now the outlook is plus 15% versus ‘19 versus your initial down 4%. So, I guess, the question is, given the constraints that you articulated very well, why does this investment rate still make sense? If you can’t grow at the rate that you hope to grow, why invest at a rate that assumes a much higher growth outlook at some point? Well, to be clear, I think we can grow at United. I don’t think the industry can grow for all the reasons that we’ve set. I think at United, we can grow. We are clearly able to hire pilots, pre-pandemic, like most of we ever hired there’s about 900 in a year. We were right at 2,500 last year. Our team -- our flight training team has done an amazing job. There was a lot of work to do to get that training machine humming. It also helped that we had enough foresight to build 14 new simulators during the middle of the pandemic when everyone else was pulling back and shrinking. But that’s part of the -- that’s one of the probably the most complicated thing that airlines are struggling with, and we have that machine humming. We’re here in Houston at the flight training center and we acquired 4,000 flight attendants this year. We opened a new flight training center, another investment we made last year. I mean, really, the point is we invested to be able to grow. And I think we can grow. We have the other benefit. We’re taking 300-plus regional jets out of the system. So, that creates a natural slack in terms of departures. If you got FAA issues, air traffic control issues, if you’re a single fleet type airline, you buy all A320 family or all 737s, like you don’t have anything to take out to give you room. We do have 300 aircraft to take out. But really, the point is all the investments -- I mean, like one of the investments that I like that speaks to the foresight that we had coming into this was clubs, and we increased our club space by 48% during the pandemic, like that’s always a challenge. Trying to close clubs when they’re full in a constrained airport environment, it’s always tough on customers, like the pandemic was once in history, not once in a generation, once in history, a chance to do that with minimal impact because we didn’t have nearly as many customers flying in 2020 and 2021. And we’re the only ones that did it. And like there’s just stuff like that everywhere that United did differently. So to be clear, while I don’t think the industry can grow, I think we think United can. My guess is because of the [Technical Difficulty] our full target because those will be behind. We’re going to be filing a lower utilization than we were before, and there’s going to be less regional. So, we probably won’t be all the way to our target. But I think we can uniquely grow and expand margins in this environment when everyone else can’t, and it’s because of all the investments we made to set up for this. Thanks for that, Scott. And obviously, hindsight is 2020. It’s been a unique set of circumstances. But I guess the question is, had you invested at a rate more aligned with your DNA where there’s real free cash flow to point to here, how much higher with this CASM outcome have been? In other words, if we’re up mid-teens relative to 2019, could you have invested at a much more modest rate and gotten to the same outcome? And I appreciate your thoughts on it. I think if we -- I mean, look, if we’d invested -- if we had done the same thing everyone else did, we’d have the same problems they have right now. Instead of canceling 1% of our flights today in Denver, we would be cancelling 33%. That’s higher cost. Our costs would be higher. This isn’t just investment, like [Technical Difficulty]. Anyway, I think when you get to the end of the year, add dollars to donut, we have the lowest CASM, the best CASM performance. I recognize other people have better guidance and then maybe they will have better guidance. But I think in the real world, we’ve come to grips with what the real world means and how -- which you have to do to operate it. And you can see it in the data, you can see it in the operating stats, you can see it in the financial stats. And it’s a new world. You can’t run the airline like you did in 2019. I remember -- I read all the transcripts. And I read one of the transcripts, and Jamie asked someone, I don’t remember which airline it was, but asked someone when are we going to get back to pre-pandemic normal. And I don’t remember who it was or even what they said because I immediately thought the answer to that question is never. And I don’t think anyone else just figured that out yet. The answer to that question is never. It isn’t a new environment, it’s a new industry. And that creates higher costs. It does, but it’s also creating higher revenues. And I think it’s going to lead to across the board higher margins, but particularly for United. Hey. Andrew, I just wondered if you could sort of [Technical Difficulty] about what’s embedded in the TRASM guide for being flat? I know you mentioned PRASM was up 2 to 3 cargo down. What are you expecting out of the card program and the other revenue line as we think about ‘22 to ‘23? We’re still expecting really strong results, but it’s just -- it’s not keeping up with the ASM growth rates that negative headwind. But our card program is doing really well. The partnership with Chase is just top-notch, new members into the MileagePlus program, relative to where we were in 2019, I think, were up about 50% in the same time period in 2022. So, all of that’s moving in the right direction. It’s just not keeping up with ASM growth in 2023, which creates that inversion between PRASM and TRASM. And obviously, you understand the cargo part of that. Okay. And then, maybe, Scott, just to ask the question, it just kind of came up as you’re talking about the challenges around the industry having to reset its cost structure. Do you see any risk that as you’re kind of looking out and building the revenue plan around your own cost structure, setting fares at a level where you can recover that cost pressure that the rest of the industry maybe doesn’t get there. I guess, if the rest of the industry isn’t quite recognizing what the cost pressure of operating in the new normal is going to be, do you think they’re going to be under pricing and potentially creating some problems for you to absorb some of the costs that you’re building into the network? Thanks. Well, if they’re right -- I don’t think they are, but if they’re right and they can return to 2019 utilization and efficiency, then we can, too. That will be easy to just go back to flying. So, no. The short answer is no. I’m not worried about it, because if they are right, it will be really easy for us to just fly the aircraft a little harder. And because we’re growing within a few months, just slow the hiring down and within a few months, you’d be back. To be clear, I think that’s extremely unlikely to happen. But we could adjust our cost structure down if it turned out that we were wrong, and that’s the new normal pretty easily. I just kind of want to go back to fuel for a second, just because it has dominated my conversation so far. I guess, when you think about it conceptually, looking at your 2023 guide, it seems like you’re assuming fuel is going to $2.70 per gallon 2Q to 4Q. And Gerry, you said fuel is a pass-through. So I think that’s down like at least 30% from current market. Just how do you underwrite that kind of 2% to 3% PRASM growth in 2023 if fuel is coming down? Let me start. Look, what I’d tell you is that I do think fuel is a pass-through in both directions and that it is dynamic on when we pick the number and we -- we adjust the revenue forecast for it. But more importantly, where we are in terms of demand and supply and cost convergence, as Scott just spoke about in quite a bit of detail, has just given us, I think, significant ability to utilize our revenue management system to make sure that the price points are where we need them to be. And we did that all through last year. And in fact, we did that all throughout the entire pandemic, where we led the industry, I think, 11 out of 12 quarters. So, we feel really good about where our revenue performance is. We feel really good about where our bookings are. We feel really great about our Q1 guidance, and we feel really good about where the RM system is currently managing price points for Q2 and beyond. We definitely believe in the GDP relationship. It is converging, and it’s converging for all the reasons that Scott talked about earlier. So, we feel really bullish about the outlook and the ability to achieve the revenues that we need to achieve. Got it. Understood. And then, Andrew, you gave some pretty robust booking figures for February into March and kind of your whole outlook. Any color that you can provide in terms of how you’re thinking about 1Q by region, which regions might you see accelerating, which decelerating from here? Just kind of get a sense of how you’re seeing the world right now? Thank you. Sure. I’ll go to try. I will say that I started with earlier, the global long-haul environment where capacity ex United is negative and capacity with United is just slightly about at 2019 levels relative to where GDP is this year, provide just an enormous set up to hit a home run on TRASM on our global long-haul network. So, we couldn’t be more bullish about that. And it’s simple, right? Supply is flat versus ‘19 and the propensity to travel along with the economy and GDP is dramatically higher. That sets up a very good opportunity for RM systems, and they’re actively working to do that. And bookings for spring and summer look really strong. So, to Europe, I just think it’s going to be another record RASM and margin year based on that setup, and it looks really good. Across the Pacific, the same exact capacity setup, by the way, where it’s slightly negative without United and about 100% with United relative to 2019 capacity and a very similar setup, but we also have the opening of China and all three markets, Hong Kong, Beijing and Shanghai, ultimately. And we think there’s going to be a significant bounce back in demand like we’ve seen in Korea and Australia and other places in the region. The only I think thing we’re watching more carefully is Japan, where the numbers look really good, but it’s based on U.S. point of sale at this point and not Japanese point of sale. We expect the Japanese point of sale to kick in later this spring and summer. So, that one has been slower to rebound. But again, U.S. point of sale just had an enormous, I think, pent-up demand and is ready to fly and is doing -- so really covers the numbers. Once Japan comes back on line from a point-of-sale perspective, I think that further strengthens that as well. Latin America, near Latin America is the best I’ve ever seen it from a TRASM, RASM type perspective at this point. And Deep South America is also very good, but it’s just not nearly as good as the amazing performance we’re seeing eclipse in Latin America. So the setup for our global network is, I think, unbelievably good. And it’s really a very simple math, and there’s very little capacity growth out there and a lot of GDP. And if you look at our capacity guide, while we haven’t given you an international and domestic breakout, you can look at what we’re selling. And you can see how we’ve leaned into it for 2023 to make sure we maximize the profitability of the airline. And we think that we’ve done that very well. Domestically, I also want to say, Scott, talked about this cost convergence. We talked about the capacity constraints. What people think they’re going to fly in 2023 is not what will really be flown, that happened 2022. We think that’s going to happen in 2023. And given where we think total revenue is and ASMs will be less than that. We think there’s a chance for a positive TRASM domestically as well. And it’s a really good setup. So, across the globe, amazing setup; here at home also a very good setup for a positive outlook for the year. So, just one question here. When we look at air fares and we compare, say, premium economy to where business class was pre-pandemic, it seems like the price points moved to that level, right? So, you have some economy fare. Then, you have a premium fare in economy that seems to be equal to what business was, and you seem to have business that is significantly higher. So, A, is that observation correct; and B, what’s your expected load factor in the front of the cabin? All right. There’s a lot of numbers you put out there, Helane. What I’ll try to say is that paid first-class load factors, particularly here domestically are up a lot. They’re up 6 points. And so, our RASM growth in the first-class cabin versus the main cabin domestically is 15 points higher. So, it’s doing incredibly well, which we’re excited to see, obviously, because of our move towards more dual-class aircraft and monetizing the premium cabins. On our global long-haul fleet, I think it’s a little bit different than maybe what you said. The public price points may be exactly what you said, I don’t know. But the performance, I would say, is that Polaris is not back to where we’d like it to be just yet. But the middle cabin, the Premium Plus cabin is and better and the coach cabin is and better. And so, the RASM performance onboard the aircraft is a little bit more tilted towards the back of the aircraft or the middle of the aircraft on the global long-haul fleet than it is the front. And why I’m also particularly excited about this recovery in large corporate traffic is that is how we tend to fill the front of the aircraft. And so, the trends we see in January look just really good. And that also is a positive TRASM tailwind to the global network as we do a much better job of filling up Polaris with higher quality yield than we did in 2022. And I’m confident when we end 2023, we’ll be able to report that the Polaris paid load factors and paid yield are much closer to their 2019 baseline than they were in 2022. Okay. That makes perfect sense. And then just for my follow-up question. I’m not sure whether you said that or Scott said this, but if ‘22 -- if nobody flew their capacity original plans in ‘22, which they didn’t, and they don’t in ‘23 and the infrastructure issues -- and I don’t see the government rushing to invest in air traffic control. In fact, I see it getting worse. I don’t see the FAA investing. As you think about this, doesn’t ‘23 get worse than ‘22 and ‘24 get worse than ‘23? And doesn’t that accelerate to the point where you can’t -- the industry just have more because you run out of space? Pretty close to yes is the answer. We’re near the limit on capacity -- on flights in the system. There are places that are at the limits, and we’re near. And you can see it, like it works fine, and you can add more on good weather days when absolutely nothing goes wrong. Something goes wrong every week. I mean, there’s weather, there’s systems issues that happen at the FAA, they happen at individual airlines, there’s pipelines that get cut for fuel at airports, there’s vendors that fuel airplanes at airports that are short staffed or have higher sick calls, just the stuff that happens every day. And we’re near the capacity limit in terms of total number of flights. And Scott, we should add to that though, what you said earlier that we’re getting rid of a large number of regional jets. So, the departure activity that we’re planning from our 7 key hubs in 2023 is still materially behind where we’re in 2019 from a departure level. The ASMs are a whole another story as we’ve talked about because of what we’re doing with gauge. But we’ve created the room in our hubs to be able to execute our plan. We have sufficient runway and gate space to do so. I got one near term and then one bigger picture question. Just when I just look fourth quarter to first quarter, the RASM guide, the implied revenue guide just worse than normal seasonality. Just given everything you were saying about February, March bookings, just help square with the revenue and RASM guide, please? Yes. What I would say is that we definitely see a different set of numbers for like January 6th through February 15th than we do beyond that. And as I think about it, it’s our hypothesis that we do have a bit of a different type of seasonality post-pandemic than we did have pre-pandemic. So it just depends on the year -- the quarter-over-quarter year that you’re looking at. But look, the trade-off would be every weekend is potentially a holiday, allowing us hopefully to be able to depeak the summer and run a more constant level of operation from mid-February all the way through October, that’s really exciting and a lot more upside than maybe a few weeks in January that don’t look as good as they used to be. So, I think the trade-off is fine. But our hypothesis at this point, it is a different type of seasonality related to a post-pandemic environment. Okay. And then, Scott, so bigger picture, if you’re not getting the unit cost leverage from capacity growth that maybe you thought you would have gotten a year ago, I guess, why grow so much and risk adding too much capacity to the market and risk pricing? And maybe just asked differently, if you didn’t grow as much, do you think you’d still hit the 9% margin, but at the same time, just generate better free cash flow? Well, to be clear, we’re focused on margin, not CASM. We’re focused on margin. And while we aren’t updating -- upgrading our margin guidance, we’re already way ahead of the Street. I think everything we had in our deck today and everything we’ve talked about today certainly creates a plausible case that margins are going to be higher for all the reasons we’ve talked about. If we were not growing, I think our margins would be lower. I mean, clearly, it would impact our CASM. But I think the capacity that we’re going to add would be soaked up by someone else. And I think that -- anyway, I think our margins would be meaningfully less if we weren’t doing what we’re doing. And so, we’re doing it because we think this is a -- look, I think this is a once in the history of the industry opportunity. This is an event that’s never happened before. And I get that most of you on the sell side disagree. And I accept that you disagree and -- but I think the world has changed and the industry has changed. And by the way, we do have a lot of flexibility. And what I would say, you didn’t ask this as a question what I would say is if we’re not -- if there’s some reason that we -- doesn’t look like we’re going to hit our targets, if we’re structurally missing our targets, if we’re underperforming the industry and missing our targets, we won’t do all this growth. I mean, we have a ton of flexibility to move aircraft around. And we won’t do it. So, it isn’t just like [Technical Difficulty] damn the torpedoes. This is as long as it’s working, we’re going to keep moving. But I will tell you, every single data point increases my confidence at least it’s working. So look, we had with the highest pretax margins and fourth quarter of the big network carriers at least, we -- amazing enough, if you look at -- actually, we had the highest free cash flow in 2022 with the lowest net debt if you use traditional GAAP accounting with operating leases and include pensions. We had the lowest leverage ratio, like -- I mean, it’s working. If you look at our operating results, what’s happening in Denver today, like it’s working. So, we’re not going to change course on something that’s working. But if it stops working, then we absolutely have the flexibility to adjust. Just curious if you’re benefiting at all from book away from Southwest after the holiday meltdown, and also if you’re benefiting from pilot attrition coming from Southwest. And second question, do you see any impact from many travelers that are cashing in on their miles this year that they might have built up during the pandemic, and does that help or hurt you? Thanks. I’ll give it a try, Leslie. It’s Andrew. I think we’re benefiting from running a world-class great global airline. When we look at the data and particularly not over like one week, right, over one quarter, when we look at the data over the last year plus, our team has been just hitting a home run and the data shows it. So, I think we’re really proud of where we’re at. We intend to keep that online. We have the appropriate buffers to make sure we can continue to deliver for our customers going forward, and we shall. In terms of frequent flyer growth, what I was going to say is the program is incredibly healthy. The redemption rates are quite normal given where we are with inventory availability and our customers are using their miles to fly all over the world in the largest global network of any U.S. carrier. And on the pilot front, what I’d say is, it’s an amazing change. I tried to get out to the pilot training center and see new hire classes, and we’re hiring 200 a month, and I’ve started asking where they come from and show of hands. It used to be like from any of the large airlines, ULCCs, LCCs, big airlines, hardly any because you had to give up seniority to come. We now have a high percentage of people in those classes that are coming from all airlines. And I think the reason is because United has -- if you’re a pilot -- well, if you’re any one and you aspire to a career in aviation, United is a place to go. We’re well on our way in to be the biggest, but also the best Andrew talked about the brand, the reputation that matters a lot to people. Our pay rates are going to always be -- vary depending on the timing of contracts, but always basically going to be at the top of the industry. If you’re a pilot, United has the most growth opportunities and most opportunities, the fastest path to captain. The most widebodies of any airline by far in the country, like we’re the place to go. And people are actually giving up their seniority at all of our competitors for the opportunity to come and have a future at United that’s a testament to what all the people of United have accomplished and how bright we feel like the future looks. Just wanted to ask about the FAA outage last week. And I don’t know how you’re thinking about that. Is there a concern that there are other sort of -- of these systems that are vulnerable or that you think of as single points of failure and how you’re thinking about it? And what kind of conversations you’ve had with the FAA since? So, I think this ought to be a wake-up call to -- for all of us in aviation -- something many of us in Aviation have been saying for a long time that the FAA needs more resources. By the way, I think they do an amazing job. During the Christmas struggles with the weather, a bunch of great things that they did. But 2, in particular, the water main break that flooded the tower in Newark and the same thing happened at one of the towers in Chicago, and they really quickly moved into backup facilities and kept the operation running. I mean, just a lot of people jump through a lot of hoops and deserve a lot of credit for that. But the hard facts are the FAA’s budget in real terms, it’s lower than it was 20 years ago. But the amount of work that they’ve been asking to is significantly higher. Huge resources devoted to space launches, drones, thousands of people were working on aircraft certification programs in the aftermath of the MAX disaster. And so, they’ve had to rob Peter to pay Paul. And they’ve done -- asked to do more, and they’re doing it less money. There’s fewer controllers than there were 30 years ago. And it’s people, it’s technology. And look, here in the United States, we should have a world-class best aviation system in the world. And we’re putting at risk if we don’t invest in it. And this is infrastructure. It was great that we passed a bipartisan infrastructure bill. This ought to be bipartisan as well, by the way that we passed the bipartisan infrastructure bill. But this isn’t concrete, but modern systems, modern technology and the right number of people for the FAA is an infrastructure investment that will pay dividends many times over for the country. And so, I hope that what this is, is an opportunity for us to look at this just like we looked at the country at the infrastructure bill in a bipartisan way, get the agency, the resources that they need because we have asked them to do more, and we’ll all be better off. And then, if I could ask one more just on restoring flights to China. Are there like approvals either in China or the U.S. at the government level or like diplomatic things that need to happen in order to ramp that flying back up? There are. At this point, United Airlines holds the rights to fly 4 flights per week to China. We intend to convert our current one-stop service to nonstop sometime in the next few weeks, hopefully. But we do not hold rights at this point to increase our service any further. And I believe that is an industry-wide type of situation. So, at this point, there’s no green light to go beyond what we’re currently flying. Hi. Thanks for taking my call. I appreciate you guys doing this, this morning. A couple of questions I had have been asked and answered. So I’m going to kind of shift gears into something that might be coming out of left field. But the Biden administration announced last week a plan to get the transportation sector down to net zero emissions by the year 2050. I know the aviation industry has that goal as well. But how realistic is that really? And what is the cost to an airline like United to try to shift to sustainable aviation fuels to possible hydrogen-powered engines, that sort of thing? Well, I haven’t seen the details of their plan. But, I think as a global citizen, it’s probably the most important thing that our generation needs to accomplish. I’m proud at United that we are not -- we are the leading airline around the globe on real sustainability initiatives, and we are one of the leading corporations. We are focused at United, but I think it’s the right focus for aviation on a number of fronts. One, unsustainable aviation fuels, -- by the way, the build back -- the inflation Reduction Act has a number of provisions -- regardless of what you think about everything else in the act, the sustainability provisions are meaningful, not just for our industry, but for everyone. And I think our transformative legislation makes it viable to start making investments in hydrogen and SAF. And we’ve been the leader and we’ve got even more coming, but a lot of projects that were going to be hard to do all of a sudden start to pencil out, at least potentially pencil out. And so I think it’s driving -- it is driving a lot of investment, and you can expect more from us on that. A lot of excitement in electric aircraft, what we’re working on there. And while I can’t replace everything because it’s never going to be big airplanes flying long distance, it will be a part of the solution. And then finally, carbon sequestration, I’m a climate change geek and have been for 30 years. And I used to have conversations like this. It wasn’t too long ago, even just a couple of years ago, and I would have to explain what the word sequestration meant. It’s real progress actually that people know what it is now and there’s more investment. We’re here in Houston. Occidental is our partner in a sequestration project. They’re a leader on that -- in that front. But a lot of others are moving into sequestration and the 45Q changes that happened in the Inflation Reduction Act are also really consequential for carbon sequestration. So I’m more encouraged today, I think, than I’ve ever been at the possibilities, but it’s a lot of hard work ahead, and it doesn’t happen overnight. I mean they’re not a magic silver bullet. But I’m also proud that United is leading, and we partner with everyone that would include the DOT, anyone that’s interested in doing the right thing and solving this in a real way, we’re happy to be partnered with. Just a quick follow-up. What is the cost of all this, especially if governments, not just the United States but governments globally start imposing mandates to ship to alternative fuels that they cost a lot more to develop and use? Well, I think what we need to do is drive the cost down. And so the -- for SAF, for example, what I like to think about is wind and solar energy, which because I’ve been a climate change geek for 30 years, I followed it, but it was 20 years ago, certainly 30 years ago. 20 years ago, everyone, everything you read or talked about wind and solar was it could never compete with fossil fuels, it could never be economic. Well, guess what? We passed legislation that had credits -- a carrot instead of just a stick, carrot. That carrot drove massive investment in R&D, drove economies of scale. And today, it’s cheaper to produce a megawatt of electricity from wind and solar than it is from fossil fuels. And the same thing can and I believe will happen with SAF. It is more expensive today, but we are in the very early phase of the development curve. And that’s what’s great about the Inflation Reduction Act is it creates those same kind of financial incentives that existed for wind and solar. And that is -- we know it because we’re involved with the companies. It’s driving investment into the space. And that’s what is needed right now at this phase, and that investment is going to lead to breakthrough is going to lead to economies of scale. And I think the costs are going to come down. I have two quick questions. The first, I believe if I understood, Scott, previously, you mentioned an unprecedented number of new pilots actually coming to United from other airlines. And I understand, of course, hiring especially, but not limited to pilots as a big industry constraint, a big effort, so. But I’m wondering, can you say anything more about that? Is this an effort specifically involved here now to recruit away from competitors in a way that you haven’t in the past? And if so, how do you go about doing that practically from -- besides simply positioning the airline is a good place to work? And I would have a follow-up. It’s really the latter. It’s not a targeted airline to go after them, but people pay attention and United is the best place to work. And if you’re a pilot and want to work at the best place, a lot of them are just putting their applications in. We don’t need to do anything more than be the biggest and the best airline in the history of aviation, and that’s enough of a sell point. Well, I don’tknow what the numbers are I’m -- by anecdote I asked people. And I would guess that 30% of the people in those classes come from one of the large airlines. That’s just my eyeballing it in the room. But somebody at United probably knows the numbers, but I don’t know the specific numbers. I’m just proud of everything that team is doing. And if I can just -- my other follow-up here. In previous calls and interviews, you’ve talked about kind of changing customer demographics, including things like the rise of work from anywhere of leisure passengers. I’m just wondering, if you have anything more to add to that now in terms of how you see that changing structurally in the post-pandemic world. It’s a really interesting trend and we saw it again over the Thanksgiving and Christmas holidays. For example, for Thanksgiving, we saw a lot of people leave dramatically earlier for their vacation than they would normally do. And this year, Saturday, because if you left early, Saturday was actually one of our biggest return days, didn’t display Sunday, which is obviously always the biggest, so completely different pattern. And we saw that throughout the entire second half of last year. And it’s really exciting for our business because it allows us to DP things ultimately, run the airline differently and more efficiently. And remote work, while I’m sure will evolve and adjust over time, which is driving this, remote work does seem like a permanent feature in our workplace here in the country. And so we’re optimistic that this continues to be the trend based on everything we’ve seen. And it really is just -- it’s a different type of demand. It’s a different industry, and I think we’re well prepared for it. And it’s very exciting from a capacity and revenue management and customer point of view across the board. Thanks, Candice, and thanks for everyone joining the call today. Please contact Investor or Media Relations if you have any further questions, and we look forward to talking to you next quarter.
EarningCall_1543
Good morning. Welcome to Weber Inc.’s 2022 Fiscal Fourth Quarter and Year End Earnings Call. All lines have been placed on mute to prevent any background noise. At this time, I will turn the call over to Brian Eichenlaub, Vice President of Investor Relations and Treasurer for Weber. Mr. Eichenlaub, you may begin. Good morning, and thank you for joining us today for our 2022 fiscal fourth quarter and year-end earnings call. I’m joined this morning by Alan Matula, our Interim Chief Executive Officer; and Bill Horton, our Chief Financial Officer. I’ll start with our forward-looking statements disclaimer. As you are aware, certain statements made today, such as projections for Weber’s future performance, are forward-looking statements. Actual results could be materially different from those projected. For further information concerning factors that could cause results to differ, please refer to our public 10-K SEC filing, our earnings release and our SEC filings, all of which are available on the company’s website. During the call today, the company may also discuss certain non-GAAP financial measures. For a reconciliation of these measures to GAAP reporting, please refer to the company’s earnings announcement, which has been posted on the company’s website at investors.weber.com and can be found in the company’s SEC filings. A recording of today’s webcast will be archived for at least 90 days on Weber’s Investor Relations website. Thank you, Brian, and good morning, everyone. Earlier this week, we announced two large developments for Weber. First, we announced the go private transaction with BDT Capital Partners. Over a decade, BDT has been a long standing strategic partner with the Weber team With their continued support, our global team will move forward in executing our long term strategy with consumers and customers as our top priorities. In addition to this transaction, we've optimized our capital structure to navigate the current operating environment. In early November, we entered into an unsecured term loan agreement with BDT managed investment funds for an initial aggregate principal amount of $61.2 million. Then earlier this week, we secured incremental funding from BDT in the form of an unsecured $230 million revolver and $120 million unsecured term loan for incremental financing of $350 million in aggregate. We intend to utilize the revolver and the loan for general corporate purposes, including repay, existing indebtedness, making necessary capital investments that support our new product initiatives, and funding working capital for the upcoming 2023 outdoor cooking season. This financing offers the organization an immense flexibility as we continue to execute our growth and margin expansion strategies from a liquidity standpoint. We expect to remain in compliance with all of our credit agreement for the foreseeable future. Now let's review a summary of our fiscal results and Bill will provide additional detail shortly. In fiscal 2022, we generated net sales of $1.6 billion, a 20% decrease versus last year. Our business is performing amidst the challenging operating environment and we're executing around the world. If we look at performance on a three-year basis, sales have increased 22% above 2019 levels or $290 million, highlighting the strength of this category and the Weber brand over the long-term. This perspective is important as we maintain significant top line growth compared to pre-pandemic levels despite the recent global consumer sentiment changes, whether it's a growing business positioned to navigate current headwinds. Adjusted EBITDA decreased to a loss of $1 million from $307 million last year. Management is focused on margin expansion in fiscal year 2023 and we've taken the necessary steps to address our profitability profile. Operationally, we continue to execute on our mission and purpose to deliver the highest quality, most innovative products and best-in-class customer service around the world. Our unmatched global infrastructure, unique manufacturing footprint, and own distribution channels continue to be our greatest differentiators in driving efficient operations. Our new product reviews and customer satisfaction scores have continued to be excellent, remaining above a 4.5 star average out of 5 stars from the purchasers online. Now I want to take a moment to update you on market trends we are observing. The consumer behaviors and dynamic market ships we've experienced over the second half of our fiscal year have persisted. The outdoor cooking sector continues to contract from pandemic sales levels. The industry has seen a significant drop-off in year-over-year point of sales data with sharply reduced shopper traffic both in retail stores and online. We see indications that some of these pressures are softening and I can confidently say, we're addressing challenges we see in the operating environment head on. This is demonstrated through the ongoing improvement we're making in one of our greatest strengths, our global supply chain. We are enhancing this core competency through a number of digital initiatives. We are prioritizing disciplined investment in our processes and technology to build one of the most agile global supply chains and distribution networks in the industry. Our systems, we have launched centralized processes and add efficiency. We believe they'll have immediate benefits to our margin profile in fiscal year 2023. With that, I want to now turn it over to Bill, who will review the fourth quarter and full year performance. Bill? Thanks, Alan, and thank you everyone for attending our call today. Turning to our financials, fiscal year end 2022 net sales decreased 20% or $396 million to $1.59 billion from $1.98 billion last year. As Alan mentioned, on a pre-COVID three-year basis, sales increased 22% above 2019. Excluding the negative impact of foreign exchange on a three-year basis, sales increased 27% versus 2019. Of the year-over-year sales reduction, foreign exchange accounted for $65 million or 16% of our year-over-year decline, driven by U.S. dollar strength against the Euro, GBP and Australian dollar, excluding the impact of foreign exchange, net sales declined by 17%. For the Americas, net sales decreased 26% or $283 million to $820 million from $1.1 billion last year As a point of reference, for the last non-COVID impacted fiscal year end 2019, Americas net sales were $715 million and on a three-year basis, revenues increased $105 million or 15% versus 2019. For EMEA, net sales decreased 16% or $113 million to $613 million from $726 million last year. On a three-year pre-COVID basis from 2019, net sales increased $129 million or 27%. The year-over-year decrease was primarily attributable to slowed consumer purchases due to macroeconomic and unfavorable foreign exchange rates. Excluding the impact of $56 million of negative foreign exchange headwinds, net sales contracted 8% versus the prior year. In addition to foreign exchange, the year-over-year sales reduction was primarily driven across our big markets, like, Germany, the U. K and Denmark along with the suspension of operations in Russia. While overall EMEA sales were down, we did grow charcoal, pellet and electric product families above last year's levels. In Asia-Pacific, net sales decreased 0.2% or $0.3 million to $154 million, essentially flat versus prior year sales. On a three-year pre-COVID basis from 2019, APAC net sales increased $56 million or 58%. While flooding in certain regions that Australia adversely affect product demand, we were able to offset this challenge with solid growth in New Zealand, South Korea and China. For the year, foreign exchange negatively impacted sales by $7 million, primarily driven by the Australian dollar weakness against the U.S. dollar. So on a constant currency basis, sales grew 5% above last year. For the year, as expected and indicated on previous calls, gross profit decreased $391 million or 47% to $434 million from $825 million last year, and gross margin decreased 1,427 basis points to 27.4% from 41.6% last year. The decreases in gross profit and gross margin were primarily driven by higher inbound freight costs, higher commodity costs, unfavorable foreign exchange impacts and lower sales volumes that were partially offset by price increases. Selling, general and administrative costs for the fiscal year end decreased by $154 million, or 21% to $585 million from $739 million last year and decreased 42 basis points to 36.9% from 37.3% of sales last year. The decrease was primarily driven by lower stock-based compensation expense, reductions in advertising and corporate marketing expenses, and lower incentive compensation expense. For the year, net income decreased by $336 million to a net loss of $330 million from net income of $6 million in the prior year. As previously discussed, the decrease was primarily driven by lower sales, cost of goods sold increases including inbound freight and commodity costs, foreign exchange losses, higher income taxes and restructuring costs, partially offset by reductions in SG&A. For the fiscal year end, adjusted EBITDA decreased $308 million to a loss of $1 million from $307 million last year and decreased 1,542 basis points. Adjusted EBITDA margin came in at negative 0.1% versus 15.5% last year. Turning to cash flow. Net cash used in operating activities was $363 million versus $54 million of cash generated by operations in the prior year. Increased cash usage was driven primarily by our net loss. The cost management plan we introduced last quarter was created to reduce structural costs and improve cash flow. Since our last call, we have merely completed all of our restructuring initiatives in addition to suspending our dividend. In total, this will yield annualized cost savings in excess of $110 million net of restructuring costs. Before we transition to Q& A, we would like to ask the questions remain focused on the fiscal fourth quarter and full year operations. We are not going to share any additional details with respect to the dual private transaction or any forward looking guidance. Thank you for joining today. And I'd just like to thank everybody on the Weber team for all the efforts over the 2022 year and wish everybody a very happy and healthy holiday. So thank you for joining.
EarningCall_1544
Thank you for standing by and welcome to the Accolade Third Quarter Conference Call. At this time all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] As a reminder, today's conference call is being recorded. I will now turn the conference over to your host, Mr. Todd Friedman, Senior Vice President of Investor Relations. Please go ahead, sir. Thanks, operator. Welcome everyone to our fiscal third quarter earnings call. With me on the call today are Chief Executive Officer, Rajeev Singh; and our Chief Financial Officer, Steve Barnes. Shantanu Nundy, our Chief Medical Officer will join for the question-and-answer portion of the call later. Before turning the call over to Rajeev, please note that we will be discussing certain non-GAAP financial measures that we believe are important when evaluating Accolade’s performance. Details and relationship between these non-GAAP measures to the most comparable GAAP measures and the reconciliations thereof can be found in the press release that's posted on our Web site. Also, please note that certain statements made during this call will be forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause the actual results for Accolade to differ materially from those expressed or implied on this call. For additional information, please refer to our cautionary statement in our press release and our filings with the SEC, all of which are available on our Web site. Thanks, Todd, and thanks, everyone, for being here. While we still have one quarter left to finish the fiscal year, our Q3 call really marks the end of the calendar selling season and the start of the new planning year for many of our customers. As such, on this call, we're happy to provide our preliminary outlook for the next fiscal year and share the foundational details that give us confidence in our market position, and our outlook to drive sustainable growth and profitability. We had a successful 2022, adding new customers, expanding existing relationships and increasing our footprint with our growing portfolio of offerings. The market is speaking clearly that employees and their families want and deserve a better health care experience. Accolade's years of proven results, especially our ability to scale with the most demanding and growing customers are factoring heavily on the minds of buyers, and they responded by helping us achieve our strongest booking performance in company history. Steve will give you more detail, but we expect that with fiscal 2023 is complete, we will have grown ARR bookings by more than 30% over last year, giving us confidence in fiscal '24, but also providing the early foundation for continued growth into fiscal '25. Most notable is the mix of those bookings. Continuing the trends that we've described over the past year, our new renewed and expanded commercial customer relationships were spread across customer size, across distribution channel, across solution and across industry verticals. It's that diversity that validates our strategy and our approach. Accolade solutions are resonating across the board, especially as we see the majority of new deals evaluating and selecting multiple solutions. Our renewals are also increasingly expanding to add additional Accolade solutions and partner solutions as well. More and more, we're hearing customers talk about their employees health care experience as a key strategic imperative for driving employee satisfaction and retention. One of the places where we see this clearly is the volume of advocacy deals this year. In 2022, we saw a renewed focus on the employee health care experience and on return on investment. And advocacy was once again front and center for our customers and the consultant community. With our expanded offerings that we're now able to leverage that advocacy discussion to also include other things like primary care, mental health and expert medical opinion. Again, Steve will cover this in more detail in the guidance section, but our confidence in our fiscal '24 guide is rooted both in the growth in our newer solutions, as well as the strength of the advocacy market and our position as the leader of that market. That leadership was borne out by a performance in this fiscal year, and we intend to press our advantage in the years ahead. The focus on employee experience and return on investment is true of our health plan relationships as well. Health plans have been an important contributor to our growth this year, both from a logo and a revenue perspective. Certainly one of the key reasons behind that attraction is the expansion of our offerings to include expert medical opinion and virtual primary care and mental health. This growth has positioned Accolade and the core strategic partner as health plans also look to the member experience as a critical measure of success. Today, member satisfaction is an executive priority for most health plans and Accolade's high NPS is very attractive as a complement to their existing solutions. Before I touch on our consumer and primary care business, I'd also like to give you an update on our government business. By now most of you have heard that the Defense Health Agency made an initial selection for the vendors who will service T-5, the next generation of health plan services to their 9 million plus beneficiary. Humana was awarded the Eastern Region and TriWest was awarded the West. While the vendor selection still needs to be finalized pending a likely appeals process. We were thrilled to hear the decision as we've been anticipating an award for some time. There were three bidders for the T-5 award, we have teaming agreements with two of the betters and a strong relationship with the third. With this decision, we're positioned to serve a significant number of TRICARE families once the implementation begins. Until that time, we'll continue to work on our current government contracts demonstrating the tremendous value Accolade brings to our current military families through the TRICARE Select Pilot and the Autism Care Demonstration. And we will work with the selected T-5 vendors to define our potential scope and we'll provide an update when that scope is finalized. But we're very excited to be moving past the evaluation phase of this opportunity and into the planning and execution phase. For our category of services, we're extremely well-positioned to see the government sector be a driver of growth for our business in the years ahead, as it has been for several years. With respect to our virtual care business, PlushCare has continued to deliver outstanding results quarter-over-quarter. Our PlushCare team led by founders Ryan McQuaid and Dr. James Wantuck have been in front of the market since its inception. We deliver a wow experience for our members and a rich platform for our physicians. The result has been increasing subscriber counts with well managed customer acquisition costs. Importantly, on January 1, we turned on a number of enterprise virtual primary care customers, significantly expanding the number of lives we are prepared to serve. A combination of our consumer focused business, which requires a different level of user experience to drive acquisition and retention and our commercial business, which requires a different understanding of how to scale to serve millions of lives create a powerful platform to drive growth for years to come. About a year and a half after the acquisition of PlushCare the core hypothesis of this transaction has been validated in both the consumer and enterprise segment, and we're bullish on the future of this business. Before I talk a bit about the upcoming year and our strategy to continue our momentum, I want to take a minute to highlight something that many people take for granted, but it's really the foundation of our customer satisfaction. Every year between October and December, almost all of our customers go through an open enrollment process, especially when a customer is changing their benefits in some way. This is not only the busiest time of year for our frontline care teams, but it can also be the most stressful times for our members and their families. To give you some comparison, at the time of our IPO in 2020, Accolade had roughly 50 customers in total. This year, we managed open enrollment for hundreds of customers. We're now operating at a level of scale with millions of members and high engagement rates that will place us among the largest carriers in the country by membership. Aside from the obvious importance of delivering the service at scale with high member and customer satisfaction, open enrollment presents something far more critical for Accolade's success. Our new customers is usually the first touch point that a new member has an has with an Accolade Health Assistant. It is the moment that we plant the seeds of proving the value of creating a personal relationship with every engagement opportunity. It is that ability to build personal relationships with millions of members to drive better health care outcomes that differentiates Accolade from our competitors and it's the key reason for our high win rate. Turning to the outlook for the next fiscal year, and why we believe strongly that we're set up for continued success. I'll start with the financials and we'll end with a word about our strategy and our identity. Simply put, our ARR booking success in the past selling season gives us great visibility and high-level of confidence for our fiscal 2024 revenue guide and our profitability outlook. Steve will give me more details here, but we're pleased coming through a difficult macroeconomic environment with this outlook. We have a business that's diverse in many ways. It's diverse in how we sell. We sell across a number of channels, including our direct commercial sales force through our health plan partners, leveraging our trusted partner ecosystem and to the federal government and direct to consumers. It's diverse in the mix of solutions we offer. Our service offerings allow us to meet customers where they see fit, either with individual solutions or increasingly as bundled with multiple offerings. Our growing primary care business allows us to impact both health outcomes and overall health care costs in more meaningful ways. And it is diverse in terms of its revenue foundation. Our highly visible revenue model allows us to set our investment strategy to pursue the areas of most impactful growth to help drive us towards cash flow positive in the next year and beyond. This diversification is now a core strength of our business, a driver of complementary value across offerings, segments and solutions, and stands in stark contrast to our business even just 3 years ago. As we make the turn to free cash flow positive in fiscal 2025, which begins just 14 months from now, we will be one of the few scaled diversified health care disruptors in the market. For our customers while they want to know that we're financially strong, they're far more focused on who Accolade is as a business and as their personalized health care partner. They know that we've built solutions and services that are engineered to care. Accolade has spent more than 15 years engineering a better health care experience, one that predictably engages members to understand their care needs, proactively navigates under quality care and informed health care decisions, and addresses barriers to taking health care actions, including social determinants of health, all while delivering exceptional personalized experience. For employers and payers looking to improve the health care and benefits experience for members while reducing the cost of health care, Accolade is the one company that delivers improvements in outcomes and planned performance by guiding members to the next best clinical action in their personal health care journey. And we do it at scale across entire employer population. Unlike our competition, Accolade Solution is predicted, proactive and personalized, allowing us to address barriers to care and offer proven results. When we say that Accolade is engineered to care, it's important to recognize the multiple dimensions of what it means to care, cares about the act of physically or virtually delivering medical care, whether that is through one of our own physicians and nurses through a trusted partner like Berta or Carrot Fertility, or through our members' own trusted medical providers. The care is also about the act of caring for another human being. It's the empathetic listener instead of the anonymous call center agent. That is a personal element of the care journey that we can't fully replace with technology, but that we can make better through engineering. It starts with a fully integrated set of offerings that we can deliver value singularly, but really begins to transform the health care experience when it's used in concert. It's about having a robust and modular open platform that allows us to plug in third-party services and solutions with trusted partners. Our intelligent technology and proprietary approach help Accolade care teams build lasting personal relationships with everyone we serve. This unique approach rest on three foundational pillars. The promise of being engineered to care is that we enable predictive engagement, deliver proactive care, and address barriers to health care access. You'll be hearing more about these pillars in the months to come. But in short, our predictive engagement model continuously captures critical population and unique member health insights, so we can proactively address clinical and cost related risks across organization. Supported by this intelligence, our team proactively identifies and engages individuals in need of care, guiding each member to the next best clinical actions so they can achieve the best possible outcome. And lastly, Accolade's diverse care team supported by predictive data is trained to understand and address the needs of each member, so we can engage those likely to face barriers to care and guide them to the right care. You'll hear more about our engineered to care approach in the months to come, and I look forward to sharing more customer success stories around this vision. Thanks, Raj. First, I'll recap the results for the third quarter of fiscal 2023 and then provide some details on forward guidance for the fourth quarter and next fiscal year. We generated $90.9 million in revenue in the third fiscal quarter, which was ahead of our guidance, primarily due to strength in our direct-to-consumer business, as well as member counts for our commercial customers, which has stayed relatively strong despite the macroeconomic environment. Does it the quarter also benefited from about $1.2 million of performance guarantee revenue timing that was not included in our Q3 guidance. Fiscal Q3 adjusted gross margin was 45.9% compared to 47% in the prior year period. Last year, Q3 included some performance guarantee revenue timing that benefited gross margin and adjusted EBITDA. For a more relevant comparison, note that our 9-month to date adjusted gross margin was 45.4%, which compares to 43.1% for the 9-month year-to-date period last year. Adjusted EBITDA in the third quarter of fiscal 2023 was a loss of $10.2 million, which was ahead of our guidance and compared to a loss of $11.9 million in the prior year third fiscal quarter. We are currently at an adjusted EBITDA loss of $39.3 million year-to-date, and expect to finish the fiscal year in the range we have consistently provided throughout the year. Turning to the balance sheet, cash and cash equivalents totaled $326 million at the end of the fiscal third quarter, and accounts receivable DSOs were in line with prior quarters at about 20 days revenue outstanding. And finally, we had about 72.4 million shares of common stock outstanding as of November 30, 2022. And now turning to guidance and elements of our financial model progression towards breakeven. We're updating our guidance today for fiscal year 2023 and are now forecasting revenue will be in the range of $361 million to $365 million representing year-over-year growth for approximately 17% at the midpoint. And we forecast adjusted EBITDA loss guidance between $36 million and $40 million. With respect to the fiscal fourth quarter, we're providing guidance today on revenue in the range of $97 million to $101 million and adjusted EBITDA in the range of $1 million loss to positive $3 million. On today's call, we're also providing a preliminary look at fiscal 2024 revenue and adjusted EBITDA. We've said throughout the year that we believe we can sustain a 20% revenue growth rate and we reiterate that outlook today. For fiscal year 2024, that 20% growth will be net of contract, which will contribute approximately $23 million of revenue to fiscal year 2023. Based on that math and our current year revenue guidance, we're providing preliminary fiscal year 2024 revenue guidance of approximately $410 million. We expect that adjusted EBITDA loss will improve on both a percentage and absolute dollar basis to a range of 5% to 7% of revenues in fiscal 2024. It's our intention to invest strategically in the growth of the business, returning any top line upside back into the business while maintaining the adjusted EBITDA target as we have done historically. And I'd like to provide a couple more data points to help you model out next year and our path to profitability the following year. First, as Raj mentioned earlier, we've had a very strong selling season. You'll recall that we signed roughly $54 million of ARR bookings last fiscal year. So in calendar 2022 close and more deals still in the pipeline for January 1, 2024 launches, we are well on pace to deliver ARR growth of more than 30% over last year. That success is the foundation of our revenue growth forecast for fiscal year 2024 and it's already forming the basis for additional growth in fiscal 2025. Second, as you build your model, of course, towards breakeven or better in fiscal 2025, I'd like to give you some guidance on where to model operating leverage across P&L line items. We will provide more detail after the fiscal year closes. But at a high level, you can expect us to continue improving adjusted gross margin by 100 to 200 basis points per year with a goal of 50% adjusted gross margin in fiscal 2025. On the operating lines, the greatest leverage is in the product and technology line, followed by G&A and then sales and marketing. So if we were to improve each of those line items by roughly 100 basis points each year, that would get us the 5 to 6 percentage points you need in order to achieve breakeven and beyond over the next 2 years. I'd like to make one important point to help you understand our view towards these goals. These are rough guidelines for building models, but we are not as focused on 50 basis points here or there. We're focused on the objective of reaching breakeven and driving profitability thereafter. If we see a reason to invest more in one area, we'll adjust other spend to accommodate it. In other words, the goal is not a G&A target of X percent per se. The goal is adjusted EBITDA and free cash flow positive in fiscal year '25 and beyond. I will also take a moment to anticipate some questions we may get in the Q&A. First, we've been asked a lot about the labor market and how we forecast member accounts in the face of an uncertain macro environment. We take a relatively conservative view on member count when formulating our guidance. But it's more notable that we have a business today that is widely diversified across customers, industries, solutions and distribution channels. 2 years ago this was a more relevant discussion when we had 50 customers, one of which represented about 20% of revenue and another 20% of revenue was concentrated in two airlines dealing with COVID. But today we have a business that serves more than 700 customers with no single industry vertical representing a concentrated portion of our base. Second, we're often asked about our commitment to achieving positive cash flow and adjusted EBITDA in fiscal 2025. The answer continues to be that we remain committed to fiscal discipline and our timeline to profitability, and have consistently demonstrated our ability to manage the business in order that we maintain our bottom line targets. To that end, we will continually look at our business to find areas where we can operate more efficiently. For example, we're continually finding synergies across the business as we combine all of our capabilities to create an integrated health care platform. In addition, we continually assess where we concentrated our talent across our various office locations. Because we're well situated already in some lower costs -- lower labor costs markets like Prague and Vancouver, for example, where we can be opportunistic in our growth investments. Given our track record of steadily improving gross margin and adjusted EBITDA, we are confident in our ability to manage the business appropriately to stay focused on this goal of adjusted EBITDA and free cash flow positive, regardless of the economic environment. And as I noted last quarter, our convertible bonds are not due for more than 3 years. So with $326 million cash on hand, we have more than adequate liquidity to achieve our financial plan without going back to the capital market, placing us in a strong position to execute against our objectives. In short, we continue to believe passionately in the strength, depth and breadth of our platform, the diversification of our offerings, revenue streams and customer base, and that we have an engine built for growth and sustainability which will ultimately drive significant positive cash flow. Operator, we are ready to take questions. Thank you. Hi, Valerie. Are you there to take questions? Operator, are you there? For a moment, we're just -- our operator seems to have disconnected. And so we're working through some difficulties if you hang with us for a moment, we'll work through it and we'll be -- we'll start taking Q&A shortly. [Indiscernible]. Michael Cherny, if you can hear us you can ask your question. Go ahead. Okay, great. Yes, appreciate the color on both the selling season and into next year. Maybe, Raj, if I can start a bit on some of the selling season commentary. Can we just dive a little deeper, you mentioned the employment dynamic, but also there's a lot going on relative to employers decisions beyond their employment levels about whether or not they want to take on new benefits or not, how they think through their benefit offerings. Can you maybe give a little bit of push and pull in terms of what resonated most from the -- whether it's a Accolade total care approach versus point solutions. And maybe if there was anything that had a little bit of a, either a pause or a pullback or not now call me in 6 months mentality relative to your ability to layer on new benefits. Yes, appreciate the question, Mike and sorry about the technical difficulties there. We'll see if Mr. Friedman [ph] is capable of moderating itself from here, but glad we got the first caller -- the first question. A couple of ways to answer your question, Mike. I think it's a really important one. The first is to really start and when you think about the growth rate of the company, think about the diversified revenue stream. Think about our primary care business and the consumer, the growth rate of that consumer primary care business and then also think about the growth in our bookings numbers, which is what I want you to refer to. As it relates to bookings that as relates to employer buying patterns, one of the things that we continue to see is that employers are interested in looking at drivers of employee satisfaction, and of course, those drivers of employee satisfaction that can measurably provide return on investment lower in cost. And so solutions in our category have continued to be really valuable to them. Now, I think the next really important question is, why are we winning more than our fair share of those transactions and delivering a 30% growth in our bookings on a year-over-year basis. And I spoke to it a little bit in the context of our engineered to care capability -- as our engineered to care delivery vehicles. And so I'm going to -- with that, I'm going to turn it over to our Chief Medical Officer, Shantanu Nundy talk a little bit more about why we're winning. And then I'll maybe jump back in and answer your final question about employer being. Shantanu? Yes, it's a really great question. I think what we're hearing pretty consistently from the customer is that who were in sales conversations with and our prospects and our current customers is that, they're continuing to look for the same thing for as they're looking for, who can get to the right numbers at the right time, right. And that's where our predictive engagement comes in. We are looking for -- looking at the quality of care and who can get the better outcomes. That's the proactive care. And increasingly, they're saying, who can help us also improve health equity, and that's where our approach to addressing barriers is coming in. And just one evidence for that we were -- we just had a piece in Harvard Business Review magazine just a couple of weeks ago, that really highlighting our approach to health equity, and specifically highlight some of the work that we did with United Airlines, which we think is pretty pioneering on the front of improving health care for marginalized groups. So I think all of those themes are continuing to pull-through and driving the numbers that Raj and Steve [indiscernible] earlier. Yes. So last part of your question, Mike was, if there was any themes around people pushing transactions on a year-over-year basis, what were those themes? Look, the bottom line is, we've really strong growth in bookings across the categories that we deliver and we think the reason we're seeing that growth is people aren't pushing those transactions. And the reason they're not pushing those transactions, is we do both we deliver employee satisfaction, and we deliver tangible measurable ROI that we warrant with our performance guarantees and our incentive savings. So that's why we think we're seeing this kind of traction right now. Appreciate the question, Mike. Got it. And just one more quick follow-up. I know you have the long multiyear targets and you talked about TRICARE being in the various different phases of appeal or whatnot, can we just confirm that there's nothing in the long-term targets tied to the T-5 announcement? And how you think about the visibility you'll have into that? I appreciate the question, Mike. We're extremely excited about how well-positioned we are in that TRICARE space in our category and the capacity to grow in the innovations. When you think about our business there, our current plan, as you know, has about $10 million-ish or revenues associated with our existing relationships with the government. Those are [indiscernible] demonstration as well as our TRICARE for next select navigator program. If those programs were to grow, as they are and as they're currently defined, they could grow to 4x or 5x ex their current size. Of course, the timing on that will be variable in the T-5 agreement, having just announced that towards have some variability associated with the appeals processes, et cetera. All of that said, and this is maybe the direct answer to your question, we have nothing in our 2024 or 2025 model, in terms of our top line revenues that imply anything other than the simple continuation of the existing revenue stream with the modest growth associated with that. The way to think about our TRICARE business is the way I would perhaps we've positioned in the past, the strategic accounts based for us, but there are large transactions out there in the federal government, there are no larger transactions on the federal government or space like this one where you can't predict the timing, what you can do is put yourself in an extraordinary position to be ahead of your competition to take advantage when the timing of those transactions does manifest. And so yes, the answer is we've got nothing baked into our plan outside of what the current revenues are in '24 and '25. And we're bullish on the capacity when those -- when the -- when that transaction actually does reveal itself, that will present some upside to our models going forward. Thanks so much [indiscernible] with the technical difficulty. I think we have an operator on line now. Victor, are you there to take over? I'm here. [Operator Instructions] Our next question comes from the line of Ryan Daniels from William Blair. Your line is open. Yes, guys, congrats on the quarter. Thanks for taking the question. Another bit of a follow-up there in regards to health equity and social determinants of health. We're also starting to see a lot of Medicare Advantage plans and managed Medicaid RPs from the states requiring that. And it seems like health plans don't have as robust solution sets there, so they're going out to partners. And I'm curious if you see that is an opportunity to continue to expand your distribution channel, doing some partnerships with payers on a go-forward basis, given your expertise there. Thanks. Yes, first of all, thanks for the question, Ryan. It's great to talk to you. I will start the answer and then again, I'll turn it over to our Chief Medical Officer, who is -- who will maybe end the answer around social determinants of health and those capabilities. One of the things that we really are enjoying by our relationship with health plans is we are growing -- as we keep growing those relationships from their foundations and expert medical opinion, it is the componentization or the capacity to deliver different components of our capability to those health plans in a means that allows them to take their -- our capability to their customers in the way that they want to deliver them. And so to us, different capabilities and advocacy, for example, are becoming more and more important to health plans and those capabilities being delivered via health plans to their members is an important growth opportunity for us moving forward. We think potentially those capabilities around social determinants of health are also an opportunity in that regard. So yes, is the answer to your question. But I will let Shantanu describe kind of some of the things we do from a SEOAs perspective, that might be compelling. Yes, I think it's a fantastic question. I mean, I think active approach to social determinants of health really has been honed in the commercial states, right? It started with this really simple idea of having our health assistants that really represent the community that we serve on the proprietary model that we've built, which is a behavioral science approach to really be able to understand members understand their specific needs. And over the last couple of years, really a lot of the investment in data and technology was infused to be able to scale that. So what was really interesting about the work we did with the VA [ph] population is that it was sort of proof positive that our approach that we've taken is extensible, right. So we developed it, honed it around a commercial population. But what we found taking care of really, really sick and complex veterans with the model extended extremely well. And so I think that bodes really positively in terms of thinking about other populations that we might want to address over time. But ultimately, the barriers that the different populations face, whether it be Medicaid or Medicare population based are near a lot of the same challenges that they are working for and work in the American space. And so we think there's really a huge opportunity to Raj to be able to address those populations over time. Thank you. One moment for our next question. And our next question comes from the line of Cindy Motz from Goldman Sachs. Your line is open. Hi, thanks for taking my question and congratulations on the quarter. I was just wondering, because usually Steve, give us some maybe a breakdown of the divisions. It sounds like experts doing pretty well and it looks also like PlushCare is continuing to grow higher than we would have expected. But maybe just a breakdown there. And then would you expect that to continue like sort of representative into next year? Thanks. Sure. Cindy, thanks for the question. Let me give me some comments and color on that for the third quarter and also on the look ahead basis. For the Q3, over our performance versus our guidance, we saw strength across the different categories. Advocacy has strong performance. PlushCare businesses continue to grow in the range of 30% on top line, and Expert Medical Opinion business has rebounded quite a bit from a couple of quarters back. As we look ahead, there's strong bookings that we seen in this calendar year that Raj spoke about in his comments, give us a lot of confidence that the advocacy part of the business is on track to begin to get back to that 20% growth rate, in addition to PlushCare continuing and perform over and above that 20% growth rate on the virtual care business. And the expert medical opinion business growing in the neighborhood of 20%. So importantly, Cindy, the diversification of the platform and the different revenue streams that we have and the different business units and sources of revenue we have are really turning to be quite an asset in terms of new business as well as ongoing customers. Thank you. One moment for next question. Our next question will come from the line of Craig Hettenbach from Morgan Stanley. Your line is open. Yes, thank you. Raj just had a question on just the element of cross selling in the portfolio today. So after the acquisitions of PlushCare and 2nd.MD, now that you have many quarters under your belt, just how are the customer discussions changing in terms of what they're valuing the most? And how may that be kind of helping you in the marketplace? Appreciate the question, Craig, great to talk to you again. I think the -- let me approach this in a different -- from two different vantage points. Existing customers who would take advantage of our advocacy solution have a platform by which they can drive engagement for other solutions. They've known that forever, because we've been coming to them with our trusted partner ecosystem, talking them about Berta, talking to them about Cara [ph], talking to them about SWORD, and we saw great uptake in those solutions within our customer base, because those customers knew that we could drive engagement at higher levels than they could do independently. When we came to market with an expert medical opinion and a virtual primary care and mental health solution, our customers had to first evaluate the capacity of those solutions. Were they functionally superior? Did they deliver the value that they were expecting or better and how did they compare to our competition? What they found was that we checked all those boxes. We had best-in-class solutions that drove extraordinary value independently. They already knew that we could drive extraordinary engagement. And so what do we see post those that that early evaluation process post the acquisition, we saw great uptake. I think we talked last quarter about the fact that 10% of our lives are now live on more than one solution at Accolade, that number continues to grow. And what we're seeing is most of our new deals now switching to the second vector, new deals and new transactions, new customers getting to know us full stop are buying more than one solution as they go through the process. I think maybe going back to a macro trend track that you and I have talked about in the past. Benefits buyers are fatigued by the idea that thousands of solutions that they're getting approached by every single day. They want a single place to go to find the value that they need, but we think we've done exceptionally well over the course of the last 2 or 3 years is we've together the highest value solutions. Those things that provide the most clinical value with the right levels of engagement, and in turn drive lower costs and better satisfaction. And so we're seeing in both of those vectors, that the conversation is now shifting to when should we deploy it? And what order should we deploy it versus are these the right answers for us. Thank you. One moment for our next question. Our next question will come from the line of Glen Santangelo from Jefferies. Your line is open/ Oh, yes, thanks for taking my question. Good evening. Steve, I wanted to talk to you about the forward guidance. If I look at the fiscal '24 guidance you sort of laid out, it kind of assumes rough numbers like an incremental $45 million to $50 million in revenues, and maybe about 14 million of an improvement in EBITDA at the midpoint, which would kind of imply an incremental 30% adjusted EBITDA margin, is that the right way to think about it? Because what I'm trying to do is sort of extrapolate that through to '25, right, I mean, to get, depending upon what you think the incremental margins are, I'm trying to get a sense for what you're expecting, revenue growth to be in fiscal '25. And sort of comparing that to what you told us a long time ago, historically about the long-term EBITDA margins of the business in the 15% to 20% range. Thanks. So if you could just sort of reconcile all those numbers, that'd be helpful. Sure. Thanks, Glen. Thanks for the question. First of all, we're really pleased on the strong bookings of fiscal '23. Here are coming off the calendar '22, to be able to provide preliminary guidance at that 410 number. That's north of 20%, excluding the Comcast termination this year, and to reiterate over and again, the importance to us by fiscal '25, breaking Q2 to breakeven. And so Glen, we think it's a combination of a few things. First of all, diversification on the top line and growth rate, we've got good visibility to that and confidence in coming off of the booking season this year. Secondly, with respect to gross margins that certainly has continued to expand over time, we can see -- we see that on a continued march up from there. And then finally, we're continuing to see leverage on OpEx, while at the same time we're investing in the business against that growth opportunity. All that taken together because of that profiles words, what we laying -- what we're laying out today and seeking essentially the EBITDA loss from 10%. 11% of revenues into that 5% to 7% range, and then to breakeven and positive 2 years out from now. In the fourth quarter call when we finish out the year, we'll provide more color on all of that and more detail on the forward guidance. But I think all of that sets up and what we're essentially saying today is we're reaffirming with confidence that model that we've laid out and that steady march towards breakeven and profitability while we're growing the top line of the business in a very, very healthy way. And maybe just to add to the question and we can jump to that. So let's add Steve's answer for Glen's questions before we jump to the next one. Yes, Glen, what -- I think what we tried to lay out today with a view to fiscal '24 revenues is just based on the performance of the business so far this year that we feel really good about top line next year. In fact, we took the top line guide to a little bit ahead of the consensus numbers that are out there right now. And we feel really good about our path to profitability. We'll give a ton more guidance around how all that works. As you noticed, I think in the -- in your preliminary note earlier, we don't typically give a whole bunch of detail in the Q3 call. We give a lot more detail in the Q4 call. We plan on doing that in the Q4 call when we talk about '24 and a preview to '25 as well. One moment for our next question. Our next question comes from the line of Jonathan Yong from Credit Suisse. Your line is open. Hey, thanks for taking my question and congrats on the strong results and solid season. I guess extending your comments about what employers are looking for how the hurdles to achieve performance guarantees risen, and during the selling season has the asked from employers to you increase more than normal, given the backdrop on enhancing benefits? And I just asked this to get a better sense of are you -- are they asking more from you and just competitors just aren't able to keep up and you're just massively outperforming them. Thanks. I appreciate the question, Jonathan. It's great to talk to you again. Maybe let me [indiscernible] that in a little different way. I don't think they've changed dramatically. I think a couple of things have happened though. We've lived in a competitive universe. Since we were, since the beginning of time. And by competitive universe, I mean, we lived in a universe where customers have extraordinary demand in terms of the return on investment associated with our solution. Since the company was founded, we've been putting fees at risk. Since the company was founded, we've been warranting cost saving on a comparative year-over-year basis. That's different than most categories of health care benefits delivery. Most categories have looser ROI requirements and the one that exists in our category, I think what perhaps has changed, it's not the rigor of which customers are asking for measurement and asking for accountability. But instead the fact that we now have most of our competitions, there's been a lot of new competition in the space over the last several years. Most of our competition has not had to live through 1 or 2 years of actually delivering improving, they can deliver against that value. Accolade's proven history of having done so for 7, 8, 9 years and then doing so again in the last year, is proving to be a competitive advantage. Customers are seeing our history and our proven capacity deliver return on investment against some of our competitors, perhaps not being able to do quite as much as a driver of us getting more market share. Thank you. One moment for our next question. Our next question comes from the line of William Hoover from Canaccord. Your line is open. Yes, thank you. I'm on for Richard Close. Thanks for taking our questions, and congratulations on the quarter. So I was hoping you could provide a little more color on your health plan sales. I know I believe last quarter, I would say the health brand sales were double-digit percentage of the new ARR coming on. And I wonder if you could try to have more color on how that's progressing and kind of expectations with new relationships, and the expansion of the existing relationships, maybe some timing for the future quarters on the expectations? Thank you. I appreciate the question. And thank you, William, for being here. When we break down the channels by which we deliver our service and then I'll come back to the health plan as a growth vehicle. I don't think we give a bunch of detail as it relates to the percentage of new ARR. But instead, what I can tell you is we've got our direct to employer segment, we've got our direct to via the health plan segment, we've got our government segment, and we have our consumer segment. Each of those, when we look at them have a capacity to grow in the 20% to 30% range, depending upon the market segment that we're in. And what we're seeing across each of those is the capacity to deliver our primary care business, our EMO business and our advocacy business. We think each of those segments, and each of those categories have an opportunity to grow in the 20% to 30% range. What we've seen with our health plan business is particularly strong, delivering capabilities like expert medical opinion, virtual primary care, which is becoming increasingly important to that channel, and individual components of advocacy. As Shantanu spoke about earlier, the answer to the question around social determinants of health. And so what we continue to see with that health plan channel and hopefully this answers your question William is opportunities to go into the channel our existing partners with new capability, some of them that are a component of the advocacy solution we deliver to our customers, and a capacity to grow the health plan partners over time. What we love about that channel, and we love about our midmarket offering and what we love about our consumer business is that each of those channels continue to sell even when the so-called selling season for health care in the enterprise segment stops. And so what that's creating is less and less seasonality in our business and more and more predictability based on [indiscernible]. Thank you. One moment for next question. Our next question comes from the line of Jailendra Singh from Truist. Your line is open. Thank you and good afternoon, everyone. Actually want to ask about some long-term high-level question. One of the trends we are seeing in employer market is that more and more employers are trying to narrow down the benefit vendors they're working with. Various vendors have talked about trying to get into more risk based arrangements so that to drive more engagement with these vendors. If these trends accelerate, how do you think about the value of employee -- employee advocacy and employee engagement service you guys provide, if we do see these trends kind of moving forward and continue in the next few years. So just maybe give us some high-level thoughts on that from 3 to 5 years from now? I think that trend exists. Jailendra, first of all, it's great to talk to you again. I got super excited to answer your questions, not forgot to be polite. It's good to talk to you again and thanks for being here. That trend that you're speaking to, do employers want to consolidate the number of vendors that they're working with? Yes, and they have for the last several years. And so that trend already exists, will it accelerate into the future? I don't know the answer to that question. But I think all times point to yes. If that's true, do they want return on investment as a driver of value, because they're tired of buying 10 different point solutions, all of them saying they're going to save money, and yet their overall health care trend line goes up? Answer to that is also yes, of course they do. And so are they going to be more demanding as it relates to return on investment guarantees and performance guarantees? I think the answer to that is also yes. Then the question becomes what do you need? Well, very clearly, you need an engagement engine to be able to get your people to the solutions that you want them to use in order to lower costs. You need a population health strategy that helps you understand which solutions you need. And you need a means of reaching that stratified population with the right actions. We call them through off actions that Accolade with the capacity to guide them to the solutions that they need when they need them at the right time at the right place. That is exactly what I believe does. And so, in that context, if you already had a platform that was already based on -- that was already measured on performance guarantees and return on investment, you would leverage that platform to answer the question that you just talked about. Jailendra, I think when we look at a 30% growth rate on bookings this year, I think what we're seeing is the trends -- the very trend that you're talking about manifests in the behavior that's happening in our space. And so if that behavior continues, it bodes well for our company. Thank you. One moment for next question. Our next question comes from the line of Ryan MacDonald from Needham. Your line is open. Hi, Raj and Steve. Thanks for taking my questions and congrats on the preliminary good news with T-5. My two questions really are just focused on that. First off, with Humana and TriWest winning the two regions, does that still place you in a position to win both opportunities if they go through appeal and sort of stick with those two carriers. And then second, as we look into fiscal '24, in the preliminary guidance you've placed in there today, on the adjusted EBITDA side, are you already contemplating incremental investments that you'll need to make to start to scale up the staff for launching TRICARE in preparation for a 2025 launch? Thanks. Thanks for the question, Ryan. Let me hit both of those and then Steve, if you want to jump in if I've missed something. So first, the first part of your question as it relates to do we have an opportunity in both regions if the regions remain awarded as they are? The answer to that question is absolutely yes. I think what we've talked about and we're only able to publicly disclose that we've signed teaming agreements with two of the partners, we've got a really -- excuse me, with two of the parties that bid the agreement, we have a really strong relationship with the other. We believe there's opportunities to team across both of those regions, regardless who ended up winning, even after the appeals process. But that's part one of the answer. Part two of the answer then is and I agree with you, we're really optimistic about the future of our capacity to grow the business in that category. We'll -- have we already factored in investments. Well, I think that here's the really great news there. We've already built a service infrastructure to serve the government. We've done that in our Autism Care Demonstration. We've done that with our TRICARE select navigator program. Oftentimes building out a new service and a new service offering the most expensive part of that story is the initial build up and phase in of the offering. We've already done that work. So our capacity to grow from here really is leveraged off of variable costs associated with the growth of population. That's a business we're very familiar with and we're quite comfortable that we've modeled well. Yes, the only -- hey, Ryan, this is Steve. The only thing I'd add to that is when you see the preliminary guide there to the top line in the 5% to 7%. On the bottom line, what you're hearing from us is any variability in there will be about investment into fiscal '25 and the same committed to the breakeven and other free cash flow in fiscal '25. But giving some room there, pending some opportunities is on growth. Thank you. One moment for next question. Our next question comes from the line of Jessica Tassan from Piper Sandler. Your line is open. Hi, thank you guys for taking the question and congratulations again on the quarter. So I was just hoping for some detail about the size and the duration of the Autism Cares Demonstration. Can you remind us what services you're offering and how you were kind of able to transform the Accolade Navigation offering to specifically suit that population? And then maybe if you could remind us how much is that contract contributing to the P&L? And is the renewal tied to the T-5 contract at all? Thank you. Fantastic. Thanks, Jessica, for the question. Autism Care is a unique program. It's a clinical pilot program being run in a core set of regions to actually deliver an extraordinary amount of clinical value for families who are wrestling with the challenge of managing children who are on the spectrum, Dr. Nundy is here in case we need any more details on the program itself. But the nature of the agreement is to actually deliver as a -- as an increment to or a standalone from the T-5 arrangement. But that demonstration has actually been renewed. And like all government contracts, it's a year-over-year renewal process. The agreements are one year in nature, it's been renewed. And we are seeing extraordinary value and we believe there's an opportunity to grow from its current region into new regions moving forward. And it does, in fact, do so as we've talked about in the previous answer to the previous question that would represent outside to the model and the way we're thinking about it. Steve, or Shantanu, I think you asked for that. I think the only thing I would add it from a clinical perspective, and your question around what did it take to be able to adapt the model? I mean, I think what we're finding again, is that our model, very extensible, right. I mean, I think if you think about what we're doing on the commercial side, we're oftentimes dealing with people with really complex medical needs for addressing them in a full person way. We're doing care coordination for those families. And so whether that transplant, whether that's oncology, or in this case, whether it's around autism, it's a very similar set of foundational capabilities we need are mostly incremental investment was around some of the specific requirements that the government has around data. But we found that the model we have is was very accessible to the population. We've been very happy with the outcomes we're getting. Thank you. One moment for next question. Our next question comes from the line of Stephanie Davis from SVB Securities. Your line is open. Hey, guys, thanks for taking my question and congrats on a solid quarter. Raj, I thought it was notable that we always think of you as an employer facing solution. And then your prepared remarks, essentially just focused on the government and payer business. So with that in mind in those prepared markets potentially reflecting a changing mix in business, I was hoping you could talk about what sort of mix shift that creates in your investment spend, and how you're looking at hiring across engineers versus sales folks versus care teams, as you go more towards the outside of the employer base. First of all, thanks for the questions, Stephanie. It's great to talk to you -- Stephanie, it's great to talk to you again and thanks for being here. Stephanie, I think -- here's the way we think about the business. And we'll always think about the business. We've got a diversified set of channels that we deliver to, and a diversified set of solutions that we delivered to those channels. And we've kind of walked through those in the -- I won't walk through each of the commercial sector, our direct to employers segment, and our reaching that segment, either via our direct sales team or VR health plan channel continues to be an extraordinarily important part of our business and the majority of our business. And so if there was any implication or anything that you took out of my prepared remarks, as it relates to our focus on the government business being larger or potentially outside to our commercial business, or even our consumer business, that was not intended. Instead, I think what we believe is we have really healthy growth opportunities in the commercial segment. We've talked in the past about, when you think about the commercial segment and the fact that I think the last time we talked about the number of customers we had, we talked about north of 600. There's 30,000 35,000 opportunities in that commercial segment. We've got plenty of room to grow there and plenty of room to build a billion dollar company just there. We also think there's a segment in the government space, that has an opportunity to be hundreds of millions of dollars on a long-term basis as well. And beyond that, we think the consumer segment of the direct-to-consumer segment has an opportunity that could potentially be a $1 billion business of its own. That’s why we're excited about the business, each of those is going to grow at different rates and therefore require different levels of patients, different level of capital investment, et cetera, we've got to do that within the context of being a $500 million company that's pre cash flow breakeven, or better in fiscal '25 and that's what I intend to do. So I wouldn't say we were over -- we've shifted our focus in some material way only to say, every quarter we aspire to give you color on all the things we're working on, because I think in fiscal 2021 -- in 2021, when we went public, we were a one product company with one segment. And sometimes we want to make sure that the market as a whole understand that this is a fundamentally different business, more diversified, more capable, and with far more predictability to the go-forward revenue streams and P&L. Thank you. One moment for next question. Our next question comes from Stan Berenshteyn from Wells Fargo. Your line is open. Hi. Thanks for taking my questions. Maybe I can share a couple here. First, can you quickly just quantify the extent performance-related revenue hit the third quarter? And then within your core navigation and advocacy services, can you share with us what mix of member communications navigation versus advocacy? And whether you've seen any changes in that mix over the past couple of years? Thank you. Stan, this is Steve. Nice to talk to you. Thanks for the question. So I think your first question was the mix of TGs [ph] versus kind of base fees in the third quarter. While we don't have that specifically laid out right here for the call, what I will say, Stan, it's an interesting dynamic and it goes hand to hand with what Raj just described is the evolution of the business over the last 3 years or so. In 2020 when we came public, you'll remember that TGs were roughly a third of the revenue and 85%, 90% of those savings-based TGs are recognized in the fourth quarter of the business. What we have fast forward today is the advocacy businesses comprises 60% plus of the revenue. So we've got a diversified set of revenues and the TGs of the business are being recognized much more ratably during the year. So rather than 90% of them being with us in the fourth quarter, it's something like half of them are recognized through the year, and I'm talking now about just the savings-based component. And call it, half of them are recognized in the fourth quarter. And then along those lines, the mix of those on a typical advocacy deals is something like two-thirds of the revenues are fixed and a third of them are variable and within that, call it, 10% of the total of our savings base. So all of that adds up to a diversified, predictable set of business. I'm going to hand it to Raj for the other part of your question. Yes. Sure. Stan, as it relates to member communications and the breakdown between Advocacy and Navigation, we probably need to follow-up on this one. I'm not so sure I understand the question. We are really good at being able to break out the type of engagement we have with the member, whether it's a benefits question or claims question, a provider search question or a clinical need broken down by clinical category. We don't necessarily break out our communication, sort of our messaging by advocacy versus navigation. In fact, we look at both of those things as really an actually tied to the solution that we deliver. Thank you. One moment for our last question. And our last question will come from the line of Robert Simmons from D.A. Davidson. Your line is open. Hey, thanks for taking the question. So when you're building your preliminary fiscal '24 guidance, what were the key three [ph] factors that you considered? And then kind of where would you say is the most potential upside? And where is the most potential downside to your numbers? Robert, we -- first of all, it's great to hear from you. Will you repeat the question, you cut out a little bit right in the middle. Yes, yes. So I was wondering what are the key three [ph] factors that you considered as you're building your preliminary guidance for next year and where you see the most potential upside or most potential downside? Got you, Robert. This is Steve. Thanks for the question. Let me hit that. I think this is the last one. So I'll hand it to Rajeev for any closing comments. First of all, when we walk into fiscal '24, a couple of things and picking up on [indiscernible] before we've got a diversified platform of 60%-ish of the revenue coming from the advocacy business and the balance the virtual primary care, mental health and expert medical opinion and trusted partner ecosystem revenues. When we put those all together, we walked into the year with a set of contracted revenue. It goes back to the earliest comments Raj made in the call, which is a strong bookings year on top of that set of existing customer base. It gives us a good forward look. And then what we layer on top of that are the consumer revenues, primarily from the PlushCare platform. When you think about opportunities on the upside, certainly, the opportunity on consumer revenues, in year bookings for next year being even stronger. And then certainly, the macro environment, it's on everybody's mind what are our assumptions. We make fairly modest assumptions around the macro environment as it relates to our customer book. So when you add all that together, we are really pleased to enter today's call given preliminary guidance of that 20%-plus growth rate ex the impact of a lost customer earlier in the year. And as you can hear from us today, we're really enthusiastic about the strength and breadth of the business and the demand environment for our offerings. With that, we've come to the end of our prepared remarks as well as the Q&A session. We are thrilled to have an opportunity to share our results with you, and we appreciate all of you being here. Thanks, everyone. Have a great day.
EarningCall_1545
Good day, and welcome to the AZZ Inc. Q3 2023 Earnings Conference Call and Webcast. 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, operator. Good morning, and thank you for joining us today to review AZZ's financial results for the third quarter of fiscal 2023 ended November 30, 2022. Joining the call today are Tom Ferguson, President and Chief Executive Officer; Philip Schlom, Chief Financial Officer; and David Nark, Senior Vice President, Marketing, Communications and IR. After the conclusion of today's prepared remarks, we will open the call for questions. Please note, there is a webcast and slide presentation for today's call, which can be found on AZZ's Investor Relations page under latest earnings releases presentation at azz.com. Before we begin, I would like to remind everyone that our discussion today will include forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward looking statements by their nature are uncertain and outside of the company's control. Except for actual results, our comments containing forward-looking statements may involve risks and uncertainties, some of which are detailed from time-to-time in documents filed by AZZ with the Securities and Exchange Commission, including the annual report on Form 10-K for the fiscal year ended February 28, 2022. These statements are not guarantees of future performance and therefore, undue reliance should not be placed upon them. Actual results could differ materially from these expectations. In addition, today's call will include a discussion of non-GAAP financial measures. Non-GAAP financial measures should be considered as a supplement to and not a substitute for GAAP measures. We refer you to the reconciliation of non-GAAP to the nearest GAAP measure included in today's earnings release and investor presentation for further detail. The earnings press release and Q3 presentation are posted on our website and have been included in the Form 8-K submitted to the SEC. Thank you, Sandy. Welcome to AZZ's third quarter earnings call and thank you for joining us this morning. We accomplished a lot this quarter, including completing the divestiture of 60% of our Infrastructure Solutions segment. We also paid off over $230 million of our debt, which improves our leverage to 3.4 times EBITDA. Both of our business groups grew their sales significantly and I will get into the specifics shortly, but let me first express, how appreciative I am of our AZZ Metal Coatings and AZZ Precoat Metals leadership teams. I commend them for the professionalism they have demonstrated as they have maintained focus on their customers, while dealing with continual supply chain and labor issues, as well as storms and other distractions. Working with leaders that demonstrate so much pride and passion for their teams and business is truly invigorating. As you can see here, we achieved nice flow through of adjusted EBITDA on higher sales generating over $71 million or a 79% increase versus prior year. Net income on adjusted basis was $22 million, up 4% resulting in adjusted EPS of $0.88. Philip will talk about the one-time write-down on AIS shortly. Metal Coatings had another strong quarter with sales up 17% to $158 million. The growth was a result of volume, the earlier acquisitions of DAAM and Steel Creek and adding tubing to the Metal Coatings as it was not divested along with the rest of AIS. Operating income was only up slightly versus prior year due to inflationary pressures, particularly as zinc cost peaked in most of our kettles. We continue to maintain our pricing discipline and focus on delivering value to our customers. Tubing is a good business, albeit relatively small and was significantly lower margins than our galvanizing business. Additionally, service technologies underperformed for the quarter. The net of these two things amounted to about 100 basis points of margin headwind for Metal Coatings. Metal Coatings team has already taken actions to strengthen Surface Technologies leadership and improved performance. EBITDA of almost $42 million was up 3% over prior year. We continue to benefit from our investment in DGS for the Digital Galvanizing System, which is driving both productivity and customer service. We are also seeing potential in the longer-term to improve performance of our kettles of rising out of technology efforts in conjunction with Texas and [indiscernible]. The outlook in the fourth quarter is for a typical winter season and we would hope to not experienced any more major storms like we navigated in December. Precoat in its second full quarter with AZZ had nice sales growth to $215 million, which generated over $34 million of EBITDA. While Precoat did grow its underlying unit volume modestly versus prior year, sales were lower than the second quarter due to normal seasonality as we have noted previously. The lower volume sequentially has about a 100 basis point impact due to the deleveraging effect on fixed cost. Precoat's underlying business performance was solid given the continued inflation on indirect materials, labor shortages and extraordinarily high customer-owned inventories that caused significant inefficiencies and costs. We have taken actions to improve the inventory situation and have focused initiatives to improve productivity at several plants, but are still dealing with skilled labor shortages and some logistical inefficiencies. Additionally, we have taken pricing actions to address the indirect material inflation and higher logistical costs. We have made progress on the $10 million of synergies we had noted at the time of the acquisition. And while so far the benefits have been balanced by the cost, these will be showing up in our run rates in fiscal year 2024. Year-to-date, our business on a consolidated basis has done well. To put it in perspective, we have generated sales approaching $1 billion in the first nine months, which used to be what we did all year. We have generated over $238 million in adjusted EBITDA, which doubles the prior year. Adjusted net income of $97 million and adjusted EPS of $3.89 are up 56% versus the prior year. For the AIS joint venture, we have recognized a little over $1 million of equity income. While it has been a tumultuous year, we are positioned well as we finish up this fiscal year and prepare for fiscal 2024. Thanks, Tom. As Tom noted, we closed on the divestiture of our controlling interest in the AZZ Infrastructure Solutions segment to Fernweh Group at the end of September 2022, after just completing the second quarter. As a result, we are required to report the results of operation as continuing and discontinued ops from the second quarter onward. My commentary will focus primarily on the results from continuing operations. I will also walk through the consolidated adjusted EBITDA and adjusted EPS and bridge results to our 2023 full year guidance ranges. For comparability, I may refer to Precoat or AIS sales, so investors can track quarterly sales inputs or exclusions. Our adjusted numbers primarily exclude impacts from additional non-cash loss recorded on the finalization of the divestiture of AIS and excludes the depreciation and amortization related to the purchase accounting effects of the Precoat acquisition on both the quarter and year-to-date results. AZZ generated third quarter sales of $373 million, $158 million for Metal Coatings and $215 million from Precoat. One month of sales from the Infrastructure segment for September prior to the divestiture of $42.3 million were included in the results from discontinued operations. Third quarter sales reflected continued stable demand with Metal Coatings up 17.2% and Precoat Metals up 14.8% on a comparable prior year same quarter basis. Gross profits from continuing operations for the third quarter totaled $73.1 million or 19.6% of sales. While aggregate profits are higher from a dollar perspective, the gross margin reflects increased cost of zinc flowing through our kettles within the metal coatings as well as transitional operational expenses and warehousing costs for Precoat. As Tom mentioned, we have taken steps to address these issues. Operating margins from continuing operations were 12.2% of sales for the third quarter, as compared to 15.8% in the prior year. Excluding the impact of the Precoat purchase accounting related amortization and depreciation of $8 million, operating margins for the quarter would have increased to 14.3% of sales. Third quarter calculated EBITDA was $26.2 million, compared to $39.8 million in the prior year same quarter. When adjusted EBITDA for the quarter was $71.2 million or 19.1% of sales, up 78.8% compared to the prior year. Earnings per share from consolidated operations was a loss of $0.97, which included a $45 million loss associated primarily with the non-cash write-off and discontinued operations of the AZZ Infrastructure segment related to historical currency translation adjustments. Excluding the loss and including the D&A from Precoat purchase accounting, third quarter EPS was $0.88, an increase of 3.5% versus 85% -- a $0.85 in the prior year quarter. Year-to-date sales from continuing operations were $987.1 million, generating reported EBITDA of $63.3 million and adjusted EBITDA of $238.5 million. Year-to-date reported EPS was a loss of $2.35 as a result of the finalization of the AIS divestiture. Year-to-date adjusted EPS was $3.89 (ph). Year-to-date diluted EPS from continuing operations was $2.17, an increase of 39% compared to $1.55 diluted EPS from continuing operations through the third quarter of last year. Cash flows from continuing operations for the nine months were $68.6 million compared with $45.9 million in the prior year. Our year-to-date capital expenditures from continuing operations were $35.1 million compared with $15.8 million in the prior year. The year-over-year cash flow (ph) increase was planned and contemplated in our strategic rationale associated with the Precoat acquisition. In terms of capital allocation, the company's balance sheet is strong, and we continue to maintain a prudent capital allocation strategy. Utilizing proceeds received from the divestiture of AIS in addition to cash from operations. We reduced outstanding debt by $230 million. We invested $18.3 million during the quarter on capital expenditures. We expect to invest roughly $45 million in capital expenditures for the full fiscal year as we shuffle capital spending around due to continued supply chain disruptions. Shareholder returns to common shareholders included Q3 dividend payments of $4.2 million, which represents an estimated annual dividend yield of 1.6% based on Friday's closing price. We have an active pipeline of acquisition targets. However, do not plan any actionable transactions in the near-term horizon. As we focus on reducing debt, we do not anticipate any share repurchases. As described above, we reduced our Term Loan B by $230 million and improved our leverage to 3.4 times, a good step towards our 2024 target of getting back to or under 3 times leverage. As discussed last quarter, we have roughly 50% of our existing Term Loan B debt covered by swap agreement to reduce further interest rate exposure. Lastly, other than our current $3.25 million mandatory quarterly principal payments on our term loan, we do not have any maturities into 2027. Thanks, Philip. Market activity generally for Metal Coatings is normal given we are in the seasonally slower winter months. Fabrication activity remains solid. Zinc costs have peaked in most of our plants and will begin to normalize with current market levels. Precoat is more reliant on the construction sector, so they are typically more impacted by the winter season and major storms like we had over Christmas. We are beginning to see customer inventories normalize as supply chain disruptions are easing somewhat. And due to some of the actions we have already taken. Our pricing actions are also catching up to some of the inflationary labor, energy and non-paint materials costs. Naturally, we are continuing to focus on debt reduction, monitoring customer credit carefully and ensuring effective CapEx deployment. We are maintaining our sales guidance of $1.275 billion to $1.325 billion and also our adjusted EBITDA guidance of $285 million to $305 million. We are raising our adjusted EPS guidance by $0.25 from the $3.80 to $4 range to $4.05 -- from $4.05 to $4.25. This is based on the strong third quarter and the outlook for the businesses that we have previously discussed. This guidance does not include any potential equity income that we might receive in the fourth quarter from our 40% share of avail. I will also note that the fourth quarter EPS will be impacted by a more normalized tax rate than we experienced in the third quarter. Dividends in preferred equity or dividends on preferred equity and seasonally slower volumes. Our guidance reflects these impacts. As a reminder, we will be getting back into our normal cadence on annual guidance and we'll be issuing fiscal 2024 guidance in a few weeks. AZZ is the leading independent hot-dip galvanizing and coil coating company with an irreplaceable footprint serving a broad and diverse set of markets. As a high value-add tolling business, we are not directly exposed to metal commodities. Have the ability to shed variable costs quickly and thus are able to protect our margins pretty well during downturns. We generate great margins, returns and free cash flow by focusing on providing outstanding value to our customers, emphasizing operational excellence and continuing to innovate and develop our technology. We will now begin the question-and-answer session. [Operator Instructions]. The first question comes from John Franzreb with Sidoti & Company. Please go ahead. I'd like to start with the Metals Coatings business and the -- incurring the high zinc cost. Can you talk a little bit about where you stand as far as those costs coming down and what's the margin profile look like in the current quarter versus Q3? On the margin profile, I think our zinc has peaked in December. And so we'll start to see some decrease as we move forward into the fourth quarter and into fiscal year 2024. We really don't disclose that. But I'd say typically, we're -- well, because of -- keeping in mind that our -- we try to price in line with those zinc costs, so while we've kept our pricing discipline, I think the overall impact, we probably -- I'd say, we're looking at maybe 100 basis points overall, just kind of that headwind as we have about six months of zinc in our kettles and dependent on -- but there's a range of cost in each kettle across the fleet. Okay. And on the precoat side of the business, you talked about productivity issues at several plants where I thought you said, Tom. And you also talked about lower volume hurting the op margin profile by about 100 basis points. I guess two questions here. Is the balance of the volume sequentially? Is that the productivity issue? Is there anything else going on? And can you just remind us what the productivity issues are and when do you expect them to be resolved? Yeah. We've got a couple of different things going on. I think we've mentioned the very extremely high levels of customer inventory, which if you go into one of -- most of precoats plants, that tends to, to get in the way of being efficient logistically and moving materials which were a material handling business. So that's in the majority of plants that high inventory issue. As we noted, that's coming down and I think, we're probably within a couple of three months of being to more normalized levels in the majority of the plants. We do have three or four plants that have struggled with, I'll call it, the mix of their business, so taking some of the lower margin type activity to maintain absorption levels and keep flow. That's something that's going to take us probably a couple of quarters to work out. We've made some adjustments. We have several initiatives. There's a really good team within precoat of operating support and focus on quality. So -- but that's going to take a couple of quarters. We're going to be into next year before we see that move significantly. In terms of -- we talked about the fixed cost leverage, that deleveraging effect as we had talked about, kind of just mostly because of how our fiscal quarters fall for precoat tends to hit the worst five months of the year in the third and fourth quarter. So fourth quarter is basically all winter, which construction activity is less and a lot of the metals building customers are kind of managing their inventories and managing their business. So that part of the fixed cost deleveraging will continue through the fourth quarter. And then we hope for an early spring in March and bounce back to the really strong first and second quarters. Hi. Thanks for taking my question. First, I was wondering if you could expand on the underperformance that you mentioned in Surface Technologies. And if you could quantify that impact, that would be great. And maybe how quickly you think that you'll start to make some of those improvements that you referenced? Yeah. It's not a huge impact overall, but it's enough to move the needle. So you're looking at a business of, what maybe $6 million, $7 million a quarter, but really low margins lower than we've experienced. So that the leadership changes were made several months ago and so I think that takes a little bit of time to gain traction. We like the initiatives that the team has going there. But I think we're going to be into the first quarter probably well through spring before we start to see any significant improvement there. Part of it is just making sure we're going after the right kinds of business. We find powder coating to be better than the plating side. So these are all adjustments in how we're targeting the customers, how we're approaching the business and then driving the normal focus on efficiencies, productivity at the six plants. Okay. Great. And then I recognize you said you're giving guidance in a few weeks. But maybe could you give us some early thoughts on how you're thinking about the outlook, particularly for Precoat as we look into the next fiscal year? If you could just walk us through some of the puts and takes in terms of growth. I know obviously, you're continuing to gain share or see increased penetration of pre-coated metals. But I would think some of the more residential or consumer facing parts of pieces of the business might see a little bit more of a headwind. So could you just give us a sense of sort of how you're thinking directionally about growth? Thanks. Yeah. I think when it comes to residential construction isn't a huge piece. I'm going to let David talk to the markets a little bit here in just a second. But -- so for Precoat, the focus is obviously, it was disruptive to the Precoat leadership team going through this whole process and then coming on board with AZZ. And it's been a great, I'll call it a great onboarding process. So we've tried to make it as minimally impactful on them as possible, but it's still disruptive to come into a new organization, new processes of a public company. I'd say we're through the vast majority of that. We don't anticipate any major systems, integrations or activities that can be disruptive as we go through at least the first part of next year. So I anticipate -- we don't anticipate, I know the focus is going to be on continuing to drive value with the customers. I do think there's opportunities to more quickly drive productivity and efficiency improvements. The team is really focused on that. And as some of these customer inventories are coming down, which they are. That's starting to open up the ability to drive their traditional productivity and efficiencies in their plants. The plants that are underperforming there's a plan there and the team is very, very focused on that. It just takes a while. These are highly automated plants, so it takes a little time to gain traction on that. But these are things that we've been focused on since we've -- they've been in full. So I think what -- but those market headwinds you mentioned, that is going to have -- that is -- those are true headwinds. I think we'll focus on continuing to grow share. And then we'll see how the economy goes. But -- so our focus is going to be more on let's improve our profitability on the volumes that we have and drive the efficiencies, make sure that we maintain that stability. We do think there's some synergies between on the sales side. And so we have really good effort going on there. But that will take -- that takes two or three quarters to gain traction on. So as we get through the first quarter and into the second. I think we'll start to see the benefits of those things. The hard synergies, we've generated some of those and -- but the cost have offset it. So I'm pretty enthusiastic about both of our businesses, but both of them are going to be focused more on protecting their profitability, driving improvements. And then, we'll see where the volumes go. And David, if you want to talk about where you see construction things. Sure. Thanks, Tom. Yeah. Couple of things, Noelle, non-residential construction still remains pretty good, particularly on the Precoat side with metal intensive sectors like warehousing and manufacturing faring pretty well. We do have a specification of pre-painted insulated metal panels and things like data centers and cold storage construction, which continues to be a positive trend for them. When you take a look at the residential construction, as you know, single-family housing starts have struggled in the broader market, but multi-family remains quite strong. We do have the use of prepayment metal roofing, continuing to gain traction in multiple markets within residential. So we think that's going to be a positive for us going forward. Appliance and HVAC shipments have eased quite a bit from the solid pace experienced earlier in the year. And again, that related to general market and economic slowdown in the U.S. But the container market, which we've talked about on previous calls, particularly the beverage can shipments have benefited from favorable secular growth trends and the switch to aluminum for recyclability and consumer packaging preferences. So those are some of the highlights on the Precoat side specific to your question. Okay. Great. That's really helpful. And then I know you're not including the JV income in the fourth quarter. Would you anticipate that you would start to include that in guidance as you look at next year or is that still sort of a TBD item? Thanks. We did have our first Board meeting yesterday, and we like the leadership team. So they're very disciplined and focused. They're getting through the usual purchase price accounting things to go from being part of AZZ to being a private company. I think I'd like to give them a little bit of time, call it, a quarter. So I don't think we're going to be able to give guidance on what that equity income is going to look like as we issue our guidance. I do think as we get into next year, I think we're going to be able to start providing some general guidance on what that equity income is going to look like for the balance of next year. But I think we've got to let them get through another -- at least another quarter of their operations and how they're managing the business and what their focus is. So my intent is not to have it in this guidance that we give towards the end of January. But that hopefully, we can start to provide better context as we hopefully, by the time we do our full year earnings call. Tom, going back to the Precoat, you mentioned that a couple of facilities took on some, I guess, lower margin business. And I guess as you look forward, how do you balance that against maybe some weakness in general market activity. How do you balance maybe taking maybe additional lower margin business versus saying no and risking maybe a little bit more deleveraging of the cost side of the equation? Yeah, I think that's -- we're spending a lot of time with the Precoat team, which was actually really enjoyable because it's so similar to our galvanizing business. But yeah, we're focused on profitable growth. And so -- but they've got great indicators in terms of how they're running their paint efficiencies, productivity, line feet per hour per day, all that kind of per minute. So there's a balancing act, but I think we want to defend our market share. We are focused on what things are more profitable than others. We have made some leadership team, some leadership changes in a couple of those plants already. And we anticipate that, that's going to start to drive better performance, better consistency. And because right now, it's hard to say for sure that certain business isn't all that profitable when you've got some underperforming operational issues. So dealing with that and the team has been dealing with that. So it's not like they've been sitting there. But those plants are also in markets where labor is even more constrained. And while I'm not going to give any specifics on which plants those are, they are in more labor constrained market. So we're having to pay more to get the folks we need, which we're willing to do because labor is still a relatively small piece of our overall cost structure in precoat. So -- but yeah, we want to defend share overall, take care of our customers and then carefully balance the fixed cost absorption in those plants as well as against the overall. So that's a mouthful that I just gave you, but I can tell you, it's a daily, weekly review that the Precoat team does on this. So they're looking at this every single day. And moving business between plants, if they're finding they're not serving their customers. So sometimes it's where we've been taking some expense to move it to the right places where we can service the customer the best. Yeah. Okay. Secondly, on the galvanizing metal coating operation, you talked about zinc costs being relatively high. But natural gas costs have come down sharply here in the last 90 days. How much of an impact might that have on the margins of the business? Well, it's actually a significant spend, it's fairly de minimis in terms of the overall margin impact. And also because of the way our commitments flow with the utilities, we won't be seeing some of that until we get into next year anyways. Hi, guys. Thanks for taking the follow-up. Just a little bit of questions about the guidance here. [indiscernible] has the nine month number at $3.52 (ph). And I believe on Page, was it 7, you have it at $3.89 and your guidance is $4.5 to $4.25. I just want to know if we can kind of reconciliate what the number is we should be using as a baseline number in relationship to your guidance because if we use that $3.89 number, it seems like a really sizable drop in the fourth quarter. Can you just help us there? Yeah, I think, John, it's a good question. And fourth quarter will be seasonally lower than the first nine months of the year. We've been working -- we've had a lot of change in the operations with the acquisition of Precoat Metals and the divestiture of the controlling interest and avail or AIS infrastructure. And so some of those outlets don't have fully updated numbers. So David's been working with those outlets on getting better historical numbers, but $3.89 is where we're bridging from for the guidance. Yeah. That's the way it will flow. Obviously, it's significantly lower volumes on the seasonality as we've talked about for -- particularly for Precoat. On the Metal Coatings side, I think we will kind of see the tailing off of these high zinc costs, and we are doing everything we can to hold price and so yeah, this is the -- probably our ugliest quarter. And then Q1, we get into the spring and build up into what I think going forward will traditionally be our strongest two quarters in the first half of the year. And I guess just a nagging question, what kind of share count are you using on that $3.89 and what are you thinking about for the full year? It's kind of bounced around based on profitability, I guess, level? It's based on the dilutive and un-dilutive (ph) features, we're using about 25 million shares in the calculation, John. In the fourth quarter to finish out on Tom's question, what's putting pressure as we seasonally have lower sales, and we do have the fixed cost of our interest on the debt and then the preferred dividends on our Blackstone preferred equity. So that's what's pushing a little pressure in that seasonally low fourth quarter. Well, we also had the unusually low tax rate in the third quarter. And so that starts to normalize or go back towards normal in Q4. Yeah. We really are excited about the addition of Precoat Metals and particularly as we see how well the culture and leadership teams fit with our Metal Coatings team. Both teams live by the same values have almost identical operating cultures. So we look forward to sharing next year's outlook and guidance within the next few weeks. As we get back into the normal corporate operating mode, I also look for us to be able to provide a lot better clarity and transparency on what our -- what's in our margins and how to look at those going forward. I know everybody would prefer that. So we'll get out of the big adjustment mode into a stable operating mode that drive where we're demonstrating the great margins that both of these businesses can have and talking about our business from the normal markets, operational things that drive it and how we're getting back to growing share and driving profitability. So thank you for joining us today.
EarningCall_1546
Good day, and thank you for standing by. Welcome to the Greif Fourth Quarter 2022 Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there'll be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Matt Leahy, Vice President of Investor Relations and Corporate Development. Please go ahead, sir. Thanks and good morning, everyone. Welcome to Greif's fourth quarter fiscal 2022 earnings conference call. This is Matt Leahy, Greif's Vice President of Corporate Development and Investor Relations and I'm joined by Ole Rosgaard, Greif's President and Chief Executive Officer; and Larry Hilsheimer, Greif's Chief Financial Officer. We will take questions at the end of today's call. In accordance with Regulation Fair Disclosure, please ask questions regarding issues you consider important because we are prohibited from discussing material nonpublic information with you on an individual basis. Please limit yourself to one question and one follow-up before returning to the queue. Please turn to Slide 2. As a reminder, during today's call, we will make forward-looking statements involving plans, expectations and beliefs related to future events. Actual results could differ materially from those discussed. Additionally, we will be referencing certain non-GAAP financial measures and reconciliation to the most directly comparable GAAP metrics can be found in the appendix of today's presentation. I'm extremely proud of the results, our colleagues delivered in 2022, easily the most successful in financial terms in Greif's history. We believe these outstanding results are driven by the high engagement among our teams. Our focus on delivering legendary customer service and our consistent commitment to value over volume approach. This year has seen headwinds related to volatility in both raw materials and other input costs, complex macroeconomic issues including the war in Ukraine and varied regulatory responses to the ongoing COVID-19 pandemic. Internally, it was also a year of change. A new executive leadership team created our Build to Last strategy, which we presented at our Investor Day in June. I believe that change opens doors for opportunity and our results this year are evidence of the global Greif team's ability to capture those opportunities. Therefore, before discussing our detailed fourth quarter results, I'd like to express my heartfelt appreciation for the resilience, dedication and consistency of performance from our whole Greif team. We ended the year with a strong balance sheet, record free cash generation and strong EBITDA and earnings performance when compared to a historically strong full-year '21 comp. We do anticipate some challenges heading into 2023 but are confident, our team can manage well through any market environments and I'm excited for the year ahead. Regarding our long-term strategic objectives. The team has made excellent progress on all four missions of our Build to Last strategy. During the past quarter, we formally launched our fifth and sixth Colleague Resource Groups furthering our diversity, equity and inclusion objectives and our goal of creating thriving communities. In the quarter, Newsweek recognized this progress by announcing Greif as number 58 on their 2022 America's Most Loved Workplaces publication. In regard to Legendary Customer Service, we released our 12th Net Promoter Score survey, resulting in a five point improvement from the prior year. Lastly, by the end of the calendar year, we plan to release our 2030 sustainability targets, which are designed to help accelerate our progress towards protecting our future. Our sustainability leadership was recognized in the quarter through AA MSCI rating, Gold EcoVadis rating and ranking number 49 on Investor's Business Daily Top 100 Best ESG Companies. In addition to the record results our team achieved in 2022, I'm also excited to further discuss today, our planned acquisition of Lee Container and what that acquisition means for our strategy. Please turn to Slide 4. As discussed at Investor Day, the acquisition priorities in our GIP business are to grow in resin-based products with jerrycans being an important part of our strategic growth plan. Our most attractive targets are close to our core business of industrial packaging and add diversification benefits in product offerings, geographies and end markets served. Financially, our ideal M&A targets are immediately margin accretive supporting our margin expansion and return on capital goals outlined at Investor Day. Lee Container is an outstanding example of utilizing our disciplined M&A framework to drive growth and value for our company and shareholders. Lee provides a strong foothold in the North America small plastics and jerrycan business segments, one in which we have expertise elsewhere in the world, which furthers our expansion into less cyclical end markets and provides a platform for continued growth through both organic and inorganic investments. Lee's exposure to the attractive agrochemical and specialty chemical end markets support above average growth and the sustainability element of their packaging as to the attractiveness of our products and future partnership opportunities for our customers. We see the Lee team as an excellent addition to our GIP business and anticipate closing the acquisition prior to year-end. I'm very excited to welcome our new colleagues to Greif. Let's now return to our quarterly results on Slide 5. Our Global Industrial Packaging business experienced growing headwinds during our fiscal fourth quarter. Volumes fell across our GIP platform in most geographies as we saw sequentially declining demand through each month of the quarter. Global steel drum and plastics were down mid-single digits year-over-year. EMEA saw a step down in demand due to impacts to our customers from energy inflation and challenges related to the war in Ukraine. Similar to prior quarters, our APAC demand remains sporadic with a continued strict lockdown protocols in China impacting supply chain and industrial production, resulting in softness in most end markets excluding automotive, which has seen a modest recovery as a result of government's incentives. North America also experienced sequential demand weakness as domestic spending and manufacturing activity slowed. Our LatAm business remain strong in Q4 up mid-single digits of a strong Q4 '21 comparison, due to robust demand in the citrus and transportation markets. In the fourth quarter, our GIP business also faced headwinds from the rapid decline in steel costs. In North America, steel prices declined over 43% from June to November, with a similar trend although not quite as severe in EMEA and LatAm. As we have explained in the past, rapid declines in steel negatively impacts our profitability. The lag effect on price cost drives near-term margin compression as we work through higher cost steel inventories all orders over the past three plus months, while selling at lower index adjusted prices. This headwind is temporary. But in the near term, we expect this margin pressure to continue in our steel business during the first half of fiscal '23, as our price adjustment mechanisms continue to reset. The combination of these factors, along with unanticipated currency impacts resulted in a year-over-year decrease in adjusted EBITDA for the fourth quarter of approximately $25 million or $17 million, excluding the $8 million contribution from our divested FPS business in Q4 '21. Despite a lower fourth quarter, our GIP team again put up record adjusted EBITDA performance for the full fiscal 2022 on a very difficult 2021 compare and I'm proud of the team and their contribution to Greif's results this year. Now please turn to Slide 6. Paper Packaging's fourth quarter sales rose by approximately $44 million versus the prior year due to continued favorable price cost dynamics despite sequential month-over-month volume erosion through the quarter. This decreased demand resulted in a total 26,000 tons of economic downtime during the quarter, approximately 23,000 of which occurred in the month of October. Fourth quarter volumes in our CorrChoice sheet feeder system were down high single-digit per day compared to the very strong Q4 '21. This demand decline was in line with the overall box industry, which was down approximately 8% over the same periods. Fourth quarter cube and core volumes were down high single digits per day versus the prior year due to softness in film core, paper core and textile end markets despite relative strength in some end markets such as construction tubes. Despite declining demand and continued raw material cost inflation, favorable price cost led to an approximately $33 million increase in adjusted EBITDA in our PPS business, capping off a strong year of record operating performance for this business. I'll now turn you over to our CFO, Larry Hilsheimer on Slide 7 to discuss our Q4 financial review as well as outlook for fiscal 2023. I want to start by reiterating Ole's opening comment of how proud we are of our team's performance in 2022. This was a record year financially for Greif across every measure and I attribute our success to the relentless dedication by every Greif colleagues to serve our customers with excellence. Clearly, we've had some economic tailwinds the past few years. But as they rapidly disappeared in the second half of fiscal 2022, our teams did an outstanding job of managing through the challenges. Now onto our results. I'll start by addressing the obvious. In early November, we announced a reaffirmation of our Q3 guidance as part of our participation at the 2022 Baird Industrials Conference. Our final Q4 EPS result of $1.83 results on - results in a full year non-GAAP EPS of $7.87 per share, which is $0.03 below the low end of our reaffirmed range. Our affirmation was issued with the best information available as of the date release, which was prior to finalization of our year-end clos procedures. While our above the line results came on the lower side of our expectations due to demand deterioration, it was that plus the combination of higher other expense from $4 million of negative currency impacts and higher than anticipated tax expense resulting from an unfavorable mix of jurisdictional income and tax return examination adjustments that drove our earnings per share below the low end of our range. While this was a frustrating development related earnings, I'm pleased to report that in Q4, we posted solid gross profit and EBITDA growth despite lower sales, as well as stable SG&A on a percent of sales basis and another quarter of record free cash flow. I would like to specifically recognize our teams for their strong execution on working capital as volumes slowed in the fourth quarter. We've often cited our potential to generate cash when demand turns and this was -- this was a quarter with a prime example of our agility and further evidence of the resilience of our business model. We closed out 2022 having crushed the midpoints of our original 2022 commitments made at our Investor Day in June of 2019 by nearly $60 million on EBITDA and over $75 million on free cash flow of the commitments we made at our Investor Day was that we would achieve gross profit margins over 20%, SG&A below 10% and operating profit above 10%. We delivered on each at 20.7%, 9.4%, and 11.3 %respectfully. I'm extremely proud of our team. Let's now turn to Slide 8 to further discuss 2023 outlook and guidance. We've made the decision to begin presenting guidance on an adjusted EBITDA and adjusted free cash flow basis and de-emphasize earnings per share as the primary guidance metric. We feel that EBITDA and free cash flow are better representations of the ongoing results of our business, especially given our intention to continue to grow via acquisitions. Earnings per share is often transitionally impacted by below the line adjustments made to accommodate impacts from acquisitions and divestitures, as well as changes to our capital structure, resulting from transactions and changing leverage from other non-operating adjustments and from a changing mix of jurisdictional income, which impacts accuracy around tax forecasting. We firmly believe that EBITDA and free cash flow are better representations of the true economics of our business and guiding along these measures will provide better transparency and clarity to both internal and external shareholders. We will continue to report adjusted earnings and earnings per share as before and while we are no longer formally guide to EPS, we will give directional and information - informative context to our below the line expectations as part of our quarterly earnings call. With that context provided for fiscal 2023, we anticipate generating between $820 million and $906 million of adjusted EBITDA and between $410 million and $460 million of adjusted free cash flow for the full year, which includes the impact of higher planned CapEx. On Slide 8, we provide the key assumptions, which are included in our guidance range. You will note that our range is slightly wider than usual. We anticipate refining our range during fiscal '23. However, given the highly uncertain macroeconomic environment, we have determined there's too much variability and expectations to release a range tighter than what is provided. We will be monitoring the dynamic changes in the market and we'll update the investment community further, as we progress through 2023 and will revise our guidance range as warranted. Please turn to Slide 9. In closing, I want to remind investors of the strength of our balance sheet and our commitment to our capital allocation strategy outlined at Investor Day. As we come off a record year in 2022, and enter a more uncertain path in 2023, our focus on disciplined capital allocation becomes even more important. We currently sit over 25 basis points below our target leverage ratio range of 2x to 2.5x net debt to EBITDA and with the acquisition of Lee Container, we anticipate being back to the low end of our range by the end of 2023. We remain committed to our plan to increase our dividend, continue our share repurchases and invest in our business. Our M&A pipeline remains robust and Greif will continue to pursue our acquisition strategy to elevate the breadth and quality of the businesses and our portfolio. I am proud of the work we've done and the work we have ahead of us as we enter 2023 and advance on our Build to Last strategy. To sum up our thoughts, fiscal 2022 was a record year for Greif in many respects and we again would like to thank each and every one of our colleagues for being a part of making those results possible. As we look into 2023, uncertainty does exist. And while our guidance reflects expected results lower than in 2022 numbers due to the macroeconomic environments, we have discussed, they will constitute the second highest EBITDA and free cash flow output in the 145 year history of Greif. We have been through downturns like this. The teams know how to win in this environment, and we will be successful. We are excited for the year ahead and to continue to produce results worthy of your investment in our company. We thank you for your interest in Greif. Thank you. [Operator Instructions] Our first question comes from the line of Ghansham Panjabi with RW Baird. Your line is now open. Thank you. Good morning, everyone, and congrats on a really amazing year. As we kind of think back to fiscal year '22 and as we came into the year, it was clear that the PPS segment will start to benefit from margin expansion and is likely be some sort of moderation in GIP, just given the outsized fiscal year '21 for that segment. On that basis, how do you sort of think that segment dynamics will play out in fiscal year '23 based on what you see occurred? Yes. Thank you, Ghansham. This goes back to what we've talked about the fact that our two business units tend to offset each other, just because of the pricing lag in PPS. And it did, as you mentioned play that way through '22. For '23, our first quarter in first half of the year, GIP is going to be extremely weak. The demand deterioration in the market has been pretty significant and that combined with the rapid decrease in the cost of steel, it plays out through us as we've explained in the past and as Ole commented in his comments, that will squeeze our margin pretty significantly. We expect that the things will -- with that our price adjustment mechanisms will catch up with that through the second quarter and in the rest of the year demand should pick up and you'll see sort of the opposite flow through where our PPS, we believe will be very strong for second quarter and should continue reasonably well through the year as we think things will pick up in the second half of the year. Okay, perfect. And for my second question, Larry, maybe you could just help us with the bridge on EBITDA, '23 versus '22, obviously you have a very wide range for '23. So, maybe the mid-point differential? What are the big moving pieces there? Yes, Ghansham, we -- usually we would walk down the midpoint. But I'll tell you, given the macroeconomic uncertainty we have approached it in a different manner this year, where we just really took each of the variables and did multiple scenario plans and laid them across the chart and just use that to frame our upside and downside. And so for example, we looked at OCC and we think that it will be somewhere in the range of 35 to 90 throughout the year and probably trending upward through the year. Everybody keeps talking about capacity additions, as capacity comes on, there'll be some, I'd say artificial bump in demand on efficiency because they can only produce so much and markets got to have end demand for everybody, at some point but, so we scaled out our OCC assumption. We've done scenario planning on pricing and paper business across our grades, multiple different ones, you've flat, you have some increase, decrease. We don't actually have any with increases in pricing at any time in the year but modeling out different alternatives. And then just pace demand on the side of the GIP business. So I know that's not all that helpful in terms of a midpoint analysis, but if I give you a little bit, I would say from an operation standpoint, we think the high end of things is a potential decrease of $12 million from this year's overall EBITDA to a potential decrease of $98 million on EBITDA across all of the operational factors. That does include uplift from Lee Container. We also have, just remember, we had a divestiture of FPS which was about $16 million of EBITDA that was included in fiscal '22, so that's gone and we also cats and dogs immaterial things that we're in the process of disposing. They'll take another $10 million to $12 million of EBITDA out and generate some proceeds from us for us as those things play out over the next couple of quarters. Thank you. One moment please for our next question please. Our next question comes from Adam Josephson with KeyBanc. Your line is now open. Ole, Larry, Matt, good morning. Thanks very much for taking my questions. Hope you're well. Larry, just -- it sounds like in the PPS business, you're expecting to have a much better year than in the GIP business, and I know, aided by OCC having fallen quite considerably, you gave us your range for OCC. Obviously, you're not -- I presume you're not going to talk about your containerboard and boxboard pricing assumptions relative to your OCC price assumption. So can you help us -- I mean this is a spread business, obviously. And it's hard to know how to think about how conservative or perhaps aggressive your guidance is without knowing what spread you're assuming between prices and costs next year, along with whatever you're assuming demand will be. So is there any more clarity you could give us on what you're assuming in PPS in terms of the spread between prices and costs and what you're assuming for demand? Yes. Not really, Adam. I mean we -- like I said, we did a bunch of different scenario plans have looked across it. And so what I gave in the answer to Ghansham as deep as we're going to go into specifics on it. What I would say is, look, our worst-case scenario that takes everything bad that we can come up with for next year still delivers $820 million of EBITDA. And I go back and it's interesting, if I look across all of our analyst group a year ago, today, the consensus among everybody for EBITDA across the group was $807 million for '23. So even our worst case is better than the whole group thought we could do for '23. So we're pretty happy about where we think '23 is going to be. As always, that's still going to be our second best year ever, even if it's the worst case we have. So -- but there's just too many macro uncertainties right now to give you any more detail than that on the pricing side. Got it. Thanks Larry. And on the GIP business, can you -- are you at liberty to talk about what your volume assumptions are? What your steel price assumptions are? And relative to the $100 million onetime price/cost benefit you had in steel in fiscal '21, what -- I assume you're assuming a pretty significant onetime hit, particularly in 1H '23. Any details you could give us just along all those lines and the GIP business would be helpful. Thank you very much. Yes. Yes. So on -- so let me give you a broad -- for the U.S. business, the CRU index for 2022 averaged 1,806. Okay? Started out the year at 22.93, ended up the year at 12.54. For '23, against that 1,806, we're showing an average for the year of 1,056. So a pretty dramatic increase in the index side of that. For Europe, which is by far and away the largest, it's 4x the size of U.S. in terms of volumes. But we show a -- in '22, it was 1,155. So $1,155 a ton. And in Europe, it's 814 is the average for our '23 assumptions. And from a volume basis, we are forecasting for the year, the volumes down -- on a global basis, Adam, about just shy of 3%, just shy of 1% in plastics, fiber down 3%. IBC is even down 1.5% sort of at the middle of our ranges that we did in those spaces. Now to give you a further breakdown, North America were up -- just shy of 6%. So dramatic decrease in North America, and EMEA about 3%. If I go volume-wise, now this is a mix of things we've got kind of different assumptions across shutdowns and all that kind of thing, but I won't talk about mills because there's all kinds of different things on downtimes planned for maintenance and that kind of thing. But in our sheet business, we're expecting about 3%, same thing on tube and core, down 3%. And just on the onetime hit that you're expecting from falling steel relative to the $100 million onetime benefit you had in fiscal '21? Thanks a lot. Larry, Matt, Ole, good morning, and congratulations on the progress in '22. I guess my first question would be within your guidance, and thank you for going through the detail that you could provide. Larry, I thought I heard you say that you do have something for Lee Container built in. If I heard that correctly, can you help us out a bit in terms of what we should be baking in both in terms of EBITDA? And how much it contributed to the interest expense uplift? And then I had a follow-on. Yes. Thanks, George. So I'd put somewhere between 25 and 30. It's going to just depend on some of the -- we haven't worked through all of the impacts, what valuation adjustments might have on inventory opening day and those kind of things. So I'd say 25 to 30 would be a good range to put in on Lee for this year, and then we expect that to expand nicely beyond that in the future years. On the interest expense, you look back, we ended up paying down about roughly $300 million of debt in 2022. We'll be taking on about $300 million in 2023. We've generally had a policy of fixing 40% to 60% of our debt. And we moved that up beginning in March, April this year when we did some refinancing. I asked our team to start to trend up to the top end of that 60%. And then as we rolled out our strategy and knew we would be going in the acquisition space, I asked our treasury team to move it up even further, to get ahead of our plans and roll it up to where we are approaching in the 80, where we're at now after we do the Lee acquisition will be about 65% fixed. And we believe that helps us manage our capital structure in a flexible manner and gives us more repayment opportunities if we don't find other acquisitions. So the bottom line of it is, if you look at it, last year, our interest expense was about $61 million, so 3% of $2 billion of debt. If you say we're going to be at about that same level of debt, I don't fluctuate through the year. But if you have 35% of that is floating with interest rates, you say, 35% of that $61 million. Floating rates have about tripled. So you've got another $60 million, $65 million of interest expense that will be related to that and puts us at an overall of $100 million to $105 million. Larry, that's great. We appreciate all that color. Very, very helpful. I guess my other question and just on exit rates on volume, you mentioned that volumes were declining sequentially across GIP. Could you talk to us -- and certainly, they were down also in PPS. Can you tell us where early in the new year, volumes are trending? And it would be helpful, obviously, because we have at least your volume forecast for the year, relative to the other Q&A. Thanks. I'll turn it over. I'll take that one. So obviously, we saw demand enrolling sequentially throughout the quarter. That softness has continued into November, but is stabilizing as we see it. We also believe there is some destocking going on, both in Q3 and into Q4, but primarily on the paper side. Larry, you said indirect destocking. So you meant downstream and how that flows back to your business? Would that be a clarification -- Thank you. One moment for our next question. Our next question comes from Aadit Shrestha with Stifel. Your line is now open. Hi, good morning. Thanks for taking my call today and my questions. Just coming in for Michael Hoffman. He couldn't make it. My first question is just regarding FX. And do you have anything built in for that within your guidance? And obviously, it was a big headwind this year, but I think the rates are sort of a little bit better now. So how do you see that going forward? Yes. We -- so we factor it in based on futures and currency every year in our budget process. And when I end up -- when we end up giving quarterly guidance, we do factor in some range of expectancies on currency. And the -- so what -- and normally, if everything doesn't go against you, it sort of goes within the range and it ends up being a material item for us. Clearly, for this year, two things happened to us. One is we used to have a good natural hedge with our FPS business. And when we sold that, we lost some of that natural hedge, and so we did more financial hedging. But we saw an overall impact for the year, roughly $9 million, which is more than what we would have had in the past. Going forward, next year, based on what we see in the currency markets, we have, on our revenue side, about $160 million to $170 million headwind next year is what we estimate right now from currency. But we do hedge decent amounts of the bottom line impact should be immaterial. Okay. Great. Thank you. And as a follow-up, just regarding the free cash flow guidance. I think you have working capital to be a source of cash of around $70 million. And I think you had a pretty sizable $90 million source to 4Q '22. How much more working capital improvements can you drive in the near term, basically? Is this all sort of captured within the next year? Or do you see incremental working capital benefit at 2023? Yes, we actually believe that we have more working capital opportunities. We brought in a very seasoned and knowledgeable supply chain leader last year. And she has spent a good part of this year really diving into our operations, and we have a glide path that we're going on, on actions to execute that we do believe provides us the opportunity to drive even better improvement in our working capital. I mean our team did a phenomenal job in the fourth quarter, as we said, executing on what we've said to people before, when demand decelerates, we are able to generate cash. And they did an excellent job. But we do think there's upside. We think we'll have a benefit somewhere $50 million to $90 million from working capital in the coming year. Thank you. One moment for our next question. Our next question comes from Adam Joseph with KeyBanc. Your line is now open. Larry, Ole, thanks very much for taking my follow-up. Just to follow up on George's question about exit rates, volume trends. Can you talk about, relative to down, call it, 8% in the October quarter, what volume was down by month and then what you saw in November? Now I can give you some -- so we'll look at it on units per production day, Adam. And so if I go to CIT, we want August, we were 212,000 a month. September was 201,000. October was actually 204,000, and then November was about 194,000. And in PPS, I just want -- just trying to get a sense of what the exit rate was. In other words, if November was down -- You're seeing trend lines go down for sure on -- across all of our businesses. And so -- but much less so in our - in the PPS operation. I mean we did see some deterioration in November more in that business. So put it in a downtime perspective, Adam, we had 30,000 tons downtime in November, about half of that containerboard. In Q3. So November -- I mean Q4 of our last fiscal year. So yes, November was a big downtime month. Got it. Okay. And that was kind of -- and what you're saying is that trends in now are similar to what they were in November? Got it. Okay. Just on Lee Container, you mentioned that it's a platform deal. It's going to make the business less cyclical. Can you just talk about how much of that business is industrial versus consumer? Is it an entirely different customer base for you? Just give us a little more detail as to where these jerrycans and small plastic containers are sold? Again, is there any customer overlap, et cetera? Adam, there's a considerable amount of similar customers or customer overlap, but primarily, the business is within the agrochemical markets, where the jerrycan you produce in that market they're pretty sophisticated. So it's not a commodity market. That's the biggest element. Then you have, on the consumer side, a very small element of jerrycan that goes into things like in the pits and cat sad and that sort of thing. And then you have a growing pharma market as well, which we do like, and that's also part of our strategy to expand into those markets. So ag is a growing market. You will see food shortage as we go forward in the coming years. We like that. Pharma is a growing market for us as well, and we like that as well. So all in all, you will see this acquisition help us being even less cyclical. Adam, about 15% of that business, you could call pure industrial, which serves like the lubricants and oil petrochem, fuel additives, [indiscernible] market. But outside of that, it leans more to those segments that Larry and Ole highlighted. Thank you. And Larry, just one last one, if you don't mind. Back to GIP. So -- the segment's EBITDA had been running around $300 million for a number of years. And then in fiscal '21, it went up to, call it, $450 million, and it was similar this past year. And obviously in '21, you had that onetime steel benefit. Last year, you didn't have that, but nonetheless, you were able to hold profitability at that same level. Can you give us any sense of what you think normalized EBITDA for that segment is? I assume you think it's higher than what it used to be pre-pandemic of around $300 million a year, but I also assume you don't think it's $450 million either given the onetime benefits during the pandemic. So any thoughts you could give there, I would appreciate. Yes. And just, I mean, during the pandemic, our EBITDA was -- in fiscal '20 was $320 million. The growth really happened through '21, which, yes, there is still ongoing thought pandemic for sure. But it's way clear to $450 million than it is to $350 million. I would tell you that. I mean we think it's clearly north of $400 million on a going basis. We have a significant hit built into our guidance this year because of the combination of the dramatic decrease in steel cost and volume deterioration. I would tell you, in our fiscal '19 Investor Day, I stood up on the stage and told everybody thought we were in an industrial recession. I'll tell you, it feels like that right now. I mean it's talking to our customers across all of our spectrums, everybody's volumes are off. And so I know there's a lot of economists think they see a recession in the latter half of next year, that might be when the consumers start running out of the money that was handed out to them by the government. But right now, you're seeing -- we're seeing it in the industrial space. But the good news for us is, like I said, we've modeled all that out, and we're still going to have a great year. Thank you. I'm currently showing no further questions at this time. I'd like to hand the conference back over to Matt Leahy for any closing comments.
EarningCall_1547
Hello, and welcome to Banc of California's Fourth Quarter Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] There will be a question-and-answer session following today's presentation. [Operator Instructions] Today's call is being recorded and a copy of the recording will be available later today on the company's Investor Relations website. Today's presentation will also include non-GAAP measures. The reconciliation for these and additional required information is available in the earnings press release, which is available on the company's Investor Relations website. The reference presentation is also available on the company's Investor Relations website. Before we begin, we would like to direct everyone to the company's safe harbor statement on forward-looking statements included in both the earnings release and the earnings presentation. I would now like to turn the conference call over to Mr. Jared Wolff, Banc of California's President and Chief Executive Officer. Please go ahead. Good morning, and welcome to Banc of California's fourth quarter earnings call. Joining me on today's call is Lynn Hopkins, our Chief Financial Officer, who will talk in more detail about our quarterly results. Banc of California generated record net income in 2022 and I am tremendously proud of our entire team. Our results and overall performance reflect the strength of the franchise and high quality balance sheet that we have built over the last several years. We were able to achieve what we set out to do in 2022, which was to generate solid earnings by capitalizing on our strong stable deposit base and disciplined expense management. As we have continued to demonstrate over the last several quarters, our balance sheet has migrated to a balanced portfolio of high quality loans and stable commercial deposits. As we forecast on this call many quarters ago, we said that warehouse balances would migrate down, but we would continue to move our earnings forward. These last several quarters have proven out that plan. Our fourth quarter was strong even as we remain selective in our new loan production given the macroeconomic uncertainty. As a result, while we had a slightly smaller average balance sheet in the fourth quarter, our core earnings were a bit higher than the prior quarter and we generated a significant increase in our tangible book value per share. Our growth in tangible book value per share is important to highlight as it reflects our steady financial performance and prudent balance sheet management. For the full year, our tangible book value per share increased by more than 2% notwithstanding the impact of higher interest rates on AOCI, and the significant capital actions we took, including the completion of our $75 million stock repurchase program, our $24 million acquisition of DeepStack Technologies, and the repositioning of a portion of our securities portfolio this quarter that will contribute to our future earnings. Lynn will discuss this repositioning a bit later in the call. Our loan fundings were lower than the prior quarter due to a combination of lower loan demand resulting from higher interest rates and borrowers being more cautious given the economic uncertainty, as well as our decision to be more selective in the loans we are adding in the current environment. But excluding warehouse, we were able to slightly increase our commercial loan balances during the quarter and keep our overall loan balances essentially flat. We continue to see higher yields in the portfolio, which enabled us to realize more margin expansion. When combined with the actions we have taken this year to manage our funding costs, and our stable non-issuing deposit base that remained around 40% of total deposits. In terms of the launch of our payments business, we remain on track with our projected schedule. Earlier this month, we completed the integration of DeepStack Technology into our internal platform and we have begun processing payments on our rails with Banc of California as the sponsor bank for select smaller clients. We continue to build out the infrastructure necessary to process transactions at scale with targeted completion around the end of the second quarter, after which we will be more broadly developing our pipeline. Now, I'll hand it over to Lynn, who will provide more color on our financial performance. And then I'll have some closing remarks before opening the line for questions. Thanks, Jared. Please feel free to refer to our investor deck, which can be found on our Investor Relations website as I review our fourth quarter performance. I'll start with some of the highlights of our income statement and then we'll move on to our balance sheet trends. Unless otherwise indicated, all prior period comparisons are with the third quarter of 2022. Our earnings release and investor presentation provide a great deal of information, so I'll limit my comments to some areas where additional discussion is helpful. Net income available to common stockholders for the fourth quarter was $21.5 million or $0.36 per diluted share. As Jared mentioned, we repositioned a portion of our securities portfolio during the fourth quarter and recognized a pretax loss on sale of securities of $7.7 million, which had a $0.09 impact on diluted earnings per share. On an adjusted basis, net income totaled $26.88 million for the fourth quarter or $0.45 per diluted common share when the loss on sale of securities, net indemnified legal costs and net losses on investments in alternative energy partnerships are excluded. This compared to adjusted net income of $26.7 million or $0.44 per diluted common share for the prior quarter. There were no securities sold in the prior quarter. It is also worth noting that on an adjusted basis, net income has more than doubled since the fourth quarter of 2021. Our net interest margin increased 11 basis points from the prior quarter to 3.69% as our overall earning asset yield increased by 46 basis points and our total cost of funds increased by 38 basis points. Our earning asset yield increased to 4.79% due to higher yields on both loans and securities during the fourth quarter. Our average loan yield increased 38 basis points to 4.92% due in part to the higher rate on loan production and the average yield on securities increased 81 basis points to 4.19%. The higher securities portfolio yield is due mostly to the CLO portfolio resets and the impact of the investment portfolio actions we accomplished in mid-November. We sold $119 million in securities, recognized a net loss of $7.7 million and reinvested in the net proceeds in securities with a higher average yield of approximately 230 basis points compared to the securities we sold. We estimate this allocation of capital has a tangible book value earn back period of about three years and will cause the overall investment portfolio yield to increase 20 basis points to 25 basis points going forward. Our average cost of funds was 117 basis points, up 38 basis points compared to the prior quarter and our average cost of deposits was 79 basis points for the fourth quarter, up 32 basis points. This increase in our average cost of deposits was primarily driven by rate increases in our money market and interest bearing checking accounts, as well as the impact of the CDs that we have added to lock in some longer term funding as market interest rates have continued to climb. This was partially offset by the positive impact of our average non-interest bearing deposits increasing to 41% of total deposits in the fourth quarter from 38% in the prior quarter. As market interest rates have increased and liquidity has continued to be absorbed by the market, the expectation of deposit yield has also increased. And while our cost of deposits increased 32 basis points quarter-over-quarter, the average federal funds rate increased 147 basis points over the same time period. As a result, the difference between our average cost of deposits and the average federal funds rate widened from 171 basis points last quarter to 286 basis points for the fourth quarter. The net interest margin drivers page in the investor presentation deck illustrates this information. Our non-interest income decreased $7.1 million from the prior quarter due to the loss on sale of investment securities. Other areas of non-interest income were relatively consistent with the prior quarter, with the most significant variance being higher gains from equity investments of $724,000. Our adjusted non-interest expense increased $1.1 million from the prior quarter, which was a reflection of an increase in a variety of areas focused on internal projects, including, but not limited to, DeepStack. All of our other areas of non-interest expense were relatively consistent with the prior quarter as we continue to maintain disciplined expense control while investing in areas of the business that we believe will create long term franchise value. The effective tax rate for the fourth quarter was 29.6% up from the prior quarter's rate of 29.1%. The higher effective tax rate for the current quarter decreased net income by approximately $170,000 compared to the prior quarter. For 2023, we estimate an annual effective tax rate to be approximately 28%. Turning to our balance sheet. Our total assets were $9.2 billion at December 31, down slightly from the end of the prior quarter. Our total equity increased by $7.6 million during the fourth quarter, that’s $21.5 million in net earnings and $1.7 million positive shift in AOCI were offset by capital actions, which included common stock dividends and the repurchase of $19 million in common stock. With the fourth quarter repurchases, we completed the $75 million stock buyback program announced earlier this year and during 2022 we repurchased 7% of our previous outstanding shares. Our non-interest bearing deposits remained strong, averaging 41% for the quarter and ended the quarter at 40%. We continue to use wholesale funding sources to strategically manage both liquidity and funding costs when we believe these sources are better options than rate sensitive client deposits. This included adding $100 million in FHLB term advances in the fourth quarter. Turning to credit quality. Our credit quality remained strong in the fourth quarter. Non-performing loans excluding single family residential loans or SFRs decreased slightly quarter over quarter. While SFR NPLs did increase, they are well secured with very low loan to value ratios and we do not see loss exposure in our SFR portfolio. SFR NPLs represented 38% of our NPLs at year end. In addition, at December 31, 35% of our non-performing loans were either loans and a current payment status but classify non performing for other reasons or the guaranteed portion of loans that have an SBA government guarantee. Similar to NPLs, most of the increase in delinquent loans was driven by SFRs, which totaled $60.8 million or two-thirds of total delinquencies at period end. As frequently happens, we saw a drop in delinquency after quarter end and our SFR delinquencies dropped by $23.7 million by the middle of January. We did not record a provision for credit losses in the fourth quarter given the lower loan balances which offset the impact of weaker economic forecasts. Our allowance for credit losses at the end of the fourth quarter totaled $91.3 million compared to $98.8 million at the end of the prior quarter and our allowance to total loans coverage ratio stood at 1.28% compared to 1.36% at the end of the prior quarter. The $76 million decrease in the allowance for credit losses was due primarily to a $7.1 million charge off of a specific reserve for a purchased credit deteriorated loan from the PMB acquisition. Excluding the reserves associated with loans individually evaluated for impairment, the total coverage ratio increased from 1.24% to 1.25% quarter-over-quarter. And excluding warehouse loans, which have lower relative risk in our reserve methodology, the ACL coverage ratio stood at 1.36% at December 31. Our ACL to non-performing loan ratio remained healthy at 165%. Thank you, Lynn. 2022 was a very successful year for Banc of California in terms of executing on our strategic initiatives, delivering strong financial performance and continuing to build long term franchise value. And I want to thank all of our colleagues at Banc of California for their outstanding effort and performance. One of the pages in our deck lays out what we set out as goals for 2022 and how we checked each of those boxes. It is important we continue to deliver for our shareholders by doing what we say we are going to do. Turning to 2023, we believe that the franchise we have built positions us well to manage through the current environment and to continue delivering strong financial performance. We have a very stable base of non-interest bearing deposits as a result of the work we have done over the past several years to bring in high quality commercial relationships that value the level of service and expertise that we provide. We have a well-diversified conservatively underwritten loan portfolio and we have a high level of capital with our total capital ratio and TCE ratio finishing the year at 11.4% and 9.3% respectively. We have been very successful in attracting talent to the company and we expect that to continue this year as we see many highly productive bankers that want to be part of Banc of California. We also continue to invest in technology to further enhance efficiencies and elevate the client experience, with a priority being placed on investments that will further improve our ability to attract low cost deposits. Since my first day as CEO, our goal has been to build a robust core deposit gathering engine, which we have successfully done. We firmly believe that franchise value is driven by the deposit base. And we remain committed to ensuring that we have the best-in-class technology, service levels and specialized expertise for targeting deposit rich verticals that will enable us to continue taking market share and adding more commercial deposit relationships. 2023 has begun with economic uncertainty, which makes it challenging to forecast at this point, most notably around the level of loan growth, which is going to be largely dependent on the economic environment and there's a wide range of possible outcomes. But with our consistent success in deposit gathering, we expect to have opportunities to profitably invest those inflows and generate higher earnings. If we don't see enough lending opportunities that we like, then we can put money to work in the securities portfolio, given the attractive yields that are now available. Absent an economic turnaround, we would expect earnings to be slightly up in 2023 compared to 2022's core results. Recognizing that the first quarter tends to be slower than the fourth quarter and we expect earnings to build throughout the year. We remain steadfastly focused on credit quality and continuing to grow a high quality deposit base by bringing new commercial relationships to the bank. Let me take a minute to touch on the vision we have for this company going forward. Today, we have over $9 billion in assets with 40% non-interest bearing deposits, a slightly asset sensitive balance sheet with a healthy net interest margin, growing earnings, plenty of capital, a very safe credit portfolio of which approximately 65% is secured by residential real estate at low loan to values and we are located at the heart of the fifth largest economy in the world. We have a core banking business serving commercial clients with exceptional solutions and niches in real estate, entertainment, healthcare, education and in few other areas. As the world moves away from checks and toward card and cashless transactions, we are building on payment and core merchant processing solutions that allow us to be the hub of this ecosystem. Processing card transactions directly on behalf of the merchant without intermediate software or sales partners with a promise of greater visibility into transaction activity and faster receipt of funds for the client. And eventually, card issuance as well, helping our clients with payments in a very complete way. We have a significant number of existing clients that will benefit from these solutions and we know there are an even greater number that we will target that are not our clients today. The synergy of banking and payments should be abundantly clear and our track record of execution should also be very clear by now. While we have laid out general timing, it is important to stress that we are building solutions for the long term and focused on doing it right. While our progress remains on track, we are building a true business line and these things take time to do it right and we will not be deterred however long it takes. Even with an uncertain economic backdrop, given the fundamentals I just laid out and the strategic initiatives we have underway, 2023 is going to be an exceptional year for Banc of California. I can't be exactly sure where the loan growth will shake out, but I do know we have amassed an incredibly talented team, we have an exceptional mission driven and values based culture and with the vision and roadmap we have ahead, 2023 will be a year that continues our track record of driving even greater returns and long term value for shareholders. Thank you. We will now begin the question-and-answer session. [Operator Instructions] Today's first question comes from Matthew Clark at Piper Sandler. Please go ahead. Maybe just starting on the earning assets. I know loan growth is difficult to pinpoint, mortgage warehouse may be nearing the bottom. But give us a sense for how you're trying to manage maybe overall earning assets? Is the plan to kind of stabilize them from here and maybe even grow them incrementally with some leverage or not? Sure. Good morning. I think we'd like to keep assets relatively flat. If we can grow them great, there's probably opportunities to use a little bit of leverage and maybe grow them a little bit more. But we'd like to at least target asset level staying flat where they are to keep earnings power where it needs to be. And then if we see opportunities to grow a little bit, we'll do it. The pipelines are not huge right now. They're probably the slowest they've been since I've been at the company, but we're not -- we’re also not pressing, the environment is pretty uncertain and we're being very selective in the deals that we do. Okay, great. And then maybe for Lynn, just your thoughts on the non-interest expense core run rate, the $48.5 million this quarter, where that might go this coming year? Sure, sure. I think we've provided previously a range of $48 million to $50 million, we were at the lower end of the range. I think our expectation is $48.5 million probably the lower end. I think the range is still appropriate though at $50 million. Maybe I think we'd be at the higher end of the as we look into first quarter has seasonally higher expenses. And then as the year unfolds, I think we've continued to invest in many initiatives. And I think that will put us, like I said, closer to the higher end of the range. Okay. And then just any updated thoughts on your interest bearing deposit beta where you think it might settle out this cycle, 39% in cycle to date? And I think it was in the mid-50s last cycle? Yes. I mean, we continue to focus on bringing in low cost deposits and I'm really proud of kind of how our -- I know there were questions. We grew non-interest bring deposits from 12% to 40% and people said, is that real? Is it going to hold up? And what we've said last quarter and the prior quarter was, as the economy contracts, we expect there to be outflows of liquidity, but we don't expect our mix to change very much because it's -- the economy is moving downward overall and that's what we're seeing in our book and that's what's been holding up. So we're going to try to keep growing our non-interest bearing percentage and our deposit beta is really -- it's not something we track very much honestly, Matthew, because it's an outflow. Excuse me, it's an output of kind of all the other efforts that we have. And this quarter what Lynn pointed out to me was that, our% of the Fed increases was much lower than prior quarters, which meant we did a better job of not increasing deposit costs as much relative to the market. So I don't know that we have a target number. We just want to -- we're still slightly asset sensitive. We think there's probably a little bit of room for our margin to expand. But I would say that given we're getting closer to peak interest rate increases based on what the Fed has indicated they're going to do. We're likely to move at some point to neutrality to optimize earnings for the long term. And we'll be smart about it and protect shareholders. So we don't have a specific deposit beta number. It really is -- we don't know where it's going to end up in the quarter. We just keep trying to grow non-interest bearing and we'll make sure that we have enough deposits to fund the growth that we see or make investments. I know that's not a direct kind of specific answer to your question, but that's how we talk about it internally. Lynn, I don't know if you have anything to add there. I think the only thing I would add is, I think you were looking at it relative to prior cycle and the trend of us being lower beta from the numbers that you provided is I think a result of the fact that our non-interest bearing deposits are a higher% of our deposit base or our funding base. So to that extent, when we look at a prior period versus now or prior interest cycle compared to now, I think our expectation is that it would generally be lower. And then to Jared's point, the focus on non-interest bearing deposits and managing our core funding base, we expect that mix to continue and to have a positive impact on deposit beta as we move forward. Okay, Great. Thanks for the color. And then last one for me. Just on capital. You started to accrete capital here again, 11.9% CET1 buybacks done. What are your thoughts on authorizing another share repurchase program at this point of cycle? Well, we've got a -- we haven't made any announcement there. I mean, I think there's a couple of things that we could do here. We're going to be looking at and we have Board meetings coming up in early February. Looking at what are the investments we have planned for the company of the year, including the number of initiatives we have. And what's the best use of capital going forward in terms of dividend, buyback and all those things. So we're going to look at all that stuff. If our stock is trading at a low level, then obviously buying it back in many cases makes sense, and hopefully it won't be there for very long. Okay. And then actually if I could sneak one in, just a point of clarification. In your opening comments, I think you mentioned that you expect earnings to be up modestly in 2023 relative to 2022 on a core operating basis. I just want to make sure we're using the right base. I assume that's on a pre-provision basis since you had a big recovery last year [Multiple Speakers] Yes, I was thinking about -- Exactly. I was thinking about that -- backing out that. That recovery was the thing I was thinking about when I made those comments. That was, obviously, one time and unusual. And so when you back out the unusual stuff, we would expect to be a little bit higher and have it built through the year. Where we sit now, that's kind of how it looks. Maybe just following up on the last line of comments. So is that assuming that there's essentially a zero provision for the year if kind of current asset growth projections play out and there's no real change in the CECL methodology? I don't think it's reasonable to expect zero provision this year. I think that we're going to have to look at the landscape. And we feel really, really good about our credit quality. There's an uptick in [DQs] (ph) and some SFRs, but we've never seen any loss in that portfolio. And we don't expect it now based on how it's underwritten. Overall, our quarter was really solid. We do, as Lynn laid out, I thought really well in her comments, like our coverage ratio is pretty darn high. It's certainly relative to peers with similar portfolios and every time we stress our portfolio, we come out well. I'd like to have some loan growth this year that makes sense. And if so, we'll have to look at whether provisions are appropriate and they would be for growing our portfolio. If the portfolio stays flat and the economic climate deteriorates, I would think that provisioning would be appropriate. And we just haven’t seen it yet and so it’s a little bit economy dependent to more, but I see what everybody else sees in terms of where things are going right now. Yes, that all makes sense. And then maybe just circling up again on DDA, which you guys have done an excellent job in keeping in house and appreciate the comments that it will keep kind of the mix shift unchanged, while the liquidity picture plays out. I guess how much liquidity is still at risk here? Is there much visibility and does that kind of outflow lag the last rate hike or is much of that already effectively in the numbers? Let me -- Lynn, I don't know if you have any immediate thoughts, but I would say that we're continuing to see pressure on -- if I'm answering your -- if I understand your question correctly, we're continuing to see pressure on deposit pricing. It's not fully baked in. I mean, there was an interesting article that came out yesterday about what could happen if the government defaults on debt and how that could cause liquidity problems for banks? We feel obviously very good about all of our sources of liquidity, primary, secondary and tertiary and they're meaningful and very, very healthy. We are managing at a 100% loan to deposit ratio, I think extremely comfortably and holding earnings to where we want them to be. But I would say that liquidity stress still exists in the market. It doesn't concern us based on all the things that we've been able to do and the ways that we can pivot. One thing I think it's really important to keep going back to is our tangible book value growth and our lack of ACI -- AOCI impairment relative to others. I mean, we really have true very, very little and Lynn and her team have done an exceptional job of managing our securities portfolio and that's real liquidity for us. We don't have these big marks that would keep us from having to sell it or cause a big drop in capital if we chose to tap into that. We don't see any of that coming to play. We think that things are stable for us and we think we're managing it well, but I think it's a differentiator that's worth pointing out, especially with our existing high levels of capital we have that on top of it. Great. And then just last from me, looking at the expense base at $48 million to $50 million range. Is that encompassing the investment needed to stand up DeepStack? And then I guess how should we be thinking about that investment both in magnitude and kind of timing? Sure. Yes. Thanks for following back up on that. I should have sort of added that. The $50 million does include the additional expense from the fourth quarter with DeepStack. And I think as we look forward, we do expect that it will move with some higher fee income. So we expect to be able to leverage the expense base that we have for some of the initiatives including DeepStack. So I think it answer your question, yes, it includes it Timur. Good morning. Lynn, I wanted to ask about the broker deposits added in the quarter. If you could kind of give us an idea of what the timing and kind of term and rate is on those deposits? [Multiple Speakers] [Multiple Speakers] go pull maybe some of the detail. I think just a general comment. Our observation, we've kept our balance sheet I think fairly nimble. So as we've brought down some of the warehouse balances, we've let some of the funding associated with that also migrate off. So a portion of the broker deposits are shorter term in nature versus using maybe overnight advances, so they can be 30 to 60 days. They're actually less expensive to a certain extent compared to overnight. And then the rest have terms that move out to about two years. So [indiscernible] pull more specific information. Okay. No, thank you. That's helpful. And then just in terms of DeepStack, Jared, I appreciate your confidence and obviously you're going to be thoughtful about kind of building that business out. I had thought that you might be providing a little more in the way of kind of expectations or initial expectations for how you're thinking about that business for this year. Whether it's in terms of kind of -- or maybe I'll just ask, how you're thinking about in terms of deposit flows or KPIs to be thinking about over the course of the year as it relates to that business? Sure. I think we want to get it completely stood up. As I mentioned in my comments, we've now started onboarding client on our rails. We're doing it very slowly, making sure we get it right. There's a lot of things that we want to get right, particularly on the regulatory side and compliance side and make sure that all the systems are working well so that we get all the feeders and we're exercising our right of -- our responsibility of oversight of all the transaction volume that we expect to be able to handle. And so, we have a roadmap of how we're rolling this out. And I think our team is doing a really good job with it. We are slated to be, as I mentioned, by the end of the second quarter to kind of be closer to scale. And by then, I'll be more comfortable saying, okay, look the pipeline and how do we give people indication of what we should expect. For now, it's going to be kind of in the rearview mirror, as it happens, we'll be sharing it. And as we get through the second quarter, it will be easier to be a little bit more forward looking. Okay. And just to clarify, when you say onboarding clients to bank rails, that means you're moving existing DeepStack clients over to your platform, correct, as opposed to onboarding? No, the new clients. We on boarded one or two new clients so far this quarter, which is great. And we wanted to do it in what I call it a soft test environment. You don't want to put on massive volume. You want to put on the volume that you can monitor and if something happens, you can -- it breaks, you can fix it without it disrupting. So it's moving the way we thought and our team is doing a great job. We're excited to share and really to open up the floodgates as it were to get this thing moving at a faster speed. We're just not ready to do that yet until we've pressure tested in and make sure that we can fulfill our compliance obligations. Thanks, Gary. I was able to pull that one piece of detail for the benefit of everybody. So our brokered CDs have a tenure of about nine months and our rates are -- weighted average rate is about 3.85%. So you guys have been -- just kind of following up on the DeepStack stuff, you've been pretty active in the tech and the payments side with the Finexio investment and DeepStack now and you've been pretty forward looking from that standpoint. I guess at a high level, as you step back and think about it, are there any other innovative aspects in banking that you're interested in expanding into, any other pieces that may be additive to these businesses that you have now? And just kind of how do you think about that? Or do you have all the pieces now that you need and it's really just execution and growth from what you have? Well, I think we have all the pieces and certainly all the people. We just added a new head of payments risk [indiscernible] who's got a deep background in payments and she joined us yesterday and she's going to provide a big lift to the team. There aren't a lot of people in the industry that have been in payments that long and also have been at banks. And so we're thrilled to have her here. Continuing to add really, really high quality talent. I would say, David, that from a vision standpoint, we have the people, we have the technology, but we see, as I mentioned in my comments, being able to build out a complete ecosystem for payments. And so we're pursuing in parallel paths both what we have on the DeepStack side as well as what we think we can do on the issuing side. And our Chief Operating Officer, John Sotoodeh has both of these pass underneath him and he's kind of pursuing them directly and in parallel. And there -- so we're rolling out solutions for clients that we think will provide complete solution. So we can also be the issuer as well as the merchant processor. And what JP Morgan created many years ago was a closed loop system where they were on both sides of the transaction and that's obviously very attractive if you have the systems to get there. So we are forward looking. I think we're thinking about it potentially differently than others and we're putting the pieces together that will allow us to capture as much as possible, but it's early. So I'm just -- I'm excited to share the vision, but we obviously have to execute and demonstrate each of these pieces before we get too excited about the endgame. Yes. And if we're able to outperform that, that would be great. But I think that's right with a look at it. Okay. And you touched on this several times about having maybe a bit more of a cautious outlook, which makes a ton of sense. I'm just curious, where are you seeing loans come across your desk that still bring risk -- attractive risk adjusted returns? And just any other thoughts on or commentary from the demand side from your standpoint, where demand is slowing, where it still remains solid, especially just in light of some of new hires that you've made? Sure. That's a good question. So where we see opportunity that we think is attractive, we continue to see good opportunities in financing streaming content. It's slowed a little bit, but there's still a lot of content creation going on. These channels have to get filled even as other things slow down. And that's been really stable for us. We've carved out a really good niche. Our team is excellent at it. And we've now got a lot of people coming to us asking for our financing and we've put together really good programs. So I would also say healthcare as an area that continues to thrive in our market and there are opportunistic things to do in specialty hospitals and financing physician practice groups and things like that and our team is smart there. Education charter schools is something where we have a niche, that is deposit rich and continues to be good in terms of financing charter schools with basically revolving lines of credit that help them bridge the receivables they get from the state. And there aren't a lot of banks that know how to do that. And so we've been successful with that. On the real estate side, it's very, very slow, certainly on the permanent financing side, the things that are getting done today are the things that need to get done because people basically just flipped into a floating rate note or they reach maturity. There is some bridge stuff. So our most sophisticated borrowers are the ones that are seeing people who are in -- who are caught in a situation where they can no longer afford the loan and are trying to be opportunistic to take stuff out. So when we have strong guarantors who know what they're doing and they did this in the last cycle, we want to be there to support them. They personally guarantee the loans, they're a loan to values and they have a track record of execution. So -- but that's a lot slower than it was. That activity is still being impacted by rates. Everything else is pretty slow. I mean, C&I is, as we said is very, very slow. I worry about businesses that get caught with oversupply and then they get slow paid by their own buyers. So we're just being super cautious, but that's some color. Maybe staying on that topic, what are some -- just from your perspective, I know you guys are sitting kind of in the catbird seat with really low risk loan portfolio. But if you look at the market, I mean, what are you seeing that is causing you some concern? I mean, investors are obviously focused on CRE and notably some of the segments within there like office and those types of things. But just curious, maybe from your standpoint, what are some of the segments that you might be more cautious on and continue pull back on? And just the credit environment and the market for -- from a credit standpoint in your opinion? Well, so hospitality is not something that we traffic in. And so I would start by staying away from that. Second is office. We don't really have much and we would stay away from it now for sure. I mean, there aren't a lot of -- there isn't a business that I have heard of that isn't thinking about reducing their space. And so there begs a lot of questions. When leases come up, how that's going to perform. Construction is obviously something that you got to be careful. Now the good side of construction is that, supplies are more available, teams are more available and the best developers know that downturn is sometimes the best time to build because you're building when there's no demand and then soon as you come out of the ground, you can fill it up pretty quickly. And certainly for infill housing, there's opportunity. So I wouldn't say that you would avoid all construction, but what's the price of the land that they're contributing. What's the building cost today? Some of the building costs have actually gone down that can offset some of the rate increases. But I would say that on most cases, you're going to be extremely careful on construction. And I go back to just core C&I, things that are -- things that are going to get triple hit with interest rates, labor shortages and supply chain. And you think about distribution and warehouse and things like that that could be hard hit. If you're doing C&I right now, you better have a good ABL team, because that's one of the safer ways to do C&I in this sort of environment, but even there you have to be super cautious. I would say on the other side, SFR remains safe and we continue to see opportunities on the SFR side that look very attractive. And if it makes sense to pull the trigger, we will. We don't originate, but we have -- as you know, unique channels to get that asset. And if we see good stuff, we wouldn't hesitate. Jared or maybe for Lynn, just looking at the 2023 strategic objectives. Hoping you could just maybe expand on what type of balance sheet opportunities you might look to take advantage of when speaking about enhancing kind of longer term earnings? Just maybe some incremental color there. Yes, I mean, I think we just touched on a little bit and it was touched on the beginning. It's a good question. We can -- there are opportunities to buy securities that might be more attractive than loans. You could borrow to buy securities if you're able to match it right and really benefit as when rates come back down, you're going to have your funding costs come down and your securities yields probably going to go up. So there's good opportunities there. We are seeing lending opportunities, so they're just not robust. I agree with your comments. I think we started out talking about looking at average earning assets maintaining them and to the extent that there's not opportunities in loan portfolio. I think we view that there's opportunities in securities portfolio. Especially as we continue to manage funding costs. So I think those are primarily and I think we have to recognize the economic landscape that we're going to be operating within, but I think there's an ability to accomplish that. Yes. Okay. That's helpful. Thank you. And maybe if I could move really quickly to the non-interest bearing deposits. I know the end of period was down maybe a bit more than the average was throughout the quarter. I was hoping just to hear any kind of color you have regarding trends so far in January? I'd say we're running about the same place we were at the end of the quarter. The average for the quarter was 41% and the period end was 39.5%, so it's pretty close. We look at within a 5% band up or down as kind of reasonable, though we didn't expect to be that wide. So right now we're running where we were at the end of the quarter. I would say that, as I mentioned earlier, I think the pressure on pricing continues to -- it continues. I wouldn't say it's increasing, it just continues. And said it's probably going to bump rates here a few more times and that's going to roll down the hill the way it has. And so we're just trying to optimize our relationships. The way that we're looking at this is, we're trying to be selective and not reprice our entire deposit portfolio by just promoting rates. So we still have a strategy where we are pricing relationships individually and monitoring relationships, reminding them the service that provide and then when people ask for higher rates, we're having direct conversations. It's a lot more work and -- but it's I think protected our overall deposit base and that's one of the reasons why we've grown out to the brokered market or even the whole -- the non-core market to get funding so that when we want to buy it in bulk, so we don't have to reprice groups of deposits here by providing that rate to everybody, because a lot of people aren't asking for it, believe it or not. And a lot of our CDs just roll over automatically. And so we're trying to be pretty selective about it and strategic about it. Okay. And then last one for me. I just wanted to ask on the -- I think the non-accrual loans were up about $12 million or so this quarter. Just was hoping to get maybe a little bit of color on what drove the uptick and was this an acquired credit with the PCD mark already against it or one that that BANC originated? Well, we consider -- I don't think it was a -- the charge off that we took that was specifically reserved against, that was a PMB credit and that was -- that kind of proceeded as planned and I think we were well reserved on it. The other ones, I don't remember if the loans came from PMB or not at this point. And I just -- we own the loans and we're responsible for them. And I don't know that they had specific reserves on them, but we think that we have reserved properly at this point and we don't see a lot of credit noise down the road. So far, in my history here, we really haven't had any from the way that we've been underwriting and I think we'll be able to manage these just fine. It's certainly not a trend from my point of view. Thanks for the question. Most of mine have been asked and answered already, but if I could swing back to the warehouse book. I know that's difficult to predict, but wondering if there's any sort of minimum amount of activity you expect that to bottom out at? As well as if you remind us the deposit relationships that come with that in terms of either loans deposits [indiscernible]? First of all, we have a really, really good warehouse team that does a fantastic job of kind of managing relationships and managing kind of quality of credits. And so, they're very selective in who we're going to lend to and how we're going to manage it. And so we've been fortunate that things for us have gone smoothly despite kind of the rundown and kind of that industry generally. Let me tackle the deposit piece first. We have a good amount of deposits with that business. Those deposits are very stable, they're institutional depositors who -- they operate through warehouse but not necessarily on the origination side, sometimes they're on the buy side, they're buying loans that have already been funded. So in that way, it's true C&I. And they're kind of sitting there with cash buying loans as needed and we're helping to fund that. So there's -- the deposit flows have been very stable and as warehouse balances have come down, warehouse as a business, a higher percentage of it is self-funded. And so we monitor that very closely, but it's pretty stable. In terms of where the balances are going to flow out, I'm trying to pull up the most recent numbers. And Lynn, you may have them in front of you have kind of where we think warehouse will fall out. I tell you, I don't know like whether it's going to go down more. At the end of the fourth quarter it was $600 million, $603 million. I don’t know -- yes, go ahead. I think maybe just -- Yes, maybe just to add, I mean, we expect the warehouse to continue to pull back. I think the decline was mostly in line with maybe what we observed across the entire market. I think as we look forward, I think that decrease is expected to moderate given where rates have gone. So it may be that it comes down somewhat, but not at the levels that we observed I think in the fourth quarter. And I think maybe the averages will pan out to be about the same. So I think it's less of a headwind as we look forward and we've obviously built up the book in other places. Yes, I think to that point, Kelly, if I can just add. We certainly feel like we've done a good job of diversifying our portfolio outside of the concentration warehouse that we before and continue to grow earnings through that. And so we don't see warehouse getting way back up even as rates come back down, but our team has done a good job of staying within a band. And so we've always said like up or down $100 million, warehouse was kind of the band. As it shrunk, maybe that's too big a band now, but we're going to be, I don't know, between $600 million and $650 million probably. It's hard to peg it exactly. But it’s our guessing today, I'd say that's probably pretty close. I appreciate all the color on both sides. That's very helpful. Last question from me, a bit nitpicky, but I saw customer service fees are down quarter-over-quarter from where they've been running the past couple of quarters. Wondering if that’s activity driven, just less customer activity or if there's anything structural in -- I don't know if that's positive service charges and maybe some change in the way you're charging there? Just interested in any color that would be helpful on a go forward basis. I can probably add a little bit. Yes. So included -- I would say that included in there is both deposit and loan customer service fees. And so with some of the loan production volume being a little bit lower that I think impacted the number for the quarter. And then I don't see much in the way of the deposit service fees. I think those -- while we are still competing heavily for our customers business. I expect that we would have a similar deposit customer service fees. So I think what we're seeing just in the fourth quarter is mostly to do with the loan side. And I don't know that we would see it going any further down. Yes, sir. So this concludes our question-and-answer session and 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_1548
Good afternoon, everybody. I'm Chris Schott at J.P. Morgan. And it's my pleasure to be introducing AbbVie today. From the company, we have a presentation from Rick Gonzalez, AbbVie's Chairman and CEO. And after the presentation, we're going to have a Q&A session with a broader swath of the management team, including Rob Michael, President of AbbVie; Chief Commercial Officer, Jeff Stewart; and Chief Medical Officer; Roopal Thakkar. So with that, I'm going to turn it over to Rick. Happy New Year, and thanks for joining us today. Well, thank you, Chris, and good afternoon, everyone, and certainly a pleasure to be here with all of you. Before I begin, please take a moment to review the forward-looking statement. I know it's the most enjoyable thing that you have here for a couple of minutes before we move forward. This is certainly an exciting time when we think about our company. We're just finishing up our 10th year operating as an independent company. AbbVie has grown over the past decade to become a leading pharmaceutical company with a market capitalization of $285 billion, and a track record of consistently delivering top tier financial performance and strong execution. We've also become a company that has evolved over time to have very strong operating characteristics. We have a diversified portfolio with significant leadership positions in several major therapeutic categories supported by industry leading commercial capabilities and execution. We have an R&D engine that has discovered and developed five major blockbusters over the past decade. These assets are expected to generate approximately $16 billion in annual revenues in 2022. And we have a robust pipeline across all stages of development. We have also strategically acquired and successfully integrated several differentiated assets to further support AbbVie's long-term growth. These efforts have resulted in an outstanding total shareholder return of more than 600% since our inception. We certainly created a very strong foundation as we enter 2023. The event that we have all been long planning for here to AbbVie, the U.S. Humira loss of exclusivity, which will begin later this month, will have an impact on AbbVie's total performance in the near-term. We've now secured Humira formulary access for more than 90% of the U.S. covered lives this year. When we issued formal 2023 guidance, on the fourth quarter call, it's important to note that the lower end of our EPS outlook range will represent [floor earnings] [ph] for the company. Regardless of the shape of the erosion curve over the next two years, we do not anticipate that 2024 earnings will be lower than the initial 2023 EPS guidance given that the momentum and growth from another year of our broader portfolio is expected to more than offset any potential incremental Humira erosion that could occur in 2024. Ultimately though, we remain well-positioned to absorb the impact from the Humira LOE and quickly return to strong growth starting in 2025. We continue to anticipate a clearer path to strong sales growth in 2025 with high-single-digit compounded annual growth rate to the end of this decade. With our robust long-term growth outlook, AbbVie clearly represents a unique investment opportunity, well-positioned for attractive shareholder returns. Following the U.S. Humira event, we expect AbbVie's revenue growth to be among the highest in our industry. We will also have one of the lowest LOE exposures through the end of this decade and expect our strong business performance will generate substantial cash flow to support our capital allocation needs. This includes investing in innovative R&D across our therapeutic categories, as well as the capacity to continue to do business development to augment our pipeline in our portfolio. Growing our dividend, this remains a key priority and reflects an attractive yield for our shareholders. Last October, we announced a 5% increase in our cash quarterly dividend, which we have now grown by 270% since our inception and this further underscores our level of confidence in AbbVie's long-term outlook. And finally paying down debt. We have made substantial progress and remain on-track to achieve roughly $34 billion of cumulative pay down through 2023. Now moving to Slide 5. Our long-term growth will be driven by numerous differentiated assets across each of our core areas. Let's start with immunology. In immunology, our performance and execution has been outstanding and we're well-positioned for sustained leadership. Skyrizi and Rinvoq are now commercialized across all of Humira's major indications, plus a distinct new indication, atopic dermatitis. These two new therapies are demonstrating impressive results with more than $7.5 billion of combined sales expected in 2022. We also have several promising R&D programs underway in our core disease areas within immunology, and in areas of immunology where there are few or no effective treatments. Areas like lupus, GCA, HS, Alopecia, Vitiligo and PMR. Turning now to Slide 6. The rapid indication expansion of Skyrizi and Rinvoq took place in less than half of Humira's development timeline. With the addition of atopic dermatitis, these two assets together now span a greater portion of the global immunology market than Humira did. And we expect they will remain major growth drivers for the company through the end of this decade and beyond. Based on the strong launch trajectory across the currently approved indications, as well as the progress that we're making with additional label expansion Skyrizi and Rinvoq are now on pace to deliver more than $17.5 billion in combined sales, risk adjusted sales in 2025, well above our previous expectations. We now expect global sales for Skyrizi to reach more than $10 billion in 2025, an increase of $2.5 billion versus our previous guidance, reflecting higher performance across basically all of the indications. We continue to expect Rinvoq to achieved more than $7.5 billion of global sales in 2025. This outlook now contemplates higher sales, in IBD based on the strong approved label for UC and the robust data demonstrated in our clinical program for Crohn's disease. This increased momentum in IBD is expected to be offset by lower contributions in rheumatology, given the impact from the global update to JAK inhibitor labels. As we look beyond 2025, we expect combined sales for Skyrizi and Rinvoq to exceed the peak revenues achieved by Humira, which was more than $21 billion. We expect that to happen in 2027 with continued significant growth anticipated in the following years. Moving now to Slide 7. AbbVie has built a significant leadership position in hematological oncology with Imbruvica and Venclexta. While Imbruvica is expected to generate significant cash flow through the end of this decade, recent challenging market and share dynamics attributed to both the pace of COVID recovery, as well as new competitive entrants has significantly lowered our sales expectations for Imbruvica. This expected revenue impact will be partially offset by the continued strong growth from Venclexta, our first-in-class BCL-2 inhibitor for multiple hematological malignancies. Venclexta’s [proven indications] [ph] in both CLL and AML are both seeing robust share of performance. Potential ongoing label expansion in other important areas such as multiple myeloma in the T1114 patient population, as well as high risk MDS also have the potential to drive meaningful long-term growth for this business. As a result, the near-term outlook for Imbruvica, we now expect global oncology revenues to decline to approximately $5.7 billion in 2023 and anticipate sales will remain relatively flat for 2024 and 2025. As we look at Slide 8 now, we expect our oncology pipeline to return to sales growth in 2026 with the anticipated launch, and indication ramps of several new products for both blood cancer and some solid tumors. These promising late stage oncology opportunities include Epcoritamab, a potentially best-in-class CD3xCD20 bispecific for B-cell malignancies, including DLBCL and follicular lymphoma. The initial approval is anticipated later this year. Navitoclax, a novel BCL-2/BCL-xL inhibitor with the potential to improve symptoms, reverse fibrosis, and modify the course of myelofibrosis. We anticipate approval of that asset in 2024. And Teliso-V, our c-MET ADC with the potential to become an important new treatment option for non- squamous non-small cell lung cancer, we anticipate approval for the initial indication in 2024. As you can see on Slide 9, beyond the late stage programs that I just outlined, we have a pipeline of early stage assets that are aimed at both heme and solid tumor. We've begun to see some very exciting data from several solid tumor programs, including our anti-GARP antibody ABBV-151, and our PTK7 ADC, ABBV-647. We expect proof-of-concept data from roughly a dozen additional early stage oncology opportunities over the next couple of years. Now moving to Slide 10. In neuroscience, we have compelling therapies for migraine, psychiatric conditions and neurodegeneration. I'll start with migraine, where our distinct therapies are demonstrating robust growth. Our leading portfolio includes UBRELVY, an oral CGRP treatment for acute migraine, that provides rapid and sustained pain relief with convenient dosing. UBRELVY continues to demonstrate robust growth and has the potential for peak sales in excess of $1 billion. We also have Qulipta, the only oral CGRP treatment specifically developed for the preventative treatment of migraine. Potential label expansion in the U.S. as a preventative treatment for patients with chronic migraine and a new therapy approval we expect in Europe will further support Qulipta’s utilization and we believe that Qulipta’s peak sales can exceed $1 billion as well. Rounding out our migraine portfolio is Botox, a unique treatment with a dozen approved therapeutic indications and is the clear branded leader in chronic migraine prevention. Turning now to Slide 11. In Psychiatry, we're focused on treatment options for mood, thought, and anxiety disorders. Vraylar continues to demonstrate robust growth in a heavily genericized market. Vraylar is differentiated by a strong benefit risk profile relative to other atypical antipsychotics, including efficacy across multiple indications with minimal impact on weight, lipids, and fasting blood glucose. Vraylar was recently approved as an injunctive treatment for major depressive disorder and is now the only antipsychotic that is a dopamine and serotonin partial agonist approved for the treatment of the most common forms of depression, Bipolar 1 and MDD. With continued share gains and the MDD approval, we now expect Vraylar’s peak sales to approach $5 billion. As you look at Slide 12, we're also making good progress advancing an innovative pipeline of neurodegeneration assets. ABBV-951 is a potentially transformative treatment for patients with advanced Parkinson disease. With a subcutaneous non-surgical delivery system, we believe 951 can significantly expand the patient population currently addressed by DUOPA. We anticipate regulatory approval this year and believe 951 has the potential to achieve peak sales in excess of $1 billion. We also have R&D efforts aimed at discovering and developing disease modifying therapies to treat Alzheimer's. Our pipeline includes an optimized a-beta antibody program for faster amyloid clearance with low ARIA and patient friendly dosing schedule. Approach is for clearing intracellular tau aggregates and investigational assets that modulate neuroinflammation response. We recently began a Phase 2 study in AD for our lead a-beta antibody ABBV-916 and look forward to providing updates on our neural programs as that data matures. Moving to Slide 13. We're the clear leader in aesthetics, a $14 billion global market, which is largely cash pay. Our portfolio is anchored by well-known brands that span several core areas, including Botox Cosmetic, the market leading neurotoxin, JUVEDERM, a leading portfolio of injectable and dermal fillers, as well as numerous products and technologies for body contouring, plastics, skincare, and regenerative medicine. We see substantial room for further market penetration across each of the aesthetic categories and we've made strategic investments to support that long-term growth. Those efforts include a focus on new product innovation, including a pipeline of innovative toxins, as well as novel biostimulatory and regenerative fillers. Targeted field force expansion in major global markets including China, Japan, and Latin America, as well as increased direct-to-consumer and enhanced services to drive consumer activation and retention. As a predominantly consumer facing category, aesthetic treatment procedures can be impacted by changing economic conditions. And while it's difficult to predict, how inflation and consumer confidence may play out this year in the U.S., our large installed base of existing patients, as well as the rapid and sustained recovery of our aesthetics portfolio experienced following the 2008, 2009 recession gives us a tremendous amount of confidence that any near-term economic impact will be transient. Over the long-term, aesthetics continues to be an extremely attractive underpenetrated market with significant growth potential. And we remain confident in our ability to achieve total sales of more than $9 billion by 2029. Turning to Slide 14. Our goal with Eye Care is to help protect and preserve vision. We have a strong commercial foundation with a broad portfolio of treatments for multiple different eye diseases. We also have been advancing several new products and novel therapies to address areas of significant unmet need. This includes RGX-314, which is an anti-VEGF gene therapy that has the potential to be a one-time treatment for wet AMD, diabetic retinopathy and other chronic retinal conditions. Moving now to Slide 15. AbbVie has built a productive innovation driven R&D organization with a robust pipeline. We set aggressive goals across our discovery and development organizations and we're proud of our ability to develop medicines that have clearly elevated standard of care for patients. AbbVie’s R&D efforts continue to demonstrate strong progress with more than 80 clinical and device programs across all stages of development. The breadth and the depth of our pipeline is there to be able to support our long-term growth outlook and we anticipate numerous important pipeline milestones will occur over the next two years. As you can see on this slide, Slide 17, we anticipate the potential approval of roughly a dozen new products or major indications in 2023 and 2024, which will collectively add meaningful revenue growth over the next several years. This includes multiple new product approvals, such as Epcoritamab, 951, Navitoclax, and Teliso-V, as well as expanded indications for Skyrizi, Rinvoq, Venclexta, and Qulipta, as well as many others. Over this two-year timeframe, we expect proof-of-concept data from more than 15 early and mid-stage programs. These programs have the potential to drive additional growth for AbbVie over the mid to latter part of this decade. So, in summary, what I'd say is, we are obviously executing well across the business. We've assembled an impressive set of diversified assets and that gives us a tremendous amount of confidence in being able to drive the long-term growth outlook of our company. Thanks very much. We'll get in focus on stage here. I thought as an opening question, obviously, we're right on the cusp of biosimilar Humira coming to market. So, can you maybe share your latest thinking? I know you'll give specific guidance in a few weeks, but latest thinking on how we should think about Humira dynamics as we go through 2023? I think you've talked about the product having 90% of covered lives at parity with biosimilars. I'm just trying to get our hands around how to think about, kind of volume and price and just any…? It's obviously an important question and an important issue for investors and let me take a high level cut at it and then Rob and Jeff certainly can add anything from their perspective. Obviously, one of the most important things was for us to ensure that we could get broad access for Humira. And I'd say the team has done a very nice job. We now have a little over 90% access for next year for Humira at parity. What that means is, essentially it will be on formulary with biosimilars, but there won't be any difference between the biosimilar and Humira from a co-pay standpoint or any kind of a step editing. So, essentially, it will compete head-to-head against those biosimilars, which is obviously a good position for us to be in. As you look at that, and you try to analyze what will the erosion look like? I think the best way to think about the erosion is this. Based on that formulary access, obviously, the 10% that we don't have, we're likely to see fairly significant volume erosion in there. We'll probably see some level of volume erosion in the 90% that we do have coverage, although I would say it's probably going to be much more modest. Because there's not as much motivation for those physicians to be able to make a change. The second part that you have to think through is you're trying to model the impact on Humira going forward would be price. So, the bulk of the impact that we will see in 2023 will be driven by price reductions in order to get that formulary access. Obviously, we had to compete against the biosimilars in order to be able to get that level of access. And because one biosimilar will enter the market at the beginning of this year, but 7 or 8 will enter mid-year. What you ultimately will see is a certain level of price erosion in the first half of the year and a higher level of price erosion in the second half of the year when the environment was more competitive. So, the contracts are structured for the most part in that manner. So, you should expect higher level a price erosion in that second half. So, that's how I think you can think about 2023. And as you think going forward to 2024, there are a couple of things that you have to, sort of factor in. One is that point I just made and that is because there will be higher erosion in the second half of the year, you have to annualize that erosion going into 2024. That's one of the things that's important to do. I think it's likely that we will see more volume erosion in 2024 than we would have seen in 2023. Because there'll be more – all the biosimilars will be on the market. There will be more – there'll be more accustomed to them at that point. So, we'll be an even more competitive environment. But as we said before, regardless of the shape of what that erosion curve looks like, our intent is to give you floor earnings within that range. And then the growth of our current business is more than sufficient to be able to offset any incremental erosion in the event we were to see that curve shift out a bit into 2024. Anything you’d add, Rob or Jeff? That's good. Maybe just to add one thing. I mean, over the fall, obviously, we were still in the heart of the negotiations. But to the point that Rick highlighted with the 90% that's from a parity lives perspective, that's a certainty now. So, we've gotten signed agreements with all of the major U.S. payers and so we feel very good as we go into that fourth quarter call that's upcoming. Great. Can I talk about – a new question for Rob? Operating margins have kind of hovered in the low 50s over the last couple of years, and I think you've talked in the past about a margin range maybe in the 46%, 47% range as you go through this LOE cycle. So, I guess the first question is, are you still comfortable with that range to the extent you can comment on it? And then as we exit this period and growth resumes, how do we think about a normalized margin for AbbVie longer-term? Yes, that's right, Chris. So you think about 46% or 47% would apply for – in 2023, we stay at that level in 2024, then it was we return to strong revenue growth in 2025, we'll start to see operating margins expand once again. Now, the pace of expansion will depend on investment. These will obviously fully fund R&D and SG&A to grow the business long-term, but you will see us expand operating margin. We will be top tier even at the trough levels, but you should expect to see operating margin expansion starting in 2025. Okay. And can I ask a question on capital deployment? I know the company has pretty rapidly paid down the Allergan debt. It seems like we're going to position in 2023 that we can maybe think about capital deployment in a more meaningful way. So, talk a little bit about how you think about priorities for the organization right now? And kind of what's the sweet spot of what AbbVie would be considering in that transaction? No, it's a great question, Chris. I mean we look at business development, it’s something that we do on an ongoing basis to be able to support the long-term growth objectives of the business. We always assume that a certain percentage of our growth is going to have to come from assets that we acquire on the outside and either bring in and develop or just acquire on the outside businesses that we might acquire going forward. Having said that, when we look at our long range plan, we're obviously very comfortable with our ability to be able to grow it at a top tier level from 2025 and beyond with the assets that we have today. So, we're obviously in a very good position. Much of that is driven by the products we've talked about before. Skyrizi and Rinvoq, when you think about those assets, being able to surpass Humira's peak sales by 2027 and continue to grow they are massive drivers of growth for this business going forward. And then you have the migraine franchise. You have Vraylar. You have the Aesthetics business. So, you have a number of different growth drivers that are allowing you to be able to get there. So, what I would say is, we're not in a position where we have to go out and do business development in order to be able to support our growth objectives. Having said that, we obviously continue to look for opportunities. I'd say our focus primarily is bringing in assets that will allow us to be able to continue to drive that high single-digit top tier growth 30 and beyond. So, we want to bring in assets that basically can start to contribute in the latter part of this decade is our primary focus. We obviously look for assets primarily in the areas that we're in now. We have a fairly broad based business, immunology, neuroscience, oncology, and aesthetics. So, we have a broad based business that we can bring things into to be able to grow that. To your point though, obviously, we're in a position where we've rapidly paid down the Allergan debt. So, we have more capacity if we wanted to do something bigger. And we always evaluate is there something out there that can really fundamentally help us make the business stronger? And if there is, can we get it at the right value point that we can bring it in and create value. I think the Allergan transaction is a classic example of a large transaction that fit that. We're able to buy Allergan at a good value. We brought it in. We integrated it. We pulled $2.5 billion worth of synergies out. And then we accelerated the growth of the business from what it was as part of Allergan. And that allowed us to create a tremendous amount of accretion. And that's obviously the right formula that you want to look for. Now, you don't find those opportunities that often, right, let's be fair? But we continue to look for those or other kinds of opportunities. The other thing I'd say is, if there are opportunities that would allow us to be able to more rapidly build a franchise that we have, like Eye Care as an example. We have this REGENXBIO asset in Eye Care. It's one I'm tremendously excited about. The early data, it looks very interesting. But Eye Care is a business that Allergan had a very strong position. It's a market we like. It's a fairly concentrated group of physicians clinically oriented from a data standpoint. That's what we tend to do the very best. So, we can find more assets, more proprietary pharmaceutical assets to bring into that franchise, that's something we will be motivated to do. Okay. So kind of wide range of things that could be looked at, but it seems like kind of maybe the priority is, kind of extending growth beyond 2030 at this point versus something in the near-term. Can I ask on oncology, I know you gave the target for 2023, 2024. I think it was a bit below where consensus was. I guess one of my questions with this is, the return to growth, why does it take to 2026 to get back to growth? And I kind of think – I think I understand that Imbruvica hit in the near-term, but as we think about it's been collected as label building out, you've got some launches on your own. Help me a little bit about the recovery curve as we, kind of get through this Imbruvica erosion? Well, I think we have a number of assets that will start to return that franchise to growth. Epcoritamab, the indication expansion in Venclexta, the T1114 and the MDS label expansion, and then Teliso-V and Navitoclax. But all of those basically occur around 2024 or 2025. And the initial indications like Epcoritamab will occur this year, but the initial indication is relatively small. So, we need some time to be able to build up those indications to get them large enough to be able to start to drive a franchise of that size, right? Almost $6 billion kind of franchise. So, it's just a question of being able to get enough momentum out of those other assets. And that will take a year or two to be able to get there. Okay. Quick update on the Aesthetics business. Kind of sequentially, has there been any signs of either stability or further weakening or just anything to report in terms of how that's been performing? So, as you probably recall, last year, up till May, the Aesthetics business and the market was growing very, very rapidly, right? And in the month of May, we saw this step down and then step down a little bit more in the summer. The leading indicators that we look at, the economic indicators that we look at started stepping down in sort of the March timeframe. So, we know they were an early indicator, but we didn't see it in the business until we got to May. If you look at those indicators as we've been following them throughout the year, they come down and they pretty much stabilize where they are now. So, we have seen some stability in both the business and in the market itself, but at those lower levels. Now, the parts of the business that have been most impacted are the higher price point products. So, as an example, body contouring, the price point is about $3,000 to $4,000. Fillers, price point is about $1,000 to $1,500. They have been more impacted by the economic pressure. Toxins we've seen some impact, but a lesser impact. But the price point for toxins is about $500, so it's less sensitive to that. So, I think as we look at 2023, the key call is going to be, is the economy – what's going to happen, especially in the U.S. economy going forward? Are we going to stabilize where we are now? And so, I would expect these indicators to continue to be stabilized and the business stabilized at this level or are we going to see that the U.S. goes into a recession? And if it does go into a recession, is it a shallow short recession? Hopefully, right. Or is it deep and long? And what happens to unemployment? If it's the latter, I would expect we will see more impact. If it's the former, then I would expect it's going to be close to where we are now. And then the question is, how long is it going to last through 2023? From a growth standpoint, when we get to May, the percentage changes will be lower because we'll have lapped 2022, right? So, it'll start to improve from a pure growth rate standpoint. But this is a market where there's a tremendous opportunity in growing this market. It's very underpenetrated, single digit kind of penetration. So the real key to growing the Aesthetics market is driving market penetration. And so, we need a broader economic support to be able to do that at the levels that we experienced in 2021 and the early part of 2022. Now look, we still feel very strong about the outlook for this business. We did not change the long-term outlook. It was greater than 9 billion [indiscernible]. In our presentation last year, we've maintained that. So, given the low penetration rates and given what we've seen in terms of how this business has rebounded in the past, we still feel very confident we'll rebound strongly, it’s just a question of when. Okay, great. I think AbbVie's pipeline maybe gets a little less attention than peers just given some of these huge immunology drugs, Humira, etcetera. You've got a broad swath of assets you're looking at. What are the kind of 2, 3, 4 products that you're most excited about as you think about R&D portfolio? Yes, sure. So, Rick has talked about several of these in his presentation, but maybe I'll mention some and go into a little bit more detail. So, for example, we've talked quite a bit about Rinvoq and you've seen the main approvals, the four in RA, UC, and IBD, Crohn's coming, atopic dermatitis, but we're also – the team is getting ready for Phase 3s in lupus, Alopecia areata and Hidradenitis suppurativa, all still areas of what we would say is, high unmet need. This year, we'll get a readout in vitiligo and potentially move into Phase 3 there. So, still quite a bit of work and a whole another wave of Rinvoq to come that might be underappreciated. I would say something similar for venetoclax as well, our BCL-2 blocker, where we have CLL. In fact, we have a five-year data making its way through labels across the globe in frontline treatment, which is fixed duration. And we're seeing even 65 months out maintenance of PFS and OS and the 0.72 range. So, that's coming in CLL. MDS was covered multiple myeloma T1114 is roughly 20% of patients will have that. So, that's another set of data that's coming out soon, which could also be very exciting in a very large piece of multiple myeloma. And staying in oncology. I'll mention AML with venetoclax as well, where we have approvals in those that are ineligible for transplant or high dose chemo, which is about 50% of AML. And right now, the utilization is quite high depending on the country's 60% to 70%. What we don't have is the other 50% of the patients that can take high dose chemo. So, we have three Phase 3 programs there to cover the other 50%. Post-transplant maintenance and those that for whatever reason don't get the transplant, and in combination upfront with high dose chemo. Rick mentioned [epco] [ph], that's our CD3-CD20 dual engager and DLBCL, very high levels of efficacy, particularly in pre-CAR-T space, 70% ORR, CR is above 40%, and adverse event profile with CRS, mostly Grade 1 and Grade 2. If you look at Grade 3 only 2.5%, and the subcu offering. And then even if you get even more refractory in post-CAR-T ORR rates are 54% and CR rate is above 30%. So, very strong data. I think quite a bit of excitement there. I mentioned subcutaneously the other thing in neuro, which we have is our 951 product. Rick mentioned this, of delivering levo/carbidopa without the need for surgery, which can be a barrier right now for many patients and may not want surgery, may not want deep brain stimulation. Now, asset like 951 can really open up the space for those that can have a singular injection subcu patch essentially that will last for three days. And we'll be able to deliver a dose like we have with DUOPA and get really nice efficacy levels of additional almost approaching three hours of on-time, better time that the patient can move on with their activities of daily living. The other one I'll mention in oncology is Teliso-V, which is our c-Met ADC, which intermediate and high expression of c-Met is roughly 25% of patients with relapsed non-small cell lung cancer that roughly split 12.5%, 12.5% gets you to 25% when you combine the two. We have breakthrough therapy designation there and response rates exceeding 50%. So, I can keep going, I don't want to. But just to let you know, there's quite a bit in the pipeline that I'll tell you that R&D team is very excited about. I think one thing that investors may not appreciate about the comment about Rinvoq and these additional indications, if you think about Humira, Humira was the only anti-TNF to ever achieve $20 billion of revenue and there were other anti-TNFs. And the reason Humira was able to do that and the others were not was the breadth of the indications that Humira was able to cover. And that's a very important concept when you think about. When you have a mechanism that has the ability to span broadly across multiple immune-mediated diseases, the revenue opportunity goes up exponentially. And the reason for that is, if you think about it, these are chronic drugs that patients take. So, I can build the drug within that category and the more patients that get on it, [faster or grow] [ph]. I can grow it much faster if I can spread out across many diseases at the same time and grow share across those. And that's what we do with Humira. We were able to get 13 different indications and that gave us the ability to create what Humira was. Rinvoq has more breadth than Humira did. And I think that's a concept unless that you were in this business and you did the Humira experience, it's not necessarily obvious to you. I think we're just out of time. Look forward to the updates. Obviously a big year ahead for you guys and look forward to the guidance in a few weeks, but thanks for joining us today.
EarningCall_1549
Ladies and gentlemen, welcome to the Core & Main Q3 2022 Earnings Call. My name is Glenn and I will be the moderator for today’s call. [Operator Instructions] I will now hand you over to the host, Robyn Bradbury, Vice President of Finance and Investor Relations to begin. Robyn, please go ahead. Thank you. Good morning, everyone. This is Robyn Bradbury, Vice President of Finance and Investor Relations for Core & Main. I am joined today by Steve LeClair, our Chief Executive Officer; and Mark Witkowski, our Chief Financial Officer. Steve will lead today’s call with a business update and an overview of our recent acquisitions. He will then highlight an example of how we help build sustainable water resources for the communities we serve, followed by a discussion on the resilience of our end markets. Mark will then discuss our third quarter financial results and full year outlook followed by a Q&A. We will conclude the call with Steve’s closing remarks. We issued our fiscal 2022 third quarter earnings press release this morning and posted a presentation to the Investor Relations section of our website. As a reminder, our press release, presentation and the statements made during this call include forward-looking statements. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. Such risks and uncertainties include the factors set forth in our earnings press release and in our filings with the Securities and Exchange Commission. Additionally, we will discuss certain non-GAAP financial measures, which we believe are useful to assess the operating results of our business. A reconciliation of these measures can be found in our earnings press release and in the appendix of our fiscal 2022 third quarter investor presentation. Thank you for your interest in Core & Main. I will now turn the call over to Chief Executive Officer, Steve LeClair. Thanks, Robyn. Good morning, everyone. Thank you for joining us today. If you are following along with our investor presentation, I will begin on Page 5 with a brief business update. I am pleased to report another strong quarter as we continue to build on our momentum, achieving double-digit growth in both net sales and adjusted EBITDA. This marks our eighth consecutive quarter of double-digit net sales growth, with third quarter net sales exceeding our expectations due to healthy end market demand, robust performance across our growth initiatives, and continued price realization. This is an impressive accomplishment considering the 39% sales growth we achieved in the same period last year. Our teams continue to execute at a high level to grow the business and support our customers, suppliers and communities. We achieved strong volume growth in the third quarter, driven by a combination of end market growth and share gains from the execution of our product, customer and geographic expansion initiatives. Municipal repair and replacement activity was strong. We expect it to remain positive through the end of the year and beyond. Municipalities continue to benefit from healthy budgets, allowing them to invest in improvements to their aging water infrastructure. Additionally, we believe the funding available through the Infrastructure Bill will start to flow to municipalities at some point in 2023. During the quarter, we saw non-residential construction activity strengthen as suburban communities expand, which increases the demand for our waterworks, storm drainage and fire protection products. Historically, non-residential construction activity has lagged residential housing development by roughly 12 to 18 months. We believe we are currently seeing non-residential construction strengthen due to the growth in residential development we experienced in late 2000 and 2021. We expect continued strength and resilience from both our municipal and non-residential end markets. Shipments for residential projects were healthy throughout most of the quarter. However, we began comparing against very strong volumes at the end of the quarter, both year-over-year and sequentially. Residential bidding activity varies across the country. Many areas remain positive, but in some areas, project scopes are shrinking in size as developers assess the evolving economic environment and the recent reduction in housing starts. Over the long-term, we believe homebuilders will continue developing lots and that the lack of home supply will continue to drive growth in residential market over a multiyear period. Supply remains constrained for many of our products. Certain products continue to have long lead times or lead times that are inconsistent which has made it difficult to fully optimize our inventory levels. As the quarter progressed, we began to see product availability and lead times improve for certain products, including PVC pipe. We saw PVC pipe prices stabilize and remained elevated during the quarter, despite the improvement in lead times and availability. We believe the specificity of our products to our industry has provided resilience against price volatility, but we are monitoring closely to assess the impact of improving product availability and slowing demand due to normal fourth quarter seasonality. As product availability improved and lead times became more predictable for certain products, we began to reduce inventory levels for those products as the quarter progressed. In such cases, we no longer need to carry as much inventory to maintain service levels with our customers. We expect to continue optimizing inventory levels in the fourth quarter and into next year as supply chains improve for other product categories. On the M&A front, we welcomed four new companies to Core & Main during and subsequent to the quarter, strengthening our product lines, geographic footprint and talent, while highlighting our ability to drive sustainable growth through M&A. We have now surpassed $800 million in combined annualized historical net sales from acquisitions since becoming an independent company in 2017. Acquisitions are a key source of new talent and expertise and they continue to enhance our competitive position as we grow. Our pipeline remains robust with significant opportunity for continued growth through M&A. We also opened a new location in Fort Collins, Colorado, our second greenfield this year. This new location extends our waterworks product offerings in Northern Colorado and Southern Wyoming, building in our commitment to make our products and expertise more accessible in every region we serve. We issued our 2022 environmental, social and governance report in October. At Core & Main, ESG and sustainability is an integral element of our business. We are focused on supporting our nation’s critical water infrastructure needs, while delivering long-term value to our stakeholders. Our approach to ESG is holistic strategy that spans from our vision to our core principles and policies to how we meaningfully engage with our associates, customers, suppliers, shareholders and communities. As we continue to make progress toward our ESG priorities, I am pleased to share Core & Main’s accomplishments in our second ESG report, which demonstrates the impact of this important work and the goals we strive to achieve in the coming years. I will now discuss each of our acquisitions in greater detail on Page 6. Inland Water Works Supply is a single branch full service distributor of water and wastewater products space in Southern California. With a focus on personal service and attention to detail, Inland Water Works has proven itself to be a supplier of choice in its local market for 70 years. This strategic acquisition will allow us to better serve our combined customer base alongside a highly experienced and passionate team. Trumbull is a distributor of pipes, valves and fittings, storm drainage products and meter products with additional capabilities that will significantly expand our private label offerings. Trumbull operates out of three locations, two of which are distribution facilities and one of which specializes in private label products serving municipal and industrial end markets. Trumbull brand is well-known and trusted throughout the industry for their tools and accessory kits using the maintenance and repair of water infrastructure products and facilities. We will leverage our scale, internal purchasing processes, sourcing network and distribution footprint to grow the Trumbull brand as we expand our product offering into new categories. Distributors, Inc. is a full-service distributor and fabricator of fire protection products located in Hawaii. Operating out of its facility in Honolulu, Distributors, Inc. provides fire protection contractors with quality products and services for new fire protection systems and the maintenance and repair of existing systems. Our recent acquisition of Pacific Pipe expanded our waterworks product offering in Hawaii for the first time. After more than a year of building our capabilities in this market, we are excited to now offer a complete line of fire protection products through the acquisition of Distributors, Inc. Linear municipal supply is a full-service distributor of water, wastewater, storm drainage and meter products operating out of 4 locations across Florida and Georgia. They have spent the last four decades building a reputation as a leading distributor in the Southeast. The depth of knowledge and expertise they bring to us strengthens our position as a leading specialty distributor in the region. This acquisition adds key talent and expands our product offering in an underserved market. Each of these businesses align well with our core M&A strategy, offering expansion in new geographies, access to new product lines and the addition of key talent while adding approximately $115 million of combined annualized net sales. On Page 7, we highlight an example of how we build sustainable water resources for the communities we serve. The City of Waukesha, Wisconsin needed a new sustainable water solution to continue supplying clean water to its community of 72,000 residents. The area relies primarily on a local sandstone offer for their water, but the water levels in the aquifer were dwindling as time passed due to a growing population. The city formed a specialized task force to address this issue and completed thorough studies to find a sustainable solution that would serve the community’s clean drinking water needs for the long-term. It involved transporting water from Lake Michigan to the City of Waukesha and then transporting the water back after it was used and treated. Core & Main was selected to help address this infrastructure challenge. Our local experts led training to educate project partners on potential solutions and supplied 26 miles of 30-inch ductile iron pipe, including all the necessary valves, fittings and accessories to build a new pipeline from Lake Michigan to Waukesha. Our product expertise, combined with the lead contractor, provided an all-encompassing approach to developing a complete and environmentally effective water infrastructure solution. We are proud of the work we do to support local communities, whether it be supporting access to clean drinking water, water conservation efforts, solutions to reduce the impacts from droughts and flooding or through the safety provided by our fire protection systems. We believe that our people, products and services make a positive impact to communities. Now, turning to Page 8, I’d like to spend a few minutes discussing our end markets and the resilient demand for our products and services. We have diversified end market exposure between municipal, non-residential and residential construction markets nationwide. We maintain a balanced mix between new development and repair and replacement projects. Our municipal end market, which makes up roughly 39% of our net sales, consists primarily of repair and replacement projects to existing infrastructure. Municipal repair and replacement demand has exhibited stable growth over the long-term due to the consistent and critical need to replace aged water infrastructure. However, the pace of investment in our nation’s water infrastructure has lagged the need for investment, especially over the last decade and an estimated $2.2 trillion is required for repairs and upgrades over the next 20 years to close the growing water infrastructure gap. In recent years, access to capital increased water utility rates and necessity of increased municipal investment in water. We expect funding from the Infrastructure Investment and Jobs Act to strengthen investments in municipal water infrastructure in 2023 and beyond. The first tranche of funding has been distributed to the state revolving funds and municipalities are in the process of applying and evaluating whether their projects qualify. Once funds are awarded and allocated, municipalities will begin building them into their fiscal budgets. At that point, we expect they will begin spending these funds on new projects. Our non-residential end market, which makes up roughly 39% of our net sales, consists of a balanced mix between new development and repair and replacement projects. It includes everything from commercial and industrial development to less cyclical road and bridge rehabilitation projects, which benefits our storm drainage product lines. This market also encompasses most of our fire protection projects, including the installation of fire protection systems and new buildings, along with the retrofit of existing systems to comply with changing regulations or redesigns. Our residential end market, which makes up roughly 22% of our net sales, consists primarily of the water, sewer and storm drainage products supporting new lot development for residential building sites. Land developers often purchase large tracks of land for development that were not previously connected to utility infrastructure. We supply our products to the underground contractors installing the infrastructure to support the community. Over the long-term, we believe the lack of developed lots and the undersupply of new homes will continue to drive growth in our residential end market. I am proud of how our team continually executes and want to thank our associates for their dedication and commitment to customer service. I also want to thank our customers and suppliers for their continued partnership. We continue to execute across our key growth strategies, deepening our competitive advantage and building on our foundation of long-term profitable growth. I will now turn the call over to our Chief Financial Officer, Mark Witkowski, to discuss our third quarter financial results and full year outlook. Go ahead, Mark. Thanks, Steve. I will begin on Page 10 with highlights of our third quarter results. We reported net sales of $1.8 billion, an increase of 29% compared with the prior year period. The increase was partly due to price inflation from passing along rising material costs to our customers, mid single-digit volume growth, driven by a combination of end market growth and share gains and approximately 3 percentage points of contribution from acquisitions. We outperformed our end markets and gained share in the quarter due to our strong execution across our product, customer and geographic expansion initiatives. We continue to experience rising material costs across many of our product lines in the third quarter. As supply chains improve for certain products, we are beginning to see those costs stabilize, most notably in our municipal PVC pipe category. If prices hold steady from where they are today, we expect price contribution to moderate in the fourth quarter, as we anniversary the price increases from a year ago. Gross profit increased 35% to $500 million in the third quarter and gross profit margin increased 110 basis points to 27.5%. Gross margin was positively impacted by our margin enhancement initiatives, accretive acquisitions, utilization of lower cost inventory, and a favorable mix benefit. Selling, general and administrative expense increased approximately 23% to $231 million in the third quarter. The increase was primarily due to an increase in personnel expenses, which was driven by higher incentive compensation costs from higher sales and profitability. In addition, distribution and facility costs increased due to higher volume and inflation. SG&A as a percent of net sales improved 70 basis points to 12.7%. The improvement was due to our ability to leverage our fixed cost on the increase in net sales. Interest expense in the third quarter was $16 million compared with $12 million in the prior year. The increase was due to our borrowings on the senior ABL credit facility and an increase in interest rates on the unhedged portion of our short-term – our senior term loan. Our effective tax rate in the third quarter was 18.3% compared with 18.6% in the prior year. The reduction reflects certain fixed tax expenses and permanent differences decreasing as a percentage of pre-tax income, partially offset by a higher percentage of income attributable to taxable entities due to the secondary offerings that were completed in January and September of 2022. During the third quarter, a secondary public offering of 11 million shares of Class A common stock was completed, our largest current shareholder, Clayton, Dubilier & Rice. We did not issue any new shares in the offering and we did not receive any proceeds from the sale. Following the offering, CD&R affiliates ownership in Core & Main decreased to roughly 65%. We recorded adjusted net income in the third quarter of $165 million compared with $105 million in the prior year. The improvement was due to our strong sales growth, gross margin improvement and SG&A cost leverage partially offset by higher interest expense and an increase in income taxes. In preparing adjusted net income, we exclude the effects of non-controlling interest as we evaluate and manage the business as a whole. Adjusted EBITDA increased approximately 46% to $275 million compared with $189 million in the prior year. Our adjusted EBITDA margin improved 160 basis points to 15.1% due to our strong net sales growth, gross margin improvement and leveraging our cost structure and the increase in net sales. Now, I’d like to provide a brief update on cash flow and balance sheet on Page 11. Net cash generated from operating activities during the quarter was $154 million, an improvement of $121 million compared with the prior year period. The improvement was primarily due to higher profitability and actions we took to optimize inventory, partially offset by higher cash taxes. We expect to generate stronger operating cash flow in the fourth quarter from normal seasonal working capital unwind in addition to our inventory optimization efforts if our supply chains continue to improve. Net debt at the end of the quarter was nearly $1.6 billion. The decrease in net debt from last quarter reflects a $52 million reduction in borrowings under our senior ABL credit facility. Net debt leverage at the end of the quarter was 1.7x, a 1.1x improvement from the prior year period due to an increase in adjusted EBITDA. At the end of the quarter, we had over $1.1 billion of liquidity consisting of excess availability under our ABL credit facility. Turning to Page 12, we highlight our capital allocation priorities. Over the long-term, we envision maintaining a balance sheet with significant available liquidity and a net debt leverage target of 2x to 3x. Historically, we have had generated significant levels of cash flow from operations and we have been able to make continued investments in organic growth and operational initiatives as well as acquisitions, while simultaneously deleveraging our balance sheet. We expect to keep organic and inorganic growth as our top priorities for deploying cash. In addition to these opportunities, we expect to continuously evaluate our capital deployment opportunities, including returning value to shareholders through share repurchases. While share repurchase programs are often utilized in such situations, our current float is modest relative to our market capitalization and open market purchases would likely not be our initial path. Considering that CD&R is our current largest shareholder and is likely to monetize its ownership position over time, it may make sense to consider a repurchase directly from them from time to time, which maybe directly negotiated or in conjunction with concurrent secondary share sales to the market. I will wrap up on Page 13 with a discussion of our outlook for the rest of the year. We have sustained great momentum through our summer and fall selling seasons, delivering impressive results despite the strong prior year growth we are comparing against. Demand indicators remain positive for our municipal and non-residential end markets and our customers remain busy with strong backlogs. Municipal repair and replacement activity, which makes up roughly 39% of our net sales, continues to grow. This market has proven to be more durable than new construction and we expect it to remain positive in the fourth quarter. We are seeing an acceleration of non-residential construction activity as suburban communities expand, which increases the demand for many of our products. Non-residential bidding activity and backlogs are both positive and we expect demand to remain positive through the end of the year. As Steve indicated earlier, we are beginning to comp against strong residential volumes in the fourth quarter of last year and single-family housing starts have continued to weaken in recent months. We are gauging the health of residential market by assessing our bidding activity and by having discussions with our customers and field teams. Based on these factors, we are expecting pressure in the residential market during the fourth quarter. Despite the potential for near-term pressure, we remain positive over the long-term, believing that homebuilders will continue developing lots and the lack of available home supply and developed lots will continue to drive growth in this market. As a reminder, residential lot development makes up roughly 22% of our net sales. In total, we expect our end markets to provide a solid foundation for us to continue driving above-market growth from the execution of our product, customer and geographic expansion initiatives, while delivering tremendous value to our customers. As a result of strong demand and continued supply chain challenges for many of our products, we have experienced a better pricing environment for longer than anticipated. This has resulted in elevated prices through the third quarter, which we expect to persist through the remainder of the year, though price contribution will be sequentially lower as we anniversary the price increases from a year ago. If supply chains continue to improve and demand softens, it is possible we could start to see the cost of certain products come down in 2023. However, based on our current demand and supplier indications, we expect cost increases to continue for many product lines and we will work to pass them on accordingly. Potential inflation in these product categories, are likely to offset a portion of the potential future deflation on certain commodity-based products. With respect to gross margin, we delivered another strong result in the quarter, some of which was driven by a mix benefit that is likely temporary. We could see a sequential margin rate decline in the fourth quarter as our inventory cost catch up with market prices and mix returns to normal. Given the continued benefits from our inventory investments, the favorable pricing environment and our recent mix benefit, we now estimate that roughly 100 to 150 basis points of our year-to-date gross margins maybe temporary in nature and could reset once supply chains and costs fully normalize. However, we expect continued margin enhancement from our gross margin initiatives, including private label and synergies from accretive acquisitions which would help offset this potential reset and gross margin rate. Taken altogether, we are raising our expectations for fiscal ‘22 net sales growth to be in the range of 31% to 33% and adjusted EBITDA to be in the range of $910 million to $930 million. Consistent with the expectations we have shared since the beginning of the year, we anticipate normal fourth quarter seasonality this year. We had 50% net sales growth in the fourth quarter last year, which included a longer selling season due to unusually moderate weather. Regarding operating cash flow, we saw steady improvement in the third quarter and we anticipate stronger operating cash flow in the fourth quarter from normal seasonal working capital unwind in addition to our inventory optimization efforts. We expect to end the year with 40% to 45% operating cash flow conversion from adjusted EBITDA. In closing, we have a resilient business model and a leadership team capable of quickly adjusting to changes in the market. We are strategically positioned with multiple paths of sustainable growth and we remain focused on executing at a high level and delivering value to our customers, suppliers, communities and shareholders. Thank you. [Operator Instructions] We have our first question that comes from Matthew Bouley from Barclays. Matthew, your line is now open. Hey, good morning everyone. Thanks for taking the questions and congrats on the results. I wanted to ask a question on – you mentioned in the prepared remarks around pricing kind of commodities versus some of your other product lines. I think I heard you say that you are expecting cost increases for many product lines and that could offset commodity-based deflation in other categories. I am just curious if you can kind of expand on both of those? I know you mentioned a lot around PVC, but just kind of any specifics around what level of commodity deflation we could expect into the new year and then where are you seeing those kind of offsetting product line increases? Thank you. Yes. Thanks, Matthew, for the question. In the third quarter, we really saw some nice momentum in a lot of the non-commodity products. We saw some nice cost increases come through, which our suppliers had indicated that they were working on and we are able to get those passed along to our customers. I’d say on the commodity side, those prices were fairly stable for the quarter and that was despite some improvements to supply chain there. So that was a positive, I’d say, development for us as we look forward and what could happen as we get into 2023. We are still expecting non-commodity products in those areas to see some additional cost increases and we will work those through, as we mentioned, still too early to say on the commodity products and what could happen there. But I think the momentum we saw coming out of the third quarter and in the fourth quarter could help if there is any potential declines there, as we go forward. Alright. That’s helpful. Thank you for that. And secondly, shifting to the margin side, I think I heard you say that you now view potentially 100 to 150 basis points of temporary margin may have been achieved year-to-date, which I guess would suggest sort of mid to high 25% gross margins would be normalized. I guess, number one, how quickly do you think we reach that level? And number two, as you reach that normal level, should we kind of think of that as the new baseline after which your margin initiatives that you have been working on kind of organically could then see that margin expand from those levels? How should we think about all that? Thank you. Yes. Thanks, Matthew. On the gross margin side, yes, we did increase that expectation to – from 50 to 100 to 100 to 150 now. So I think the baseline you are looking at there from kind of 25 – mid 25.5 up to 26 is a reasonable baseline to look at. In terms of the timing of that, it does depend a bit on ultimately what we see on some of these other product categories and if we continue to see some price opportunity. We still have a lot of, I’d say, low-cost inventory in a lot of the non-commodity products. So, if those market prices keep rising that will help defer some of that maybe into 2023. So we will keep an eye on that, but the timing of it, I’d say, is going to still depend on how that supply chain frees up. Thank you. Good morning, everyone. First question probably for Mark. A lot of distributors these days are flagging elevated variable comp expenses in the inflationary environment. Could you talk to us in dollar terms, approximately by how much is your variable comp elevated relative to what you would consider normal right now? Yes, Dave, I can talk to you about how that works. And as we generate higher product and gross margins that we’re – that’s how we commission our sales reps. So as you see, expansion in gross margins like we’ve had both through volume and margin expansion, you would typically see those types of variable plans expand at a higher rate than the sales that we’ve had. And then similarly, we’ve got other structures in place for bonuses based on profitability and return on investment, which have all performed very well. So we have seen some elevated incentive compensation costs that are flowing through SG&A and – at the same time, if we were to see any kind of economic uncertainty happen or reductions in top line or margins, then that kind of cost comes out very quickly as well. So we have seen some elevation there. It’s flowing through SG&A. But given the overall performance, we’ve still been able to leverage that and deliver some really nice EBITDA percentage increase. Yes, thanks. And I assume that’s tens of millions of dollars. Is there any way you can put a slightly finer point on that or we could follow up also? Yes, Dave, I’d say that’s a reasonable way to think about it. It’s definitely at those levels. It’s a larger component of our personnel expenses, which makes up about 75% of our our SG&A and a good chunk of that is variable compensation. Okay. And then second, you talked a little bit about the trends you’re seeing in residential lot development. Could you discuss the great financial crisis and some of the leads and lags you saw at that time? Obviously, it was a very overbuilt situation then, but are there any insights that, that experience gives you relative to the current downturn that we’re seeing? David, there is a couple of things that we saw back during that – during The Great Recession. Number one, our business was positioned very differently at that time as well, too. About 50% of our business was really geared towards new lot development and residential. So we were much more dependent upon that sector. The other thing I’d share with you is during that time period, lot development continued to happen after the recession really appeared. And so we continue to see a lot of vacant undeveloped lots that permeated through that entire sector that took years of work to finally work its way through the network. And I think we’re in a different spot now because lot development is almost hand-to-hand with new housing starts to some degree. And builders are trying to get ahead of that. they are also anticipating that, hey, at some point, whether it’s next year or in ‘24, they are going to need these lots ready to go to see the expansion again in the long-term needs for this housing development. So it’s a much different profile that we have for our business, and it’s a much different situation of where housing is, particularly a lot development than where we were coming out of that – The Great Recession. Thank you, David. We have our next question, comes from Kathryn Thompson from Thompson Research Group. Kathryn, your line is now open. Hi, thank you for taking my questions today. Just – the first one is just a cleanup from your guidance question or your guidance from today, and I appreciate all the color you’ve given. But what is embedded in terms of volume assumptions going for Q4? And then as you look into either the balance of calendar ‘23 or for the next fiscal year, what are your high-level expectations of that balanced contribution price versus volume? Yes, Kathryn, it’s Mark. I’ll take that one. In terms of the guide for the fourth quarter, what we’ve got embedded in there, I would say, is kind of volume down kind of mid-to-high single digits. And again, primarily due to the really difficult comps we had last year. If you go back to Q4 of ‘21, volume was in the – up in the teens, and we had really, I’d say, unusually strong weather season for – in particular in our northern climate. So we’re capping against a tough quarter there. I think as you look forward, we do plan to issue guidance as part of our Q4 release, but recognize there is a lot of interest in what’s going on in the end markets in volume. I’d say, as we mentioned in the prepared remarks, we are anticipating some near-term softness in the resi market, which is just about 20% of our mix. Say it’s too early to tell really the extent of that softness. But given the slowdown in single-family starts, we believe that likely correlates into some softness in the lot developments. On the non-resi side, we have seen strong construction activity and that should continue to benefit us and certainly is a lagging end market relative to resi. So I do expect non-residential be a positive contributor, but that’s an area we are watching pretty closely. And then from a municipal standpoint, that’s been very steady and we would expect that to continue. So as you kind of take those together, I think that sets us up again pretty strong foundation as we go into 2023 from a volume standpoint. And I’d say, beyond the market, we do expect to continue to grow in excess of the market by 200 to 300 basis points. And that’s really a result of the – our organic growth initiatives that we continue to deliver on. And then the acquisitions for another 100 to 400 basis points similar to our historical results that we’ve seen there. That’s helpful. The second question really is a bigger picture and more on material substitution. And Texas is allowing drainage with plastic and PBC instead of just concrete and there is a bit a widespread shortage of cement, which is obviously a critical component for concrete. So this paves the way for greater use of your products versus concrete, how does this benefit Core & Main? And how do you – are you – is this just a unique event to Texas or is there a push for change for other states? Really, what are the opportunities for that line of business? And as you think broadly about material substitution and how that benefits Core & Main? Thank you. Yes. Kathryn, Texas is a good example of where we’re starting to see some of those specifications change. They were a heavy reinforced concrete pipe for their storm drainage need. And one of the areas that you’ve seen is the use of alternative products along those lines, particularly corrugated, high-density polyethylene storm drainage and retention systems that, in many cases, can be easier to install, easier to work with and have some additional benefits and characteristics for the flow of water through there. So what we’re seeing is this has been part of what our team has been working closely with, with a couple of the key suppliers on getting these specifications modified and changed to allow that product in to be able to test it. Texas is a great example on a large scale where we’re seeing entire states relook at some of those specifications and we think it has great opportunity for us, medium-term, short-term and long-term. Certainly, as you look at it at a state level, there are a number of bigger states on there that have been heavy RCP users in the south and the southeast. And then as you get into some of the more refined areas, there is still a number of municipalities that on a local level, we continue to drive those specs and introduce them to the product and help to understand how that product can be utilized in some effective ways as a good alternative. Thank you, Kathryn. We have our next question, comes from Mike Dahl from RBC Capital Markets. Mike, your line is now open. Good morning. Thanks for taking my questions. My first question is just around kind of the inventory management and supply chain. It sounds like there is been a little progress and some improvement in the supply chain, which is allowing you to work down inventories a bit. Could you elaborate on just what products you’ve already seen it in and it sounded like that might broaden out in the fourth quarter in terms of where you can start to strategically normalize your inventory levels? So maybe if you could give some color on, again, which categories seems to be evolving in the right direction and allowing you to take down some of those inventory levels? Yes, Mike, we saw some pretty good progress and availability of products and lead time reduction in many areas across multiple categories, although there are still pockets where lead times are extended out for some of these areas. So certainly, we saw with PVC a normalization of flow and production and lead times getting back to near pre-COVID-type lead times and many of the core products there associated with that the typical diameters of bread-and-butter-type product has really gotten back into more traditional lead times and availability. Prices has remained firm through the end of the quarter on that. So we’re pleased to see that. We’re going to be watching that one closely. The other areas that we get that are real specific to our sector, particularly when we get into valves, hydrants, ductile iron pipe. Some of these are still dealing with extended lead times, as capacity is still constrained to meet demand. So we’re continuing to see some price increases coming in from those product categories. And then we just have some your regularities and inconsistencies on a couple of different other product categories, where extended lead times have just become the norm. And we see that with a lot of like large diameter-type work, specialty valves, specialty fittings, those things along those lines are still not only in short supply, but very long lead times. So we’ve had to take a real active approach here and be able to manage our inventory where the lead times have gotten more consistent to be able to balance that and optimize our inventory levels to best serve our customers. And then still where we’re seeing items in short supply, making sure that we’re stocked appropriately getting access to that product. That’s very helpful, thank you for that color. And then as my follow-up, Mark, in response to Kathryn’s question, I think you mentioned that maybe the initial expectation is that maintenance – that municipal remains fairly steady. When we think about potentially kind of budgets resetting and then infrastructure funds flowing in at some point, are there offsets to why we wouldn’t see some improvement in municipal or is that just kind of a conservative approach until you actually see the funds hitting or some timing issue? I know you explained the lag a little bit, but maybe just a little more color on why we wouldn’t see better traction on municipal next year? Yes. Thanks, Mike. Yes, just to clarify, I would say what the expectation for muni is that we see steady growth and definitely has the potential for some incremental infrastructure spending at some point during 2023. So that would definitely be upside on the – any kind of municipal steady growth that we’ve experienced historically. So that’s how we’re thinking about it as we move forward. Thank you, Mike. We have our next question, comes from Keith Hughes from Truist Securities. Keith, your line is now open. Thank you. Question. You made some comments on PVC and some of the prices are coming down. Is PVC going to be down year-over-year in the fourth quarter or are you still dealing with some latent inflation on just a year-over-year basis? Hey, Keith, we said that pricing really normalized through the third quarter and remained at elevated levels. So we haven’t seen a price decrease in PVC. We’re watching it closely to see particularly how seasonality affects it and how we’re dealing with the improved availability and lead times, but we have not seen a price deflation in PVC through the end of third quarter. Okay. And I guess, switching over to the municipal business. You talked about some of the infrastructure spending coming in. Is there any sort of clarity at what time of ‘23 that would really start to hit municipality projects? Yes. It’s difficult to tell. Most of the budgets have been set for a lot of the projects that have been scoped. So we’re just now seeing some of the funds trickle in. And in fact, we’ve seen a couple of projects that have popped that have been treatment plant expansion projects that are going to be utilizing those funds and some really early bidding activity. But that that’s a handful that we’ve seen so far. So there is still – we’re still watching that closely. We’re looking at the bid activity that’s coming in. We’re looking at how those types of funds get allocated into the budgets and the project scoping. we will start getting a real clear picture, I think, as we get into spring and the bidding activity to see how that starts flowing. But up to this point, like I said, we see a handful of projects that have been utilizing those funds. Thanks. This is Vivek Srivastava on for Joe Ritchie. Maybe I wanted to understand the market share dynamics at play here. If you can provide some color how much market share you’ve gained year-to-date and maybe where you stand on the market share front? And then just a follow-up on the same question is just during the last residential downturn, did the market see some kind of trade down to either lower priced or more private label products as bidding activity got more aggressive? And what happened to your market share during that time? Hi, Vivek, this is Steve. So I’d say that we’ve – it’s difficult to quantify exactly what we’ve seen so far in terms of market share gains, but what we have experienced so far is that certainly, with a lot of our smaller competitors that have been limited with access to product, we’ve been able to get preferential access along those lines, given our size and scale, and that’s allowed us to gain some good amounts of share, certainly against a lot of the smaller competitors out there and the regional folks. You talk a little bit about what we experienced through the downturn in the last recession? Very different dynamic back then as I shared during one of the earlier questions and our business was positioned much differently. At that time, we were about 50% residential. Now you look at it, we’re about almost 40% municipal, 40% non-res and just over 20% residential. So our exposure was very different. We built a lot more sustainable opportunities and product categories that help to enhance that municipal sales and the non-residential sales. So our business is just much more diversified than we were back then. Certainly, through that downturn, things got very competitive as – particularly in the residential area. But that was a different environment than – that was – it took a while for those lots that were way over developed to be replenished once housing started to get back on its feet again through 2012 and the 2016-’18 in that time frame. Right now, what we’re seeing is a real shortage in lots. So even as housing starts to build out and as we started to see a little bit of a pause, the medium- and long-term demand for lot development is still going to remain strong, we believe, and that creates a little different environment than what we’ve seen in that past in the deep recession that happened 12 years ago, 13 years ago. Thank you. That’s super helpful. Maybe my next question more focused on the strategic inventory investment and mix benefit this quarter. Any quantification you can provide on those two buckets? And then maybe more specifically on the mix side, what really was that mix driver? And how should we think about mix aspect of your business going forward, maybe next quarter in a bit more medium-term? Yes. I’d say, Vivek, on the inventory investments that we’ve made, I’d probably bracket that somewhere in the $300 million to $400 million of inventory where we’ve bought ahead of a lot of these price increases more recently on some of these more non-commodity-type products that will work to continue to optimize as we get through the fourth quarter and into 2023. In terms of the mix benefit, I’d probably give you – as you look at those gross margins sequentially from Q2 to Q3, we picked up about 60 basis points. I’d say a lot of that came from the mix benefit that we saw in the quarter. As we get through the fourth quarter right back into 2023, we will see that mix probably return back to more normal, which is part of that kind of 100 to 150 basis point reset that we expect to happen at some point. Hi, thank you. Good morning. Nice to see the free cash flow in the quarter was positive, but since you’ve taken down the conversion guide throughout the year, I just wanted to see if you could update us on what you see as the normalized free cash conversion level for the company? And then how we should think about that into next year in light of what you’re hoping to do from an inventory perspective? And maybe if you could give some color on how much inventory you think dollar-wise could come out to normalize things? I think you said $300 million to $400 million in response to the prior question is that, that number that you’re talking about or is it something else? Yes, Patrick. Thanks for the question. As you saw, we had some nice operating cash flow conversion in Q3, and we will look to expand on that as we get into into Q4. I’d say, yes, the $300 million to $400 million of inventory is an opportunity there that we think as we get back to more normalized supply chain environments that we should be able to release at some point. I’d say our – the way to think about it normally is probably 60% to 70% of our EBITDA we’d expect to convert into operating cash flow. So as you think kind of going forward, if we can capture some of that inventory, there should be some upside to that conversion rate into 2023. Makes sense. And then last one is just kind of a mechanical question around the capital allocation discussion. Just curious how you go about evaluating potential share repurchases from a share owner that remains the largest holder and also as members on the board? Yes, Patrick. Obviously, as part of our governance, we’ve got independent directors, we’ve got independent audit committee. So to the extent we look at a transaction like that, we would obviously go through and apply the appropriate governance to any potential transaction there. But yes, I understand the question, but that’s how we’d look at that. Thank you, Patrick. We have our next question, comes from Andrew Obin from Bank of America. Andrew, your line is now open. Good morning. This is David Ridley-Lane on for Andrew. I wanted to go in a little bit on the non-resi revenue strengthening. We did see some indicators suggesting potential future weakness in non-residential, like the Architectural Billings Index fell below 50 and ConstructConnect is forecasting non-resi starts to decline for 2023. Do you think you’re gaining market share? Is it a regional mix that you’re benefiting from here, something else to explain the non – strength in non-res? Yes, David, I think what we’ve seen is that while there is been some pressure in a couple of areas in the East Coast and West Coast, we’ve really strengthened our position in the Sun Belt, certainly strengthened our position in the Midwest over the last several quarters. And I think that’s paid off in some share gains for us. We’re continuing to see a lot of work as well, too, which we bucketed a non-residential in the storm drainage world. So we shared a little bit earlier about some of the conversion of specs from RCP into polyethylene and other storm drainage products. We’ve been helping to lead that effort in a lot of areas are continuing to see prolonged growth there. So non-residential has been a real good mixed bag for us of a lot of different areas with fire protection products and storm drainage products, where we’ve been able to accelerate some growth there and gain some share. Got it. And how does the macro backdrop sort of change the way sellers are thinking? Is potential residential weakness ahead of them making them more willing to transact? How are sellers thinking these days? Well, I think we’ve certainly seen from an M&A pipeline, as you’ve just seen in this last quarter, we’ve had a healthy pipeline. We continue to do that. We’ve been able to tuck-in some great businesses, almost across the spectrum on us from a fire protection distributor to waterworks distributors, it continues to be a very robust and healthy pipeline. Sellers have been through quite a bit over the last several years between COVID between getting through this whole supply chain challenge and everything else that’s been encouraged and now you look at a potential – many are worried about what could happen with residential. It just plays well to our strengths as the acquirer of choice in the space, and we continue to see just a robust pipeline of opportunities for us and from the M&A front. Hi, this is Asher Sohnen on from Anthony. Thanks for taking my questions. Just following-up on a previous question around share. As availability in PVC and some of your other products kind of normalizes, do you expect to seed a portion of that share back to competitors or share kind of a little bit more sticky than that? Well, certainly, as we look at one product category and another with availability, what we generally see with the projects that we execute are a series of different types of product categories that go into each project. So if you can imagine, there is pipe valves fittings, there is hydrants, there is – you name it. So having access to be able to complete a full project is really the strength that we provide. And we still have, what I’d say, a pretty significant competitive advantage right now and the ability to gain share by doing complete projects along those lines. So while we may see one product category or a couple become much more available in lead times get back to normal. We still see the opportunity with a lot of these specialty products that have limited availability right now and extended lead times to have an advantage for us. And beyond that, we’re obviously working to continue to share our value proposition with all of our new customers as we go through here and continue to win their business on a go-forward basis. Right. Yes, that makes a lot of sense. And then my next question is sort of just specifically on the residential end markets. As that market slowed? Do you see prices kind of slipping there or is maybe prices for – across your end markets kind of – set across the end markets and maybe the demand from public will try to buoy that pricing? Yes. Certainly, what we anticipate is that for a lot of the products that go into new lot development are essentially used in the municipal space as well, too. So the prices tend not to be swayed by one sector or another. And I think we’re watching closely to see how this infrastructure build and those funds start flowing. So there is some – we would like to see that as if residential does get soft, the ability for municipal to pick up on that infrastructure bill will help support some of that volume we may see that could be reallocated into the municipal world as those budgets increase and we start seeing those funds flow. Thank you. We have no more further questions on the line. I will now pass back to Steve for closing remarks. Well, thank you all again for joining us today and your interest in Core & Main. We are very proud of our third quarter performance and our ability to drive profitable growth and operating cash flow. We are confident that our underlying demand trends and impending investment in the U.S. water infrastructure paired with our robust M&A pipeline and key growth initiatives will position us to achieve sustainable growth for the remainder of 2022 and beyond. Thank you for your interest in Core & Main. Operator that concludes our call.
EarningCall_1550
Good morning, and welcome to the Neogen Corporation Second Quarter Fiscal Year 2023 Earnings Call. All participants will be in a listen-only mode. [Operator Instructions] Please note, this event is being recorded. Thank you for joining us this morning for the discussion of the results of the second quarter of our 2023 fiscal year. I'll briefly cover the non-GAAP and forward-looking language before passing the call over to our CEO, John Adent; who will be followed by Steve Quinlan, our retiring CFO; and Dave Naemura, our current CFO. Before the market opened today, we published our second quarter results as well as the presentation with both documents available in the Investor Relations section of our website. On our call this morning, we will refer to certain non-GAAP financial measures that we believe are useful in evaluating our performance. Reconciliations of historical non-GAAP financial measures are included in our earnings release and the presentation, Slide 2 of which provides a reminder that our remarks will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These forward-looking statements are subject to risks that could cause actual results to be materially different from those expressed in or implied by such forward-looking statements. These risks include, among others, matters that we have described in our most recent annual report on Form 10-K and in other filings we make with the SEC. We disclaim any obligation to update these forward-looking statements. We're pleased to be with you today to provide the first view of the company's performance since the completion of the Food Safety acquisition from 3M. We've delivered solid core growth in both of our segments and, notably, a level of profitability well ahead of where the company was prior to the acquisition. The former 3M Food Safety business is a great business and highly complementary and we're excited about what we've seen in the first four months of our ownership. Clearly, we have still got a number of things to do, and we're early days in the integration, but we're off to a great start and we have numerous work streams fully underway across the organization to integrate our systems, products, processes and people. Our integration philosophy has always been the best idea wins with the willingness to make any changes necessary to improve the business and ensure long-term success. We've made significant progress to-date in the realignment and coordination of our commercial efforts. We combined CRM systems on day two, modified geographic coverage areas and worked together to identify and prioritize the highest potential revenue and synergy opportunities. We've had successes within the marketplace with customers responding positively to the new products and solutions available to them. Neogen's reputation for technical expertise and excellent customer service has been a considerable asset as we've begun to move forward as one company with one combined portfolio. Planning the relocation of manufacturing operations for our new Food Safety facility in Lansing and maximizing their efficiency are also key integration items receiving significant focus and attention. The manufacturing engineers from the former 3M business are assisting in the design and layout of the production process, while construction of the new facility continues on track. In the interim, the manufacturing and distribution of the acquired products will continue under transition service agreements, and we've been collaborating with 3M to address the production and backlog issues that materialize between signing and closing of the transaction. There's still work to be done, but things are moving in the right direction and we're implementing plans that we believe will lead to further improvements as we move through the second half of the fiscal year. While the integration activities are a broad organizational priority, we're not losing our focus on our customers. The Food Safety segment, which now comprises approximately 70% of our total revenues, grew nicely in the quarter on a core basis, including the indicator testing category, which is the most significant and profitable piece of the acquired Food Safety business from 3M. Our Animal Safety segment had a similar level of core revenue growth, led by genomics and our portfolio of biosecurity products. And tomorrow, we will be having the grand opening of our new expanded distribution center in Mount Sterling, Kentucky, which will shorten customer lead times and allow us to ship more efficiently to our customers. While the elevated level of macro uncertainties led to some softening in our markets, we believe the business is resilient and well equipped to drive future growth. We have an excellent team in place with each member working hard to ensure the new Neogen we are creating will continue its upward trajectory, gaining market share and helping our customers around the world keep the people and animals they care about safe. Jumping right into the results. Our second quarter revenues were $230 million, an increase of 76% compared to the same quarter a year ago. Core growth, which we're introducing to replace our measurement of organic growth, excludes the impact of both foreign currency and acquisitions and was a solid 7% for the quarter. Acquisitions added a further 73%, while foreign currency amounted to a 4% headwind compared to the prior year. At the segment level, revenues in our Food Safety segment were $161 million in the quarter, an increase of 140% compared to the prior year and included core growth of 6%. The sales of our Culture Media & Other category grew mid-single digits, driven by increases in our Neogen Analytics platform and other Culture Media products. Our recently acquired Petrifilm product line performed well in its first quarter under our ownership. Sales of Bacteria & General Sanitation products were mixed, up low single digits on a core basis with growth of Neogen Filters and Ampouled Media and AccuPoint general sanitation products, partially offset by lower sales of rapid microbial testing products. Rounding out our larger Food Safety product categories is natural toxins, allergens and drug residues, sales of which were down slightly on a core basis. Natural toxin test kit sales were up mid-single digits on a core basis due to higher levels of aflatoxin in domestic and international grain harvest. Allergen test kits were roughly flat due to softening market conditions and supply disruptions for certain products, while drug residue test kits were down primarily due to lower sales to international dairy markets. Quarterly revenues in the Animal Safety segment were $69 million, up 8% over last year's second quarter. Core growth was 7%, while acquisitions contributed 2% and partially offset by 1% in negative foreign currency impact. Sales in the rodent control, insect control and disinfectants category had a strong performance, up low double digits on a core basis. The growth was driven by share gains in the animal protein market and sales of dairy hygiene products, as well as new insect control product introductions. Revenues in the vet instruments and disposables category were up mid-single digits on a core basis, led by strong market demand and additional sales to a large retail customer. Gross margin in the second quarter was 48.9%, representing an increase of 250 basis points from the 46.4% in the same quarter a year ago with the increase primarily driven by the addition of higher-margin business from the 3M Food Safety transaction. Excluding the inventory revaluation charge associated with the transaction, gross margin was up over 400 basis points on a comparable basis year-over-year. Adjusted EBITDA was $64 million, representing growth of 116% from the prior year quarter, driven primarily by the merger with the former 3M Food Safety division. Adjusted EBITDA margin was 27.8%, a year-over-year increase of 510 basis points. The increase was driven by the gross margin expansion and also by lower operating expenses as a percentage of sales. As part of the Food Safety acquisition, certain costs conveyed directly to us, while others did not and will need to be added overtime to accommodate the larger scale of the combined business. The adjusted EBITDA margin in the second quarter is higher than what we would expect to see over the next several quarters as we ramp up these additional costs. With respect to earnings, we reported a net loss of $42 million or $0.19 a share compared to net income of $11 million or $0.10 a share in the same period last year. The decline in earnings was primarily the result of expenses related to the 3M Food Safety transaction, professional fees, interest expense and the amortization of intangible assets. Adjusted net income, a non-GAAP measure we are introducing for comparability purposes, was $31 million for the quarter and adjusted earnings per share were $0.15, compared to $21 million and $0.19 a share, respectively, a year ago. The increase in adjusted net income was driven by higher adjusted EBITDA, more than offsetting the increase in interest expense while adjusted earnings per share were impacted by the increase in weighted average shares outstanding, resulting from the Food Safety transaction. In connection with the acquisition of the Food Safety division, Neogen took on some debt, which we recognize as a new position for the Company. However, team members of the management team have experienced operating with leverage and we believe the current debt level is very reasonable, particularly when considering our targeted revenue and profitability, as well as a resilient nature of our end markets. We ended the second quarter with gross debt of $940 million and net debt of $664 million for a net leverage ratio of 3 times the last 12 months pro forma adjusted EBITDA. You'll note the gross debt amount is lower than at the closing of the Food Safety transaction and reflects $60 million of term loan repayment in the quarter. Following the close of the quarter, we repaid an additional $40 million in December. During the second quarter, we also converted a portion of our floating rate term loan to fixed via an interest rate swap, and therefore, we currently have a 65-35 fixed to floating ratio for at least the next 12 months, which we believe is a prudent course of action in the current interest rate environment. You'll recall that in November, we updated our outlook for achieving $1 billion in revenue and $300 million of adjusted EBITDA, shifting the timing to fiscal 2025 due to changes in the macro environment and exchange rates, as well as the performance of the acquired business during the first eight months of calendar 2022. The lower-than-expected business performance was related to some supply and productivity issues that we expect to be temporary in nature. And in fact, we did see signs of improvement in the second quarter. We remain firmly committed to this outlook that we previously shared. As we look forward to the second half of fiscal year 2023, we anticipate continued core growth in the mid-single-digit range, which includes some level of macro softening. This would result in full year core growth on a pro forma basis also in the mid-single-digit range. As Steve noted earlier, the Q2 adjusted EBITDA margin of approximately 28% was higher than we anticipate running in coming quarters as we continue to add cost in support of the larger combined organization. Our expectation is for a full year adjusted EBITDA margin in the mid-20%-s range. Additionally, as we think about adjusted net income, we anticipate a full year effective tax rate of around 20% and interest expense for the full year of approximately $57 million. Under our new capital structure, deleveraging will continue to be a capital allocation priority moving forward. We will allocate capital to building our new manufacturing site in Lansing and other organic growth drivers, but deleveraging will be a priority for us. As appropriate, we will continue to execute bolt-on M&A that accelerates our growth strategy and provides for attractive returns. Like Steve and Dave said earlier, there's a lot of things to be excited about as we move forward. We completed the transformational acquisition of a high-quality asset, firmly positioning Neogen as a pure-play leader in food safety. This is an attractive growing end market with what we believe are long-term secular tailwinds, including heightened pathogen awareness, the increasing prevalence of food allergies, and increasingly health-conscious consumers who want to know what's in their food. Neogen is a resilient business, having grown now in 122 of the last 128 quarters, due largely to the consumable nature of our products, which play critical roles throughout the food supply chain. After the acquisition of the Food Safety division of 3M, approximately 95% of our total revenues come from consumable products, which we believe positions us to continue to grow despite the current level of macro uncertainty. The feedback we've consistently heard is that the former 3M Food Safety division has a great portfolio of products. It is the industry standard in indicator testing. We believe the focus we brought to the business compared to the previous situation is a very small piece in a very large organization has been energizing. Our new team members are eager to demonstrate their capabilities and strength of their products, which we are able to combine with our leading product portfolio to offer even greater value to our customers. I appreciate their efforts and commitment, and I couldn't be happier to have them onboard and working with us to build One Neogen. Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Brandon Vazquez from William Blair. Please go ahead. Hi, guys. Good morning, and thanks for taking the question. I wanted to start first on the second half guidance for fiscal '23. Can you talk a little bit more about what the investments you need to make are as you kind of scale more? And then, the follow-up question to that would basically be as you make these investments, which makes sense as you scale, when do you expect to see more ROI off of those? Yes. So, the question was around second half guidance. Just talking a little bit more about the investments that you guys said you were going to make, why the step down in EBITDA margins just a little bit in the back half of the year? And then, basically, the timing for when you'll see ROI on those investments and when you can start to see margins expand again? Yes. So, what you're seeing there, Brandon, is us ramping up the business to be able to bring over the 3M and move off of the TSA and TDSA, which is the service and distribution agreements. So, as you remember, we didn't witness -- with this merger, we didn't get any back-office staff. So, we have to ramp up the IT, the accounting, logistics teams and kind of the back-office HR and others. So that's where you're seeing that ramp up because those agreements were 12 months with six months extensions. So, you don't add all that headcount immediately when you close, it takes us a little time to build those teams. Okay. And then, I guess the follow-up question to that is, are those investments that may take six to 12 months to start to see an ROI? Or are they upfront costs? And then right away, you can start to see some benefits? You'll see an offset. Because what will happen is it's really an offset of cost, because as we roll off those agreements, we no longer have to pay 3M for doing those service functions. So, what you're seeing more is the roll-off of expense. Okay. And then, one more on kind of the profitability side, just switching to gross margins, though. Even when backing out the inventory step up, it came in a little bit below our expectations just given the proxy filings of 3M's gross margin. So, kind of curious if you guys could walk through what kind of margins you're seeing or gross margins on both the Neogen side and the 3M side, just to give a little bit more color on the progression of gross margins from here. Yes. I think I'm really pleased with what we saw on the gross margin side coming out of the legacy business. You saw early on some margin deterioration even between sign and close with the historical 3M business. And that was really around raw materials moving in that business, not pricing to match the raw materials. I think, we've had this discussion before, right, about Neogen did a 6% price increase, 3M business did a 2% price increase during the same period in 2022. We implemented price increases January 1. So, we think we have an ability now that we run that business to really manage that closer to what we do than what historically was done. Okay. And then last one for me, and I'll hop back in queue. Just around Petrifilm, it sounded like from a high level, the updates were positive. Hoping you could give a little more color. You guys in terms of supply, are you kind of unconstrained at this point? It sounds like maybe not. What's the time line to kind of get to a point where you guys feel comfortable and you're not supply constrained there anymore? Thank you. Yes, you're right. We're not unconstrained. We did see the business back orders go down in the quarter. We're continuing to work with 3M to drive performance to eliminate the back order issue. And we're hopeful that in the second half of the year, we can get that fixed. Hi. Thank you for taking the question, and congrats on the first quarter done of the full acquisition. So, you gave a lot of -- you gave guidance and maybe I'm being a little bit picky here, because I am pleased to get the guidance, but there's a lot of moving parts in terms of like what core revenue is and -- versus solid revenue. And I think you gave this mid double -- mid-single digit guidance for the back half of the year. Can you maybe -- can you give me some kind of a guide rail in terms of what that is for revenue, like, an actual solid revenue number? Because I mean, I'm a little confused on whether I should do mid-single digits on core, and then, I just kind of don't know what to do with 3M? Yes -- so is there any kind of framework on what that means? Yes. Hey, David, it's Dave. So, a mid-single-digit core in the second half, if we look at today's currency rates would imply some currency offsetting that still in a step-down level. Acquisitions other than 3M don't have that major of an impact going forward. It gets a lot lower. So, we think on a reported basis, we would see growth in kind of a low single-digit type range, which -- and that's on a pro forma basis. So, I think what you'll see is second half average around, if not, a little lower than what we saw in the second year with underlying core growth in that mid-single-digit range. Yes. And like we talked about, the markets are a little bit tougher than last year, and we're seeing some softening. But some of the stuff that I really like about being in these markets are a couple of things that just recently happened. One, was that allergen is now listed -- sesame is now listed as a major food allergen. And so that's the first time the U.S. has added a major allergen since 2004, we have eight, U.S. 14. So, we continue to see -- and we saw a nice bump in our sesame allergen kits because of this, because now you have to test. I think long term, you're going to continue to see that grow. Secondarily, we talked about in my release about pathogens. Last year, over 1.3 million Americans had Salmonella, and I was one of them. And trust me, you do not want it. It is a great way to lose weight, but you do not want it. And what happened in August was the USDA declared that Salmonella is going to be an adulterant in frozen breaded chicken products. But that's just the start, right? Because we're going to start with frozen breaded chicken, then we're going to move to other chicken products. And again, that's going to continue to drive testing for Neogen. So, this is why we're in such relevant markets. And even though the overall general economy is softening, things like this happen to help us continue to drive growth throughout the year. Got it. Okay. And going on a continuation of understanding the growth rate, I mean, I think you put core revenue as being 7%, and correct me if I'm wrong, on core. So that's without 3M. And then, Food Safety did do 8.4%. Does that imply the legacy Neogen Food Safety business was about 5% to 6%? Is my math here all right? Yes, Dave, I think maybe you had to add a little backwards. Animal was at 7% core. I believe it was 8.5% may be reported. And then, Food was closer to 6% core, so that -- those are kind of the numbers for the quarter. Perfect. Okay. No, thank you very much. Okay. And then, just a little bit of continuation of Brandon's question on the gross margin. I think over the longer term, I think our out-year guidance has a little bit more in the mid -- approaching the mid-50%-s. So, this was a little bit of down versus where expectations were. That was a mix thing. So, I think Animal Safety, generally speaking, had -- has a lower gross margin than Food Safety. So, I mean, some of this could be mixed. Is there anything else you want to call it other than just that mix? Well, and I think not only mix between those units, but also as is now the Food Safety 70% of the business, you've got to be aware of the mix within the Food Safety business. And again, we're not through the headwinds on the Petrifilm, but we are -- we've got -- still have back orders to where -- that's one of our highest profitability lines, and we have more demand than what we can sell today. So, when we get that fixed, that's really going to help. And that's the one thing that I hope you guys have taken away, too, is like even just after the first quarter, we bought a great business. I mean, it has a great margin profile. It's a highly profitable business. The new Neogen, the One Neogen is now much more profitable than we were pre-acquisition. Got it. No, that's super helpful. So, as -- we'll get the benefits as indicator -- the indicators can actually come to market. Got it. No, that's incredibly helpful. I'll just ask one more, and I guess I'll get the rest offline a little bit later. Can you talk about the H2 EBITDA assumption? It kind of -- it sounds like maybe you got a little bit of a pull-forward benefit in terms of timing. I mean, is that kind of the case is that you did have some cost avoidance in this quarter that will come into H2? Yes. Look, I think that's a fair way to think about it. We're on a ramp here, so we'll see that come up. That's why we wanted to say that we came in probably a little hot at the adjusted EBITDA margin line item here in the quarter just completed, and we'll see those costs come in and will normalize back down in kind of the mid-20%s. Got it. All really helpful. I'll let -- maybe Brandon has some follow-ups and I'll ask the rest of those offline. Thank you so much. There are no more questions in the queue. This concludes our question-and-answer session. I would like to turn the conference back over to John Adent for any closing remarks. Great. Thank you. And I want to thank all of you for joining us this morning. And I hope that you had a happy and safe holidays, and that your 2023 is off to a great start. We're really excited here at Neogen about what the New Year brings with our new One Neogen business and really helping our customers perform in 2023. So, thank you again for joining us, and we look forward to talking to you again on our third quarter call in the spring.
EarningCall_1551
Tim Long here, Barclays IT hardware, comm equipment analyst. Happy to have Corning with us. We have Ed Schlesinger, EVP, CFO. Relatively new to the role within a year. It's been done a pretty good job in some tumultuous times so far this year. So, maybe we've been starting with a lot of the companies just talking a little bit higher level kind of priorities maybe for the next year or two. So maybe if we could start there and then we'll start digging into some of the business line questions. Yes, sure. So thinking for a couple of years, which is a great time frame, we usually were so focused on the next quarter. I think we have a lot of great growth opportunities really across all of our businesses. So allocating capital and how we are thinking about how we are going to do that, maintaining a strong balance sheet through this sort of cycle is important for us, that's a huge priority. But I think just couple of things that I feel good about Optical Communications next couple of years, certainly beyond that, a lot of growth. So how that plays out or making sure we have capacity available for that is important. Solar, we've started talking a little bit more about that. We restarted capacity. I feel great about it in the next couple of years. It's definitely a priority for us. And then I think, if you think about this year and sort of the last couple of years to some extent, kind of normalizing the supply chain is a big thing, getting our costs back in line with where they were pre-pandemic levels to the extent we can do that, continuing to raise price to offset that. I think those are big priorities over the next year or two. Okay. Great. Excellent. And then, let's start getting into the divisions. Everyone tends to start with display. So we'll start there. It's obviously been crazy times kind of had COVID rebound. So maybe just, I know you guys had some corrections in your business just based on what's going on in the panel market. So, just give us your latest update on kind of how you are viewing that industry and kind of re-nearing that bottom where we start to see better dynamics as we go into 2023. Yes, sure. So, maybe I'll back up a little bit and start kind of as we enter 2022. We knew at some point, panel makers would have to take their utilization down. They were producing more than they needed to. And we expected that to kind of happen earlier in the year and it took maybe to the middle of the year until it really started happening and then it really happened sharply in the third quarter. And as we articulated on our call back in October, we exited the third quarter really at the lowest runrate for panel makers in over ten years, the lowest rate in the quarter. So, pretty bottom as we would see it. And we are starting the fourth quarter or started the fourth quarter the same way and our view is that it doesn't go down from here and the real question is when does it start to tick up. We look to see panel prices tick up, which they've done a little bit. So that's a good sign. We'll look at inventory through the entire supply chain as that kind of reports out for the quarter. We believe that's getting healthier, maybe a little bit in the third quarter, definitely in the fourth quarter and then at some point, the good news is that will be in a really good place and those are two positive things. And then ultimately, in the end how much retail plays out in 2023 and beyond will have an impact on to what extent panel makers tick up. Our view is that their production will go up just when and how much is hard to say. Okay. Maybe two more here, one, can you talk a little bit about, I know you've used this opportunity to do modifications and set up for a better margin structure going forward. So can you kind of walk us through some of the benefits that you guys have seen from this industry disruption? Yeah, I mean, we were really running our tanks or running our glass, our own glass supply tight for the last few years. So using this time to take some of our end-of-life tanks offline, put new technology on, that's good cost improver over time. We'll regulate when we bring those tanks back online, depending on demand, replenish our own inventory, which is also a good cost improver, because we were doing things to move our inventory around to our customers. That was a little bit unnatural in the supply chain environment. So having a little bit more inventory helps us. I think both of those things are good. I think our competitors probably do the same thing. So I think that helps the supply/demand balance to stay reasonably tight or certainly balanced even in this lower utilization time period. Okay. And then last one on Display. When we are coming out of this, do you think there is any change to the competitive landscape with Corning and the two main competitors. I mean, I think you guys are a little bit over-indexed to 10.5 plants, which should be a benefit. So, do you think that market share or any of those dynamics are different a year from now? I don't think so. I think the Gen 10.5 comment you made is an important one. We have three out of four Gen 10.5 facilities. That's not going to change. That captures a huge section of the market. Another dynamic is our competitors are far less profitable and in this time window, it's hard to imagine they are making any money in this really low volume window. So I think that helps to keep the competitive dynamic similar to where it is. Right. Okay. You mentioned Optical Communications as one of the real growth areas. It's been great for you. So maybe just talk a little bit about the trends you are seeing – maybe split it between carriers in the enterprise hyperscale markets? Yeah, I think if you think about 2022, we saw good growth really both in cloud and hyperscale and in carrier, fiber-to-the-home being kind of a big driver of that, especially in the U.S. I think those two dynamics will continue to play out over time, both well, both growth will grow well over time. As we sort of exit the year, we've seen certainly a slowdown in the carrier space in the fourth quarter sort of dynamics around various different projects for carriers them managing their own inventories or their own costs as they sort of exit the year. I don't expect that to have a long-term impact on what we see going forward, could have a couple of quarter impact. The business is definitely lumpy. If you go back to the beginning of the year, we had 20% growth rates, both carrier and enterprise growing sort of above maybe even the levels we would expect kind of over time. So that just has to normalize as you kind of go through the year and I think as we talk to our customers and we think about the government incentives that are out there, we expect the growth to continue for multiple years. Okay. And this Q4 type of – would you attribute this to macro? Because clearly, a business like Display is going to be macro impacted. We tend to think of telcos a little bit less, but we are starting to see some signs of the macro headwinds. Yeah, I think it's hard to decouple anything in some sense from macro completely. I think the dynamics that we are seeing here now are probably less macro maybe than in a lot of the other industries where we participate like Display or Consumer Electronics where clearly, there is a macro impact to those industries. I would say that companies manage their own spending based on the macro to some extent. So I think it's hard to say that carriers or enterprises or cloud data center or hyperscalers aren't doing that as well. But I think it's more around just the dynamics of them managing their own deployments of networks as opposed to it being really a big macro thing. Okay. And the hyperscale cloud piece is important. People tend to be worried about that. Have you seen any changes there? And obviously, you got a lot of data center construction and upgrades where optical is working its way in there a lot more. So you do have very positive dynamics underneath it, but any changes there that you guys have picked up on? Nothing that I would say makes us feel any different about the future than we did six months ago. Could it impact in a given quarter or a given period of time, for sure, but nothing material. Okay. And you are still looking at this overall business is kind of around 10% growth the next few years? Do you think that's a pretty good bogey? And then maybe last one here, talk a little bit about margin profile for this business. I think you did mention you guys have been adding capacity. So maybe talk about the different dynamics and puts and takes on profitability here? Yeah, this is – so we've talked about inflation a lot in 2021 and 2022 and it hits us in our different businesses in different ways. This is a business that has been hit pretty hard. Transportation cost, industrial gases, energy and in the middle of 2022, certainly the back half of 2022, we are definitely seeing a lot of inflation hitting the business. So I think that's impacted the margin. To some extent, the ramping of capacity impacts our margin for a period of time until that capacity is fully utilized and fully at the right level of productivity. But I think a lot of it has to do with inflation and we've been raising price. We are raising price again. We'll continue to raise price until we offset that. It does mute your gross margin percentage or your margin percentage because you're offsetting it dollar for dollar, but it brings your percentage down even when you do that. So I think margins stay muted even as we grow, I think our margins will expand, but maybe not as fast as they normally would because of the higher costs, higher input costs. And those ASP increases, I mean, it's happening everywhere. I am assuming from a customer standpoint, it's not a surprise. I mean it's probably been more surprising on Display, but that was kind of a year, year and a half years ago where that kind of inflected. I am assuming in this business, it's much more obvious that the supply chain has to raise? Yeah, I mean, so far, so good. I think the fact that there is not a lot of available fiber and cable helps, right? The industry is constrained to some extent. I think that helps with our ability to pass price along. I think we will continue to do it to the extent we can. I mean, we may test the balance of that at some point, but so far, so good. Yeah, okay. I did want to go over to Hemlock. You mentioned solar. Maybe just give us – because it's still a relatively new business, just how you look at kind of the end-market there and restarting capacity and it just seems like it's been a great deal, great timing for you guys and it seems to be reflecting very positively. Yes. So – maybe I'll back up a little. Hemlock, we are a minority owner. We acquired 40% from DuPont back in September of 2020. They make polysilicon for the semiconductor and the solar industries, which I think are two really great relevant industries right now for the long-term. They have a very strong semiconductor business. It's growing around the rate of the market. There aren't a lot of competitors, pretty high barrier to entry. So I think that part of the business is in great shape generating cash and growing and we expect that to continue. On the solar side, they had exited the business back in like the late 2018, 2019 timeframe, primarily because the industry had really moved to China for the most part and they are unable to sell in China because they are blocked out by tariffs. And as the industry became constrained and as the U.S. put legislation in place to block certain polysilicon from various different regions within China or to incent U.S. based polysilicon, it gave Hemlock the opportunity to sell out any inventory they had and to restart capacity. So we have sort of two types of capacity. We had a tranche of capacity that had been running and we have mothballed it. We've restarted that pretty low cost. It's pretty much sold out. Prices are really strong. I am sure prices will come down a little bit over time, but I think we feel great about that portion of the business. We've also got a tranche of capacity that had never been started and we're in the process of figuring out what happens next. So I think we can grow the business from where we are and I think as you all know, there is a lot of incentives out there now in the U.S. related to the solar industry and we are looking at what that means for us and whether or not we think a U.S. solar supply chain can be built out, which I think bodes really well. There are not a lot of polysilicon makers in the U.S. You've got Hemlock and Wacker. We are the biggest one. So I think it puts us in a pretty good strategic position long term in that space. Okay. And there is increased investor attention. So maybe talk to us a little bit about visibility we are going to get into this business as it ramps, does it get its own little bucket or how do we think about that? Yes, it's a good question, a popular question. We are working on it and I think we're probably just a little too soon for us to break it out at some point, we might. Regardless of whether we break it out or not, I think over time, we'll provide some transparency about how we are thinking about it, what it might mean from a growth perspective, how we play, how we see the U.S. market kind of playing out, but we are sort of a little early in that process in our thinking about it. Okay, and the semi piece of the business here, do you think that's kind of decoupled from semi industry cycle, which is pretty bad, but this business is doing pretty well. Yeah, couple of reasons why I think our semi business is fine. We have long-term take-or-pay contracts that go out a decade. There is not a lot of polysilicon. So it's not one of those industry components that sort of oversupplied. It's not tight, meaning that there's not any available. But I am not too worried about it in the macro sense if the industry doesn't grow significantly in the next twelve months, I think it doesn't really have much of an impact. I think quite the opposite if a U.S. supply chain were to be built out over time, I think the industry could be constrained, not in a one or two year time frame, but maybe in the five year time frame. It's not inexpensive to put new capacity in. So I think it puts us in a position where we have a great asset and how we use that asset down the road and what happens with respect to how much polysilicon is needed, if there are two sort of parallel supply chains for semiconductors will be an interesting thing for us. Okay. Maybe if we shift to Environmental and Auto, auto has been in other end-markets has been kind of all over the board. So maybe talk to us a little bit about broadly in auto and then we could kind of get into the ways you play in there as well. Yeah. So, I said this a little bit at the onset. a lot of our markets are sort of in recession, right? I mean, I don't know that we're necessarily technically in a macro recession, but if I think about display, mobile consumer electronics, auto, they are all way down auto has been down for three years below where we think the normalized number of cars to be produced should be. So I don't know how you don't call that a recession of some sort. Now if the dynamic, I think is different than the other industries where there is a demand driver that's kind of causing the market here. I think it's still more supply than demand driven. I've been wrong a couple of times. I think the industry experts have been wrong around when the auto market really frees up and you start to see more cars produced. So, I'm certainly not going to predict when that happens. I would say we are not counting on it happening anytime soon. We are ready for it to happen. So I think in our Environmental business, if I use that as an example, we've got capacity. We have some inventory. So if the industry were to free up, we think we would be in a great place and we would be able to grow kind of right out of the gate. Whether that happens in '23? I don't know. Right. And then for the GPF piece, any, obviously, the China exposure, there is Europe. Any new developments there where other markets open up or kind of what you're seeing in those two end-markets? Obviously, Europe has got a little bit more macro risk to it? Yeah, I think China has been constrained in my mind because of COVID more than anything. I think it probably has constrained the demand for autos in 2022. I would say maybe not so much in 2021. I don't know. I think it will constrain the demand in 2023. But it also has constrained the supply significantly and I think we're seeing that play out even here in the fourth quarter even though the lockdowns are different than they were, let's say in the second quarter where they really impacted the Chinese economy and the supply chain. Europe, I think the demand could be muted because of macro conditions, but people clearly have purchased way less cars than they normally would over the last few years. So, I don't see that as being a big long-term demand-driven thing. GPS, for us, obviously, are important. They're important in both China and Europe. They are important in hybrids as more cars are made, hybrid use filters, more filters than an ICE vehicle. So, even if more BV-type cars are made, if they're hybrid, that's helpful for us. Eventually, we think the U.S. passes legislation that requires GPFs, probably not for a few years. So I think that space bodes well and potentially allows us to grow above the market over a longer period of time. Okay. And then maybe just talk a little bit about auto glass, kind of where you in the per vehicle and as you continue – as we continue to see more screens in vehicles. How are you guys doing there and design wins and moving that along? Yeah, I think that unlike the environmental space is going to be a growth opportunity for us for sure, regardless of the number of cars made. It's a much smaller business, but we've won a lot of business and a lot of that will come – kind of come online as new model years unfold. We'll see growth in 2023 and growth in 2024 and 2025 as we kind of start to fill the backlog that we've got out there. I think that is a sort of a reasonably certain sort of outcome for us. I think the opportunity set is also really large as new cars are made. They're being made with more glass on the interior. That bodes well for us. A lot of that has to do with the connectivity, the way cars are used today versus, say the way they were used in the past. Our capability set is really good for large form factor glass on the inside of a car and that's where we are seeing a lot of opportunities. So I think that actually is a nice growth opportunity sort of regardless of the auto market, what kind of cars are produced, how many cars are produced. We're also seeing opportunities on the exterior, in particular, in electric vehicles, light-weighting the vehicle, soundproofing the vehicle are two good examples for what we think the value prop is. And then in other specialty glass areas like LiDAR, for example, any case where the glass needs to be really strong and have good optical properties that hits kind of the sweet spot for us and we're seeing those opportunities. And I think as cars become more advanced, you'll see cars contain more content. So it just gives us a larger TAM if you will, in that space. Okay. And maybe go over to Specialty, you mentioned kind of some of your macro impacted areas, obviously, phones is one of them. So I think you've been kind of talking a little bit more conservatively about this. So maybe talk to us where you think we are in that end-market. Yes. I mean clearly 2022 wasn't a great year for smartphones or PC, IT, monitors, things of that nature. I don't know whether you grow significantly from here in 2023, but it's hard to imagine a repeat kind of a year in 2023 in those markets, right? I mean they're down double-digits phones being down 14% or something like that for the year. We've, I think, taken our view down to a pretty good place for 2022. We haven't guided anything yet either on the market or our own view of how it will play out in 2023. I think we can still grow faster than the market. So even in this down market, we are currently growing faster and I think we can continue to grow faster as we add content into the devices that we serve, as well as substitute materials into those devices as well. So I think those drivers still exist for us. I think there is some runway on that. And then how big the market is next year will remains to be seen. Okay. Anything in that business, new products or evolution, new form factors that over the next several years you think could be something interesting to spark a little bit of growth there. Next couple of years I would say, we'll continue to innovate and introduce new, more content, new materials there's nothing specific that I'd call out. If you go beyond that window of time, I think AR, VR are areas where we could play. I think the question is, what does the device really look like? How big is that market? We believe that if the market exists and it is sort of a device-driven market that we can have the content per device at a much higher level than a phone, so I think the opportunity set is quite large, but I would say that's out a while, at least sitting here today hard to imagine a significant market in the next couple of years. Right, right. Okay, maybe if we pivot to Life Sciences, we could throw a velocity valor in there. Also it seems like a rollercoaster ride with COVID and just a lot more attention in business pulling forward, but still a lot to go on approval. So there is a longer term. So maybe just if you can break down for us kind of the outlook there? And are we still expecting a pretty long-term strong growth as these technologies get more approval. Yeah. Maybe I'll start for a second with our legacy Life Sciences business and then I'll talk a little bit about Valor Velocity. In our legacy business, we saw really strong growth 2021, primarily driven by the COVID – the need for COVID consumables. We've seen that sort of taper off a good bit and the sort of demand moving back towards the more traditional research type products. I think growth will come from gene therapy, things of that nature that are sort of the future of that space for us. How fast that kind of inflection comes? Hard to say, but I think we'll grow a little faster than the market. So, I feel pretty good about that over the next few years. Valor Velocity for us has been rough in terms of getting it launched. COVID actually allowed us to really accelerate and build out quite a lot of manufacturing capability. We now have a high volume manufacturing facility running in North Carolina and built and sold tons of pharmaceutical packaging devices for COVID. I would say that what really remains to be seen now is, as COVID tapers off, how fast can we take what we've learned in this process, accelerate FDA approval and find a solution that works in the marketplace that we can sort of scale. I think that's the hardest thing so that you're not sort of going drug by drug to get your product on those drugs. We've got some innovative business model ideas that we are thinking about. Velocity is a good one. It's different requirements for approval than Valor and I think there is opportunity there. I would caution that I don't see that as a huge near-term growth driver. Right. Okay. Maybe we've got a few minutes left. Maybe we'll pivot to some financial questions for you. Talk a little bit about recapturing margin. There is just been a lot going on with license, you mentioned inflation, logistics costs, adding capacity, redoing your tanks. So, walk us through kind of the next few years on how that gross and operating margin can look. Yeah, I think there are three dynamics that will move our margin around our ability to grow. So making sure all our capacity is full, that clearly is one of the strongest drivers. And right now, if you think about the back half of 2022, display volume is really low, display is a very profitable business. Our specialty materials volume is very low. It's a very profitable business. So, just from a sales perspective, that impacts our margin. That will come back. I have high confidence in that. Second is inflation. We've been chasing inflation now for a few years. We're not caught up. That's clearly impacting our margins. I think we have a shot at getting caught up on a dollar basis, but I don't know on a margin basis, right? So I think that could be with us for a while unless we start to see some form of deflation, right, come back into play and costs kind of normalize and come back down maybe to 2019 levels. We have a lot of initiatives underway. I mean, we talk a lot about price, because it's easy to talk about and it's an important lever. But I think longer term, we are looking at if we baseline our costs to pre-pandemic level, how do we get them back to that level? What would we have to do to be able to do that. I think that is in that inflation bucket, the harder of the things and it will take longer, but I think we'll make some progress there. And then, I think, the other thing that is going to always have an impact on our business is you talked about it in the form of capacity, but I think it's also the mix of our businesses and how we grow and where we grow. Some of our businesses have higher margins – to the extent those are growing at a faster rate, that obviously moves our corporate average up to some extent as some of our newer businesses, auto glass is a good example, ramp you may be in a window of time for years where you are really kind of in this ramping phase and there's a little bit of a drag on margins. So I think that will be with us for a while. And if we continue to grow, margins will definitely be better than where they are today. Okay. And then, just really quick because we're running out of time, just on the cash flow side, equally kind of stabilized, I would guess any meaningful changes in cash flow would probably be more success-based where you need capacity or the new 10.5 plant? Or is that how we should kind of think about CapEx and cash flow impacts? Yeah, I mean, cash flow is really important to us to try to stabilize our cash flow. We've been managing our CapEx. Obviously, we need capital to grow. So we'll never be a zero capital company. I mean, even just to maintain our assets, we need about $1 billion a year of capital, right? I would say that we are not building any new Gen 10.5 facilities anytime soon. We'll certainly be adding capacity in various aspects of our business. So we will be spending capital, but I don't see it as a huge dilutor of our free cash flow in the next few years.
EarningCall_1552
Good day, everyone, and welcome to the Darden Fiscal Year 2023 Second Quarter Earnings Call. [Operator Instructions] Today's conference is being recorded. If you have any objections, please disconnect at this time. Thank you, Todd. Good morning, everyone, and thank you for participating on today's call. Joining me are Rick Cardenas, Darden's President and CEO; and Raj Vennam, CFO. As a reminder, comments made during this call will include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to the risks and uncertainties that could cause actual results to differ materially from our expectations and projections. Those risks are described in the company's press release, which was distributed this morning and in its filings with the Securities and Exchange Commission. We are simultaneously broadcasting a presentation during this call, which is posted in the Investor Relations section of our website at darden.com. Today's discussion and presentation includes certain non-GAAP measurements, and reconciliations of these measurements are included in the presentation. Looking ahead, we plan to release fiscal 2023 third quarter earnings on Thursday, March 23, before the market opens followed by a conference call. During today's call, any reference to pre-Covid when discussing second quarter performance as a comparison to the second quarter of fiscal 2020. Additionally, all references to industry results during today's call refer to Black Box Intelligence's casual dining benchmark, excluding Olive Garden, LongHorn Steakhouse and Cheddar's Scratch Kitchen. During our second fiscal quarter, industry same-restaurant sales increased 3.6% and industry same-restaurant guest counts decreased 5.7%. This morning, Rick will share some brief remarks on the quarter and our focus moving forward, and Raj will provide more details on our financial results and an update to our fiscal 2023 financial outlook. Thank you, Kevin. Good morning and happy holidays, everyone. I'm pleased with our results this quarter. All of our brands performed at a high level by remaining focused on our back-to-basics operating philosophy anchored in food, service and atmosphere. At the Darden level, we continue to strengthen and leverage our 4 competitive advantages of significant scale, extensive data and insights, rigorous strategic planning and our results-oriented culture. Being brilliant with the basics starts with achieving and maintaining appropriate staffing levels in our restaurants. Across our brands, our teams are doing a great job of ensuring we are ready to run 14 great shifts a week. At each of our brands, we are fully staffed at the team member level, and manager staffing is at historic highs. As a result, our teams are executing more consistently, which in turn is driving strong guest satisfaction across our brands, according to both internal and external sources. During the quarter, 4 of our brands achieved all-time high internal guest satisfaction ratings and the others remain near all-time highs. Also, within Technomic industry tracking tool, a Darden brand was ranked #1 among major casual dining brands in each measurement category. I am particularly proud of Olive Garden's performance. During the quarter, they brought back their most popular limited time offers, never any possible. As you may recall, when I talked last I shared that any promotional activity or brands introduced should be evaluated with the following 3 filters. First, it needs to elevate brand equity by bringing the brand's competitive advantages to life. Second, it should be simple to execute. We will not jeopardize all the work we have done to simplify operations which allows our teams to consistently deliver exceptional guest experiences. And third, it will not be at a deep discount. We are focused on providing great value to our guests, but doing that in a way that drives profitable sales growth. Three years after it was last offered, the 2022 version of never any possible checked all 3 of these boxes. First, it leveraged Olive Garden's iconic brand equity by perfectly reinforcing their competitive advantage of never-ending abundant craveable Italian food. Next, it was amplified by only offering existing menu items with limited add-on choices, which made it easier to execute, resulting in great guest experiences. Finally, it was priced $3 higher than in 2019, which significantly improved the margin of this offer while still providing tremendous value for our guests. Never ending possible exceeded expectations, and we saw a step change in Olive Garden's positive gap to industry traffic during the 7 weeks at ramp. I'm even more encouraged by this performance, given that it was supported with about 3/4 of the media past years. Going forward, the team will build on their learnings and share insights across our brands but this may be the only limited time offer we do at Olive Garden this fiscal year. Across our brands, we continue to drive strong execution of the off-premise guest experience through ongoing investments in technology that reduce friction for our guests and our operators. For example, many of our guests still prefer to call in their to-go order. However, taking payment over the phone or when the guests arrived is both inefficient for our teams and inconvenient for our guests. To help address this, we rolled out online payment for call-in orders during the quarter, enhancing convenience for our guests and making our to-go specialists more efficient. To-go sales remain sticky across our core casual dining brand, accounting for 25% of total sales at Olive Garden, 14% of Longhorn and 13% at Cheddar's. Digital transactions accounted for 62% of all off-premise sales during the quarter and 10% of Darden's total sales. The holidays are the busiest time of the year for our restaurant teams, and they have enjoyed welcoming even more guests back into their restaurants this season. In fact, the Capital Grille, ADB and CD52 enjoyed all-time daily sales record on Thanksgiving Day, and bookings for this holiday season are encouraging. The holidays are also a great reminder that being of service is at the heart of our business. and we embraced a higher purpose to nourish and delight everyone we serve, our guests, our team members and our communities. One of the ways we serve our communities is through our harvest program. One in 8 households in our country live without consistent access to food. To help fight hunger, our restaurants donate fresh, unused food to local food banks and nonprofits in their communities on a weekly basis throughout the year. Since the inception of this program, more than 131 million pounds of food have been donated, which is the equivalent of more than 100 million meals. The impact of our harvest program takes on added significance during the holidays. And I am delighted that our teams are helping to make a difference in some in communities across the country. I'm so proud of the focus and commitment our teams continue to display. Their disciplined approach in executing on our strategy is what enables us to succeed regardless of the operating environment. This is evidenced by the fact that just last week, we surpassed $10 billion in sales on a trailing 52-week basis for the first time in Darden's history. On behalf of our senior leadership team and the Board of Directors, I want to thank our 180,000 team members for everything you do to serve our guests and our communities. I wish you all a wonderful holiday season. Thank you, Rick, and good morning, everyone. Total sales for the first quarter were $2.5 billion, 9.4% higher than last year, driven by 7.3% same-restaurant sales growth along with the addition of 35 net new restaurants. This same restaurant sales performance outperformed -- outpaced the industry by 370 basis points and our same restaurant gas counts are performed even more as they exceeded the industry benchmark by 550 basis points. Diluted net earnings per share from continuing operations were $1.52, an increase of 2.7% above last year. Total EBITDA was $330 million, and we returned $249 million of cash to our shareholders this quarter, consisting of $149 million in dividends and $100 million in share repurchases. Total pricing for the quarter was approximately 6.5%, 200 basis points below total inflation of roughly 8.5%. Now looking at the details of the P&L compared to last year, Food and beverage expenses were 240 basis points higher, driven by commodities inflation of approximately 13%, which significantly outpaced our pricing. As we expected, chicken dairy and grains continue to be categories experiencing the highest levels of inflation. Produce especially let us was much higher than expected due to poor growing conditions and weather-related events in the quarter. However, our scale and vendor partnerships help minimize this impact relative to the general market. National labor was 30 basis points better than last year, even with total restaurant labor inflation of 7%. Our restaurants continue to run efficient labor despite hourly wage inflation of 8.5%. National expenses were 20 basis points favorable as we leveraged higher sales that more than offset elevated inflation on utilities as well as higher repairs and maintenance expense. Marketing expenses were 30 basis points higher than last year as we increased media support for the reintroduction of never-ending possible. This was in line with our expectations heading into the quarter. G&A expenses were 40 basis points below last year, driven by sales leverage and a lower incentive accrual, which was in line with our plan. This favorability was partially offset by higher mark-to-market expense on our deferred compensation. And as a reminder, due to the way we hedge this expense, this favorability is largely offset on the tax line. Page 13 of our presentation illustrates the roughly 20 basis point reduction to operating income from mark-to-market expense and the 150 basis point benefit to the tax rate. The effective tax rate of 12.1% this quarter would have been 13.6% without the impact from the hedge. Now looking at our margin performance versus pre-Covid, we grew operating income margin by 160 basis points, while underpricing inflation by more than 500 basis points. Increased food and beverage costs were more than offset by improved productivity, reduced marketing, and other cost savings initiatives. Looking at our segment performance. All of our segments significantly outperformed their respective industry benchmarks on both traffic and sales. Sales at Olive Garden were 9.2% above last year driven by same-restaurant sales of 7.6%. Average weekly sales at Olive Garden were 104% of the recovery level. LongHorn sales were 9.7% above last year with same-restaurant sales growth of 7.3%. Average weekly sales at LongHorn were 125% of the pre=COVID level. Sales in our Fine Dining segment were 7% above last year, driven by Same Russian sales of 5.9% and average sales -- weekly sales were 117% of the pre-covid level. Our other segment sales were 10.5% above last year -- with same-restaurant sales of 7.1% and average weekly sales were 109% of the pre-covid level. Turning to our financial outlook for fiscal 2023. We have updated our guidance to reflect our year-to-date results and expectations for the back half of the year. We now expect Total sales was $10.3 billion to $10.45 billion, same-restaurant sales growth of 5% to 6.5%, 55 to 60 new restaurants; capital spending of $525 million to $575 million, total inflation of approximately 7%, and we plan to continue underpricing total inflation with annual pricing of approximately 6%. Furthermore, we expect commodities inflation between 8% and 9%. An annual effective tax rate of approximately 13% and approximately 123 million diluted average shares outstanding for the year. All resulting in diluted net earnings per share between $7.60 and $8. Looking at the third and fourth quarters, we expect the EPS growth rate year-over-year to be fairly balanced. In the third quarter, we estimate the outsized sales growth from lapping Omicron last year to be partially offset by underpricing inflation by approximately 50 basis points. In the fourth quarter, we expect inflation to further moderate on our pricing gap drivers contributing to margin growth. Now to wrap up, let me say that we're very pleased with how our teams are managing their businesses and delivering strong results. We remain disciplined in adhering to our strategy and providing value to our guests in the face of strong inflation. We're confident in the underlying strength of our business model and our team's ability to continue managing through this unpredictable environment effectively. Just a real quick one on the promotional strategy. I think you said that never any possible will be the only LTO that you run this year. But you also brought back that $6 take-home offer, which I'm guessing you would consider to be an LTO. But -- so maybe you could talk about your expectations for that offer? Because if I remember correctly, that was a fairly strong comp driver in the past. Eric, thanks for the question. Never any possible, we said in our prepared remarks is maybe the only limited time offer, likely only been a limited time offer. As you talk about the $6 take home, that's on our core menu. So it's not considered limited time, it's on our menu. But for competitive reasons, we're not going to discuss any more promotional plan details. And so we're going to continue to use our filters that we mentioned, first, elevating brand equity by bringing the brand's competitive advantages to live; second, simple to execute; and third, not at a deep discount. As you'll probably see on ATV today, we're currently airing our open big pastas, which are core menu items for us. So they're not a limited time offer, and it includes our new Ravioli Carbonara, none of these items are discounted. So we're going to stick to our strategy, as Raj said, core growth, core discount growth, and we're going to react accordingly. And then just on the marketing spend, do you still expect to be in that 1% to maybe 1.5% range for the year? Yes, Eric, we're going to be close. So I think that as we said, it should be close to 1 -- we said 10 to 20 basis points above last year. That's how we think about it. Congratulations on strong results. question on Olive Garden also. The underlying same-store sales this quarter showed a clear inflection versus the last few quarters, and particularly relative to the other brands, the 3-year comp accelerated to above 11%. And how much of this dynamic would you attribute directly to bringing back never-ending possible at the strong price point you did in -- and how much would you attribute to other factors? And do you believe this kind of underlying trend on a 3-year basis is sustainable? Or should we be tiny modeling a more conservative 3-year term moving forward for Olive Garden? Yes, Brian. First, let me say how proud I handle the work Dan and his team have done working on keeping with our strategy at Olive Garden. As we mentioned in our prepared remarks, Olive Garden already had a positive gap in same-restaurant sales to the industry before never-ending possible, and that gap increased when we brought never-ending possible back for 7 weeks. So it ran about half of the quarter. We're not going to kind of talk about how much nevering possible and contributed to the quarter, but it was a good jump for us. And so as we think about the rest of the year, our guidance contemplates continued strength in Olive Garden, but probably not at the strength that we had for nevering possible. Remember, this is an iconic limited time offer, uniquely positioned, and it covers all 3 filters that we mentioned. And as I said in our prepared remarks, we have exceeded our expectations. So -- and that's a pretty pleasant surprise for us. If you think about given the higher price point, the lower media support, but it does speak to how iconic that brand offer is and the things that Olive Garden brings in such a compelling way. And then finally, we haven't run in 3 years. So guests were really excited for the return, and it fits really well in our second quarter. So if you think about our lowest volume quarter of the year second quarter, never any possible helps keep our traffic a little bit higher so that we don't have to think about bringing team members hours down and then bringing team members back when the holidays go up. So we really were appreciative and we really love with the work that Olive Garden did and where nevering possible was. But not to say that our 3-year stack is going to stay the same as it did in Q2. And Rick, just more broadly, just you have a seat where you get to witness the consumer across multiple different brands. You have one of the best seats to kind of see how the consumer is behaving. There's obviously a lot of cross currents out there, and there's a lot of different views on where the consumer is going into calendar 2023. Can you just maybe describe your view of the consumer and how you're feeling about the overall consumer into '23 and maybe some puts and takes? Yes, Brian, I won't necessarily talk about 23. I'll just talk about what we're seeing, not being an economist, I listen to what they have to say. But as you all know, everybody on this call knows, consumer spending drives the U.S. economy. The -- we've seen a shift in spending though, from durable household goods or durable goods to leisure services, and the restaurant industry has benefited from that shift. Casual dining same-restaurant sales improved from Q1 to Q2 and our positive gap to the industry improved even more during that time. So one of the benefits of our portfolio, as you mentioned, is we have a wide range of consumers. We serve a lot of them all across all of the spectrum. And our data indicates the higher-end consumer hasn't seen the same impact as consumers at the lower end of the spectrum. But if you think about the prepared remarks, sales at Thanksgiving were a record for Fine Dining and Seasons 52 and bookings for this holiday season are encouraging. So it seems like the higher end consumer is doing pretty well. And I know there's been a lot of talk over the year about consumers that's below $50,000 in income because high inflation impacts that consumer more disproportionately, but we've seen a little softness in that consumer over the last 6 months, but the mix of the 50,000 income and under is still above pre-covid levels for us. Even though that shift has come down a little bit, we're still above pre-covid levels at the 50,000 and below. And I would say, keep in mind that a lot of our consumers below $50,000 are single, are retirees are living in multigenerational households. So maybe $50,000 goes a little bit farther for that consumer. But without commenting on the future, we have seen a pretty good performance across all of those consumers over the last few months other than the fact that the 50,000 below consumer is lower than it was 6 months ago, but still higher than it was pre. Great. Notwithstanding the strong 2Q performance and the higher fiscal 2023 guidance, but if we were to see some macro deterioration impact the industry in fiscal 2020 -- your calendar 2023, excuse me, what's kind of the pecking order or your preference of magnitude of how you'd respond to that? Should we expect perhaps a tighter taking of the belt and just more of a focus on reducing overhead? Will we expect you guys to potentially invest more in the marketing, potentially invest more to value. How do you think about the contingency plan if we were to see some deterioration in calendar 2023? Andrew This is Rick again. If we see deterioration in the calendar 2023, we always look at ways to tighten and find ways to improve productivity and improve our administrative expenses. We think we're actually really good at doing that. So if something gets really -- shifts really badly in the wrong way, we're going to find ways to at least find places to tighten. On the marketing spend, Raj talked about what our marketing spend is for the rest of this year and for the whole year. We don't anticipate making a big change in that no matter what happens over the next 6 months. We're going to continue to use the filters that we mentioned. And I will say Olive Garden, as I said before, we'll always have advertising in their mix because of their scale. But we're going to stick to our strategy of core growth. We're going to react accordingly to whatever happens. And as we've said in the past, and Raj said it too, if and when we increase our marketing spend, we'll expect it to return -- to earn a return compared to what it would have been without the spend. So we're going to -- as you've seen us in the past, we react when things happen, and we think we'll do the same thing going forward. Very helpful. And if I could sneak one in to Raj, what's the small step hire in CapEx guidance as you maintain new store openings? Is that construction costs were perhaps running a bit higher than expected, there are some incremental investments in technology or something else we should be thinking about? It's truly inflation on the construction costs and some equipment costs as well. So it's really -- a lot of it is new restaurant related. Some is on the -- even on the facilities CapEx, there's a little bit higher inflation. Just a question on traffic, particularly on-premise. If you look at the industry numbers, on-premise traffic is down double digits for casual dining. And even Olive Garden is not back to where it was. I wonder how that informs your strategy? Do you feel like that's an opportunity? Or you just have to be patient, particularly with some lapsed users, maybe that under 75,000 household income user but maybe this isn't something you want to chase either. So I'm wondering how you view that as opportunity that informs the strategy. David, if you think about what we've done over the last few years, we have significantly reduced marketing spending at Olive Garden. And we've talked in the past at how that could be about a 10-point drop in traffic for us. But we're focusing on driving core users to Olive Garden, core gas versus promotional users. And so what we see as an opportunity, we've got more capacity in our restaurants than we did before. But a lot of that in-restaurant experience has moved to the off-premise experience. As you see Olive Garden still at 25% off-premise where prior to COVID, it was much lower than that. So we see it as an opportunity to continue to focus on our strategy of pricing below our competition, pricing below inflation by finding other cost savings to help offset that and give our consumers a great value so they don't need a promotional message to come in and they just get a great value every time they come. Actually, on your slide deck, I just had a quick question on Slide 20. Your food inflation outlook looks like it's less inflationary on many of those line items, beef, chicken, dairy oil versus what you had previously, but your food inflation outlook is still the same at 7%. Is there some offset to what we're seeing? And I'll pass it on. Yes, David, it's really the fact that last 2 quarters were 15% was in the first quarter, second quarter was 13%. So as you look at the back half, really, Q3, we're thinking it's going to be mid- to high single digits and then Q4 is closer to flat. So if you do that, what that translates into on the year is closer to that 8% to 9% that's really the difference. I think when we spoke the last time, we expected a step change from the first half to the second half. And we are seeing that. However, it's not as big as we thought. It's still a pretty big change. I mean, as I just mentioned, we're going from mid-teens to high single -- mid- to high single digits as we get into Q3 and close it to flat for Q4. So pretty big change, but there were a few there are a few items that are higher than we would have expected, namely dairy, grains and produce, and quite a bit of this is weather-related and so that's actually baked into our expectations going forward. Great. Thanks for the question. I think this was the first quarter that we've seen or the largest quarter of opens at Cheddar's and maybe several years. So I just wanted to get a sense of an update on the brand. I know it's a little bit of a lower income skew there as well. So maybe some commentary on the performance there and what you're seeing from a customer standpoint and if there's anything in terms of regionality where these new units were opened. Just any update on the brand would be great. Jared, let me talk high level about chatter and talk a little bit about the opening. Cheddar's has made significant improvements in their business model. versus pre-COVID, even with significant inflation, they had a lot of productivity enhancements with the simplified menu and a streamlined menu so that we felt more comfortable opening restaurants at a quicker pace. Not only that, they have really built their leadership pipeline and have been able to staff all of these restaurants with managing partners that have run Cheddar's, and we have a pipeline of more ready to go as we open restaurants. So yes, this was our highest quarter of openings for Cheddar's. We opened 7 restaurants. Yes, versus last year. We had 7 restaurants versus last year at Cheddar's 4 in the quarter. And we -- those restaurants are performing really well. So they're primarily in markets close to where Cheddar's already exists. It's not like we're -- we have a lot of restaurants opening in brand-new markets. But we are looking at newer markets to open Cheddar's in. But as we mentioned early on in the acquisition of Cheddar's, we thought we had more room to infill markets that they already have restaurants. So that helps us leverage our scale in those markets that helps us leverage our supply chain and our people. But again, high level, really proud of the work that JW and his team have done at Cheddar's, really proud of the progress they've made in staffing their restaurants, building their pipeline, and we're seeing some pretty strong performance in these new restaurants. Maybe just to follow up quickly on the commodity comments. Do you see any kind of risk to the second half just based on some of those items that are -- have kind of surprised to the upside recently? Or are those things that can't necessarily be contracted? How do you feel about that at this point? I think there's always risk. As you think about, that's why we have a range of 8% to 9% as our assumption going in. We'll have to see how this plays out, right? I mean some of the stuff, like I have mentioned earlier in my prepared remarks, Q2, the impact on product produce especially led us -- no one expected that. It came out of nowhere. It was weather related. There were 2 hurricanes and Florida, 2 hurricanes in Mexico, they just really destroyed the crops. And that cycle stuff is always a risk. We contemplated some of that in our guidance. Okay. And then you made the comment about just sharing some of the lessons from never ending possible at your other brands. What are you thinking about there? Is it kind of a change to promotional architecture? Or are there things you’re not doing at some of those brands that you could be doing to kind of echo never in possible? Yes. As you think about never ending possible, there were other things that we did during that time. We did a little bit more digital testing and those kind of things that we can leverage across our brands. But – more importantly, those filters that we use on what we’re going to communicate. We’re very strong and helped our brand – helped Olive Garden continue to build their business, elevating brand equity, very important, and we’ve learned that, simplified the offer. We’ve learned that and not a V discount. So all the investments we’ve made over the last few years to price below what the consumers are seeing in inflation means that we don’t have to really go into the net discounting range – the never-ending possible was $3 more expensive than it was in the past, and it was still a strong promotion for us. But that’s not to say that everybody is going to be on television now, right? So Olive Garden is the 1 that has the real scale to be on television. The other brands have learned things about the digital testing that we did and just the fact of the construct of the promotion. My question is on unit development and your comment, Raj, about construction costs escalating. And I just wondered if you could comment specifically on the returns you're getting on the recent openings or the expected returns you're getting on your upcoming openings? I know there's a lot of moving parts and I guess the main question is, is the numerator of the return equation keeping up with the escalation in the denominator? And are you seeing similar returns? Or are you getting to a point where the returns are starting to come down? Any color there would be great. Yes, David, let me start by saying pretty much on average. Our new restaurants exceed cost of capital by quite a bit. We had a big margin to begin with. Now the construction costs have gone up, so have our unit economics. So if you look at overall performance of where we are, I just mentioned earlier, our operating income this quarter was 160 basis points higher than pre COVID. So our 4-wall unit level economics have gotten better that helps mitigate some of the construction cost increases. Now with that said, we already -- we obviously want to continue to maintain the pace of opening. But we continue to monitor inflation in construction costs. And we are being very disciplined. There are a few times where we have walked away from some deals because the cost was too high even though that would have probably exceeded our cost of capital. We're just being a little bit more selective on that front. Now all that said, we're starting to see some green shoots on the construction side. The last few bids, I think, were more closer to or below -- slightly below elevated budget. But at least it's a positive sign. So we think there are -- there's some -- potentially this could lead to some decrease in the level of inflation over time. Great. And I guess a follow-up to that is, are there projects going on inside the company to try to trim costs out of the box I know -- I think a prior question commented, the dine-in traffic has been softer for the industry. Are you thinking about building smaller dining rooms or anything of that nature to get the cost equation down? David, as we think about our prototype designs for the future, we always look for ways to trim costs out of our prototypes and find new ways to build the new materials to use. We have built some slightly smaller prototypes or at all of our brands, not necessarily because of the to-go versus the dining room but because it makes it to go experience a little easier by shifting where that to-go area is. Remember, the dining room is the least expensive part of the building. right? So if you really want to take a lot of the cost out of the building, you got to take the cost out of the kitchen. And we think we've got a great kitchen, but we'll find ways to rightsize the prototypes for the market that they're in. without overcomplicating so that we have 50 different prototypes. But we, as I said, our development team is focusing on finding the most efficient building in the markets that we compete in. We've also taken some existing sites as restaurants have closed or their leases have expired for other brands. we've actually gone in and infilled those restaurants, which are slightly less expensive because you don't have some of the framing costs and some of the plumbing. So it helps us in that respect. Curious as it relates to pricing, if you could speak a bit more to kind of what you've seen to date as it relates to the customer response to the pricing, obviously, with the strong sales trends, I'm assuming not a whole lot, but any thoughts with respect to resistance or customer feedback to pricing and how that impacts how you think about pricing going forward? Dennis, I think the reaction is not that dissimilar to historical meaning we are getting a pretty decent flow-through from pricing north of 90%. And so really not seeing any major pushback. We haven't seen any moderation on the check mix. There have been things here and there where maybe advertiser pricing, we may not have gotten the exact level of flow-through. But overall, when you look big picture, it doesn't look like there's a lot of resistance. Now we are pricing a lot less than our competitors. So I don't know what is happening with the industry itself, but our pricing is well below the industry. And maybe that's part of what -- why we're not seeing a lot of existence. Great. I appreciate that, Raj. And just one more. Just wondering if you could speak a bit more to the staffing situation and the execution in restaurant. I think very encouraging that you spoke to being fully staffed, manager staffing levels at all-time highs, feedback scores from the customers sounds strong. But as it relates to the level of execution currently versus the potential, is there anything with respect to maybe the 10-year of your average employee right now, may be shorter than pre-COVID that can build going forward? Anything there as it relates to where operations are now versus maybe where you would -- where they can go or where you'd like them to go. Dennis, we have a lower tenure today than we did before COVID because of the turnover over the time through COVID. Our turnover is still elevated from the pre-Covid levels, but it's getting better and it's getting -- we're working on getting it closer to what our pre-COVID turnover levels were. As we've mentioned in prior calls, our focus is on training these new team members and getting them more efficient and getting them more productive. And as we continue to get our turnover levels down, that will continue to be a focus for us. also training our existing team members to make them better and give them more opportunities to learn and grow. So we will continue to train. But your point on a slightly lower tenure that is true. And we think as our tenure gets back to more historical levels, which is going to take a little while. But as it does get back to historical levels, then we will improve our productivity slightly from there, too. So clearly, a lot of focus on Olive Garden this morning, but I was hoping you could provide some more thoughts on LongHorn and just the continued momentum you're seeing there. Maybe just any thoughts on how the brand is performing relative to the category? And then just anything else you're seeing that's driving the continued strong sales there. Yes, Chris. Todd and his team, as we've said in the past, have been on a journey investing in quality and portion and that continues to pay off. They had over 7% same-restaurant sales this quarter. coming off a very strong result last year, right? So it was a pretty strong performance for Longhorn. Raj mentioned average weekly sales are longer and 25% above the pre-COVID levels. Now the state categories benefit over time, but Longhorn is holding their own in that stay category. They're doing really well. I would say traffic, unlike most of casual dining traffic in the long run down room is up versus pre-Covid. And it's, I think, one of the only full-service restaurant companies out there that have positive traffic in the dining room of anybody of scale. So we're really proud of what they've done. Remember, they were on the journey of simplification before COVID. So they're ahead of everybody else in our portfolio on where they were. And so they didn't have to worry about kind of flushing out that promotion guest that already happened. So really proud of what they're doing. I will also say the state category in general is doing well because they've got a great value. The state category in general has a great value. If you think about what we put on the plate for the dollars you spend, the consumers know that. And so we're going to continue to provide a great value at Longhorn and at all of our brands, but particularly a long run with the quality focus they've had, the simplicity that they've always had and the culture that Todd's building. Great. And then maybe just following up on the earlier comments around the consumer. Can you provide any more detail in terms of like what you're seeing regarding mix contribution to the comp any kind of trade up or trade down, any shifts in behavior there, if any? Yes, Chris. If you think about the mix, we're not going to comment as much about the mix impact to comp we did have a strong performance for everything possible that helped our comp. But we're not seeing -- as Raj said earlier, we're not seeing a big check management. We're not seeing a lot of shifting in mix because we've got a very strategic way methodical way we price so that we don't get mix changes when we take price because we've learned this system over time, and it's a proprietary way we do it, -- we use it with our data scientists here. So we haven't seen a whole lot of mix shift. And as I said in the beginning, we've seen -- and the economy has seen a shift from good to services. So that could be why you haven't seen a whole lot of shift in mix in our business and maybe in other -- maybe in our competitors' businesses. Great. Two questions. The first one just on the competitive outlook. I'm just wondering whether you've seen any change in competitive behavior. Again, you're obviously servicing all ends of the spectrum here. So just wondering what you're seeing from the competition. I know some are concerned of a potential uptick in discounting to drive traffic if commodity inflation were to continue to ease, I know that's contrary to your strategy, to make sure not to deep discount, but just wondering what you're seeing across the competitive landscape? And then I had one follow-up. Jeff, we haven't really seen a lot of deep discounting in the competitive landscape. There aren't many that are even on television. We've got one of the brands that had come off of TV over the years that have indicated they might come back on, but they're not talking about the discounting when they knew that. I think as Raj mentioned, our margins are about pre-COVID levels. I think we were maybe 1 of 2 companies in the public space that had improvement in margin versus pre-COVID. And most of them are talking about trying to improve their margins. So I'm not going to talk about what I think they'll do, but I'll get you back to what we're going to do. We're going to continue to focus on our filters to evaluate our promotional messaging or any messaging that we do, elevating brand equity, simple to execute, not at a deep discount, sticking to our strategy of core guest growth and reacting accordingly. So whatever the -- whatever our competitors do, we'll watch, but we're going to stick to what we've been doing. Understood. And then the follow-up is, broadly speaking, as you look at your fiscal '23 guidance, whether Raj, on the specific numbers or Rick, just in terms of the broader thought process. But what do you think is to prioritize the best to worst line of -- or in terms of all your guidance components, whether it's comps, inflation, earnings, prioritize the best to worst line of sight to any of those. Just wondering what you find more or less difficult to potentially forecast as you think about the next few quarters going into potentially slowing economy. Well, I think the biggest -- all the one that's going to have the most uncertain data is the traffic. I mean, what kind of traffic are we going to see? And we -- obviously, we've used a wide range of roughly 3% on the back half to accommodate some consumer shifts, but there's a meaningful change. That's -- obviously, that's something that could have an impact. That's really the big one. Dennis, inflation has been heard deferent, I mean there have been a multitude of factors that have been impacting inflation, right? You start with start off with the supply shortages and other things, labor impact. But now as labor starts to come down or get into a better shape, you've got weather events, obviously, global events. So there's a lot going on. inflation is probably the second one. And to me, those are the 2 things. Outside of that, I think everything else was probably pretty well buttoned up. Great. Just 2 questions. First, on the never-ending possible promotion. Do you feel like the benefit of that never never-ending possible promotion, does that extend beyond the promotional window the 7 weeks? Are you able to hold on to those guests even though they might be purchasing something else on the menu? Yes, Peter, as we think about any promotional activity or any limited time offer activity more specifically. We want to make sure that, that limited time offer still elevates brand equity as we've said before. And so we think there is a little bit of a halo over that. Now is it going to be as strong as when you've got the promotional message coming out there, a limited time offer message, probably not. But as we've said -- I think we said in prepared remarks, our year-to-date, our quarter-to-date comp sales are equivalent to our year-to-date comp sales. So it's not like we've seen a big slowdown since we stopped never-ending possible. Now that's across Darden, not necessarily across Olive Garden. But I think that's the idea of marketing or messaging is that should endure longer than the limited time offer, and we think this one did. Great. And then just on the competitive environment as it relates to new restaurant formation, there's been a lot of discussion around the surge in construction costs. Can you talk a little bit about what you're seeing more specifically on new restaurant formation from the competition, maybe more specifically independents? Are you seeing more newer restaurants being built? Or is there a pullback in development given the surge in construction costs? Any insight on that would be helpful. Yes, Peter, there are always new restaurants being built. The question is how many are closing to offset the new restaurants being built. As trade areas move, you're going to see restaurants open. But as we think about the number of units that have closed since pre-COVID, but it's still double digits. We're not seeing that number get smaller or bigger, right? So it's starting to level off a little bit. But some strong competitors still opening restaurants on a net basis. We are opening restaurants on a net basis, but we're not seeing a whole lot of net unit growth in total for the full-service restaurant space. Now as the construction costs start to weigh and as Raj mentioned, maybe you'll see a little bit about that. But I think the margins make it a little bit more challenging. Rick, you mentioned 4 of the brands that are running at all-time high internal guest satisfaction levels. What do you think is driving these record levels? And any sense of how this might compare to guest satisfaction across the industry broadly? Well, Lauren, I would say what's driving it is the things that we've been doing over the last few years. We talk about simplicity and how simplicity makes it easier for our teams to do what they do. And if they don't have a lot of different things they have to learn and execute, it gets easier. As we streamlined the menu over the last few years, as Gene even mentioned it a year ago, streamlined the menu, you have more items being -- fewer items being made more often. That means the team gets better at those items versus having these 1 or 2 items that you sell in a week. So that helps experience. Our team members have left to learn on the selling side because there's fewer items. So they get -- they understand the items more. Now what we've seen in our performance is our performance in our brands are getting stronger. We're not necessarily seeing the competitor situation move. They might have been flattening out or maybe a couple here or there have gone a little bit on the negative side. But our satisfaction, we're really proud of it. We're proud of both the internal measures and the external measures. And then finally, I will say we've made significant investments over the last few years in our food and in our people. and that will eventually show up in guest satisfaction, and it has. So we feel really good about what we're doing. And our brands having -- being #1 in all of the categories for Technomic, having a Darden brand being #1 in gets the first time ever. That's amazing news for us. And we're going to continue to do what we've done to improve satisfaction, to make it easier for our restaurant teams to do what they do and to invest in our people and invest in our food. Great. And just a follow-up on the holiday season. Gift card sales are generally pretty important for early calendar '23. Anything you can share on what you've seen with gift card sales so far this season? I see they're pretty consistent with last year. I don't -- I mean, again, there's also gift card sales, the day before Christmas matters a lot. So there's still a little bit of time to go. And then we haven't discounted. We -- a lot of -- before COVID, we used to have some offers for gift cards. We have stop doing that. So pretty much all of our big brands, we don't discount. We don't provide any additional discount to buy gift cards. So for us to see the strength we are seeing without any discounts, we feel pretty good. Just a follow-up on the capacity comments. I appreciate the detail on sort of net growth I guess my sense is though that there's growth coming from chains and shrinkage coming from independents. So maybe capacity, if you will, hasn't come down quite as much as unit count would suggest, given the chains tend to, I think, have bigger boxes and higher volumes. So I guess I'm just wondering if you have any kind of thoughts on that, this idea, there's this notion that maybe it's been more of the chains that have gotten hurt and therefore, there's still a fair amount of capacity out there being added. And then I just have a quick follow-up question on labor, that was, I guess, in line with expectations of the wage inflation, but we've been seeing such a moderation in wages, I guess, I'm trying to understand for some concepts, perhaps. So I'm trying to understand if there's maybe a difference across markets or geographical or segments, full service versus maybe limited service where statutory minimum wage increases have more of an impact. Just any color you can give on that because I would have expected, I guess, a bit more moderation there. Sarah, this is Rick. I'll take the capacity question and I'll give Raj to get the labor question. So on the capacity, you're absolutely right. We've seen more independents, which some -- in some places are a little bit smaller in total seats than the chains. But I don't know if you can get 11% of the restaurants to come out and have capacity in seats grow. We have seen the chains that still are -- still opening restaurants, but not at the level they were before, and it's not helping offset all of the other capacities coming out of the system. And with the inflation on construction costs and the margins that a lot of folks have, it's a little bit harder to open restaurants as Raj said earlier, we've actually walked away from deals even though they were above our cost of capital because we thought we had some better deals. We're not quite sure that everybody can do all of that and still get -- open their restaurants and still get the same kind of returns they were getting before. So long answer to your question, but capacity is impacted by what kind of restaurant is opening or closing. And you're absolutely right. The independence is generally a little smaller. Yes. And on the labor side, as you look at where we started the year, the hourly wage rate in our first quarter was mid-9. So I think we said 9.5%. Second quarter was 8.5%. So you saw like a full point change in the rate of inflation. We expect that to continue to go down maybe 50 basis points a quarter for the next 2 quarters. So we are seeing moderation Obviously, this takes time in terms of once you give somebody an increase, that's there, that impact for the full year. And then as we bring on new people, we are seeing that the -- there's not as much pressure on the starting wage as it used to be. It's still high. It's still way higher than pre cover, but it's not -- it doesn't continue to go -- it's not continuing to go up. And so hopefully, that answers your question. I just had 2 questions going back to kind of the food cost outlook. The first one as you move towards flattish commodity inflation or what have you in the fourth quarter, is there an opportunity to be a little more aggressive locking in where you can to improve that visibility on the cost side? Or are there still challenges doing that or maybe you think prices are going even lower. And so that's at play. So curious how you're thinking about that, number one. And number two, it seems like you're maybe a bit more optimistic on where food inflation is headed than some of the commentary from your peers recently. I know there's the food basket, there's timing differences. But I'm curious if there's anything else maybe that's driving that divergence in particular, I'm wondering if maybe this is the scale benefits playing out. So curious how you think about that as well. Andrew, there's a lot in there. So I'm more to try to just address all the pieces. Let's start with the ability to lock in I think for some products, we have that for some, we don't. Like if you think about beef, for instance, I don't think -- I think a lot of suppliers are innovating more. They want to see what's going to happen with supply and really understand the price. So at this point, very few suppliers are willing to last beyond 90 days. So that's truly a structural issue in terms of really the ability, I guess, on that. But there are other products where we can lock in, and we are locking in. So we are continuing to kind of look at wherever there's opportunity to lock in at a good price, we're doing that. That's why you saw that for chicken, for example, we're 90% coverage for the back half. So we did find a price that we thought was good and we -- and closer to flat to last year as we get into the Q4 of this year. So we lock some of that in. And so we are playing it by the year. Our supply team chain team does a great job kind of really thinking through the best strategy to minimize inflation for us while leveraging the relationships. Obviously, as you mentioned, scale helps. Our contracts are bigger, and that gives us the ability to have a little bit more leverage. And again, this is Big part of this is long-standing relationships our teams have built teams have built with the suppliers that help us get to a better number overall rate that we pay. Question relates to margin. And Raj, EBITDA margin has been up about 110 basis points, I think, relative to 2019 in the first half of the year, and I think your guidance kind of implies that the margin could be up 120 basis points or more in the second half of the year. I'm just wondering if you're expecting G&A to continue driving that improvement? Or are you looking for the restaurant margin to become a bigger contributor to the back half improvement? Yes. I would say that G&A actually the way -- because of the way we do incentive accruals, G&A is going to be probably higher in the back half than the first half. The restaurant-level margin should improve relative to pre-COVID in the back half versus where it was in the front half. But overall, if you step back, look at overall, your point is right. We do expect growth in the back half now. I'll point out that the starting point is way higher for the back half because our margins were very high in the back half to begin before cold. So we had more room to grow in the first half, and you saw that. But G&A, definitely, we expect G&A in the back half to be higher as a percent of sales than it was in the front half. And just secondly, the segment margin at Olive Garden, I think, compressed about 320 basis points year-over-year this quarter. Can you help parse out what drove that? And how much of it was intentional in terms of menu or labor investments? And how much of it was just due to inflationary pressure? It's really inflation. If you think about the 3 items I mentioned that have the highest inflation -- had highest inflation in the quarter, chicken, dairy, and we -- well, that's all has gotten for you. We got 20-plus percent. They have a little over 20% inflation on the commodities this quarter. So that -- when you take that into consideration and look at the fact that we only had 6.5% pricing at Darden level and Olive Garden, obviously, would be pretty close to Darden price in our price level. That's the biggest piece. And then one other piece I mentioned on the call was lettuce while we did not experience the same level of inflation as the general market, it was a big surprise. It was, call it, $4 million to $5 million impact in the quarter, that's meaningful. I was wondering, in the context of potentially slower market environment, what gives you the confidence to raise the outlook for same-store sales? And in particular, on which brands you are elevating your expectations. Well, so actually, let me kind of explain how we got there. If you think about our pricing we had in the earlier guidance was 5%, now we're at 6%. We raised the coupon of our sales by 0.5 point. So essentially, we're saying on the top end, we're actually brought down traffic by about 0.5 point. And then on the bottom end, we basically raised it by the full point, which kind of gets to that pricing. So that's really the driver of our change in guidance. then the costs out of the cost -- we have some visibility into costs and we have some ranges around the ones where we have some risk, and that's how we came up with this guidance. And can you also provide some context on perhaps the frequency of visits of your consumers by brand and whether you're seeing the frequency differently today versus historical averages, maybe by by some type of consumer cohorts or brands? No. I think look, our casual dining average frequencies and we call it in that 3 to 4x. And what we see with the core -- all of our brands are seeing over time, the investments we've made pay off and transmitting into a slight tick up in frequency. But again, this is a slow build. We always believe that we -- that's our bet is that this takes time. But we are seeing -- it is -- we're seeing signs of positive momentum. And I think is the fact that we outpaced the industry by over 500 basis points on traffic, tells you that things we've done over time are translating into some increased frequency. My question is on Olive Garden. I think you said it was outperforming the industry comp even before the launch of the ring Pasta, which I think is a change versus the last several quarters. And -- just curious, what do you attribute that to? Have you seen the lower end consumer trade down in recent months? Anything in your data there? Or maybe it's execution and guest scores that are starting to kick in and really gain traction on traffic maybe some other dynamic you might offer up. Yes, Brian. Oliver outperformed in Q1 as well. Just the outperformance got a little bit better. When you think about where we were last year, I would say that Olive Garden was probably more fully staffed than maybe some of the other brands in the first quarter of last year. And so other brands may have had a little bit of benefit from more team members. We continue to believe that the investments we made in Olive Garden will continue to pay off over time. And their staffing levels are back to where they were pre-COVID. There are improvements that they've made since pre-COVID in their food. And then finally, Olive Garden, California last year was a big jump for us, and we have a lot of restaurants in California, maybe there wasn't as much across the industry. And so -- that's why we believe that our gap to the industry got better from Q1 to Q2, even though it was positive in Q1. All right. That's helpful. And sorry if I missed it, but on pricing, what was menu pricing in the second quarter? And what's a reasonable expectation moving through Q3, Q4 on menu pricing, just how you're thinking about that? Yes, Brian, it was approximately 6.5% in Q2. And for the full year, we're saying it's going to be closer to -- so the way to think about it is Q3 is likely going to be low 6s, and Q4 is likely going to be closer to 5%. Guys, it's nice to see you coming back to brilliant with the basics. I mean, I think we probably first used that maybe 20 years ago or so. So it's definitely like a trade markable quote for you guys. And especially in the context of increased turnover. And I'm just curious in terms of like where you're seeing that, why you're seeing it first. Are you seeing some of the very high kind of unexplainable like fast quits like some others are? Or are you seeing -- is it a 6-month term over 12-month turnover 24? Is it happening in front of house, back of house? And is there anything that you can do to, I guess -- and the answer might be no, but can you make it a better job for them? And when they are leaving Darden, are they going to other restaurants? Or are they just going to other types of employment? Yes. I mean what is the -- I'm trying to determine what is you guys, what is the industry versus just what is the change in employee. Yes. No problem. Yes, brilliant with the basics. It's been here since the jelly days. I remember when that was coined a long time ago. So we've been talking about reeling with the basics for quite a long time. And we believe that we got a little bit more basic, which is the right thing, right? So simplifying our menu, we went to the basic things and we did that better. That said, if you think about our turnover today versus what it was pre coved a lot of the turnover, at least over the last 6 months was 90-day turnover, right? So you come in to start work and then you leave within 90 days. A big chunk of our turnover was during that time period. So we -- all of our general manager conferences happen in August. And the focus and theme August and September, I guess, the theme of those conferences were making Brand X Y Z an even better place to work. how do we continue to make the team member experience better by giving them the tools that they need to do their job, treating them with respect and listening to their concerns. Our turnover is improving. Now I think about where the turnover happens. It generally happens in more of the entry kind of jobs. Our higher turnover is generally in the host area dish area. And generally, in the kitchen, we have more turnover than in the front of the house. That said, we've just completed our engagement survey with Gallup, and we feel really good about the engagement in our team. and we're going to continue to make our brands better places to work by continuing to invest in our team and continuing to teach them and give them opportunities to grow. So where they're going? Don't know, right? So we don't necessarily do exit interviews for every hourly team member on where they're going. But I would guess many of them are leaving the industry. We do have a lot of people that come to work for us that a board for others. So I can't say that we don't have people leave us to go work somewhere else. And gosh, over an hour ago, you guys -- one of the first comments you made on the call was manager staffing, I think, at historic highs. I mean is that the GM and all assistant manager positions or -- just give a little bit more color in terms of the stability in that essential role. Yes, John, that is all manager positions in our restaurants. So General Manager, Well, general manager, it's a little bit harder to be all-time high, if you have one general manager for every restaurant -- that makes sense. But we're pretty close to that. So if you think about our restaurant manager staffing, it's at all-time high. We have more managers per restaurant today than we did before COVID. And part of it is because we are giving them opportunities to grow and we are proud of the fact that we do a lot of promotions from within. So when somebody knows the brand they're working for and they become a manager there, there's a little bit more loyalty to that brand. So -- and then the other thing, when you think about all the things we did during COVID, we made sure that our managers were we didn't really eliminate our manager teams during Cove. We kept them on because we knew how important they award to bring our team members back. And that's why we feel like we're well staffed and we're fully staffed to manage level. Just a follow-up to an earlier question. I think you said you expect total restaurant labor inflation to go down by 50 bps sequentially through the end of the year from the 7% that we saw in Q2, that would imply for the year something around 7%, maybe slightly lower than 7%, but your total inflation guidance is 7% with 8.5% commodity inflation at the midpoint. So just maybe reconcile how we get from the combination of where total labor inflation and commodity inflation guidance is versus the total inflation guidance. Yes. I think the point here is you have to look at other line items. So utility is probably in that mid-teens -- low to mid-teens. That's part of it. And then we are seeing all other costs being in the low to mid-single digits. So when you take that into consideration, the total inflation of is what we're expecting. So yes, you're right, total restaurant labor inflation is approximately 7%. And you combine that with 8.5%, the big point of that 8% to 9% on prudent beverage. And then utilities in that mid-teens and all other costs low to mid-single digits, that's how you get to 7% on the total. So we're talking about the total cost base. That includes everything. Got it. And then as we kind of think about the inflation gap versus food at home, the gap has been pretty favorable for restaurants for a few quarters now, and that's potentially narrowing and maybe even may reverse next year in terms of calendar '23. How are you thinking about the promotional cadence and the overall competitive environment as that grocery gap maybe even reverses. Yes, Nick, if you think about what people get when they go to a full-service restaurant, they get more than just the food. They get the experience. And that was -- that's what people are coming to us for. a great value already, but there's more than just the commodity that we put on the plate. It's all of the service, all of the other things that people get to do and being able to sit and spend time with their family and friends. And so yes, if there's a little bit of a shift in away from home versus at home, we still think we've got a great value proposition. That said, we're not going to get into what happens in promotional cadence happens, right? So if our competitors start doing significant discounting promotions, Can't say what I think they'll do. I just think their margins are -- makes it a little harder to do that. We're going to react the way that we've been talking about. We're going to continue to focus on driving our core guests driving profitable sales growth, and that's our focus for now in the near future. My first one is on the commentary of expecting less traffic than before. So taking the traffic assumption down by 50 basis points. And I just really want to understand what is driving that? It seems like the -- in the second quarter, it seemed pretty solid or not diversion from expectations. So are you -- the question really is your outlook for the next 2 quarters a little bit less than you were thinking before? We've seen when [Navtec] put out for November, the slight deceleration year-over-year but also a deceleration versus '19. So if you could maybe comment on that -- on the industry and what -- how concerned investors should be about a deceleration just on the industry-wide in November? Jake, I think you're activating too much signs to this method here because when we look at how we do this, the midpoint of our guidance is about 75 basis points higher than last time with 1% pricing. So really, what we changed the midpoint by 25 basis points on traffic. That's within the margin of matter of many models we build. I mean, I wish we only had a 50 basis point margin effect around our models. It's obviously a lot wider. I hate to admit it, but I don't think -- we're not experts at prognosticating this business on. So we're doing the best we can, and that's our best estimate at this point. Okay. And maybe just within that, if you could talk about just what you assume in your guidance for a macro environment. We're seeing, obviously, continued wage inflation. But if you build in -- others have talked about a modest recession or what have you. What is your basic framework on a macro perspective that's embedded in your sales outlook? Well, I think what we're incorporating is some potential shifts, changes in consumer behavior. That's why you have a range of 3 percentage points on traffic. If you look at the back half -- and if you look at -- translate that into the guidance range we have, that implies a range of 3 points, that is to accommodate potential changes in consumer behavior, but not a step change. And I said earlier, if there is a major step change, that's not really contemplated in our guidance. Great. And then a quick question on G&A as a follow-up. I believe the guidance kind of -- before you've been talking about $400 million as being a good number for the year. You're running significantly behind that run rate in the first half, you commented that you expect it to go higher. But just roughly, what should we expect for just G&A as a whole for the year in '23 -- fiscal '23? Thank you. At this time, it appears we have no further questions in queue. I'd like to turn it back to management for any additional or closing remarks. Thanks, Todd. That concludes our call. I'd like to remind you that we plan to release third quarter results on Thursday, March 23, before the market opens with a conference call to follow. Thank you for participating in today's call. Have a great holiday and happy new year.
EarningCall_1553
Greetings. Welcome to Tilray's Second Quarter 2023 Earnings Call. At this time, all participants will be in a listen-only mode. Question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded. Thank you, and good morning. By now, everyone should have access to the earning press release, which is available on the Investors section of the Tilray brands website at tilray.com and has been filed with this SEC and SEDAR. On today's call, we will be referring to various non-GAAP financial measures, which can provide useful information for investors. However, the presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. The earnings press release contains a reconciliation of each non-GAAP financial measure to the most comparable measure prepared in accordance with GAAP. In addition, we will be making numerous forward-looking statements during our remarks and in response to your questions. These statements are based on our current expectations and beliefs and involve known and unknown risks and uncertainties, which may prove to be incorrect. Actual results could differ materially from those described in these forward-looking statements. The tax in our press release issued today includes many of the risks and uncertainties associated with such forward-looking statements. Today, you will hear from key members of our senior leadership team. Irwin Simon, Chairman and Chief Executive Officer, Tilray Brands Inc.; and Carl Merton, Chief Financial Officer, who will provide a quarterly financial review as well as reaffirm our full year free cash flow and adjusted EBITDA guidance. Also joining for the question segment of this call are Denise Faltischek, Chief Strategy Officer and Head of International; Blair McNeill, President, Tilray Canada; and Ty Gilmore, who recently joined the team as President of our U.S. Beer Business. Thank you, Berrin, and hello, everyone. We appreciate you joining this morning and hope everyone had a nice holiday season and a great start to 2023. We head into this New Year with momentum and a real-line platform centered around three priorities to create the world's leading and most diversified cannabis lifestyle and consumer packaged goods company in the world across adult use medical cannabis, beverage alcohol and wellness consumer products. These priorities include pursuing our most profitable core business to drive growth now and over the long term which we're well on our way to realizing this. Maintaining our number one leadership position and growing market share in recreational cannabis in Canada, the largest [federated] (ph) legal market in the world. Maintaining our leadership position and growing market share in medical cannabis across Europe and a strong position to capture the adult-use market when legalization does occur, and winning in the U.S. despite delayed federal cannabis legalization, which we do not expect to happen at any time in the near future. we've invested in leading and profitable cannabis adjacent CPG lifestyle brands across craft-beverage alcohol and wellness consumer products that resonates powerfully with consumers that are ideally positioned in key markets. When federal cannabis legalization does occur, we will leverage our U.S. brands and business, their distribution and marketing networks to enter and capture opportunities by essentially creating a broad set of cannabis-infused and focus CPG brands. We are also, of course, diligently focused on optimizing our global operations while remaining that low-cost producer. And last but not least, strengthening our industry-leading balance sheet and driving our cash position because it affords us opportunities for growth, expansion, including through cannabis adjacencies within the context of economically uncertain environment. I want to emphasize the value potential of Tilray brands built on growth opportunities and our foresight to diversify both organic and acquisitive. I am confident in the fundamental potential of Tilray brands as the most diversified cannabis lifestyle company and consumer packaged good leader. We have already made notable progress in quarter two and exceeding against these priorities. As it is evident by significant improvements in operating cash flow despite a challenging top line performance, we have, of course, a long view generating free cash as an integral part of our business model, in turn, enable us to deliver on our highest priority delivering sustained durable shareholder value. Close observers of Tilray brands and our team know one thing, we moved quickly and decisively to adapt to the market changes. And I'm proud to highlight that even with the breadth of the platform and our sheer scale, we remain agile, pivoted quickly making smart strategic decisions and executed against them with our free cash flow objective accomplished. For example, during the quarter, we opt to build cash by temporarily slowing down production in our cannabis facilities because of the longer-than-anticipated march toward legalization in key markets. This included cutting headcount and reducing other operational costs. I want to highlight at the outset our bottom line initiatives, first, and our top line initiatives second, this is appropriate given the market and the incredible progress we have made to drive efficiencies and a [lead] (ph) built-to-last platform. I want to start this discussion with our cost optimization plan. We have already removed over $100 million of cash costs when compared to a year ago. These cost reductions, which I'll detail shortly, have guided us to achieving over $29 million of positive operating cash flow and $25 million of positive free cash flow this quarter. The components of this effort include cost synergies realized from the Aphria-Tilray business combination, which closed nearly two years ago, represents the starting point for building an efficient and agile foundation. Recall that our revised post-closure target was increased to $100 million from $80 million in cost savings, which, as of Q2 has been completed. Beyond the Aphria-Tilray synergies, we launched an additional $30 million cost optimization plan, of which we have already achieved $19.6 million on an annualized run rate basis to further solidify our status as the industry-leading low-cost producer. And finally, our robust balance sheet consists of approximately $433 million of cash and marketable securities, with over 70% of our debt set with fixed interest rates. This solid financial foundation enables us to be opportunistic in capturing market share across global cannabis and CPG adjacencies as we watch what unfolds with respect to legalization in the U.S. and elsewhere. Having discussed cost structure initiatives and our commitment to maintaining a strong balance sheet, I would now like to focus your attention to our potential to seize top line opportunities across both geographies and business lines specifically. In Canada, we maintained our number one market share position in recreational cannabis despite pressures caused by difficult operating conditions, ongoing price compressions and high excise tax, forcing both industry consolidation and a reduction in roughly 925 licensed producers that are operating today. Despite these challenging conditions, Tilray remains the number one cannabis market share position with an 8.3% market share in Q2. In Q1, Tilray led the next largest license producer by 54 basis points while in Q2, we expanded the lead to 176 basis points. Our share was up 28 basis points outside of Quebec. Recall that this data is sourced from Hifyre for all markets except Quebec, where we utilize Weedcrawler for more accurate reflection of the marketplace. We continue to build a thoughtful approach to innovation, quality over quantity. In Q2, we launched products in regions, segments and categories where we had gaps in our portfolio. We leverage our leading proprietary consumer research to ensure we understand clearly what consumer values are in those regions, segments and products. As an example of this, we relaunched RIFF flower, focusing on a segment where we had gaps in our portfolio. Moving forward, our thoughtful innovation will also be easier on the environment. In 2023, Tilray will convert all flower, vape, pre-roll packaging to hemp, diverting 158,000 kilos of plastic away from landfill sites. In Canada today, we have the leading internal capabilities in low-cost flower production infused and non-infused pre-roll automation, BHO, live resin, distillate, vape production and state-of-the-art beverage formulation and production and further manage overhead more efficiently, help stabilization and sustain Canadian cannabis industry, we have reached out to numerous industry partners to leverage our expertise low-cost environment and existing capacity in co-manufacturing partnerships. We understand the challenging nature of cannabis in Canada. Our investment in consumer insights, innovation, cost optimization and market-leading sales coverage have allowed us to be stable during a time of instability. From our vantage point, we think we're best situated to thrive as these dynamic play outs and we intend to stay the course for the long term. In Europe, we are seeing momentum across the continent that we expect to result in 27 countries working together to establish a collaborative effort on cannabis regulation. The EU has already embraced medical cannabis with broad scale adult use legalization expect to follow over the next couple of years. When this happens, we're strongly positioned to further seize on the opportunity. European cannabis business offers having built an unrivaled platform through our growing facilities in Portugal and Germany. The shift is supported by growing acceptance of medical cannabis for treatment of numerous conditions and followed by growing support for cannabis legalization of adult use as well. We believe we're exceptionally positioned to benefit from the meaningful economic growth that will come to our industry as a result of these positive changes because of our end-to-end EU GMP supply, which enables us to leverage existing assets to meet demand for medical and adult-use cannabis when legalization does happen. However, in the near term, our industry along with almost all others are contending with a difficult economic environment in Europe because of soaring inflation which is due at least in part to the ongoing war in Ukraine. This is affecting all key cost inputs, but particularly energy prices and is doing so negatively affecting consumer behavior. In Germany, our Tilray-branded medical business increased in the second quarter over the prior year quarter by 4% and 20% on a constant currency basis. In Poland, we completed our first two shipments of medical cannabis in Q2 and submitted additional doses for new products. In Italy, we expect to commence the distribution of our T25 medical cannabis extracts in quarter three. Consistent with our approach of all our businesses, we are relentless focused on both improving the quality and consistency of our medical cannabis products as well as our cost structure in order to be that low-cost producer in Europe. Therefore, we have developed a plan to take approximately $7 million of cost out of our European business. We strongly believe that our competitive differentiators in Europe are being that low-cost producer of high-quality consistent cannabis. Our integration of CC Pharma, our medical cannabis teams to enhance and improve our sales function with CC Pharma's strong pharma relationships, both in Germany and throughout Europe, bringing credibility to cannabis. Our regulatory expertise to navigate the challenging regulatory landscape throughout Europe will continue to solidify our leadership position. In summary, while there are some near-term headwinds, we view this as an exciting time for us across Europe. Anchored by our strategy, our people, assets and resources and the tremendous opportunity we see ahead. Turning now to the U.S. and our CPG portfolio. In the U.S., participation in the adult-use cannabis market has always been very important to us and integral to our long-term strategy. However, as long as cannabis remains federally illegal in the U.S. we will not engage directly in business that touch the cannabis plant to fully optimize the value and strength of our U.S. business we appointed veteran beer and beverage industry executive, Ty Gilmore as President of Tilray's U.S. beer business, a newly created position. Ty joined us from Glazer, beer and beverage where he served as an Executive Vice President since 2020. And prior to that, he spent the majority of his career at Diageo. As you may already know, SweetWater is the tenth largest craft brewer in the U.S. now available in 42 states, including most recently, California. Our past year SweetWater and our two iconic Southern California brands, Green Flash and Alpine have vastly expanded distribution throughout our partnership with Reyes, the largest beer distributor in the U.S. In November, we acquired Montauk Brewing Company the fastest craft growing beer and number one craft brewer in Metro New York. Its success has been driven by its loved product portfolio, premium price point and over 4,700 points of distribution including top national retailers, including Target, Whole Foods, Trader Joe's, Stop & Shop, King Colin, Walmart and 7-Eleven also Costco, BJ's and Speedway convenience stores. The Montauk Brewing transaction was immediately accretive to EBITDA, and we expect it will deliver strong revenue and adjusted EBITDA growth as we move forward. Additionally, we are already leveraging SweetWater's existing national infrastructure to significantly expand Montauk Brewing distribution network beyond its concentrated presence in the Northeast further driving Montauk growth across key national markets, including California, Georgia, Florida, Connecticut, and while rounding out the presence of our Craft-Beverage portfolio across the U.S. I'd like to briefly discuss our leading lifestyle Bourbon and Spirit brand business, Breckenridge Distillery. Despite headwinds in the spirits industry, this brand is poised for accelerated growth through Republic National Distributing Company with expansive distribution network on and off-premise retailers and customers across 38 states and the District of Columbia. Now turning to our wellness segment, which is a very important segment for us as we move forward. Our wellness segment continues to grow its branded hemp food business, Manitoba Harvest in quarter two and Manitoba Harvest is the world's leader in hemp-based foods where product distribution across 17,000 North American stores and present in 15 established international markets. The Manitoba Harvest brand expanded its U.S. market share leadership position in quarter two continued to deliver a better than 50% dollar share within branded hemp seed and growing over 10% and in multi-outlet retailers in the last 12 weeks reporting. Manitoba Harvest is now delivering dollar growth in each of its top 10 U.S. retailers, Whole Foods, Sprouts, Walmart and Kroger. Manitoba Harvest market share in Canada remains near 80%. The drivers of growth include distribution expansion, a strong innovation pipeline and pricing put in place in quarter two and coupled with our increasing consumer interest in hemp products given the key role they can play in plant-based, low carb and keto diet. Tilray wellness will be launching a new CBD wellness beverage Happy Flower via direct-to-consumer e-commerce platform in early 2020 through our partnership with Southern Glazer, the leading distributor of beverage alcohol and CBD beverages in the U.S. we will look to expand the brand into key markets throughout 2023, focusing on states where CBD is permissible. In short, we continue to build out our wellness business of hemp foods and beverages with more to come. And with that, I will now turn the call over to Carl Merton, our Chief Financial Officer, to discuss financials in greater detail. Carl? Thank you, Irwin. Our focus on operating efficiency or adjusted EBITDA and free cash flow have always been critically important, but even more so in today's economic environment. As we balanced our business decisions between adjusted EBITDA and free cash flow in the past, we often chose adjusted EBITDA over free cash flow. In the current year, our focus has shifted, and we are prioritizing free cash flow even if it occasionally comes at the expense of adjusted EBITDA. These decisions are evidenced through our ability to generate positive operating cash flow of over $29 million on free cash flow of almost $25 million in the quarter, an almost $50 million improvement from the same period last year. Before I review our quarter, let me first remind everyone that our financials are presented in accordance with U.S. GAAP and are in U.S. dollars. And throughout this call, we will reference both GAAP and non-GAAP adjusted results. Our earnings press release also contains a reconciliation of our reported results under GAAP to the non-GAAP measures identified during our remarks. For the quarter, net revenue was $144.1 million, down 6% from the sequential quarter of $153.2 million and down 7% from the year ago quarter of $155.2 million. These declines are due to lower net cannabis distribution and wellness revenue that were only slightly offset by higher beverage alcohol revenue. Similar to recent quarters, our revenue income and adjusted EBITDA are being impacted by the strength of the U.S. dollar, particularly given our largest revenue sources currencies are the euro and the Canadian dollar. On a constant currency basis, our net revenue rose slightly to $157.6 million with our distribution and beverage alcohol businesses also up in their base currencies compared to the year ago quarter. Reported gross profit was $40.1 million, a 22% increase from $32.8 million in the year ago quarter. Adjusted gross margin held at 29% and despite the reduction in net revenue. This was made possible by our success in implementing numerous cost savings programs, offsetting part of our allocated overhead from intentionally reducing production coupled with the revenue realized from our HEXO transaction. Net loss was $61.7 million compared to a net loss of $65.8 million in the prior quarter and net income of $5.8 million in the year ago quarter. Our adjusted net loss improved to $35.3 million or $0.06 per share compared to $45 million in the prior quarter and $38.8 million in the year ago quarter. Reported adjusted EBITDA was $11.7 million, down 15% from $13.8 million in Q2 last year. Still, we were able to extend our track record to 15 consecutive quarters of positive adjusted EBITDA. The decrease was due to the negative impact of our cannabis gross margin as well as an increase in bad debt expense. As we have stated over the past several quarters, we are keenly focused on being free cash flow positive, and this is evidenced by our significantly improved operating cash flow during Q2 and even if it resulted in a reduction in adjusted EBITDA. Further, absent the onetime charges we took in the quarter for the return allowance and existing business relationships, adjusted EBITDA would have been $14.8 million up $1.3 million from the prior quarter. Turning to our business segments. Gross cannabis revenue was comprised of $6.4 million in Canadian medical cannabis revenue. $52.4 million in Canadian adult-use revenue, which marks 5.7% growth from the prior year quarter, $7.7 million in international cannabis revenue all offset by $16.8 million of excise tax. This resulted in net cannabis revenue of $49.9 million, representing a 15% decline from the year ago period, largely related to reductions in international cannabis revenue, including a charge of $3.1 million related to international cannabis returns, which we do not expect to reoccur. On a constant currency basis, the decline was only 11%. The decline in the Canadian dollar and the euro resulted in $2.3 million of the revenue decrease compared to the prior year quarter. Cannabis gross profit increased 37% to $18.6 million from $13.5 million in the prior year quarter, while the gross margin percentage increased to 37% from 23%. In Q2, we also recognized a one-time sales return adjustment, which reduced our top line as well as an inventory disposal incurred as exit costs from both Israel and Uruguay. Together, these had a combined impact of reducing gross profit by $4.2 million or gross margin by 7.5%. Also impacting the decrease in the adjusted gross cannabis margin is a shift in strategic priorities to focus on pursuing cash flow-generating activities previously discussed. We consciously desired to lower production in our cannabis facilities as a result of slower-than-anticipated legalization globally by reducing operations, reductions in headcount and other operational costs and continue to assess other cost-saving initiatives. We view these activities as temporary as supply requirements stabilize in the Canadian cannabis market and as European cannabis markets proceed with legalization. Distribution revenue, which has derived predominantly through CC Pharma, declined 13% to $60.2 million from $68.9 million in the prior year quarter. This was primarily impacted by the strengthening of the U.S. dollar relative to the euro. On a constant currency basis, revenue would have actually increased 3% and to $71 million for an additional $10.8 million of revenue. Adjusted distribution gross profit increased to $7.7 million from $7.6 million in the prior year quarter. While distribution gross margin increased to 13% from 11%. This was the result of a positive change in product mix and our focus on higher-margin sales including the decision to exit the medical device reprocessing business line. Looking ahead, we think we can continue to drive larger business profit margins despite not increasing revenue as we approach full utilization of our facility. Turning to our beverage alcohol segment, we generated $21.4 million in net revenue, which was 56% higher than the prior year quarter of $13.7 million. This was primarily due to our acquisition of Breckenridge and the Green Flash and Alpine beer brands in December 2021, coupled with our more recent acquisition of Montauk in November 2022. We remain bullish on expanding this segment over time as we leverage our increased distribution, regain brand acceptance with Green Flash and Alpine, Foster brand acceptance with SweetWater in California, build out an extensive innovation pipeline and, of course, potentially pursue other acquisitions. Beverage alcohol gross profit increased 28% to $10 million from $7.8 million in the prior year quarter. Adjusted gross profit, which includes $1.1 million in purchase price accounting step-up rose 42% to $11.1 million. However, adjusted gross margin of 52% decreased from 57% in the same period in the prior year. This decline is a result of the SweetWater Colorado expansion, which is still in the startup phase of operations compared to last year when the expansion had not yet begun. Also, the Breckenridge and Montauk acquisitions were not completed in the prior year comparison and operate at a slightly lower margin than SweetWater. Finally, for our wellness segment, revenue decreased 8% to $12.7 million from $13.8 million in Q2 last year. Adjusted wellness gross profit was $3.9 million up slightly from $3.8 million in the prior year quarter, while gross margin increased to 31% from 28%. Turning back to the topic of free cash flow, we took steps during Q2 to pivot from business lines in both our distribution and European cannabis businesses that were no longer accretive so that we can focus on areas of the business that generate positive cash flow. This, along with the strategic decision to reduce production in our cannabis facilities have provided the necessary cash savings to achieve free cash flow of almost $25 million in the quarter, A roughly $50 million improvement from the same period last year. Our cash, cash equivalent and marketable securities balance as of November 30 was a healthy $433.5 million, a more than $100 million increase from the year ago period. Our working capital balance, which allows us to meet our operational and capital requirements decreased to $388.2 million from $393.4 million over that same time horizon. For fiscal 2023, we are reaffirming our expectations of generating $70 million to $80 million of adjusted EBITDA and being free cash flow positive across all business segments for the year. In conclusion, I am focused on improving our industry-leading balance sheet, continuing to reduce our debt thriving free cash flow, aligning product with demand, minimizing CapEx and properly aligning our expenses with revenue expectations. With that, I will conclude our prepared remarks and open the lines for questions from our covering analysts. Afterwards, we will take a few questions from our retail shareholders through the safe platform. Operator, what's the first question? [Operator Instructions] Our first question is from the line of Vivien Azer with Cowen & Company. Please proceed with your question. This is Victor Ma on for Vivien Azer and thank you for taking the questions. So first off, based on Hifyre trends ex-Quebec, it seems like that the share recovery is continuing as you gained dollar share sequentially in 2Q. But there are still some losses in pre-rolls and vapes, I know innovation will address these losses over time. But can you maybe offer some color to dimensionalize the headwind from legacy pre-rolls and vapes SKUs, and then the tailwind from new SKUs and also comment on the stickiness of new innovation? Thank you. So I'm going to let Blair jump in here because he's on the call with us to talk about it. But I think a lot of it has to do with timing and when we're able to get these products into the different provinces. And Blair will tell you how many new products that we have and the timing. Blair, you want to jump in and just go through what's happening with vapes and pre-rolls, and just how many new products that you have coming out? Yes. Thanks, Irwin, and thank you, Victor, for the question. Certainly, what we've noticed in vapes, I'll start there, is the higher potencies and fruit forward nature of vape. So, we definitely have a plan to build up on the potency side. And to Irwin's point, you'll see over 150 new listings from us in vapes and pre-rolls over the next two quarters. On the pre-roll side, you're really moving to fruit forward infused pre-rolls, really stealing share from traditional pre-rolls. We have some big news coming in Q3 and Q4. Good supply that you'll see us be very consistent with that trend. And then just a comment on your -- the stickiness of innovation overall, if you look at Q2 in Ontario alone, there was 859 new products in a market that was sequentially at least from a quarter standpoint, flat. So there's definitely some dilution of SKU productivity moving forward. We're calculating that into our innovation pipeline. We're cognizant of the dilution effect of that, and we feel very confident that with leveraging our insights, leveraging our category dynamics and leveraging our coverage model will be very strong in these categories over the next two quarters. Thank you, Blair. Victor. Just let me emphasize two things. We have the number one share. We're 176 basis points ahead of our closest rival, number one. Number two, this year versus last year in our revenue it's almost $12 million of price compression where prices have come down over a year ago. And I think as we see the market settling out and Blair has a plan in place between new innovation, new distribution, taking share and potentially other acquisitions in the Canadian market, how he gets to a double-digit share back in that marketplace. So listen, yes, we lost some share. I think it's timing, but considering what price compression considering the marketplace, I think where Tilray is situated in Canada today is in a very, very good place. And the innovation that is coming out is tremendous, and that should help share and growth overall. And just pivoting to beverage alcohol for my second question, with down trading in beer and wine apparent in Nielsen’s scan data. Just curious, if you've noticed consumer weakness in your beverage alcohol portfolio and could you remind us of your annual pricing algo for SweetWater and Breckenridge and now also Montauk? Thank you. So again, I'll just switch it over to Ty for a second, but we're still from SweetWater, the 10th largest craft brewer in the U.S., Montauk, which we just acquired in December is the number one craft brewery in New York City, tremendous brand and basically only sold in New York with some sold in New Jersey, Connecticut and [put in these] (ph) together. From a pricing standpoint, and I'll let Ty talk about it, there is some pricing opportunities. We probably have been a little slower on taking price increase, but it had to endorse some of the higher costs. From a Nielsen standpoint, I think we've picked up some distribution. Recently, we picked up a lot from a Kroger standpoint. So, Ty, do you want to jump in here for a second and introduce yourself? Yes. Thanks, Irwin. Good question, Victor. Yes, we're definitely -- there is some down trading going on, but we're also seeing some consumer trade up going on across several segments, super premium domestic Mexican imports, flavors and higher ABB. So, we continue to see some tailwinds with the space that we operate in and expect as we go into Q1 of 2023, that there will be continued pricing opportunities that we're going to take advantage of, both in the on and off-premise, which will be beneficial. And there is also a major pipeline. And one of the things we've done in SweetWater and Montauk is now on our timing of when we can launch products. And we have numerous new products that will be launched as we move into the spring. We have our 420 Fest, which is coming up so there's a lot of event marketing based around our beer business. The other thing, Victor, just something you mentioned, we've seen some nice increase in our Breckenridge Distillery, our bourbon business, some great increase in our vodka business moving over to RNDC and some of the new distribution. So, we're quite happy, and you can see we're up nicely on our beer and our spirits business quarter-over-quarter and year-over-year. Two questions for me. So first of all, you called out that we grew international cannabis business in your prepared remarks. Could you perhaps break down the factors driving this in more detail on how we should think about this part of the business performing in the remainder of the fiscal year? And my second question, nice to see the Canadian adult use sales actually growing year-on-year. Could you break down this growth between volume, mix and price since there's a lot going on there? And how are you thinking about that over the coming quarters? Thank you. Great. So number one, let me -- I'm going to switch over the piece on Europe to Denise, who runs our European operations. But I think listen, a lot going on in Europe, whether we can blame it on the war, we can just blame it on the economy over there. We can blame it on in regards to cost. But I think as we're situated in Europe today, with our facility in Portugal, our facility in Germany, where we sell in over 20 countries from a medical standpoint, we're well situated. We spent a lot of time in Europe, and you heard me say how much costs were taken out, some of the countries that we're going to deemphasize. Do we believe legalization is going to happen in '23? No. Do we believe it will happen sometime in 2024? Yes. But we've now combined our businesses in Europe to one business unit between our CC Pharma, which is our distribution business into 13,000 drug stores and our operations in Portugal and our operations in Germany. So, we have a strong business in Europe with distribution with brands [with grow] (ph). Unfortunately, controlling - legalization is not something that's in our hands, but it's something that we're going to focus on how we grow our business. Denise, do you want to jump in and add to that? Yes. Thanks, Irwin. So just building on what Irwin said in terms of our business in Europe, very strong business in Europe. As Irwin mentioned, deprioritizing certain countries. We really, in the last few quarters, as we've talked about in the past, we've made some active decisions to not pursue certain revenue in Israel, given the volatile market that is currently going on in Israel. And if you look at the quarter the prior quarter last year, we had about $4.6 million of revenue in the prior year quarter as it related to Israel sales. So, we are deprioritizing certain markets in lieu of chasing more profitable and sustainable business. And just building again on how confident we feel in terms of Europe, while we are very much closely following adult-use legalization efforts by Germany, we are also very confident that even in the absence of adult use, we are still very well positioned to win in the medical business. We are -- with our CC Pharma business, we have credibility when it relates to medical cannabis. And as we pursue doctors and pharmacies, we take that credibility with us when we visit with them. We are also well positioned with our two EU GMP facilities one located in Germany, one located in Portugal. And the medical market in Europe is going to be a $13.8 billion market by 2028. So, we do feel very, very confident about the business. And I think as we look at Europe, I like Europe as opportunistic. I think that there's over 600 million people. There's a big population there. And if you come back and think no different than the U.S. Europeans want cannabis legalized, okay? And I think it's just working through the EU, and I'm sure if Ukraine didn't happen. Germany might be legal today, but we're ready and will be ready. And we're going to look at other business opportunities in that European market because we got that infrastructure. We've spent a lot of time have taken a lot of cost out, have streamlined our business with our facilities in Portugal and Germany, we're looking at other opportunities there where we can grow and we're profitable there, and we're going to look how to grow that business. In regards to your second question in regards to our mix and volume, listen, in Canada, flower is still number one. The good news is the Canadian market is really the only market in the world where adult use cannabis is legalized, okay? And from a positioning standpoint, we're well positioned with our growth facilities. We have 12-plus brands. We have tremendous innovation there, and that's the key to that marketplace. And you're going to see a lot of falling out of that market with other LPs. It's a tough market to do business from an excise tax. We still spend $1 a gram. We paid as a company over $120 million in taxes in Canada last year, an excise tax in the last two years. We paid almost $0.25 billion. So, it's a tough market, but again, it's the only legal market. And whoever wins there, which we believe we're going to there's big opportunities. Blair, do you want to just talk about your mix and pricing from a standpoint in Canada? Definitely. Thanks, Nadine. Yes, you've largely got it right or when in terms of the dynamics in the marketplace. I would say, just in general, you can look at a year ago there was over $12 million in price compression in the market. So generally, you are seeing volumes on the Tilray side go up relative to the industry, although those segments definitely are experiencing a lot of price compression. So, from a volume standpoint, it's really driven for us by the resurgence of our flower business. You'll recall that I talked on earlier calls about having 46 strains in alpha and beta programs that are now commercialized that are now starting to hit the marketplace. So we expect to have a real pipeline of flower moving forward. And to Irwin's point, flower is still the biggest segment. It's about 40% of the total business. So we continue to have a very robust pipeline of innovation, but also of genetics for flower moving forward. And I think the thing is -- I think the big thing -- I'm glad I largely got it right, Blair. But I think the big thing is, we now have the facilities to grow and taking those costs continuously out. And you heard us mention in the quarter, we're going to run these businesses and drive them for cash. And that affected our EBITDA because we have all these fixed costs. And we will be out there looking to sell cannabis to other LPs. We'll be out there looking to grow for others, but we are that low-cost producer there and that's something we're going to focus on. The other thing is we're going to focus on innovation and what's new. And that's sort of what drives a lot of the growth in Canada is new innovation. Got it. If I could just squeeze one more, given that you mentioned that on Germany. What are you seeing with regards to adult legalization about use legalization in particular with a focus on the EU commission when you think it could be a realistic outcome? Thank you. Yes. So we originally expected that we might see adult use legalization take effect as early 2024, based on where we are, I think we view that it might be later in 2024 than originally expected. And I think if Germany could make that decision for Germany without the effects of the rest of the yield, it would happen much quicker. But as we all know, borders are open. Once it's legal in Germany, how do you stop it from going to other borders are some of the biggest issues there. So -- and listen, we have a plan in place, how do we expand our medical business. And ultimately, that is partially recreational in Israel and other countries today, even though it's sold as medical the biggest percentage of the use is in recreational. I'll ask one question this morning, just kind of multipart, I guess. Looking at the sequential -- you've reiterated EBITDA guidance for the year, $70 million to $80 million. Regarding the step-up that you need to achieve that in the second half, could you walk us through the, number one, incremental cost savings I get the bad debt expense isn't going to repeat. The Canadian adult use was shipments well below consumption give us any idea of the magnitude of what that hit was? And then incremental EBITDA from Montauk in the second half as well as kind of give us a reminder on the seasonality of beverage alcohol? Thanks. Thanks, Andrew. Just trying to walk through as many of those pieces as I can. There was about $3.1 million impact on sales in the quarter related to the return. We had about $4.2 million that was came out in my script on the slowdown in production, which is the -- effectively unabsorbed overhead. And then we see all of the optimization plans, the majority of those benefits are coming late in Q3 and Q4. And so, we had the $100 million from the Aphria-Tilray optimization plan. I think we've got about another $20 million of that that has to hit the income statement still. It's been achieved just the full year savings hasn't flowed through on the Aphria One optimization plan or the Canadian cannabis optimization plan that's $25 million in total. The vast majority of that was back-end loaded as we got systems in place to be able to realize those savings. And then, we have the continued impacts of HEXO. And Andrew, I think the big thing is, as Carl was saying is a lot of our cost savings are back-end loaded. There's additional cost savings coming out of Europe. In regards to beverage alcohol, our beer business is back end in regards to sales there and same with our bourbon business with RNDC, now getting into distribution expansion in more and more states. But back to your point, we talked about it before, Canada has a major plan in place with a lot of innovation, a lot of growth in its back half, and that's a big part of it. So, it's about growing our volumes, growing our distribution, managing our costs. And I can tell you, we've done a great job of taking our costs out of the business with the free Tilray was over $100-plus million. We've stepped up again as we look at Europe right now and taken out another $7-plus million. We've taken out other costs in the Company, getting cost savings working with HEXO, but the key is getting that growth in these marketplaces and volume is ultimately what's doing that. And being that low-cost producer in our growth facilities is very, very important. So, it's a combination of all those -- as you know, things do happen up there. But as we look into our crystal ball, that's what we see today. So just for me, I want to talk a bit on M&A opportunities available to you, specifically in Canada, as you mentioned, you're getting back to double-digit share in your prepared remarks. You talked about the tough market doing business there for excise tax, obviously impacting a lot of the smaller players in addition to yourself. So just want to know if there's any more attractive opportunities that you've seen come up in the market. There appear to be an increase in CCAA. So from your standpoint, are you starting to see somewhat of a shakeout come for you guys might have more M&A opportunities available and then maybe different parts in the supply chain that you might see those in the Canadian sector? Thank you. So, in the Canadian sector, absolutely, I think we have two major facilities in Leamington, Ontario. And what you heard us say before, it affected us from an absorption standpoint, there's a cash benefit to it, but bringing more and more grow into our facilities is absolutely very much accretive to our gross margins and accretive to our earnings. It also -- as competitors come out of the marketplace, there's less competitors out there and it also helps with some of the price compression. So absolutely, it's got to make sense. It's got to fit within our growth facilities and it's got to be accretive to Tilray and its Tilray shareholders. So we're very interested. Listen, the Canadian market is the only market out there. It's a $10 billion projected growth at retail. It's still a big market and it prepares a lot for when legalization does happen in the U.S. And just to step back, you only asked me about Canada, as you see in our headlines today, is we don't rate and house anywhere in the near future, legalization happening in the U.S. We very much like beer and spirits business with great margins in those businesses. We see great growth opportunities. We have an excellent management team both with Brian Nolte and with Ty Gilmore now in running those businesses. And we'd love to find some more Breckenridges or some more Montauk and SweetWater. We're now also focused on that wellness business. We've been very successful with Manitoba Harvest. And we think with that, from an acquisition standpoint, the whole wellness area is an area we're going to focus on and look at acquisitions there. And upon legalization, there will be foods that will be infused with hemp. There'll be foods that will be infused with THC. And that's why the name of the Company is Tilray brands. We're a diversified company focusing on adult-use cannabis, medical cannabis, beer, spirits and wellness products. And we, as a team, have a lot of experience in that. So there's a major focus on additional acquisitions and to diversify this company. Because we don't know when legalization is going to happen in the U.S. and we want to grow this business as we've always said out there. Well. I just wanted to come back to your comments around exploring manufacturing partnerships with other LPs in Canada. And you said, I believe, if I heard correctly, you've been reaching out around this. Could you maybe give some more details here what these agreements would look like exactly? Have you had any initial interest? And then obviously, you're able to do this due to spec capacity in your facilities currently, what would happen when demand increases and you perhaps need that your own product again. Thank you. So I'm going to let Blair answer that because he's the one out there doing that. But let me tell you something. We have the ability to grow in our facilities over 265,000 kilos. We have facilities in the West Coast in Vancouver, and we have other facilities that we've taken down since the Tilray acquisition. So right now, I'm not worried that we run at the capacity -- and let me tell you something to fill it up to 265,000 kilos will change our financial lease tremendously. And with that, we have the ability to grow. The other thing is we look at facilities today, there's food shortages in the world have let us tomatoes, strawberries. And we're looking at utilization potentially where do some of these facilities if we have. We're overcapacity, how do we start growing fruits and vegetables in some of these facilities and supply food to the world where there's major shortages and there's price opportunities there. So, one thing I want to make sure is where utilization assets. We're giving cash, we're generating cash, and we're growing the Tilray brands company. Blair, do you want to address that in regards to some of the stuff that you're working on in Canada? Yes. Thanks, Irwin, and thanks, Owen, for the question. Very fair, Irwin hit it right on the nose. We've got a tremendous amount of capacity on the flower production side at a low-cost opportunity. We've got beverage capability. We have vape capability not just distillate vape, but BHO live resin. We have just a tremendous facility. The team has done an unbelievable job of building world-class facilities that can operate at a very low cost. And we know in the industry today, a lot of our competitors are focused on survivability and not sustainability. So for us, it's an opportunity, I think, to utilize some of our excess capacity and help our industry thrives and get to that $10 billion industry in Canada and $100 billion globally. In terms of the conversations, yes, they're very productive, fruitful. There's a lot of interest. We've got a few different LPs that we're talking to today as of right now. And I think we'll partner up in the near future with those opportunities moving forward. It's a relatively simple question. It's on the guidance, which implies a pretty significant step-up in EBITDA even if you account for Montauk -- and you some of the cost measures you have underway, but I wonder, can you get to the EBITDA guide with the current level of revenue? Or does your guidance assume some pretty meaningful sales growth. So if you remember from the start, John, we talked about the onetime sales adjustment that we had. So obviously, we're using that more as a base than the 144 that was in our financial statements this quarter. But the answer to your question is, yes, with the cost savings we have coming with the addition of Montauk with the $7 million cost reduction that we're looking at in Europe, more than half of which will be achieved by the end of the year. We see that as the basis for reiterating our guidance. I wanted to come back to a comment you just made about some of the capacity and how to think about opportunities there. And you mentioned things like fruits and vegetables as an opportunity. But you also had just a little bit earlier reiterated how you think about the Company's name and Tilray brands and you don't really see branded produce, at least not with kind of any margins and there's not any of those companies who have multiples that are really interesting. So you also touched on just some of the fixed costs as a consideration for EBITDA. And I guess, maybe instead of trying to be a farmer would you just rationalize more capacity? How do you think about weighing those trade-offs? So, I think there's multiple going into it. I think we're working on a plan on rationalizing our facilities versus and then how do we focus on our brands and is there two businesses here, et cetera. So I think as we come back today, utilization of facilities is important today for us. We're not going into the branded vegetable business and don't take that away for a second. But one thing I want to make sure is we have facilities out there that we've invested a lot of dollars into their world-class facilities. And getting utilization, if you look at it just in this quarter, our amortization on our facilities, in the $30 million, $40 million range, okay? So we got to make sure we're utilizing our facilities to grow something out there and hopefully it's cannabis. But we don't want them to sit idle. And we're again, sitting here looking at multiple opportunities as these facilities are world-class. So that's what I'm saying, and there's lots of things that we're looking at to do with these facilities, but growing cannabis is first and foremost for us and growing branded cannabis is first and foremost for us, being in diversified businesses, whether it's spirits, beer or other wellness products is what's our priorities. We're not out there saying we're going to become farmers. So I guess maybe can you just clarify how you thought about that? Is it, I mean, I think you pointed to it as an opportunity? Is that maybe just under the right circumstances or as a temporary kind of bridge? Under the right circumstances or as a temporary bridge ultimately to make sure our facilities are being utilized. That's what's the important thing here, and they're contributing cash sitting there idle, doesn't contribute anything just contributes cost. And we, as a company, are focused on driving our top line, driving our growth and utilizing our facilities to contribute cash. Look, two questions. The first one, just remind us how you're thinking about the target of $4 billion in revenue by fiscal year '24. I suppose that's being delayed. But without holding you to it, I suppose that there were different pieces you had talked about they are North American cannabis, Canadian, U.S., international, CPG wellness. Does that mix change? And the reason I'm asking the question, given all the delays and legalization you're talking about, could there be a scenario where you decide to bulk up the branded, high-margin beer and alcohol business, right? And I'm not saying you want to buy Molson Coors, but would we have a scenario in '24, '25 that we had an alcohol account for 90% of our Tilray brands revenues? And the second question and I know it's hypothetical. If we go about what Canopy growth has said, that if NASDAQ doesn't allow them -- doesn't approve the Canopy U.S.A. structure, they would potentially the least and just remain listed in TSX. Would you consider following -- and they start buying U.S. assets on the Canopy side, that could put you in a disadvantage potentially, right? So if they were to get -- if they were to do that, start buying U.S. assets delis from NASDAQ remain in TSX, would you consider a similar move just not to be a disadvantage when they are buying U.S. assets and you are not? Thanks. Pablo, thank you. Good questions here. Number one, I've said before the $4 billion mark and set that out that I believe legalization would have happened in the U.S., and I believe legalization would have been a part of Europe, and I always make sure that it was contingent on legalization. Listen, the spirits business has been a very good business for us so far. It's very profitable, good margins, other companies, whether it's Constellation or Diageo there. I like their multiples, I like their margins. And I think one day, and as I've been out there meeting with alcohol distributors and other -- everybody is focused on cannabis because they realize one day upon legalization, the cannibalization in the whole Spears beer business is going to come from cannabis. And trust me all these major alcohol companies have an eye on cannabis, no different than the tobacco companies. So with that, if I today can't do anything in the U.S. and have to sit there, why not get bigger into some of these craft brewers like a SweetWater like a Montauk, like a Breckenridge like we did. And you know what, I like the wellness area. You know my past in the wellness area. So with that diversify our portfolio with adjacencies. So we can't buy cannabis assets. We can't grow cannabis assets in the U.S. And right now, look what's just recently happened in New York in regards to valuations, how they've come down. On the other hand, the store that opened in Manhattan here with lines and lines and lines around the corner, you see the demand for it. You walk down the streets of Manhattan. You smelt cannabis on every corner there. So with that, absolutely, we're going to look to grow. And I'm very clear in our headlines of our press release today. We're going to diversify this company into multiple categories that have adjacency to the cannabis business. And no, we're not out there buying Molson Coors, but we want to be that large craft brewer out there that owns multiple brands like we did with SweetWater Lake. We did with Green Flash like we have with Montauk like we have with Breckenridge and looking at other spirits businesses and like we have with Manitoba Harvest. So, you're absolutely correct on that. Your second question. Your second. No, no, no. I got -- no, I just. No, I was going to answer your second question. Listen, right now, being on the NASDAQ is important for us, having the trading volume, having the shareholders that we have -- right now, it would not be of interest to us to be exiting the NASDAQ and moving to the TSX or an exchange that allows us to own U.S. assets. And if Canopy does it, good luck to them. But right now, our focus is to diversify our business grow where we have strong, strong cannabis opportunities in Canada where we have strong opportunities in Europe and grow our consumer packaged goods business because one day, you will see beer with THC and in the U.S., one day, you'll see spirits with THC in the U.S. And if anything, where is the cannibalization going to come from, it will come from the spirits businesses. So our focus is not to move away from the NASDAQ now. Just wanted to pivot back to the M&A side of things, particularly in the U.S. So clearly, you guys have had a very specific strategy of acquiring adjacent businesses to THC that are self-sustaining, but when you look at some of the other deals that have been done in this space for sort of optionality. I know that the deal you guys had done with MedMen, there were some financial cash flow considerations to that that may make sense. But do you think just given the frustration of nothing happening at the federal level, changes your view on how to allocate capital or how to position yourself given some of the headlines or lack thereof in December? And then also just Irwin on your comment of anticipating a legalization event in 2024, do you think that's more likely from what Joe Biden had said with respect to some of his initiatives? Or do you think something could actually happen in this new Congress, which is now split? So, I wish the speaker of the house cannabis was one of his focuses, but it's absolutely not. Listen, I come back, and I've said this before, we are not going to buy options and by pieces of U.S. companies. There's a lot of good things happening with MedMen and we're excited about how the cleanup has been going there and what is ultimately happening. And upon legalization, we'd be very interested in having that asset as part of Tilray upon legalization. In regards to legalization, listen, I'm frustrated that legalization or nothing, whether it's safe bank, whether it's Mor-Act whether it's de-scheduling, whatever, nothing has happened within cannabis and almost all the different faces out there. So with that for our business, we got to focus on Canada, where it's legal. We've got to focus on Europe today and change some of our strategy in Europe, which we're doing upon legalization, but focus on that medical business, but there's a whole third market out there where they're using cannabis as recreational, but buying it from the medical market and really focus on integrating now our CC Pharma business from a distribution standpoint. We've been successful with SweetWater. We've been successful with Breckenridge. The Montauk was a great asset for us to buy these niche beer businesses. And we've seen a great turnaround in our wellness business. So right now, in the U.S., we're going to focus our acquisitions on buying adjacencies to the cannabis business. And if it's '24, '25 or '26, we're not depending and sitting here waiting for Congress and the Senate to make decisions, and that is ultimately the results of going to affect the results of our business because I don't want the effects of the results for our shareholders and our business be affected by politicians in Washington. Just on the price environment in Canada, in 2022, we continue to see price compression. And obviously, as you mentioned, it has been almost unsustainable with excise taxes and so on. So my question is, do you expect any significant shift in Canada in 2023 in terms of pricing what could be the driver there? Is there any chance of that happening? Or do you believe that sort of price pressure will persist in 2023? Thanks. So, I'm going to answer it partially, and then I'll turn it over to Blair, and we can also talk about what we see in price compression everywhere else. I think cannabis is probably the only product out there where inflation hasn't hit, okay? But again, that's going to -- and quarter-over-quarter, we've seen very little price compression out there. Year-over-year, we've seen almost $12 million from our standpoint. But the focus got to be building brands and brands do have to matter. At the same time, innovation got the matter, and that's coming out with different potencies different types of products and innovating product, and that's ultimately where you're going to get the right pricing. And as you're going to see other LPs go away, you're going to ultimately see that too. And us being that low-cost producer will be able to be that price leader in the marketplace out there. Blair, do you want to add anything to that? Yes. So just overall, I would say it is going to be unlikely to see rate changes in pricing over the next 12 months. What you may see is category mix, a little bit of a shift to pre-roll which can improve the pricing from a mix standpoint or just volume across provinces. And then finally, to Irwin's point, on the brand side, I referenced it in my answer earlier. But if you look at how we're approaching innovation, we're really thinking about those consumer segments where we have opportunity to grow and those sub-segments within category. RIFF is a great example of where we're entering into a category with higher-quality offering, which will drive some average revenue up, but it will take time. I would say from a when do we see it changing? I think I've been saying for 12 months that as we see industry consolidation as we see the number of LPs start to go down or normalize and the inventory levels over the industry normalized. I think then you'll start to see a real sustainable push in terms of being able to build rate into your economics year-over-year. And Federico, I think the important thing is listen, let's step back for a second. Cannabis in Canada is only a four-year-old business, okay, and the same with the U.S. So we're building out a whole new industry, no different than tech no different than electric cars. At the same time, we're building brands and brands take a long time to build out at brands take a long time for consumers to get used to it. At the same time and trying to get the right -- what's the right price out there. Today, there's bourbon prices out there at $300 a bottle, there's bourbon prices out there at $39 a bottle. And I think it's just ultimately settling out the consumer. The Canadian cannabis business that retails between $7 billion to $10 billion, and I think how does it get to $10 billion, one of the biggest opportunities that we have not talked about is a whole beverage category, where you can walk into a convenience store and ultimately buy a drink with you can walk into any store and buy THC products. You can go into a bar and buy THC beer on tap. So it's going to be an evolving industry. And I think that's the important piece of it today. And some of the things that we have to deal with, there's over 900 LPs out there. The excise tax is $1 gram no matter what the price is. The infrastructure that was spent on building out these grow facilities were billions and billions and billions of dollars. The shakeout will happen, but there's going to be a winner, and it's going to be tilted. Thank you. And now, we will take questions from the Say Technologies platform. The first question is. What are some positives to look forward to in 2023? Listen, I think. As I've said throughout all these questions today, there's a lot of positives out there. As Tilray is today, it's a diversified company with the adult use cannabis business in Canada has a medical business as we move into the drinks business, the edibles business, and we have a lot of innovation behind it. We're number one in the medical business sold in over 20 countries in Europe today, with a lot of great growth facilities out there. We have a CC Pharma business, which will integrate into these businesses, so we could have a strong European business and continuously focus on that. As a company, we've diversified and gone into the spirits business have gone into the beer business and have a wellness business in regards to Manitoba Harvest. We've built out our balance sheet. We have over $400-plus million of cash today, and we have a strong, strong management team in place that knows how to execute. And I must tell you, it's not an easy industry. There's no industries out there that's easy, but it's an industry today where we have brands. We have a strong management team we have a strategy. And yes, strategy has to change. And I've said I wanted to be a $4 billion business out there by the end of 2024. But unfortunately, if legalization happened tomorrow, that's possible without legalization it's not going to be achievable just with the cannabis industry. If we diversify into other categories, it absolutely can happen. So there's a lot of things happening at Tilray and there's a lot of good moving pieces out there for us to execute upon in '23 and '24. Listen, I come back and say this here, I'm proud of a lot of the things that happened at Tilray. I would like to see our stock at a different place. The markets have been tough markets in 2022. The whole cannabis industry is down over 50-plus percent. And I think there were a lot of expectations out there upon legalization. We just got to do better than that, and that's why we have to diversify and not sit here and wait for the politicians to make decisions on legalization. And when legalization does happen, we'll be ready to pounce upon every one of those opportunities with cannabis, whether it's beer, whether it's spirits, whether it's food or other products. But one thing I can tell you is this company in the cannabis industry whether it's in R&D, whether it's new quality, whether it's in grow, whether it's in brandy, we're well into it, and we'll be ready for it upon legalization. Thank you, everybody. And as you can see, there's a lot going on. And as you've talked -- as I've talked about, we have an excellent team in place to help execute upon this, A lot going on in Canada, a lot going on in Europe. You heard from Blair, you heard from Denise, you heard from Ty, Brian Nolte runs our Beverage business; Jared Simon, who runs our Wellness business. We have excellent teams in our financial area, our operational area, our IT area, our legal areas. So, there's an incredible team in place that works alongside of me here at Tilray today. And that's what's key. We have a strategy in place ultimately, it's shifting because as we sit and expect legalization then how do we shift to that, and we're shifting upon that. We focus on our balance sheet. We focus on cash. We focus on how to take cost out. We focus on top line growth. There's a lot of hurdles that get in our way and how do we overcome them and ultimately what can we do. We have in Canada 10 different customers. And that said, we can't go to Walmart, Target, Loblaws and Sophie's and go sell our products. There's limitations that we can sell our products in Canada. There's no limitations where we can sell our beer products or our spirits products in that in the U.S. or a wellness food. There's limitations where we can sell our European products to the doctors in the scripts. But with our CC Pharma business, there's no limitation that we can sell into the 13,000 drug stores. So, we want the world to be a oyster to sell products. We want to sell brands. We want to sell consumer brands. We want to sell products that contribute margins and contribute free cash flow to the Tilray brands business. We're looking at multiple opportunities, and we'll continue to do that. We're looking at multiple acquisitions that we'll continue to do that. But before I conclude, I'd like to mention that Tilray brands has had to adjourn its Annual Meeting of Shareholders to January 18 because we do not yet have sufficient participation from our stockholders. I'd like to urge all Tilray brands stockholders of record as of September 26, 2022, and have not yet voted to vote today. The charter amendment is intended to simplify Tilray's capital structure and ensure that all stockholders of common shares have equal voting rights or one vote per share. The elimination of Class 1 stock will not be dilutive to stockholders or increase the number of outstanding shares. They're already outstanding there. So, it is not dilutive. This is a key initiative to ensure best corporate governance, and that is key for us and practices that help the Company protect influence of our stockholders. Your support is really, really important no matter how many or how few shares you own, if you need help with voting or you have any questions, please contact our investors@tilray.com. And with that, I want to thank everybody for joining us today. Thank you for your support and I look forward to speaking to you very much in the near future. Have a great day and a happy new year.
EarningCall_1554
Ladies and gentlemen, good afternoon. Thank you for standing by, and welcome to the Intuitive Quarter Four 2022 Earnings Release. At this time, all lines are in a listen-only mode. Later, there will be an opportunity for your questions. [Operator Instructions] And as a reminder, today's conference is being recorded. At this time, I'd like to turn the conference over to our host, Head of Investor Relations, Mr. Brian King. Please, go ahead. Good afternoon, and welcome to Intuitive's fourth quarter earnings conference call. With me today, we have Gary Guthart, our CEO; and Jamie Samath, our CFO. Before we begin, I would like to inform you that comments mentioned on today's call may be deemed to contain forward-looking statements. Actual results may differ materially from those expressed or implied as a result of certain risks and uncertainties. These risks and uncertainties are described in detail in our Securities and Exchange Commission filings, including our most recent Form 10-K filed on February 3, 2022, and Form 10-Q filed on October 21, 2022. Our SEC filings can be found through our website or at the SEC's website. Investors are cautioned not to place undue reliance on such forward-looking statements. Please note that this conference call will be available for audio replay on our website at intuitive.com on the Events section under our Investor Relations page. Today's press release and supplementary financial data tables have been posted to our website. Today's format will consist of providing you with highlights of our fourth quarter results, as described in our press release announced earlier today, followed by a question-and-answer session. Gary will present the quarter's business and operational highlights. Jamie will provide a review of our financial results, and I will discuss procedure and clinical highlights and provide our updated financial outlook for 2023. And finally, we will host a question-and-answer session. Thank you for joining us today. The fundamentals of our business were healthy in Q4 and for the full year 2022. Procedure growth for the full year approached pre-pandemic levels. Installed base growth was solid, and customers concurrently increase utilization of existing systems. Our investments in product development extended our multi-port, single-port and flexible robotics ecosystems through new instruments, accessories, digital products and indication expansions. Finally, the fine work of our operations teams and supply partners largely mitigated the supply chain challenges that persisted through the year. Turning first to procedures. We saw 18% procedure growth for the quarter and the full year. Areas of strength included general surgery in the United States, particularly benign procedures such as bariatric surgery, cholecystectomy and hernia repair. Colon and rectal procedure growth also continued. Strong growth beyond urology outside the US was accretive to our global performance. We attribute this diversification to the value of our ecosystems and our strategic investments in organization, clinical trials, data products and market access. Regionally, the United States, Japan, Europe and India stood out in the quarter and year. Procedure growth in China was hampered by the COVID wave in Q4, with procedures progressively declining starting in November through the end of 2022. Ion procedures showed continued strength, with 218% growth in 2022 compared with 2021, and SP procedures grew 38% over the same period, with the majority of its growth coming from Korea. Global core procedure areas of urology and gynecology moved toward recovery in the year, both exceeding their three-year compound annual growth rates in 2022. On the capital front, we placed 369 systems in Q4 compared with 385 in Q4 2021. For the full year, we placed 1,264 systems compared with 1,347 in 2021. Our installed base growth rate was 12% for multiport, 149% for Ion and 22% for SP in 2022. Overall, our capital placement trends showed sustained demand for additional capacity in multiport and strong interest in expanding capacity for Ion with several hospitals now operating multiple Ion systems in their programs and variable demand for SP as we continue to pursue our additional indications. System utilization is an important predictor of future demand and utilization grew 5% for multiport in the year and 10% for Ion. Utilization was roughly flat for SP over the year, however, utilization increased by 9% in Q4 measured year-over-year as our organization incorporated learnings. Touching on our finances, revenue grew 9% in 2022. Revenue was impacted by the strength of the dollar in the year and the decline of the trade-in population of third-generation multiport systems. Our expenses landed at the higher end of our spend guidance reflecting continued R&D investments that support the growth of our platforms and digital products, expansion of our manufacturing and commercial capabilities, and capital amortization driven by expansion of our global footprint. Structurally, we have been increasing our own capital expenditures as we continue to build the company to supply the globe at industrial scale. This is an important investment as several procedures using our systems have become the standard of care in several countries. We have been vertically integrating key technologies to develop a more robust supply chain and bring important products to market at attractive price points. These investments include increased ownership of our imaging pipelines, strategic instrument and accessory technologies, and software and digital products that allow us to serve our customers. The investments make our business more capital-intensive than years past, in support of industrial dependability, a more robust supply chain, and lower product costs. I'd also like to take a moment to walk through our platform investments. Intuitive starts with the end in mind. Coordinating our efforts to enable our customers' pursuit of the quadruple aim in specific procedures, for example, those in general surgery. We design all our systems to allow for the addition of new functionality over time. For our multiport platform, this design philosophy has enabled us to continuously strengthen our fourth generation da Vinci Xi by adding new regulatory clearances, a new model with the da Vinci X, new instruments and accessories, new imaging capabilities, and new software products. These products include our stapling lot of instruments as well as our advanced energy instruments, which contributed approximately $890 million in revenue in 2022 with revenue growth of 18% in the year and are a key enabler of the general surgery growth discussed a minute ago. We added 65 representative clinical procedure indications in the United States to our fourth-generation multiport platform since its launch. Our multiport indications now spans six surgical categories and total over 70 procedure indications for multiport platforms in the United States today. We routinely improve our platform operating systems with roughly 10 significant fourth-generation OS releases since launch and dozens of smaller software upgrades. We launched our next-generation Xi visualization, Endoscope Plus, and have been integrating digital products, including virtual reality training Intuitive Hub and the My Intuitive app. We expect to launch additional Gen 4 compatible products and operating system software this year. Concurrently, we invest in new generations of our multiport platform that bring new and significantly enhanced capabilities. For our multi-port system development programs, we prioritize as follows. Our highest priority is the improvement of core surgical capability targeting improved patient outcomes, often through innovation in robot and instrument precision, imaging and sensing while focusing on dependability and product quality. Next, we designed to improve usability, care team's skill acquisition and analytic power, including digital products for the operating room, personalized learning for care teams and efficiency analysis and services for surgical programs. Next, we design platforms and their ecosystems that can lower the total cost to treat per patient episode. And finally, we designed with the flexibility to add future capability to systems post launch. Given the time required to design and validate new architectures at any given moment, we're typically developing more than one system architecture beyond that in the market. In the current global regulatory environment, core technology changes often require human clinical trials and substantial review. These are multiyear investment cycles, and we're making good progress. As we start this year, we do not currently expect a new multi-port system launch in 2023. Turning to Ion. Adoption has been healthy based on its ability to meet an unmet clinical need in lung biopsy. We're focused on improving the manufacturability, cost and robustness of iron products to support its rapid growth in the US. We have also submitted a regulatory dossier for a review in Europe, Korea and in China's green channel. We expect clearance in Europe in 2023. We don't have a firm forecast on the time for Ion clearance in China at this time given pandemic related adjustments ongoing in the Chinese healthcare system. Ion is also a platform with strong opportunities for future clinical applications. We're conducting advanced development and clinical research to extend Ion to other indications in the lung. While our Ion flexible robotics offers an opportunity to provide value in the body outside the lung, our focus is on completing what we started for pulmonologists and thoracic surgeons. Our single-port platform, da Vinci SP, has supported strong adoption in Korea and has recently obtained PMDA clearance with broad indications in Japan. We expect first installs of SP in Japan in the coming months. Next, we plan to submit our dossier on da Vinci SP to our notified body in Europe midyear 2023. So far, customer feedback on the clinical utility for SP has been healthy with strong multi-specialty use of SP in Korea. In the United States, some indications have required prospective clinical trials, and we're currently conducting IDE trials in colorectal surgery and thoracic surgery. We're pursuing additional indications for SP beyond these two, and we'll share more information on these indications in 2023 as the requirements for our regulatory pathway for them are established. We're continuing to invest significant resources in R&D, where the portfolio we have under development is positioned to support leadership in existing categories and expansion into new ones. Our capital investments will increase to support supply chain robustness, product cost reduction and global industrial scale. On the SG&A front, we are making some foundational investments, and we'll turn to pursue leverage in enabling functions. Recognizing economic conditions for 2023 are hard to forecast, we're targeting a deceleration of fixed cost growth rate in 2023 relative to 2022. We expect pro forma operating margins to fluctuate in the next several quarters and then improve over the mid-term. In closing, our priorities for 2023 are as follows; first, increased adoption and focused procedures defined by country through outstanding training, commercial and market access execution; second, pursuit of expanded indications and launches for our new platforms; third, excellent performance in the continuity of supply, product quality and services provision as we emerge from pandemic stresses; and finally, pursuit of increased productivity and our functions that benefit from scale. Good afternoon. I will describe the highlights of our performance on a non-GAAP or pro forma basis. I will also summarize our GAAP performance later in my prepared remarks. A reconciliation between our pro forma and GAAP results is posted on our website. Q4 and 2022 revenue and procedures are in line with our preliminary press release of January 11. I will briefly review full year 2022 performance before describing our Q4 results in greater detail. 2022 procedures grew by 18% as compared to 2021, or 15% on a three-year compound annual growth rate basis. During the year, we placed 1,264 systems at customers, down 6% year-over-year, driven by a decline in trading volumes of 165 systems due to the declining population of SIs in the field. Recurring revenue, which is correlated to ongoing use of our products represented 79% of total revenue and grew 15% over the prior year. Total revenue of $6.2 billion increased 9% year-over-year and grew approximately 12% on a constant currency basis. Pro forma operating margin was 35% of revenue and reflected the impact of several headwinds, FX, supply chain challenges and inflation together adversely impacted 2022 pro forma operating margin by approximately 1 percentage point. During the year, we repurchased $2.6 billion of our stock or approximately 11.2 million shares, and we have a remaining authorization to repurchase our shares of $1.5 billion. Turning to Q4. With respect to capital performance, we placed 369 systems, 4% lower than the 385 systems we placed in the fourth quarter of last year. There were 110 trading transactions in the quarter, as compared to 117 last year. 51 of the 110 trading transactions were with OUS customers, higher than recent trends primarily driven by customers in Japan and Brazil. As of the end of Q4, there were approximately 620 SIs remaining in the installed base, of which 134 are in the US. Given the continuing decline of older generation systems in the field, we expect trading volumes to decline significantly in 2023. Q4 revenue was $1.66 billion, an increase of 7% from last year. On a constant currency basis, fourth quarter revenue grew approximately 10%. For full year 2022, revenue denominated in non-USD currencies represented 24% of total revenue. The US dollar has weakened recently, and as a result, on a revenue-weighted basis, using current rates, the US dollar is approximately 100 basis points stronger than the average rates realized in 2022. Additional revenue statistics and trends are as follows: in the US we placed 181 systems in the fourth quarter, lower than the 235 systems we placed last year, reflecting cautious capital spending by customers, given the macroeconomic environment and a decline of 21 systems associated with trade-in transactions. Average system utilization in the US increased by 6%, reaching an all-time high. Outside the US we placed 188 systems in Q4 compared with 150 systems last year. Current quarter system placements included 70 into Europe, 51 into Japan, and 14 into China compared with 63 into Europe, 37 into Japan, and 14 into China in the fourth quarter of 2021. As of the end of 2022, there were 34 systems remaining under the current quota in China. There are now four local competitors that are registered in China and they're active in tenders under the existing quota. Delays in the granting of a new quota in China will constrain our ability to further grow the installed base and limit capacity for procedure growth. Leasing represented 42% of Q4 placements compared with 37% last quarter and last year. The higher lease mix was primarily driven by the mix of customers in the US who prefer to lease and reflected in part an increase in placements acquired under usage-based arrangements. While leasing will fluctuate from quarter-to-quarter, we continue to expect that the proportion of placements under operating leases will increase over time. Q4 system average selling prices were $1.43 million as compared to $1.45 million last year. System ASPs were negatively impacted by FX, partially offset by a favorable regional mix and a higher mix of Xi jewel placements. We recognized $17 million of lease buyout revenue in the fourth quarter compared with $17 million last quarter and $26 million in Q4 of 2021. da Vinci instrument and accessory revenue per procedure was approximately $1,820 compared with approximately $1,800 last quarter and $1,940 last year. On a year-over-year basis, FX negatively impacted I&A per procedure by approximately $50 and customer ordering patterns had a negative impact of approximately $40 per procedure as customers, particularly in the US and China, reduced their inventory levels. Turning to our Ion platform. In 2022, we tripled procedures to just over 23,000 and double system placements to 192 as compared to 2021. In Q4, we placed 67 Ion systems as compared to 31 in Q4 of 2021. The installed base of Ion systems is now 321 systems, of which 132 are under operating lease arrangements. Fourth quarter Ion procedures of approximately 7,900 increased 169% as compared to last year. Leveraging previous investments we have made in our da Vinci ecosystem, during the quarter, we commenced the launch of My Intuitive app for Ion users, providing them real-time access and insights to their Ion usage statistics. Moving on to the rest of the P&L, pro forma gross margin for the fourth quarter of 2022 was 68.2% compared with 70.1% for the fourth quarter of 2021 and 69.8% last quarter. As a reminder, last quarter's gross margin included a one-time benefit of approximately 50 basis points relating to the favorable conclusion of certain indirect tax matters. Pro forma gross margin was lower than last year, primarily due to increased fixed costs relative to revenue, the stronger US dollar and higher component pricing. The supply chain environment was challenging in Q4 and indicators of supply and inventory health did not improve as compared to last quarter. Higher fixed costs relative to revenue reflect a combination of manufacturing related inefficiencies given the environment and investments for future growth. Fourth quarter pro forma operating expenses increased 19% compared with last year, driven by increased headcount, higher travel costs, increased customer training activities and higher R&D related project costs. Fourth quarter 2021 operating expenses included a $30 million contribution to the Intuitive Foundation, which can support their efforts for the next couple of years and did not repeat in 2022. The pace at which we are increasing headcount continued to moderate in Q4 with net additions of about 330 employees in the quarter compared to a net increase of approximately 530 employees last quarter. More than half of the employees we added in Q4 were production staff in our instrument factory in Mexico to support procedure growth. While we are slowing our hiring pace and pursuing leverage in our enabling functions, we are planning for balanced growth in operating expenses in 2023 given the opportunity to advance our next-generation robotics capabilities and the relatively earlier stage of our investments in Ion, SP and digital. In 2023, we expect a significant increase in expenses related to clinical trials. Brian will provide our outlook for operating expenses later in this call. As we look forward to our growth plans over the next several years, we are planning to make significant capital expenditures. Capital expenditures for 2022 were $532 million, and we expect 2023 capital expenditures in a range of $800 million to $1 billion, of which approximately two-thirds will be for facilities to expand our manufacturing capacity. Our manufacturing investment plans include advanced proprietary facilities for production of new products and the Ion platform in California and da Vinci systems in Georgia. Internationally, we are increasing our product development capacity in Germany, building a new low-cost endoscope manufacturing facility in Bulgaria and establishing manufacturing capacity for domestic Xi production in China. We will also be expanding the footprint of our high-volume, low-cost instrument site in Mexico to support procedure growth across all of our platforms. These investments allow us to consolidate our manufacturing into larger centralized hubs, such as our headquarter campus in Sunnyvale, California and our East Coast hub just outside of Atlanta, while we will co-locate surgeon training, technology development and manufacturing capacity. These are multiyear investments. And as a result, we expect depreciation expense to increase in 2023 and increase more significantly in 2024. Pro forma other income was $21.8 million for Q4, higher than $7.2 million in the prior quarter, primarily due to lower foreign exchange losses from remeasurement of the balance sheet and higher interest income. Our pro forma effective tax rate for the fourth quarter was 18.2%, lower than prior quarters, primarily as a result of a more favorable geographical earnings mix and a discrete tax benefit of $7 million associated with the foreign tax matter. Fourth quarter 2022 pro forma net income was $439 million, or $1.23 per share compared with $473 million or $1.29 per share for the fourth quarter of last year. I will now summarize our GAAP results. GAAP net income was $325 million or $0.91 per share for the fourth quarter of 2022 compared with GAAP net income of $381 million or $1.04 per share for the fourth quarter of 2021. The adjustments between pro forma and GAAP net income are outlined and quantified on our website and include excess tax benefits associated with employee stock awards, employee stock-based compensation, amortization of intangibles, litigation charges and gains and losses on strategic investments. We ended the year with cash and investments of $6.7 billion compared with $7.4 billion at the end of Q3. The sequential reduction in cash and investments reflected share repurchases of $1 billion and capital expenditures, partially offset by cash from operating activities. And with that, I would like to turn it over to Brian, who will discuss clinical highlights and provide our outlook for 2023. Thank you, Jamie. Overall procedure growth for the full year 2022 was 18% and increased 15% on a three-year compound annual growth basis. Overall procedure growth was comprised of 16% growth in the US and 22% growth outside of the US. In the US, fourth quarter 2022 procedures grew 18% year-over-year, compared to 16% for the fourth quarter of 2021 and 18% last quarter. The US procedure growth rate reflected a favorable comparison to the quarter a year ago, given the impact of the Omicron variant in December of last year. On a three-year compound annual growth basis, US procedure growth was 13%. Outside of the US, fourth quarter procedure volume grew approximately 18% year-over-year, compared to 28% for the fourth quarter of 2021 and 24% last quarter. On a three-year compound annual growth basis, procedure growth was 19%. Turning to Europe. Procedure growth in the quarter was led by strong growth in UK, Germany and Italy. In the regions noted, procedure growth outside of urology was strong in general surgery and gynecology categories. Specifically in the UK, we experienced strong early-stage growth in colorectal surgery and continued strong growth in hysterectomy. Turning to Asia. Growth outside of China continued to be solid, with notable strength in capital and procedure growth in Japan. Procedure growth in Korea was healthy and India and Taiwan continue to experience strong early-stage growth. In Japan, as Jamie noted earlier, 51 systems were placed in the country, the most in a single quarter. Overall procedure growth in Japan for the quarter was led by general surgery, with strong early stage growth in colon resection and hysterectomy and also in urology with newly reimbursed nephrectomy procedures. In China, midway through the fourth quarter, we observed the decline in procedures. Towards the end of the quarter, we saw a significant decline in procedure volume as hospitals were dealing with increase in COVID cases once the Zero-COVID policy was removed. As a result, China procedures experienced a modest year-over-year decline in Q4. Now turning to the clinical side of our business. Each quarter on these calls, we highlight certain recently published studies that we deem to be notable. However, to gain a more complete understanding of the body of evidence, we encourage all stakeholders to thoroughly review the extensive detail of scientific studies that have been published over the years. While still in the early stages of adoption in the US, robotic-assisted bariatric surgery has been one of the fastest-growing procedures in general surgery for Intuitive. In October 2022, the American Society for Metabolic and Bariatric Surgery and International Federation for the Surgery of Obesity and Metabolic Disorders released major updates to the 1991 National Institute of Health guidelines that recommended lowering the BMI for metabolic and bariatric surgery, or MBS, from 40 to 35, regardless of the presence, absence or severity of comorbidities. These guidelines note that, 'MBS is now preferably performed using minimally invasive surgical approaches, laparoscopical robotic'. And that 'MBS is the most effective evidence-based treatment for obesity across all BMI classes.' In another bariatric analysis, Dr. Wayne Barley from St. Luke's University Hospital in Bethlehem, Pennsylvania, recently published a descriptive analysis from the NBA SIP database identifying the proportion of MBS procedures in the US performed between 2015 and 2020. Using a robotic or laparoscopic approach and found up to a threefold difference in the proportion of various robotic-assisted MBS cases per year. We believe our investments in advanced instruments and surgeon training are helping to drive adoption of robotic-assisted surgery in bariatrics. We look forward to continuing to support surgeons and their care teams as they provide high-quality robotic minimally invasive care for an even greater portion of the population under the new guidelines. A recent rectal cancer study by Dr. Fang from Fudan University in Shanghai and on behalf of the RealStudy Group, published short-term outcomes from a multicenter randomized controlled trial in the Lancet. This study impaired robotic-assisted and laparoscopic approaches performed by experienced surgeons for middle and low rectal cancer across 11 hospitals in China, with approximately 580 cases included in each approach. With respect to very operative outcomes, the rate of patients with a positive circumferential margin was 3.2% lower in the robotic-assisted group as well as a 3.6% higher rate of complete macroscopic resection. Furthermore, patient laparoscopic arm experienced a 2.2% higher rate of conversion to open. A 3.3% higher rate of intraoperative complications was also reported in the laparoscopic group. Notably, 5.8% less abdominal perineal resections were performed in the robotic group. Postoperatively, patients in the robotic-assisted arm also had a faster gastrointestinal recovery postoperatively as well as a one-day shorter length of stay an approximately 7% lower rate of postoperative complications with the Clavien-Dindo of 2 or higher. In summary, the authors concluded that short-term outcomes suggests that for middle and low rectal cancer, Robotic surgery by experienced surgeons resulted in better quality resection than conventional laparoscopic surgery with less surgical trauma and better postoperative recovery. I will now turn to our financial outlook for 2023. Starting with procedures. For 2023, we anticipate full year procedure growth within a range of 12% to 16%. The low end of the range assumes continued choppiness with COVID hospitalizations and staffing pressure at hospitals globally throughout the year. In addition, it assumes ongoing staffing, significant challenges with COVID in China and uncertainty with the timing of the new capital quota. At the high end of the range, we assume no new significant impact from COVID throughout 2023, and assume continued growth in general surgery in the US and diversified growth beyond urology outside of the US. The range does not reflect significant material, supply chain disruptions or hospital capacity constraints similar to what we experienced at the start of the pandemic. Beyond the uncertainty with COVID in China, we expect similar seasonal timing of procedures in 2023 as we have experienced before the pandemic, with the first quarter being the seasonally weakest quarter as patient deductibles are reset. With respect to revenue, as we have mentioned previously, capital sales are ultimately driven by procedure demand, catalyzing hospitals to establish or expand robotic system capacity. Capital sales can vary substantially from period to period based upon many factors, including national health care policies, hospital capital spending cycles, reimbursement and government quotas, product cycles, economic cycles and competitive factors. Turning to gross profit. Our full year 2022 pro forma gross profit margin was 69.2%. In 2023, we expect our pro forma gross profit margin to be within 68% and 69% of net revenue. The lower estimate of pro forma gross profit margin in 2023 reflects the impact of higher infrastructure investment costs, higher supply chain costs, and a greater mix of new products, in particular, from our Ion platform. Our actual gross profit margin will vary quarter-to-quarter depending largely on product, regional and trade-in mix, procedure mix and volumes, fluctuations in foreign currency rates and the potential impact of competitive pricing. Turning to operating expenses. In 2022, our pro forma operating expenses grew 23%. In 2023, we expect pro forma operating expense growth to be between 9% and 13%. The operating expense growth reflects investments to advance our platform capabilities, digital products, along with continued expansion into markets outside of the US and spending to support regulatory clearances and clinical trials. We expect our non-cash stock compensation expense to range between $610 million to $640 million in 2023. We expect other income, which is comprised mostly of interest income to total between $140 million and $160 million in 2023. With regard to income tax, in 2022, our pro forma income tax rate was 21.8%. As we look forward, we estimate our 2023 pro forma tax rate to be between 22% and 24% of pre-tax income. Great. Appreciate it. Thanks for taking the questions. Maybe to start, the OpEx guide came in a lot better than expected, but balance that with taking it longer to get through the regulatory cycles and bring to market with a new robot. So maybe you could talk about what exactly is taking longer? Are there certain trials that maybe had to be done in the past that are now being required? And is this global regulatory lengthening of time, or are there specific markets that are taking longer to come with a new robot? All right. Thanks, Robbie. I think, we've been sharing with you over several quarters now. In terms of new technologies and new indications, we've seen in many of the core markets, not every single one, but many of them, additional data requirements. That changed probably four years ago, but has been playing all the way through. So it's not so much that the environment has changed over that period, just the implications of that. And you see that in things like SP, our SP trials, five or six years ago would have come to market differently and they're requiring some prospective human clinical work. That's not unique to SP. It really has to do with what the underlying technologies are and what new indications might be. So I think that is playing through relative to prior iterations of systems and features. That's true. Certainly in the United States, we've seen with the European regulatory changes over the years, increased data requirements in Europe and then it kind of varies by country from there. In terms of OpEx, perhaps I'll let you ask a follow-up question for Jamie on that one. Yes. And Jamie, maybe to follow up on the OpEx and I'll tie in CapEx here, because there is a good investment there for the future. Maybe talk to where you're seeing the decrease in OpEx, SG&A versus R&D? And where the lower spending growth rate year-over-year is coming from? Thanks. Yes. It's fair, Robbie, that we're investing differentially across the areas of investment and the functions within the company. Our priorities for 2023 with respect to operating expenses to drive growth in the areas of focus, and we're being focused there. We're looking to execute some opportunities to expand markets by gaining additional clinical indications and geographical clearances. And obviously, we want to advance our technology. Within SG&A, what you see in subsets of the G&A functions is us looking to pursue leverage as we've described. And generally, from an R&D perspective, there are some investments that, as Gary has previously referenced were sequencing, and that's partly motivated by the way in which headcount has expanded over, let's say, the last year or two, and we've moderated our headcount growth as described, and that gives us the opportunity to absorb some of that headcount. So there's differential investment within SG&A and R&D. If I look at R&D and SG&A kind of in aggregate, they're likely to grow at relatively similar rates next year. Good afternoon. Thanks for taking the question. One, on your -- Gary, your new system comments and one on the industrial scale comments that you made today at JPMorgan. So you talked about core technology changes often requiring the clinical trials and that you won't launch a multi-port system in 2023. So Gary, my question is A, will you start a clinical trial and a new system in 2023; and B, if you did start a clinical trial, would you disclose that publicly even if the trial were outside the US, say, in a developing market? Across our systems, we are doing trials in all sorts of places for all sorts of reasons, whether it's SPI or otherwise. And -- so the answer there is we have some places where those are publicly disclosed per normal rules. For competitive reasons, we don't try to detail them too much, and that's the position we'll take going forward. Good. Fair enough. And Gary, you talked a lot about -- you used the term industrial scale a lot recently. What does that mean exactly? And what are the implications for Intuitive financially? Thank you. I'll take what does it mean and I'll ask Jamie to help me on detailing on the finance side. One of the things that's going on is that we are becoming well integrated into many surgical practices in several countries. I think that's a great opportunity for us and a serious responsibility. As we've seen in the last couple of years with regard to supply chain robustness and other things, making sure that -- we have supply chain stability that we want vertically integrating where we can. We have been doing that. A lot of the imaging pipeline work that we've done. We think that both gives us higher quality. It allows us to lower cost to the customer and it gives us robustness. We can plan for that robustness. That's true not only in imaging, but in some core technologies and instruments and accessories. And we think those are good long-term investments. So, that's been really positive. There's another place where our digital tools and our digital products, one of the things that's going on that I think is powerful for the company is not just product architecture, but business architecture. And what I mean by that is that our supply chain can support multiple platforms in multiple countries around the world. It can -- by that, I mean, multiport, single-port and Ion, our digital products architecture also is seamless and can integrate and support those platforms. So, that gives us a great quality advantage, it gives us a leverage capability, and allows us to lower the total cost for our customers and the cost to serve for our customers. Those things take some planning and some forward investment and it can be in core technology. For example, in digital, it can be in facilities, in manufacturing base, so we can build our products. But it's that opportunity. It's a global opportunity to help support the standard of care in multiple countries. I think that the customer advantages are quite clear and I think the cost robustness and long-term durability advantages for the company are quite clear. But that takes some play out over time. Jamie, any help you'll give? I would just say industrial operating -- industrial scale is linked to the capital expenditure plans that we've described, the $800 million to $1 billion of investment in 2023. I'd just add the financial ROI calculations on those investments are relatively straightforward. And we think there are real advantages in having large, highly automated factories that run at scale and that's an advantage both for us and for our customers. So, the return calculations are relatively straightforward and they're essentially the incremental gross margin dollars we can drive from growth. Hi, thanks for taking the question. Just curious, Gary, I mean, you mentioned no new multi-port platform in 2023, but curious how you're thinking about upgrades to Gen 4, but that's mostly just around the software upgrades you mentioned, or if we could see something more material with capability upgrades on hardware, imaging or things that bring the customer procedure down? Yeah. We continue to add capabilities into Gen 4. We expect to do so this year as well. Some of it will be in advanced instrumentation. We are doing some nice work in our energy systems on the -- both on the hardware side and some of the software side, and we think there's some capability improvements that we're going to be developing over time around core imaging capability in Gen 4. So we continue to make progress. Okay. But not saying if anything to come to 2023 or not on that front? And then while I have you, just any early comments on the capital funnel in 2023. I think last year, kind of, January, February time frame is when customers are evaluating budget. So I just want to make sure things seem fairly stable with the capital funnel? On the capital funnel side, what I'd say is, given the macro inputs from customers are our sense is that they are still relatively cautious. I think there's quite a bit of uncertainty still in the macro. And while, for example, staffing shortages have improved, they're still quite a bit worse than pre-pandemic levels in terms of labor costs, vacancy rates for hospitals. So they are being careful from a financial perspective and they're cautious given macroeconomic uncertainty. I think our experiences in the second half of 2022 has been where customers are seeing nice growth in their robotics programs. da Vinci stays as a relatively high priority in terms of their capital budgets. But beyond the fact that they're cautious, I wouldn't say there's anything specific I'd highlight in terms of 2023 outlook. Good afternoon. Hi, Gary. Starting off maybe with the new system, thank you for being so clear about your thoughts about the timing of a new system, i.e., not in 2023. But at a high level, could you talk to us about your thinking about why or why not? I mean, I know obviously, you've -- you're always -- the company -- for your entire history, you're always thinking about what's next and getting ready for it. But how are you -- is it the technology that you wanted to have isn't ready yet, or this is more about competitive positioning or the difficult external environment on capital makes you hesitant to go ahead this year. Just trying to understand your thinking about it and what that might say about the future? Yeah. Thank you for the question. We think mostly about what can we do that changes the experience of surgery for the patient in terms of outcomes and the care teams in terms of how they deliver that set of outcomes. And what we can do in terms of technology basis, products and services and training that can help that happen. That is the primary thing. That's the thing that is front and center. And we do design studies, research, usability effort, all the things you would expect for us to make progress. We don't do too much perfection of timing about what we think the hospital capital environment is going to be. We don't -- you can imagine somebody doing that, that is not my highest motivation. I think these things are sophisticated enough and complex enough to bring to market, that trying to time it perfectly with regard to the macroeconomic environment is not what we're really driven by. We work closely with our technologists who are, I think, spectacular. We work closely with regulatory bodies around the world to understand what their needs and requirements are. And of course, we work very closely with key customers to understand whether the things we think matter, matter. And those are the things that we really do and once we find a pathway, then we work down that pathway. I have to say that supply chain disruptions that have happened in the last three years have impacted not only production capability, but impact new product development as well, because that puts waves and ripples into what kind of items people can procure for prototypes and other forms of focus. So there's a little bit of that in there, too. Thank you. And just as a follow-up, just if you could expand further on your China comments, particularly related to new tender quota expectations. And I just want to make sure I'm understanding carefully or we're all understanding your thoughts or your embedded thoughts about procedure recovery as flow as the year unfolds? Thank you, very much. Yes. I think what we're saying is, we saw China procedures impacted in November. That got more severe in December, has continued so far in the early part of January, and we expect, therefore, procedures in China to be at least impacted in Q1 and perhaps beyond. And I think it's difficult for us to predict, given the relatively unique situation China is in relative to the Zero-COVID policy that they have had. So we're not making any specific predictions as to when and how that might recover. Brian laid out how that's reflected in the procedure guidance that we provided. Separately, on the quota, we're in the third year again of kind of new quota period, the last two quotas have been issued in the third year. We only use that as a historical reference, nothing more. We don't have any particular insight as to when a new quota might come. Hi. Thanks for taking the question. I wanted to ask one on China. You talked about the uncertainty with refreshing the quota and then some new local competitors that are competing for tenders. I wondered if you could kind of flesh that out a little bit and talk about any insight you have into when and how much the quota could be? And then, could you give us a flavor for how competitive you think the local competitors will be to compete for the tenders in China and beyond? I would just say that, underlying demand for robotic technology in China, if you take a mid- and long-term view, is quite strong. And our experience so far has been that surgeons care about the capability and feature set of the products that they use there. Again, we don't have any particular insight with respect to timing and size of quota. We saw the last quota we received was higher than the previous one, but we have no ability to predict that it will be larger again. So we'd love to be able to give you greater clarity than that. But what's the second part of your question, Matt? Why don't I take that one? That was a little bit about local competition and what kinds of things we're seeing. First, I think the entry of competitors in China is natural and should be expected. I think in some ways, it's probably a net positive in terms of how people think about the quota. That's more people advocating for the value of this in the market, it's probably a net positive over time, therefore, for market development also. In the near-term, early markets, we've seen this everywhere around the world with new systems entering. The very early entry is different than the middle is different than the late. And the early, there tend to be a lot of placements, a lot of things around clinical trials, a lot of things around setting up early capacity that are, in some sense, not indicative of value-based or feature-based competition, and we're going to see some of that early on. And then after that wave goes through putting your clinical trial systems out, then it starts to settle down, and you see a little bit more of what the core competitive dynamics look like. So, we're really, really in the early innings with what we're seeing in China competitors. I expect them to be active and assertive. Thanks. One, on overall pricing as it relates to just the update here on the multiport system and then a follow-up on procedure volumes, specifically in the US. On pricing, just trying to understand the dynamics here. We have higher input costs as it relates to R&D, there's inflation, and there's a heavy CapEx cycle. So, you can sort of, on the one hand, push that through the higher pricing for NextGen robot. But on the other side, we have, obviously, hospitals somewhat constrained here and Intuitive now has a licensing model. So, when we think about an elongated regulatory cycle, how does that influence the pricing strategy on the next-gen robot? And then just quickly on procedures, the lower BMI threshold, the new guideline, 40 to 35, it seems like a big deal. Is that contemplated in the 12% to 16% procedure guidance? Thanks. Just with respect to pricing, I'll only comment on current products in the portfolio, as you described. What we're seeing is core costs in our supply chain, the prices we pay our suppliers, the wage costs we pay our production staff. They have gone up, and that looks sticky. We have a routine process we use to monitor pricing on an ongoing basis. We'll continue that process. There's nothing that we would highlight at this point with respect to any specific decisions that we've made relative to pricing, but it's something that we're monitoring carefully through the existing processes that we have. With respect to your question on bariatrics and the change in BMI guidelines, I think it's really early to determine what effect, if anything, that might have in terms of the total surgical term for bariatrics. And so therefore, there's nothing reflected in the 12% to 16% guidance that we provided, and I wouldn't expect it to move that quickly. And there are -- by the way, in bariatrics, there are kind of real protocols patients have to go through with respect to a set of activities that they undertake before they become eligible for surgery, even with this change in guidelines. Maybe I'd add a tiny bit on pricing and margin. On the pricing side, we look all the way across the total cost of ownership for our customers and make sure that's matched to value. So what's the value we bring and then what is the pricing that does that. We do that, as Jamie said, routinely, and we do it by country. It's a global look. With regard to some of the pressures on margin, whether they're inflationary or what have you, Jamie's point, some of those are sticky. We understand the levers that we have, whether it's in design or scale or production or other opportunities. And we're in pursuit of those. I don't think we're confused about where to go from here. Some of them take a little while. So some of the investments we're making, some of the automation that we talked about, some of the factory automation we’re talking about those are things that give us better control of cost over time. And so I don't think we're confused or really caught off guard by some of the changes of the cost influence. Great. Thank you for taking the question. Just a clarification and then one on Ion. On the new system, you said not 2023, but could we expect something in 2024, or if you have to initiate a clinical trial and depending on the size of fed et cetera, are we looking at a launch beyond the 2024 time line? Just any preliminary color would be helpful. And then you did talk about the lowering the total cost to treat, as well as expansion in different kinds of procedures. Any color beyond what you provided on the call on what, kind of, advancements or any look into what could allow you to achieve that in the new system? And then on Ion, I was just wondering if you could talk a little bit about the expected impact of the full set of the PRECIsE two-year results. And also any progress that you're making on indication expansion and the ablation technology? Thank you for taking the questions. Okay. Nothing further to detail on multi-port beyond what we've discussed already. With regard to opportunities for our platforms period, we have opportunities across our set. We'll -- I talked to you a little bit about what we're doing in SP already. We'll detail that more as it unfolds in 2023 as to where we see opportunity for SP to create indication expansions and to open new procedure markets for us, which we're excited about. On the Ion front, you asked a little bit about the PRECIsE tier data. I don't have anything more to detail on that. Feedback from the field we have outside of that specific study has been that it's delivering on the promise. Folks are finding that it's usable that it is supplying the outcome that they had hoped and we're seeing that reflected in the adoption. So we're pleased with that. With regard to ablation, we are -- as we said last quarter, we're just at the early innings of engaging customers in Europe and looking at the trial data. We're excited by it. I think there are several indications in the long that we'll pursue over time. We'll detail those more as we get more experience and more time. There are opportunities outside the long too, I want to be clear. We think those are interesting, but they're not areas of current focus. We really think finish the job we started. We have great engagement with pulmonologists and thoracic surgeons. We have opportunity to continue to support them to make our products ever easier, more robust and to move the margin structure where we want it to go. We're going to focus on that. And then we'll move to other indications in the lung. And then from after that, we'll have earned our opportunity to do the next step. So thank you for the questions there. That was our last question. In closing, we continue to believe there is a substantial and durable opportunity to fundamentally improve surgery and acute interventions. Our teams continue to work closely with hospitals, physicians and care teams in pursuit of what our customers have termed the quadruple aim: better, more predictable patient outcomes; better experiences for patients; better experiences for their care teams; and, ultimately, a lower total cost of care. We believe value creation in surgery and acute care is foundationally human. It flows from respect for and understanding of patients and care teams, their needs and their environment. At Intuitive, we envision a future of care that is less invasive and profoundly better, where diseases are identified earlier and treated quickly, so patients can get back to what matters most. Thank you for your support on this extraordinary journey. We look forward to talking with you again in three months. And ladies and gentlemen, that does conclude our conference for today. We thank you for your participation and using the AT&T Event Services. You may now disconnect.
EarningCall_1555
Greetings. Welcome to the Helen of Troy Limited Third Quarter Fiscal '23 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to Jack Jancin, Senior Vice President of Corporate Business Development. Thank you. You may begin. The agenda for the call this morning is as follows. I'll begin with a brief discussion of forward-looking statements. Mr. Julien Mininberg, the company's CEO, and Noel Geoffroy, the company's COO, will comment on business performance of the quarter, Project Pegasus and current trends. Then, Mr. Matt Osberg, the company CFO, will review the financials in more detail and provide an update on our financial outlook for fiscal 2023. Following this, we will take questions you have for us today. This conference call may contain certain forward-looking statements that are based on management's current expectation with respect to future events or financial performance. Generally, the words anticipates, believes, expects, and other words similar are words identifying forward-looking statements. Forward-looking statements are subject to a number of risks and uncertainties that could cause anticipated results to differ materially from the actual results. This conference call may also include information that may be considered non-GAAP financial information. These non-GAAP measures are not an alternative to GAAP financial information and may be calculated differently than the non-GAAP financial information disclosed by other parties. Before I turn the call over to Mr. Mininberg, I like to inform all interested parties that a copy of today's earnings release has been posted to the Investor Relations section of the company's website at www.helenoftroy.com. The earnings release contains tables that reconcile non-GAAP financial measures to their corresponding GAAP-based measures. The release can be obtained by selecting the Investor Relations tab on the company's homepage and then the Press Releases tab. Thank you, Jack. Good morning, and thanks to everyone for joining us. Today, I would like to provide you with an update on Project Pegasus, discuss our third quarter results and the consumer and retail trends we saw during the quarter. As discussed in our October call, Pegasus is a comprehensive restructuring program launched this past summer with the goals of significantly strengthening and accelerating our platform for operating margin expansion, reducing inventory, improving ROIC, and improving cash flow. Pegasus is a multiyear initiative with a three-year arc designed not only to improve profitability, but also provide additional investment fuel to more efficiently leverage our proven value creation flywheel as we return to growth. Pegasus goes well beyond the typical belt-tightening exercise. With the macro environment not indicative of a rapid reacceleration due to higher inflation, higher interest rates, uncertainty about the future financial health of consumers and foreign exchange headwinds, we used this summer to take a hard look at ourselves. We zeroed-in on ways to accelerate efficiency projects already underway and identified a comprehensive set of new savings opportunities. The key initiatives in Pegasus include optimizing our brand portfolio, accelerating and amplifying cost of good savings projects, enhancing the efficiency of our supply chain and distribution network, optimizing our indirect spending, streamlining and simplifying the organization, and reducing inventory. Pegasus also includes initiatives to return to operating margin expansion and improve our organic growth rates. Over the past few months, we have made significant progress; all workstreams are underway, leaders and teams are in place, and they're focused on speed and on executional excellence. I have asked our Chief Operating Officer, Noel Geoffroy, to walk through that progress. Beyond Pegasus, Noel is also working closely with the business segments and operations, so she will also join Matt and I in the question-and-answer on both Pegasus and the business segments. Thanks, Julien. Today, we are sharing details on the progress across several Pegasus initiatives, including streamlining and simplifying the organization, optimizing our brand portfolio, and further sharpening our investment choices. Specifically, on the organization, we are announcing three major structural changes. The first is to consolidate from three business segments to two. The second is to create a North American Regional Market Organization that will be responsible for sales and go-to-market for the United States and Canada. And the third is to further centralize our global shared services for operations and finance. Let's go through each of the three areas. Starting with the consolidation from three business segments to two, we are combining our current Health & Wellness and Beauty segments into one, and renaming it, Beauty & Wellness. Our other business segment will continue to be Home & Outdoor. Both segments will be even more focused on delighting consumers with outstanding brands and products that people trust and adore. They will retain and use their deep understanding of the brands, consumers and competitors in each category, focusing on developing even more outstanding consumer-centric innovation and marketing programs that will further differentiate our world-class brands. The second major organizational change is to create a North American Regional Market Organization. Very similar to the RMOs we already operate in EMEA, Latin America and Asia Pacific, the new North American RMO will capture the benefits of increased focus on sales and go-to-market with further attention to shoppers in the United States and Canada. The North American RMO will also create new savings and new capabilities both externally and internally. Like our other RMOs, the North American RMO will be responsible for go-to-market activation on all brands and channels, will capitalize on the scale of Helen of Troy's diversified brand portfolio, and leverage the strong strategic customer relationships we have worked so hard to build over many years. New savings will come from increased speed, eliminating duplication, streamlining interfaces with shared service functions, and standardizing processes. The North American RMO is being staffed with an emphasis on continuity of key sales leaders and maintaining the needed category and channel specialization in areas such as outdoors and prestige beauty where there is less overlap. There will be no change to the international RMOs and it will continue to be led by our President of International. The third change is to further centralize operations and finance. This is a continuation of the theme of shared service centralization we started in Phase I for IT, Legal and HR. As always, our shared services are designed to support our business segments and RMOs with their expertise, gain speed and efficiency from applying best practices, eliminate duplication, standardized processes, streamlined interfaces, and better leveraged scale. We are further centralizing operations under our Chief of Global Operations, who will now own all sourcing and supplier relationship and will create a center of excellence on supply and demand planning to help improve forecast accuracy and inventory management. In finance, we are reconfiguring our finance leadership support to match our new organization structure, centralizing our global accounting function and aligning reporting for the full global finance organization under our CFO, all at a reduced headcount versus today. The new structure will reduce the size of our global workforce with impact across all business segments, departments and shared services. Our overall global workforce will shrink by approximately 10%. The majority of the role reductions will be completed by March 1, and the savings will largely be realized in fiscal '24. Nearly all of the rest will be completed before the end of fiscal '24. We did not take this decision lightly. Our global leadership team has worked very carefully on the new organizational structure and on the specific staffing for each role. We all have immense respect and gratitude for the highly-talented associates who will be leaving us. We've been careful to ensure continuity of leadership and expertise in the new organizational design. The two business segments, International and the new North American RMO, will each be led by proven current presidents, who will continue to report to me. Nearly all shared service functions, including Operations, Finance, IT, Legal and Corporate Business Development, will operate under the current proven leaders who serve with me on Julien's global leadership team. Turning now to our initiatives to optimize our brand portfolio. We have three specific Pegasus workstreams to highlight. They include sharpening our discretionary spending choices, SKU rationalization, and assessing which brands might be good candidates to exit. As always, our objective is a portfolio with faster growth in fleet average, better ROIs on our spend, and higher margins. While it is still too early to share our specific choices today, here is an update on each. The first action focuses on making more targeted investment choices. Investing disproportionately in businesses that deliver superior value has differentiated market leaders with higher margins that have the most compelling growth adjacencies and that are the most asset efficient. Under Pegasus, we are creating more rigorous tools to better determine which brands, innovations and channels will get the most focus and support, which ones to maintain a steady performer, and which ones will receive less focus. The second action is a Pegasus workstream focused on simplifying our SKU assortment by prioritizing better selling items that have the highest growth potential and best margin. This includes eliminating hidden costs and long-tail complexity to improve the efficiency of assets, such as inventory, distribution centers, new product development teams and supply chain teams. We believe these first two actions will translate into more robust support for our highest-potential brands and a more efficient product assortment for omnichannel distribution. The third action area is acquisition and divestiture. We have demonstrated our ability to use accretive acquisition to enter new growth areas where we can add value. We have also demonstrated our ability to divest good businesses that were no longer a long-term priority for Helen of Troy or shut down significant underperformers. We will update you with specific news as this evolves under Pegasus. Now, let me turn the call back to Julien to discuss the third quarter and the external trends we are seeing. Thanks, Noel. Our third quarter financial performance was better than the outlook we provided in October. The result was primarily due to higher sales from what has so far been an above-average cold and flu season and some pull-forward of sales from the fourth quarter into the third quarter of this fiscal year. On a fiscal year-to-date basis, core's net sales are up 33% on a three-year stack versus the pre-COVID base of fiscal year '20. Over those same nine months, core adjusted and diluted earnings per share is up 6.6% on a three-year stack despite the negative impact this fiscal year from inflation, higher interest rates, and lower operating leverage. During the third quarter, consumers continue to tighten their purchasing patterns in some categories in response to high inflation and higher interest rates. As consumption slowed, some retailers continued their conservative repurchase patterns to further reduce their inventory. Our promotions across online and in-store channels were slightly elevated on certain parts of our business, such as Beauty and Health & Wellness, helping to support the consumer trends we are seeing and helping our retail partners better reach their inventory reduction goals. The holiday season started off slower than expected with discretionary categories generally under pressure from these trends. In some categories, performance improved in late December, ending largely in line with our expectations. Looking at our business segments, I'll start with Health & Wellness. As highlighted in the media, there has been a market increase in the various viruses that cause the symptoms our products help relieve, such as fever, cough, runny noses, congestion and sore throat. While it was still early in the season during our third quarter, we are seeing elevated incidents of these conditions from cold, flu, and the latest Omicron COVID sub-variants. Symptoms this year have further been raised by a surge of other respiratory infections in both children and adults. The result has been strong sell-through of our thermometers, humidifiers and inhalants under the Vicks and Braun brands. Since U.S. retailers generally had sufficient inventory on hand from last season, elevated incidents did not translate into year-over-year shipping growth during our third quarter, but it did quickly reduce inventory for our major retailer customers and even led to out of stocks for some, especially in humidifiers. Internationally, we saw shipment growth, especially in thermometers. As we start the fourth quarter, replenishment orders from retailers have been much stronger, especially on humidifiers, and we are forecasting strong shipments of our cold and cough related products this quarter. The exact amount will depend on how long symptoms persist, how aggressively retailers replenish, and our ability to serve the increased demand. Turning to Home & Outdoor. Total sales, including Osprey, declined 7% versus a very tough comparison to the prior year when the segment grew 10.7%. OXO continued to see POS below peak prior year levels at brick and mortar as the overall home category continued to slow. Importantly, total POS for OXO remains solidly ahead of pre-pandemic levels as we focused on our marketing to introduce the brand to new consumers. OXO performed very well at our largest online retailer during the Black Friday and Cyber Monday period. Hydro Flask continues to hold its Number One position at our largest online retailer where sales almost doubled during the Black Friday and Cyber Monday period compared to the same period last year. This helped to offset the broader POS decline at brick and mortar in the quarter. Turning to Beauty. Core segment sales declined 12.2% in the third quarter. Primary driver was the overall beauty appliance category decline from the high base of fiscal '22 in both online and the U.S. mass merchandisers. It was partially offset by some pull-forward of orders in third quarter ahead of this year's holiday period. Even though consumers continue to trade down to lower price appliances, our market share at the largest online retailer and at the brick-and-mortar retailers that make up the majority of our sales are now showing growth over the past 52 weeks. The Revlon One-Step Volumizer continues to be, by far, the Number One selling item in the category, selling it twice the rate of the Number Two seller across nearly all retail customers. With prestige liquids, which are among our most profitable businesses, both Drybar and Curlsmith achieved solid performance. Turning to International. Results were ahead of expectations with net sales up 15.3% and particular strength in EMEA and Asia. Contributions from the acquisitions of Osprey and Curlsmith were the main drivers. All three Home & Outdoor brands performed above expectations internationally, with Osprey doing very well in Europe. Braun outperformed as we were able to partially overcome supply shortages to help meet the increased thermometer demand in EMEA and in Asia. Regarding Pegasus, I would like to say that the workforce reduction we announced today is one of the hardest things I have done in my entire career. We have an exceptional team and a team that has delivered outstanding results over many years. My respect for the people who will be leaving us and the work that they have done is immense as is my gratitude. Changes we are announcing today are the right ones. They are a natural evolution of the major themes we have been focused on from the start of our transformation. While change is never easy, I want to reiterate how encouraged I am about the progress on all of the Pegasus' workstreams. Helen of Troy has an outstanding track record of adapting to change and transforming itself with significant positive results. We have done it three times in the recent past: has proven in Phase I of our transformation; has demonstrated further in the first three years of Phase II, both before and also during the pandemic; and in our Beauty segment under the Refuel initiatives. Rather than grind through the present challenges, we greatly prefer to proactively shape our future through Pegasus and then build on it with Phase III. With regard to timing, we see fiscal '24 as a transition year. From a macro standpoint, we see a very challenging near-term economic backdrop. We are focused on Pegasus, on launching our pipeline of consumer-centric innovation, and on executing our commercial plans for fiscal '24. The faster we secure our Pegasus efficiencies, the more that we can invest in accelerating revenue growth and building market share for our most promising brands. With the largest portion of Pegasus' savings slated for realization in fiscal '25, we expect to generate fuel to invest in the value creation flywheel further. As we execute the full suite of Pegasus' initiatives over the three-year arc, I am confident we can return to growth on the top-line, lower our input costs, expand operating margins, improve cash flow and further reduce inventory. I look forward to sharing further progress on Pegasus as well as our fiscal '24 outlook when we report our fourth quarter results on our normal timing in late April. Thank you, Julien, and good morning, everyone. I would like to begin with an overview of our third quarter results, then review our updated fiscal '23 outlook, provide an update on Project Pegasus, and conclude with some high-level thoughts on fiscal '24. Looking at the third quarter, results were ahead of our expectations as we benefited from a more severe start to the cough, cold and flu season, driving higher-than-expected sales in certain health-related categories, such as thermometry and humidification, as well as the benefit of the shift of approximately $10 million of sales that occurred in the third quarter that were forecasted to occur in the fourth quarter, and lower interest expense. These factors were partially offset by holiday selling season that did not start off as strong as expected, as macroeconomic pressures continued to impact consumer purchasing behavior, a more unfavorable gross profit margin, particularly in Beauty and Health & Wellness, and higher effective tax rate. Our consolidated net sales decreased 10.6% in the quarter, as organic sales were impacted by lower consumer demand, unfavorable shifts in consumer spending patterns and reduced orders from retail customers due to higher trade inventory levels. The net sales comparison was also unfavorably impacted by the pull-forward of approximately $15 million into the third quarter of last year as retailers accelerated orders to try to avoid supply chain disruptions during the holiday season. The contributions of Osprey and Curlsmith partially offset the decline in organic sales. GAAP consolidated operating margin for the quarter was 13.8% of net sales. On an adjusted basis, operating margins declined by 0.4 percentage points to 16.6%, primarily driven by unfavorable operating leverage, the unfavorable impact of less Beauty segment sales within our consolidated net sales revenue, and a less favorable product mix within the Home & Outdoor segment due to the acquisition of Osprey. These items were partially offset by higher gross margin due to a more favorable customer mix within the Home & Outdoor segment and a more favorable product mix within the Beauty segment primarily due to the acquisition of Curlsmith, as well as lower annual incentive compensation expense. Net income was $51.8 million or $2.15 per diluted share. Non-GAAP adjusted diluted EPS decreased 26.1% to $2.75, primarily due to lower adjusted operating income, higher interest expense, and an increase in the effective income tax rate, partially offset by lower weighted average diluted shares outstanding. We generated $125 million of operating cash flow in the third quarter, primarily driven by a sequential decline in our inventory levels from the end of the second quarter of $106 million. We are now at lower inventory levels than the end of fiscal '22, and we continue to expect a further decline in inventory in the fourth quarter. Our new expectation is to reach approximately $500 million of inventory by the end of fiscal '23. Even with this accelerated improvement in inventory levels versus our previous expectations, we continue to expect slightly negative free cash flow for the full fiscal year. We ended the quarter with total debt of $1.08 billion, a decrease of $89.3 million from the second quarter as we used our positive cash flow to pay down our debt. This brought our net leverage ratio down to 3.1 times compared to 3.16 times at the end of the second quarter. We continue to expect our leverage ratio to decline in the fourth quarter and to end fiscal '23 with the leverage ratio in the range of 2.75 times to 3.0 times. Now turning to our revised outlook for the current fiscal year. As outlined in our earnings release, we have raised the lower end of our full year outlook for fiscal '23 for both sales and adjusted diluted EPS while maintaining the top end of the ranges. Given the volatility and uncertainty we have experienced this year, coupled with the current trends in the market, we remain cautious in our outlook for the fourth quarter. The consumer continues to feel the impact of inflation, and, as we have seen during the holiday period, was seeking to buy discounted or promotional items. We are seeing positive signs that inventory at some key customers is beginning to rebalance, and we will continue to monitor closely as retailers finish their holiday season. Our revised outlook reflects several factors, including the timing shift of sales into the third quarter versus our previous expectation of those sales occurring in the fourth quarter, higher sales in our Beauty segment due to an improved outlook for Curlsmith and a less than expected category decline in hair appliances and higher sales in our Health & Wellness segment due to a more severe start to the flu season. These factors are offset by lower-than-expected consumption trends in our Home & Outdoor segment and our assumption of lower customer replenishment orders impacting the fourth quarter following the slower start to the holiday season. Although we are seeing a more severe start to the flu season, it is unclear how the remainder of the season will progress. Additionally, due to our strategic initiative to decrease inventory levels and our previous expectation of a flu season in line with pre-COVID historical averages, we will be somewhat limited in our ability to supply at elevated demand levels in certain categories in the fourth quarter. Our adjusted diluted EPS outlook is being impacted by our expectations for sales, a more unfavorable gross margin, particularly in Beauty and Health & Wellness, higher marketing expense, lower interest expense, and a higher effective tax rate. For fiscal '23, we now expect consolidated net sales revenue in the range of $2.025 billion to $2.05 billion, which implies a consolidated decline of 8.9% to 7.8% and a core decline of 7.5% to 6.4%. By segment, we now have the following net sales expectations: Home & Outdoor growth of 2.5% to 3.5%, including net sales from Osprey of $180 million to $185 million; a Health & Wellness decline of 11% to 10%; and the Beauty core business decline of 18.5% to 17.5%, including net sales from Curlsmith of $35 million to $40 million for the 10-month period of ownership in fiscal '23. As a reminder, the fourth quarter of last year included accelerated sales from certain retailers securing additional supply ahead of expected price increases, the favorable sales impact of health-related products from the initial Omicron wave, and approximately two months of sales from the Osprey acquisition. Despite the macroeconomic challenges we have faced this year, we are particularly pleased to see Osprey continue to hold the sales outlook we provided at the beginning of the year and to be able to increase our sales outlook for Curlsmith. We now expect consolidated GAAP diluted EPS of $4.82 to $5.11, and consolidated non-GAAP adjusted diluted EPS in the range of $9.20 to $9.40, which implies a consolidated decline of 25.6% to 23.9% and a core decline of 24.5% to 22.8%. This includes an adjusted diluted EPS contribution from Osprey of approximately $0.35 to $0.40 and a pro rata fiscal '23 contribution from Curlsmith of approximately $0.20 to $0.25. We continue to expect to slightly expand gross margin in fiscal '23 and consolidated adjusted operating margin is now expected to decline approximately 100 basis points to 120 basis points, with roughly the same year-over-year decline in each of our segments. The consolidated adjusted operating margin decline is expected to be driven primarily by unfavorable operating leverage, the net dilutive effect of inflationary price increases, the dilutive impact of the Osprey acquisition in the Home & Outdoor segment, and an unfavorable product mix in the Health & Wellness segment. Our outlook for the estimated after-tax impact of incremental inflationary cost declined slightly to approximately $50 million to $55 million or approximately $2.10 to $2.25 of adjusted diluted EPS. Our outlook for interest expense declined to approximately $42 million to $43 million. While we still expect the Fed to increase interest rates by 450 basis points in calendar year '22, we benefited from previous assumptions on the pace of rate increases, our ability to pay down debt, and the forecasted amount of capitalized interest related to the construction of our new distribution center. During the quarter, we made good progress on our Project Pegasus initiative, as we reduced inventory levels, improved cash flow, and advanced many other workstreams that we believe will create future operating efficiencies, expand our margins, and provide a platform to fund future growth investments. We believe we are on track to achieve the total savings and timing objectives that we introduced in our second quarter call and that we reiterated in today's earnings release. As Noel discussed in her remarks, changes to the structure of the organization in connection with Project Pegasus will include the Beauty and Health & Wellness operating segments being combined into a single reportable segment, which will be referred to as Beauty & Wellness. Therefore, beginning with our fiscal '23 Form 10-K, our future disclosures will reflect the two reportable segments, Home & Outdoor and Beauty & Wellness, with historical periods' segment information recast to be on the same basis. Additionally, when we issue our fourth quarter earnings release, we will provide two years of historical quarterly segment data on a comparable basis. Looking ahead to fiscal '24, there remains considerable uncertainty in the near-term macroeconomic and consumer outlook. We expect that many of the same macroeconomic factors that made calendar '22 so challenging may persist into calendar '23, as well as the compounding effect of the uncertainty of a potential recession and whether or not can -- the Fed can execute a soft landing. These factors continue to make the ability to forecast consumer behavior patterns difficult. We believe that fiscal '24 sales growth will be challenged and highly dependent on the health of the consumer, and that the variability of these factors could drive a wide range of potential outcomes, which will be impacted by the depth and length of any potential recession. As previously discussed, we also expect to face a number of cost headwinds in fiscal '24, which include: higher interest expense as we annualize the increase in interest rates in fiscal '23; incremental depreciation related to our new $225 million distribution center, which we expect to put in service at the beginning of fiscal '24; and higher annual incentive compensation expense, as we reinstate expense associated with our estimates to achieve fiscal '24 compensation targets. We do expect fiscal '24 tailwinds from healthier retailer inventories and more aligned sell-in and sell-through sales patterns, savings from Project Pegasus initiatives, and lower ocean freight and product costs. However, the benefit from freight and product costs are generally expected to be realized in the second half of our fiscal year, as we move through the cycle of purchasing new inventory and turning it through cost of goods sold. While our fiscal '24 may be a transition year as we see macroeconomic rebalancing and navigate some cost headwinds, I am confident that the strength of our brands, efforts of our associates, strategic growth investments, and the initiatives we are executing under Project Pegasus will help position us to return to sustained long-term growth as we look to fiscal '25 and beyond. Good morning. Thanks for taking my question. So, I guess, I'll just start with the Hydro Flask brand. Just curious what's driving the disconnect between what you guys are seeing online versus some of the weakness you're seeing at brick-and-mortar? And then, as you look at Hydro Flask, is that gaining or losing share at this point from your perspective? Yes. Hi, Rupesh. Nice to talk to you, and glad for everyone that we're out of our quiet period and able to speak openly. Noel, could you fill in on this topic? Sure. Hi, Rupesh. Thanks for joining us today. When we look at Hydro Flask, we do see channel shift, and you touched on that in your question. We see a lot more sales transitioning to online where we are performing very strongly, as Julien outlined in the script, leading share brand in the leading online retailer. I think that's a function of shoppers to shifting more and more to online, especially for items like the -- like Hydro Flask. As we look at Hydro Flask over a two-year stack, we do see the brand growing and strong. And so, we still are very excited about Hydro Flask and its performance. Yes, my only build there -- thanks, Noel. My only build there is that, on a share basis, if you looked at the last three or four years in total, Hydro Flask is roughly flat, call it, four years ago basis. So, there's been some ups and downs along the way. And in the case of the channel shift, my only build on that particular topic is that we've been active in the area. We disclosed I think a quarter or two ago that we went from a third-party manager of our online sales at the biggest online retailer to first-party, and that made a big difference for us. And DTC, in general, is a big investment area for us. We've been very clear that we have major initiatives in that area. And we're very pleased actually with the progress. It did not change the online retailer results during the quarter, but it is influencing our DTC. We mentioned that DTC did extremely well during the Turkey 5, Cyber Monday period in our prepared remarks, and we have much more to come on the subject of DTC on very short timing for Hydro Flask and other brands. Thank you. Just want to follow up on some of your comments as it relates to the outlook. Obviously, you guys said and we've heard from many companies that visibility into calendar '23 is lower than normal due to the inventory corrections at retail and also the potential recession next year. So, the question is what changes operationally in a low visibility environment for you? What do you do differently in it, if anything? And how can this impact the year overall? What are the kind of issues that it could impact the year as a result? Yes, let me just say a little, and then I'll pivot to Matt and Noel, because I think they can help on this one. First, just a general comment, and this is for everybody. We're at that funny time of year when I think everyone is extremely interested in calendar '23 or our fiscal '24, which starts on March 1, and yet, our normal cycle is to go through the rest of our budget process, prepare the last of our year and then disclosing in April. So, we won't be in a position to put specificity. I know that people were asking even as recently as long ago as October, and we were laughing a bit, saying, well, I guess people knew about 18 months from now. I know you're not asking for that kind of specificity. You're asking at the macro level of what you do in a lower visibility environment. So, going to that question, the key answer for me is about focusing on the controllables. We mentioned the specific ones in the prepared remarks. The first is Pegasus, of course, and we talked quite a lot about that. That's the source of fuel. It's also the source of additional efficiencies, and it will help us in all the ways [at heart] (ph). Now, the second big controllable is our significant pipeline. We're a winner on innovation. Our products are winning awards all over the place. Noel might be able to speak to a little of this. We have some market share wins, actually a few market share losses. But in general, consumers not only prefer our products, but buy them. And the result is that we are continuing to focus on innovation and we're investing in innovation, and that's controllable for us. We love consumers. We love delighting consumers, and kicking butt in the marketplace on that topic is a control. In the second -- the third controllable, just commercial plans. And Noel can speak to a little bit about some of them, but the idea is to focus on controllables. As far as inventory, we can control what we buy. We can't control what retailers choose to buy, but we do work very closely with them on helping to manage their inventory. So, you heard us say in the prepared remarks that in this environment, we are extremely focused on making sure that retailer inventory is healthy. We're helping where we can. We're being careful with consumers to be sharp on price and we are bringing our own inventory down in a big way. That's a whole another controllable for us. And the last is around cost and footprint kind of the things, where we've been pretty aggressive. On the marketplace, we've not given up. We believe in the economy. We believe in the consumer. And we believe in the long-term health of people's interest in improving their lives. So, we're making that bet. There's just a choppy period ahead where we don't have that kind of visibility and it does create a fairly broad set of potential outcomes. So, for Matt or Noel, I don't know if there's any further specificity that you guys might want to put there, but the key message is controllables. Yes, good morning, everybody, and Happy New Year. This is Matt. Bob, the only thing I would add to what Julien said is, he talked about focusing our controllables and what we do differently. I think Pegasus is part of that too, right? I mean, so we've already put Pegasus in place and I think that will help generate some things that will give us some headwinds for next year. The other is, I think you can just take a general planning approach as you go in, which we've done before in similar years where there's more uncertainty where you take a little bit more of a conservative spending approach, cash management approach, and then, what I call, spend into success, right? So, as you see the sales develop maybe more positively than you would have gone in, you are ready with plans to start spending into the success. And I think as we look at our budgeting approach for fiscal '24, that's kind of the mentality we're taking is planned for maybe a more conservative approach, but then be ready with alternative plans as we see success to be more aggressive and capitalize on it. Yes. The only other build I have to what Julien added is, it's just -- and it builds on what Matt said is prioritizing where we do spend as we do that. So, really using the budget season that we've got upon us to think about which of those brands that we think have the best growth potential, the best profitability, the best momentum in the marketplace and leaning in there and then trying to treating some of the other brands as more steady stronghold that maintain their position and that allows us to make sure we get the very most and the best out of the best parts of our portfolio. As Julien said, we do continue to innovate. We've got some great innovations. We've earned a lot of awards, not only on design, but also from some of the preeminent women magazines on many of our products. So, we know that our consumer-centric innovation continues to resonate. And commercially, we also continue to do very close joint business planning with our major customers, making sure that our distribution and assortment is appropriate for kind of this given time horizon where the economic uncertainty is there for consumers. And it's one of the magic of Helen of Troy's diversified portfolio. We have things that cover a broad range of price points to enable us to do that. By the way, on that awards thing, people might think, we might be talking more about all those volumized awards or the traditional industrial design awards that OXO would win. There was a pretty healthy slate in Health & Wellness quite recently and some pretty major international ones. And even in Beauty, by the way, and not in the volumizer area, the dual plate straightener, the one that has the floor plates, looks like a tuning fork, you've seen it from us before on Hot Tools where we extended it from the original Revlon, just won a Cosmopolitan Holy Grail Award for 2022, like a week or two ago. Great, thanks. Good morning, everybody. My first question is, first a clarification on the consolidation of Beauty and Health & Wellness divisions into one, because it sounds like it's both the cost savings maneuver to reduce headcount, but also you're expecting it to help with brand development innovation and focus on marketing, at least that's what it says in the press release. So, I'm trying to understand the savings component fairly straightforward. But can you talk about how you expect that consolidation to help you drive innovation and presumably faster sales growth over time to start? Thanks. Yes. Hey, Olivia, good to talk with you again. We do [indiscernible] the cost savings aspect of it is obvious, but we do see significant additional synergy by combining Beauty and Health & Wellness. The two business units have the largest overlap of core customers. Of course, we've got Drybar and Curlsmith that are more prestige beauty, but when you think about mass merchandisers, food, drug, mask, et cetera, there's a lot of overlap there. So, good synergy there as we get our North American RMO up and running. And then, many different synergies in the cost areas, some third-party manufacturers, a lot of common plastics and resins. So, when you think about some of the cost of goods, workstreams that we have on that side of things, we see a lot of synergies there. Plastic and resins, as well as common motors and blowers, those sorts of things. So, there's really a lot of areas. It may not be obvious on the surface, but when you really dig down into it, there's a lot. And then, the other place is just when you have fewer business units, not only do you need less overhead or less people, as you talked about, but just the streamlined interfaces. As we get our shared services even more centralized, interfacing with two business units versus three is more efficient. Our processes can be more standard and be more efficient. So, those would be some of the areas that we see as beneficial as we kind of come together as a new Beauty & Wellness business unit. Got it. That's helpful. And then, my second question is on inventory and consumer demand. And can you talk about where you stand on retailer inventory within key categories, particularly those have benefited from outsized demand obviously in the last two -- three years? And kind of your view on when sell-in and sell-through more or less converge? And then, the other side is then, on your own inventory, getting to $500 million, great progress over this year, of course. But what's the end goal? Because even if we adjust upward for acquisitions and place and et cetera, inventory is still a fair bit higher than pre-pandemic levels. So, what's the end goal? Maybe a little bit of color on that after that $500 million? Thank you so much. Yes, good morning, Olivia. Yes, so good questions. Obviously, we're very pleased with the amount of progress we've been able to make in the quarter to bring down our inventory levels and get to $500 million this year. And then, to your point, I think there is some adjustment for some of the acquisitions that we've done. As I look forward, I think a good measure for us we're going to be looking at is turns. And so, inventory levels are the leading indicator and the turns are the lagging indicator just because of the look back and how you calculate it. We work a lot closer to three turns in the past and we've drifted down to the low twos at this point in time. We really want to get back to the three turns level. I think that -- I don't know if we'll get there next year because of the lag impact of it and what happens with the macroeconomic environment, but I think as we look forward, we definitely want to get to three and then above three on more long-term basis. I think that'll be really efficient. Our new distribution center, the consolidation of our distribution footprint will be a lot of things that can help us be more efficient in inventory. And so, I think that, that will help us get to that turns level. I definitely think we want to get down much more below $500 million just from an inventory level perspective, and we'll have to look at what that means by the end of next year. But I'd say, overall, focus on turns, and we'll need a little bit more time to get to that three times turn and then beyond. But, for us, I think, there's a lot of good tailwinds for us that are going to help us get there over time. Yes. One example on that one is, remember, we've spoken a lot about balancing between China sourcing and rest of world sourcing, including in the Americas and especially, Mexico, which leads to nearshoring for the US and Canadian market and even the Latin American markets. That nearshoring has the obvious benefit of shorter lead times. Shorter lead times by definition means less inventory, and it -- also less exposure to the sea freight market. And so, lots of reasons why those initiatives which are much bigger than just the speed of turn -- sorry, than the sourcing or the comments that Matt is making will help us bring the speed of turns up. On the retailer inventories -- sorry, I want to say one other thing about this, about [hours] (ph), which is, you've heard us talk about SKU rationalization in Pegasus and Noel might mentioned this because that's going to help us on the topic of not just how much inventory we carry, but how quickly it turns. And on the retailer inventory, Noel, I don't know if you might speak to that and also any other builds on how our inventory will continue to come down. Yes, sure. Starting with our inventory, as Julien mentioned, SKU rationalization in a really robust comprehensive way through Pegasus will help us I think on inventory. As we start to simplify your line-up and really look to focus on your most productive items both from a consumer and a retailer perspective, and cut out some of that long-tail complexity, that's going to help us from an inventory management standpoint and from a forecasting standpoint, which also then helps inventory. From a retailer inventory standpoint, what I would say, Olivia, is, it does still vary category by category and retailer by retailer. As you might expect, we play -- we have a diverse portfolio. We play across a lot of retailers. But we are clearly in a better place now than what we were in last quarter and the quarter before that. We do continue to see some retailers in certain categories ordering less than consumption, suggesting that we do still have some pockets of higher inventory in retail than we might like. We continue to partner closely with our retailers on the right commercial programming to move through that, but we are pleased to see the kind of sell-in and sell-out kind of get closer to one another as we progress through the year. So that's kind of where we stand there. One quick thought before we move from this one, Olivia, is things change quickly. And what I mean by that is, we just saw it in the cold and flu numbers and yet, I think people are used to, whether it's because of the consumer buying pattern shifts from the pandemic or the retailers having swollen inventories in the last six to nine months, people are used to this narrative that the inventory needs to turn slowly and the consumer is down for the count. Things turn quickly. So, just now, when people have a need, like in the cold and flu, we're in a situation where we literally just can't ship enough humidifiers right this minute. In the case of thermometers, everyone knows what it was like during the pandemic. Air purifiers, a little bit later in the pandemic. And so, things change quickly. Our products are diversified. So, when needs come, we do have what people want, whether it's in health-related category or home-related category and outdoor-related category, and when the need is there and consumers go for it, not only do they prefer our products, but things change quickly for us. So, I just had a question kind of about maybe the bigger picture longer-term thing here. When you look at your operating margin for this year, I don't know, I guess, I haven't updated here, but it's around 15% or so, give or take. And that's actually not down a ton from your high, from your peak margins. You've achieved really good margins through all your hard work. And I guess, as mostly a durable goods company with like a 15%-ish operating margin, I guess the question I get a lot from people is like, well, what's the potential long term? I mean, one would argue that, that's already high. And so, I'm just curious if this Pegasus restructuring, is it kind of like to stem further decline, or is it actually to drive that margin to even newer -- new highs? I guess, I just want to understand kind of what your thoughts on there? Yes, I think -- again, we've talked about various different workstreams in Pegasus and many of them do look at improving our margins. I just talked about SKU rationalization in the prior question, and that's a good example of it. When you do that kind of work, you're really looking SKU by SKU, and looking for those opportunities to prune any items that maybe aren't as productive and aren't as profitable and the margins aren't as good. And so, that starts to help from a margin standpoint. We're looking at all this different cost of good savings projects. So, there's many different aspects of Pegasus that will help. And when we think about it, we also want to reinvest with Pegasus. So, I would say, we certainly don't look at Pegasus to only improve our operating margin over time. We're looking -- as we generate the savings to be able to reinvest back in the business and drive growth for us in the future. And that's a big part of it. The faster we can get some of these projects going and turning through cost of goods and inventory, as Matt mentioned, the faster we we'll be able to reinvest back in the business. Yes, the only build I would have, Linda, is I think you've kind of got the margin outcome this year. We guided today, in my comments, to down 100 basis points to 120 basis points. But to your point, within that, us getting to that approximately 15%, like you said, there's a lot of deleveraging. I mean, with the amount of sales decline that we had, there's a lot of deleveraging in that number. So, if you just, let's say, snap your fingers and take out the deleveraging impact and you get to some growth next year and you get a little even, [God forbid] (ph), a little favorable leverage that's a building block. And then, what Noel was saying on Pegasus is there is an opportunity in Pegasus to create margin improvement and that could be dropping some of the cost savings. It could be lower product costs. It could be making space to reinvest and drive leadership brand growth, which is going to drive better mix. I mean, think about -- we've had a huge favorable impact this year from Curlsmith. And although it's not the biggest brand we have, it really punches above its weight in terms of mix. And so, being able to invest in those brands that we purchased over the past couple of years are going to drive higher mix. I think there's a lot of tailwinds when you look at our operating margin trajectory. And of course, we'll have to fight cost headwinds like everybody else, and we've got some big ones next year. But I think if you look in the longer term, I think there's still a lot of tailwinds on our ability to continue to expand margins. Yes, I couldn't agree more. And, Linda, I'm so glad you asked this question. And for your question and for all, frankly, on this call, there is a message from us. And the message from us is that the best is yet to come over time on margin from Helen of Troy. In the short-term, there is pressure. You just heard us describe the minus 100 points. I think everyone on the call knows that Helen of Troy is up several hundred points on margin over the course of the transformation years. To lose a 100 basis points or even 120 basis points during this fiscal year is extremely painful, and we've certainly taken our beating on that topic. So, for the short-term, folks, they're right that, that's painful. For the long-term picture and not just Pegasus, but also the Phase III plan, which will follow it, the intention is to not only return to the margin peak that we saw last year, which was in, I think, the 16% range for adjusted operating margin, but to surpass it. So, we're not making particular Phase III promises, we're not putting a specific long-term goal out today, but there is a message. And the message is, we've made several hundred bps of progress, we've lost about 100 basis points of them. We not only intend with Pegasus to quickly try to earn it back, but to surpass it in Phase III using the fuel from Pegasus to reinvest in the flywheel. Okay, thank you. That's very helpful. And then, can I just ask about, in the Health & Wellness, we all know the whole story in the past about the EPA relabelling issue, et cetera, et cetera, and you had lost some sales from that. It actually looks in the [IRI] (ph) data like you're actually gaining back a lot of share. Is that the case? And are you kind of catching up and now that you're able to reship? Are you actually gaining a lot of share, as well as the cough, cold, flu season helping? I mean, is that kind of what I'm seeing going on there? Yes, Linda, as we touched on in the prepared remarks and you see it all over the news that this is a particularly high illness season, and the products that we have, in many cases, really help with those symptoms. So, our humidifiers, for example, is one where -- Julien just said it, we obviously -- they're selling very well. Our share is very robust there. We look very positive in that regard. And frankly, we don't have necessarily enough to meet all of the elevated demand from a supply standpoint. Thermometers is another place. Now, there's a lot of ups and downs in thermometers, since we've kind of come out of COVID and we've had very different participants come in, but that's another place where we see strength. So, we do see strength in a few of our share positions in Health & Wellness in this most recent time period. And we were also down pretty hard in air purifiers because of the EPA matter. So, yes, it's true that we've bounced back in part. It's quite competitive these days. There is a lot of inventory out there. So, there's more promotion than I think anybody would like. But in that battle to see our share improve and hold our own, that's good news. But the idea that we're back to pre-EPA positions, that would not be the case in market share for air purifiers. Hi, good morning. Thanks for taking my question. Nice to see the improved inventory position. I'm curious just on the M&A environment, just kind of what you're seeing out there, potential acquisitions starting to become more attractive from a valuation perspective? And then also if you could give us an update just on your thoughts on leverage? It sounds like you still expect to be 2.75 times to 3 times at the end of the year. I'm curious how you're thinking about. If there's any early thoughts of next year? If you're happy with that level? And then also any other thoughts on just the floating rate debt and maybe moving that more of a fixed rate? Thanks. Yes. Hi, first of all, Susan, and welcome. We're very pleased that you initiated coverage and I believe this is the first call since you did. So, we're out of our quiet period. So, very nice to meet you. We're looking forward to meeting you in person next week. So, it's great news. Yes, pleasure. Yes, thanks. Let me say just a little, and then from Jack on the subject of M&A and Matt on the topic of debt levels. Our general goal is as we've been talking quite a lot in the last few months is to improve our cash flow, reduce our inventory, bring down our debt, and invest in the most important initiatives, that's where our money has been going. It's been our strategy for a while now. In the case of the progress, you've heard it reported today and thanks for your comment, we did make progress on inventory. We've made progress on debt a little bit actually, not that much. And on the subject of cash flow, also progress despite the investments in the big new distribution center. Sure. Hi, Susan. So, on the M&A side, we are actively looking at a number of different projects. What I can tell you is that we're not really seeing the types of assets that we would like that will fit our criteria. We are rather picky with selecting and bringing new assets in. They need to sweeten our mix. And we also look to ones that we can make better but also can help make us better. So, at this point in time, we're continuing to look, but we're not seeing anything that is getting us to lean in at least at this point in time. But hopefully, there will be something in the near future and we do will have something to share about it. By the way, valuations to your comment, they are coming down, right? Money is not cheap. And there is a different marketplace that many people are selling into. So, we're keenly aware of that. You were not following us at the time, but you probably saw our comments when we bought Curlsmith. We bought an extremely strong prestige name with a significant position in its unique space of textured hair for roughly 10 times, and that's unheard of in the prestige space. So, we took advantage of that opportunity. It's been good for us, as you've heard us say. And as we see others that have the right mix of better together, as Jack always says, and the sweet spot on valuation, and then put that together with the cash flow and debt story, not only why not, but that's our entire track record as a company. We've doubled this company in the last 10 years in terms of sales and a portion of that came from acquisition and many of those were outstandingly good financial deals. Hey, Susan. This is Matt. I'll just add onto the leverage component of it. Obviously, if you look back at our history, the amount of cash flow we'll generate this year, free cash flow is much lower than we've done in the past. And as you look into next year, I think we've got tailwinds for being able to continue to reduce our inventory levels, as well as we're not going to spend $150 million of CapEx on our new distribution center we're going to spend this year. So, just take those two things and put them together, and that's a big tailwind for us from a cash flow perspective. So, we expect to be able to continue to bring down our leverage. One thing for us is we typically generate more of our cash flow in the third and fourth quarter than the first and second quarter. So, as we kind of look at our general cash flow cadence, I'd expect more of the reduction in our leverage to occur in the second half of the year than the first half of the year. So, first -- so given some of the trade down comments Julien that you said and as well as the current state of the economy, does that make you guys maybe rethink your product strategy? Or do you think just a low-end type of products are just as too commoditized? Just would love to get your thoughts on that. There is a sweet spot, Anthony, and hi, and Happy New Year to you, too. There is a sweet spot where the products can differentiate the brands and justify their excellence, their pricing and delight the consumers. They're below that sweet spot, the commoditization comments starts to kick in, and that world of opening price point, much like the world of private label products, it's fully undifferentiated, and that's not a place where brands distinguish themselves, it's not a place where innovation is rewarded. It's a place where people who just want to spend less money will buy. I would say, this too shall pass, but I think that's a bit too dismissive. There's simply a shift for a short time, and this happens when there are economic cycles like this. So, what we've done about it, as we talked in the last call, is to make sure, especially in beauty appliances, that we have some lower-priced products in the mix. And while that's not as good for margins, it does help on this topic. We also spoke about our -- in the world of good, better, best, our better thermometers like the Vicks stick type of thermometers, which picked up share when we last reported it, which I believe was last quarter, helped during the trade down area. And so, you can see us navigating in this area. So, it's diversification not just in category, but in the world of good, better, best, but not all the way down to the commoditized opening price point. And all that said, Noel, if you might comment, just because we have like a moment left before the call will break, the thoughts in the hair appliance category, especially large mass merchandisers where there is an opportunity to improve the mix a bit in the direction Anthony is talking about. Yes. As mentioned, that was the place to really make sure that our assortment was as robust as possible to cover the good, better, best range that Julien just referred to. So, we've done that in mass, in particular, the channel where that consumer and that shopper tends to shop. We have rounded out our assortment in that regard and that helped us in this quarter and that's part of what helped our share in the beauty appliance category. And we look to continue to do that as appropriate during this time when we need to meet that full broad range of consumer and shopper needs. Yes. So, we'll see some improvements in that area in upcoming distribution planogram as our expectation as well, and it just helps balance it all. But if you have the question of, are we strategically going to shift, go down market and become commoditized and then duke it out on price where people sell their mother for a nickel, the answer is no. Yes. Well, I know we've run just a minute or two long, so I'll be very brief. First of all, just a thanks to everybody. It's a new year. There's a lot going on. And we're grateful for people to continue to follow and take interest in where we're going. We're in a very special point in our career. You see -- sorry, in our trajectory. You hear all the things that we said today, so you know what I'm talking about. We look very much forward to seeing quite a few of you actually in-person next week, and then, virtually over the next week or two in the upcoming conferences. I know we have a number of other meetings scheduled with you. So, looking forward to it, and with the analysts as well. It's an exciting time for us, and we're very happy to communicate. Thank you. This will conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.
EarningCall_1556
Ladies and gentlemen, thank you for standing by and welcome to Sprinklr's Third Quarter Fiscal 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' remarks, 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 over the conference to our first speaker today, Mr. Eric Scro, Vice President of Finance for introductory remarks. Please go ahead sir. Thank you, Diego and welcome, everyone, to Sprinklr's third quarter fiscal year 2023 results financial call. Joining us today are Ragy Thomas, Sprinklr's Founder and CEO and Manish Sarin, Chief Financial Officer. We issued our earnings release a short time ago, filed the related Form 8-K with the SEC, and we've made them available on the Investor Relations section of our website, along with the supplementary investor presentation. Please note that on today's call, management will refer to certain non-GAAP financial measures. While the company believes these financial measures provide useful information for investors, the presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. You are directed to our press release and supplementary investor presentation for a reconciliation of such measures to GAAP. Thank you, Eric and hello everyone. Thanks for joining us today as we share the financial results of our third quarter and FY 2023. I'll get us started with a few highlights, including what I'm hearing from customers and some of our key wins. Manish will then share details of our financial results. Turning now to the quarter, I'm very pleased to report that Q3 was another strong quarter that exceeded guidance. Q3 total revenue grew 24% year-over-year to $157.3 million and subscription revenue grew 27% year-over-year to $139.9 million. And with our commitment to operational efficiency, we generated $6.9 million in non-GAAP operating income for the quarter, due to prudent financial management and greater operational discipline company-wide. Before providing key takeaways from this quarter, I'm excited to share that we have appointed the former Chief Revenue Officer of ServiceNow, Kevin Haverty, to our Board of Directors. Kevin joins us at an exciting time in Sprinklr's journey, and his experience will greatly benefit our go-to-market execution, something that we are very focused on now. Kevin currently serves as a Senior Advisor to the CEO at ServiceNow and has been a CRO there under three different CEOs. I also want to thank Matt Jacobson, Partner at ICONIQ Capital, who has retired from our Board after serving us for eight years. ICONIQ joined as an investor in Sprinklr in the very early days and helped chart our course back then. We are very appreciative Matt's contribution, and I wish him all the best. Now, moving on to Q3. I was fortunate to meet with well over 100 customers around the world from across the U.S. to India, Singapore, South Korea, Dubai, Mexico. The excitement of brands transitioning from point solution KOLs and customer-facing functions to Sprinklr's unified CXM platform is truly palpable if you talk to these customers. And the results they are seeing in terms of reducing customer service costs, increasing revenue by making that ad dollars and marketing dollars work harder and innovating faster, while mitigating risk by listening to customers in real-time. It's truly inspiring. A new story line, that is clearly emerging in these conversations, especially from our newer clients is how Sprinklr’s AI is helping model and automate omnichannel journeys that can potentially eliminate the need for human service agents by up to 95% for some use cases, while improving customer satisfaction scores at the same time. This use case is real at Aramex, the largest multinational logistics provider in the Middle East that someone referred to me as the FedEx or the UPS of the Middle East, who recently consolidated their digital contact center stack on to Sprinklr. I met their Group Vice President of Technology in Dubai, it was great to hear how they have been able to automate 95% of their resolution for several common customer inquiries using Sprinklr's, AI and chatbot and automation, while continuing again to improve CSAT scores. While we continue to win deals across all our four product suites across a variety of industries, more than a third of our bookings in Q3 came from our Customer Service Suite or our modern care suite, where voice-led CCaaS was a key driver for us. We are pleased with our momentum in this space and are confident that technology and our pace of innovation will further differentiate us in this very interesting marketplace. We believe that you can have great customer experience management with our great customer service. However, the current macro environment is leading to delays in purchase decisions and longer sales cycles. And like many other enterprise software companies, we did experience additional pressure on deals in Q3 versus Q2, particularly in Europe. We expect these longer sales cycles and tightening of budgets to continue in light of global uncertainties. While we can't control the macro climate, we can control how we manage the fundamentals of our business. You will see us continue to focus on delivering value to our customers and generating a clear path of profitability for our shareholders as we go forward. Since founding Sprinklr, we've been clear that the market will move from point solutions that don't work well together to a handful of best-of-suite platforms that become more and more tightly integrated. Furthering our intention of becoming the third or fourth major front office platform for the enterprise, in Q3, we announced an expanded partnership with Salesforce and Accenture. Enterprise customers will now be able to incorporate their massive CX data set within Sprinklr with their CDP and CRM data sets inside Salesforce. And Accenture is a key partner in our go-to-market strategy. They are the experts in helping brands bring technology and data together to deliver best customer experience as possible. We're also actively working with Salesforce to support customers through their transition from social studio to Sprinklr. This work has been well underway this year, and we're seeing positive momentum from those customers. During the third quarter, we continued to add new customers, as well as expand with existing customers. Some examples of these world-class brands include Geico, HEMS, Honda, IPG Health, and Overstock. I'd like to provide a few examples of how customers are currently using Sprinklr across our product suite. As a reminder, these suites include our Modern Care suite, Modern Research suite, our Social and Sales suite, and our Marketing and Advertising suite. Let's start with our customer service offering, the Modern Care suite. In Q3, one of the largest global consumer software and hardware players further expanded their partnership with Sprinklr by adding over 500 more care agents, doubling their current agent count to over 1,000. They are now supporting 60 of their product lines across 16 languages on modern channels using Sprinklr. And their agent support has gone from 90% coverage in one hour to 95% coverage in under 30 minutes. With Sprinklr's AI Studio, they're also achieving over 95% accuracy, which has reduced manual processes significantly. Since first becoming a customer in 2014, they are now using 24 Sprinklr products across all four product suites. Another great example of impressive customer service results for us is with one of the world's leading global streaming services. They conducted an extensive RFP process with 20 of today's leading CCaaS providers to select a technology partner that they could use to help transform their legacy CCaaS infrastructure that currently has around 5,000 agents. They chose Sprinklr and in large part because of our full set of CCaaS capabilities on a single, unified AI-based platform, and also our architectural flexibility to integrate with their large number of homegrown tools that exist currently. Turning to Modern Research, this quarter, one of the largest food and beverage companies in the U.S. expanded its partnership by adding product insights to their already expansive portfolio of Sprinklr products. They chose our product insight solution to access competitive insights and better predict the success of the current and future product lines in the marketplace. By using our AI, they are creating a real-time closed-loop data that connects voice of the customer feedback to their product and their customer service teams. Moving to our social engagement and sales suite. In Q3, BMO, one of the largest banks in North America expanded its partnership with us, adding over 2,200 users on a distributed product. If you recall, distributed product for us, it's a key product that's used in the financial services sector for advisers to engage with and sell to their customers across modern digital channels in a compliant way, very essential if you are in one of the regulated industries like financial services. In 2019, they unified seven-point solutions onto Sprinklr and today, they have scaled to nearly 8,000 distributed users and 25,000 seats for employee advocacy. BMO is a showcase of what can be done by a financial institution across social selling, employee and executive advocacy and branch social enablement. And lastly, global technology leader, Siemens, expanded their partnership with Sprinklr this quarter by adding 150 modern marketing and advertising seats. Within four years, Siemens has consolidated eight siloed solutions into our unified CXM platform. Today, nearly 2,000 communicators in more than 60 countries work from the Sprinklr platform every day to plan, manage, distribute, and optimize content across social, web, blogs, and e-mail. Rounding out on the product front, I'd also like to share that we continue to make progress with our Lite products in Research and Care. As we've stated previously, the goal for our Lite products is to accelerate and drive greater efficiency in our in-bound demand generation efforts. This is a self-serve way for enterprises to try an easy to use light-weight version of our platform free of charge, which we see as a gateway for companies that are at the earlier stage of their digital journeys. Before wrapping up, I'd like to applaud our customers for the work they are doing to improve their customers' experiences and for co-creating unified customer experience management as a category. I also want to celebrate Sprinklr's incredible engineering team, who make all of this possible. They continue to innovate at a breakneck pace and speed that differentiates Sprinklr's platform in the marketplace. Whether it's improving our proprietary AI every day or taking on a channel like voice that has over 40-years of maturity in the CCaaS space or making user expedient simpler, this team shows no fear regardless of how daunting the challenges. In closing, I'd like to reiterate that we remain focused on the fundamentals in our business. We will continue to execute on our efficient growth strategy, balancing revenue growth, and profitability, while being disciplined about our strategic hiring and expense management. But we will also stop at nothing to provide the innovation our customers deserve. Our collective belief has never been stronger. Brands want a no-compromise, unified approach to create better customer experiences at the edge of their brand. And that -- the emergence of unified CXM asset category is inevitable. Thank you to all of you, our customers, partners, employees, and most importantly, investors for believing in that vision. With that, let me hand over the call to Manish. Thank you, Ragy and good afternoon everyone. As you heard from Ragy, we delivered another strong quarter across the Board, exceeding expectations across all key financial metrics. Our third quarter results demonstrate our ability to generate strong growth with a clear path to profitability. We are benefiting from multiple long-term tailwinds that we believe will support our business for the foreseeable future, namely our customers transforming their digital edge, the breadth of our product offering, and how the value of our unified CXM platform is resonating with customers. However, we are not immune to the current macroeconomic environment in the short-term. Many of the macro trends that we saw in the second quarter worsened through the third quarter with a general tightening of budget for both new and existing customers. In addition, during the third quarter, we saw the operating environment become increasingly challenging, most notably with a more pronounced slowdown in our EMEA business. Turning to our financial results, for the third quarter, total revenue was $157.3 million, up 24% year-over-year and slightly above the high-end of our guidance range. This was driven by subscription revenue of $139.9 million, which grew 27% year-over-year, also above the high-end of our guidance range. Subscription revenue outperformance was driven by more new business closed earlier in the quarter than expected. Services revenue for the quarter came in at $17.3 million, down marginally from the recent quarterly trend. This is driven by a focus on margins for our services business as we have been thoughtful about not taking on lower margin services business. We will continue to actively manage our professional services margin, which may impact the absolute level of our professional services revenue moving forward. Our subscription revenue-based net dollar expansion rate in the third quarter was 125%, consistent with our Q2 result. I had alluded to this earlier as we have continued to be successful in upselling existing customers at renewal time as we drive significant new business from existing accounts. This metric continues to demonstrate how strategic the Sprinklr platform is for our mid to large enterprise customers and how we expand with them as they mature. Our gross renewal rate in Q3 was again on par with leading enterprise software companies. We believe this high renewal rate, coupled with the expansion in our installed customer base, is a testament to how important Sprinklr is to our customers' daily workflows. This should also provide further evidence that Sprinklr's position in the front office software suite remains resilient even in a potentially recessionary environment. As of the end of the third quarter, we had 107 customers contributing $1 million or more in subscription revenue over the preceding 12-months, which is a 34% increase year-over-year. Our platform and the traction we have with the world's largest and most valuable brands continues to grow. As a reminder, we calculate this customer count using $1 million in recognized revenue from these customers on a trailing 12-month basis as opposed to ARR. Turning to gross margins for the third quarter. On a non-GAAP basis, our subscription gross margin increased to a record 81.4% as we continue to drive efficiencies in our cloud operations, leading to a total non-GAAP gross margin of 74.7%, another record for us here at Sprinklr. Our professional services non-GAAP gross margin came in at approximately 20%, much higher than in recent quarters as we have become more selective in taking on new services business. We estimate the non-GAAP services gross margin to be in the mid-teens for Q4, which we believe to be a sustainable level moving forward. During the third quarter, total non-GAAP operating expenses increased 8.5% year-over-year to $110.5 million, representing 70% of revenues. This is, in fact, down from 80% of revenues during the same period last year and total non-GAAP operating expenses are down $4.1 million sequentially. We continue to generate efficiencies in sales and marketing, which is reflected in our results this quarter with a 750 basis points decrease year-over-year. We also continue to generate operating leverage from G&A, which decreased by 200 basis points year-over-year. As you may recall on the last few earnings calls, we had said that the investments we made in the second half of FY 2022 and early in FY 2023 were partly the result of catch-up investments from prior years due to the unknown impact of the pandemic at that time. That level of catch-up investment has concluded and we estimate the magnitude of year-over-year increases in non-GAAP operating expenses to further moderate in the coming quarters. Turning to profitability for the quarter, non-GAAP operating income was $6.9 million or $0.02 per share on a non-GAAP EPS basis. This 4% operating margin for the quarter was the result of revenue over performance, improved gross margins, coupled with operating expense discipline across every department. This was also the first quarter of positive non-GAAP operating income since Q4 of FY ‘21, and we achieved positive bottom-line performance one quarter ahead of our Street guidance. To that end, in terms of free cash flow, we had a marginal burn of $1.7 million during the third quarter, compared to a burn of $4.1 million in the same period last year. The free cash flow improvement in the third quarter was driven by ongoing operational improvements, slightly muted by the timing of our billings and subsequent collections. And as mentioned on prior calls, given the seasonality and low duration of our billings, we estimate that adjusted free cash flow will be negative here in Q4 and on a full-year basis for FY ‘23. However, we remain committed to generating positive free cash flow in FY ‘24 on a full-year basis, an improvement on what we have communicated on our previous earnings calls. We ended the quarter with a very healthy balance sheet, including $544 million in cash and investments and no debt. This puts us in excellent shape to continue investing in strategic initiatives that will drive growth in a profitable manner. Calculated billings for the third quarter were $138.4 million, an increase of 19% year-over-year. And just as a quick reminder, our third quarter billings have historically been the lowest quarter for us given the quieter summer months in Europe and the general timing of our renewals. The dynamics of our billing trends, as outlined on the last few earnings calls, notably, the seasonality we experienced with Q4 being the highest billing quarter and our overall billing cadence having a duration less than 12-months remains in place. For the first nine months of FY ‘23, calculated billings are up 22%, compared to the first nine months of FY ‘22. And as noted previously and reported here in the third quarter, we expect the delta between revenue growth and billings growth to continue to hold with billings growth lagging revenue growth by approximately five percentage points, assuming all else remains the same. As of the end of Q3, total remaining performance obligations or RPO, which represents revenue from committed customer contracts that has not yet been recognized, was $586.1 million, up 28%, compared to the same period last year; while current RPO was $420.2 million, up 27% year-over-year. As expected, the third quarter was a seasonally slower quarter for both RPO and CRPO given the timing of our renewals. We continue to believe that subscription revenue and RPO growth are the best metrics to evaluate the underlying health of our business. Our billings can fluctuate significantly relative to revenue based on the timing of invoicing cadence of renewals and the duration of customer contracts. Moving now to our Q4 and full-year FY ‘23 guide and business outlook. As noted on our last earnings call, we faced tougher comparisons in the second half of the year given the strong growth we demonstrated over the last three quarters of FY ’22. We also recognize that the macroeconomic environment has worsened in the third quarter with additional scrutiny along with tighter budgets on new spending. Given this environment, we're taking a prudent view of the near-term growth expectations for Q4. Starting with Q4 FY ’23, we expect total revenue to be in the range of $162.3 million to $163.3 million, representing 20% growth year-over-year at the midpoint. Within this, we expect subscription revenue to be in the range of $145.5 million to $146.5 million, representing 24% growth year-over-year at the midpoint, we expect non-GAAP operating income to be in the range of $6 million to $7 million and non-GAAP net income per share of $0.01 to $0.02, assuming 264 million weighted average shares outstanding. For the full-year FY ‘23, we are tightening both our subscription and total revenue outlook for the year. We now expect subscription revenue to be in the range of $545.8 million to $546.8 million, representing 28%growth year-over-year at the midpoint. We expect total revenue to be in the range of $615.2 million to $616.2 million, representing 25% growth year-over-year at the midpoint. Note that the full-year FY ‘23 guide is impacted by our decision to actively manage services margin going forward, impacting the absolute level of professional services revenue, as previously mentioned. For the full-year FY ’23, we now expect a non-GAAP operating loss to be in the range of $1.3 million to $2.3 million, equating to a non-GAAP net loss per share of $0.04 to $0.05, assuming 260 million weighted average shares outstanding. The non-GAAP operating loss for the year at the midpoint is an operating margin improvement of $34 million versus FY ‘22 and a $44 million improvement versus our original guide for FY ’23. This is the result of our continued focus on operating discipline, specifically go-to-market efficiencies and better allocation of resources. As a quick reminder, in deriving the net loss per share for modeling purposes, a $9.5 million total tax provision for the full year FY ‘23 needs to be added to the non-GAAP operating loss range just provided. We booked a $7 million tax provision in total for the first nine months of the fiscal year. Therefore, we estimate the tax provision to be approximately $2.5 million for Q4. FX continues to be a very topical discussion given the macro environment, so I want to reiterate our position here. FX does not have a material impact on our financials because even though we have approximately 35% of our business outside the U.S., most of our billings are in U.S. dollars. Before moving into Q&A, I would like to provide some high-level commentary on fiscal year 2024. We will provide formal guidance on our Q4 earnings call sometime in March, which is our normal practice. But given the uncertainty in the market, we believe it is helpful to give investors a view of our thinking for next year. As you heard today, long-term demand trends and engagement for Sprinklr remains strong. However, in the near-term, we believe we will continue to be impacted by the current macroeconomic environment. We expect the macro trends from the last three months to continue through FY ’24 resulting in further tightening of budgets and lengthening of sales cycles. With all that said, we expect revenue growth to moderate in FY ‘24 from the Q4 growth rate I just outlined. Based on what we are seeing today; we estimate total revenue growth to be approximately 15% for the next fiscal year. In terms of our path to profitability, we are proud of the improvements we have made over the course of FY ’23. We will build upon that success next year and expect to generate meaningful non-GAAP operating income that is at least equal to the non-GAAP operating margin we just reported for Q3 FY ‘23. And as mentioned earlier, we continue to expect to be free cash flow positive on a full-year basis for FY ’24. Lastly, I would like to thank all our employees for delivering a strong third quarter during an uncertain macro environment and continued volatility in the financial markets. I'm grateful for the confidence that our customers have placed in us and the dedication of our employees. We remain focused on building a track record of successful execution and operating discipline across the business. Thank you. At this time, we'll conduct our question-and-answer session. [Operator Instructions] Our first question comes from Raimo Lenschow with Barclays. Please state your question. Hey, this is Frank for Raimo. Thanks for taking my question. I want to ask if you could walk if there are any specific changes made to the go-to-market playbook just given the recent sales leadership transition and the changed macro environment? Thank you. Absolutely, [Raimo] (ph). Good to talk to you again. This is being, as I outlined last year, has been a significant focus for the company. And you probably saw from our recent Board Director announcement to the changes that we're squarely focused on it. We have an initiative in the company across the Board, which is our number one priority across the four priorities we have set for ourselves in this year that is to make it easier to sell Sprinklr. And the way we look at it, we have a business that has pretty world-class retention rates and expansion rates, which just means that if we make it easier for customers to come in the door and for our field folks to sell, then the business should grow better. We have a fairly comprehensive plan. I'll give you a few high-level details. One is to move from selling products to verticalize and sell solutions for each vertical. That's a multiyear project that's already underway. Two is to go from the focus on capacity to start focusing on productivity, which gives us a much more nuanced way to decide where to invest our dollars. And traditionally, we've been more focused on geographic expansion, and we're going to switch that now to investing where we're seeing growth and being a lot more prudent in where we put our chips on the table. There's a lot more behind it, but there's going to be increased focus on new logos forever with companies just considered a dollar as a dollar, whether it comes from an existing account or a new account. And we're making changes to have dedicated teams focused on new logos. So, I'm not going to go through everything, but there is a clear seven-point plan that translates to about different goals and KPIs, and it's translated to several hundred OKRs for the entire company. So, that's a big priority for us. Great. Hey guys, thanks for taking the questions. One question on the guidance for next year. It seems like you're calling for about a 10-point decel. Maybe Ragy, help us understand what you're hearing from CIOs in terms of how they're thinking about budgets for next year? Are you hearing them resetting budgets lower dramatically? Help us understand what's kind of guiding that guidance? And maybe, Manish, you can chime in with maybe some of the assumptions around expansion rates, new business bookings. How are you kind of building that guide? Yes. Yes. I want to make sure that we're communicating what we're trying to communicate. What you're seeing us do here is in my mind, us taking a slightly more defensive posture for next year. We read -- everything Manish said or listen to him, basically, what we're seeing, we've taken the top-line down a little bit and adding it to the bottom-line. And that, I think, is the prudent thing to do given what we're seeing in the market place today. Manish, can you comment on that before I really answer the question? Yes. So, Pinjalim, let's just quickly go through the math behind it. So, it isn't a 10-point decrease. So, consensus is 21%. And I think we're saying as a starting point, use 15%. And the math there is very simple because based on what I see today, if you take the midpoint of the Q4 guide, that is a sequential increase of 3.5% over Q3. And if you now apply that same 3.5% across the arc of FY 2024 fourth quarter, we'll get to a starting point of just around 15% for next year. And I think what we are saying, before Ragy adds more color, is given the visibility that we have right now, this would seem to be the prudent place to start. And to the point that Ragy mentioned earlier, and the thing that I want to make sure people do take into account is we demonstrated a 4% non-GAAP operating margin for Q3. And we are comfortable at this point saying you could apply the same 4% for the entire FY 2024, which will give you a significantly higher operating income number for next year. So, said differently, we're turning the dials based on what we can see today. And we're obviously looking at seeing productivity and uptick in customer demand before we turn the dials back again. So, if that makes sense, I'll turn it back to Ragy. Yes. So, Pinjalim, your question on what I'm seeing in the marketplace, when -- gosh, you know I've been on the road non-stop and listened to what the C-suite's saying in every continent. What we're hearing them say is very, very clear. We don't know just like VTK always said, we don't know how things are going to turnout. So, everyone is just much, much more careful and deliberate and intentional. Our -- I mean you all are following a ton of companies in the marketplace. I think what you're hearing us do -- and you're seeing our growth rate moderate from a defensive place. But the reason we're not swinging from like a 40% growth down to 18% growth is because we have a very balanced portfolio of product suites, four product suites that play in everything from customer service to marketing through voice of customer and research to sales and engagement. That's what's really helping us cushioning this up. What we're seeing is companies universally wanting to save money and for the -- our ability in customer service to automate and self-serve and bring down the costs, while improving customer satisfaction and time to respond and resolve is working really well. Marketing and advertising, as you would expect, that's not the hot area right now, understandably. Our research product, our voice-to-customer product feeds into our care. So, that gets a natural pull as care becomes more successful. And our sales and engagement product, again, I'd say, is very, very modest in terms of our outlook for its growth for now. There's a lot of things going on in the traditional social space, which we -- where we come from, the advent of Reddit as a major data source, money moving to TikTok, things that are going on Twitter, but the balance portfolio is what's helping us. And I alluded to Europe and what we're seeing in Europe in my prepared remarks, that's an example of a region for us that was slower to focus more on customer service. And we have regions where like the U.S. and the Middle East, where we have swung a little more towards selling customer service and getting into CCaaS, we're seeing much better success. So, do we have a strategy to deal with it as we go through it and a lot of that is going to come down through execution. Hi, this is Michael Vidovic on for Michael Turits and thank you for taking my question. I was wondering if you could comment on what you're seeing in terms of customer size? Is high enterprise doing better than, let's say, mid-market? Or is it relatively the same for you? We wouldn't know, Michael. We've been playing in the enterprise space fairly squarely. There's been a lot of temptation to go down market, something that we thought as a company and a strategy was something we're focused on. So, what I can tell you is large companies are spending money to save money. Large companies are spending money to mitigate risk. And they're cautiously spending money to go revenue. Are they a little more tightfisted than they were a year ago? Absolutely. Are we seeing that more in Q4 than we saw in Q3? Absolutely. Are we seeing in some parts of the world, more than in other parts of the world? Absolutely. But I think it is much more muted compared to -- and I'm speaking that from Sprinklr experience, broadly from friends who are playing in the SMB space, it's a lot more muted than the bigger swings we are seeing down market. Okay, great. And then just one quick follow-up from me. Would you expect any pressure on average revenue per customer on our initial deal sizes in light of macro headwinds? Or are you really not seeing that at this point? Well, you heard, Manish, say that our -- we have over 107 customers who pay us over $1 million, right? So, we have customers -- now multiple customers are going to pay us north of $10 million. So, our strategy is not focused on that initial land deal. Our strategy is landing that customer that has the potential to keep growing, keep paying us hundreds of thousands and potentially millions of dollars. So, we are less focused on the initial land deal and more focused on the type of customers. So, we're pretty clear. We have a list of 100,000 companies and a list of 10,000 companies and 5,000 companies within that, that's in our sweet spot and we keep expanding down from there. To answer your question directly, we're not see much pressure there. We're not in the volume game. So, that might really explain why we have this answer. Hi, it's Max Osnowitz on for Parker Lane. Thanks for taking my question. For starters, is there any single solution that you guys are seeing drive a majority of the customer interest right now? Or is it still a good mix of all the core features even in this uncertain environment? Yes. Like we said, we saw over one-third of our bookings was in our customer service product suite. That's kind of what reflects our focus, but it also reflects where the market is focused. We're seeing excitement in not rip and replace CCaaS, but really kind of modernize CCaaS and then put automation on it. And traditionally, if you're doing it without Sprinklr, you're working with a legacy CCaaS player. And then you're trying to bring a shiny automation or AI company into it, which is fraught with a lot more integration and breakage points inside the infrastructure. And so we're seeing a lot of excitement in automating customer journeys. If you recall, we talked about a large bank -- our first-to-go a big implementation in CCaaS. That's going really well. They've automated 80 customer journeys. And we talk about our other customers. Most of them are on this journey of identifying modeling and automating at least the low-hanging fruit when it comes to service inquiries. So, that's something that we're seeing a lot of excitement. Omnichannel is something that we're seeing a lot of excitement around. Customers looking to -- I talked about Aramex in my prepared remarks. What he said to me it was fascinating. He said, look, WhatsApp was a very important channel for their customers. And before Sprinklr they just really didn't have an SLA. So, you could try to reach them on WhatsApp and your inquiry may be unanswered for days. And from there, because of the bot that now services WhatsApp as a gatekeeper their first response is in eight seconds, and many of their use cases are completely handled by the bot or seamlessly hand it over to the human and back to the bot when there's human and bots involved. So, those are the areas we are seeing excitement. Got it. And then thinking about a comment that Manish made earlier on the outlook for 2024. I understand waiting for demand to improve before kind of dialing up the spending. Is that communicating that we'll see a decrease in margins once that time comes? Or are you guys committed to margin expansion kind of for the long run? Yes, we're committing to margin expansion, if you're referring to gross margins and operating margins. We're committing to that for the long-term. What we are saying though is given the limited visibility that we have and given the preponderance of factors that are beyond our control, our ability to start with a different number, if that makes sense. Great. thank you so much. Thank you for the color around -- on next year, that was super helpful. In your comments, you highlighted just customers focused a lot on saving money, especially with single modules like efficiency with the customer care. But we're also hearing just broadly in the market, a willingness to consolidate spend with IT vendors to save more money. So, I just wanted to get a sense for what are you seeing in terms of the willingness to consolidate vendors, kind of, displace other solutions? And is that happening at a more accelerated rate? Or is that something that takes a little bit longer to play out? Elizabeth, great question, and thank you for asking that and giving us an opportunity to highlight something that we've always believed in. You remember, we were the first ones to kind of keep using the phrase point solution chaos. And traditionally, this is a major strategy for the company. So, we're actually on the receiving end of that trend, and that's reflected in our net expansion rate of 25%, that's reflected in our retention rates. So, once a customer is in, we now -- in many verticals, we have a clear path of how they should expand and how they should consolidate. What I'll point out in our case is a transition that we seem to have made. If you talked to us three years ago, typically, the companies we were replacing were social publishing tools or social listening tools, advocacy tools, and advertising tools and all that. But what we are now replacing in the contact center is a different slew of systems like Zendesk with ticketing being replaced with Sprinklr like a module from something like a NICE is being replaced with our AI and our sentiment analysis. Our knowledge base is replacing another little suite or a homegrown system, our self-service community is replacing another community solution. And all of this because it's a platform works very well together. So, we are now replacing -- and our AI is replacing a pure-play AI that's promising to automate the contact center. So, we're taking out three to seven contact center point solutions. And that's for me, as I talk to customers, it's an interesting new phenomena we're seeing, a different set of competitors in that market. Great. Thank you so much. And just as a follow-up, I wanted to ask on the customers that are spending over $1 million. You actually saw an increase quarter-over-quarter, that was higher than what we've seen previously, not by a ton, but I just think that's surprising just given the environment you spoke to about a quarter a bit into design new logos that expand. So, what's driving kind of that momentum still in the large customer spend? How much of itis landing of new logo on a big size versus existing customers, kind of, spending more consolidating on the platform? Elizabeth, almost all of that is existing customers consolidating and spending more. What is driving that hard ROI, like nonnegotiable hard ROI. Every one of our expansion deals and the big ones are preceded by making a business case. And that has a hard -- here's how much you're going to save, here's how much you're going to automate, here's how much more you're going to expect in advertising dollar optimization, here is what those insights pan out to do. So, our go-to-market in expanding is just very business case-driven. And as you can imagine, if someone's paying $5 million or $7 million or $10 million, there's no way we are retaining the way we are if that's not all backed up by not just shiny objects, but hard dollars. And so we're able to now take a use case show how an AI automation can automate some of that free of the agent's time to do other things. We're able to show how you can convert unhappy customers and happy advocates and quantify the marketing impact. So, there's a whole slew of models that we've developed that we show and validate with customers that they sign off before they buy. And we're increasingly doing a lot more proof of concept. Traditionally, it's not something that we did, increasingly because we're so confident. And I encourage everybody on the call to call our customers and talk to them. We're still confident that our technology is superior, and the results are very real. We do a proof-of-concept and then they buy taking the risk out. Hey guys. Thanks for taking the question. Ragy, I know you mentioned new customers are becoming a priority and you're dedicating a team to that. Can you just talk about the timing before you start to see tangible results? And new customers land with that team and maybe put that into the context of this macro environment where I think newer customers are maybe a little bit more hesitant to spend on new software solutions? How do you see that playing out over the next year or so? So, yes, great question. We -- look, we have not been disclosing new logos, right, on a quarterly basis, the change -- Manish made. I can't disclose that, that number is on the rise. And our early efforts to focus on that is panning out really well. There's a lot more to optimize, but we're still kind of heavily weighted on upsells, compared to new logos. And we've made a lot of progress this year. And we are modeling and continuing to focus on making more progress next year because we think the TAM is so big. We are very encouraged by how customers behave once they're on, and they understand what it is to work with us that I think a dollar is a lot more valuable for us if it's a new logo, and we're just going to invest a little bit more. Okay, got it. That makes sense. And then just in terms of Care, it was impressive to hear that a third of the bookings are coming from that Care module. As you think about just the near-term pipeline of that solution, do you see that being more resilient than some of your other suite that you have, especially as you look into Q4? Meaning is that seeing less scrutiny from executives and buyers than some of your other solutions? Yes, we are and I'll confirm that. It's a lot more of a slam up business case with very much less risk factors. And the reason, if you recall, Arjun, many quarters or two, three years ago, we basically started talking about Care and kind of, focusing more on that. Again, the strategy is always built in this unified platform. Within that, we think in the next few years, there's a big opportunity coming up with everybody trying to move contact centers to the cloud, consolidate data centers. And what's happening is the traditional CCaaS vendors put a lot of their energy into building the telephony infrastructure, which 10-years ago, that was a differentiator. Can you keep the calls, manage the calls? Can you keep the cost down? Can you route a call? And can you give the call and can you make the IVR work? And today, we're in a place where that just got, in my mind, fairly completely commoditized, right? And good players like Amazon will continue to kind of make that as a part of the infrastructure. And we got lucky in that the avenues we've just been building the app layer, making the agent more productive, putting more AI to working in understanding conversations and responding back has bought and picking up all public data and connecting to all channels. So, that's the advantage we have. And so we're able to kind of, like I said, go into a company and say, let me show you the 15% of your service complaints that are not being responded, give me your average SLA. And let me beat it. I've said this to you before, the company -- one of the largest tech company that user care. One is our first definition partners, right? An average case, that's resolved in Sprinklr cost them 30% advisors responded to 50% faster and have 80% less dissatisfaction. We can quantify it. We won the award this year as one of the top vendors for CX. So, this becomes -- to your point, it's a little bit more of a clearer articulation to value with fewer variables to play. Great. Thank you. So, Manish, first of all, I'm really grateful to you, and I'm sure Ragy had a part in this too, for guiding to 2020 to next year, fiscal 2024. So, many companies aren't doing it. And I think it's a real service to us and to investors when you do. Now, that being said, no good deed goes unpunished. So, I just don't understand why if you're going to go from 24% growth down to 15%, why wouldn't you be able to drive the operating margins higher than where you are right now? So, great question, Patrick. So, let's step back a little bit. So, if you look at what we did last year, we grew -- in FY 2022 subscription revenue, 26%. Even with the slightly reduced Q4 guide for this year, subscription revenue growth is going to be 28%, which is very respectable given what's happening in the macro environment. Having said all of that -- and I'm still at the topline, I'll address your bottom-line here in a minute. It would not be prudent for us to start conjecturing call it 60 months before FY 2024 ends, what that full year ought to look like, which is part of the reason you're seeing us taking a prudent view just using the same sequential growth rate for Q4 and applying that for the rest of the year. Now, you would be correct in assuming that our operating margin ought to move up, and it most likely would. But again, given where we sit it doesn't make sense for us to conjecture what it would be for the full year. We're obviously comfortable saying use 4% for the full year. If you apply that to the $708 million, give or take, you'll get for the topline for next year, you will get a number like $28 million, which is much higher than I think where consensus is. And you've got to give us a little bit of room to maneuver as we see how the book of business builds here inQ4 and what the outlook looks like when we guide in March, if that makes sense. That's actually really helpful. And then Ragy, how -- I think you've kind of addressed this, but just to be direct about it, how is November? Good. Beautiful. No. Listen, I think we -- with the portfolio like we have, Patrick, it's kind of -- you should not get excited with green shoots [ph] and you should not get pessimistic when the region doesn't do well in a product with so many variables. We feel good about where we are. And I actually feel really good about how -- yes, we are moderating up and down a little bit, but our fluctuation is in a limited bandwidth and that's a better place to be. So, we feel good. So spend was good, and I think it's all in line with what we are telling. We -- you know that we want to build a fundamentals-driven company. We want to be as transparent as we humanly can and just do what you all expect us to do and what you would expect from a good company that's focused on 10 years, not the next two quarters. Yes, thanks for taking the question. So, just going back to some of the prior questions around the assumptions that you're assuming in your outlook. Maybe you could just kind of clarify how much of this is what you're seeing today in terms of deal delays? Are you anticipating that maybe there'll be some down sell pressure on renewals? Or is this simply, kind of, deal delays based on what you're seeing in the macro or what you're seeing in your customer base? Just really want to get at exactly what you're assuming in terms of how Q4 plays out and the assumptions for next year. I'll confirm that it's mostly based on macros. I think we're focused on our optimizing our go-to market, which -- Tyler, you know that's relatively new for us, for a company of our scale. It's -- most other companies would have been a little bit ahead. So, we feel pretty optimistic. So, it's mostly based on the macros. We think it will be a clear strategy. Leading with Care in this recessionary environment is something that we think we can apply across markets. And where we've -- further ahead, we're seeing better results. So, we think we have an antidote to deal with it. We just don't know. And every quarter, we've been watching this. Q3 is the first time where -- which is clear to us that Europe is slowing down, and the decisions are not being made, but it's like another layer and deals just like not getting approved after very clear business cases. And the answer is, let's just wait a little bit, right? Now, is that really weighting is that -- people are going to pull the budget? We don't know. So, we have a lot of uncertainties, mostly based on macros. Internally, we feel pretty good about how we're optimizing our go-to-market and becoming more and more efficient. So, I'll comment to you that Rule of 40 is kind of -- or the metrics that drive towards the Rule of 40 is something that the executive team here is very, very squarely focused on. Hey thanks. Appreciate you taking the question. I want to go back to the expansion rates because this was held in at 125%. It's better than what we're seeing across a lot of companies in the sales and marketing software stack where that metric is starting to revert back a little bit. Can we first just kind of focus on what's driving the stabilization at least so far? And then given the guide for next year, it does sound like you'd expect that metric to revert going forward. So, can we just talk a little bit about the push-pull between getting customers to consolidate onto the platform and expand? And then what you're seeing in the macro and how that informs maybe the delta between the15% assumed and the 125% and expansion you're seeing? Thank you. So, let me start and Manish can add more details. Look, I think the push-pull you've said is very clear. Now, I submit to you that we have -- we're probably one of the few companies, right, that literally has a play in sales marketing research and care, voice of customer and care. So, it's a little more broader portfolio. That's what's driving the ups and the downs. I can tell you that we're seeing traction with care, like I said, and that's driving the upsell. I can tell you that our customer satisfaction rates, both the way we measure it and then totally speaking to a lot of customers is kind of almost at an all-time high, customers are consistently happy. And so I would tell you that it's just directly attributable to the macro environment that we see. That's where our conservatism is coming from. And we're doing things internally, but the variables are too many for us to kind of predict beyond what we are predicting. Yes. And just to add to that. So, I think we have said publicly that just around two-thirds of our new business comes from existing accounts. So, you would imagine as we sell into the installed base and sell them more modules, the net dollar retention rate, the way we calculate is on a dollar recognized basis over the last 12 months. So that, by definition, ought to grow. You're seeing that show up even in the $1 million customers and above, which is growing at a much nice -- and so you're correct in that, that metric has maintained a very healthy growth trajectory. We also mentioned earlier in the call that we are now beginning to focus more on new logos. We don't want to just be farming the existing installed base. So, that metric will ebb and flow, partly driven by macro, as Ragy was saying, partly driven by our push towards getting additional sort of large enterprise logos. So, there's a number of things baked into that metric. It's hard for us to project what that number would look like next year. But certainly, given the existing go-to-market motion, the plethora of products that we bring to our existing installed base that metric has remained rather healthy over the last several quarters, if that makes sense. Yes, good afternoon. Thanks for taking the question. I appreciate that you're starting to see some weakness Europe. But maybe looking at it from a little different lens, are there any particular verticals that continue to be very strong? Or any that stand out as already showing material weakness that maybe give you some additional reason to have the prudence in your guidance? Thank you. We are not seeing any pronounced vertical trends. Our top verticals as we've mentioned before, our technology. And financial services, travel, hospitality, the ones that we'd expect -- we have 12 verticals that make up about 90% -- around 90% of our business. And I can tell you that post-COVID travel and hospitality has rebounded quite strongly. I can tell you -- well, we don't have that much exposure. But the crypto meltdown will -- I'm sure will impact companies that are focused on start-ups. But we're not seeing any sector-specific trends that's materially affecting us. Headcount plans over the next 12 or 15 months or so. How have those moderated? And are there any areas that you're still going to continue to push forward on hiring? Or do you feel like you're at sort of a capacity level that will allow you to grow into those 2024 expectations? Thank you. Yes, great question. So, we explained in our current quarters and previous quarter commentary that we over-invested coming out of COVID given that we had starved the field when we pulled back during COVID. That -- those investments are largely kind of behind us. So, we don't expect to grow headcount the way we have grown two years ago. I think we have capacity in the business to support the growth we have. And we stand by prepared to add more capacity if we need to. So, headcount projections for the next year is fairly moderate compared to the previous years. Manish, you want to add something? No, I think the only nuance from my perspective is, given the investments already made, both in terms of product development as well as go to market, we're just stepping back a little bit, waiting to see the fruits of those investments before we make any more incremental in that. We've been very clear that we are focused on productivity, and that is across the board. And I think, as you can imagine, in any enterprise software company, there needs to be some gestation period before we get productive. And we're sort of in that phase where we had invested a fair bit in FY 2022 and the first half of this year. Now, we just need to take a little bit of a digestive approach going forward. Thank you. I'll summarize by saying that this quarter was a strong one. We're going into uncertainties. We think we have a strategy to play it out and we are taking a slightly more defensive posture to next year. We think it's still very, very early in the category. We're very excited by more and more analysts now referring to front office and CXM the way that we are referring to it. So, we're excited about what the future has. It's great to see all of you. And I'll just remind you that we are here trying to build a long-term business based on fundamentals. Thank you.
EarningCall_1557
Good evening and thank you for standing by for New Oriental's Fiscal Year 2023 Second Quarter Results Earnings Conference Call. [Operator Instructions]. Today's conference is being recorded. Thank you. Hello, everyone and welcome to New Oriental's second fiscal quarter 2023 earnings conference call. Our financial results for the period were released earlier today and are available on the company's website as well as on Newswire services. Today, Stephen Yang, Executive President and Chief Financial Officer and I will share New Oriental's latest earnings results and business updates in detail with you. After that, Stephen and I will be available to answer your questions. Before we continue, please note that the discussion today 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 inherent risks 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 our public filings with the SEC. New Oriental does not undertake any obligation to update any forward-looking statements, except as required under applicable law. As a reminder, this conference is being recorded. In addition, a webcast of this conference call will be available on New Oriental's Investor Relations website at investor.neworiental.org. Thank you, Sisi. Hello, everyone and thank you for joining us on the call. This second quarter is a successful phase of manifestation as we have turned over a new leaf in our business and embarked on innovative journey for rich business opportunities since the beginning of fiscal year 2023. Before going into details of our financial performance for this quarter, I would like to take this opportunity to extend our gratitude to those who have been delivering and supporting New Oriental along the way. I'm delighted to share with you that after a year of restructuring process, New Oriental has successfully generated fruitful yields from our new business ventures, combined with our existing business and innovative business opportunity. Despite the seasonality of some of our major businesses which has historically resulted in a slower period for every second quarter, it's immensely encouraging to see that we have achieved a meaningful profitability and a better-than-expected margins in the second quarter. We have achieved a non-GAAP operating margin of 2.6% for this quarter as compared to negative 112.0% in the same period of prior fiscal year which was characterized by the several significant one-off expenses incurred from class cancellations, school closures and employee layoffs. Our key remaining business have continued to demonstrate remarkable resilience. In particular, overseas test prep business and overseas study consulting business have recorded remarkable year-over-year revenue increase as global COVID restriction eases and overseas study market is recovering. Our solid profitability, strong performing remaining business lines and then emerging new business initiatives in this quarter have again strengthened our confidence in preferring innovative endeavors and profitable growth through the rest of the year. Now I would like to spend some time to talk about the quarter's performance across our remaining business lines and new initiatives to you in detail. Our key remaining business have achieved promising trends, while our new initiatives have shown a positive momentum. Breaking it down, the overseas test prep business recorded a revenue increase of 17% in dollar terms, or 30% in RMB terms year-over-year for the second quarter. The overseas study consulting business recorded revenue increase of about 14% in dollar terms or 27% in RMB terms year-over-year for the second quarter. The adults and university students business recorded a revenue decrease of 9% in dollar terms or 2% increase in RMB terms year-over-year for the second-quarter. As for our new business initiatives, as mentioned in the past quarter, we have launched several new initiatives which mostly revolves around facilitating students all-round development. I'm glad to share with you that these new initiatives have further exceeded our expectations by sustaining a positive momentum and generating meaningful profits to the company. Firstly, the non-academic tutoring business which we have rolled out in over 60 cities, focused on cultivating students' innovative ability and comprehensive quality. We're happy to see increased market penetration in both markets we have tapped into, especially higher-tier cities with a total of 477,000 enrollments recorded in this quarter. The top 10 cities in China have contributed about 60% of revenue of this business. Secondly, intelligence learning system and device business, is a service designed to provide a tailored digital learning experience for students. It'll utilize our path to teaching experience, data and technology to provide a personalized targeted learning and exercise content. Our continuous investments in technology has fueled our comparative edge which drives our navigation amidst the chain of challenges from the last year. Together with our teachers monitoring and accessing the learning curve for students at the back-end system, this new innovative education service not only greatly improves students learning efficiency but also cultivates students proactive learning habits. We have tested its adoption in over 60 cities with 108,000 active paid users in this quarter and are delighted to see improved customer retention and scalability of this new business. The revenue contribution from top 10 cities in China is around 60%. Last but not least, our smart education business which comprises smart teaching, smart hardware, science, technology and innovation education and other service serves local governments, education authorities, schools and kindergartens. Our educational material utilizes the smart study solutions, the self-learning system which leverages advanced technology, enables students to have complete control over the pace and the flexibility of the learning age where remote learning becomes increasingly mainstream. We also offer exam prep courses designed for students with junior college diplomas to obtain bachelor's degrees. The above-mentioned business has been gaining wide traction and contributes the overall growth of the company and has attained instrumental profit since the last quarter. Coming to our OMO system. We continuously invest in developing and revamping our OMO teaching platform and have leveraged our educational infrastructure and technology strength over the remaining business and new initiatives to provide more advanced and diversified education service to our customers for all ages. Our OMO system has been a core support to our business, especially with some of the strict social control measures were implemented in the past months. We have invested a total of $21 million in the quarter on our OMO teaching platform which provide us the flexibility to continue to offering high-quality service to students during the pandemic. Now I would like to give you all an update on Koolearn's latest performance. In the first half of this fiscal year, Koolearn has achieved incremental breakthroughs in both business operations and financial performance. This significant progress was made as a result of Koolearn's strategic transformation from focusing on online education to livestreaming e-commerce. In 2021, Koolearn expanded its livestreaming e-commerce business and established Dongfang Zhenxuan which has since become a well-known platform for promoting healthy, top-quality and cost-effective products to the public. The platform has formed a part of the tight supply chain management and after-sales service system which strictly abide by a set of relevant laws and regulations. Leveraging our deep understanding of customer needs, Dongfang Zhenxuan continues to expand its product selection and SKUs through proactive cooperation with third parties, coupled with the development of our Dongfang Zhenxuan private labeled products. The platform's business developments has gratefully benefited from the maturity of China social infrastructure and the contributions and support from the community. To summarize, the Koolearn food bearing growth and profitability with our financial performance, for the first 6 months of this fiscal year, Koolearn recorded the revenue of plus nearly RMB2,080.1 million which represents a 590.2% increase from revenues from continuing operations of RMB301.4 million in the same-period of last prior fiscal year. Koolearn recorded RMB585.3 million of net profits, a 638.5% increase from the net loss from the continuing operation of RMB108.7 million in the same-period of prior fiscal year. In the first 6 months of fiscal year, the gross profit of Koolearn reached around RMB982.5 million, accounting for 47.2% in terms of the GP margin. As we continuously map the platform's strategic transformation, the fast-growing Dongfang Zhenxuan is also committed to give back to customers and the community. Since its launch, Dongfang Zhenxuan has stood firm to not charge commissions from customers or any fees. And have always taken close reference to industry standards, focusing on its partnerships, the mostly beneficial long-term collaboration with various parties, so as to maximize benefits to customers. Dongfang Zhenxuan also ensures to attain the cost-effective performance as one of its development principal. On one hand, Dongfang Zhenxuan focuses on enhancing product capability. We're continuing to establish its cultural content. On the other hand, Dongfang Zhenxuan has also organized to diversify -- diverse outdoor livestreaming activities to promote special agriculture products and contribute to the cultural tourism. Through its unyielding aspiration to create value in related industries which have also attracted and retained a larger pool of talents, cooperators as well as followers and members, Dongfang Zhenxuan has successfully received in return meaningful revenues and a loyal customer base during the reporting period. With regard to the company's latest financial position, I'm confident to share with you that the company is in a healthy financial status with cash and cash equivalents, term deposits and short-term investments totaling approximately $4.2 billion. On July 26, 2022, the company and the Board of Directors authorized a share repurchase of up to $400 million of the company ADS or common shares during the period from July 28, 2022 through May 31, 2023. As of January 16, 2023, the company repurchased aggregate of approximately 3.1 million ADS for approximately $79 million from the open market under the share repurchase program. Okay. Now I'd like to walk you through the other key financial details for this quarter. Operating cost and expenses for the quarter were $640.7 million, representing a 55.1% decrease year-over-year. Non-GAAP operating costs and expenses for the quarter which excludes share-based compensation expenses, were $621.9 million, representing a 55.4% decrease year-over-year. The decrease was primarily due to the reduction of facilities and number of staff as a result of the downsizing in the fiscal year 2022. Cost of revenue decreased by 31.6% year-over-year to $336.2 million. Selling and marketing expenses decreased by 15% year-over-year to $95.5 million. G&A expenses for the quarter decreased by 74.6% year-over-year to $209 million. Non-GAAP G&A expenses which excludes share-based compensation expenses, were at $190.9 million, representing a 75.7% decrease year-over-year. Total share-based compensation expenses which were allocated to related operating costs and expenses decreased by 39.5% to $18.8 million in the second fiscal quarter of 2023. Operating loss was $2.5 million compared to a loss of $768.1 million in the same period of prior fiscal year. Non-GAAP income from operations for the quarter was $16.3 million compared to a loss of $737.1 million in the same period of prior fiscal year. Net income attributable to New Oriental for the quarter was $0.7 million compared to the loss of $936.5 million in the same period of last fiscal year. Basic and diluted net income per ADS attributable to New Oriental were $0 and $0 respectively. Non-GAAP net income attributable to New Oriental for the quarter was $17.8 million compared to the loss of $901.6 million in the same period of last year. Non-GAAP basic and diluted net loss per ADS attributable to New Oriental was $0.11 and $0.10 respectively. Net cash-flow generated from operation for the second fiscal quarter of 2023 was approximately $173.7 million and capital expenditure for the quarter were $11.4 million. Turning to the balance sheet. As of November 30, 2022, New Oriental had cash and cash equivalents of $1,029.9 million. In addition, the company has $1,033.2 million in term deposits and $2,145.7 million in short-term investments. New Oriental's deferred revenue balance which is cash collected from registered students for courses and recognized proportionally as revenue as the instructions were delivered at the end of the second quarter of fiscal year 2023 was $1,139.1 million, an increase of 6.9% as compared to $1,065.8 million at the end-of-the second-quarter of fiscal year 2022. Thank you, Sisi. Looking ahead into the rest of fiscal year 2023 with the restructuring process largely completed and our new business in their early stage, we expect our school network and geographic coverage to stabilize. The company remains tireless in seeking new opportunities with greater flexibility and strong cash flows. We're confident in the sustainable profitability of all our remaining key businesses, as well as the growth and the prospects of our new initiatives. For our new business, as we observed in the first-half of this fiscal year, the encouraging performance that these businesses have achieved proves that we are heading towards the right direction and we firmly believe that business will be able to maintain a upward growth trajectory and generates meaningful profits to the company in fiscal year 2023. As for evolving pandemic development in China, since late November 2022 many cities are experiencing certain level of disruption on business operations. Although we're expecting a negative impact, our financials in the coming 1 or 2 quarters, we remain confident and optimistic that the overall impact will be temporary and manageable. Hence, we expect total net revenue in the third-quarter of the fiscal year 2023 to be in the range of $702.8 million to $719.8 million, representing a year-over-year increase in the range of 14% to 17%. The projects of the increase of revenue in our assumptions of the currency RMB is expected to be in the range of 24% to 27%. As the profitability we recorded in this fiscal quarter has reaffirmed our success and dedication in turning a new page and generating profits for the rest of the year, bottom-line wise, we're confident in achieving greater operating profit in the full year of fiscal year 2023. To conclude, we're now taking multipronged operational actions to promote our key remaining businesses while we're cautiously investing in new initiatives which will remain new growth engines that accelerates our recovery and the pursuit of profitable growth. At the same time, we will continue to seek guidance from and cooperate with government authorities in various provinces in China, in alignment with the efforts to comply with the relevant policies and regulations as well as to further adjust our business operations as required. I must say that these expectations and forecast reflect our considerations of the latest regulatory measure, as well as our current and the preliminary view which is subject to change. This is the end of our fiscal year 2023 Q2 summary. At this point, I would like to open the floor for questions. Operator, please open the call for this. Congratulations on the on the topline as well as the guidance. My question is on the COVID impact. I know that COVID has come pretty viciously in December but now we're past the peak. So I'm just wondering how has COVID impacted our February quarter. If there is any quantifiable metric that will be very helpful. And my second question is, what's the expectation of our various businesses from here? If you were to rank the fastest to more stable business, how would you rank your various business segments? Thank you, Felix. Yes, as for the evolving pandemic development in China since the last December, yes, I know the peak in the past, right. And yes, in many cities, I think some of our business are effectively impacted. But as our current estimation, I think the net impact is small and so we remain confident and I'm optimistic that overall impact from the pandemic will be temporary and manageable. And yes, you look at our guidance for Q3 is very strong. And the different business lines, the revenue outlook for Q3, right -- can you repeat the second question? Yes. Yes. So maybe for Q3 and for the whole year which are the business lines that you think will grow the fastest and which are the ones that are more stable? I think that -- we have 2 kinds of business. The number one is the traditional business, the remaining business, the overseas related business including the overseas test prep and consulting business which contributes the 24%, 25% of the total revenue. What I'm saying is that for the whole year, 24% or 25% of the total revenue. I think we got suffered the impact from the last year. But this year, I think we're seeing the revenue growth is booming. Things are 2 quarters above. And the new business within the schools, we started the new business last year, the year before last year, right? November 2020, yes, last fiscal year. And the growth is, we just started the business 1 year ago. The growth is extremely high. So this isn't the -- ranks number 1, the revenue growth within all business lines and also we do have the Dongfang Zhenxuan. And Dongfang Zhenxuan, they reported, the management of Dongfang Zhenxuan reported the first-half year reports today and you saw the growth, you saw the numbers. And so we're excited for the exciting performance for Dongfang Zhenxuan. And so, yes, the new businesses within the EDU side, the K-12 schools and Dongfang Zhenxuan are the 2 top performers within the business lines, Felix. So congrats on the profitable status for this quarter. And my question is, since COVID restrictions have been lifted in China, do we expect higher-growth rates of our new business line in the next quarter and also in the next fiscal year? And is there any new opportunities within our new initiatives business? Yes, for the new business, yes, as we saw in this quarter and last quarter, the encouraging performance proves that we are heading towards the right direction and we firmly believe that the new business will be -- we will be able to maintain upward growth in Q3 and Q4 and the next fiscal year, what I mean is fiscal year 2024. And we started the new business last year but I think we ramped up the new business very quickly. And as a good news for us is the merger for the new business in this quarter, it's already over 10%. So think about that. We started this business last year and took us to spend like 2 to 3 quarters to get to breakeven point and then we make it profitable. So it sounds very good. And I think we are on the good track and I think management of New Oriental will pay more efforts where it creates more opportunity, business opportunities to develop the new business as it is in Dongfang Zhenxuan and the new business in this year. And so we will do more -- to do more creative in future. Yes. Actually the new pandemic situation with the gradual opening up after these recent developments of the new situation, I think, probably we can see more opportunities in some certain kind of new initiatives such as the study tours and research camping business that we mentioned, 1 to 2 quarters ago that as one of the new initiatives. But as the pandemic situation happened after 1 to 2 quarters, we did not have a very good chance to rollout business domestically. But with the new situation, we have confidence that there is more opportunity for this business to perform better. Congratulation on a profitable quarter. Could you please give us some color on the revenue breakdown this quarter and as well as the margin profile for different business lines? I know, Stephen, you already mentioned the new business is 10% OP margin. How about the rest? Yes, for the reported quarter, the overseas related business including the overseas test prep and consulting contributed roughly about 21% of total revenue and the domestic test lab, the adults university students' business contributed roughly about 6% and the school business, including our remaining like high-school business and also the new initiatives for younger students together contributing roughly about over 40% of total revenue. And the rest are Koolearn and some other businesses. So that's the rough contribution, yes. Lucy, I just want to share with you the margins by different business lines. The overseas related business, overseas test lab combined with the consulting business, the margin for the whole year, fiscal year 2023 will be around 10% to 15% margin. What I'm saying the margin is before the corporate overhead. And the adults and the university study business, I think the margin profile, I think the business will be breakeven in this year. And the school business, including the remaining business and new initiatives as Sisi said contributed 45% of total revenue. The margin should be somewhere around 20% to 25% or little bit higher. So the others, this is the big others, including the Koolearn, Dongfang Zhenxuan and others, I think, if you follow the numbers, the Koolearn, the first-half year report, I think you will see more color on the margin profile of the Koolearn and the others, Lucy. Yes, we talked about it in the prepared remarks. So for this quarter, like U.S. dollar terms, overseas test prep business increased by roughly 17%. Actually, for RMB term, you should add another 10%, 15% more. The university students' business is stable and in U.S. dollar term it is negative 8% but RMB term is positive. And the -- yes, the school business actually increased because of the new initiatives. And also Koolearn and other business increased a lot. Congratulations on the very strong set of results and also on the strong guidance for next quarter. My first question is related to the third-quarter revenue guidance and also the profitability that we are aiming for. So firstly, can you give us a break, rough breakdown of revenue for the third quarter and also in terms of the operating margin, how should we look at it for the third quarter, given the strong revenue? Okay. In the Q3 forecast, I think the number-one, the overseas related business, test lab and consulting business will contribute 24%, 25% of total revenue in Q3. And the second, the adults and university students business contribute 2% of the revenue because of the COVID. And the school business, including the traditional business and remaining business and the new initiatives will contribute 43%, 44% of total revenue. And the other 30% comes from the Koolearn, Dongfang Zhenxuan and the other business like the books or the other 2 businesses. And the margin profile, I think the margins -- let us start with the margin analysis from this quarter. In Q2, you saw our GP margin and OP margin increased a lot compared to last year. And I think this is mainly driven by volume of reasons. Number-1, in last year Q2, even before last year before year, the first 3 quarters, we had the considerable one-off cost related to the class cancellation, the learning center closures and the staff layoffs. In this quarter and even in this fiscal year, we have no one-off cost. Number 2, I think the downsizing learning center numbers led to the lower fixed cost. So it strives the margin up per learning center. Number 3, the new businesses, the margin is over 10% this year. I think it's good news for us and also the recovery of the remaining business, for example, like the overseas-related business, generally has the higher-margin than that of last year. And the last reason, number 4, the Dongfang Zhenxuan, the Koolearn, the last streaming e-commerce business enjoys higher margin. So it makes the margin, it drives the margin for the whole group. And going-forward, I think all of this is aligned. We are, will contribute even higher profit and drive the whole margin up year-over-year. So we are quite optimistic of the margin profile of the whole year, fiscal year 2023. So my second question is related to the regulations, recently in late December that we saw, we saw that there's new document about the non-academic tutoring activities. So do we see impact on our business overall, like in terms of pricing and also the expansion? Actually, since the government has issued the policy last year, I think we have the authority exploring the new business direction and follow all of the central and local governments authorities, the rules. And so, yes, you mentioned that the new rules in last October, in October last year, I think there will be no material impacts to our business. Stephen, this is Felix. And my follow-up question is on your learning center network. I know that you opened 2 centers in this quarter. So I think that's a good step forward, although a small step. Could you share some color on your expansion outlook from here may be this year and next year? Okay. I think in the rest of this fiscal year, I think we have no big plan to set-up new learning centers. I think the learning center number will be stabilized because we made a loss on the OMO system in last -- in past so many years and we moved a lot of cost from the offline to online. So it saves the cost from the areas. And also -- and we changed from the traditional business, classroom areas to the new businesses. So this is the internal change. And the next year we do hope we'll open more learning centers. But so-far, since it's too early to say how many learning centers we set up for the new year because we have not finished new year budget. I think I want to share with you the new learning center expansion plan next quarter earnings call. My question is about the ratio of teachers to students. Could you share some color on the teacher to student ratio on each learning service segments? And do you have more plans to recruit more teachers in the next 2 years? I can't share with you the teachers number. By the end of this quarter, we have 26,000 teachers in total. And because we started a new business, just I think the last year, so I think it's too early to like calculate the teachers to student ratio. I think maybe next quarter, we'll be in the new year, we'll disclose the ratio. And yes, I think we are hiring new teachers, because you know we started new businesses. And for some non-academic courses or the other new business, we do need to hire more features. But the key is, we don't hire more teachers. So we can't move above the elevation and the efficiency of the whole company, so I think we believe we will keep the higher utilization and the higher efficiency for the whole company in the future. Congrats on a strong result. I actually just have 1 quick follow-up question on all your comments regarding margins. Can I ask how much of corporate overhead costs shall we expect at this stage, i.e., I remember, corporate overhead used to be like high single digit-ish revenue pre double reduction policy like 2 years back. So given much smaller or reasonably smaller revenue base now, I'm wondering how much about overhead we should model and expect for this year either as percentage of revenue or dollar term would be appreciated. Yes, I think since the last year, we cut-off some fixed costs and expenses in the headquarters. So I think the headquarters expenses as a percentage of the total revenue will be stabilized and roughly at 6%, 7% of total revenue, this is the total expense from the headquarters. That's very impressive and a greater margin guidance. If I may follow-up again on all your comment on the expansion plan, I don't want to ask too much about the number of learning centers but may I check for non-subject tutoring classes. Where do we see incremental demand opportunity say top tier cities, top 10 cities versus the rest of the nation by, like do you see stronger demand and where do you think we would open more stores and more centers in terms of the geographical exposure and that's all from me. I think the new business developments in the top-tier cities is a little bit better than the low-tier cities. And this is -- we have seen in the past quarters. But I do believe even in some low-tier cities, I think they will catch-up because they start with the business, it's a little bit slower than the top-tier cities. And so, almost everywhere we're seeing the business opportunities for the non-academic courses, almost everywhere. And, yes, that's all. Capacity, as I said, now we don't have the capacity expansion plan and we just want to keep the same learning center numbers moving next quarter or even for the -- till the end of this fiscal year. And next year, maybe we'll expand, we will extend some new learning centers. But so far, we don't -- we haven't finished the next year budget. I will share with you the numbers next quarter. Stephen, I have a follow-up questions. I noticed that there is a significant increase in non-academic tutoring enrollment in Q2. Would you like to specify the driver behind? And do we have any target for the enrollments during the whole year? I think the markets always there. And we do have the famous brands and we do have the teachers. And yes, we started business just a year ago that you saw the numbers. And the exciting news for us is that the profitable of the new business is exciting. It's much better than we expected. And for the new business, I don't believe in the rest of this fiscal year, the new business, the revenue growth will be accelerated again. And even for the next new year, fiscal year 2024, I believe the revenue growth of the new business will be high, yes. So we're optimistic about the non-academic courses business. Yes. And by the way, the non-academic tutoring business, according to our experience in the last several quarters, we think that its seasonality is not that apparent as some other test prep business. So every quarter, probably the enrollments will be relatively stable if we do the Q-on-Q comparison. And also as new business development in all the local cities, probably you can see strong momentum. As we have seen that Q2's growth or the enrollment trends are also similar or even better than Q1. Yes. I think the retention rate is related to the traditional K-12 business. But we closed on the K-9, this is last year. And -- but for new businesses like non-academic courses, we just follow up -- we just trace the retention rate. The good news for us is we are seeing the retention rate is getting higher and higher. And for example, as for the non-academic courses, the retention rate now is between 65% to 70%. We just started the new business and the retention rate now is better than we expected. And we believe the retention rate will get higher going forward. And overseas test prep and the university students business? We are now approaching the end of the conference call. I will now turn the call over to New Oriental's Executive President and CFO, Stephen Yang, for his closing remarks. Again, thank you for joining us today. If you have any further questions, please do not hesitate to contact me or any of our Investor Relations representatives. Thank you.
EarningCall_1558
Okay. Good afternoon, everyone. I am being told to progress, to maintain the clock. And I also understand that I am the last speaker between you and the bar. So even more important that I get this right and follow instructions. Brian, forgive me. I started without you. Sorry. I was under instructions, Brian. Okay. So today, Editas is changing. Editas is changing so that we can be the leader in in vivo programmable gene editing leveraging cutting-edge technology. We aim to deliver therapies that revolutionize the treatment of previously untreatable diseases, improve patients' treatment journeys by simplifying the usability of gene editing and minimize the burden on healthcare systems, all while developing novel, differentiated medicines. Today, I am pleased to share our strategy to achieve this vision. The underlying pillars of the strategy are: an expanded focus on hemoglobinopathies and in vivo editing, a strengthened discovery engine focused on in vivo gene editing in multiple cell types and tissues and an increase in business development efforts. And we are well on our way towards this vision as we've begun to execute these changes. In the near term, Editas would expand its focus on hemoglobinopathies in three ways, building on our recent clinical success with our EDIT-301 program. We will continue to advance our ex vivo 301 program in sickle cell anemia and beta thalassemia. We will pursue milder conditioning regimes to lessen the burden and risks suffered by patients on their clinical journey, and we will pursue in vivo editing of hematopoietic stem cells. Now during today's presentation, I will make forward-looking statements. Actual results might differ materially from those projected in such statements. So please refer to our federal securities filings for additional information. But let me pause for a second and introduce Editas to those who are less familiar with us. Editas is a clinical-stage gene editing pioneer that has built a cutting-edge biotech platform in order to develop differentiated medicines for patients with previously untreatable or inadequately treated diseases. The company was formed nearly 10 years ago and since then has driven our technology forward across a range of in vivo and ex vivo programs, and this is where this pioneering work has brought us to today. Editas has important strengths that provide building blocks for the transformation that we are undertaking. And these strengths include Editas' core technology that includes a differentiated high-fidelity AsCas12a CRISPR nuclease with the ability to delete and/or correct disease-causing mutations in clinical application, core expertise in guide RNA design and chemistry, advanced bioinformatics and well-developed CMC quality and analytics. It also includes a strong IP portfolio covering Cas9 and AsCas12a and a set of human proof of concept readouts in the past three months. AsCas12a is our proprietary high-fidelity, high-specificity nuclease and has demonstrated superior characteristics that increase the efficiency of editing and significantly reduce off-target editing seen with other nucleases. Moreover, preliminary data from our RUBY study suggests we have achieved human proof of concept utilizing AsCas12a in our EDIT-301 program. I joined Editas because I saw a huge opportunity to help transform Editas from a technology platform company into a commercial therapeutics company. I was appointed as CEO six months ago with a few near-term objectives: to hire a world-class Chief Medical Officer, to sharpen our focus on clinical execution and to refine Editas' strategy. I am pleased with our progress on these three objectives to date. First, in July, we hired Baisong Mei, our Chief Medical Officer. Baisong brings over 20 years of experience in the biopharma industry and most recently served as Senior Global Project Head for Rare Disease and Rare Blood Disorders at Sanofi. Baisong and I are delighted at the opportunity to work together again as we had worked in the past at Biogen together. Second, we have driven clinical execution to two clinical readouts in the past three months. And third, we are ready to share Editas' vision, strategy and structure for the future and the objectives that we have set for 2023 on our path to realizing our new vision, a vision where Editas would be the leader in in vivo gene editing. As I stated a few minutes ago, we have recently generated human proof of concept data in two clinical programs and made milestone decisions on both. First, less than two months ago, we announced human proof of concept for our in vivo EDIT-101 AAV-delivered Cas9 therapy for LCA10, or Leber Congenital Amaurosis 10, an inherited retinal disease. However, due to the limited addressable population size, we made the tough decision to pause enrollment in our BRILLIANCE trial until we found a partner. Second, one month ago, we shared very encouraging initial data from the RUBY Phase I/II clinical study of our ex vivo autologous EDIT-301 therapy in severe sickle cell disease. The readout suggested human proof of concept that EDIT-301 could safely drive expression of fetal hemoglobin to clinically meaningful levels and correct anemia in sickle cell disease patients. It also demonstrated that Editas has a potential product that can give robust clinical benefit to patients and has the potential for clinical differentiation in the long term. With our current technological strength and these clinical data, Editas is poised to redefine its vision and strategic priorities. Now where is Editas going as a gene editing clinical-stage therapeutics company with a clinically validated technology? We are changing. And our long-term vision, to be a leader in in vivo programmable gene editing that leverages cutting-edge technology to deliver therapeutics that includes the simplifying the usability of impact -- and impact, excuse me, of its therapies by minimizing the burden to patients and healthcare systems and to avoid a me-too mindset by selecting therapeutic targets where Editas can meaningfully differentiate from the current standard of care. So how will we do this? First, we are narrowing the focus of our discovery to in vivo-administered genome editing medicines while continuing to develop our existing ex vivo drug candidate for sickle cell disease and transfusion-dependent thalassemia. We will no longer discover or develop standalone cell therapies, and we'll seek to divest stand-alone allogeneic NK oncology assets. We will continue supporting our partnered cell therapy programs. This includes our T cell programs with both BMS and Immatics. And additionally, we have terminated our AAV IRD platform and seek to divest those assets. Second, we are strengthening our discovery engine and capabilities. We have split our research division into separate technology and drug discovery groups, strengthening the capabilities of each. Our technology group will have a focus on targeted delivery starting with HSCs, or hematopoietic stem cells, and enhancing our gene editing toolbox to enable targeted gene repair. This technology group will be headed up by Bruce Eaton, a veteran technology entrepreneur, who will assume the role of Chief Technology Officer. The drug discovery group will initially focus on in vivo therapeutic target selection in hematopoietic stem cells. We are also looking beyond HSCs, or hematopoietic stem cells, at other cell types and tissues and look forward to sharing updates in the future. We will select therapeutic targets we believe have a significant probability of technical, regulatory and commercial success. And with the change in the structure and our move away from AAV IRD, we have initiated a search for a new CSO. Mark Shearman, our current CSO and an AAV IRD expert, will support a smooth transition through the end of the first quarter of this year. And third and finally, we are increasing our business development activities to complement our internal technological capabilities and to leverage our IP portfolio. This strategic focus -- or refocusing allows us to concentrate on our talent. It has also reduced our headcount by 21% and increases our expected cash runway into 2025. Moving to our development plans, the EDIT-301 data in sickle cell disease have shown us where we can start to be most transformative and effective. We will pursue a leadership position in HSC therapeutics for hemoglobinopathies, both ex vivo and in vivo delivery settings, by building off our foundational knowledge from EDIT-301. One of our key objectives will be to accelerate clinical development of this lead program, and specifically, we will add to our program by taking three actions. First, we will increase our investment in editing capacity and enrollment of patients in our RUBY and EDITHAL trials as we continue to advance our ex vivo 301 program for sickle cell and beta thalassemia. Second, we will pursue milder conditioning regimes, improving the therapeutic proposition for our sickle cell and TDT patients. This should increase adoption of an EDIT-301 therapy by reducing or eliminating the acute burdens of immunosuppression at the time of transplant and reducing the long-term burdens of infertility and oncogenesis associated with current toxic conditioning regimes. And third, we will pursue in vivo editing of hematopoietic stem cells through enhanced targeted delivery of our AsCas12a nuclease through our clinically validated hemoglobin gamma 1/2 promoter site. Before talking about the specifics of our EDIT-301 clinical program, I would like to provide a bit of background on sickle cell disease and the patient experience. Sickle cell disease affects millions of people worldwide, including approximately 100,000 people in the United States. Severe sickle cell disease is an inherited, life-threatening and disabling hematologic disorder manifesting shortly after birth and characterized by unpredictable and severe attacks of acute pain or vascular occlusive crisis, progressive organ damage, chronic anemia and shortened lifespan. Patients with severe sickle cell disease experience daily challenges in addition to those painful vascular occlusive crises. Their anemia causes fatigue, low exercise tolerance and cardiopulmonary strain. They may also suffer strokes, MIs, renal damage, resulting in ultimate organ failure. Current treatment options for sickle cell patients are limited. Allogeneic bone marrow transplantation can cure sickle cell disease, but less than 20% of patients can find match donors and there's a risk of serious complications beyond simply those of conditioning. Other approved treatments show limited effectiveness and do not address the underlying cause of the disease. EDIT-301 seeks to increase the expression of fetal hemoglobin using our novel AsCas12a nuclease to edit the promoter regions of gamma globin genes one and two in patients' HSCs. This unique approach mimics the natural mechanism of hereditary persistence of fetal hemoglobin, thereby reducing the probability of sickling of red blood cells in sickle cell patients. We announced initial data for EDIT-301 last month with the preliminary data suggesting that Editas Medicine has a product that can give robust clinical benefit to patients with severe sickle cell disease and has the potential for clinical differentiation in the long term. In the first patient treated with EDIT-301, fetal hemoglobin fraction increased from 5% to 45.4% and total hemoglobin increased from 11.9 grams per deciliter to normal levels at 16 grams per deciliter five months after transplant. 96% of patient 1's red blood cells express fetal hemoglobin, that is a ubiquitous expression, and mean corpuscular fetal hemoglobin levels reached 13.8 picograms per red cell after five months, thus reaching and exceeding a threshold that will prevent sickling of individual red cells. We have confidence that we will continue to see these effects in our growing clinical patient series in RUBY. The clinical data from RUBY recapitulate our preclinical experience in both the magnitude of the fetal hemoglobin response and the distribution of fetal hemoglobin across red blood cells or F-cells. We expect EDIT-301 to be well positioned to capture a meaningful segment of sickle cell and thalassemia patients. We believe that EDIT-301 will be part of the evolving market for next-generation hemoglobinopathy medicines and that the vast majority of eligible patients will still be untreated, owing to slow uptake and reimbursement ramp at the time of our launch. We have seen this experience across multiple specialty and rare disease markets in the recent past. We will increase our investment to grow our EDIT-301 editing capacity to support increased clinical trial enrollment and dosing now that all sentinel patients have been dosed in a graft. We already enrolled additional patients for the RUBY and EDITHAL trials and collected and edited their hematopoietic stem cells and are scheduling their transplants as we continue to screen new patients at current sites and activate new clinical trial sites. Turning to in vivo. We will focus our technology on targeted in vivo editing. Our initial focus is on in vivo editing of HSCs, or hematopoietic stem cells. EDIT-301 ex vivo demonstrates successful hemoglobin induction and creates a strong foundation for that initial in vivo project. The ability to edit hematopoietic stem cells directly in patients without transplantation will allow the treatment of much larger patient populations. In fact, the majority of sickle cell and thalassemia patients has no myeloablative conditioning is required. Indeed, pheresis would actually also not be required. Such a product could be used across multiple health systems with a much lower burden on patients and treatment centers. Beyond HSC, we will also focus our discovery efforts on other tissues, and we look forward to updating you on additional areas of focus as our discovery efforts progress. Now on the business development front, we will partner and collaborate to extend our reach, access, capabilities that are complementary to our current technology and accelerate programs as we drive our programs towards commercialization. We will continue to out-license EDIT's -- or Editas' technology for promising areas. And we will also leverage our IP around Cas9 and AsCas12a to increase our BD activities where our strong IP position creates value directly and through additional BD opportunities. As things stand today, Editas is the exclusive licensee of the Cas9 IP portfolio owned by the Broad Institute for Human Medicines. That is, any company that wants to commercialize a gene editing product in the U.S. as well as in other markets that uses the Cas9 enzyme for human therapeutics would need to obtain a license from Editas Medicine. Now with our narrowed focus, we plan on progressing EDIT-301 through clinical trials while currently advancing our earlier-stage hematology initiatives and other initiatives, as outlined earlier. We look forward to executing on our strategy, continuing our transformation and sharing our progress with you. As we look more specifically at 2023, our strategic objectives for the year include: hiring a new CSO with specific expertise aligned to our vision, resetting our discovery group, initiating discovery of in vivo editing of HSCs and in other tissues. And on the development side, we plan to execute on the following: providing a clinical update from the EDIT-301 RUBY study in mid-2023, which will include the initial two patients that were dosed last year as well as additional patients from the ongoing RUBY trial. In addition, we will have dosed 20 patients in our EDIT-301 RUBY program by year-end. We will dose the first patient in EDIT-301 EDITHAL trial for thalassemia in the first quarter of this year, and we look forward to providing early data from our sentinel patients in the EDITHAL trial for TDT later this year. Last year was a pivotal year in Editas Medicine's history as we reset our vision, began execution on this vision and hit multiple milestones of progress for this changed Editas. And we expect this year to be even more eventful. Looking forward, we will deliver on Editas' potential by resetting and strengthening our discovery platform and efforts to focus on in vivo editing using criteria that maximize the probability of technical, regulatory and commercial success; by increasing our investment in EDIT-301, enhancing the patient experience and looking beyond ex vivo therapy to in vivo editing of HSCs; and increasing and enhancing our business development activities to create value. It is really exciting to be part of this next chapter in Editas' journey as we transform to deliver curative medicines to people living around the world with serious diseases. Thank you very much. Welcome to the Q&A session. It turns out to be extremely difficult to go from session to session in the Westin. So maybe just to kick start the conversation. I think when we look at the gene editing space, in the last couple of months, we've seen a lot of debates on what the regulators think about gene editing in general, right? You see other gene editing companies having a little bit of a hurdle to get things done in terms of getting the first clinical studies in the U.S. cross-checked and started in the U.S. Maybe just one broad question to kick-start is to, maybe Gilmore can answer this, is how do you think about just the current receptivity from the regulatory agency on gene editing? And what is your strategies to -- as you turn a new page on your portfolio, what's your strategy that you think would be the best to get -- advance your portfolio the fastest? Yes. Thanks, Brian. So obviously, I'm going to articulate some opinions about regulatory agencies, which should be seen as just that. The good news is that I have substantial experience in working with regulators around the world and with the FDA, and I'm actually joined by Baisong here, who also has substantial experience. And I think between the two of us, we have had 10 drugs approved and have seen all the vagaries of development challenges, discovery challenges and regulatory challenges. So how are the regulators looking at gene editing if I think about it? Well, I think in many ways, we've actually also had a very good experience just in the last year if we look more comprehensively than through targeted CRISPR-based gene editing in that we have seen an approval for a lentiviral-edited therapeutic. And I think what that demonstrated is a regulatory agency that actually weighs very carefully, and obviously listens to important advice for the AdCom, but weighs very carefully benefit risk. And obviously, looking at or targeting diseases that are very serious, have significant morbidity, have an inadequate established standard of care for patient needs in the context of therapy with either yet to be defined or comprehensively defined risk or a well-defined risk, as we've already seen with lentiviral, the agencies and the FDA specifically are well able to actually approve those medicines. So I think that's a very important point. I think you touched on something else around some of the issues in recent months with other interactions with regulators. And I think the important piece there is that the agency quite rightly focuses very much on the creation and development and manufacturing of your clinical supply as well as, ultimately, your commercial supply. And that's actually a reason why Editas upfront has invested significantly on both its research analytics for risk management as well as on its CMC analytics and quality. Those are -- what I would say, they're not as sexy as drug discovery, but they're absolutely vital. They're kind of the black box that no one wants to look at. Or as I said recently to somebody, when you're flying an airplane, you're looking at the air quality, how much seat room you have. But ultimately, the things that are actually keeping the thing in the air are the engines and it's -- they're not visible to you, but they're the things that keep the engines -- or the plane in the air. So I think the key point is to really, our priority, look forward to managing risk, and that includes both from a discovery point of view as well as really thinking about your manufacturing. Then from our point of view, our strategy, how we think about that, I've kind of actually hinted at that, which is select diseases that are very serious certainly at initial or certainly early on with this technology because then you can get your benefit-risk right. I also think, frankly, that actually, while ultimately we want to expand the use of gene editing to very large patient populations, I think in the beginning, you have to think about managing risk in two ways: balancing the risk and benefit in individual patients; and then for regulators, recognizing they also have to consider the risk of a public health risk, which is releasing a new therapeutic where the safety profile is being -- or is evolving into large populations. That is -- those are two ways to actually manage that. I think Baisong and myself had significant experience in bringing newer technologies to market. I don't know, Baisong, if you want to add to that. No, I agree with you, Gilmore. I think as we are developing novel therapies, right, so I think the most important thing we are interested as well as regulatory agency interested is benefit-risk balance of that. Can I just say one other thing? Because we've talked about risk a lot. I think this has actually been a really -- last year was really a very interesting and exciting year for, I'd say, programmable or CRISPR-based gene editing because in that year and even in the year before, we have actually seen -- in 10 years after the original publication of the use of CRISPR for eukaryotic cells, we've actually seen multiple proofs of concept with in vivo and ex vivo therapeutics from multiple sponsors. This is a phenomenal achievement, and I think it actually is the prelude to really exciting developments. Managing risk is very important, but managing risk when you have robust efficacy with the technology is much easier. So just to follow up on that is when you think about your next step -- you previously guided that you would disclose the strategic priorities and -- which you did very recently, and thanks for giving us a recap on the priorities and how you envision the next year and beyond look like for an Editas. Maybe just to backtrack a little bit as to you have proof of concept in a few inherited retinal diseases. You also have proof of concept of 301. What gave you the confidence to push for 301? And you also have also divided your R&D into two divisions as well. Maybe just some thoughts on what is giving you the confidence that this will be the right strategy to move forward. I think there are a number of factors. I did outline, maybe not in sufficient detail, our approach to target selection and therapeutic selection. One, we just discussed a little bit about, was selecting very serious diseases with significant morbidity with inadequate standard of care. The other was ones which are clearly monogenic and where the genetics and the biology are really well understood. Indeed, if there's a natural experiment that actually helps you define a likely dose response through allelic interrogation -- allelic series interrogation, et cetera, even better. Wonderful examples of that are hereditary persistence of fetal hemoglobin and the SMA experience where you can actually even predefine therapeutic or biological therapeutic thresholds based on a natural experiment in humans. The other is to look at translatability. And I think this actually feeds into one of the decisions where we've got IRDs or retinal dystrophies, which is the ability to test a biological parameter easily, repeatedly if necessary, and that biological parameter is very close to or proximal to the editing target. A very good example of that, for example, is fetal hemoglobin, which is easily sampled by venipuncture. Unfortunately, in contrast, no such assay -- or robust assay exists for retinas today. And then finally, obviously, looking at the regulatory path. And here, Baisong and myself, with the experience of bringing 10 drugs to approval, have a very good sense of what that looks like. You don't have to have precedent, but you need to actually know what it looks like and actually have passed the reg phase test. And Baisong and I, I think, collectively have certainly experienced enough reg phase tests over the years to really know what that looks like. And then finally, make sure that this is commercially viable both from a competitive landscape and again, more importantly, around the established standard of care. So just to hone in on this point, you laid out a few pillars as to how you think about the next step, right? One of them is commercial viability, translatability. And so we know that EDIT-301 is your key focus, but you also laid out the fact that you're also looking into next-generation in vivo assets. Any color on how we should think about what would be, just the broad area that you'll be focusing on, what would be an interesting disease that could be -- could go well with what you have today? Well, I think the first in vivo therapeutic we're going to actually zero in on is the editing and targeting of hematopoietic stem cells. Why is that actually a good idea? Well, we have actually validated by in-human proof of concept the target, which is the gamma globin promoter, and the mechanism for editing AsCas21a. What we now -- it actually enables us to kind of reduce the magnitude of the problem to one of targeted delivery at -- to hematopoietic stem cells in vivo. And we've actually started some work on that and obviously, we'll need to continue. One of the things that gives me confidence is other elements of our strategy. Unfortunately, I'm stealing, Michelle's thunder by saying that as part of this effort, we actually have freed up cash, extended our cash runway and been able to redeploy our capital in ways that can actually critically help us advance beyond just 301, but on the in vivo side in growing and strengthening our internal efforts. But actually also philosophically, and this is another part of our strategic change, a philosophical change to actually embrace the idea of bringing in or partnering other technologies that will complement ours in actually delivering to the targeted tissue here, HSCs, with a view to developing one of our in vivo targets. So that's an example of a disease and the reasons why we have some confidence -- or a lot of confidence there. Beyond that, I really want to bring in our CSO who will be partnering with Bruce Eaton, our CTO; and Baisong, our CMO, to really think very robustly about the targets that we will bring forward using the criteria that I've just outlined for selection, with a real focus on not being a me-too. And then we'll be looking forward to sharing that with you in the future. Okay. Maybe just turning over to EDIT-301. What are the next steps for the program? And maybe remind us -- remind the audience, what is the bar for fetal hemoglobin that you're shooting for and just the next steps moving forward for the program? Yes. Forgive me. Yes. So our next steps, I'm going to sort of divide it into two pieces. I'll talk a little bit about what we're doing with regard to investment in editing capacity. So one of the things we've actually restarted with the redeployment of capital is actually grow our editing -- our internal editing capacity, which includes both manufacturing and quality analytics, so that we can actually guarantee supply -- clinical supply to the clinical program as that advances. Quickly, I'll say that the -- one of the key biomarkers is fetal hemoglobin. Fetal hemoglobin actually speaks for itself. It's the hemoglobin that circulates in our veins until we're born, and then we switch it off and switch on adult hemoglobin. We do that by switching off gamma globin, switching on beta globin. Unfortunately, patients with sickle cells or thalassemia have mutations in the beta globin gene, and the natural experience of hereditary persistence of fetal hemoglobin has shown that switching back on fetal hemoglobin substantially mitigates the complications of disease. Indeed, in patients who are at risk of sickle cell disease, there seems to be a dose effect -- or a dose-dependent effect on multiple complications well beyond VOCs. But with regard to the next steps with the clinical trial, I'd like to pass it to Baisong. Yes, because I think we saw a couple of updates for fetal -- in the same disease. I wonder if you have any updates on how you think about just what you want to show? Yes. Well, I think there are two things. One is that I talked about the hereditary persistence of fetal hemoglobin and sort of a number of academic analyses of the data suggest that you get a dose-dependent effect: higher fetal hemoglobin, better control of multiple complications of sickle cell disease. From a bar point of view, from the elimination of VOCs, it certainly looks in that experience that VOCs can be largely controlled or eliminated by hitting a bar of about 30% fetal hemoglobin. However, it is not unreasonable to expect that if you go higher, and certainly with our first patient, we've achieved levels of 45% fetal hemoglobin, you would anticipate more control and better outcomes, including for the control of other complications because as I said in the presentation, sickle cell disease is about much more than VOCs. For those of you who are used to multiple sclerosis or have any experience there, multiple sclerosis has acute attacks, but an underlying chronic degenerative disease that ultimately causes incapacity. You can think rather loosely in similar terms that VOCs are acute attacks, extraordinary unpleasant and unpredictable attacks, but underlying that is a progressive vascular and vasculopathy and damage to multiple end organs: CNS, heart, kidney, et cetera. So actually, going higher, we believe, may actually have a real benefit from a bar point of view. And I think that's important, I think, as you talk about other recent disclosures. Sure. Yes. As Gilmore mentioned earlier, one of the priority that Gilmore and I joined the company is to focus on clinical execution, right? So we've been working on rare disease for many years, and you have to reach out to patients. You have to reach out to community. You have to reach out to investigators. So with this effort by the team, really, we see big momentum in terms of patient enrollment. So we now have two patients dosed and have multiple patients enrolled but also have their cells collected and edited and ready for infusion for the transplantation of that. So really, what we're looking into that is we will have data released in middle of this year to have the data for these two patients -- longer-term data for these two patients dosed as well as the data from multiple patients to be dosed in the next few months. So this is on the sickle cell side. And we also have huge momentum from the EDITHAL study, which is for beta thalassemia patients. And we also have quite a few patients enrolled already, actually have been processed, been -- either already completed pheresis editing or in the process of doing that, and we plan to dose those patients very soon. And we also plan to release the data for EDITHAL patients end of this year. So we have huge momentum for the EDIT-301 study. And then to reiterate our specific target or objective for this year, we will have dosed 20 patients in the RUBY study by the end of the year. Just want to be sure that... Yes. Maybe just on the preconditioning regimen that you're working on. How does that fit into -- does that have any implication in the RUBY trial? Or are you thinking about working on it in a separate study? Well, let me just say, and then Baisong can talk more, what I want to say is just from a strategic point of view, the intent is to drive 301 to approval as rapidly as possible. The milder conditioning regime enables us to expand the availability of the medicine upon its approval. So it doesn't necessarily have to be developed at the same time. Essentially, it's going to be, we believe, an important evolution, as do others, in stem cell transplantation in general and specifically for sickle cell and thalassemia because patients who would not otherwise be eligible, for example, for busulfan conditioning would be eligible and be able to tolerate a milder conditioning just because of general bone marrow health or other health issues. So you should look at it more as a step. Whereas we go for 301 approval, the next step is to expand use and availability by milder conditioning. But the ultimate or, I'd say, the omega point, the real target or north star is to actually get to in vivo editing where you can essentially eliminate a substantial amount of risk that has nothing to do with the therapeutic. It's more tied to the conditioning. You can reduce the consumption of healthcare resources by eliminating the need for pheresis, for isolation units, et cetera. And obviously, you make the risks and the tolerability of the therapy much greater for patients. Baisong, I think with regard to your thoughts about developing... No. I think well said, Gilmore. I think from clinical development strategy perspective, we really wanted to push this EDIT-301 to the finish line, right? But we are taking a parallel approach to really also look into the milder conditioning, and this milder conditioning, in terms of channel strategy wise, is not going to be just for sickle cell alone, right? It's going to be beneficial for many different things in there. So there will be really a development for its own and will benefit for EDIT-301 as well as other potentially, transplant wise. Maybe one question for Michelle. How does -- the strategic reprioritization that you announced earlier, how does that impact your expenses moving forward? And as you think about new programs rolling into your portfolio, how does that change your cash runway? Sure. So as Gilmore mentioned, the narrower focus in the strategy has resulted in our cash runway extension into 2025. This is important for a couple of reasons. The first one is that it's going to allow us to fully invest in 301 as we move it through to the value inflection points: the accelerated enrollment in 2023, continuing to invest in CMC and then data readouts and ultimately, a registration. It also opens up capital allocation to drug discovery, as Gilmore also mentioned, and additional in vivo therapeutics. So given the unfriendly state of the equity markets, we feel really comfortable that this cash extension will really put us in a good position for once we get to the value inflection points that got away. Maybe one last question, maybe for Gilmore or Michelle. What are the key data catalysts that -- or milestone that you see for your company in the next 12 months that investors should focus on? Well, I think that -- and Michelle, I'll hand to you in a second if you want to add to that, I think the key milestones will be as I outlined. I think there are some strategic deliverables. I think we need to bring in that CSO, and I think people will have to get to know the CSO. But sort of the key ones I think I would focus on right now would be in our 301 data readouts, if you're looking for those immediate catalysts in the short term, and obviously, our execution and then our delivery of data in the middle and the end of this year. And then finally, obviously, as we reboot discovery, our CSO joins, we look forward to being able to share more about our targets and -- beyond HSCs. But I think, as I said, the key catalyst really in the near term this year will be around our 301 data readouts, and we're really excited about this program. Great. I think that's -- we're at the top of our 20 minutes together. Thank you so much for joining us. That concludes the presentation and Q&A today. Thank you.
EarningCall_1559
Good afternoon, ladies and gentlemen, and welcome to the Aurubis AG Conference Call regarding the Annual Report of the Fiscal Year 2021-2022. At this time, all participants have been placed on a listen-only mode. The floor will be open for your questions following the presentation. Thank you very much, and welcome ladies and gentlemen. My name is, as he already said, Angela Seidler. And I would like to welcome you. I am sitting here together with our CEO, Roland Harings; our CFO, Rainer Verhoeven; and the COO, Heiko Arnold. They will lead you through the presentation this afternoon. We are very sorry that we were not able to publish the figures at the beginning of December, but the cyber attack on our IT systems unfortunately required a postponement. So, happy to have you all in here so close to Christmas. We know that this is not the easiest time of the year. Yesterday evening, we published, after the supervisory board meeting and ad hoc announcement concerning our growth project, our dividend policy change, and the forecast for the current fiscal year. Yes, thanks, Angela. Also from my side, warm welcome to our call to see our annual results call this year. And again also, apologies for being late this year due to the cyber attack, but we will come to this subject, cyber attack, and how we went through this [during it] [Ph]? What a year? My colleagues on the Executive Board and I are very proud to have led Aurubis so successfully through this crisis-filled year together with our strong management team. We managed to generate the highest earnings in the company's history, and have therefore proposed the highest dividend since the IPO, and despite multiple crisis management, most recently during the cyber attack just mentioned, we stuck to our strategic course and, yesterday, presented important growth projects to the supervisory board, which were approved. You were informed of this yesterday in an ad hoc announcement, we are just -- and we are also taking Aurubis into sustainable growth path that we intend to finance from our own resources. We managed the company through [strained] [Ph] supply chains caused by Russia's war of oppression in Ukraine, rising energy prices, and most recently the cyber attack. And despite all this, supported by good metal, product, and sulfuric acid markets and a good smelter performance we were able to increase our operating EBT by as much as 40% in the end, and the ROCE went up to 19%. The cash flow of €288 million is lower than last year, but can easily be explained by the build-up of inventories, in particular of input materials during the shutdown in Hamburg, and will turn around quickly in the course of the current fiscal year. Our strong performance combined with our impressive growth path has prompted us to reconsider our dividend policy. At the same time, we will continue to allow shareholders to participate in the success of the company. Our proposed dividend [technical difficulty] €1.80 per share, the highest dividend since our IPO. Coming to the next slide, and have a brief look at the production [technical difficulty]. Despite the major expenses in Hamburg, we were able to increase our throughput of concentrates at our primary smelters. With a good overall performance of the smelter network, the extraordinary successful performance in Pirdop is particularly worth to mention here, with more than 400 days of production without any interruption, without any standstill. Regarding recycling, including our smelters in Beerse and Berango, we were again able to process over 1 million tons of recycling input materials with attractive refining charges. Capital output was mainly in line with the previous year, running at full capacity. Based on very good demand for our copper products, we see high production figures with wire rod, shapes, and flat rolled products. Specifically flat rolled products, has to be taken into account the sale of the plant in Zutphen, and the [service tender] [Ph], and also the renovation of our plant in Stolberg after the flooding event in July, 2011. Sulfuric acid production was again in line with the concentrate throughput at a high level and also therefore above last year's figure. Going now to the market conditions, '21-'22, the copper price showed volatile development during the reporting period [technical difficulty] before then declining and floating at a level close to $7,700 at the end of the fiscal year. Looking at the different markets now, we saw a sufficient supply in quantity and quality of concentrates, with rising TC/RCs towards the end of the fiscal year. Underpinned by significant greenfield and brownfield projects, the concentrate [offer] [Ph] is anticipated to grow by 3.7% in 2022, with further significant increase in the next calendar year, according to Wood Mackenzie and our own research. The anticipation of a better supplied concentrate market in the next calendar year is also reflected in the newly set benchmark TC/RC of $88.00 per ton, and [8.10 cents] [Ph] per pound for framework contracts in the next calendar year. This represents a 35% increase compared to the benchmark of the current calendar year. Again, as you know, our policy is long-term supply, long-term contracts. We are already well supplied with concentrates into Q2 '22-'23. And we maintain our long-term supply strategy with long-term annual or even longer-term contracts. A short look at the recycling markets, over the course of the fiscal year '21-'22, we have seen the sufficient availability of scrap material on the global sourcing markets with [indiscernible] RCs during the reporting period. On a lower level compared to the year before, where we had some extraordinary price [effects] [Ph] and RCs, specifically on scrap number 2. CRU estimates an average RC of about €300 per ton during the fiscal year '21-'22 for scrap number 2 without logistic costs. This compares to €522 in the year before, so this underpins how significant the numbers were in the year before. The RCs for complex recycling material were yet again more stable, and less volatile during the fiscal year. Looking forward, our production sites are already supplied with material beyond the first quarter of the current fiscal year. Some statements regarding sulfuric acid, the sulfuric acid markets were tight with very high price levels well into Q3 of the last fiscal year. Driven by subdued demand, both from European chemical and also fertilizer industry, costs due to high energy prices, and specifically natural gas prices, we saw a reduction in demand and also a drop in acid prices towards the end of the fiscal year. This resulted in a different significant earnings contribution by -- Well, reduced contribution towards the end of the quarter of the last fiscal year. The current market situation is that we still expect lower earnings contribution from acid sales in the current fiscal year. However, you have to keep in mind that we have long-term contracts in place, and some of the markets are very short-term from the pricing, and we some more stabilization, but although Rainer will talk about the market outlook in more detail later. Regarding ACP, our Aurubis copper premium for calendar year '22, this number was set at $123.00 per ton. Reflecting the strong demand in Europe and also some cost increases, we have announced our ACP for the coming calendar year '23 to a level of $228.00 per ton, and we see that this is reflected and accepted in the market by our client base reflecting the strong demand that we see. U.S. dollar, we have a long provision of about $500 million in the fiscal year '22-'23. And in line with our hedging strategy, we have hedged 70% at a rate of 1.133 for the current fiscal year, and around 35% at a rate of 1.082 for the fiscal year '23-'24 already. Thanks, Roland, and good afternoon everybody. Let's have a look at our key financial figures for the year '21-'22. Our revenues increased significantly, by 14%, driven by the higher metal prices, of course, that we saw throughout the year, as well as the higher sales of all copper products, to €18.5 billion. The gross profit increased accordingly to 13%, in line with this higher revenues and the very strong market conditions, but as well also a good operational performance. We'll get to the details when we talk about our segments here. Despite significantly higher costs, we managed a 40% increase in our operating EBT overall compared to last year, resulting in the best annual result in the company history so far. Last, not least, with an ROCE of 19%, we strongly exceeded our ROCE target of 15%. At this point, I'd like to mention the adjustment of our operating EBT definition in comparison to last fiscal year. In order to better reflect the operating earnings situation of the Aurubis Group, independent of valuation effects that derive from the IFRS accounting standards, we adjusted the operating EBT definition by also eliminating the unrealized reporting data-related effects of market valuation of the energy derivatives. So, we took out mark-to-market valuations of the energy derivatives, and in the last years, we only took out the metal derivatives so far. So, that is new, the energy derivatives are included now because we had high volatility, and you saw that in the annex to our annual report, that we had otherwise quite extreme positive results from those derivatives. Going to the next page and having a look at our gross margin splits, you will see that the gross margin splits in '21-'22, shows the well-balanced different earnings pillars of the Aurubis business model. And they are pretty much comparable to the last year. Driven by higher metal gains arising from increased prices for metals, the metal gains made up the most significant component of the gross margin with 38%. Premiums and products also contributed very significantly driven by high sulfuric acid prices as well as increased sales of copper products. Year-over-year, the contribution from treatment and refining charges, both from concentrates and scrap number 2, were subdued especially due to the reduced scrap RCs compared to last year. If we now go to the cost situation of the group, [technical difficulty] [12-month figures] [Ph], we see a general cost increase for all [technical difficulty] here shown with €1.9 billion. Energy costs are the biggest contributor to the group-wide cost increase year-over-year. The overall picture of our 12-month figures show that the cost split remains rather stable versus last year. However, energy shows the biggest increase in costs with an increase of 65% from €207 million to €342 million in this fiscal year. Personnel costs were rather stable at just an increase of 3%. Here, the, let's say, result of our performance improvement program helped to stabilize this cost. Consumables, like chemicals and packaging materials, have also shown an increase mainly due to the higher production volumes, so more transportation, more packaging, but also a steep increase in prices for certain input materials such as chemicals. If we now look to the energy price development, we have, let's say, broadly discussed those already in the calls of the last fiscal year, but we saw a significant energy increase of 65% or €135 million year-over-year for the Aurubis Group. This was mainly driven by the restricted natural gas deliveries caused by the Ukrainian war. And just as a reminder, the figured displayed here show the energy costs less any deductions from indirection CO2, electricity compensations, as well as state refunds provided to our sites, for example, in Bulgaria. So, we show the net costs of energy for the Aurubis Group here. Looking forward, we will continue to work on the further electrification of our production processes and invest in decarbonizing our production. We will get to more on this when we come to the projects later on. One thing is for sure, secure supply of energy at reasonable prices remains the most if not -- Yes, well, I would say the most relevant topic for the Aurubis Group in general. Looking out to the key performance indicators, we see a continuing solid and robust picture. An equity ratio of 54%, a negative debt coverage ratio, and a net cash flow of €288 million mirror the excellent result from the last fiscal year. The very good earning situation also allowed us to further reduce our financial debt. Compared to last year, we have to say the net cash flow is clearly reduced due to the buildup of inventories of the raw materials and intermediates as already explained by Roland earlier due to the extended maintenance shutdown in our Hamburg plant. But again, these fluctuations will pan out throughout this current fiscal year. This good financial position provides the basis for continuing on our strategic growth path. Now let's have a look at our balance sheet. On the asset side, inventories increased in connection with the buildup of inventories due to the standstill in Hamburg already explained, and continued high average metal prices, which have been already mentioned earlier. The trade receivables increased due to stronger sale of copper products, reduced cash position -€259 million is mainly due to the early repayment of our financial debt, of our promissory notes in the amount of €256 million. Even though the balance sheet has grown by some €450 million year-over-year, the equity ratio increased to an incredible 54%. Main reason for the strong reduction in provisions is the increase in interest rate especially for discounting our pension liabilities. The other liabilities increased mainly due to further trade payables in connection with the inventory buildup already explained, from our Hamburg plant. Let's have a look at the segments. As most of the earnings drivers have already been explained, I will be brief on highlighting some key figures here at the multi-metal recycling segment. All in all, the throughput levels and cathode production has been on comparable levels to last year. At €205 million, the operational EBT was lower. However, €51 million, if I am not mistaken, below the previous year's figures. On the positive side, MMR benefited from high metal gains based on high metal prices and higher refining charges for other recycling materials for instance, shredder material. However, significantly lower scrap RCs for scrap number two combined with a steeply increased energy costs for both electricity and natural gas had a negative effect year-over-year on the segment result. Due to the outlook on scrap number two and constantly high energy prices, we booked an impairment of €26 million in the MMR segment on goodwill and intangible assets by the end of Q4 last year. As a result, we show reduced EBT but continue with an ROCE of 25.7% which is still considerable above our target of 15%. In the CSP segment, the operating EBT more than doubled to €390 million compared to last year. The segment benefited significantly from higher sulfuric acid prices or revenues and due to let's say prices but also sales volume, increased metal gains, and a very strong demand for copper products throughout the year '21-22. These beneficial market conditions combined with good operating performance especially in our primary smelter in Pirdop with concentrate throughput considerably above the prior year. On the cost side, the segment also faced significant headwinds from high energy cost and increased prices for consumables. We managed, however, to pass on those costs to a good extent to our customers. On the product side, rod demand was extremely stable, earlier mentioned by Roland, at high level over the entire year, shapes production rose significantly by almost 20% compared to the previous year. The volume on the flat rolled side was negatively influenced as a consequence of the flat even that we had installed back last year. In addition, the volumes for system plant were only included until the end of July this year. Return on Capital Employed, ROCE, reached 18.7% compared to 11.2% in the last year, very good result made up with the increasing capital cost. [Technical difficulty] already announced yesterday and in line with the investment package for [technical difficulty] its current dividend policy until further notice. And we will propose the highest dividend in the company's history at the end of general meeting and will continue to allow our shareholders to participate appropriately in the company's success in the future. Therefore the executive management board recommended dividend of €1.80 per share. This will correspond to a dividend yield of 3.3% based on the share price of almost €54 at September 30, 2021. This corresponds to a dividend payout ratio around 18% of the Group's operating result. In the coming years, we will consider [technical difficulty] investments needed and the legitimate interest of our shareholders when determining the dividend payoff. Coming to the outlook for the market for the current fiscal year, the concentrate market remains on a growth track from both the supply and demand side with the additional supply outpacing smelter demand in calendar year '22 and '23 according to CRU and Wood Mack's latest projections. With the new benchmark set at $88 per ton and $8.8 per pound, an increase of 35% [technical difficulty] for current fiscal year. Based on our [technical difficulty] first quarter of the current market, the short term market [technical difficulty] with recycling materials of both types beyond Q1 2022 and '23. On the sulfuric acid, the ICIS and CRU both expect reduced demand from the European fertilizer and chemical industry due to the high energy cost. And we see that already currently happening. Given the next expectation of prices, we foresee a clearly reduced earnings contribution from assets for the current fiscal year. The Aurubis copper premium for the calendar year 2023 has been set at $228, well above the previous year level. From which, we expect positive earnings contributions or we can clearly calculate them. Coming to our copper products, rod, shapes, and the flat rolled business, we foresee a stable demand trend. And expect this to continue during the coming fiscal year '22-23. Product demand for rod, shapes, and flat rolled products is still expected at high levels for the foreseeable future even though we currently see a small dent due to the let's say approaching Christmas period. Now coming to the cyber attack, rather special event, I would say something not really needed. After the closing of our fiscal year '21-'22, Aurubis was the victim of a cyber attack on October the 28th. We informed the capital markets and you already of this via an ad hoc message. For security reasons, all relevant systems had to be disconnected from the Internet for an in-depth analysis of the implications of that attack. The following data showed that, first of all, Aurubis has a very resilient IT infrastructure and scale, the important message we were able to maintain production at all smelter sites during the whole effect. With a reliable crisis management of the Aurubis Group, within a couple of days, communication systems were back up and running and communication with clients, customers, external and internal stakeholders was functioning again, extraordinary effects from all our employees and we thank everybody for that. And of course, the external service providers, Aurubis was able to restore all IT systems inside a very short timeframe and again, proved its resilience to the various crisis that came up in fiscal year '21-'22 and again the financial loss is rather below one for Aurubis on that end. Coming to the financial guidance, based on our latest assumptions for both the earnings drivers and the cost components, Aurubis provides the forecast for the group reside and continues to expect a very good operating EBT between €400 million and €500 million for the current fiscal year, and an operating ROCE between [technical difficulty] we expect an operating EBT between €100 million and €150 million and an ROCE between 11 and 15%. For Custom Smelting product segment, we expect an operating EBI of €350 million and €410 million in the range of and an ROCE of 15% to 19%. Thanks, Rainer. Let's talk about our strategy. Exactly one year ago, we at our Capital Market Day and I can really say today we are in full swing of execution. Our strategy is precise and defined plan for sustainable growth based on three pillars, secure and strengthen the core business, pursue growth opportunities, and industry leadership in sustainability. First, let's speak on our core business, it includes primary smelting, our multi-metal processing, and specifically our precious metal recovery, and of course recycling. It also covers our cathodes and wire business, and the core products such as sulfuric acid and iron silicate. In the middle, you can see that we will be strengthening our business. Here we have defined and are currently executing specific projects. These projects will make us stronger. The next pillar is about growth. I think we can be very happy about one key finding in our strategic process. Our markets, our suppliers, and our customers need Aurubis to grow. We can even go one step further. For sustainable future the economy and society needs us to grow, including recycling quarters, the push for closing recycling loops, the target to reduce CO2 emissions, and therefore transport and export distance and volumes. All these means that more capacities are needed to treat more and more complex recycling materials, and we can use these growth opportunities, we can invest in these capacities. We have the financial means and the experience and the technology and this is our core business. Our third strategic pillar is sustainability. It's core of our reason for existence. It's our purpose. We work sustainably and our products and service support sustainability. We have defined clear and ambitious targets to measure our sustainability progress. Our most important growth project in the fast growing markets for recycled materials is our new recycling site in Georgia, in the U.S. Yesterday, we have seen the announcement our Supervisory Board approved the investment for the second module, due to the very good market outlook, we decided to accelerate this investment, you will remember that we broke ground for the first module in June of this calendar year. Our project continues to progress. Over the course of the year, additional contracts for the construction of the plant were completed, pending regulatory approvals have been granted. And we have started with recruitment. Due to the high proportion of copper paste from [Aaron 1] [Ph], just reflecting on our modular concept of extending our recycling capacity, the engineering efforts for RM2 is significantly lower. Many block areas are sufficiently dimensioned even after the expansion example select treatment casting plans to cope with the expansion from the second module. The additional space required for the expansion is small and covered by existing property. [Technical difficulty] The expansion is integrated in the optimized materials and the extensions were already considered in the original environmental permits. We decided that it's time for the second module is now. U.S. Recycling Market is continuing to grow. And this offers a sound investment case. The recycling boom in the U.S. is leading to good availability of relevant recycling materials. And we see an increase in the importance of sustainability in the USA as well. There is an increase of local recycling markets due to the decline of copper scrap exports to Asia, supply of relevant recycling materials, PCB, ITW, and metal smelter growing at 5% to 6% per annum through 2030 in North America, rising collection rates, falling exports sorry and industry growth are key growth drivers and supply the underlying basis for our investment case. Combined with low attractive energy prices and good stable availability, this results in a highly attractive and profitable investments. With the second module, we will double our smelting capacity with recycling input materials and our end product copper. We will build two more TBRCs and one additional lead tin furnace in the plant enrichment. So, four top blown rotary converters and two lead-tin alloy furnace will be there in operation in total. The current property and infrastructure are already being prepared. And we should not forget that there is still plenty of room on the site for even further expansion. On the next slide, you'll see the ambitious project timeline with module number one, starting in '24 and now plan module number two starting in '26. This well underlines our ambition on the screen feed expansion plans to pursue the growth opportunities in this very attractive recycling market. [Technical difficulty] And on top of the Model 2 expansion, we are also taking into account a capital expenditure adjustment for additional infrastructure on the site requirements or preparing the site for the future. And also taking the inflation and costing reasons that we see in the U.S. now into account of €90 million for model number one. In total, the €640 million investment will generate an EBITDA of €170 million and will generate around 200 new jobs in the region. Cost items like construction has become the main cost item of Aurubis Richmond. Full order books of construction companies led also today's rising prices and the expected cost increases especially with respect to electrical equipment, steel structure and concrete will be closely monitored and are now included in our business case. With this significant project that we are doing in U.S., I would like to hand over to Heiko Arnold, who will talk about the other very important investment projects that we have decided now for Europe. Thanks, Roland, and warm welcome also from my side to this call. I'm happy to present another very profitable project under the pillar secure and strengthen the core business. The CRH project, which stands for Complex Recycling Hamburg is a further investment in our site here in Hamburg, CRH is a process developed in house to increase metallurgical capabilities within the Aurubis smelter network. The new facility at our site will treat both internal and external, intermediate, and recycled materials with additional treatment and refining charges and metal recoveries. It will further optimize the utilization rates of existing facilities and enhance the flexibility of input materials for our smelters. CRH will further enhance independents from third parties and allows increased output of precious metal with a shortened process time. Let's have a closer look at some project, this CRH project is another important project for further internalized [Technical difficulty] €150 million for the new state-of-the-art facility at our Hamburg site. This facility includes the construction of the new Top-blown rotary converter or TBRC for short, as well as a process gas cleaning system to ensure that we adhere to the most stringent emission standards. CRH will process roughly 32,000 tons of TBRC bearing material external input material while also processing internal complex, intermediate, and recycled materials to process and extract more valuable metals with this process, Aurubis is further closing the loop of value chains and extracting metals in the most sustainable way. Following the construction and the ramp-up phase of the facility in Q4 2025, we expect very positive earnings contribution of approximately €40 million EBITDA per annum once in full production. Let's move sides to our other primary smelter side in Pirdop, where we continue our path towards decarbonisation of Aurubis. On top of our strategic investment for growth and recycling and securing and strengthening the core business, we also have new projects under the pillar industry leadership in sustainability. With the construction of two additional solar parks, Aurubis is taking the next step towards sustainable multi-metal production. Aurubis Bulgaria will consequently work towards a greener electricity mix, and meeting the sites energy goal to cover 20% of the energy needs of own renewable energy production by 2030. Let's hear again have a closer look on the detail. Aurubis will invest an additional €12 million into the further expansion of the solar parks on our site in Bulgaria, was what we have learned from the first PV plant in Bulgaria, we will be able to generate very good recovery rates for the solar panels. After one year of green electricity production, we can announce that the PV 1 plant has exceeded our anticipation of 11,000 megawatt hours production and was able to generate 13,500 megawatt hours per annum of green electricity for our site in Pirdop. With the additional solar projects now planned, Aurubis will be able to reduce the smelters external electricity consumption by around about 30,000 megawatt hours annually and we will not stop there, we aim to invest an additional €8 million for additional expansions that are already in planning and with the additional €8 million of CapEx, the modules, so the solar panels are already being purchased. These projects will result in CO2 savings of 34,000 tons per annum compared to a coal fired power generation and directly contributes to our CO2 reduction targets. Okay. Thanks, Heiko. Aurubis has a strong track record in sustainability and we are proud of extending our leadership in the sustainable production of copper. Our leading position in environmental protection today arises from early investments into our production plants, with projects investing in first measures for energy efficiency, and second increasing the recycling input and industrial heat recovery. These investments form the foundation for Aurubis [Technical difficulty] we will continue to see work on initiatives for significant reduction. From the last update we shared with you, 2019, we were able to yet again reduce the carbon footprint of our lifecycle assessment down to just 1,460 kilogram of CO2 per ton of copper produced, compared to the global average of 3,833 kilograms of CO2 per ton of copper. We are proud of these achievements, and we will strive for further reduction in the future. Last but not least, we need enablers to successfully implement strategies in the company. In the Fusion Project, which involves the migration of all major Aurubis sites to a uniform SAP S4/HANA system, and the standardization of business processes, our goal and aspiration is to create synergies across locations and departments. The investment volume of about €60 million is noteworthy. We will initiate numerous changes in the company that will affect almost every department. The goal is to design seamless interlocking processes across all departments and locations to reduce repetitive tasks and manual data entry. This will make our processes, such as material and financial flows, faster, more transparent, and less prone to errors. When implementing strategic project, these enablers should not be forgotten because they create room for the actual strategic tasks. Now, coming to the last slide, putting it all together, we have updated our financial guidance with all the projects now approved by the executive and supervisory boards. Correspondingly, we have updated the financial guidance into three pillars. The first short-term pillar includes all approved investment and projects. The second pillar includes all the project included in our midterm planning but which have not yet been approved as projects or investments. And the third pillar includes all projects derived from the long-term perspective until the end of this decade. In total, we decided on a growth CapEx budget of roughly €1.00 billion, with an EBITDA contribution of €230 million. Not included in our medium-term planning are additional modular recycling projects in Richmond, and also projects in the battery recycling that we are working on that which are not decided and not yet in the plan. Our strategic growth area does not stop here. The project pipeline continues until the end of this decade. With these CapEx decision of our further growth, we have decided to adopt a more flexible dividend policy. In line with our strategy, we will develop Aurubis into a clear growth stock. Yes, thank you very much, gentlemen, Roland, Rainer, and Heiko. We are now ready for answering your questions, and happy to receive them. Yes, sorry. Good afternoon, and thanks for taking the question. I have a few questions on CapEx and cash generation. Can you give us guidance on what you expect in terms of CapEx this year? And can you break it up between your normal CapEx envelop and what you specifically aim for gross investments. And in this context, can you also give us kind of a rough idea, based on the project you outlined today, when you see the peak in the gross CapEx occurring as of now? So, thanks for the question, Mr. Brauneiser. Rainer Verhoeven here. So, we expect some €600 million to €700 million of CapEx in the year '22-'23. For when will it be peaking, I would say pretty much in the year thereafter. That is currently the goal. So, we will be, to the highest, I think to €800 million, something like that, in the year thereafter, which is '23-'24, that should be the peak year as of today. But please bear in mind, as Roland mentioned earlier in his presentation, we are talking on the current midterm planning, we are talking about the projects that are included on the last page, in the left column, and in the middle column. We are not including further strategic growth projects which might come and might be decided at a later point in time, which also will then change, of course, the guidance on our CapEx exactly, that was the slide with the growth strategy where we showed the CapEx, no, that's what I was referring to. Okay. Can you shed some light on your expectations regarding [indiscernible] free cash flow based on the EBITDA, the guidance you have given for EBITDA of €400 million to €500 million. Are you expecting to be free cash flow positive under that circumstances? And regarding the dividend payment, would you be willing to pay a dividend, if needed, from the substance rather than from free cash flow? So, free cash flow [technical difficulty] with this CapEx figures, I mean it's clear, even with the EBT guide of €400 million to €500 million, you know that our -- yes, our depreciation is increasing, which also means that our EBITDA is increasing. But still, I mean, by this investment, over the next two, three years we will look at negative free cash flows overall. That's [with the year] [Ph]. Nonetheless, on the dividend, as mentioned earlier, we will consider and reconsider every year how the situation is. And our shareholders will participate in the profitability of our company, also in the running business, so -- because why do we have a negative free cash flow? Not because of bad running business, but because of the high investments. So, we will look at our EBT figures year-after-year, and decided based on that what will be the dividend payout to our shareholders. And we will, of course, also even with negative free cash flows, tend to pay a dividend to our shareholders. Okay, understood. And probably in that context, probably just on -- can you maybe say or share what you think about your share buyback policy and what you are doing with the existing treasury sales you have in your books? Yes, I think just repeat the position that we have also stated in the past. We have acquired these shares, and we take them either for finance purpose or M&A activities. And that's how we are standing today. And there is no change of this policy. Okay, good. And then the last point is on the battery recycling project. Can you give us an update where you stand here? And is the starting point for that project changing with the acceleration in the U.S. and have you already thought about where to build such a battery plant? Is this more a story for the U.S. or you still seeing it's more on the home turf? Battery? Yes, we have started our recycling pilot plant for battery for the so-called "Black Mass," in March this year. And we have achieved very, very encouraging positive results of recovery of all the precious materials in this black mass. Now, we are in intensive discussions with all market participants. And you know we all know that this is a very, I'd say, a market which is still going to be established. [Clearly also] [Ph] battery volumes for recycling -- significant recycling volumes will only be available in the market towards the end of this decade. So, we are not in a rush to build up significant capacities. And we have also, therefore, not decided where we are going to put the investment in the first place. Clearly, we are open. Europe is a very attractive region, as U.S. is a very attractive region. So, we are not ruling out or not focusing on any region at this point in time. Good afternoon, gentlemen, and thank you for the presentation. The first question maybe just to put things into context. Wanted to get a bit more color behind what was the trigger in your understanding and the reason behind the decision to accelerate so much investments in [indiscernible] not exactly the most reassuring compared to the last few years where we were used a version of Aurubis was living within its means, and making sure shareholders would benefit from a return on their investments through the cycle. My first question, so why this acceleration at this point in time? My second question on the build-up of at Hamburg, if you could help us quantify that number, if you look at there, year-on-year difference in balance sheet, that looks like a €400 million impact, but not all of that would have been Hamburg alone. So, if you could help us strip out that effect, please? Thank you. No, I think to answer your -- specifically your first question, clearly we are in the growth mode. We have announced, with our Capital Market Day, last year, that we see significant opportunities in these three pillars as I mentioned, strengthening and securing the core, building up growth opportunities in the recycling market, and then on the area of sustainability to further decarbonize our production. Having said this, we see even more attractive market conditions in regions, like U.S., than we have seen then in the year before. With our announcement and the execution of the project, the feedback from the market, from our business partners and suppliers has been extremely positive. And this really led the -- our decision to accelerate the next module of our recycling expansion in U.S. That's also the strength and the beauty of our strategy, that we have modules that we are able to accelerate and add capacity without doing all the engineering and all the work again, but that we can really take additional capacity into the market faster than if you would do this on a traditional greenfield, complete new investment. And if fine, and perhaps also your question regarding shareholders, just to remind, we are proposing through the General Assembly, the highest dividend ever, with €1.80 per share. So, I think this is more than a strong participation of our shareholders to the successful growth of the company. And we will also continue to do so and give them a fair, good participation in our success. But we are not, let's say, see ourselves kind of locked in to this 25% ruling because investing in our rules, investing in our growth agenda is, from our perspective, an extremely good value proposition for our shareholders, which is how I would define it for the second part of your question. Yes, thanks. There was a question on the inventory build-up. Let me try to answer it in a bit a different way. We had a net cash flow of €228 million this year, if I am not mistaken. And we have €800 million, something like that, in the last year. So, there is a huge swing. And I need to start with the last year because there is quite a tsunami sloping into this year. In the last year, end of last year, we had the [stanza] [Ph] in our [indiscernible], where we emptied pretty much the tankhouse. Our electrolyte, this plant, was running pretty empty. With that, the net working capital was there, let's say, artificially reduced. [Technical difficulty] in addition to that, we had [technical difficulty] led to the fact that we had the strong build-up there towards the end of the year of our net working capital. Please bear in mind that also [technical difficulty] [speak for us, be about] [Ph] real figures, how much is it? Well, you can easily count some €400 million inventory build-up. As you can see, year-over-year, we had an increase in inventories of €432 million, so that is, in principle, the effect. Breaking it down to what is now intermediate product, what is the different types of metals? I think that doesn't make sense at this point. Just one follow-up maybe on costs, if you could help us understand what carryover cost inflation should we expect, more so in say the first-half of the year given you guys have already covered the first quarter of your current fiscal year, what sort of remaining inflation trends across your, let's say, controllable costs, including or excluding energy? Are we looking at the moment please? Thanks. So, yes, let's say, first of all, as I said earlier, I mean energy remains an important topic. And on the other side, you can see that even though energy is an important factor for costs, all-in-all, the increase on the energy side is rather I would say, "Harmless," because we are pretty much hedged. What does pretty much hedged means, we in the group are consuming some two terawatt hours of electric energy per year. One terawatt hour we consumed in our German plants, this one terawatt hour is based on a pricing formula, which includes the fixed components. It includes the CO2 component, and it includes the coal component, it does not include any gas, nor any prices, which means year-over-year, we have seen an increase, but it's a completely different level than the EX prices that we are currently seeing. So, for the German one terawatt hour, we are pretty fixed. Let's take the Foreign terawatt hour on electricity, on the foreign terawatt hour, rather half of it is consumed in Bulgaria. In Bulgaria, we have seen a cap at 250 Bulgarian Lev, until the end of December 2022. So, the full calendar year 2022 more or less. Now, just recently, it has been announced that the Bulgarian government has decided to lower that cap even to 200 Bulgarian Lev, all-in-all, including distribution fees, I'm not 100% sure now, we are looking at energy prices of €114 per megawatt hour. Yes, expensive compared to before the prices but nothing in comparison to the EX prices that we've seen. So, the other half is pretty much Belgium, there we have two plants, one is fully hedged at absolutely reasonable prices, the other one is not hedged at all. Overall, we can say on the electricity, we have no issue, on the natural gas side we have some hedges available still at a low level we have to admit. But we are switching pretty much in the beginning of next calendar year, 40% of our total natural gas consumption two alternative energy sources we have talked about that is LPG, fuel oil. And we will change the smelters here in Germany. So, that also besides the fact that we get security for those plants, we also get better prices on those alternative fuels. So, the energy topic is a topic for Aurubis and will remain so. But nonetheless, we are pretty safe on that end. And on the others, I would say on the consumables we have seen steep increases, if we look to caustic soda to whatever chemical you want to take, we have seen increases two digit even up to three digit or even doubling the prices. I would say that, especially those chemicals are driven by the energy prices, as well, as we see the energy markets coming further down now, or let's say, calming down, I would say we have seen the worst in the chemicals market as well. So, we don't expect further big increases on the consumables side which is then the next major impact factor on the costs. And then of course you have personnel expenses. They are a big cost factor for Aurubis and here for sure we will see inflationary tendencies also coming up. We are looking to the normal inflationary tendencies that we have, let's say, all over the place highest in Bulgaria. That is -- I would say that is the summary hopefully to your question. That's let, Rainer. This is also known and taken into account with our prognosis of the range of €400 to €500 because there are no unknowns in these cost positions going forward. And again to underpin what Rainer said on the energy side, we have compared to other energy intensive industries and industry players, we have a very, very stable and predictable situation here as [technical difficulty]… Perfect. Perfect. Thanks very much for the presentation. A few questions from my side, the first, again, going back to CapEx, you have several growth projects in the pipeline. You did mention €600 million to €700 million for fiscal year '23. But just wanted to figure out, what's the sustainment component of CapEx that you're looking to incur in fiscal year '23, and by how much the sustaining CapEx raise once you have all those projects fully up and running, and I'm talking about the ones you have announced as part of the €1 billion total CapEx? Yes, so the numbers we shared with you today in the call, these are all growth projects, we have not talked about our sustaining CapEx, the magnitude of sustaining CapEx has just been looked up. But to give you an idea for example, in product, a major standstill is about €40 million of CapEx, but I think the exact number will be around €200 million on top of our growth CapEx that we have announced there. And if you look at the total numbers, if you adjust the growth strategy chart, where we have these three pillars, on the short term, medium term and long-term, if you have the short term and the medium term, again in the first column was $1 billion is decided and in execution will deliver €230 million EBITDA bottom line. And in the medium term, we have around €400 million plans with the results of about €100 million, these are in our midterm planning included, but yet not decided. We are working on this. So, if you add in the midterm plan these two buckets together, we are talking about €1.4 billion of investments, delivering €330 million bottom line. So, this is our growth agenda in the framework of the MTP. In addition, there was the question from Ioannis also, how does the level of the sustaining CapEx move after all the strategic projects have been implemented? I can only answer with a typical bathtub curve. So, once you have invested, you will have a couple of years where the reinvestment in those completely new plans will be rather low. And then the investment starts kicking in. But we did not calculate this figures yet for sustaining CapEx in let's say it will be 2030 and further years. Okay, thank you. Second question, again on CapEx, in the past few quarters, you talked about your extensive derisking steps up the Richmond project that will allow you to keep costs in check. In this context, can you talk about this €90 million CapEx increase? What aspects of the project were exposed to inflation because my impression was that you had locked in all the major inputs and how much of these €90 million is attributed to some additional infrastructure corporate requirements that you alluded to earlier in the call? Yes, sure. That's to distinguish here, what we have stated we have locked in and have signed contracts with SMS regarding to supply of the equipment. This is the fact and that's also contract with a fixed price. But the execution, the construction side in U.S. has turned to be a much more dynamic market than we anticipated at the time. So, there are a couple of factors. So, first of all, it's a different market environments or certain cost position have increased, other to our assumptions at the time. And we have also decided to enlarge the scope of the project, because we are preparing the infrastructure and I think I mentioned this shortly in my short presentation here that we are building now the site and the infrastructure for the growth in RM2 but also some investments anticipating further potential steps in U.S. So, like I will give you one idea, the craning of the site. So, what is the total plot of land? So, we have decided that we do this once without knowing when and if we are going to do further expansion programs, however, we said this is money well invested, because we do in ones and one because, and then we have this inflation side, which we have also taken to council, in a project of €300 million investment in this inflationary and very dynamic environment in U.S., I state we have done well, while containing and keeping this project still within this reasonable cost increase that we have seen and announced yesterday. Most clear, thanks very much. And then switching to the fiscal '23 outlook, the EBT guidance of €400 million to €500 million appears fairly robust in a historical context for the group. Yet if we look at the return on capital employed pretax as you are guiding for this 11% to 15%, if I take the midpoint that would be actually below your stated target to be above 15%, right? So, I guess part of it would be explained by the high reward deductible that you already talked about, but how much do you think you can actually release as you are now building new processing capacities that would probably also look in some materials throughout the data production chain. And ultimately, is there any part of the group from today's point of view, which may be under earning in fiscal year '23, relative to history? So we're looking to the questions, first of all, a robust earnings. Yes, true. And as announced by us in our speech, there is quite some earnings components. If we look at the top line, which [technical difficulty] contracts for shakes for current running fiscal year. The unknowns are as always, the sulfuric acid and the scrap RCs for scrap number two, mainly the rest is pretty much foreseeable right now, cost components, I have explained already on the energy side, we got a couple of other cost components. Also, they're not yet fully fixed, but I would say pretty much therefore, yes, the EBT guidance €400 million to €500 million robust figure and we are pretty convinced that we can deliver on that figure. So, why is the ROCE now a bit subdued, if you want to say so. For sure, I mean, we are investing something like €600 million plus into our plants on an annual basis, which clearly exceeds the depreciation which is a bit above €200 million currently in our company. So, therefore, we have an increase in capital employed. And we will especially see that of course in the MMR segment due to the fact that Richmond build count into the MMR segment. So, for a couple of years, we will not achieve our 15% on the MMR segment, due to the investments. Okay. And just to clarify on the methodology, what sort of capital employed data you're using for this target? Is it end of the fiscal year '23 or end of year fiscal year '22? We always use the capital employed of the end of the fiscal year, which means if we calculate for the 30th of September 2022, we look at the balance sheet and capital employed in the balance sheet of '22. And we take on the EBIT side, the last four quarters which then is the total fiscal year '21, '22 from 1st October 2021 until 30th of September 2022. Very clear, very clear. Thanks for that. And just the last question for me on going back to the energy costs. There are several moving parts and you already talked about the electricity and gas components of your energy cost base. But if we were to look at your exit rate in the last quarter, you just reported right, if I look at the energy costs you had around €110 million for the quarter, and annualized is around €440 million, €450 million? Is that a reasonable base for fiscal year '23? Or shall we expect to see a further increase in energy costs year-over-year, based on your I guess, guidance, based on the guidance range? Yes, good afternoon. Yes, considering the fact that that we'll be spending a lot of CapEx over the next few years that you will be free cash flow negatives, yes. Would you rule out any M&A in that context? And because I understand you're very much focused on organic growth and related to that, are you envisaging to set up the net leverage target something like that to that, I mean the financial community has a better grasp of your financial policy? Thanks. So regarding your -- the first part of your question, which I will take, Rainer will answer the second. M&A is not excluded, definitely not. It's part of our continued search to find some M&A targets, as we have stated in calls, this excellent target that we have acquired with Metallo, there are unfortunately, no more Metallos at least to our knowledge in the world, if so, we would go after, but we are permanently looking into additional adjacent business opportunity in our multi-metal arena. And the answer, M&A is not included with our growth agenda and the organic growth that we are pursuing. Second Part, Rainer will take. Hello, Maxime. So, you were asking on a net leverage target. So, the target that we have of course is to keep an equity ratio above 40%, that is due to the fact that we need to have a solid balance sheet, because we need to be the bank of a solution also for the concentrate suppliers, which use typically our long-term contracts to get the loans at their banks, that is typical. That's a quite well received with the banks. So, therefore, the 40% equity ratio stays in place. Okay. Okay. And regarding the newly announced CRH project, I thought it looked a lot like I mean, the former FCM project, I mean, that was shared in 2019. So, can you perhaps get us through how it differs from the former project? And what lessons maybe you have learned from the failure of the project? I mean, considering I mean, this new large scale 1? This is Heiko Arnold speaking. Regarding your question and whether the CRH project looks like the FCM, clearly it is not. The CRH project is the value of tapping into a portfolio of TCRC bearing materials in the copper lead area, which we want to expand. The FCM project was much bigger, and content included a lot more projects. Okay, okay. And just finally, regarding the battery project, when do you expect to make a decision? I mean, is this year I mean 2023 or will it be further ahead? And I understand that the main hurdles probably lie in the difficulty to set up the full value share and offer one-stop solution to automaker rather than the technical difficulties which seems to have been overcome more or less, so I mean it will be helpful here to give us more color in that respect? Yes, we are not in a position to announce any decision there yet. One thing is clear, we have a very good technology and recycling business with very, very good recovery rates for all the important metals and also within, which is very important going forward with a very attractive OpEx position. So, what are the production costs to recycle these materials? And with this, we are in the different investigation, what is the next right step, but we have no fixed timeline on when this decisions will be taken. And therefore, if it's '23, '24, no statement here, important is the real recycling market, end-of-life recycling market will only be there of significant volumes in Europe or North America towards the end of the decade. So, therefore, there's also no rush in order to go in with significant investments too early, because these investments, if we enter will be industrial scale, and they need volume. That's where Aurubis is strong, recycling complex materials at industrial scale. So, therefore, we will not make any hard timing on the decision going forward. And to your second part of the question, the total supply chain, we are the expert in metallurgy. So, recycling black mass is our core competence. What is the needed on the, let's call it the upstream and the downstream side around recycling or recycling these batteries. This is something which we certainly will do with partners. And we are not excluding even JVs at this point in time. But we don't see ourselves being the disassemblers and the collector for batteries, this is not our core competence, there are other companies who are better positioned and have already networks in place and here we are discussing. So, clearly our positioning is black mass recycling, and the upstream, downstream is in discussion how it is going to be set up. Yes, thank you for taking my question. Good afternoon. Just one remark, some times, the line was a little bit bad. But nevertheless, I hope it works now. Sorry, coming back to the €90 million, I take it a little bit at a cost overrun over the €300 million investments in Richmond. Just a year ago, you stated this was conservative, and there is enough headroom and so on and so forth. And we say the plant price is fixed and also investing a little bit into the site going forward. So, there is a 20% to 25% cost or something like that. So, how will you clarify or see that this will not happen again with one-off or other projects going forward. What have you changed? Yes, no, you're right. But as a bit of a defensive statement, the world has really changed massively in the last 12, or in last 18 months. We have not and that's the fact, we have not foreseen this extreme inflationary environment in which we are working today, there is still very tense situation on supply chains on getting certain components and on some of the equipment which we have not contracted, have not contracted at the time that also these equipments with this huge industrial activity now, investment activity in the U.S. has also put this into a bidder market and not into a buyers market. So there are certainly effects which you're absolutely right, we have not foreseen to the extent as we have seen them today. Having said this, today we have a very high confidence level as we are well advanced in the engineering and a detailed engineering of the project in Richmond, that we have here now, we have seen it, we have seen the cost increases, we have seen what is really inflation, what is also as I mentioned before, a decided scope increase which is also part of the €90 million. Regarding other projects, I think lesson learned is here. We decided in the project in U.S. to go fast. We focus all our activities on the equipment, signed the contract, and had to design and build approach on the construction, on civil engineering. This is something we are reconsidering for other projects in order to have stability and better predictability of the investment to take this project in all categories to a different maturity level, to a different design level in order to be able not just to sign contracts like we did for Richmond for equipment but also for other major parts like civil engineering or other engineering component. So, that's something which we -- but clearly we are going to balance out between speed and precision because there is always a trade off to go fast and take some more, let's say, accepted risks or to be safe and be slower. So, that's really the balance, and we tend or I personally tend also go at the new Deutschland speed, which is not a statement. So, that we go fast and really within a certain say framework to take controlled risk in the execution. Okay. Thank you for that. Then coming back also again to the American market, can you give us some details or examples what really has changed that you decided now to accelerate the investment in the U.S.? When we announced the first step, we were already sure that there is an highly effective market as we area also sourcing materials for Europe already, U.S. market so we are connected to the market already today. And, what was really encouraging us was the feedback from the supplier base. It's a huge market for recycling. That's around 6 million ton of recycled material available in U.S. And therefore, the pre-processers were very, very positive about this investment. And we saw that we have very strong supply base for project. This on top with the very good -- sorry, permit process in U.S. where we have now all the permitting done, all before the second phase, we did both module 1 and 2 in one permitting process which is there plus also that we have the size, the execution, the investment, and the site in full swing, all these aspects of strong market -- confirmed strong market push for more local production. So, we believe there is also -- And, yes, Rainer just popped in that energy cost stability in comparison to Europe we have to say U.S. is paradise for energy, for supply, stability, security, price level, hedging possibilities. It's exactly what an energy intensive industry like ours is looking for. So, this was another important step to build and strengthen this important pillar for Aurubis in the U.S. market. Input material? Yes, the market is not that you buy. This is a market where we are in close contact. There are some say agreements but not must take, must pay agreements. This is not in place at this point in time. And it's also not needed because material is available. And to repeat, this is the first plant of its kind in U.S. and is largely a market which will go on stream in mid '24. So, there is absolutely no concern about availability of material. It's rather the opposite that we can cherry pick, that we really can pick the best input material for our plant at the time. Okay, thank you very much. Then last but not least, question concerning the -- it's all about execution then going forward, I would say you say, you have -- [there is] [Ph] two modules of industrial [indiscernible] and then I will talk back to recycling and disclose additional, you have up to eight projects for the next let's say, eight to 10 years. And then on top of that, you would like to transform everything into a major -- there is a major IT project going towards S4/HANA. And how you make sure that the entire management structure is able to deal with all that? And that you can oversee that? And you are not running into some kind of execution problems or maybe that you do not see any problems that might arise at one of these major projects? So, how do you secure that? Have you changed the structure of management and controlling? No, I think it's an absolutely spot-on question. And to be clear, the biggest challenge for us, which we all do announce with our -- On the Capital Market Day with the development of our strategy. We have, therefore, decided to significantly increase our management capabilities, for example, with the centralized engineering group, engineering organization which we are setting up to manage the technical side of the project and also the project management side. The same is true for the procurement side. The same is true for the IT side. And the good news is even in a challenging labor market with this Aurubis as a company with this purpose being part of the circular economy, a sustainable and proactive company in this market field, we attract talent. We can really get the right people on board. For the execution of project, we have ourselves put the [indiscernible] in place that we only start project when we have the resources available. So, that's our clearly the must condition for the execution of projects because I fully agree with you if we would overload the system with these many activities and would not have the necessary resources, we are at a very execution risk. And this is exactly what we have addressed from day one when we launched our strategy process. So, we are building up the organization in all the necessary aspect, and we are very prudent to start projects and only start them with the necessary capacity and capabilities. And last but not least if I may chip in here. We have extended our executive board from January 1st onwards. I mean this also reflects that we as let's say we call them sponsors. We as the executive board, we are sponsors of one or other project. And make sure that the workload is still doable also on the executive board level. Okay, thank you very much. So, we are looking very much forward going into '23 and about the execution of everything. So, all the best and Merry Christmas to all. Thank you. Yes, first of all, thank you very much for the question -- for the details questions and your interest in Aurubis. Looking at our financial calendar as we are already facing closing of our first quarter, we are going to publish our Q1 results February 6. And will host our shareholder meetings at February 16 2023. Now I would like -- yes, last words Roland to you. Last words, yes, I think first of all mentioned I think after again a very intense 2022 with many many crisis management everything, it's time now to say take a couple of weeks off during the holidays here and reenergize. And I would like to extend big thanks to the Aurubis team because what we have achieved this year and I think the summary from Christian about our projects and what we have all on agenda is only possible because we have an absolutely dedicated strong management team here on board. I have to say it's a real pleasure to be at the helm of this company and to drive this very, very ambitious agenda for growth of the company. So, with this, I am also very happy now that it's the 21st of December, and I happily take off a couple of days after an intense couple of months here. And I think on behalf of my colleagues of the all management team, I would like to thank you for your permanent, for your continued interest and challenging of the Aurubis team here. And I also wish you a very nice Christmas Day, nice holidays, good time with your family and friends. And then we will see and talk again beginning of next year. And our contacts are available, so Ferdinand and Angela are here. So, any further questions, anymore point which come up, don't hesitate to talk to them. They are -- not between the holidays, but after the holidays, they will happily answer all your questions again.
EarningCall_1560
Good day, ladies and gentlemen, and welcome to Hancock Whitney Corporation’s Fourth Quarter 2022 Earnings Conference Call. At this time all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. As a reminder, this call may be recorded. I would now like to pass the call over to your host for today’s conference, Trisha Carlson, Investor Relations Manager. You may begin. During today’s call, we may make forward-looking statements. We would like to remind everyone to carefully review the safe harbor language that was published with the earnings release and presentation and in the Company’s most recent 10-K and 10-Q, including the risks and uncertainties identified therein. You should keep in mind that any forward-looking statements made by Hancock Whitney speak only as of the date on which they were made. As everyone understands, the current economic environment is rapidly evolving and changing. Hancock Whitney’s ability to accurately project results or predict the effects of future plans or strategies or predict market or economic developments is inherently limited. We believe that the expectations reflected or implied by any forward-looking statements are based on reasonable assumptions, but are not guarantees of performance or results and our actual results and performance could differ materially from those set forth in our forward-looking statements. Hancock Whitney undertakes no obligation to update or revise any forward-looking statements, and you are cautioned not to place undue reliance on such forward-looking statements. Some of the remarks contain non-GAAP financial measures. You can find reconciliations to the most comparable GAAP measures in our earnings release and financial tables. The presentation slides included in our 8-K are also posted with the conference call webcast link on the Investor Relations website. We will reference some of these slides in today’s call. Thank you, Trisha, and good afternoon and Happy New Year to everyone. Thanks for joining us on what I know is a very busy day. While we look forward to the start of a new year, we also want to celebrate a successful Q4 and a strong conclusion to 2022. We are exceptionally proud of the Hancock Whitney team and the Company’s overall performance during a remarkable year of volatility. The results revealed not only progress made in ‘22, but also the culmination of decisions made the last several years to better position the Company. With year-over-year earnings up $61 million, PPNR up nearly $104 million, net loan growth up $2 billion, NIM up 31 basis points and an efficiency ratio in the low-50s, we view 2022 as a very successful year. We see another year of potential macro environment changes coming in 2023 and expect the bulk of investor interest to be more about the future. As such and as promised, we have updated our three-year corporate strategic objectives or CSOs, and we provide 2023 guidance on slide 18. Our guidance for ‘23 shouldn’t be a surprise or a trend much different from what you may hear from others in our industry. Loan growth in the low to mid-single digits reflects the recognition of a likely slowdown in the economy, and we are mindful of managing risk in such an environment. We expect continued hurdles with funding loan growth with deposits and are guiding to an environment where core deposit growth will be available, but perhaps a little bit more rate sensitive. Our intense focus will be on core relationship lending with accompanying deposit relationships, which create meaningful value in our balance sheet through the cycle. This focus will have the impact of a slowing loan growth in ‘23, but a better chance of funding lending with deposits. We fell short of that goal in Q4 as loans outperformed and the timing of seasonal deposit inflows and outflows was different than we expected. We said for the last couple of years that line utilization would begin returning to pre-pandemic normal, at the same time, excess commercial deposits are spent, and that trend was evident in the last several quarters, including Q4. But with that said, we intend to grow deposits in ‘23 in the low single digits with a downside case of flat where we use cash flow from the bond portfolio to fund any shortfall in deposits. To the extent deposits outperform, we will adjust to reinvesting in bonds or deploying into loans dependent upon the environment at the time. The rate environment, while beneficial to net interest income negatively impacted fee income with secondary mortgage being the hardest hit. With trending strong performance in wealth and card fees, though, we believe we can grow total noninterest income 3% to 4% in 2023, including in covering the replacement of $10 million to $11 million of lost income from the elimination of certain NSF/OD fees beginning in December of 2022. Inflation pressure, pension expense and notable increases in FDIC assessments are a few of the drivers guiding to a 6% to 7% increase in ‘23 noninterest expense. Backing out the pension and FDIC increases, we project a 4% to 5% increase compared to ‘22. Our efforts over the past three years in reducing expenses have put us in a position to better adjust to these increases and still maintain an efficiency ratio in the very low-50s. And finally, as it relates to guidance, we believe today’s results for both the quarter and the year reflect the Company positioned well for today’s economic environment. Credit metrics are at historically low levels. Initiatives executed in ‘20 to ‘22 helped drive an efficiency ratio below 50% in the fourth quarter. New bankers hired over the past 18 months should help attract and enhance relationships in growth markets. We’ve proven our ability to proactively manage expenses and are introducing technology focused on scalability and effectiveness. Capital remains solid, our reserve is solid and our balance sheet is derisked and positioned well. We ended 2022 with fourth quarter EPS of $1.65, up $0.10 linked quarter. Net income of $144 million, was up $8.4 million from the third quarter. PPNR was up $10.3 million. And finally, our efficiency ratio came in below 50% at 49.81%, certainly, a nice way to end a very solid 2022. Loan growth came in stronger than expected during the quarter at $528.5 million or up 9% annualized from last quarter. Line utilization continues improving and is trending back to pre-pandemic levels, while our residential onetime close product drove a sizable increase in mortgage loans. Deposit growth for the Company came in lighter than expected at $119 million or 2% annualized from last quarter. Typical seasonality in public funds contributed $494 million while time deposits were up $493 million due to a CD promotion during the quarter. DDA and interest-bearing transaction deposits were down $692 million and $176 million, respectively. We recognize that deposit growth will be a challenge in 2023 for both, our company as well as the industry. Commercial clients are deploying excess liquidity into working capital, while consumers are becoming more rate sensitive. You can see on slides 13 and 14 in the earnings deck that while we were successful in holding deposit betas relatively low for most of this year, we did see a pivot up in our deposit beta to around 21% in the fourth quarter. Excluding the seasonal increase in public funds, that deposit beta was closer to 14%. We still believe that when the current rate cycle is done, that our cumulative total deposit beta should be no worse than around 25%, so about the same as the last up cycle. Our fourth quarter NIM at 3.68%, was up 14 basis points linked quarter. So, while that level of widening is impressive on its own, admittedly, it did not move up as much as we expected coming into the quarter. The yield on new loans jumped 134 basis points to 6.27%, and the bond portfolio increased 12 basis points, adding 51 basis points to our earning asset yield compared to last quarter. Funding costs were higher this quarter as expected, mostly due to promotional pricing on a successful CD offering that did result in higher deposit costs and a shift in our funding mix. We still believe our NIM has room to expand with future rate hikes, but it will be small and very dependent on the level, mix and cost of deposits. Concluding my comments with credit, our metrics trended to historically low levels in 2022 and remain there. Negative provisions ended as future CECL scenarios call for a potential slowdown in possible recessionary environment. Our provisioning has been modest and charge-offs remain low, and we believe we’re positioned well with an ACL of 148 basis points. So, while that ratio did decline by 2 basis points linked quarter, we actually added $1.5 million to the reserve at year-end. I appreciate all the guidance in the slide deck. I did maybe want to jump in maybe the fee income guidance first. Obviously, a lot of moving parts this quarter. You note some of the specialty items may be lower than they have been. Typically, you’ve got the headwind with the NSF fees of about $10 million to $11 million. Is really the swing factor some of those specialty items coming back, or John, are there other segments or endeavors that you have out there that you feel like are going to be able to kind of push that number up higher towards your guidance? Yes. Good question, Brad. This is John. I’ll start off and Mike is welcome, too. You gave a quick inventory of exactly the right things to point to. The NSF/OD income, we forecasted, I think we talked about that maybe 3 or 4 quarters ago, that to be a $10 million to $11 million annualized hit that started in December of ‘22. So first quarter ‘23 will bear the full blunt of that run rate. But as balances in consumer business accounts continue easing down to pre-pandemic level, we anticipate that overall service charges from the deposit book and deposit accounts will keep going up throughout the year. We also anticipate a very strong performance from our wealth management group. Fourth quarter was very promising as we anticipated. And we think we’ll go into 2023 with an awful lot of momentum. And then finally, all things card-related continue to outperform, and we expect that to also be a very good performance for the year. So, all in all, the 3% to 4% guide is inclusive of covering the downside from the NSF/OD fee changes. You mentioned the other income bucket, and there’s a lot of cats and dogs in that bucket. And for the fourth quarter, it was unusual and that virtually every one of those categories was at a lower run rate level or lower level than we typically experienced in the run rate. And we do expect that to bounce back to something more closely to overall 2022 performance or maybe a little bit better. So, all of those factors are rolled into the 3% to 4% guide for the year. The only area that we’re not counting on, Brad, is a secondary fee income for mortgage. It does appear after about a 54% reduction in deal flow quarter four ‘21 to quarter four ‘22. We think we’re at or pretty near the bottom on that particular fee income source. So, while we’re not counting on any benefit through ‘23, any beneficial movement in 30-year rates would obviously be an unexpected benefit. So, we don’t have that expected at all in our numbers, but that would be a little bit more of an upside or a tailwind. Did I answer your question, okay? Yes, John, very helpful. And maybe as a follow-up to Mike, as it relates to the CSOs, I see that you put sort of a framework of kind of your assumptions around Fed funds for the next three years. I know rates are moving up, initially, you were looking for 4 to 6 basis points of NIM expansion with each 25 basis-point increase. Would there be a similar level of contraction on the way down if and when we get there? Or -- I know it’s probably a tough question given all the moving parts. But just curious kind of how to think about -- I can’t believe we’re talking about rate cuts already, but just how we would think about that as it relates to NIM? Yes, I’m glad to, Brad. And just to kind of close the loop on the fee income question. John is right. I mean, I can’t think of a quarter in a long, long time where we’ve kind of had every single component of specialty income kind of down quarter-over-quarter. So, BOLI, derivatives were both down to almost $2 million each, and even our SBIC income was also down a little bit north of $1 million. So, I think it would be unlikely that we would have another quarter -- another consecutive quarter where we would have those categories all down again. So, we do look for that area to kind of rebound in 2023. As far as our CSOs -- so yes, the CSOs that are there, again, as a reminder, those are our goals or targets, really 3 years down the road. So, we kind of think about those in the context of fourth quarter of ‘25. And we’ve tried to be thoughtful in terms of what we think could happen with the rate environment going forward. And nobody has a crystal ball, and certainly, we don’t have one, but this is I think certainly a plausible forecast around rates, and we’ll go from there. Related to your NIM question, yes, it is a tough question. It certainly has rates begin to come down, it becomes harder, obviously, for us to maintain a NIM at a stable level because we are so asset-sensitive, but we’ve done a lot of work in the last year or so -- last two years, really, in terms of extending the duration of our assets. And I do think on the way down, we’ll probably do better on this rate cycle down whenever it happens than probably in past rate cycles. And really, the reason for that again is the work we’ve done to extend the duration of our assets. So, we’ll see once we get to that environment. Mike, I think I heard you earlier -- and forgive me if I’m wrong on this, but I think you said that the margin had expanded but not as much as you would have expected. So, I’m just curious what -- if that’s true, what was that driver? Because I know, as you outlined, funding costs did go higher, but you guys expected that and you probably had built in the CD promotion or maybe you didn’t. And maybe that’s why it was not as much as expected. If you can just go through that. Thank you. Yes. Kevin, I think if you go back and look at our guidance coming out of the third quarter, it probably would have pointed to a NIM, maybe about 5 basis points or so higher than where we came in. And look, we’re pleased with where we came in at 3.68%. It’s still impressive on its own that we could move our NIM up 14 basis points in one quarter, not as impressive as the prior quarter at 50 basis points, but still 14 is a nice increase. I think the main reason is really why it probably didn’t move up as much as we had thought coming into the quarter. It really was more around the loss that we experienced in DDA balances. So, we were down about $700 million between the end of last quarter and this quarter. And on our balance sheet, those deposits -- those three deposits are extremely impactful. So I think that plus the 4% nine-month CD as well as a need to kind of pivot up probably a little bit higher than we expected in our overall deposit costs. So, I think those factors combined really contributed to the NIM not coming in maybe is quite as high as we thought it would coming into the quarter. Okay. That’s great. And I appreciate the guide on your outlook for deposit growth and the fact that the bond portfolio can supplement that. But based on what you see now -- like on the one hand, the balance sheet is still very liquid and with the loan-to-deposit ratio down at like 80% or a little below, actually. When you think about allowing that loan-to-deposit ratio to move higher, so in other words, maybe you’ll go after deposits, maybe you won’t, versus a strategy of getting out in front of it. Like some banks have taken a hit to the margin in the short term because they’re kind of front-loading that deposit beta in effect, where maybe that’s not the situation you guys are in because of the liquidity. So, can you speak to those moving parts in terms of how you view that loan-to-deposit ratio and whether you expect to grow deposits each quarter or if it doesn’t make sense, you won’t necessarily. Yes. I’ll start, Kevin, and I’ll pivot over to John after to let him talk a little bit about our strategy to grow DDA deposits from core customers. But certainly, the way we’re looking at 2023 is really to be in a position where between the runoff from the bond portfolio that we’ll use to fund loan growth, between that and any difference really coming from deposit growth, that would really be kind of the most optimum way that we’d like to manage the balance sheet from a loan deposit perspective. And I think that we’re certainly doing some proactive things to ensure that we kind of get a jump on that. We talked about the 9-month CD at 4% that we did last quarter. And even right now, we have a 4.5% nine-month CD that we think will be very helpful in terms of adding some liquidity to the balance sheet. We’re not really willing to give up a lot in NIM on the front end, certainly not a significant amount of it to kind of warehouse liquidity. But we do think that what we’re doing is a good mix between some proactive actions and then certainly some ability to maintain a little bit higher NIM going forward. So hopefully, that makes sense. So John, if you want to talk a little bit about DDA? Sure. Just a couple of points to add. And Kevin, to your prior question about 4Q NIM, for some time, we’ve kind of given guidance to expect as the commercial line utilization numbers begin to go back up towards pre-pandemic levels, which we still got a long way to go to get to that number. As that happens, and typically, in other rate cycles, you see some of the free money from those same relationships off just as people spend it. So, there’s not -- there’s some disintermediation of free money to IBTs, but the primary leakage in that bucket is not account loss, it’s really just people spending money, which is not necessarily a bad thing for the economy. But the line utilization up about -- I think it was up 106 basis points for the quarter is one of the larger ones for the past three or four quarters. And while fourth quarter typically has a bit of a runoff, it was pretty handsome. So, some of the runoff really just companies the same type of behavior and oversight decisions paid by commercial clients as they look at their own balance sheet. So with free money out and 100% variable money getting charged up as part of the line utilization increase, the spread on that is not going to be quite as attractive as it is if you still have that free money sitting on the books. So that’s just one additional point for you to ponder. In terms of a going-forward strategy, we had almost no digital capacity to gather deposit accounts just a year ago. A lot of the tech uplift has occurred in the past 12 months. As it draws to completion, we would anticipate gathering more client accounts digitally. Secondly, the treasury services area competes extremely well with both our size and very large organizations, and we continue to add treasury service and treasury sales professionals to that team, added one yesterday, in fact, to focus purely on our payment cards. And so as a result, I would expect to see more operating accounts come in. And in the areas of our franchise that experienced disruption and as integrations occur, I think we’ll be pretty busy trying to move folks into the book that actually help us with some of the offset to the outflow. One item that may be too far in the weeds for this call, but our incentive plans are engineered to be quite flexible. And obviously, one year ago, deployment of liquidity was very important and to that gathering, liquidity is obviously very important. And so we’ll see a fairly significant shift -- or already have shifted to deposit campaigns driving compensation for our bankers, which I’m sure will yield a very good result, it usually does. And so, the capacity of the Company to gather deposits and loans is greater than the guidance that we’re giving, but it’s primarily driven -- the guidance is driven around the expectation that the quality of what’s in the book is going to be more valuable overall than just sheer growth. And so, our focus for ‘23 and maybe for ‘24, we’ll see how the economic outlook looks at the time, is really on stability and earnings, good credit outcomes, very effective and efficient sales staff and maintaining very strong profitability compared to peer as we go through the cycle. And the CSOs somewhat overlay the same time period for what people think the recessive period may be. And so, that’s pretty much where we’d expect to earn as we get through that period. That may be more than you asked for, but I wanted to make sure we completely answer. No. very helpful. Yes. Very helpful, John. One quick follow-up to what Brad had asked about before, that the impact to the margin when rates start going down. But you guided in here on the margin that the margin peaks when the Fed is done or after the Fed is done. But if we don’t have a pivot right away to cutting rates, when we’re just stable like that, can you and would you expect to be able to keep the margin stable, or is it more likely that we have some grinding lower, just given the lag of funded costs going higher? Yes. Kevin, this is Mike again. Certainly, our intention and the way we look at managing the balance sheet and the Company would be in that environment to maintain a stable NIM. Now, stable NIM could mean that we could have a quarter where it could be up 1 basis point or 2 or down 1 basis point or 2. And so, other than things like loan growth and what we’re able to do in terms of expanding customer relationships, probably the biggest determinant of really what happens when the Fed stops is what happens to our deposit balances, namely DDAs. And so, again, you can appreciate the focus that we have on that component of our customer relationships and a desire to continue to build on that. Just curious as to you made some comments in your forward guidance on loan loss reserve and provisioning and net charge-offs. I’m wondering, John, how you’re feeling about the loan portfolio right now? And what pockets you feel are most vulnerable in a higher rate environment? And some companies have pointed out they’re worried about office down the road. I’m curious how you guys would characterize your office exposure at this point. Thanks. Great question, Jennifer. I’m going to let Chris take the first whack at that one and then I’ll follow up. Yes. Hi. So, as it relates to kind of segments of the portfolio that might be more vulnerable, and your comment about office, obviously, those customers that are probably in a floating rate environment and are maybe a little bit more levered are things that we’ve been looking at. And we’ve stress tested those loans in our portfolio and feel confident that they could largely withstand the current environment and maybe the rate rises that are anticipated in early 2023. But we continue to watch that and think about the impact there as well as, obviously, those customers that are impacted by some of the rising costs that are being incurred, especially ones that are more labor-intensive with labor costs going up, just really keeping an eye on that, but no specific worries or concerns in that regard. And then, as it relates to kind of our office portfolio, I think one of the things that we’ve been stressing for a long time now, even before I got here almost five years ago, is that we’ve been shifting our focus away from traditional office to more medical office, which I think has helped us a lot. And a lot of our office tends to be kind of mid-rise type office, not necessarily the high-rise type buildings that rely upon large tenants to take large amounts of space or the re-tenanting risk. It’s not to say that there may be some risk in office in general, but we feel fairly confident that in the markets that we operate in as well as the type of office that we’ve done and the more focus around medical office that we’re probably less worried than some would be. I wanted to ask about the expense guide, 6% to 7% and 4% to 5%, excluding the FDIC and pension. You look at the past two years, and you’ve been able to manage expenses flat, and I noticed you took out slide 28 that showed the hires. Can you maybe walk through and give us some color on what things you’re going to have higher expenses on in the coming year, maybe any initiatives that might be taking place that might also benefit the longer-term profitability of the Company. Yes. Brett, this is Mike. So yes, again, the guide -- we gave the guide two ways. One was obviously including the higher pension and FDIC expense. And look, those amounts aren’t insignificant, pension, that’s a $18 million difference -- I’m sorry, an $11 million difference. And on FDIC, it’s about $5.5 million difference. So, those are significant items that really kind of add to the expense base. So, if we take a step back and kind of back those out and look at expenses up 4% to 5%. And again, this is after a year where we’re actually down 1% between ‘22 and ‘21. I think the biggest driver is going to be personnel expenses and just the normal raises that we’ll be looking at for ‘23 and those will be around 4% or so. Aside from that, I think the biggest drivers will be some technology investments that we continue to make and to continue to invest in the Company in that regard. We have some new hires planned for next year, probably not as many new bankers in ‘23, all things equal compared to ‘22. But I think overall, we’ll continue to be opportunistic in terms of how we look at those kinds of opportunities. So overall, I think when we look at expenses in ‘23, it really kind of represents a little bit of a normalization of what we think our expense base probably is on a go-forward basis, excluding kind of the extraordinary increases in pension and FDIC. That’s okay. I was -- what I was going to add to it was just when you look at the two largest ones, which are pension and FDIC, obviously, you don’t get the FDIC expense back, right? On the pension side, there’s a likelihood that as the market may change a little bit this year or next year, to some degree, those changes swap back the other way. So, it’s painful to have all that for this year, but it should swing back and be much more positive, but it will swing back and be more positive contributor at some point next year or the year after that. The other point, Brett, you mentioned the new investment. I mean, Mike’s right, we have been investing a lot of money in technology. And it’s really not like catch-up technology core systems. They’re all forward-looking technical upgrades that help us to be more effective, more scalable, help our bankers to be faster and turnaround business. And a lot of that deployment is continuing to occur as we wrap up last year, and it should be principally done early this year. And then, that actually creates some efficiencies that can benefit on the expense side as we get toward the end of the year. And so, I don’t want to call it a bubble, but there’s -- the pension [ph] overlay to it kind of bore the number up somewhat artificially and the remainder of it are really investments in our future. In terms of the banker adds, right now, the number’s 10 to 20 or so in the plan. The big difference is the types of people that we would anticipate adding in next year. Back when we were sitting on $2 million or $3 million of excess liquidity, the desire to add bankers that can deploy liquidity, led us more towards middle market and specialty bankers. And that was helping us to start up some of the new markets we expanded to. As we look at ‘23, where our focus is more on the sectors that include full relationships. That’s going to be more bankers on the smaller end than middle market. So that $10 million to $20 million will be made up primarily what we call business bankers, commercial bankers and treasury sales staff. So, a little different mix, but continued investment in how well we do picking up talent, and we depend on the availability of people and the alignment with our values and credit posture. But I’m confident we’ll see some pretty good gains in good talent as we go to ‘23. Okay. Yes. That’s great color. And obviously, you’ve managed the efficiency ratio well here in the past two years, downward. I wanted to maybe take the deposit question in a different way. I was just thinking about the DDA and non-interest bearing DDA and that being hard to predict. Would you happen to have handy balances for commercial or retail pre-, during and maybe post-pandemic current quarter in terms of the size as maybe a way to see how much liquidity like customers have drained out of their accounts. I don’t have that per se, Brett. But, what I can share in the way of color is, if you look at our deposit book and kind of think about it in DDA deposits and then basically everything else. When you look at DDA, about 70% of our DDA deposits are commercial in nature. So, 30% consumer. When you look at everything else, it flips a little bit, and it’s about 60% consumer and about 40% commercial. So, if you think about the pandemic impacts and you think about things like surge deposits, and if you assume that most of that came from the commercial side, then yes, we probably had our fair share of that. And certainly, that was helpful in increasing our mix of DDA deposits to nearly half. And certainly, that’s come down a little bit. We’re at around 47% or so at the end of the quarter. And we certainly have guided to that number probably continuing to trail down a little bit as we go through an environment where rates kind of stabilize at a higher level. So, not a direct answer to your question, but hopefully, that’s some helpful information. Just wanted to dig into slide 7 a little bit. So, understanding that the growth is going to slow next year, but you’ve had some nice tailwind from mortgage. You kind of pointed that out in the slide there. Just wanted to see what the expectations are there? And then, can you just kind of talk about what specific areas you’re limiting CRE growth and what some of the headwinds are. Just looking for some of the puts and takes. And then, you mentioned as one of the tailwinds continued line utilization growth. But how much of that is going to be a function of maybe reducing some of those lines versus your lenders actually -- your customer is actually drawn down just given the economic backdrop that we’re in? Thanks. Yes. So on more mortgage, Mike, you can see that we’re up about $250 million or so this quarter. And really about two-thirds of that is really attributable to our onetime close product, again, on the mortgage loan side. We’ll have those kinds of impacts. In fact, they will probably increase a little bit related to that product in the first quarter and second quarter, and then really kind of begin to trail down. So, the components of our overall growth attributable to mortgage and that onetime product will be rather significant for the next quarter or two, and then again kind of trail off. So for everything else, I’ll start with line utilization. I do not expect to see the overall line availability crash down because we’re taking down the limits. I mean, that’s really a customer-by-customer decision made as we approach renewal or whether there were any covenant issues. That really hadn’t been an issue so far, and I don’t think it’s going to be an issue in the future other than the occasional cat and dog situation occurs up. So, if you look at page 7 at the top right, you see kind of where we were pre-pandemic was a little over 48%. So, if the trend in ‘21 and ‘22 is probably a good one, I think it’s dependable. So, depending on the quarter, it may be between 50 and 150 basis points of line utilization increase without much that’s going to drive that back down less because sours just tremendously, which we don’t anticipate that happening. So, we’ll still have a tailwind for the better part of probably three years at that current rate to get utilization back to where it was. So, that will be a tailwind. Our business banking and commercial banking sectors are likely to continue growing. And our middle market group will be tied to those accounts that typically bring their operating accounts with them. So, all what I’ll call the core business of the company that provides the opportunity to full-service relationships will continue to grow. And frankly, we’re directing much more attention to that because of the need for liquidity over the next couple of years to fund loan growth. The sectors that will be more of a push for the year will be those that don’t -- off excess liquidity. So presuming no real downturn in the economy that makes us get more [indiscernible] about the sector, I would expect to see CRE, healthcare, the capital market side of equipment finance more flattish for the year. They’ve been growing at a pretty nice clip for the last several years when liquidity was cheap, and it’s just not cheap anymore. So, even though the yields of those businesses tend to be very good, if we have to raise liquidity at an unattractive price, then we’re dampening NIM as the rate environment goes up and then it stabilizes. So, our driver for slower growth isn’t a lack of capacity to grow, Michael. It’s really all around making sure that the profitability and the earnings efficiency and the NIM itself is insulated while we go through a period of volatility. And we may be overcautious. And to the extent that we’re able to gather deposits at a better clip than we’re guiding to, then we probably grow loans at a faster clip that we’re guiding to. But it’s just impossible at this juncture with all the different opinions about which direction the economy is going to go to guide to anything other than what we think is a reasonable level, and that’s what we put in the numbers for ‘23. But if -- wherewithal the economy allows us to grow deposits quicker than the balance sheet may grow a little quicker than we’ve anticipated. Maybe just one quick follow-up. It looks like you guys benefited from some storm-related gains this quarter on the expenses. Do you have a sense for what the dollar impact of that was? Thanks. Yes, Michael. So, for this quarter, that was right around $3 million, and that was related to Hurricane Laura. And as a reminder, it seems like these days, we pretty much have those kinds of recoveries almost every year. Now, we had one last year in the fourth quarter related to Hurricane Michael, and we’re likely to have another one at the end of this year related to Hurricane Ida. So hopefully, that’s helpful. Well, I want to circle back to the guidance chart. And I thought it was interesting in that your ranges for fees and expenses are pretty tight ranges. But then the PPNR range is a little bit wider, which would -- has given you a little bit more of a room for what the spread -- if you kind of back into that, what the spread could be on the low end of the guide and on the high end of the guide. And so, the only way to get kind of to the low end of that guide would be if your -- if the margin maybe increases a little bit in the first half of the year and then falls from maybe current levels. And so just kind of curious how you’re thinking about that and what kind of assumptions you were thinking about in your margin as you kind of -- as you came up with that range? And is it more of a margin piece, or is it more of a balance sheet size piece that’s driving the bottom end of that PPNR range? I’m having a really hard time even getting to a scenario where you’d have 13% PPNR growth with the other things you lay out? Yes. I think the answer to the question is obviously an NII, Catherine. This is Mike. And I would say it’s probably a little bit more dependent right now as we see it on what happens with the balance sheet and specifically deposits over the course of ‘23 than really the resulting NIM. I mean, certainly, those things impacted NIM. But I think it’s really what happens with our balance sheet, whether we’re able to grow loans, as John mentioned before, a little bit faster clip than maybe what the guidance is suggesting. And that will be very dependent upon our ability to retain and even grow deposits. And certainly, as we mentioned a little bit earlier, some of the change in terms of how we’re thinking about managing the balance sheet is the introduction of using cash flows from the bond portfolio to fund loan growth. And if -- as we go through the year, we have better -- we have a better experience with growing deposits, then it’s certainly likely that we could kind of scale back on relying on the bond portfolio as much. So, I think it’s very dynamic. It has a lot of different moving pieces and parts. And we try to be very thoughtful around establishing ranges on all the components of our earnings going forward. And again, I think to kind of close the loop, the missing piece is really on net interest income and kind of how we think that might happen in trail in terms of how we go through next year. So, hopefully, that was helpful. It gave you a little bit of color I think? Yes. Very much. And then on your loan betas, last quarter you were talking about over the cycle kind of 50%, 52% cumulative loan beta. Has anything changed to date with how you’re seeing loan pricing? It seems like your new loan yields are coming up significantly higher. So, any kind of update on that would be helpful. Yes. As of right now, where we stand, really no change in the overall guidance around both, our deposit and loan betas in terms of how we think we’ll end up on a cumulative basis for this cycle. So, that’s probably no worse than about 25% or so on deposits. And then, as far as loans somewhere in the low-50s. So really no change in that regard. Great. And then, lastly, on your CSO goals, thank you for updating that and having the updated rate environment included in those goals. I found it interesting that you -- in this assumption, it looks like you’re saying Fed funds have cut in ‘24 and ‘25, and even in that scenario, you could still have an ROA above 1.55% and an ROE over 18%. So just kind of curious kind of your thoughts on there and just overall profitability strategies to kind of hit those goals even if rates pull back to the 3% level as you indicated on your slide? Yes. Again, as a reminder, the goals are really kind of fashioned to be three-year goals. So we’re looking at the fourth quarter of ‘25. And certainly, while we see some challenges in ‘23, I think the way we’re looking at ‘24, and ‘24 right now is a little bit more optimistically. And so, while we may be in a lower rate environment, we think that we may be in an environment that may be more conducive to us growing the balance sheet, more in those two years than in ‘23. So again, it’s -- some of this is crystal ball kind of work. But it really is the goals that we’ve established for ourselves. And this is the way that we’re managing the Company and holding ourselves accountable. I’m sorry. This is a time lag, I think, I’m sorry, Catherine. I didn’t interrupt you. The other color I would add is the work that we did on the expense and the efficiency side, that was real. There really were no gimmicks to it. And so, as we get to a little bit better time with an expectation of growing the balance sheet, the scalability of the operating footprint should show itself. And so, as a result, we really shouldn’t experience the type of expense increases that we had in the last expansion period, to be as -- we would expect those to be lower when we get to the next expansion period. So that’s really the fuel behind both the ROA and the ER being pretty solid is the expectation that we can have a pretty good expense number. I know the guide for ‘23 doesn’t look that way, but we wouldn’t see that type of expense growth, I think, in the future, presuming that salary costs and that sort of stuff don’t escalate in ‘23 and ‘24 like they necessarily had to in ‘22. So, a big chunk of that $23 million number is just the full year’s impact of tellers becoming 60% more expensive and apply that throughout the rest of the hourly workforce, so. But that shouldn’t recur as we get into ‘24 and ‘25. Does that help? It does. And that’s exactly where I was going. I was assuming that the expense growth would be at the 6% to 7% pace in future years. So that all rounds up perfectly right. Hey. Thanks very much for all the information today. I just want to piggyback on Catherine’s question on loan yields. When you look at the 6.25% new loan yield on variable, does that put any strain on borrowers at this point? Is there any upper bound as that most likely reset again in the first quarter in terms of just the ability for customers to handle that and/or their demand at that rate level? I don’t think so at this point in time -- Chris, this is John. The -- as Ziluca mentioned earlier, when we stress test the book that we have right now and do that in some of the different specialty sectors, the forecast as we have it right now really doesn’t point to much additional stress. We’re not presuming the Fed goes up to a 10% overnight rate, right, with that, that’d be a little different world. But -- and what we expect now the Fed futures curve, we don’t anticipate a lot of stress. Where you’ll see the byproduct is where you see them begin to diminish spending and start to -- in our expectations, they begin to warehouse operating capital on their own balance sheet versus depending on lending alone. So I think it would be more of an impact on our underwriting going forward, and our expectation is the way the customers manage their own balance sheet. Yes, I think that’s right. And as John pointed out, I mean we tend to stress our borrowers when we’re doing new underwritings or even renewals on existing loans just to make sure that they can withstand what is the anticipated rate rise is in the portfolio. And is it fair to say then that the leverage of your borrowers really is not at a worrisome level, just given their ability to handle from your stress scenarios? Yes. No. I mean, obviously, some individual customers, depending on some of their other challenges that they may be experiencing from an operating cost standpoint that we may not even be aware of, could have some challenges. But as I pointed out, we’re not really aware of any that have kind of a combination of all of those factors at this point in time. I mean, to be fair, Chris, there are always dogs and cats that show up as rates continue to go up. And none of us really know what that ceiling is going to end up. But from a systemic viewpoint or a sector viewpoint, there doesn’t appear to be a dragon on its way due to rates or really due to any other strips. So, our confidence right now is pretty high, and we’ll have to see where we stand as the future. Part of the reason that loan loss reserve is sitting out there in [Technical Difficulty] is the desire to manage the ACL to about a 75% slower growth scenario with Moody’s. And if you look at the way our customers and our markets are behaving right now, they’re acting as if it’s going to be a soft landing. And I don’t know if that’s going to happen, none of us really do. But when we build the ACL, the assumptions are a little bit more caustic, which keeps the ACL at a level that we think acts as sort of third base to the environment that we’re talking about. Does that make sense? No, it does. And just one quick related question back to the Moody’s baseline. So, you have the same weightings this quarter as you did last quarter. What would have to happen for you to shift to something higher on the slower growth as to go just from 75 to 80, just to pick a number? Chris, this is Mike. I think a little bit more conviction and certainty about a recession in the second half of the year. So, the Moody’s S2 scenario does call for a mild recession in the second half. And we haven’t weighted, we think, appropriately right now at 75%, which, by the way, we’ve kept these weightings in place for three quarters now. So we haven’t changed those. But I think, again, to answer your question, a little bit more conviction around a recession in the second half of the year. Thank you. There are no additional questions at this time. I will pass the call back to John Hairston for final remarks. Thanks to your effort for moderating the call, and thanks to everyone for your interest. We hope to see you all on the road over the next several months. Be safe and be healthy and take care.
EarningCall_1561
Good afternoon, ladies and gentlemen. Welcome to DAVIDsTEA's Third Quarter 2022 Earnings Webcast. Today's webcast is being recorded and is in a listen-only mode. Before we get started, I would like to remind you of the company's Safe Harbor language. This presentation includes forward-looking statements about our expectations for the performance of our business in the coming quarter and year. Each forward-looking statement contained in this presentation is subject to risks and uncertainties that could cause actual results to differ materially from those projected in such statements. Additional information regarding these factors appears under the heading Risk Factors in our Form 10-K, which was filed with the Canadian and U.S. Securities Regulatory Authorities, and is available on www.sedar.com, www.sec.gov as well as in the investor relations section of the company's website at www.davidstea.com. The forward-looking statements in this discussion speak only as of today's date and we undertake no obligation to update or revise any of these statements. If any non-IFRS financial measure is used on this call, a reconciliation to the most directly comparable IFRS financial measure will be detailed in our Form 10-Q. As a reminder, all dollar amounts referred to are in Canadian dollars, unless otherwise indicated. Now I would like to turn the call over to Sarah Segal, Chief Executive Officer and Chief Brand Officer of DAVIDsTEA. Thank you, operator. Good afternoon, everyone. DAVIDsTEA has not been immune to the macroeconomic headwinds that impacted retail businesses in North America in the third quarter and persisted into the fourth quarter. Although our competitive advantages remain strong, on the strength of our wellness-driven portfolio of teas, innovative product launches and broad demographic appeal of our brands, we anticipate our financial results will be under pressure until the economic environment becomes more stable. At this time, it's difficult to forecast the extent and duration of the challenging market environment, but we can lean on our Omni channel platform and seasoned management team to navigate through this trying period. Fears of a recession, exacerbated by rising interest rates have significantly lowered consumer confidence and discretionary spending. In addition, we continue to manage through supply chain disruptions, increased input costs and periodic shortages of labor resources. As a result, total sales declined double digits to $16.2 million in the third quarter of 2022 from the same period last year, while net loss and adjusted EBITDA amounted to $4.7 million and a negative $2 million respectively. I am also confident we will draw on the experience, resilience and increased operational efficiency gained from the COVID-19 pandemic to overcome current macroeconomic headwinds, while providing our customers with an unmatched shopping experience, both in-store and online during the upcoming holiday season. Turning to recent operating highlights, we went live with our new enterprise resource planning, ERP and point-of-sale POS system on September 1. The implementation of these software systems marked the culmination of several months of hard work by DavidsTEA staff to build a seamless back office for order management and customer support. For the ERP system alone, we have invested $4 million since the beginning of the fiscal year. Ultimately, these investments will reduce our cost of doing business and add incremental value to consumers when fully commissioned and optimized. We also continue to work jointly with our third-party logistics partner to optimize a 750,000 square foot distribution facility for our business. Notably during peak demand periods like Black Friday, we experience higher peak demand, causing some delays in processing orders. The mission-critical investments we have made in the past 18 months are gradually coming online, but it will take time to fully integrate and optimize them. We are focused on continual improvement and during this transition, we apologize to any customer whose experience is not perfect. We have taken steps to follow up and make it right. Finally, I would like to reiterate that we intend to move forward with plans to test our wholesale strategy in the U.S. in the fourth quarter. We will provide a curated offering of Loose Leaf Tea products on a trial basis to wholesale partners in the U.S. Northeast. The strategy involves a step-by-step launch to gauge consumer taste and gradually replicate the success we enjoyed in Canada. To wrap up, DAVIDsTEA is faced with yet another challenge in the form of the current macroeconomic environment. We have encountered other obstacles in the past, such as the CCAA restructuring, global pandemics as well as global supply chain issues and have always emerged stronger to meet customer demand. We believe it will be no different this time around as we continue along our path to value creation. While the technological upgrade, system improvements and distribution optimization needed to be done, it is paired with a challenging global environment. This combination has forced us to look at how we -- how to work smarter, leaner and more focused, which will ultimately improve all aspects of the business. Thank you for your attention today. I will now turn the call over to Frank Zitella, President, Chief Financial and Operating Officer at DAVIDsTEA. Thank you, Sarah, and good afternoon, everyone. Sales decreased 27.1% to $16.2 million in the third quarter of '22, mainly due to the macroeconomic headwinds that Sarah outlined earlier in her prepared comments. Sales from our e-commerce channel declined 29.5% or $4.3 million year-over-year to $10.2 million in the third quarter. We believe e-commerce sales will eventually stabilize coming out of this volatile market environment, so we intend to build on the wellness trend for healthcare beverages with our target audiences. Brick-and-mortar sales dropped 12.5% or $0.6 million year-over-year to $4.4 million in the third quarter of 2022, while sales from our wholesale channel decreased 41.8% or $1.1 million to $1.6 million during the same period. In September, we launched a new convenience-driven format in our wholesale channel, a fully compostable individually wrapped sachet format with an expanded assortment. Promotional tactics accelerate the sales of existing inventory has created this revenue shortfall. It should be noted that the revenue shortfall on wholesale front is predominantly a timing issue with large grocery chains, pharmacies and big-box stores. So we're not concerned about the health of this business. Sales of our wholesale segment are up 33.5% after nine months into the fiscal year. In terms of revenue breakdown, e-commerce, brick-and-mortar and wholesale channels accounted for 63%, 27% and 10% of total sales, respectively, in the third quarter. Gross profit reached $6.3 million in the third quarter of 2022, down $2.3 million from Q3 of '21. The year-over-year decrease was primarily due to lower sales, partially offset by reduced delivery and distribution costs. As a percentage of sales, gross profit was stable year-over-year at 38.8%. SG&A expenses increased 6.7% year-over-year to $10.9 million in the third quarter of 2022. Excluding software implementation and configuration costs as well as the wage and rent subsidies received under the Canadian Government COVID-19 Economic Response Plan, adjusted SG&A decreased 8.1% year-over-year to $9.5 million. This drop can be attributed to decreased -- or sorry, reduced marketing expenses and credit card fees partially offset by increases in IT expenses as we continue our transformation to become an Omni-channel organization. As a percentage of sales, adjusted SG&A expenses attained 58.9% in the third quarter of 2022 compared to 46.7% in the same period last year. We acknowledge this cost level was higher relative to our current revenue run rate. So we are weighing options to realign these costs to help cope with challenging market conditions. Net loss totaled $4.7 million in the third quarter of '22 compared to $1.9 million in the third quarter of '21. Adjusted net loss, which excludes the impact of restructuring plan activity, the wage and rent subsidies from the Canadian Government as well as software implementation and configuration costs amounted to $3.3 million compared to an adjusted net loss of $1.8 million in the same period last year. Adjusted EBITDA, meanwhile, was negative $2 million compared to negative $0.3 million in Q3 of 2021. The decrease in adjusted EBITDA reflects the impact of the year-over-year sales decline, lower gross profit and increased SG&A expenses. At quarter end, we had $16.1 million in cash held by major Canadian financial institutions. We also had a $15 million line of credit to assist with working capital needs and help us along our way for the path to profitability. We have considerable work ahead to stabilize the business and overcome the current economic and operational headwinds. With a healthy working capital position and a seasoned entrepreneurial team, we are focused on executing against our value creation initiatives and realigning our operating structure to meet the anticipated demand hit, ultimately driving towards the path to profitability. This concludes our comments on Q3 2022. We encourage Investors wishing to obtain additional color on the quarter to contact investor relations, who can coordinate access to management.
EarningCall_1562
Good morning, ladies and gentlemen and welcome to Enghouse Q4 2022 Conference Call. [Operator Instructions] Also note that the call is being recorded, Friday, December 16, 2022. I now would like to turn the conference over to Stephen Sadler. Please go ahead, sir. Good morning, everybody. I am here today with Vince Mifsud, Global President; Rob Medved, VP, Finance; Todd May, VP, Legal Counsel; and Sam Anidjar, VP, Corporate Development. Before we begin, I will have Todd read our forward disclaimer. Certain statements made maybe forward-looking. By their nature, such forward-looking statements are subject to various risks and uncertainties, including those in Enghouse’s continuous disclosure filings such as our AIF, which could cause the company’s actual results and experience to differ materially from anticipated results or other expectations. Undue reliance should not be placed on forward-looking information and the company has no obligation to update or revise any forward-looking information, whether as a result of any new information, future events or otherwise. Thanks, Steve. Good morning. I will be taking you through the financial and operational highlights for the 3 and 12 months ended October 31, 2022 compared to the 3 and 12 months ended October 31, 2021 as follows. Revenue achieved was $108.1 million and $427.6 million respectively compared to revenue of $113.1 million and $467.2 million. Results from operating activities were $33.1 million and $129.7 million respectively compared to $39.1 million and $155.2 million. Net income was $36.9 million and $94.5 million respectively compared to $30.2 million and $92.8 million. Adjusted EBITDA was $35.8 million and $140.6 million compared to $42.1 million and $168.5 million, while adjusted EBITDA margins were 33.1% and 32.9% respectively compared to 37.2% and 36.1%. Cash flows from operating activities excluding changes in working capital were $37.1 million and $145.1 million respectively compared to $42.4 million and $167.8 million. Cash, cash equivalents and short-term investments were $228.1 million as at October 31, 2022 compared to $198.8 million at the end of the prior year. Turbulent global markets, rising interest rates, high inflation and aggressive competition in the technology sector, particularly from vendors offering Software-as-a-Service or SaaS, highlighted the environment in which we operated during fiscal 2022. Despite these factors consistent with our operating approach and strategy, we continue to manage our business with financial discipline, once again generating positive operating income and cash flows, while increasing quarterly dividends to shareholders for the 14th consecutive year. During fiscal 2022, we invested $72.3 million in research and development activities aimed at ongoing product improvements and innovation. We continue with our strategy of offering customers and partners’ choice, providing various deployment options of private cloud, multi-tenanted cloud or on-premise solutions. We believe offering choice differentiates us in the vertically focused enterprise software markets in which we operate and addresses the varying needs of our customers. In fiscal 2022, we achieved adjusted EBITDA of $140.6 million or 32.9% of revenue and cash flows from operations, excluding changes in working capital of $145.1 million, closing the year with $228.1 million in cash, cash equivalents and short-term investments with no external debt. Our capital allocation focused on deploying $20.2 million for acquisitions, repurchasing $9.3 million of Enghouse common stock and paying dividends to our shareholders of $38.3 million. Revenue for the year was $427.6 million compared to $467.2 million in the prior year. Revenue was negatively impacted by the decline in our video revenue post-COVID in addition to $15.7 million of unfavorable foreign exchange and the growing shift from on-premise solutions to SaaS. Consistent with our strategy of offering choice, we continue to expand the availability of our SaaS offerings globally, primarily for our customer experience and contact center technologies, where demand for SaaS is rapidly growing. Operating income for the year was $129.7 million compared to $155.2 million in the prior year, resulting from lower revenue levels. Net income for the year increased to $94.5 million compared to $92.8 million in fiscal 2021 as a result of lower non-operating expenses and taxes. During the year, we completed the acquisitions of Competella, NTW and VoicePort, broadening our geographic reach and product portfolio, including SaaS offerings. We continue to expand our acquisition pipeline and actively pursue acquisition opportunities. Valuations are generally decreasing in the enterprise software market that we believe are the result of higher debt servicing costs, reduced ability to raise capital, and a broader focus on profitability and cash flow in response to economic uncertainty. We are closely monitoring acquisition opportunities as valuations become more aligned with our financial and operating criteria. We have consistently demonstrated even during adverse economic conditions that we can generate positive operating cash flows and augment our cash reserves to be deployed for acquisitions and further investment in our business. We believe that our financial discipline, product approach and commitment to customers, partners and employees will continue to drive long-term shareholder value. Yesterday, the Board of Directors approved the company’s eligible quarterly dividend of $0.185 per common share payable on February 28, 2023 to shareholders of record at the close of business on February 14, 2023. Thank you, Steve and to those of you that made time to join our final call for fiscal 2022. Today, I am going to take a few minutes to provide some highlights around Q4’s financial performance and commentary relating to the aggressive competitive landscape we are operating in, how our strategy around choice and micro verticals is helping our overall performance and summarize where we are making key product investments. In Q4, total revenue grew sequentially compared to Q3 2022 by $6 million to $108.1 million, up from $102.1 million, a 5.9% revenue improvement. Our recurring revenue generated from our SaaS and support arrangements hit $64.6 million, which was also up 1.6% sequentially. Software license revenue was up $5.8 million and our video product also slightly increased compared to Q3. Now, comparing to Q4 of 2021, overall revenue was down $5 million. However, foreign exchange represented a negative impact of $4 million. Our asset management division increased revenue on a constant currency basis. However, actual revenue was flat at $46 million absorbing the negative impact of FX. Our video revenue was still down compared to last years Q4. Turning now to what we are seeing in our markets, over the course of fiscal 2022 and especially in the last two quarters, the overall economic and business environment has changed quite significantly, with rising interest rates, global inflation, and general economic uncertainty. Our observation is that this environment appears to be creating differences in the way some of our competitors are operating, specifically in the customer experience market. Although the CX market is growing, we are coming up against some of our SaaS vendors becoming more aggressive in terms of product and service pricing, which makes it more difficult for us at times to retain customers or assign new projects, new customers at our target gross profit margins. During Q4, a number of our competitors in the CX market announced the discontinuation of their on-premise products, large personnel layoffs, changes in leaderships and other restructuring measures. We believe Enghouse has advantages that may serve us well during these economic times. Given we have no debt, rising interest rates doesn’t impact our operating profitability or create a need for us to change the way we manage the business. Having a cash position of $238 million and positive operating cash flow business gives customers the level of comfort they seek from mission-critical technology provider. We also continue to execute our strategy and make investments where needed. One important element of our strategy worth reiterating is around offering customer’s choice. Although offering choice might sound relatively straightforward, there are a number of engineering product and operational complexities around being able to offer choice and implement on-premise, private cloud and multi-tenant cloud products as well as the number of investments we have and will continue to make to enable us to offer choice. During Q4, we won a number of new customers as a result of providing the deployment options they preferred. And we also were successful in converting some of our large on-premise customers to our private cloud and multi-tenant cloud products thereby mitigating churn and improving recurring revenue. Offering choice this quarter and managing this complexity did translate positively to our revenue results in the quarter. The second important aspect of our strategy is around our go-to-market focus on what we call micro vertical business segments. In order to produce an efficient sales and demand gen organization, where the spend relative to the business generate continues to drive a profitable business model, we focus our sales and demand gen team on micro verticals rather than on a horizontal strategy. This is key to sales efficiency and ultimately our overall profitability. The acquisition of VoicePort in the quarter is an example of a micro vertically focused company in the CX space, specifically aimed in the print and media sector. Product development and ongoing innovation continues to be our single biggest area of investment. In the quarter, we spent $18.2 million on research and development, which was up from $16.9 million a year ago. Considerable engineering investments are being made across all our business units around optimizing our products for the cloud. In the customer experience market, the demand for SaaS is increasing, while the demand for on-premise declines. However, in our asset management division, we are not experiencing the same trend. So, the demand for on-premise continues to be the same remains consistent with previous periods. However, we have decided to continue to invest our engineering resources in product cloud readiness as we expect the market may move in that direction in the future. In summary, we finished fiscal ‘22 with sequential revenue quarterly growth, EBITDA of $145 million and a healthy cash position. This puts us in a comfortable position to continue to make product investments, cope with the economic conditions, conclude future acquisitions and keep our strategy focused around choice and micro verticals. Thanks, Vince. With respect to acquisitions, the actionable pipeline remains significant. Valuations continue to decline in this challenging environment of increasing global interest rates and the possibility of a recession in 2023. We completed two tuck-in acquisitions late in Q3 and another acquisition in Q4. These businesses had a positive EBITDA in the fourth quarter, including VoicePort, which was for a partial period. VoicePort was included since its acquisition in early September. At the end of Q4, cash on hand remained approximately the same at the end of Q3 at $228 million. We purchased 13,000 shares of Enghouse in Q4 at an average price of $28.23 and paid $14.1 million in acquisitions in Q4. With our continued strong positive cash flow and cash on hand, we have the financial resources for further acquisitions and the possible buyback of Enghouse stock. Hi. Good morning. Just wondering if you can give any color around the license wins in the IMG segment, whether that’s coming from new customers coming onto the platform or whether it’s from like up-selling, cross-selling your existing customer base? Yes. Daniel, so it’s a combination of, as I mentioned, there are some customers, existing customers, as well as new customers we won in the quarter. So, it’s a combination of both. Great. Thanks for that. And then how much of the maintenance revenue associated with these new wins are in the Q4 maintenance and SaaS numbers? Oh, not much, because normally, the maintenance starts after we implement the project. So, when you do a larger project, you win a larger deal, it takes a bit of time to implement and then the maintenance kicks in, so you wouldn’t see any maintenance. And similarly, when we do a SaaS uplift deal, where we take an existing customer from on-prem to private cloud, or multi-tenant cloud, the SaaS uplift piece kicks in after the implementation, so not much in the quarter in terms of that recurring revenue uplift. Okay. So, it sounds that we might see some uplift in the future quarters, then. Maybe just the final question on that revenue line, SaaS and maintenance, it’s declined by about $1.3 million year-over-year. How should we interpret that? Is that a sign that you are losing more customers from your platform than you are gaining? So, a couple of things. One is, overall FX did impact our recurring revenue. Video still declined in Q4 2022, compared to Q4 of 2021. So, there was still some kind of drop in video volumes. But when we move from a customer from on-prem to SaaS, we normally get more recurring revenue because we got to handle the whole DevOps and cloud infrastructure. So, that normally is an expansion of recurring revenue. Hi. Good morning, guys. Thanks for taking my questions. I got a couple. First on the resilience in AMG, it’s a pretty diverse segment. It’s got some transportation stuff in there and telecom software in there. Can you kind of parse out where you are seeing that resilience? And where you are seeing relative strength between perpetual versus SaaS? Yes. So, across the board and asset management, it’s pretty much business as usual. There is not a lot of SaaS competition there. Plus, our products are pretty sticky in that market. They are running telco networks, doing customer billing. So, they are quite integrated technologies. And it’s in both sides. It’s in public safety, in the transit side, as well as in the telecom sector. Some SaaS growth in IPTV, one of our products is internet television and we are seeing some SaaS growth in that segment. But that’s really the only SaaS piece within that part of our business. Okay. And just a follow-up to that, and then I have got my second question. On the transportation side, in particular, you guys had made some wins recently in the U.S. market. Any comments on how that’s changed momentum, or opportunities in that part of the world for that business? Yes. I would say, we were selected by the California transit authorities as a one of the three preferred vendors for the whole contactless payments area. We have just been building pipeline at this. Up to this point, haven’t signed any deals yet. But we have got some positive pipeline growth there. So, we are hopeful to get some deals in the upcoming quarters. Okay. Thanks. That’s helpful. And then my second question, I guess my third question. Vince, you mentioned some of the micro verticals you guys are targeting? Well, you mentioned that you are targeting micro verticals. Can you kind of give us a sense of, which verticals that you are seeing the most profit opportunity or the most growth opportunity? Maybe a handful that you are targeting or is that something you keep in close to your chest? Yes. I was going to say, I would like to keep it close to our chest because we don’t really want to let our competitors know because there are segments that we are in that I think are below the radar, so to speak. And so we would like to keep it that way. But I guess that’s all I can really say, and I would rather keep that close to our chest. Okay. But just are we talking about like 5, 10, 20, 30 micro verticals as a total opportunity, and you guys are focusing on 20% or 30% of that, or any kind of context you can give? Yes. There is probably about 10, ones that we have got good traction and good visibility, customer reference ability, and numerous customers within the same micro vertical. And it’s about 10, I would say. Okay. Fantastic. Well, I am sure there will be a lot of questions on M&A for Steve. So, I will pass a line and let those. Hi. Good morning. I will jump in here with the M&A question. So, Steve, hopefully, you can talk a little bit about the M&A environment and how you think about the acquisition criteria? Just given the environment, are you shifting more of a focus towards the cloud? We are sticking to our financial discipline in acquisitions, be it in the cloud or on-prem. The environment today, as you can imagine, there is a lot of companies that are having some difficulty, which is making them as we call it motivated sellers. Our backlog is high, higher than it has been in the past. And we think it will last for a couple of years. So, we are pretty optimistic on the acquisition front. And we will just have to wait and see how we do over the next couple of years. Sounds good. Thanks. And then I just want to touch on R&D as well. Vince, you mentioned a couple of times in your prepared remarks. Can you talk a bit about where the biggest investments you are expecting are going to be in fiscal ‘23? And how you think about R&D spending in the year? Yes. It’s going to be somewhat similar, like we have done a lot to get our products, cloud-ready optimized through the cloud because there is more demand there. In the Asset Management division, where we are making investments in what we call product cloud readiness as well, even though we don’t see demand. So, we are knocking off our key products, and ensuring that they work and are optimized for the cloud. And we will continue that into 2023 in asset management, ahead of kind of where the market is today. So, we are going to continue that. We are doing a lot around UI/UX, modernizing – optimizing for mobile, working in at-home environments, continuing doing that type of investment. In the video side, we are really laser-focused in telehealth, in healthcare. We are doing a lot around virtual healthcare monitoring, video healthcare type features that our customers want. So, that’s what we are doing on video. Hello. Thanks very much and good morning. Just a couple of questions here. Just on video, you mentioned it increased sequentially. What’s driving the increased uptake at video. And then do you see continued sequential growth in video going forward from here? Yes. So, I mean it increased slightly from Q3 to Q4. And in the area that we are really focused on is in virtual healthcare and telehealth. That’s the market that we are going after with video, versus being kind of like a general collaboration type platform. We have a couple of other micro verticals, we are trying out that we are getting some traction. Again, I would like to kind of keep them closer to our chest. But you can probably see it if you look at our content that we are out there producing. But yes, so we are just staying micro vertical focused in video. And we think that’s the best approach in order to kind of keep video moving forward positively. And maybe another way to ask the question is, I mean do you see the churn in the general collaboration piece of video, pretty much done at this point. And then, assuming that’s stable, the growth would come from uptake from these micro verticals? Yes. I mean we had a – we did have part of the video business in the general collaboration side, but it was – a lot of it was always at the beginning in healthcare and when we when – when COVID hit, we had a big spike in volumes in the telehealth area. So, that’s what caused it to kind of spike up and come down. But yes, the general collaboration market, we are not heavily focused on because it’s very competitive. And there are some big players there that dropped prices to a point where we don’t think it’s a good market for us. And in your prepared remarks, you had a couple of comments on the competitive environment, just in regards to IMG in general. And I think you mentioned your competitive pricing is making it harder to sign and retain customers. Is that a new comment, like, relative to Q4, do you see the competitive environment intensifying? And then, related to that, like, are you seeing any change in your retention rates relative to history? And it looks like, the strengthened licensed revenue, that you did do a good job winning new customers in this quarter. So, can you sort of tie that back to that competitive environment, comment you had? Yes. I mean I would say that the SaaS vendors, sometimes we are seeing them in deals get pretty aggressive. Relative, especially in the last couple of quarters, I would say I would characterize a little bit of the increase in discounting that we are seeing in the market, primarily in interactive and mainly the SaaS vendors. I don’t know if that answers that question. But yes, the last couple of quarters, a bit of an uptick there. Yes. So, on the retention rates, our team has gotten a lot better at our whole strategy around choice and moving customers from on-prem to either a private or a multi-tenant cloud. So, I would say we are improving our ability to retain there, mainly because of the kind of getting all of our cloud nodes up around the world and getting our team more comfortable selling cloud. So, I would characterize that as an improvement. And then just one last one for me, and I don’t know if you will disclose it, but I will ask is, like, does with the increased pricing competition, have you been more willing to price discount perhaps than what you have done in the past? I mean we are not really the kind of company that will take a deal that really low margins or negative margins, as you know. Are we – will we discount, we will, of course, discount if it makes sense. And we will still make money off of the project. In the multi-tenant world, it’s a little bit easier because you have got one cloud infrastructure, and when you add customers incremental cost is nominal. But we wouldn’t do – we wouldn’t discount much in a private cloud scenario. And so I think overall, our margin discipline is pretty much consistent. Paul, just an added comment there, you might looked at our competition, it’s in the cloud, you will see that most of them do not make money. And they are, some might say they are starting to get into financial difficulty, especially if you don’t get more funding, and with rising interest rates, because they tend to base their growth on debt. So, the environment is changing a lot right now. And there is a lot in that area, you can check the competition out, see how they are doing, we tend to want to have profitable growth where they often have gone for any growth. And I think it’s coming home to hurt them a little bit now. So, just what’s going to happen in that market for the next year or 2 years, we will just have to wait and see. Well. Hi, guys. Yes. Sorry, I do have a follow-up on the M&A side. I couldn’t resist. Two questions, if I may. Thank you. I appreciate it. Steve, I think you mentioned earlier that you are looking to add some more bench strength to the M&A team. I know you have added a lot this year and you said last quarter that your capacity is the highest it has ever been. Any updates on that and what kind of target you have to deploy over the next 12 months? And I have got a follow-up. We don’t have a really a target, whatever makes sense. And that we are capable of doing we will do. Bench strength, we are still looking for the bench strength. We are going to find the right people and we are looking for a couple of people in that regard. But we have a pretty good group already. It’s just that I think it’s going to pick up in the next year. And so I want to get some extra resources in to handle the possible extra volume. Okay. And then a follow-up. It’s helpful. Thank you. We have seen a couple of large private equity transactions on the large side, at pretty healthy valuations. I assume this isn’t hurting valuation expectations on the low side, but there has been an anticipation here of when sellers might break and start selling, especially in your snack bucket 3024. Do you have a sense of timing on that? I know you keep saying over the next few years, but like, could something change in the near-term that could accelerate things or slow things down, or how do you look at that timing, or is it just, as it comes? Generally, I don’t like to predict the future. So, when I say I expect it the next 2 years, I can tell you it’s already started. Well, thank you, everybody. We continue with our long-term capital allocation strategy and to invest in our operations to improve our internal growth. Thank you for attending the call and your continued support. Have a Merry Christmas and a happy holiday season. Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you to please disconnect your lines.
EarningCall_1563
Thank you, and good morning, everyone. As mentioned, we'd like to welcome you to Major Drilling's conference call for the second quarter of fiscal 2023. On the call with me today is Ian Ross, our CFO. Our results were released yesterday evening and can be found at our website at majordrilling.com. Before we get started, I'd like to caution you that during this conference call, we'll be making forward looking statements about future events or future financial performance of the company. These statements are forward-looking in nature, and actual events or results may differ materially from those currently anticipated in such statements. I must say we're very happy with our second quarter results as we saw continued strength of demand for Major Drilling services, especially for our complex specialized drilling services, which again drove solid quarterly results. During the quarter, we began to see the growing importance of electric vehicles and electrification market with increased demand from copper and battery metal customers. Combined with increased activity from all three of our geographic segments, driven mostly by seniors, this more than offset the slight softening in activity from the junior miners. As well, our operational leverage continued to be strong as an 18% increase in revenue produced a 65% increase in net earnings, helping to bring in an additional $43 million of net cash during the quarter. At the same time, we continued to modernize our fleet, purchasing 14 new rigs, including 7 underground drills, in line with our diversification strategy, which allows us to offer a modern and productive fleet to our customers in order to meet the growing demand in the industry. After a strategic focus to diversify our services, I'm proud to say that we now offer one of the most modern underground fleet in the industry. As we continue to move through the current cycle, Major Drilling's core strategy remains to be the leader in specialized drilling as new mineral deposits will increasingly be located in areas more challenging to access or requiring complex drilling solutions. We are committed to providing top quality service to our customers through safe and productive drill programs, as evidenced by our industry-recognized whole completion rates. We leverage our worldwide expertise and utilize our strong financial position to ensure we have the equipment and inventory required to be best-in-class service provider. With our continued focus to be an industry leader with respect to ESG, we issued our inaugural Sustainability Report during the quarter, highlighting the tremendous efforts of our organization across the globe to help improve the communities in which we operate in. The collaborative efforts from our Board to our teams in the field ensure we are aligned as a company to progress our ESG initiatives, and it remains a priority moving forward. With that, Ian will walk us through the quarter's financials. Then I'd like to discuss the market outlook before opening up the call for questions. Ian? Thanks, Denis. Revenue for the quarter was $201.7 million, up 18% from revenue of $170.7 million recorded last year as we saw continued growth in all geographic regions. During the quarter, there was tremendous volatility in the currency markets, in particular the U.S. dollar, which produced a favorable foreign exchange translation impact on revenue for the quarter when comparing to the effective rates for the same period last year of approximately $6 million, a $1 million favorable impact on net earnings. . The overall gross margin percentage, excluding depreciation, was 31.8% for the quarter compared to 28.3% in the same period last year. Margins continued on the upward trend due to enhanced productivity and price adjustments that have offset inflationary pressures. G&A costs were up $2 million at $16.1 million when compared to the same quarter last year. The increase from the prior year was mainly attributed to increased employee compensation as well as elevated travel costs. Other expenses were $4.7 million, up from $3.4 million in the prior year quarter due primarily to higher incentive compensation expenses throughout the company given the increased profitability. Foreign exchange loss was $1.1 million compared to a $900,000 loss for the same quarter last year. While the company's reporting currency is the Canadian dollar, various jurisdictions had net monetary assets or liabilities exposed to other currencies, including the U.S. dollar, which strengthened with the foreign exchange volatility experienced during the quarter. The income tax provision for the quarter was an expense of $7.5 million compared to an expense of $4.5 million for the prior year period. The increase from the prior year was due to an overall increase in profitability. Net earnings were up 65% to $23.6 million or $0.29 per share - $0.28 per share diluted compared to net earnings of $14.3 million or $0.17 per share for the prior year quarter as our earnings power remained prominent. EBITDA grew 40% to $43 million compared to $30.7 million in the prior year quarter. The operational leverage inherent in the business continued to deliver excellent results as top line growth and margin improvement generated substantial EBITDA growth. The balance sheet remains a competitive advantage and was bolstered this quarter by increasing our net cash by $42.8 million to finish the quarter with $51.3 million net cash. The company is also pleased to announce the renewal of our existing credit facility, under the same terms and conditions for another five-year term. Coupled with our net cash position, this provides tremendous liquidity and flexibility moving forward. The company remains committed to having top quality equipment for our customers by spending $13.3 million on CapEx, adding 14 new rigs, including 7 underground drills, in line with our diversification strategy. We disposed of 11 older rigs in the quarter to finish the quarter with 603 drills. Also during the quarter, the company paid out AUD 7 million in contingent consideration in relation to the McKay acquisition as they successfully met all of their year one milestones. The new breakdown of our fleet and utilization is as follows: 293 specialized drills at 51% utilization, 115 conventional drills at 48% utilization, 195 underground drills at 61% utilization for a total of 603 drills at 54% utilization. As we've mentioned before, specialized work in our definition is not necessarily conducted with a specialized drill. Rather, it is work that requires that we meet the rigorous standards of our customers in terms of technical capabilities, operational and safety standards and other related factors. Over time, we expect these standards to be increasingly important to our customers. In the second quarter, revenue from specialized work accounted for 65% of our total revenue, up from 64% in Q1. The growth in specialized drilling was driven by senior/intermediate demand requiring a certain level of expertise to execute drilling programs. We continue to see a lot of interest in our specialized work as mining companies look to replace their depleting reserves. Conventional drilling made up 12% of our revenue, down slightly from 13% in Q1 driven by the slight decrease in junior activity. Finally, underground drilling revenue held steady from Q1 at 23% of revenue. As mentioned, revenue from juniors was down slightly in the quarter due to tight financing markets. However, they maintained a healthy level at 24% of our revenue, coming off slightly 25% in Q1. Seniors/intermediates made up 76% as they added drills in the quarter and continued their plans to address their depleting reserves. In terms of commodities, gold projects represent 45% of our revenue, while copper was at 23% this quarter. We've continued to see a shift in our commodity mix as copper and other battery metals are driving our business. Gold continues to provide a stable floor, but with current market conditions, has not seen the growth and interest that other commodities have. Thanks, Ian. As we enter our seasonally slower third quarter, customer demand for calendar 2023 looks to remain strong and we're already in discussion with several senior customers. Just in the last two weeks, we have seen gold prices come back above $1,800 and copper prices above $3.85 a pound as metal prices have remained at levels well above what is needed to support exploration. As well, in the last couple of weeks, we've seen a pickup in junior financing, which is all good news for the sector going forward. . As the global demand for electrification continues to grow, the world requires an enormous amount of volume of copper and battery metals, which is significant for our outlook in the future of our business. We believe that this will increase pressure on the existing supply-demand dynamic and lead to substantial additional investments in copper and other base metal exploration projects. This increase in both activity levels and diversification of commodities continues to drive demand for our services. Our growing fleet ensures we retain utilization capacity to meet this growing demand, and our capital availability ensures we have flexibility to increase our fleet when and where to consistently meet the needs of our customers across the globe. As well, it is crucial that we continue to aggressively and successfully invest in the recruitment and training of new drillers to ensure Major Drilling remains both the operator and employer of choice in our industry. We have made great progress over the last 18 months in growing our labor force, doing so with safety in mind, and we are starting to see the results of that training through our productivity. And I want to thank our crews out there for their hard work and success. In closing, I want to wish you all the best for the holiday season and to our teams, I ask you to rest well during that time as calendar 2023 is shaping up to be another very busy year. Congratulations on another outstanding quarter. Can you comment on your ability to outperform your competitors with respect to growth in North America? They seem to be struggling, whereas you are reporting very positive year-over-year growth. Yes. Well, I think it relates to the prep work we did through the downturn. We -- in the last upturn, we were playing catch up and -- because we came out with quite a bit of debt levels on our balance sheet and we're not able to invest in our fleet. And through that upturn from 2003 to 2012, we were playing catch up and just building up the fleet as we went. Whereas this time around, we entered the downturn with a strong balance sheet. So we invested in our fleet, put rigs on the shelf. We stocked up our shelves with inventory and also kept our key people and invested in our training schools. So all of those combined allowed us to get out of the block from the get-go to tackle the quick upturn in demand that we saw. And basically, that had an impact in terms of market share we were able to get. Okay. That's great. Your Australasia and Africa segment also saw a big jump in revenue this quarter. Can you provide some more color as to what's behind that? Yes. Well, I mean, we've got customers in the region that increased activity during the quarter, added rigs to their existing. Our Australasia business, I would say, is a bit more mature, a lot more seniors, not a lot of juniors in there. And the seniors, basically, those customers added rigs to their projects. That's where most of that growth came from. Perfect. First off, congrats guys on another great quarter. Just a couple of quick questions for me here. I guess, first, just given that we're heading into fiscal Q3, which is seasonally a bit of a weaker quarter, with demand being where it is and I guess all signs pointing to things remaining strong, are you expecting, I guess, the costs, given that you typically do rig maintenance in the third quarter, to be a little bit higher than what they typically are for a seasonally weak quarter, just given the increase in demand compared to prior years? I guess compared to the typical fiscal Q3, do you think you're going to be doing a lot more rig maintenance and spending a lot more on prepping for a busier calendar 2023? Okay. Yes. Well, I mean, it's all relative. We -- in absolute dollars, yes, we are. But basically, that's because we're generating more revenue and we're on a higher level. So we are certainly -- the rates are coming back from the field. There's more rigs coming back from the field. And the way things are looking, more rigs going out back in the field that needs to be prepped. So yes, cost will be higher, but we've got more revenue to absorb that, so should be okay. Okay, fair enough. And then I guess you kind of touched on how a little bit of weakness, I guess, in the gold explorers has been offset by increased demand from seniors and some of the battery metals. Given the way things are looking, how much smaller do you think that kind of gold slice of that pie will get as it gets kind of offset by things like copper and nickel? Is there kind of -- how much lower, I guess, can that go? Well, I think you're in a better position to assess that as what the gold companies are going to do; because at this point, for us, we're still waiting for budgets. And so, we're waiting to see. But there's definitely a need to increase reserves, and the discussions we're having with gold companies right now are very positive. They're all talking about having to do at least the same amount, if not more, in certain cases. So we feel really positive on the gold going forward, that they'll be able -- we'll be able to maintain our level of activity in 2023 and then add on, tack on more work on the base metal side. Okay. Perfect. Makes sense. And then I guess maybe just one last one for me. You touched on adding 7 underground rigs. Are those more for production drilling? Or is that exploration? And I guess, maybe the rationale for my question here is, is it kind of building, I guess, a bit of a base given that it's a cyclical type of business? Is it building a bit of a base so that when exploration does start to turn, at least it gives you a bit of a cushion in that you've got a bit more of a segment with more kind of stickier, longer-term contracts? Well, whether it's exploration or production in underground, what we found in the last upturn -- last downturn is that, yes, it was stickier. And also, even through an upturn, it gives you that base. It's a 12-month a year steady revenue. Again, whether it's production or exploration, the minute you're in an underground mine, by definition, it is a producing mine. And they need to keep doing that work if the mine is going to produce. So therefore, it gives you that assurance of revenue. Whereas on surface, it's a little bit of sometimes stop and go during the year. So yes, I mean, that strategy -- diversification strategy or the investment we made in the underground rigs is completely in line with that. And it is to basically keep building that base of steady business throughout the year. And it's working out -- it's been working out well for us. Okay, perfect. And then sorry, one other one here for me and then I'll jump back in the queue. But just on the utilization rates, are there any areas, I guess, where the rates are still pretty low, where you see a lot more room for growth? Or is it pretty steady-ish around that 50% mark on a global basis? Well, on a global basis, it's different everywhere, right? I mean, it's -- in North America, it's definitely stronger than it is in South America, for example, But that is normal compared to what we've seen in previous cycles, whereas we see basically, the activity picks up in North America first in an upturn just because the money that gets raised or the investment that gets made early on in the cycle tends to be closer to home. And then as the cycle progresses and commodity prices improve, then you start to see more investments going abroad. And that's kind of what the trend we're seeing. So we've been seeing utilization picking up in areas outside of Canada, U.S. over the last six months. Whereas in Canada, U.S. and Australia, we're already seeing some strong utilization numbers in those areas. First question is around the juniors. And just wondering if you could help me reconcile some of the commentary in the release about decline or slight softening of junior activity. But based on the 24% split, it seems like it's pretty stable. So maybe just a little bit more color on what you're seeing there and whether you expect that to trend lower in the next few quarters or if we need more financing activity to push juniors higher again? Yes. Well, it's more -- in terms of growth, the growth had stopped, and that is related to the slowdown in financing activity that we saw. Now there's been a lot of money raised over the last 18 months, and that money is still getting spent in the field. And that's why that -- we were still able to hold up to 24% of our revenue this quarter. But it is -- as we progress, we're seeing more activity coming from the seniors. And the seniors are, again, in discussions, are talking about doing -- in many cases, doing more next year. So that's kind of what we're seeing in terms of how things are playing out. Okay. And then following on that, if we did not see a return of the financing markets, do you think -- and I know it's early days, but do you think it's possible we could have an increase year-over-year in results without any material junior financing, i.e., could the seniors push things higher year-over-year? Well, in our case, the juniors were working for are well financed at the moment. So the projects we're on -- we feel that -- we feel pretty good about them for 2023. So therefore, I think we should be okay for 2023. But I mean, if the financing window doesn't open, it's shored up down the road, those juniors, then we'll have to slow down their activity because they live and die by drill results. So -- and if they're not getting recognized, those drill results, through financing, then, yes, we could see that down the road. But like I say, in our case, we feel pretty good because of the juniors we're aligned with. Got it. Okay. And then on the battery metals, was the increase in the quarter a reflection of more work with existing customers? Or are you seeing net new contract wins with battery metal miners and explore cos? It's a bit of both. We saw increased activity by existing customers, but we also moved on some new projects as well in terms of copper and nickel and silver and things like that. Okay. And one last one for me. Just with respect to the miners and the new construction of projects. We've seen some pretty eye-popping inflation numbers for their CapEx budgets on new project development, would you anticipate that -- and possible deferrals next year. Would you anticipate that to impact the drilling? Or do you see them as continuing the drill programs in advance in preparation for a future build date? Well, like I said, we haven't seen the budget yet for next year. So at this point, it's still hard to call for us. All we -- while what we have to go by is the discussions we're having at this point, and they are pretty positive in terms of activity levels for next year. So that's I got to believe. And also when you when you consider that there's -- some of them are so far behind in terms of reserves and having to catch up and they've been delaying for a few years in terms of exploration and got going in 2022, I think for them it would be hard to stop that motion considering the amount of work that's still left to be done to shore up their reserves. I have a very simple question, as usual. Ian basically said, our operational leverage continue to generate excellent financial results. It seems to me that going forward, you guys are going to be almost debt-free and the contingent payments are going to be gone and you're just going to be generating an incredible amount of cash. What is -- how does that figure into your strategic thinking? Yes, for sure. From a capital allocation standpoint, and then we got asked this question last quarter, right now, we still feel it's early in the cycle. And so our focus is on growth right now. And so that's either new jurisdictions, organic growth or potential M&A, tuck-in opportunities that are out there. The balance sheet, the way it's set up, provides tremendous flexibility right now. And what we're looking for is good opportunities. And that's what we feel is going to bring the best value for our shareholders. And so at this point in time, that's the strategy. Well, the previous -- one of the previous question is asked how you're doing so well against some of your competitors who didn't get out of the gate as quickly as you did. Is that where you see opportunities to grow? Yes. I mean, there's -- again, we're still very early in this cycle. When you go back, the amount of exploration that was spent in 2012 was $21 billion. And last year, there's only $11 billion that was spent. And that's after two years of increased activity and exploration. So there's been quite a bit of a drag in terms of exploration. And therefore, the last upturn lasted nine years and we're just starting year three of this upcycle. So still a lot of room to go and to grow. And to your point, yes, I mean, there are probably opportunities out there to grow. Okay. Great. I think you guys are doing a great job. The market just opened. I wonder what that's going to mean. All right. All the best. I was wondering if you ever get inquiries or if you ever consider listing in the U.S. rather than trading on the pink sheets? Or if you could give any insight into that at all? It's not part of -- we haven't looked at it. It's not part of our of our plans at the moment, no. I mean, that is part of it. But again, it's not something that we have in our plans at the moment. Would it involve additional accounting expense? Or I mean, would you consider it? What would be the barriers to considering it, expanding your U.S. ownership? I mean, I know people can trade on Toronto, but small investors don't always have access to foreign markets. Yes. I mean, right now, the bulk of our holders are institutionally owned, and we haven't come across a big demand for listing. In terms of the accounting and back office functions, yes, there would be some additional support needed to have a U.S. listing that we have looked at. But that's not the main reason. For now, it's that our -- the main institutional interest in us can access our float on the TSX. So at this point in time, we are seriously looking at it. Hi, Denis and Ian. Thanks a lot for taking my questions and congrats on another great quarter. I have three questions for you today, and mine are related to the cycle, your competitive position and the implications of those two factors on your next peak EBITDA. So first, just revisiting the potential length and magnitude of this current upcycle. I believe the gold reserves are currently about 10% lower today than they were back in 2005, which was, call it, roughly the beginning of the last upcycle. And it took about eight subsequent years of elevated exploration activity for miners to shore up their reserves back then. And total exploration spend at the peak of that last cycle in 2012, it was about 75% higher than the expected level for this year. So I guess my question is, with that context, is it reasonable to assume that this upcycle should last for several more years and exploration spend could continue to increase well above 2022 levels if miners are going to replace the reserves that they've depleted? I mean, definitely, as you mentioned, the -- we're still a long way from the exploration spend that was there in -- at the peak in 2012. So -- and as I said, we're just in starting year three of that upcycle. Now how long will it go? I mean, nobody knows. But there's definitely a need for a lot of exploration to fix up the reserves. And when people look at metals, I mean, what you hear in the market right now, what you read is all about demand, and there's a big -- there's a lot of threat in terms of the demand coming for copper, for battery metals, for all of that. But the supply side is what drives our business. And when you look at the supply and the reserves, the way -- and I mean, you said it yourself in terms of even on the gold reserves being 10% less than what we saw in 2005. There is definitely a need for a lot of exploration going forward. And with everything getting deeper, more remote, which will, by definition, require a lot more drilling, it will be interesting to see where it gets going forward because there's going to be a need -- there's a need for a lot more exploration to shore up the reserve. And then you lay on top of that the demand for those metals that keeps increasing, then, yes, I feel really good about the future. I mean, from my perspective, it just feels like the market backdrop is so powerful that even if you do see a slight softening of the juniors, I just struggle to see how that really matters in the grander scheme of things because it sounds like we're in the earlier innings of a prolonged upcycle with further exploration activity yet to come if -- quite frankly, if miners don't want to deplete themselves out of existence. So that's a powerful macro backdrop. So I guess I'll turn to my second question, which is on your competitive position. And you've spoken about this a bit already, and I think everyone knows that your two largest competitors have had capital structure issues since the last upcycle that have materially limited their ability to invest, as you've discussed; while, at the same time, you've had a great balance sheet. And I think that would really help strengthen your competitive position. And so the way we looked at it is we said, let's pick a simple metric like revenue. And on that metric, it looks like your relative size versus your two major competitors has grown very significantly. So if I pull out just the big 3, call it, Major, Boart Longyear and Foraco, and I go back to the last peak, it looks to us like your share of revenue then was about 16%, and that's grown to around 31% now, which would suggest you've nearly doubled your market share relative to your two largest competitors, And that would seem to be proof that you're in a much stronger competitive position today? And maybe is that the case? Is that fair to assume? Yes. Well, like I mentioned, the -- in the last upturn, we started on the back foot, really. And just the fact that we had to rebuild our fleet through that upturn, and rebuild our level of crews and build up our inventory. So -- and that took time. And whereas this time around -- and at the time, we had a few of our competitors that were in much better shape financially than we were, and therefore that got out of the blocks quicker than we did. And whereas this time around, I think the rules are -- have been reversed, like you said. During the down cycle, we used our balance sheet to just prep our rigs, stock up and train people and -- so that we were able to get out early and grow. And that -- I think that's what explains the -- yes, the market share that we were able to get. Okay. Great. And so last topic for me is really just understanding the implications of all of that on the company's next potential peak EBITDA. And I guess, just to be clear from the start, I don't expect you to provide any guidance here. I just want to sense check a few of my own assumptions. So my understanding is that right now, your average revenue per utilized rig is about $2.35 million, if I updated my calculation correctly for the information on this call. And closer to a cyclical peak, your capacity utilization could be at least 75%, which would imply a little over 450 rigs out there in the field. Now if that's directionally correct and that revenue per utilized rig is sustainable, which it sounds like it is, your revenue would be north of $1 billion. Is that right? Okay. Great. And so closer to the peak of a cycle I'd expect your gross margin to be near to what you achieved during last peak. So I'll say about 32.5% is reasonable, and that's actually not far from where you are already. And that would get me to about $345 million of gross profit in a peak scenario. Is that in the ballpark? Well, as a margin percentage, I would -- during the downturn, it kind of forced us to look at ways to be more productive, be more efficient. So we've put things in place, procedures and better equipment. And so, I'd like to think that with everything being equal, that we'd be able to replicate and probably do a bit better than we did on margins if we were to reach the same peak level as we did in 2012, yes. Okay. So that suggests that that's potentially even a reasonably conservative number. So -- but I'll keep it for conservatism. And if I then add in your SG&A costs, which I'm just assuming grow with a high level of inflation as well as some variable expenses, that gets me to about $85 million in incremental expenses. And that takes me to a peak EBITDA of $260 million, which, of course, I don't expect you to comment on that, but that is significantly higher than your last peak EBITDA of $180 million. And I just don't think that the market really understands that, that's the direction you're going. And so all I can say is that from Mill Road's perspective, you guys should keep on doing what you're doing because you're doing a great job, and hopefully the market will figure it out at some point. So thanks again for taking my questions and congrats on a great quarter. Just a quick one for me on, I guess, CapEx expectations/maybe rig growth fleet going into calendar 2023? And secondly, anything we should read through? And I noticed like working capital was a net positive or cash inflow in the quarter. Anything to comment on that? Or is that just a natural flow of business? Well, on the CapEx, we're -- we offered guidance when we started the year for our fiscal year which ends at the end of April. And we projected $65 million of CapEx. At the moment, I think we're at something like $26 million of CapEx after -- I don't have the numbers in front of me, but I think we're at around $26 million year-to-date. And so we're a bit behind in terms of that spending. But we do have rigs on order coming in over the next few months. So we'll see where that goes. And then beyond that, I think you can probably expect that level to stay at about those levels going forward unless things change dramatically either way. If we had like a huge additional influx in domain in certain areas, we might have to add a few more rigs in some of the areas. But right now, I think that level would be appropriate going forward. And on the working capital question, nothing really to read into in the quarter. It's a lot of timing for receivables. At Q1, we had some outstanding that flowed in into the quarter. And then we had some payables increase during this quarter just with timing of expenses. So nothing unusual or anything to read into there. Congratulations. I just want to reiterate about listing in the United States and increasing or expanding your shareholder base. I don't know if your Board or if you guys realize that if you are a -- you're not blue skied in the United States, it seems like it would be simple for you to do this to increase your shareholder base, broaden it and possibly get coverage from U.S. research. They're not going to cover you unless they can market your stock to their clients. The world is different today. The last upturn, the regulations in the United States weren't as stringent on the blue sky. I don't know if you all know that. But you can't put an order in if -- for a retail client in the United States unless you're blue sky, that mean the computer systems block it. So an advisor cannot solicit an order, you're not going to get research. So why would you not want to broaden your -- your base is 83% institutional. And with Fidelity in there, Fidelity decides to move out of your stock. It's not going to be friendly to the rest of your shareholders if they decide they want to own it. Would you please consider getting listed in the United States? It's certainly something we're certainly going to look at. It's also -- I mean, a big thing also is the size in terms of just the -- our -- basically, our capital or the size -- we're a small cap. That's what I was looking for. We're still a very small cap stock. And so in terms of cost and everything, it is -- that's what we need to look at, is the cost benefit. But I hear you. It's something that we're going to consider seriously, especially as our -- basically, our value starts to -- continues to grow. We're certainly getting to that -- with time, we can see getting to that $1 billion mark of market cap. So once you get in those ranges, that's where then you start to be more on the radar of investors like that. And that's where it might make sense for us to be listed. So it's all a matter of market cap, timing, costs and all those things that we need to consider. At this point, we haven't considered it just because our market cap is still quite small. But it's something that with time, we'll certainly need to consider. I'm trying to get your market cap to $1 billion. So it's kind of waiting for it to get there to do this. It doesn't make sense to me. It makes sense to do it now to try to assist you in getting to a market cap of $1 billion. There's a huge market out there that might want to invest in your company or hear about your company, and they're prohibited because of the regulations. So to spend $1 million on -- the investment would -- let's say it's $1 million, but you open up the biggest market in the world for your company, it seems to make sense to me. But thank you for your consideration, and thanks for a great job. Thank you. There are no further questions registered at this time. I'd like to turn the meeting back over to Mr. Larocque. Well, thank you. And as I mentioned, I want to wish everybody the best for the holiday season, and we'll be talking to you in the new year. Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.
EarningCall_1564
Good day and thank you for standing by. Welcome to the Atlantic Union Bankshares Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] Please be advised today's conference is being recorded. I would now like to hand the conference over to your speaker today, Bill Cimino, Senior Vice President, Investor Relations. Please go ahead. Thank you, Michelle. And good morning, everyone. I have Atlantic Union Bankshares' President and CEO, John Asbury, and Executive Vice President and CFO, Rob Gorman, with me today. We also have other members of the executive management with us for the question-and-answer period. Please note that today's earnings release and the accompanying slide presentation we are going through on this webcast are available to download on our Investor website, investors.atlanticunionbank.com. During today's call, we will comment on our financial performance using both GAAP metrics and non-GAAP financial measures. Important information about these non-GAAP financial measures, including reconciliations to comparable GAAP measures, is included in the appendix to our slide presentation and in our earnings release for the fourth quarter and fiscal year of 2022. We will make forward-looking statements on today's call, which are not statements of historical fact and are subject to risks and uncertainties. There can be no assurance that actual performance will not differ materially from any future expectations or results expressed or implied by these forward-looking statements. We undertake no obligation to publicly revise or update any forward-looking statements. Please refer to our earnings release issued today and our other SEC filings for further discussion of the company's risk factors and other important information regarding our forward-looking statements, including factors that could cause actual results to differ from those expressed or implied in any forward-looking statement. And all comments made during today's call are subject to that Safe Harbor statement. Before I turn the call over to John Asbury, I wanted to remind everyone that Atlantic Union Bankshares common stock and depository shares, each representing 1/400th interest in the share of our preferred stock, are both now trading on the New York Stock Exchange. Our common stock symbol remains AUB, while our depository shares trade under AUB.PRA to conform with the NYSE nomenclature for preferred stock. Thank you, Bill. Good morning, everyone. And thank you for joining us today. Atlantic Union Bankshares delivered a strong quarter to close out 2022. Importantly, we hit our top tier financial targets during the fourth quarter as we said we would. We recorded low double-digit annualized loan growth, our net interest margin expanded meaningfully, asset quality remains strong, we kept expenses in line and generated significant positive operating leverage. As in prior quarters. I would like to begin by commenting on the macroeconomic environment and our primary operating footprint before I delve more deeply into details on our results. For perspective, traditionally, Virginia has been a stable economic area and not one prone to big swings in either direction. The federal government acts as both a significant catalyst and shock absorber to the Commonwealth's economic engine and the economic base here is diverse. Given how Virginia has fared in the past, we currently expect the effects of any potential recession to be somewhat muted as here, although we believe we are well positioned should economic conditions worsen from historical trends. Virginia's last reported unemployment rate of 2.8% in November notched up slightly from 2.6% at the end of last quarter, but it remains below the national average of 3.6% during the same time period. This is relatively in line with where it was before the pandemic. As I like to do, I've been out meeting with our clients, the Virginia business community and our teams, and I can report that, anecdotally, we still do not believe dreary economic headlines nationally reflect what we see going on in our footprint. Our markets appear to be healthy, and our lending pipelines, while down about 5% lower than the same time last year, are strong. We still don't anticipate any near-term shift away from the positive trends of low unemployment and a benign credit environment, but we will continue to monitor conditions in our markets. While we do expect the Federal Reserve to further raise short term rates in the first half of 2023. Since we are fairly asset sensitive, additional short term rate hikes over the next few quarters should support our operating results and help to offset increases to cost of funds and the rising rate environment and accelerating deposit rate competition. As usual, we remain focused on generating positive operating leverage. That is, growing our revenue faster than our expenses. Our numbers have been noisy for the past few years with pandemic-related loan loss provision swings, the revenue impact of the Paycheck Protection Program and various expense reduction items such as branch and facility rationalization. But if you drill down and adjust for those factors, which were not as material this quarter, you can see the strength of the core franchise over time. And to that point, pre-PPP adjusted revenue growth was approximately 11% year-over-year and was 7% on a linked-quarter basis from the third quarter of 2022. As a result of prior expense management actions, our adjusted operating non-interest expense run rate increased 4% year-over-year and was flat quarter-over-quarter. Company generated positive pre-PPP adjusted operating leverage of approximately 7% on a year-over-year basis and 7% quarter-over-quarter. I'd also like to point out that, excluding PPP, pre-tax pre-provision adjusted operating earnings increased 23% year-over-year and 17% from the prior quarter. Now let me turn to some of the high points for the quarter and 2022. We posted annualized loan growth of approximately 15% point to point in the seasonally high fourth quarter. And for the full year, we recorded point to point loan growth of approximately 11% excluding PPP. This was our fifth consecutive quarter of high-single digit annualized lung growth or better, excluding PPP. We believe that we are well positioned to deliver 6% to 8% loan growth for 2023, given the strength of our current pipeline, our competitive positioning, the market dynamics and fundamentals in the markets that we serve. We do recognize that the economic environment in our footprint could change as persistent inflation, higher interest rates and the threat of recession do loom, but currently we expect to remain in a moderate growth mode in 2023. C&I line utilization ticked up at the end of the quarter to 35%. And that's still below our pre pandemic levels of over 40%, but better than at this time last year, which was approximately 28%. We believe we have further upside here as working capital needs continue to normalize among our clients over time. Our loan production in the fourth quarter of 2022 nearly equaled our record production in the fourth quarter of 2021. About 43% of production in the fourth quarter came from new-to-bank clients and 57% came from existing clients. CRE payoffs continued to slow year-over-year and are well off the peaks we saw in the second through fourth quarters of 2021. As I've said for the last two quarters, rising term rates have suppressed both refinance activity into the long term institutional markets on commercial real estate and too good to refuse offers on commercial real estate properties. In the fourth quarter, we saw a notable acceleration in deposit rate competition. While deposits averaged up 3% quarter-over-quarter, we did experience runoff at the end of the year, largely in transaction accounts, impacting our point-to-point growth comparisons and more than offsetting the $418 million deposit increase we experienced in the third quarter. Nearly all of the third quarter increase was also in transaction accounts. For the full year, point-to-point deposits declined 4.1%, and that was actually consistent with our original expectations for the year. There were a number of factors behind the late December transaction account runoff. These include a relatively small set of larger commercial clients and affluent consumer clients with excess liquidity, moving funds to higher yielding alternatives, normal seasonality outflows and some spending increases due to inflationary factors. At year-end, our loan-to-deposit ratio was 90.7%, which is at the lower bound of our targeted range of 90 to 95%. As of yesterday, the loan-to-deposit ratio was approximately 88%, with the improvement coming from deposit growth we posted month to date in January. Deposit rate competition intensified in the fourth quarter along with a rapid unprecedented rise in short term rates, and we have made further rate adjustments to seek to maintain competitiveness and defend the deposit base. Since our deposit base overall is pretty granular and comprised of 57% transaction accounts, we do expect deposit betas throughout the remainder of the rising rate cycle to increase, but still be manageable. Our latest modeling shows that our net interest margin is likely now at or approaching an equilibrium point. By that, I mean we expect NIM to hold steady from here and further rate actions by the Fed will allow us to offset higher rates paid on funding with higher yields on our loan portfolio, half of which is variable rate. It's difficult to forecast exactly what will happen, but we believe this is the most likely outcome. Rob will provide additional perspective on this during his comments. I do want to touch on a few new fee-based activities I mentioned last quarter. We retooled our SBA 7(a) program in June and executed our first 7(a) loan sale during the fourth quarter. Additionally, loan syndications, originations were active and we are building a run rate with our foreign exchange program. The combination of these three new capabilities resulted in $1.3 million of fee-based net revenue for the quarter, and we expect them to generate around $6 million of net revenue over the course of 2023. Worth noting is that these new revenue streams should largely offset fee income declines from the various customer friendly NSF OD changes we made last year. Asset quality remains strong, with annualized net charge-offs of 2 basis points for the fourth quarter. For the full year. net charge-offs were also 2 basis points. Credit losses will eventually normalize to historical norms, and one-offs can come at any time. But given the continued low unemployment rate and still solid fundamentals in our markets and client base, we have yet to see any sign of a systemic inflection point in our asset quality metrics. While economic uncertainty and the threat of recession could negatively impact our markets, the current economic situation and the footprint appears to remain sturdy and, as noted, we expect the impact of any macroeconomic slowdown to be somewhat tempered here in our home state of Virginia. Because we believe we're in the late stages of a NIM expansion cycle, we also took additional expense actions during the quarter. Among other efficiency initiatives, we decided to consolidate five additional branches set for closure in March. Since the pandemic began, we have consolidated 27% of our branch network, yet still posted net positive consumer household growth for the year. In sum, 2022 was not only a good year for Atlantic Union, but also a good demonstration of the value and earnings power of the franchise we have all built. Looking back at my now six years at the company, we have been clear, consistent and intentional in our strategy. We've made great progress in successfully diversifying our product lines and capabilities, while building our core franchise, our culture and our brand. We're far from done with these efforts. And in fact, we'll never be done since we view our transformation as continuous and not an event. But we have come a long way, a very long way. And for that, I'd like to express my gratitude to our teammates, since they are the ones who make this all possible, delivering each and every day for our customers, shareholders and the communities we serve. Looking ahead, I remain confident that we're well positioned to manage our way through the challenges that lie before us. While the operating environment may be uncertain, what is certain is that Atlantic Union Bankshares remains a uniquely valuable franchise. It is dense, it is compact and great markets with a story unlike any other in our region. We're scalable, and we're growing our capabilities, operating in the right markets with the right team to deliver top tier financial performance, even in the most trying of times. I'll now turn the call over to Chief Financial Officer, Rob Gorman, to cover the financial results for the quarter. Rob? Well, thank you, John. And good morning, everyone. Thanks for joining us today. Now let's turn to the company's financial results for the fourth quarter. In the fourth quarter, reported net income available to common shareholders was $67.6 million and earnings per common share was $0.90. This was up approximately $12.5 million or $0.16 per common share from the third quarter's reported net income available to common shareholders. Return on tangible common equity was 22.9% in the fourth quarter, up from 17.2% in the third quarter. Return on assets was 1.39% in the fourth quarter, up from the 1.15% reported in the prior quarter. And on an operating basis, the efficiency ratio was 50.6% in the fourth quarter, down from 54.1% in the third quarter. Also during the fourth quarter, the company continued to generate positive operating leverage as total revenue grew approximately 7% and operating expenses were flat on a linked-quarter basis. Importantly, as John previously mentioned, we hit all of the top tier financial targets we set on a run rate basis in the fourth quarter. Turning to credit loss reserves, as of the end of the fourth quarter, the total allowance for credit losses was $124.4 million, which was an increase of approximately $5.4 million from the third quarter, primarily due to net loan growth during the quarter and increased uncertainty in the macroeconomic outlook. The total allowance for credit losses as a percentage of total loans remained at 86 basis points at the end of December. The provision for credit losses of $6.3 million in the fourth quarter was relatively flat from the prior quarter's $6.4 million provision for credit losses. Net charge-offs remain muted at $810,000 or 2 basis points annualized in the fourth quarter. And for the year, the net charge-off ratio came in at 2 basis points as well. Now turning to pre-tax pre-provision components of the income statement for the fourth quarter, tax equivalent net interest income was $168 million, which was up approximately $13.4 million or 8.7% from the third quarter, driven by higher interest income due to increases in loan yields on the company's variable rate loans due to rising market interest rates and average loan growth, as well as increases in investment income primarily due to increased yields on taxable securities. These increases were partially offset by higher interest expense due to higher cost of funds, primarily reflecting the impact of increases in short term interest rates on borrowings and deposits, increased use of short term funding and higher average deposits from the prior quarter. The fourth quarter's tax equivalent net interest margin was 3.70%. That's a net increase of 27 basis points from the previous quarter due to an increase of 66 basis points in the yield on earning assets, partially offset by a 39 basis point increase in our cost of funds. The increase in the fourth quarter's earning asset yield was primarily due to the 70 basis point increase in the loan portfolio loan yield, which had a 62 basis points positive impact on the fourth quarter's net interest margin. In addition, higher investment securities yields in the fourth quarter drove a 3 basis point increase to the quarter's net interest margin. The loan portfolio yield increased to 4.90% in the fourth quarter from 4.2% in the third quarter, primarily due to the impact of rising short term interest rates on variable rate loan yields. The 39 basis point increase in the fourth quarter's cost of funds is due primarily to the 32 basis points increase in the cost of deposits, driven by increases in interest checking, money market and time deposit rates, as well as increased wholesale borrowing rates due to rising market interest rates. Non-interest income decreased $1.1 million to $24.5 million, primarily due to declines in equity method investment income, partially offset by increases in loan syndication, SBA 7(a) and foreign exchange revenues, each included within other operating income line item. In addition, mortgage banking income decreased $1.01 million from the prior quarter due to lower mortgage origination volumes and gain on sale margins. And bank-owned life insurance declined $796,000, reflective of the impact of prior quarter's mortality benefit received. These non-interest income category decreases were partially offset by increases in loan-related interest rate swap fees of $1.6 million due to an increase in average deal size amongst swaps executed in the quarter. Non-interest expense decreased $130,000 to $99.8 million for the fourth quarter versus $99.9 million in the prior quarter. Notable expense activity in the fourth quarter of 2022 included a gain related to the sale and leaseback of an office building, refunds of prior-period FDIC assessment expenses, costs related to the closure of five branches expected to close in the first quarter of 2023, as well as other restructuring expenses, the write-off of obsolete software during the quarter and increased variable incentive comp and profit sharing expenses, as well as professional services fee increases related to strategic projects incurred during the quarter. Our effective tax rate for the fourth quarter declined to 14.3% from 17% in the third quarter due to changes in the proportion of tax exempt income to pre-tax income. In 2022, the full-year tax rate came in at 16.2%. In 2023, we expect the full-year effective tax rate to be in the 17% to 17.5% range. Now, turning to the balance sheet. Total assets were $20.5 billion at December 31, and that's an increase of $511 million or approximately 10% annualized from September 30 levels. The increase was primarily due to loan growth during the quarter. At period end, loans held for investment net of deferred fees and costs were $14.4 billion, inclusive of $7.3 million remaining in PPP loans net of deferred fees, an increase of approximately $530 million or 15.1% annualized from the prior quarter. If we exclude PPP loans, adjusted loans held for investments in the fourth quarter actually increased 15.3% annualized from September 30, driven by increases in commercial loan balances of $478 million or 16.2% linked quarter annualized, and consumer loan balance growth of $57.1 million or 10.2% annualized. Excluding the effects of PPP loans, adjusted loans held for investment in the fourth quarter increased $1.4 billion or 10.7% from the same period in the prior year. At the end of December, total deposits stood at $15.9 billion, and that's a decrease of $615 million or approximately 14.7% annualized from the prior quarter, while average deposits were actually up $123.5 million or 3% annualized for the quarter. At December 31, the transaction-related deposit accounts comprised 57% of total deposit balances, which is down a bit, a basis point from third quarter levels. And as John mentioned, the loan-to-deposit ratio is now at the lower bound of our targeted range of 90% to 95% at year-end. From a shareholder stewardship and capital management perspective, we remain committed to managing our capital resources prudently as the deployment of capital for the enhancement of long-term shareholder value remains one of our highest priorities. Regarding the company's capital management strategy, capital ratio targets are set to seek to maintain the company's designation as a well-capitalized financial institution and to ensure that capital levels are commensurate with the company's risk profile, capital stress test projections and strategic plan growth objectives. At the end of the fourth quarter, Atlantic Union Bankshares and Atlantic Union Bank's regulatory capital ratios were well above well capitalized levels. The company's tangible common equity and tangible assets capital ratio increased from the prior quarter, primarily due to the increase in the value of the available for sale securities portfolio as long term rates decreased somewhat during the fourth quarter. Again, we believe that the GAAP accounting versus regulatory accounting capital impacts of unrealized mark-to-market losses from rising interest rates in the available for sale securities portfolio will be recouped over time. Therefore, we also track tangible common equity ratio and tangible book value excluding this non-cash GAAP accounting requirement. During the fourth quarter, the company paid a common stock dividend of $0.30 per share, which was consistent with the prior quarter and also paid a quarterly dividend of $1.7188 each outstanding share of Series A preferred stock. The company did not repurchase any shares during the quarter in order to preserve capital for organic loan growth and to position the company for any adverse developments arising from the current macroeconomic environment. [indiscernible] following top tier financial targets and, as noted, achieved them during the quarter. Return on tangible common equity within a range of 18% to 20%, return on assets in the range of 1.3% to 1.5% and an efficiency ratio of 51% or lower. Regarding the efficiency ratio target, I'd again like to point out that it is difficult to compare our efficiency ratio to banks that don't have significant operations in Virginia since Virginia banks do not pay state income taxes, but instead pay a franchise tax that flows through non-interest expenses and not income taxes. The franchise tax quarterly non-interest expense run rate of approximately $4.5 million added approximately 2.4% to the company's fourth quarter efficiency ratio. So setting the efficiency ratio target at 51% or lower is akin to a 49% or lower efficiency ratio target for peer banks not headquartered in Virginia. As a reminder, our top tier financial targets are dynamic and are set to be consistently in the top quartile among our proxy peer group regardless of the operating environment. As such, we reset these targets periodically to ensure they are reflective of the financial metrics required to achieve top tier financial performance versus peers in the prevailing economic environment. We do expect to achieve our financial targets for the full year based on the following key assumptions. We expect to produce 6% to 8% loan growth in 2023. We expect the net interest margin to stabilize in the 3.7% to 3.75% range in 2023 as a result of the company's asset sensitive position and the assumption that the Federal Reserve Bank will increase the Fed funds rate to 5% and maintain it at 5% throughout 2023. As a result of loan growth and a stable net interest margin, we expect net interest income to grow by 13% to 15% in 2023 from full-year 2022 levels. We also expect that the company will generate meaningful positive adjusted operating leverage in 2023 due to low teen revenue growth outpacing mid-single digit expense growth in 2023. On the credit front, while we have not seen any systemic credit quality issues to date, due to expectations for a mild recession to begin sometime in 2023, for modeling purposes, we are assuming an uptick in a net charge off ratio to 10 basis points in 2023 from 2 basis points in 2022. I would reiterate that we do not see evidence of a return in the credit environment at this point, but one-offs are bound to pop up every now and then. The allowance for credit losses to loan balances is also projected remain within the range of 85 basis points to 90 basis points in 2023. In summary, Atlantic Union delivered strong financial results in the fourth quarter of 2022 as evidenced by hitting each of our top tier financial targets. As a result, we believe we are well positioned to generate sustainable, profitable growth and to build long term value for our shareholders in 2023 and beyond. And with that, I'll turn it back over to Bill Cimino, who will open it up for questions from our analyst community. Bill? I guess, first, bigger picture, John. Can you just remind us your views and sort of how you're thinking about bank M&A for Atlantic Union this year? I would say nothing has changed, Casey, for what you've heard for a while. We view that as a possible supplemental strategy. We believe we can accomplish what we intend to accomplish without that, which does not mean that we wouldn't consider it. We would. But it will be a supplemental strategy. Big picture, the preferred approach, if we were to look at it, would be to do something – actually, let me backup. Clearly, it would have to make a strategic and financial sense and meet our acquisition parameters, et cetera, or we wouldn't consider it. The ideal scenario would be something that is on the smaller side. And it would be more likely than not an infill within our existing markets where we can continue to increase density across Virginia, which would be the first choice and really drive brand power, extract cost, and use that for investment everywhere. We love continuing to densify in Virginia. We think we have a long way to go. We're not about to run out of room. We would consider contiguous markets. The most logical ones for us would be Maryland and North Carolina that becomes much fewer and further between. So again, a secondary strategy is not a primary strategy. It is a tough environment to do it. You have to think about the rate marks. And so, I think that one of the bigger constraints could potentially be just having to come to grips with whether it's going to pencil out in terms of financial metrics. Anything to add to that, Rob? Well, I think you've hit all the objectives that we would have from an M&A point of view. And we'll see where we go from here. But it is a secondary strategy, as you note. A lot of organic opportunities that we want to work on In this environment, a good core depository franchise becomes more attractive than ever. I would add that as well. It goes without saying you would have to have great confidence in asset quality and the due diligence. So that's our thinking about it, Casey. Just looking at the loan production this quarter, Rob, can you give us a sense for where like the new loan yields are coming on, either during the quarter or where they're coming on now? During the quarter, as we said, we had really strong production this quarter. And if you look at the various originations, about 65% of the new production came on from a variable rate – actually, it's a bit more than that, 75% when you include prime loans. Those are coming in in the 6.5% to 7% range in terms of yields. And then, the remainder is fixed. And those have been coming in, call it, the lower 5s, 5% to 5.50% on those. So, overall, it's a bit above 6% when you blend it all together in terms of new yields coming on. Of course, the spreads over the indexes, as libraries increased and primes increased, those have remained fairly constant as rates have been rising, but those will be the yields that we're seeing right now in terms of a new book. Appreciate the update guide. I guess I'm wondering what kind of position you will be in if the Fed does begin to pivot. Like, have you taken some of your assets sensitivity off the table at year-end from where you were at 09/30? Or maybe just walk us through how expectations might have to shift in that sort of environment? As I noted in my comments, we do expect that the Fed will get up to around 5%, maybe a little higher, kind of stay there for a while, likely, in our minds, in 2024 before they start thinking about lowering rates back down. Certainly, we don't expect that they would go back to a zero rate environment. But we have taken some asset sensitivity off the table. We've entered into a few swaps in terms of protecting ourselves on the downside where we're capped out on where SOFR goes, for example, put about $500 million on the books where we're in the money if SOFR drops below, I think, about 3.60% or 3.75%. So there is some of that going on. Of course, that doesn't take the full asset sensitivity off the table. So, there would be some compression, if you will, net of that, those strategies we put on, if that were the case. John, just curious from maybe a macro perspective. As you look out, depending on how the Virginia economy holds up and your experience in the market, do you expect anything different, if we do enter a recession in terms of how the state is positioned to respond? And then, in that, how you're positioned relative to maybe the financial crisis in 2008/2009? Well, I don't expect anything different, which does not mean that we couldn't experience something different. It actually was not here in 2008/2009. I was in the southeast. But I can tell you, and you know this, David, because you live in the area, Virginia would have been one of the more resilient areas, the greater Washington DC for the reason we keep pointing back to, which is you just have the stabilizing fact force of the US government, the US military, etc. The economy has only become more diversified since then. You look at all that has happened across the state, we feel quite confident. One of the things that keep looking at is the unemployment rate. And so, the unemployment rate right now is 2.8%. It ticked up 2 basis points. 2.8%. US average is something like 3.6%. And it's really hard to see it falling off a cliff. I think our CECL modeling, Rob, assumes we go to what, unemployment standpoint. From that point of view, we're very conservative in our CECL modeling, assuming there's a recession. It averages about 6% over the two years. That is a long way away from where we are currently. So, David, I would just say bottom line, if anything, the fundamentals should have only gotten better in Virginia in terms of the diversity of the economy. So, I would fully expect that we will do much better than average. Anything could happen. But that's our view of it. We're ready for anything. But we should, as we have traditionally done for good reason, fare better than most. David, maybe just another data point on that. During the height of the unemployment and during the Great Recession, Virginia's unemployment peaked at 7.6%. So if you look at that relative to where we've got our CECL modeling at 6%, you can see we're pretty conservative in that. That sort of ties to my next question regarding the CECL model. I don't know if you have this offhand. But like you said, Virginia unemployment rate forecast to 3.1%. Under Moody's, you guys are using 6%. If you were even to say to tamp that down to 5%, just curious, maybe what that would have an impact maybe from a provisioning perspective and if that's the proper way to look at it. David, you're talking about – if the rate gets up to around 5% or so. Yeah, it really be dependent on what losses were actually coming through. The model will be very sensitive to that unemployment rate, and we would be increasing, obviously, the allowance for the additional potential of losses as a result of unemployment, which would indicate that it's a fairly significant recession going on. So we would definitely be raising the allowance for credit losses accordingly. Appreciate the guidance of 6% to 8%. Just curious where you see the best prospects for growth either by loan segment or maybe geographic regions in 2023? It's going to come out of the commercial bank. Dave, do you want to speak to where you see opportunity. I think we've done a good job of diversifying the bank. We have our new business lines as well, which provides supplemental growth. I'm feeling pretty good across the board. What do you think, David? David Ring is Head of Wholesale Banking, which is what we call commercial. We actually grew in every vertical and in every region in 2022. So each region currently has pretty strong momentum. So there isn't anywhere in Virginia we don't feel pretty comfortable generating growth in 2023. I will say several things. The greater Washington region is to us like Atlanta is to the deep south banks. That's kind of the big market. So we've got plenty of room to run up there. Asset-based lending definitely has upside. That's something we've been working on for several years. We have additional capabilities there. So I think it'll be a pretty good diversified play. But, generally speaking, it's fair to say the larger markets tend to do better than the smaller markets. That's just a fact of the size of the economies. Operating expenses, I know there's some noise in other expenses. Just maybe, I don't know if you can quantify the dollar amount this quarter, maybe what we think a good run rate in the first quarter might be as the expenses reset? From that point of view, David, you would expect to see seasonally increase in the expense base, kind of the run rate we're coming out of the year with – for fourth quarter, it was $99 million, probably looking in $4 million or $5 million on top of that in the first quarter due to FICA resets and the like, and then [indiscernible] start kicking in at the end of the – in March. So, that's our thought. Now, the FICA resets and unemployment resets start to dissipate over the remainder of the year. So, you'll see kind of a spike up and then it will start coming down second, third, fourth quarter. I wanted to go back to fees. You talked a little bit about some of the initiatives that are increasing fees for this year. But it looks like your fee guide is a little bit more conservative today than it was last quarter. If you could just talk a little bit about where that's coming from. It's kind of a an apples and orange kind of thing. We changed up how we looked at it. If you look at the previous guidance, we said we would grow after we excluded the impacts of the sale of our RIA business. This time around, what we basically said is – we took that out of the equation and said, okay, we're about $910 million of non-interest income in 2022, that's going to come down mid-single digits, as we say. So we basically just took that out of the equation if you take that out. It would actually have grown if you adjust for the RIA reduction due to the sale to Cary Street Partners or the investment we made in Cary Street Partners. So it's really apples and apples when it comes down to the absolute number. But the way we described it, we changed how that got put into the deck. On deposit cost, can you give us just a sense as to where deposit costs were maybe towards the end of the quarter? Or where new deposit costs are coming on? And as you think about deposit growth over the next year, you think it's coming more in CDs or money market and maybe kind of where those really started at? Certainly, from the growth point of view, going into 2023, we're projecting kind of low single digit overall deposit growth. But to your point, most of that's coming into the higher cost categories, both money market and CDs, and we've been increasing our rates. We have some promotions and specials on those. And that's where we're seeing some growth. As John mentioned, we have seen some deposits come back from the fourth quarter or year-end. In terms of the rates going on, so if you look at our December rates for the total deposits, it's coming on at 85 basis points, is what we reported in December. So, that's ticked up. And then interest bearing, in particular, now up to 1.23%. So if you look at that versus what we reported on average for the quarter, the cost deposits was 72 basis points, average going up, that's 85 if you look at on a spot basis. And the 105 basis points on interest bearing deposits, now 123 basis points. Now, we do expect that those will continue to increase in 2023. As deposit betas actually increase, we've seen a lag in deposit betas, we now see more competition in in these categories in competition for deposits. So we are expecting that, on average, you start to see interest bearing deposits kind of landing in the, call it, 1.80% to 2% next year in total deposits, in 1.25% to 1.35%. So, again, if you look at our betas to date, we're about 25% on interest-bearing deposits, 17% total deposits through the fourth quarter during the cycle. That's up from 18% and 12%. As we go forward, we're now looking at through the entire cycle, through the end of 2023, we think interest-bearing deposits will cycle out at 37% beta and total deposits about 27%, 28%. So, you're going to see those start to pick up in a more fairly accelerated basis, some of which we saw in the fourth quarter and we expect in the first few quarters of 2023. Catherine, let's face it. As an industry, we saw the change happen in December in terms of deposit rate behaviors, increasing rate competition, not just from other banks, but US Treasury bills, money market, mutual funds, etc. And so, we've had to respond to that. Our strategy is not to pay the highest depository rates. We're in an environment now where, I hope, we'll be able to demonstrate the strength of the great deposit base, which I've referred to for six years as the crown jewel of the franchise. I am impressed that, despite having closed 27% of our branches, we actually grew net consumer households last year. I've heard through the years questions of why do you even have a retail bank at this point. This is why. So granular, diversified deposit base. I am glad that we have a diversified deposit base across these markets and isn't concentrated in any one given metropolitan area, for example. So we're not immune from deposit, beta. We'll feel it, but I think we'll be able to weather the storm. It's another reason why I am so grateful that the strategy of this company has been not to make long-term fixed rate real estate loans. That's not a good place to be right now. So having half the deposit base and variable – primarily the loan book in variable rate is why we said what we did, which is we may be at an equilibrium point right now that we should be able – on the NIM, we should be able to use additional asset beta to help cover increasing deposit bases. So we'll see where it goes from here. Certainly, it looks from the – where new loans are coming on, you've got a lot of upside from that current core loan yield. As you look out, you think the kind of quarterly betas probably continue at this pace, Rob, on the loan side. Yeah, yeah, definitely, Catherine. Definitely, on the loan side, we'll see that pace continue. It's really about how the deposit betas are going to react, both the individual banks having to fund their loan growth, but also the competition in what rates look like in terms of what betas end up being. We will be definitely competitive on that front. Maybe just one more on the margin on just on borrowings. I saw the end of period borrowings were up a little bit. How are you thinking about overall borrowing levels into this year? As we said, we had a late quarter run-off in deposits. So, we had to pull in some funding as loans continue to fund out, which we want to make sure that we put those loans and have the funding accordingly. We ended up borrowing from the Federal Home Loan Bank. We will continue to see some of that kind of as a play between what deposit growth is and what loan growth is. But we'll be pretty disciplined around using wholesale funding mechanisms, whether brokered CDs or Federal Home Loan Bank. We've typically run at higher levels through the pandemic. We didn't need to. But we got run off late in the quarter, we had to call on those resources, and we did. But we've got a number of levers to pull on that front. And the way we look at it is that the lowest cost wins the battle, if we need to… [indiscernible] levers to have, they're important from a diversification standpoint. But, ideally, you wouldn't use them at all. FHLB, in particular, I think of as a swing line, meaning we were able to tap that as we needed at year end. We'll see how things continue from here. But we've had a good month in January in terms of deposit growth. I hope that means Rob will be paying it down. But we'll go into… I was saying, we'd rather have core deposits on the books – not have to draw down on wholesale because they're obviously a little more expensive funding. But I think we'll always have some of that. Having been here in the six years, the only time I've never seen us not use the FHLB line at all was during the pandemic. So some amount of it is typical for us. Just wanted to stay where Catherine was on the funding side. I'm just trying to understand this. You had a significant jump in the short-term borrowings. And they are, on a percentage basis, one of the highest we've seen, right. So, you're up $1.8 billion. And I just wanted to make sure I sort of heard that. You're going to likely rewind that back down? Just looking at the average balances, it looks like most of that came off late in the quarter. So not rolled into, obviously, a full quarter impact. Just trying to connect all the dots there. And then, just one more question too around that. Do you have a spot margin at December 31? Or maybe even current how we should be thinking about that? As I mentioned, we did use the Federal Home Loan Bank, and that's kind of outsized borrowings at the end of the quarter. Not all of that was short term. I think it was about a billion dollars of short term laddered in Federal Home Loan Bank. We also have some long term borrowings. But those are trucks and other non-FHLB borrowings, if you will, federal into that line item. We do expect that as deposits come in, we will be paying those down. Again, I don't think we'll be staying at this level unless we see more deposit outflows than they we're expecting, but remains to be seen at this point. Laurie, one thing I'll point out is that if you step back, point to point for the full year, deposits declined just over 4%. Truth is we had forecast when we did our budgeting a little more than that. So that's better than the original expectation. It is also true that we saw an unexpectedly large run up in deposits in Q3. So, over $400 million. So, part of what you're seeing is that delta or the absolute value, the difference between big increase in Q3, yes, we saw a larger decrease in Q4 and it all came pretty quick in the month of December. And thankfully, we're on a pretty good footing. As indicated, loan to deposit ratio yesterday was 88%. We'll see what happens. The year is early, but we'll go in and out of the FHLB line as needed. Can you just comment specifically on the demand deposit drop linked quarter, going from in a round number $5.3 billion down to $4.9 billion. Go back and look at Q3. So, you're going to see the increase, over $400 million go up in Q3. You are right, is the rise in Q3 and the drop in Q4 was largely on transaction accounts. It's not uncommon for us to have some degree of drop late in the year due to some of the larger clients. You'll particularly see this in the government contractor space. But it was more than we expected. That's not just seasonality. We did, in fact, see money began to go looking for higher yielding assets. There's no question about it. Mostly on the business account side, Laurie, if you look at – on the consumer side, we had some of that with more affluent clients. But the reality is we're just looking at our consumer deposit base by quartile and it's down a little bit in terms of average balances, but it's held better than you might think. So fundamentally, there's some element of year-end seasonality that's probably explaining, in part, part of why we're seeing deposits rise again right now because we can see some more volatile deposits with some of the larger ones, some money going and looking for higher yield. And then just some usual year-end activities as small business, for example, maybe on cash basis of accounting, like a professional practice will pay out profits right at year end to minimize tax obligations. But I'd hit the main drivers of it. I guess switching over to expenses. Just a couple questions there. The one-time expenses that you have this quarter, can you help us think about that? In other words, the branch costs, branch closure costs, the gain on the sale leaseback of the office, the write down on the software, and maybe the refund that you got back on the FDIC. And then, along those same lines, what are the costs going to be on the branch closures in the first quarter of 2023 and do you have a benefit there quantified? In terms of the fourth quarter, notable items, they kind of continue as one-time non-recurring. Basically, the positives and negatives basically come out to zero. So we didn't think it was necessary to kind of dissect and report each individual component. So, if you think about it that way, the total expense that you see reported is kind of our run rate because all this other stuff netted out. From the branch closure point of view, five branches will close in March of 2023. Annualized savings is going to be about $1.5 million starting then. And we are going to incur a few more one-time costs associated with that due to getting out of some leases that we have. That's probably in the tune of about $400,000 in the first quarter. And then, overall, we're looking at mid-single digit expense growth off of the run rate that we have. So, this is kind of way to think about it. There's an uptick in the first quarter due to seasonality. And then overall for the year, we should be up mid-single digits. One more question on expenses. The total cost of the branch closure, so $400,000 in the first quarter of 2023, what's your total? Just quickly, Rob – or maybe this is to David, the jump in the commercial real estate, non-performers, the owner occupied – and clearly, your asset quality is looking great. But the jump that we saw there, was that one loan, are there several loans or can you share with us maybe even the type of loans? No pattern. John, last question to you. Can you talk a little bit about buybacks, why you're not being active? We're seeing other banks start to ramp up in that. Can you help us think about how you're approaching that? That's a capital management decision. Rob, you touched on it earlier. Just given the uncertainty out there, we like the idea of buybacks, to be clear. Do you want to pick it up from there? Certainly, we've been active in buybacks over the years. We just felt that at this point in time, with – especially, as you saw loan growth come in 15% annualized, we want to make sure we preserve our capital and keep that dry powder for growth, as well as really not knowing if we've got a recession coming and how deep that might be. So it's really, let's call it, more of a short term pause until we can see some clarity around potential recession and where long growth goes. I like that characterization. As we get more clarity, we'll revisit that decision because, as you know, Laurie, as Rob says, we do have a history of using buybacks as we accumulate surplus capital. Obviously, we want to grow the bank, but we're not a hyper growth bank under really any scenario. We are delighted to have the new analysts. We're expecting one more to initiate that will be on next quarter, we hope. Thank you all very much. It was a good year for Atlantic Union Bank. It was a good quarter for Atlantic Union Bank and we are cautiously optimistic about where we go from here. Thank you. Thanks, everybody. And as a reminder, this call will be available on our investor website investors.atlanticunionbank.com. Thanks, and we look forward to talking with you next quarter. Goodbye.
EarningCall_1565
Greetings, and welcome to the UniFirst Corp. First Quarter Earnings Call. During the presentation, all participants will be in a listen-only mode after which we'll conduct a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to Steven Sintros, UniFirst President and Chief Executive Officer. Please go ahead. Thank you, and good morning. I'm Steven Sintros, UniFirst's President and Chief Executive Officer. Joining me today is Shane O'Connor, Executive Vice President and Chief Financial Officer. I'd like to welcome you to UniFirst Corporation's conference call to review our first quarter results for fiscal year 2023. This call will be on a listen-only mode until we complete our prepared remarks, but first, a brief disclaimer. This conference call may contain forward-looking statements that reflect the Company's current views with respect to future events and financial performance. These forward-looking statements are subject to certain risks and uncertainties. The words anticipate, optimistic, believe, estimate, expect, intend and similar expressions that indicate future events and trends identify forward-looking statements. Actual future results may differ materially from those anticipated depending on a variety of risk factors. For more information, please refer to the discussion of these risk factors in our most recent Form 10-K and 10-Q filings with the Securities and Exchange Commission. Overall, our results for the first quarter came in largely as anticipated, and I continue to be pleased with the steady progress of our key technology and infrastructure initiatives. We continue to be focused on making long-term investments in our business designed to accelerate growth and profitability as well as ensure we are providing industry-leading services for years to come. I want to thank our thousands of dedicated team partners to continue to always deliver for each other and our customers. Consolidated revenues in the first quarter grew 11.4% and adjusted earnings per share grew 10.5%. Shane will provide the details of our first quarter results shortly as well as comment on our outlook for the full fiscal year, which remains unchanged from our year-end earnings call. We are pleased with the execution of our team, which continue to deliver solid performances in both new account sales as well as customer retention. Continuing the trend from prior quarters, the strong revenue growth in the quarter also reflects the impact of price adjustments from throughout 2022 as we have worked with our customers to share in cost increases we have experienced related to the inflationary environment. As we have discussed in prior calls, we will continue to be focused on three large initiatives designed to transform the Company in terms of our overall capabilities and competitive positioning. These initiatives are the rollout of our CRM system, a corporate-wide ERP system and investments in the UniFirst brand. With respect to our CRM systems project, we are making good progress deploying our new system in line with our internal schedule. As we communicated during the last earnings call, we have deployed over 50% of our U.S. Core Laundry locations, and we expect the remaining U.S. locations to be deployed by the end of fiscal 2023. The deployment of our smaller Canadian and cleanroom operations will carry over into fiscal 2024. During fiscal 2023, we will be focused on -- we will also be focused on the global design phase of our ERP project. The implementation of our new Oracle Cloud ERP system will be a multiyear initiative designed to transform our supply chain and procurement capabilities as well as provide an overall technology foundation for growth and efficiency. And finally, as we also discussed on prior earnings calls, during fiscal '22, we officially launched our new brand through a series of national TV ads. Our message focuses on serving people who always deliver for their companies, their customers and their families. At UniFirst, our ongoing focus will be to always deliver for them. Although some costs related to this brand transformation will be expended in fiscal '23, the larger one-time expenditures are mostly behind us. All of our investments are designed to deliver solid long-term returns for UniFirst stakeholders and are integral components of our primary long-term objective to be universally recognized as the best service provider in our industry. We continue to report results adjusted for the impact of direct costs related to these investments. As we continue through fiscal 2023, we'll be watching the dynamic market conditions closely. During the quarter, we did not see a significant change to the operating environment and where levels that our customers have been stable. When and what impact higher interest rates will have on our customer base and the overall market remain to be seen. Over the years, our business has proved resilient in many different economic cycles and regardless of what the next cycle brings, we are confident in our ability to execute against our plan. We will continue to manage costs in areas we can control, while assuring we don't impact our ability to execute on our transformational initiatives or adversely affect our customer service levels. And as always, we'll maintain a sharp focus on taking care of our employees, our customers and bringing new customers into the UniFirst family. And with that, I'd like to turn the call over to Shane, who will provide more details on our first quarter results. Thanks, Steve. In our first quarter of 2023, consolidated revenues were $541.8 million, up 11.4% from $486.2 million a year ago, and consolidated operating income decreased to $43.4 million from $44.8 million or 3.1%. Net income for the quarter increased to $34 million or $1.81 per diluted share from $33.7 million or $1.77 per diluted share. Our financial results in the first quarters of fiscal 2023 and 2022 included approximately $10 million and $5.9 million, respectively, of costs directly attributable to the three key initiatives that Steve discussed. Excluding these initiative costs, adjusted operating income increased to $53.5 million compared to $50.7 million in prior year or 5.4%. Adjusted net income increased to $41.5 million from $38.1 million, and adjusted diluted earnings per share increased to $2.21 from $2 or 10.5%. Our Core Laundry Operations revenues for the quarter were $477.4 million, up 11.3% from the first quarter of 2022. Core Laundry organic growth, which adjusts for the estimated effect of acquisitions as well as fluctuations in the Canadian dollar, was 10.7%. This strong organic growth rate was primarily the result of solid sales performance and customer retention as well as efforts over the last year to share with our customers cost increases that we have incurred in our business due to the ongoing inflationary environment. Core Laundry operating margin decreased to 7.1% for the quarter or $33.8 million from 8.5% in prior year or $36.5 million. The costs we incurred related to our key initiatives were recorded to the Core Laundry Operations segment. And excluding these costs, the segment's adjusted operating margin decreased to 9.2% from 9.9% in prior year. The largest item impacting our adjusted operating margin compared to prior year continues to be merchandise amortization, resulting from the inflationary effect on the cost of our products as well as higher levels of merchandise put in service with our customers in 2022 to support solid new account sales, increased activity in our energy-dependent markets, elevated wearer additions at our customers as well as certain national account investments. Energy costs also increased to 4.7% of revenues in the first quarter of 2023, up from 4.3% in 2022. Partially offsetting these headwinds was lower health care claims expense in the quarter compared to prior year. Revenues from our Specialty Garments segment, which delivers specialized nuclear decontamination and cleanroom products and services, increased to $44.1 million from $39.5 million in prior year or 11.6%. This increase was primarily due to strong growth in our cleanroom operations as well as increased project work in our North American nuclear operations. The segment's operating margin increased to 23.1% from 21.9%, primarily the result of its strong top line performance. As we've mentioned in the past, this segment's results can vary significantly from period to period due to seasonality and the timing of nuclear reactor outages and projects that require our specialized services. Our First Aid segment's revenues increased to $20.3 million from $17.8 million in prior year or 13.9%. However, the segment had an operating loss of $0.6 million during the quarter. These results reflect our continued investment in expanding our First Aid van business and building out the infrastructure necessary to eventually support a much larger business. We continue to maintain a solid balance sheet and financial position with no long-term debt and cash, cash equivalents and short-term investments totaling $351.2 million at the end of our first quarter of fiscal 2023. We did not repurchase any additional common stock under our current stock repurchase program during the quarter. Cash provided by operating activities for the quarter increased to $27.7 million compared to $7.8 million in prior year, primarily due to lower working capital needs of the business. We continue to invest in our future with capital expenditures in the quarter totaling $39 million and the acquisition of two businesses for which we paid $6.6 million. I'd like to take this opportunity to provide an update on our outlook. At this time, we continue to expect our full year revenues for fiscal 2023 will be between $2.145 billion and $2.160 billion. We further continue to expect diluted earnings per share will be between $5.50 and $5.90. This outlook also continues to assume an estimate of $40 million of costs directly attributable to our key initiatives that will be expensed in fiscal 2023. Core Laundry Operations adjusted operating margin at the midpoint of the range of 8.1%, a GAAP and adjusted tax rate of 25%, adjusted diluted earnings per share between $7.10 and $7.50, as well as no impact from any future share buybacks or unexpected significantly adverse economic developments. This concludes our prepared remarks, and we would now be happy to answer any questions that you might have. Operator, we can open the line for questions. [Operator Instructions] Our first phone question is from the line of Andy Wittmann with Baird. Please go ahead. Your line is open. Great. I just thought I would start with a question on your outlook. The organic growth in the core segment was 10.7%. Good, I'd say, a pretty good result there. But the implied revenue guidance for the rest of the year suggests total growth of like 5.8% to 6.8% for the rest of the year. So pretty market deceleration. I totally understand that this is just the first quarter, but I'm just curious as to why there wasn't a guidance raised because that level of deceleration is a little bit surprising. So hoping you can provide a little bit of detail as to the thought process behind that. Yes, Andy, it's a good question. I think when you look at next year and you look at the trajectory of our revenues and what happened in 2022 with the heavy inflation, some of which we're still obviously experiencing. We were obviously working with our customers as we've been talking about to try to offset some of the inflationary impact of all the things we've been talking about that have impacted the business. We don't expect that to be as significant as we annualize some of that activity that happened in the latter half of 2022. And so therefore, when you look at the result of our first quarter, we made the comment that it was mostly as expected. That was really the case from a top line perspective as well. So, I think that deceleration is something that we anticipate and is largely the result of some of those pricing activities, including some specifically related to the energy prices. Got it. So energy prices, maybe there's fuel surcharges or other things that might go away with prices coming down. Are there other things on the cost structure? I mean, obviously, you talked a lot about merchandise, not just this quarter, for the last several quarters, talked about labor. Are there -- are you seeing moderating trends in those other key categories that would, I guess, support lower price adjustments for the balance of '23 than you've had over the last year or so? Yes, I think when you look at the inflationary environment you've hit on a couple of the larger areas, sort of labor and energy. I would say the environment is still challenging from a cost perspective, but we are seeing some moderation. And you can see it in the cost of, say, gasoline. Some other aspects of energy are still dynamic, like natural gas was still pretty high during the quarter. Electricity has remained high. We're probably not seeing things accelerate the way they were during 2022, but there are many things we're also not seeing retreat and some -- many remain high. So, we're cautiously optimistic that the balance of '23 will be less dynamic than '22 from a cost increase perspective. But there's still pockets of challenging and labor still one of the larger ones, although we're seeing some, I'd say, minor improvements in that area in terms of labor availability, the cost of labor remains high. Thank you. And our next question is from the line of Andrew Steinerman with JPMorgan. Please go ahead. Your line is open. Would you be willing to share with us how much kind of in basis points in percentage terms merchandise amortization was a drag to the core margins in the first quarter? How much you're suggesting merchandise amortization will affect the full year? Yes, absolutely. Sort of at the end of last year, I had indicated that the merchandise headwind for the year was going to approximate about a point. I still believe that that's the case. And in the first quarter, the headwind that we saw from merchandise amortization was about a point. So, we expect that, that headwind is going to continue throughout the year. Great. And could you also tell us what you're penciling in for energy as a percentage of revenues for the year? Okay. I'd like to thank everyone for joining us to review our first quarter fiscal 2023. We look forward to speaking with everyone again in March when we expect to report our second quarter performance as well as the outlook for the remainder of fiscal 2023. Thank you, and have a great day. Thank you. Ladies and gentlemen, that does conclude today's call. We thank you for your participation and ask that you please disconnect your lines, and have a good day.
EarningCall_1566
Good morning, and welcome to the Regions Financial Corporation’s Quarterly Earnings Call. My name is Christine, and I will be your operator for today’s call. [Operator Instructions] Thank you, Christine. Welcome to Regions fourth quarter 2022 earnings call. John and David will provide high-level commentary regarding the quarter. Earnings documents, which include our forward-looking statement disclaimer and non-GAAP information, are available in the Investor Relations section of our website. These disclosures cover our presentation materials, prepared comments and Q&A. Let me begin by saying that we’re very pleased with our fourth quarter and full year results. Earlier this morning, we reported full year earnings of $2.1 billion, reflecting record pretax pre-provision income of $3.1 billion, adjusted positive operating leverage of 7% and industry-leading returns on both average tangible common equity and total shareholder return. Our results speak to and underscore the comprehensive work that’s taken place over the past decade to position the Company to generate consistent, sustainable long-term performance. We have enhanced our credit, interest rate and operational risk management processes and platforms while sharpening our focus on risk-adjusted returns and capital allocation. We made investments in markets, technology, talent and capabilities to diversify our revenue base and enhance our offerings to customers. For example, investments in our treasury management products and services led to record revenue this year. Similarly, our Wealth Management segment also generated record revenue despite volatile market conditions. And now we’re seeing positive results of our comprehensive strategy. Over the course of the year, we grew revenue and average loans while prudently managing expenses, further illustrating the successful execution of our strategic plan. So, as we enter 2023, it is from a position of strength. Our business customers have strong balance sheets. They have benefited from population migration and many continue to carry more liquidity than in the past. Our consumer customer base remains healthy. Deposit balances remain strong and credit card payments remain elevated. The job market continues to be solid with approximately two open jobs available for each unemployed person across the Regions’ footprint. We have a robust credit risk management framework, and a disciplined and dynamic approach to managing concentration risk. Our portfolios are more balanced and diverse than at any point in the past. We have a strong balance sheet that’s well positioned to perform an array of economic conditions. We have solid capital and liquidity position to support balance sheet growth and strategic investments. And most importantly, we have a solid strategic plan, an outstanding team and a proven track record of successful execution. So as we look ahead, although there is uncertainty, we feel good about how we’re positioned. Thank you, John. Let’s start with the balance sheet. Average loans increased 1% sequentially or 9% year-over-year. Average business loans increased 2% compared to the prior quarter, reflecting high-quality broad-based growth. Average consumer loans declined 1% as growth in mortgage, Interbank and credit card was offset by the strategic sale of consumer loans late in the third quarter and continued runoff of exit portfolios. Looking forward, we expect 2023 ending loan growth of approximately 4%. From a deposit standpoint, as expected, deposits continued to normalize during the quarter, consistent with a rapidly rising rate environment. Average total consumer balances were modestly lower, primarily driven by higher balance customers seeking marginal investment alternatives. Meanwhile, the median consumer balance remains relatively stable, still about 50% above pre-pandemic levels. Normalization was more pronounced in average corporate and commercial deposits, which were down 2% during the quarter. As anticipated, our business clients continue to optimize the level and structure of their liquidity position. We experienced remixing away from noninterest-bearing deposits to other options, both on and off balance sheet, including those offered through our treasury management platform. Ending deposit balances have declined approximately $7 billion year-over-year, in line with our previously provided 2022 expectations. Looking forward, we do anticipate further deposit declines of approximately $3 billion to $5 billion in the first half of 2023, reflecting continued Federal Reserve balance sheet normalization, seasonal trends and late-cycle rate-seeking behavior. We expect to experience stabilization of deposit balances midyear with the potential for modest growth in the second half of the year. Our deliberate approach to managing liquidity allows for deposit normalization and growth in the balance sheet without the need for material wholesale borrowings in the near term. So, let’s shift to net interest income and margin. Reflecting our asset-sensitive profile, net interest income grew to a record $1.4 billion this quarter, representing an 11% increase while reported net interest margin increased 46 basis points to 3.99%, its highest level in the last 15 years. While deposit repricing continues to accelerate, the cycle-to-date beta remains low at 14%. Importantly, our guidance for 2023 assumes a 35% full-cycle beta by year-end. There is uncertainty regarding full cycle deposit betas for the industry. However, we remain confident that our deposit composition will provide a meaningful competitive advantage. Growth in net interest income is expected to continue until the Federal Reserve reaches the end of its tightening cycle. Once the Fed pauses, we would expect deposit costs to continue increasing for a couple of more quarters. This equates to 1% to 3% net interest income growth in the first quarter and 13% to 15% growth in 2023, assuming the December 31st forward rate curve. Earlier in 2022, we added a meaningful amount of hedges focused on protecting 2024 and 2025. The swaps become effective in the latter half of 2023 and 2024 and generally have a term of three years. Activity in the fourth quarter focused on extending that protection beyond 2025. We will look for attractive opportunities to continue to expand this protection. We have constructed the balance sheet to support a net interest margin range of 3.6% to 4% over the coming years, even if interest rates move back towards 1%. If rates remain elevated, our reported net interest margin is projected to surpass the high end of the range until deposits fully reprice. So, let’s take a look at fee revenue and expense. Reported noninterest income includes $50 million of insurance proceeds related to a third quarter regulatory settlement. Excluding that, adjusted noninterest income declined 9% from the prior quarter as stability in wealth management income and a modest increase in card and ATM fees were offset by declines in other categories, mainly mortgage and capital markets. Service charges declined 3% due primarily to three fewer days in the fourth quarter versus the third [Ph]. We expect to offer a grace period feature to cover overdrafts around midyear 2023 and when combined with our previously implemented enhancements, will result in full year service charges of approximately $550 million. Within capital markets, increases in M&A fees were offset by declines in all other categories, including a negative $11 million CVA and DVA adjustment. Despite an increase in servicing income, elevated interest rates and seasonally lower production drove total mortgage income lower during the quarter. With respect to outlook, we expect full year 2023 adjusted total revenue to be up 8% to 10% compared to 2022. Let’s move on to noninterest expense. Reported professional and legal expenses declined significantly driven by charges related to the settlement of a regulatory matter in the third quarter. Excluding this and other adjusted items, adjusted noninterest expenses increased 2% compared to the prior quarter. Salaries and benefits increased 2%, primarily due to an increase in associate headcount during the fourth quarter and higher benefits expense. Equipment and software expenses increased 4%, reflecting increased technology investments. The fourth quarter level does provide a reasonable quarterly run rate for 2023. We expect full year 2023 adjusted noninterest expenses to be up 4.5% to 5.5%, and we expect to generate positive adjusted operating leverage of approximately 4%. From an asset quality standpoint, overall credit performance remains broadly stable while experiencing expected normalization. Net charge-offs were 29 basis points in the quarter. Excluding the impact of the third quarter consumer loan sale, adjusted full year net charge-offs were 22 basis points. Nonperforming loans remained relatively stable quarter-over-quarter and were below pre-pandemic levels. Provision expense was $112 million this quarter. While the allowance for credit loss ratio remained unchanged at 1.63%, the increase to the allowance was due primarily to economic conditions, normalizing credit from historically low levels and loan growth. These increases were partially offset by the elimination of the hurricane-related reserves established last quarter. Just to remind you, we believe our normalized charge-offs based on our current book of business should range from 35 to 45 basis points on an annual basis. However, due to the strength of the consumer and to businesses, we expect our full year 2023 net charge-off ratio to be in the range of 25 to 35 basis points. From a capital standpoint, we ended the quarter with a common equity Tier 1 ratio at an estimated 9.6%, reflecting solid capital generation through earnings, partially offset by continued loan growth. Given the uncertain economic outlook, we plan to manage capital levels near the upper end of our 9.25% to 9.75% operating range over the near term. So, in closing, we delivered strong results in 2022, despite volatile economic conditions. We are in some of the strongest markets in the country, and while we remain vigilant to indicators of potential market contraction, we will continue to be a source of stability to our customers. Pretax, pre-provision income remains strong, expenses are well controlled, credit remains broadly stable, and capital and liquidity are solid. In terms of your deposit beta, regarding that 35% beta assumption by year-end ‘23, what is your -- maybe help us think about what your assumption is around noninterest-bearing mix as a percentage of total deposits. How do you see that trending through the year? What’s underlying that assumption? Yes. John, this is David. So what we did, we’re at 39% noninterest-bearing right now. We’ve always had more noninterest-bearing than most everybody. It’s just the nature of our deposit base. We said we would continue to see deposit runoff this year somewhere in the $3 billion to $5 billion range. And for our guidance, we’ve taken all of that out of NIB. So you should expect that percentage of NIB to decline somewhat during the year. Now, that’s just what we put in the guide. We could see some mix changes from that NIB and maybe not -- that’s the most harsh it could be. So that’s why we put it in the guide. So, I don’t know if there’s a follow-up there. Okay. No, that’s helpful. And I think the other color on the beta provides some of the additional detail. But just separately, if I could just hop over to credit for my follow-up. Can you give us a little bit of color around what drove the increase in charge-offs in the quarter. It looks like that may have been in C&I, but I want to get a little bit of color around what you’re seeing there? Are you seeing any stresses in certain pockets of your loan categories that you’re watching that are starting to generate some losses? And then also what drove the 14% increase in the criticized loans? Thanks. Yes. John, this is John. So, we did see a little uptick in business services charge-offs in the quarter related to a handful of credits. We’ve identified couple areas or a couple of segments of the portfolio where we see elevated stress at the office, healthcare, consumer discretionary, senior housing and transportation on the small end of trucking in particular. We’re seeing elevated levels of -- or elevating levels, I should say, of classified loans, in particular. So, to the second part of your question, we are seeing some normalization in the portfolio. Classified loans are increasing toward levels that we would expect to be more "normalized" and the categories in which that -- we’re seeing that change are the 5 identified, but there are some odds and ends in the portfolio as well as inflationary impacts and rising rates affect isolated customers. In general, we still feel very good about credit quality. And as David said, we’re guiding to 25 to 35 basis points of charge-offs in 2023. And John, I’ll add. If you look at page 19, we tried to help you with the areas that John just mentioned in terms of the higher risk segments. And you can see on that page, the strength of the allowance to cover those increases in the criticized level that we have listed in the supplement. And we don’t necessarily have a loss in every one of those that migrated into criticized. But what we do see, we have already embedded in the reserve and it’s factored in, as John mentioned, in our guidance of 25 to 35 in charge-offs for 2023. Yes. Thanks, David. I appreciate that. If I could just ask one more on that, on the reserve, you pretty much kept it stable this quarter. Could you maybe discuss the likelihood of incremental builds here, or do you think it fairly represents the scenarios of outlook that you’re looking at here? Well, we certainly believe that it represents what we think is the loss content that exists today. Obviously, every quarter, we have to reassess the economy, the quality of the portfolio at those times. So, we think we have it covered. The only bill that you would see from this standpoint that we know of would be related to new loan growth. And we’re going to have some of that. We said we would grow loans about 4% end to end during the year. So, we’ll need to provide for that. But we think at 1.63% is a good coverage ratio for the risk that we have in the portfolio. I just want to follow-up on the funding side of the balance sheet. Could you talk a little bit about -- you guys have had that ability to just keep your loan-to-deposit ratio in a good spot. And I’m just wondering if you could kind of help us understand what you expect to do over time in terms of your wholesale debt footprint, including long-term debt? And what that would imply then for what you expect to do with the securities book over time as well? Thank you. Yes. So, we continue to have one of the lowest loan deposit ratios. I think, you were leading to that. We’re in great markets. We continue to work on growing accounts, whether it be checking accounts or operating accounts. That’s the hallmark of our whole franchise. This is the strength of that deposit base. So, we will continue to leverage that deposit base in terms of our funding mix. At least for the first half of the year, we don’t see the need to go into any wholesale borrowings. We have plenty of access to that, should we need it. Most of our peers, I think, have all tapped wholesale funding already. So, we’re being able to leverage that and that’s where we give you the pretty strong guide in terms of our NII growth for the year of 13% to 15%. So, we’ll see what the deposit flows are. As we mentioned to John earlier, the deposit outflows we see that we put in our guide is $3 billion to $5 billion. Now remember, we said 5 to 10, this past year, we were at 7. So, we’ve been estimating it pretty well, and we’re taking to offer our guide all of that out of NIB. So, we’ll see what happens during the year. But you -- don’t expect us to be looking for wholesale funding until at least the second half of the year. Okay. And then, just a follow-up. You’re going to do that grace period, and we saw you reiterate the $550 million of service charges. Can you just kind of just give an update on the state of the consumer there and behavioral changes and any other learnings and findings that kind of continue to make you confident in upholding that 550 zone of service charges? Yes. Well, Ken, we continue to see consumers maintaining good deposit balance levels. Spending is up modestly, but we think being managed very carefully by our consumer -- customer base. We feel good about the health of the consumer overall. With respect to overdrafts and the changes that we’ve made to benefit customers, we’ve seen about a 20% decline in the number of customers who are overdrawing their accounts on a month-to-month basis, which we are happy about. That’s -- ultimately, the objective is to help customers better manage their finances. And so, I would say, all in all, we feel good about our guide and good about the impact of the changes that we’ve made have had on our consumer customer base. Yes. Ken, let me add to that. Embedded in the service charges is treasury management and treasury management has had a fantastic year. If you look at the fourth quarter for treasury management, we were up 7% fourth quarter of ‘22 to fourth quarter ‘21. If you look at the entire year, we were up 9% in TM. So, that’s been a positive to us that’s helped bolster that downward trend of service charges due to all the account changes that we’ve made and will be a strength for us going into 2023 and gives us confidence, as John mentioned, that we can meet the 550 in service charges for the year. Just a big picture strategic question. Obviously, you’ve done an amazing job growing the interest income and getting the rate call right. It seems like 3 for 3 here. But I guess the flip side is the kind of revenue mix has become more dependent on rates and the balance sheet, right, as we think about the fee composition. So, anyway, long story short, the question is what strategic opportunities do you have to grow the fee revenues and maybe something that’s more from an acquisition point of view to accelerate that? Well, we’ve been, as you know, active making nonbank acquisitions, particularly adding to our capital markets capabilities. And we’re pleased with -- despite the fact that we had a bit of a soft quarter in the fourth quarter, really pleased with the contribution that those capital markets investments are making to help us continue to strengthen relationships with customers and grow noninterest revenues up pretty dramatically over the last 6 or 7 years. Likewise, we are excited about the investments we’ve made on the consumer side. Whether it be the acquisition of Ascentium Capital; which is part of our Corporate Banking group; interbank, which gives us a chance to grow loans to homeowners, mortgage servicing rights that we’ve acquired, which have been helpful. And then, in the wealth space, we’ve made some acquisitions that have been modestly incremental helpful to us, and we continue to look for opportunities there as well. So, we are, I think, positioning ourselves as we continue to accrete capital to making additional investments as we see those opportunities arise, we’re consistently looking. And I think you can look for us to continue to try to build on the investments that we’ve already made. Yes. Matt, let me add that -- so the fact that we’ve been able to grow NII is actually a positive thing. We recognize it does lower the percentage of noninterest revenue as a total. But we’re very proud of the fact that we’ve been able to manage our balance sheet in this manner. More importantly, we’re trying to take the volatility out of that line item. And so, if you look at our ability to hedge, we’re locking in what we believe to be a very strong margin range of $3.60 to $3.90 over time, regardless of what the rate environment does. And so that gives us a lot of stability there. And if that means we have higher NII and the percentage of NIR is a bit lower than it’s historically been, we’re okay with that. To John’s point, we are going to look to use our capital for some nonbank acquisitions like you have seen us do, nothing too big, but just to bolster the NIR stream to make us more resilient in just about any environment that we have. Understood. That’s helpful. And then just somewhat related, I’ve been asking a lot of your peers the same question, but you all seem to be building capital kind of well beyond what I would have thought that you would need. And you talked about kind of the upper end to 9.25%, 9.75% CET1, and that’s not new. But I guess the question is, why are you and others potentially all building what seems to be well in excess of what you need for CCAR? Are you anticipating something from CCAR changing? Is there kind of pressure behind the scenes from rating agencies, regulators or are just all the banks deciding on their own to be a little more conservative given the cycle where we are? Thank you. Yes. Well, Matt, we can’t speak for the other banks. I would say for us, it is a bit of an uncertain time. We think there potentially are opportunities to continue to make nonbank acquisitions will arise. We were fortunate enough to make 3 in a short period of time at the end of 2021. And just operating at the upper end of our range gives us some flexibility, and we’d like to continue to maintain that given the uncertain environment that we’re operating in. And if you look at CCAR degradation in capital was one of the lowest of the peer group. So, we don’t need capital to take care of the risk embedded in our balance sheet, it is really opportunistic -- opportunities we’re looking for. And frankly, having a little bit more capital doesn’t hurt us from a return standpoint. And we generated over 30% return on tangible common equity. And so, having upper end of the 9.75 won’t impact any meaningful way. A couple of questions. One, just on the loan growth outlook, I know you indicated you expect ending balances to be about 4% up year-on-year. Could you give us a sense as to how you’re thinking through the dynamics of which pieces of the loan growth are likely to accelerate, be on the high side, lower side? And then, how much longer that runoff portfolio is going to impact the numbers? Thanks Yes. So, we expect loan growth to slow just with general economy slowing. I think, our growth opportunities will manifest itself in the corporate banking group, commercial and corporate banking, as line utilization likely goes up a bit. I think there will be some opportunities in the real estate. We did have some growth of real estate, primarily multifamily, still happy with that. We do have one of the lowest concentrations of investor real estate compared to the peer group. But we look at utilizing our capital selectively with the right customers, doing the right things, in particular, like I said, multifamily. On the consumer side, our Interbank acquisition we had in the end of ‘21, as John mentioned, is doing well for us. We look for that to have opportunities to continue to grow. And mortgage, while it’s going to be challenging again in ‘23 because of the rate environment, although it’s settled back a bit, it will give us some opportunity to grow a bit in the consumer side. As you mentioned, we do have some runoff portfolios, our last one -- by the time we get to the end of this year, we’re probably not having a discussion about exit portfolios anymore. I would just add, despite the fact that we expect a small business customer to be under some pressure in more challenged economy, we’re seeing real opportunity through the Ascentium Capital platform, making loans to businesses on business essential equipment. We’re able to leverage that platform, which is very specialized in nature through our branch system into our existing customer base and over 35%-plus of our branches in 2022 originated a loan through the Ascentium Capital. We’ll see more of that grow, I think, and again, another opportunity to leverage an acquisition into our existing customer base. Yes. That was going to be one of my follow-ups, just trying to understand Ascentium and the dynamic and the driver that it is for you. And I guess the underlying question here is, is it -- what’s the average size of this loan, an Ascension loan? Is it more of a small business size or medium, or maybe you can give us some color around that. Yes. It is a small business. It’s loans originated on equipment that is, as I said, business essential. So, the thesis is that that business owner is likely to pay that loan first because he has to -- he or she has to have the equipment to operate the business. The average size of the loan is about $75,000 and the term would be 3 to 4 years on average. Okay, great. And then, just lastly, a follow-up on the funding question that came up earlier. I mean, we’re hearing from others that borrowing from federal home loan banks is interesting, even though the base rate sticker price might look a little higher. You obviously get some dividend back from the swap you also get the fact that you don’t have to pay the FDIC. So, I’m just wondering is it at all attractive to you at some point to lean in more there or not? Well, I think we’ll need to evaluate with that closer when we get to the point where we need it. We still have opportunities. We’ve had a $2 billion to $3 billion worth of corporate deposits that have moved off our balance sheet to seek higher rates that we weren’t willing to pay. Those are our customers. We own their -- still have their operating account. They just moved their excess cash elsewhere. So, there’s an opportunity to go back to those customers first before we need to seek other wholesale funding. But I think we have all avenues. We have term debt too that can help us with the FDIC as well. We’ll just have to evaluate the total cost of all of our opportunities at that time, which I said earlier is really going to be in the second half of the year. So, it’s hard to pick apart anything in this quarter, results were fantastic. I guess, the one question I get from people is, as we start to see maybe some normalization in credit is how do you really highlight for folks how much different your franchise is today versus pre-cycle? I know you’ve laid some of that out in mid-quarter presentations, the shift to investment grade and so forth. But how would you combat that pushback from some folks? I think balance and diversity is the first thing I would point to when you look at pre -- Great Recession our balance sheet, whether it be on the right side or the left side, assets or liabilities, we had concentrations in certain asset classes, and we were very dependent on interest-bearing deposits for funding. If you look at the reshaping of our balance sheet over time, our liability side of our balance sheet, I think, is really strong and provides as we’ve talked about, to this point, foundation for our outperformance, and we expect that will continue. On the asset side of the balance sheet, we have only -- less than 10% of our outstandings are in investor real estate. That’s down significantly from pre-crisis levels. And we also, I think, have been very -- very committed to concentration in risk management. We have a very active and ongoing credit risk management process, which we believe will produce much better results than we had previously delivered. We’re committed to consistent sustainable long-term performance, and that requires that we manage credit risk well. At the end of the day, I know we’ve got to deliver, and we intend to do that, but we think we’re well positioned. I would add that we also developed, not too long ago, a new tool. We call it our click, which didn’t mean anything to you. But what it does is it analyzes the cash flows of each of our customers. And we’ve built that, developed that tool to give us an idea of product and service that a customer may need from us that they don’t have. What we found is it gave us such good information on cash flows every month that it gave us an earlier indicator of potential credit stress. And that’s part of what you’re seeing when you see us move things into criticized categories. We can be more proactive because we have better information to manage credit risk management through that tool. Got it. That’s extremely helpful. And maybe just one other question for me there is loan growth, the 4% guide, I completely respect all the shifts and concerns in the environment that may take that down there. But, you put up 11% growth this quarter, utilizations continue to increase. Where could you outperform that 4%, I guess, if the environment maybe wasn’t as bad as we might fear? And -- how do you think about that shift you’ve talked about into capital markets? And what could really drive that pushing some of those customers back into that space? So, we’re currently modeling about $2 billion, I think, in current outstanding that could move back -- could move off the balance sheet, capital markets open. That’s a rough number, but that’s -- give you some indication of a "headwind" if the capital markets do open. So, that could be a plus or minus to answer your question, and I think would be the one area where we probably would see more growth than we anticipated if that did not happen. Yes. Our line utilization is still below historical levels. Every 1 point increases about $600 million in outstanding. So, we get people drawn on their lines. Perhaps that could be helpful. We’ll see what the rate environment looks like with regards to mortgage. We’ll see what the economy looks like for consumers to improve their home and leverage Interbank. So, there are some opportunities for us to outperform those numbers if the economy kind of continues along its current path. It’s still fairly healthy, and inflation is coming down. So, I think we have some opportunity to outperform there. Can you guys share with us -- you gave an interesting slide in your deck about how your deposit customers have more deposits in their accounts than pre-pandemic, I think, at slide 17. Have you reached out and what’s driving these numbers? Because obviously, you hear about the savings rate nationally is down, but you and your peers are showing numbers like this. And I was just wondering if you could share with us what your -- some of the trends that you’re seeing here that keeps these balances the way they are? Yes. The specific page on 17 on the right-hand side, we’re talking about those customers that had less than $1,000 in their account. And that -- compared to the end of ‘19, they have 6 times the balances. A big driver is that cohort was the recipient of a lot of stimulus. That stimulus could have come in the form of absolute transfer payments. It could have come in the form of minimum wage increases. Those are permanent. So, what we’ve seen is our customers actually are making more money, and they’re keeping it -- they’re keeping their spending under control even though we have inflationary pressures. So, that cohort has had more wage growth than most everybody else. And we don’t see it going away. We’re a bit surprised and we’re watching it every month to see if there’s a change, but I think the slide was fairly consistent with what we showed you last quarter as well. So, from a -- you’re really talking about just the consumer on page 17, but business customers continue to have more liquidity as well. I got it. So, the wage growth, they’re having better wage growth than most people on this call then, right, David? Moving on to slide 19. In the high-risk industry segments, a couple of questions. One, can you share with us -- and maybe you addressed this already in the earlier comments on this slide. But in the office space, is it mostly the Class B and C that -- or Class B that you’re more focused on than Class A? And then second, could there be other industry segments that could show up in this slide 6 months from now or 12 months from now? Yes. Gerard, I’d say with respect to your question about office, that would be accurate. We’re focused on, let’s say, the non-Class A -- 82% of our portfolio is Class A, 63% is in the Sunbelt. About 36% of our portfolio is single tenant. So, the portion that we are concerned about would be Class B space, a good percentage of it is also in suburban markets of 74%, I think, in suburban markets. In terms of industries or segments that we have some concern about, I would say that we’re still watching senior housing closely. I think it’s performed okay, post-pandemic, but it’s an area that we had some concern about rising cost, availability of labor, things that impact that particular segment and then consumer discretionary as people continue to feel the pressure of rising costs and/or the uncertainty in the environment, we think that -- and as unemployment begins to moderate a bit, we think that consumer discretionary is an area that could be impacted. Maybe first one, I was hoping you could provide a little bit more details on, I guess, it’s slide 7 in one of those footnotes, specifically how the $40 million security hedge benefit in the fourth quarter will, and I’ll put in quotes here, "migrate to loan yields" as those hedges on loans mature. And I guess, from a high-level trend to make sure I understand the impact of that $6-plus billion hedge on securities that matured last quarter? Yes. Sure. So, what we did at the end of December of ‘21 is we wanted to add some more sensitivity to the fourth quarter. We had some hedges that were maturing in that fourth quarter that received fixed swaps. But we wanted to move that and have those effectively terminate a quarter earlier. We could have torn those up, but it would have taken a lot of effort to do so because there are a bunch of small notionals in there and the cost and time to do that. Really, there’s an easier way to do it, which is we purchased a pay fixed swap for that quarter. And so, when that sensitivity came back, it generated about $40 million in the quarter. Now, our sensitivity naturally comes back in the first quarter because we have received fixed swaps that are maturing right at the end of the year. So, that sensitivity came back naturally in the first quarter, and that’s why you won’t see a decline due to this $40 million that we had in the fourth quarter. That is also why we’ve been able to give you guidance that we’re going to grow NII in the first quarter somewhere between 1% and 3%. So, it’s not a cliff. You don’t need to worry about having a cliff effect for it. That makes sense? It does, yes. Then as a follow-up, and I don’t mean to be too acute, but I’ve had a few people ask me. If I look at your 1Q and full year ‘23 NII guide, does -- is the -- the fourth quarter appears lower than the first quarter. So, maybe could you just talk about kind of the trajectory of NII as you think about it today? Well, we’ve given you a guide for the year of 13% to 15% up. We’ve also given you a guide from the fourth quarter to the first quarter growth of 1% to 3%. Now obviously, there’s more pressure as after the Fed stops raising rates for a quarter or two, you’re going to see deposit costs continue -- they lag. So, you’re going to continue to see pressure after that. It’s going to affect everybody in the industry that way. And so, you’ll see that decline at some point quarter-over-quarter during the year. So, that’s why it’s harder just to extrapolate fourth quarter, but we’ll see where the Fed goes. Our guidance is predicated on the December 4. If that changes, then we’ll come back and update our outlook. But that gives you enough information to be able to model and do your sensitivities. But yes, there will be some declines in NII based on the forwards sometime during 2023. I had a follow-up on capital. You guys had a nice bump up in ratios this quarter. And just given the loan growth outlook you’re talking about, it seems like you’ll be at the top end of that target range for CET1 by the end of 1Q. I know the buyback hasn’t been a big priority for you recently. But at what point do you think that it might make sense to turn back on? Yes. So, as we think of capital allocation, before I get there, let me point out one thing. We do have the impact of the regulatory change that will hit us in this first quarter as everybody. That’s about 10 basis points working the other way, so. But your question is broader, how do we think about capital allocation, including repurchases. So first off, we want to use our capital to support our loan growth. We want to pay a dividend in the 35% to 45% range. We’ve been at the low end of that. So, we would like to operate over time, at least in the middle of that. We want to use some of our capital for nonbank acquisitions, in particular, to bolster our noninterest revenue as we discussed. I forgot who asked that question. And then, the kind of we use the share repurchase as the toggle, will keep our capital where we want it to be, which we said would be at the upper end of our range of 9.75%. We just think that’s prudent with uncertainty overly negatively affect our return. So, if we go meaningfully over that, we could turn on share repurchases and we’ll just have to see how that -- the capital generation should be very strong in 2023. And we should have enough to do all things I mentioned. And if we can’t put our capital to work doing a nonbank acquisition, then we’ll give it back to the shareholders. Okay. I appreciate the color there. And then, back on the $3 billion to $5 billion deposit runoff outlook you talked about earlier. I was glad to hear you seem to be conservative with assuming all of that runoff was in noninterest-bearing deposits. Was curious regarding the big picture, what you’re seeing in the book that gets you to the $3 billion to $5 billion range? And how sensitive is that just a stronger move up in Fed funds, if we end up seeing that? And then how are you thinking about funding that runoff where that’s going to come from the securities book, which is lower rate or if you’re assuming some of that or most of that comes out of cash at this point in your NII outlook? Yes. We have plenty of cash right now to take care of that runoff. So, that’s not a big deal. That $3 billion to $5 billion, there’s some corporate changes in there that will be seeking rates. There’s some consumer changes that are seeking rates. Historically, movements like this happen late cycle. So, we’re getting there. We all think that we’re getting towards the end of the cycle. And so, people will look to capture that upside so they can lock in the best rate before rates start going the other way. So, how much conservatism we have in there? We’ll see. We had a pretty big run-up in deposits, $40 billion during the pandemic, and we’re holding on to quite a bit of that, more so than we originally thought. But I think it’d be prudent to -- we think it’s prudent to put in this runoff of $3 billion to $5 billion and again, conservatively all in NIB. Could you speak to concerns that we could see the mix of time deposits and noninterest-bearing deposits return, potentially not just the pre-COVID levels, but back to pre-GFU [ph] levels in this environment? You’ve given a lot of great detail on the strength of your deposit franchise, but it would be great to hear your thoughts on sort of that risk, both broadly at the industry level and more specifically for reasons as we look ahead from here. Yes. You’re breaking up a little bit, but I think what your question was, is how do we think about time deposits versus noninterest-bearing deposits and where will we settle out over time? So, we’re sitting here today at 39% noninterest-bearing. There have been some movements out of that to -- because we were over 40% into CDs. So, we do believe there’s going to be some remixing. That’s built into our beta assumption of 35% through the end of the year. We still think we’ll have more NIB than most everybody because that’s the nature of our deposit book. Very granular deposits, in particular on the consumer side where we have leading primacy that makes a difference. So, money goes in, money goes out. They’re not seeking rate, they use it as there -- that’s their operating account. And so, we believe that we will continue to see some decline in the NIB. Again, we conservatively put $4 billion out of that. We think there’s probably a chance that there’ll be -- it won’t all come out of NIB, but we thought that was the best thing to do from a guidance standpoint. That’s very helpful. Thank you. And then separately, I wanted to follow up on your comments around the NIM protection that you put in place, how would you respond to the view that the downside protection that banks are putting on in this environment doesn’t make a lot of sense because of the negative carry associated with it since the forward curve, discounts, everything that we see in the current environment, you’re effectively just investing at whatever the yield curve is -- whatever the yield curve is at the moment. Well, the most important thing to remember is our hedging strategy is not meant to generate increases in NII. It is a risk reduction measure. It’s a hedge, is to protect us in low rates. When you have a deposit franchise like we do that has lower costs than our peers, and that’s the way it’s been historically. As rates come down, we don’t have a mechanism to protect our net interest margin because we can’t lower deposit costs much as low as our peers can. Therefore, we have to do it synthetically. And that’s what the hedge program does. And we set these up generally forward starting. So, we don’t have negative carry until they start -- or the risk of negative carry until they start. And frankly, if we do at that time, that means rates are higher, and the rest of our book is earning that much more, and we’re okay with that. What it means is, yes, it costs us a little bit in NII, but we have a leading margin. So, we’re okay. You can’t think of it as a trade as some people talk about it as being a trade. That’s not what it is. It’s a hedge to protect us in low rate. A question on loan growth. I’m just curious how much competitive retrenchment you’re seeing from the banks you compete with most often? And how offensive are you willing to get for credits that look really attractive right now to you? Well, I would say, first of all, plenty of competition out there. And we don’t -- while there are certain segments, particularly real estate, where there are some competitors who are not as active today for a variety of reasons, in general, the market is very competitive, whether it be large banks, regional banks, smaller banks that we compete with. And so, we’ve got to be actively calling on our customers and our prospects and being very diligent in our activities, making sure that we’re in the market in front of customers. When we’re doing that, we get opportunities. With respect to how aggressive we want to be, we don’t change our approach to how we think about credit risk management, how we think about pricing and structure. We want to win because we have expertise because we provide really good ideas and solutions to customers, and we think that that resonates, and as a result, has helped us continue to build on growth in our portfolio. Okay. That’s all the calls, I think. I’d just end by saying we’re awfully proud of our 2022 results and the momentum that we’re carrying into 2023. We’ve worked hard over the last 10 years to remake our business and to build a balance sheet and income statement and importantly, a culture of risk management that will allow us to deliver consistent, sustainable performance. And we think we’re seeing that now. We’re going to continue to focus on organic growth and investing in our business, and we believe we’ll continue to deliver the kinds of results that you’ve seen in 2022. So, thank you for your interest in our company, and have a great weekend.
EarningCall_1567
Good morning, and welcome to the GEE Group Fiscal Fourth Quarter and Year-Ended September 30, 2022 Earnings and 2023 Update Webcast Conference Call. I’m Derek Dewan, Chairman and Chief Executive Officer of GEE Group. I’ll be hosting today’s call. And joining me as a co-presenter is Kim Thorpe, our Senior Vice President and Chief Financial Officer. Thank you for joining us today. It’s our pleasure to share with you GEE Group’s results for the fiscal year and for the fourth quarter ended September 30, 2022 and also to provide you with our outlook for fiscal year 2023 and the foreseeable future. Some comments Kim and I will make may be considered forward-looking, including predictions and estimates about our future performance. These represent our current judgments of what the future holds and are subject to risks and uncertainties that actual results may differ materially from our forward-looking statements. These risks and uncertainties are described in Tuesday’s earnings press release and our most recent 10-K and other SEC filings under the captions Cautionary Statement Regarding Forward-Looking Statements and Forward-looking Statements Safe Harbor. We assume no obligations to update the statements made on today’s call. During this presentation, we will also talk about some non-GAAP financial measures. And reconciliations and explanations of these metrics were included in the earnings press release. Our presentation of financial amounts and related amounts, including growth rates, margins and trends and metrics are rounded or based upon rounded amounts for purposes of this call and all amounts and percentages and related items presented are approximations accordingly. For your convenience, our prepared remarks for today’s call are available in the Investor Center of our website. With that business behind us, I am very happy to report that we achieved outstanding results in the fiscal year 2022 with revenue of $165.1 million for the year and revenue for our fiscal fourth quarter of $41.5 million. Gross profits and gross margins were $61.7 million and $15.1 million, and 37.4% and 36.3%, for the fiscal year and fourth quarter ended September 30, 2022, respectively. Our non-GAAP adjusted EBITDA for fiscal 2022 was $12.5 million, up 200,000, or 2%, compared to fiscal 2021, and that represents a 7.5% margin to revenue. Non-GAAP adjusted EBITDA for the fiscal 2022 fourth quarter was $1 million compared to $3.6 million for the fiscal 2021 fourth quarter. We achieved net income of $19.6 million, or $0.17 per diluted share for fiscal 2022 overall. We reported a small net loss of $800,000, or $0.01 per diluted share for fiscal 2022 fourth quarter. Before I turn it over to Kim, I want to say how very proud I am of our dedicated and talented people. They work extremely hard every day to insure that our clients get the very best service. This was a key factor in the outstanding performance of GEE Group in fiscal 2022 and will contribute greatly to the company’s future success. At this time, I’d like to turn over the call to our CFO, Kim Thorpe, who will further elaborate on our fiscal 2022 annual and fourth quarter results. Kim? Derek, thank you very much and good morning, everyone. As Derek mentioned, revenues for fiscal 2022 were $165.1 million, up 11% as compared with fiscal 2021 revenues of $148.9 million. Revenues for the fourth quarter of fiscal 2022 once again were $41.5 million, up slightly as compared with revenues reported for the fiscal 2021 fourth quarter. Contract staffing services contributed $138.5 million and $35 million, or 84% of revenues for both the fiscal year and fourth quarter ended September 30, 2022, respectively. Direct hire placement revenues contributed $26.6 million and $6.5 million, or in both cases 16% of revenues for the fiscal year and fourth quarters ended September 30, 2022, respectively. Contract staffing services revenues for fiscal 2022 increased $8.7 million, or 7%, as compared to fiscal 2021. Contract staffing services revenues were near level for each of fiscal 2022 and 2021 fourth quarters, although up slightly in the 2022 fourth quarter. Direct hire placement revenues for fiscal 2022 increased by $7.5 million, or 39%, as compared to fiscal 2021. Direct hire placement revenues again were near level for each of fiscal 2022 and 2021 fourth quarters. Direct hire placement revenues for fiscal 2022 set a record high for the company, exceeding even pre-COVID-19 results. The increases in total contracts and direct hire placement services revenues for the fiscal year ended September 30, 2022 were primarily attributable to increased demand in our professional staffing services segment as the negative effects of COVID-19 have continued to lessen. In addition, the volatility experienced in the U.S. economy and workforce in 2022 created many opportunities and increased demand, particularly in the direct hire placement services market. Total revenues from our professional staffing services segment, which includes contract staffing and direct hire placement services, were $149.2 million and $37.5 million and represented 90% of total revenue for both fiscal year and fourth quarter ended September 30, 2022, respectively. Professional staffing services revenues were up 13% and 1%, respectively, from the comparable fiscal 2021 periods. Our highly specialized IT services vertical, which includes Agile Resources, Access Data Consulting, Paladin Consulting, and SNIT brands, accounted for 51% of our professional services business segment revenues for fiscal 2022 and were up 23% year-over-year. The other professional services verticals: Finance, Accounting, Office Support, Engineering, Healthcare, and others accounted for the remaining 49% of professional services business revenues for fiscal 2022 and were up 5% year-over-year. Industrial staffing services revenues were $15.9 million and $4 million and represented 10% of total revenue for both fiscal year and fourth quarter ended – I’m sorry, September 30, 2022, respectively. Industrial staffing services revenues were down 8% and 9%, respectively, from the comparable fiscal 2021 periods. We continued to experience some pandemic-related conditions associated with the delta and then omicron variants in our Ohio markets in the earlier quarters of fiscal 2022. These included school and business closings and interruptions we commented on before, which were reminiscent in some respects of the early COVID-19 pandemic. Consolidated gross profits and margins were $61.7 million, or 37.4%, and $15.1 million, or 36.3% for the fiscal year and fourth quarter ended September 30, 2022, respectively. Our consolidated gross margins for the last six quarters have consistently been above 36%. The overall improvement in the company’s combined gross profit margin is largely due to substantial increases in direct hire placement revenues, which have 100% gross margins. Selling, general and administrative expenses for the fiscal year and fourth quarter ended September 30, 2022 increased $10.3 million and $2.6 million, respectively. SG&A expenses were 31.4% and 34.8% of revenues for the fiscal year and fourth quarter ended September 30, 2022, respectively, compared with 28% and 28.6% for the comparable fiscal 2021 periods. In addition to overall growth of the business, resulting in additional incentive compensation and bonuses, the increases in SG&A expenses and ratios were affected by $800,000 in charges associated with two former positions that were eliminated during fiscal 2022. Also, a $400,000 increase in bad debt expense associated with one of the company’s former industrial staffing services customers, and a $1 million charge for the settlement of a legal matter that added to our SG&A expenses in the earlier quarters of fiscal 2022. As Derek mentioned in his remarks, we achieved net income for fiscal 2022 of $19.6 million, or $0.17 per diluted share, as compared with net income of $6,000 or near breakeven $0.00 per diluted share rounded for fiscal 2021. There was also a small net loss for the fiscal 2022 fourth quarter of $800,000, or approximately $0.01 per diluted share, as compared with net income of $2.9 million, or $0.03 per diluted share, for the comparable fiscal 2021 quarter. Non-GAAP adjusted net income/loss and diluted EPS, excluding the effects of non-operating and/or non-recurring items, as outlined in the earnings press release, were $7.7 million, or $0.07 per diluted share, and a loss of $400,000, or $0.00 per diluted share, for the fiscal year and fourth quarter ended September 30, 2022. Adjusted EBITDA, which is a non-GAAP financial measure, was $12.5 million for the fiscal 2022, up $200,000, or 2%, compared to fiscal 2021. Non-GAAP adjusted EBITDA for the fiscal 2022 fourth quarter was $1 million compared to $3.6 million for the comparable fiscal 2021 fourth quarter. Again, our fourth quarter results were impacted by the accrual of additional incentive compensation and bonuses commensurate with the significant improvements in revenues, earnings and productions we produced in fiscal 2022. As we’ve commented in prior years – I’m sorry, in prior quarters, we believe these types of positive results are sustainable. A reconciliation of GEE Group’s GAAP net income to the company’s non-GAAP adjusted EBITDA, and reconciliations of other non-GAAP measures with their GAAP counterparts discussed today, can be found in the supplemental schedules as part of our earnings press release. To conclude, our current working capital ratio at September 30, 2022 was 2.7 to 1. Consolidated accounts receivable, net of allowances for doubtful accounts, at the end of fiscal 2022 were $22.8 million, and our days’ sales outstanding performance metric, or DSO, was approximately 49 days. We reported positive net cash flow from operating activities of $1.4 million for the 2022 fiscal fourth quarter and $9.2 million during the fiscal 2022 year as a whole, and non-GAAP free cash flow of $1.3 million and $8.9 million, respectively. Our cash flow from operations and free cash flow for the year ended September 30, 2022 were reduced, in part, by payment of the first of two equal installments of deferred FICA obligations allowed us under the CARES Act of $1.8 million, which was made in December of 2021, and the payment of $1 million in settlement of an old, isolated legal matter that was made in April 2022. Our liquidity position is strong, we have no outstanding debt, and our net book value per share was $0.88 at September 30, 2022, and our net tangible book value per share was 25%, both up over the prior year. Thank you, Kim. The 2022 fiscal fourth quarter and fiscal year marked our fifth consecutive quarter and first full-year of strong performance since deleveraging the company. Having consistently achieved higher margins and free cash flow for the last five quarters, we are establishing a positive sustainable track record, as well as positive momentum for the future. At September 30, 2022, the company had over $18.8 million in cash and another $15.4 million in availability under its ABL facility. GEE Group’s prospects for today – and for future profitable growth have never been better. Despite macroeconomic challenges or unforeseen events, we believe we can continue to produce solid results in fiscal year 2023 and beyond. Before we pause to take your questions, I want to again say thank you to all our wonderful people for their professionalism, hard work and dedication. Without them, we could not have accomplished all the good things we shared with you today. If you have questions, please submit those by e-mail, and we’ll start the queue. At that point, please just ask one question or rejoin the queue with a follow-up, as needed. If there’s time, we’ll come back to you as well. One of the first questions is related to the fourth quarter and the revenue in our fourth quarter was very similar to the fourth quarter of fiscal 2021. However, the SG&A was higher and thus net income and adjusted EBITDA were lower. Kim, will you address that for me please? Part of the reason why SG&A was higher is because – in the fourth quarter was because we accrued additional incentive compensation and bonuses commensurate with the outstanding performance that we had put in throughout the remainder of the year. We held off in doing that until the fourth quarter for various practical reasons. So we thought it was prudent to take the full charge for all of that incentive comp. And then also, there was – there is a progression of increased compensation and bonuses over a calendar year of which the last three quarters of this fiscal year were the first three quarters of calendar year. So there is an upward progression over the year, but those things specifically account for the increase in SG&A. And one other thing I might point out that I think is worthy. If you go back to our 2018 year, and you compare our revenues, they are literally within $200,000 of loan. Our revenues in 2018 were $165.3 million, they were $165.1 million. However, our gross profit this year was $3 million higher. And if you take that same ratio concept and instead applying the ratio of SG&A against revenue you applied against gross profit, our SG&A expenses were actually lower as a percentage of gross profit. And the reason they came in that well is because of all the extensive restructuring and expenses we took out of the business between 2018 and absolutely the [payment there]. So I just want to point that out. Okay. Thank you, Kim. Another question is it seems like in the middle of the month there were some large – there were large trades of the stock upward around 250,000 at the close. I also observed that occur for several days maybe four or five days. Is that stock manipulation? And if so, who is doing it? And I’m paraphrasing the question. The answer to that is that we just don’t know. A lot of the trades are made around the New York on some of the electronic mediums. And those trades influenced the stock price at closing or slightly after hours. That happens from time to time and we’re not too concerned about it. We don’t have a large short position in our company either. So if someone was trying to manipulate the stock price, has been suggested in the question, we’re not aware of who that might be. And I think that it’s temporary at best. The comment – a couple of comments related to stock buybacks. We were restricted until about now mid-December because of the CARES Act, PPP loans that you had one-year after the date of the last loan being forgiven. That would preclude you up until that time that we were precluded from doing a stock buyback. So now that we’re in a position that stock buybacks could be done. Those discussions are happening with our Directors at our Board meetings. And we will address that soon after these earnings releases get digested by The Street. So there are some rules on stock buybacks that the SEC [filed]. There are some rules on 10b5-1 plans, which we would be likely to adopt. So that when we – if and when we do a buyback that we can take advantage of the safe harbors in 10b5-1. So those are all things that are out there. There’s also a 1% excise tax that was encouraged by the President and adopted by Congress, that 1% excise tax is on buybacks over $1 million, just to give you a background because I had several questions on buybacks. So the answer to buybacks, historically, have done by [indiscernible] company. I’m well familiar on how to do them. And we will address that soon after the earnings are digested. The answer is no. Our working capital is sustained by our collection of accounts receivable and billings. Those accounts receivable, I think, Kim gave you the DSO number of about 49 days. So we’re not really having to tap our cash reserves and we’re definitely not tapping our ABL facility for working capital. So we’re doing very well on cash management and how we deploy that cash is a subject of additional conversations with our directors. Prospects for future profitable growth. Let me address the – what’s happened in our industry and in the general economy for labor in the U.S. So way through our fourth quarter and this was during our third quarter announcement. I said we were very optimistic, but for some issues with potential macroeconomic turbulence with recessions or layoffs or some combination of both. We have seen layoffs at customers. We have seen employment tighten up for full-time hires in a big way. 2022 fiscal year was a robust year for full-time hires. But midway during the fourth quarter, we saw some of those full-time hire opportunities reduced and the contract headcount was consistent. And what typically happens during a downturn of some type or noise in the economy, full-time hires tend to drop some and all hiring drops for a period of time. And then contract hiring starts to kick in, in a higher way. And then full-time comes back towards the end of economic cycle or when I quote the noise goes away. So we’re in that period now. And you could see – if you see the business news, Goldman Sachs laid off substantially a lot of their full-time people, interestingly enough, and that’s indicative of what large corporate employers are doing, not just in investment banking, but across the board. Goldman is a client of ours. And we were not, at this point, hurt by that. We have contract labor there. However, if there were full-time hires going in, they would put those on hold. But the contract people that we have so far have stayed out. But the point here is that the general level of hiring is somewhat muted during this period of what I call uncertainty. People don’t know if we’re going with downturn, you’ve got a high interest rate environment. Some people have to come with additional interest expense and so forth. I believe we’ll end up in the spring kicking really hard on a comeback assuming, when I say that, we’re doing quite well except perm placements will not be at the same level as they were in fiscal 2022, all of our competition said the same thing. And that’s because full-time hiring has been dampened because of potential economic turbulence on the outlook front. Additionally, in the tech sector, as you know, or have read, the Amazon’s, the Google’s, the Facebook’s and so forth have laid off people. Interestingly, a lot of those people were in our business before as recruiters and they’re coming back to us for their career. So we can pick and choose the best and the brightest. Our outlook is good. We have plenty of cash. We will not waste it. We will use it judiciously. And also on the SG&A front, we will make adaptations to our SG&A based on the volume of business and it will also go down some if the placements drop at all because commissions are included in that SG&A. So it’s a variable cost in many respects. But to the extent that we can reduce SG&A, which we will absolutely do somewhat and adjust it and according to the revenue stream that will occur as well. So some of the one-time items in SG&A will go away after the fourth quarter. So remember that as well going forward. In the last two quarters, management has indicated they would address share buybacks. I talked about that in the last two quarters. Can management please again give a little bit more color on why SG&A ballooned in Q4 of this year versus last year? Kim, I think you covered that pretty good, so I’m going to move on. Let’s see. Okay. This comment says, we’re moving into a more challenging economic environment. I address that. And what we’re doing about it with your free cash flow priorities in 2023? Things are pretty good, but there’s a lot of uncertainty, so some people are putting hires on hold. And typically, towards the end of the year in the first couple [indiscernible] to January, we do see a bit of what I call hold pattern. And then the hiring cranks up again going into the later part of the spring. And we should see some good activity then that’s our expectation. I can tell you, I’ve managed through several recessions, including 2008 and staffing companies collect more cash in the downturn because they’re not putting out as much money for payroll, but they’re collecting receivables that were on the book, books at a faster pace than they were spending money for payroll. So cash flow actually goes up for approximately 9 months to 10 months. About the time, the average time and duration for a recession. But for the 2008 recession, which had a financial calamity issue attached to it. So if you think through that, and with our cash position and no debt and the ability to draw on our credit if we need it, we’re not concerned about cash flow at all. We will not waste cash. I could tell you that. So we’ve accumulated cash exactly for the very reason that that question came up. The answer is absolutely, yes. And will you use your cash judiciously? Yes. Acquisitions, do you see them? Yes? Will you execute? Only the good ones. We’re not going to jump into one if it’s not a slam dunk. The answer to that is the macro factors may keep us from hitting that same target number, but we will do quite well in the event. The answer is we do a really good job recruiting internally. We pretty much have depicted the litter, particularly with a lot of the layoffs going on in corporate America in the recruiting side. So we’ve been able to attract some recruiters back to our industry and back to our company or to our company that weren’t with us before. Analysts coverage. We’re working on that to get more with your long-term strategy. Our strategy is to continue doing what we’re doing, managing costs, particularly adjusting it to the revenue cycle, revenue streams that we see debt-free. Let’s see. I mentioned that. Is it flat or declining a bit in fiscal 2023? And will it be at fiscal 2018 or fiscal 2019 levels? The fiscal 2018, fiscal 2019 levels are probably a better indicator of where permanent hires will be or direct hire business would be for 2023. 2022 was a bit of an abnormality. It was off the charts and that was probably because hiring was muted during the COVID era. The answer is yes. Temp will increase, but there’s a little bit of a transition period somewhere between December to February and then we should start seeing the temp hires kicking back up and perm will stay somewhat muted in that period of time, although we’re hitting perm still, but not to 2022 level, which was a pretty hard benchmark to be. They’re holding pretty good. If anything, they’d come down a bit because of the economic uncertainty and potentially turbulence in the economy. So the questions are finished. I thank everyone for being on. I can tell you that we are very optimistic absent some macroeconomic potential noise going into this fiscal year, although we’re going to manage our income statement appropriately in our expense line to match revenues, so that we can stay in the profitability areas that we want to be at and also generating substantial cash flow, which we will continue to do and which we are doing now. And we will use our cash wisely and look for some good things coming. That concludes our call today. We sincerely appreciate all of your time and effort and your investment. And I can assure you be good fiduciaries for you all shareholders and we will take care of our employees and look forward to some really good things. This is a journey. It’s not a sprint. So we will absolutely make sure the journey is successful. Thank you very much, and that concludes our call.
EarningCall_1568
Good morning. Thank you for joining myself, Miles Roberts, and our Group Finance Director, Adrian Marsh, to run through the results for the six months to the end of October 2022. We have a short presentation, after which, we're very happy to take any questions you may have. Well, firstly, during the last six months, we've seen high levels of economic volatility, but everyone who works in DS Smith has been focused on delivering for our customers. We have responded to our customers' changing needs with pace and expertise and with high levels of service and product quality and by working together to mitigate as much as possible the rising costs that we've experienced. The innovation platform that we have built continues to receive strong take-up and this is being supported by our enhanced capital investment program. We're, therefore, pleased with the development of our relationships with our customers and the value we're able to add. And this has supported a significant rise in our profitability and improvement in our financial ratios, such as return on average capital employed and leverage over the last six months. And looking forward, we expect the macroeconomic environment to remain challenging, but the current momentum in the business, together with our strengthened relationships and our investment plans, give us the confidence to expect the performance for the current full year to be ahead of our previous expectations, with the second half performing in line with the first half of this year. I would now like to hand over to Adrian, who will take us through the detail of the financial results. Thank you. By way of my normal reminder, I'll describe the performance of the business on a constant currency basis. Here are our financial highlights. Revenue was up 26% despite a small reduction in box volumes, reflecting higher sales prices across the whole business, which themselves reflect the rising input costs we've seen over the last two years. Price increases in the half more than offset significant cost increases of nearly £800 million compared with last year alone, with operating profit up 49%. Return on sales increased 150 basis points, which is quite evidently a very strong performance within a highly inflationary environment. As a reminder, in addition to selling packaging, we also buy and sell a large amount of paper, OCC and energy, the prices of which, as you're well aware, have increased dramatically, and this increases both revenues and costs on a gross basis with limited impact on profit, hence, it's dilutive to reported margin. As last time, I'll give the breakdowns to calculate underlying margin absent these gross-ups. Profit growth has flowed strongly through to EPS and cash, and I'll talk more about our continued net debt and leverage reduction shortly. The increased profitability has also allowed for a material increase in our interim dividend, and we've also taken the decision to bring forward the date which will pay our interim dividend by about three months, which we trust will be appreciated by our small shareholders during these difficult financial times. Our key metric of ROACE, which, of course, does not have the same nuance as for margins, has improved by 400 basis points, well within our target range. This is a 12-month measure, so the run rate is clearly significantly higher. I'll now go through the main moving parts of the usual bridges. We've broken out the packaging revenue from the totals and also the price mix to help you understand the impact of the pass-through of external sales of paper recycle and energy on underlying margin. The box volume decline had a slight negative impact on revenues. Other volumes as a mix of increased volumes of recycling offset by less external paper sales as we use more internally. As for last year, the major increase is clearly the sales price increase. Just over £650 million of the £950 million is packaging pricing, representing average prices of around 25% higher versus the comparative period. The balance made up of external paper, energy and recyclate sales. Turning to EBITDA. As with revenue, there's a small negative contribution from the volume decline and a similar story for other volumes with less external paper being sold, although there is a corresponding benefit on the cost side as less is being purchased. Sales price mix dropped straight through to profit, and I think we've consistently proved the strength of our business model and that we've been able to more than offset the very significant cost headwinds as well as managing our cost base through our proactive risk management and procurement processes whilst ensuring security of supply at all times for ourselves and, as importantly, our customers. On the cost side, the largest contributing factors were raw materials with external paper purchasing, OCC and other raw materials such as starch, together making up roughly half, with other costs such as labor distribution, together with energy, making up the other half. As a note, the combination of our energy risk management and our energy sales to local grids across Europe has significantly negated the impact of extremely volatile energy prices in this period. As previously guided, we still expect, on a full year basis, around £100 million increase in our net energy costs compared to last year. Overall Group margin has increased significantly, albeit, as I noted before, this is despite the inflationary environment. Regionally, there will always be short-term variations depending on the level of our own paper production. Clearly, we've seen some big moves in paper pricing and profitability in the last year and that has an impact before prices are fully reflected in packaging. Eastern Europe is the area where we're short is paper, and until the pass-through to packaging completes, the effect on margin is, therefore, greatest in that region, although profits were nevertheless up a very healthy 27%. Northern Europe has been our toughest region with volume reductions being more than the Group average, partly reflecting higher comparators in the prior period, but also the general economic environment, not least in the U.K. together with greater cost inflation than other regions. Despite this, profits were flat, while revenues increased impacted by a greater proportion of recyclate and energy sales, hence, the margin decline. On the positive side in this region, we've also the largest proportion of index contracts, which only recently reflected previous paper price rises already recovered in other regions. On the other hand, Southern Europe has clearly been the standout performer as profits more than doubled with the clear benefits from the Europac acquisition being demonstrated by very strong performance within both packaging and paper, particularly in our Portuguese kraftliner mill. North America remains a high-margin business despite a challenging overall environment at the moment, and we continue to make good progress with our multinational packaging customers as we replicate the offering they receive in Europe. Disappointingly, the availability of manual labor remains a drag on our performance. Of course, margin is an important metric, but as you know, our principal KPI is ROACE. So, whilst not surprising, it's very pleasing to see our returns back to the levels prior to our two significant acquisitions in 2017 and 2019. Our 13.2% is calculated on a 12-month basis, so clearly, the current run rate is higher and towards the top of our medium-term target range of 12% to 15%. And we respect -- expect to remain in this target range going forward. Returns and profitability have also converted well into cash. Clearly, the main driver is the improved profitability, but it's also been a decent performance on working capital despite the inflationary environment. Within working capital, you may remember, at the full year, I described an inflow of £109 million in term of the risk management of our energy hedges, which I said would reverse. That has happened. But as part of that continued counterparty risk management process, we had a net inflow of £197 million from additional margin calls during the period. As I've set out in our technical guidance, an absent of further margin calls in the second half, and we're expecting around half of this to be an outflow in the second half of the year and the other half in the first half of next year. So, overall, a very strong free cash flow, which we can see on the next slide has been a key driver in reducing our debt and leverage. Moving to the cash flow bridge. Net debt has reduced by £337 million since April. The picture in the half is relatively straightforward with the improvement driven principally by the strong free cash flow I've just described. Clearly, one of the highlights of the results is that net debt over EBITDA is now significantly below our target ratio of 2 times, driven by both an increasing EBITDA and reducing absolute debt level. And I'll talk more about that on the next slide. Just for modeling purposes, you should note the Interstate put option of just over £100 million will go out shortly. If I adjust for this and also ignore the cash received from the hedging collateral, then I’d calculate our leverage to be closer to 1.3 times. Just building on the strong cash flow and deleveraging performance in the first half, despite the many challenges of the last few years, not least COVID, I think it's worth highlighting the consistently strong cash flow from the business, which is a feature not only of our management but also the strong fundamentals of the business we operate in. We've generated £2.2 billion of free cash flow since 2019, while continuing to invest in the business well ahead of depreciation. Net debt is roughly halved with our leverage ratio comfortably below our medium-term target. We have an undoubtedly strong balance sheet and remain well placed to continue to deliver excellent results in a highly volatile environment. Our financial strength is clearly extremely important as it provides the capital to fund both future growth and returns to shareholders. As a reminder, I've reset our priorities for our financial metrics and capital allocation. We talked at the full year about the opportunities to invest to support growth with our customers, and principally, we expect that to be via organic investment in our business, investing in projects that give a return on capital over 15%. We've also maintained a progressive dividend as can be seen from our announced increase. Considering we've built a strong platform over the last 10 years, which will be extremely difficult to replicate, any M&A now will most likely be bolt-on in nature, continuing to meet our criteria for strong financial returns. In an uncertain environment, we want to retain financial strength and flexibility, investing to support further growth with our customers while retaining the flexibility to return any surplus cash to shareholders. Finally, my technical guidance. These are the usual line items you've come to expect. There's very little change since our guidance in June. Amortization now reflects the end of the SCA acquired intangibles within working capital and absent any further risk management, I'd expect the reversal of half the cash benefit of margin calls on energy hedges that I talked about earlier. And if all our input costs remain at prices as of today, then there'll be a further negative pressure, particularly on creditors, leaving working capital as a small outflow in the full year. We also expect to pay out just over £100 million for the final element of the Interstate put. As I mentioned earlier, the guidance I gave at the full year of year-on-year net energy headwind still remains at around £100 million. As a reminder, approximately 85% of our revenue is non-U.K., so 1% move in sterling equals around £7 million on operating profit. And finally, as of today, other than the small amount associated with the non-cash final unwind of the Interstate put discount, I again do not foresee any exceptional or adjusting items at all this year. But turning to our business model, a differentiated business model that's really driving ongoing success with our customers. And what are those differentiators? Our business model is very clear, consistent and robust. It allows us to be successful with our customers and an ongoing attractive financial returns. Firstly, we have a strong well-invested asset base of real scale based throughout Europe and across the East Coast of the U.S. It's a solely fibre-based business with no plastics or other formats. It's focused on the stable and profitable and evolving FMCG sector, where we have exciting state-of-the-art ongoing investments, making good incremental financial returns. And winning with our customers. We all know that the general economic environment during H1 was worse than we thought it was going to be at the start of the period. And this led to a reduction in our market size by at least 4%. And despite increasing our share, our volumes consequently fell by 3% on a like-for-like basis. And you can see from the graph that the sectors for food and beverage, for non-food consumer goods have really been very resilient. These are sectors where we are overweight, whilst the industrial sector has been more adversely affected by some of the economic headwinds. And regionally, the U.K. has been poor due to the general economic manufacturing environment in the U.K., but also along with Germany where the gas situation really has particularly affected some of the industrial sector. Elsewhere in countries like Italy, Iberia, Eastern Europe have fared much better than the Group average. Our market share gain is partly due to our ongoing relentless focus on our customers, responding really rapidly to their changing requirements, ensuring the highest levels of service, security of supply, and, of course, our innovation pipeline that continues to solve their problems. Our innovation platform is performing well. For example, in sustainability, we've seen an increasing rate of progress in the replacement of plastic format with corrugated. We've now replaced over 500 million pieces of plastic packaging since 2020. And this rate of replacement is accelerating and we expect that to continue into the second half. You may also be aware of the recently proposed EU packaging and packaging waste directive, and this inherently recognizes that the value of our closed-loop model that's operated by the corrugated packaging industry and really does support ongoing further growth of corrugated packaging against other product formats. So, looking ahead, we're pleased with our position, our investment pipeline and consumer relationships. Although the general economic environment is likely to remain difficult, our expectations are currently that in the second half of the year, we'll show an improvement of like-for-like volume performance over that achieved in the first half. And in the context of plastic replacement, I show here just a couple of examples. First, the Vanish e-commerce pack. This is about the washing tablet in an iconic, well-known brand. And here, we've been able to replace virtually all of the plastic that was used in its previous format. And secondly, our ECO Carrier. This is currently being rolled out at scale across Europe by one of the world's largest soft drink companies. As I said, these are just two examples of the pipeline coming out of our innovation facilities. And we've continued to invest in our business, not only in new capital solutions, but also in new products and services. All of these are in support of our customers. And we've created an enhanced Group-wide innovation function to take advantage of many of the ongoing opportunities to extend and develop corrugated packaging. This function has a new state-of-the-art development facility as well as the recruitment of over 30 new products and service developers. We've seen a meaningful take-up of our new products and services, some of which we've already spoken about, but also include the circular design metrics that continue to receive strong take-up from many of our customers. Our enhanced capital investment program continues to build new capacity and capability. This is now delivering those -- the new packaging plants in Italy and Poland that we previously discussed are now delivering ahead of the original budget. And we're also significantly now upgrading some of our largest packaging facilities in Germany, as well as investing behind new lightweight paper capacity in Italy. And of course, our environmental performance, our program to meet our net zero target by 2050, with an interim target in 2030. This is not only about decarbonizing, but it's also about coming away from fossil fuels to drive our longer-term competitiveness. Examples of these investments include a new biomass facility in France and also in Portugal, but also waste-to-energy plant in Germany. And it's great to see our overall achievements in ESG being recognized by many of the external agencies. We're very pleased to see S&P Global increasing our score to 73, putting us in the top decile of all companies and also the MSCI maintaining our AA rating. And to finish, our outlook. While we're pleased with the progress to date, we have been and remained utterly focused on meeting our customers' rapidly changing requirements. Our cost mitigation and pricing processes have been and remained very effective. And with the new investments backed by our customers with those attractive returns, places us in a great position to continue to gain market share. And so, consequently, we are raising our expectations for the current year, where we now expect the second half to continue at the same level of performance as the first half. Yes, thank you very much. I've got two questions. The first one is given the volatility in gas prices, what is your view on the outlook for paper prices now? How important is that gas price move? And sort of aligned to that, your energy hedging is clearly very high. Given that it's been going on for a year or so now, what's your adjustment on how other companies are hedged and, therefore, we're placed in the current situation? Thank you. Thank you, James. If I just lead on with the first part and Adrian can come to the second on the hedging. So, just in terms of volatility, you're absolutely right, the gas price of gas, you look at TTF gas, it is very -- it remains volatile. And we've seen paper prices really respond to that. And I think in terms of future paper prices, I've no doubt that this ongoing volatility -- at the moment, this increasing price of gas will ultimately feed into those -- into price of paper. Exactly when and how, obviously, is always more difficult to know, but we -- the higher rate of gas, we expect to feed through those prices. I mean on the second question, it's obviously quite hard to answer what other companies are doing. So, maybe it's easier to talk about what we do, which is we have a three-year program. It's rolling. So, we're always looking forward three years. I think gas prices came off a bit recently. They seem to be up again now as winter starts to bite. Really, if I was looking forward, is less about this winter that I think the concern is what about next winter and where gas supplies and where pricing are going to be then. And again, we're sort of very well managed against that. It's difficult for me to say what other companies do. I have no idea, but we've always had our three-year program. So, by constantly looking out three years, we're always exploiting that three-year forward curve, which is obviously materially different from where spot prices are. Good morning. I've got three on my side. I'll take them one by one, if you don't mind. Just the first one is on capital allocation. And it's a bit of a longer question, but I'd like to understand how you're thinking about this now because, Miles, you talked about your CapEx projects, you continue to invest ahead of the depreciation there. Your dividend, it's a good 5% yield at a sustainable level. M&A, you talked about bolt-ons. But when I look at your net debt to EBITDA at 1.3 times, debt is fixed. Are we starting to think about buybacks potentially moving up the agenda? Because I do understand on a cautious macro environment, maybe you -- it's no longer below 2 times net debt-to-EBITDA, maybe it's below 1.5 times net debt to EBITDA. But just wanting to understand how you're thinking about cash deployment with a strong balance sheet. That's the first question, and then I'll come back to the other two. Yes. I mean, I can answer that, Cole, to some extent, and then, sure, Miles would chip in if I miss anything. In terms of the priority, I mean, it's been a priority for me since we made the big acquisitions to get our leverage down to restore our balance sheet and to give us optionality going forward. Obviously, someone else will be coming in the summer and can take -- have their views going forward. But my priority has always been about getting us through that deleveraging to give us the optionality looking forward. Anything we do on -- in terms of returning capital, clearly, it's Board decision, taken in context with looking at our three-year plans, what it is we're looking to invest in organic growth, and if there are any inorganic opportunities. In the current climate, obviously, the waiter feeling is much more around a cautious approach, at least again, over the next six months. But you're right. I mean going forward, we set out our framework and it's quite clear that absent anything else, then we do start to look at how we return capital for sure. I mean, absolutely. And it will be wrong for me not to suggest that the Board don't regularly discuss that. And then maybe coming back to your guidance, you talked about volumes sequentially better. Should we be thinking about this just a function of you are relatively more food and FMCG, so you should be more resilient versus some other players, and then, also easier comparators versus last year, and the fact that you're benefiting from the ramp-up of two new box plants? So, just wanting to understand that sequential guidance in the second half. And then the third question is on energy. You are well hedged, 80%, at what's likely to be attractive levels versus the current forward price into 2023. How are you thinking about that hedging further out? Do you have flexibility to pull back on your hedging? Because I imagine in your position, you don't want to hedge at the wrong rate into the following year, because at the moment, you are, I imagine, a very good net winner. Just on the volumes, you're absolutely right, Cole, in everything that you said about our being overweight in the FMCG, we can see the resilience of that. I mean, it continues to give us a very solid platform. You're right about the comparators. You're right about the new investments. What I would add is we're also very pleased with where we are with our customers and about some of our ongoing contract and market share gains that we've seen coming through in the half year, particularly with the volatility and the -- and issues with supply chains. We've demonstrated how we can continue to support our customers, and that has resulted us some further awards. And that's the only thing I'd add to what -- to the issues that you said. But Adrian, on the hedging. Yes. So, on the hedging, just to be super, super clear, we look at it entirely as risk management. We have a three-year program. It allows us to maintain a constant dialogue with our customers around a relatively secure cost base despite other volatile inflationary costs at the moment. So, we haven't had to go back and discuss energy surcharges. We haven't had to go back and discuss anything to do with production impacts. We've been able to manage the business stably through, and that's what we do the risk management for. So, as we look forward to three years, is less about do we think there's going to be any opportunistic benefits or not. It's really what does that do in terms of giving us stability over our cost base, removing a level of volatility, and how we can manage it. I mean for what it's worth, the three-year forward on energy at the moment, I think, is around about €50 a megawatt hour, I think, something like that compared to peaks in the highest part of the volatility we saw over the summer of €300. So, even if you locked out everything three years forward, you're then locking that against a long-term average of around about €25, but it's still materially lower than where you are today. So, we don't look at it in terms of how opportunistic we can be. We look at it in terms of what it does in terms of the stability of our cost base and the conversations you need to then have with customers. Good morning, guys, and well done. Just very quickly, firstly, on the volumes. You guided obviously sequentially higher up half-on-half. Just in terms of the industrial focus, obviously, that collapsed quite a bit, seeming in the last couple of months. Have you -- do you expect that to bottom a little bit? Have you seen any improvement more recently in the last, I don't know, a couple of weeks or so? And then secondly, just on your full year guidance of roughly, call it, £840 million, if I read it quite simplistically, just if you could highlight your level of confidence around that? I mean, you do have box pricing relatively locked in. Energy costs relatively locked in. Volumes could be maybe a risk, but that seems higher. Yes, just your thoughts on that, please. Yes. Just on the on the volumes, the industrial was weaker. And what we saw in that peaking of the energy costs, particularly during the summer, when you look at the gas curves, you can see it sort of shooting up in the summer and then coming right back down again. Whilst we were very much protected there, we did see some of the big industrial clients ceasing, curtailing production in the light of those very high costs, and also the request really across the EU about conserving gas for the winter. We have seen those gas prices come off. We have seen storage rates and perhaps confidence about the availability of gas over the winter returning. So, we have seen some recent stability in that market. Now, it's very difficult to forecast towards. But at the moment is much more stable than it was a few months ago. And that's partly behind our sort of H1 -- H2 being greater than H1. But on the full year, I mean, you're right, but Adrian? Yes, I mean, I was just going to say -- I mean, put it this way, in my ten years, this is the first time we've given firm half year guidance for full year. So, you can read into that, the level of confidence we've got. Thank you. A couple of questions from me as well. The first one, I just wanted to understand exactly what you're saying. In terms of the volume component, is that sequentially or is that year-on-year we're talking? Because, to me, it doesn't necessarily feel like the levels of activity will be up in the second half versus what you've seen in H1, given the sort of sequential contraction of volumes as we go from kind of the Q2 into Q3 and Q4. But just to get a clarification on what the comparable is. The other component then, I guess, we are starting to see some material contraction on the paper side. And obviously, the normal dynamics would suggest that's going to be leading to some sort of box price contraction going forward. So, just your thoughts on -- well, at the same time as costs are coming down, of course, right? So, you call that energy full year [£100 million] (ph) versus the £158 million, OCC is, of course, off in your net short papers. So, there's a number of cost items that are coming down. So, how should we think about price over cost in the second half of the current year? And again, just a clarification on the volume component, what is real number? Yes, thank you, Lars. We're saying that whilst volumes fell in H1 against the previous H1 by 3% in the second half compared to the second half of last year, we're expecting the volume performance on that like-for-like basis to be better than we saw in the -- than in the first half. So, therefore, for the full year, we're expecting on a like-for-like basis to be better than the minus 3% that we saw in the first half. And again, for the reasons that we outlined previously. On the box side, we are -- the price of papers, you're right, has come off a little bit recently. Where we have our index [deal is] (ph), typically, we have a paper component and we have a non-paper component in our pricing. So, at the moment, our prices generally are still rising despite the lower paper price. Now clearly, there gets a point if paper then falls heavily, when does that start to out-weight? We just don't know. But we can see how -- and we are seeing our box prices still rise. In terms of paper, we've seen energy costs come off from the summer highs, going up a little bit. We've seen OCC coming down. So, as always, the price of paper remains volatile, but I do feel it's linked much more to the underlying costs. And if those costs come off, then I think we'll see some paper weakness. If they increase, then I think we'll see the price of paper respond. As a company, as you all know, we have extensive paper facilities, but we try to limit our exposure to the German market. We have much less of our own capacity there, simply because it's so oversupplied. The costs of OCC are generally higher there. They've got the gas situation. So, as a company, if the prices are moving down there and out of line with the cost, then clearly, we don't face that exposure. And that goes into some way as to the confidence that we have in the second half of this year despite that volatility in paper prices. Thank you. Hi, gents, and congrats on the good results. I've got a few. I'll start with the first one, which is a big picture. On this EU reuse and recycling directive, I'm wondering how it changes your views on the overall market growth over the long term. I mean, we've generally sort of thought about this market as potentially that CAGR increasing as a result of plastic paper substitution. But if this is obviously also aimed at lowering overall use of new packaging through the whole reuse dynamic, clearly, that probably reduces that overall growth in packaging. So, how do you see that impacting corrugated? I mean, do you have any expectations for what the long-term growth rate should be in that market? I'll come back to my others. Thanks. So, we've -- so, the EU recently had their draft directive for the packaging and packaging waste directive. So, it's out there. It has to be implemented nationally and, clearly, there are a few rounds of it. But it does broadly follow our sort of expectations. And that is about the inherent value of the closed-loop solution operated by corrugated against other formats, principally, but not only, but principally on plastics. And, therefore, in the secondary packaging, et cetera, where we operate, it's been large -- largely left out. We're not subject to these requirements that the packaging you make will have to be actually reused, i.e., return by the recipient, the packager of the package, back to the producer of the packaging. So, we're exempt from that. And I think the important thing is it really does recognize the value of the recycling model that corrugated uses. What we have seen from our customers is an increasing take-up of corrugated against packaging -- against plastic. We can see we're moving into a number of areas that whereas before where plastic has enjoyed just a cost benefit because it wasn't recycled and it ended up in landfill, et cetera, that it's no longer able to exploit. So, whilst total packaging use in the future, I think, will come down because of this requirement to reuse, I think that corrugated will ultimately benefit from that, and continue to grow and develop into [indiscernible] plastic is there. And we can see it today. We can sit with a rate of replacement. We can see it with the take-up of our new products. Yes, thank you. Just to clarify on that. I mean, do you think that the substitution effect is greater than the loss of overall packaging volume effect? I mean if you -- I mean do you have any feeling for a number in terms of what sort of CAGR we could expect? If it was sort of 2% to 3% growth in the past, is that still sustainable in the future, or could it be higher or lower? I can really talk about corrugated. We think this is a driver of growth for corrugated. What it does to other formats is really up to them. No surprise, I think, broadly, it will mean a reduction, but for corrugated, I think, will be a growth. Now, previously, we've talked about this, at previous Capital Markets Day, and we concluded that our growth will be greater going forward than it has been in the past. Typically, in the past, we've grown between sort of 2% to 3% per annum, and we've estimated that we should be at least 1% ahead of that, on a sort of an ongoing basis, not nearly sort of one six-month period, as the environmental debate in packaging continues to develop. So, we're not surprised by this legislation at all. And we think in terms of taxation and other things, there should be further support for our -- for the -- effectively for the corrugated and the fibre-based businesses. Understood. And just another question on the energy costs. I mean, you've said recently that you were 80% hedged for the following fiscal year. On that 80% of volume, could you give us an idea that the energy cost headwind that you've actually sort of locked in so far? Clearly, you can't go and do the other 20%, but can you give us some... Okay. Thank you. Just one point of clarity. You said the working capital, you should see a small build for this year. So, previously, I think you were talking about just over £100 million build because of the -- reverse of an item from last year. So, we're talking just about that expectation, is just that it's going to be a much smaller build than you were previously expecting about that? I think you have to strip out the reversal of the margin calls on the energy derivatives, which is just a timing difference. You get the cash in before the cost impact in the following period. So, it's a timing difference and that reverses as such. And then, on overall working capital, absent that, I expect there to be pressure to the negative this year, particularly if paper prices come off a bit, that has an impact on our creditor levels. We're still increasing, as Miles said, pricing, so on revenue and receivables, that will be -- it will still be a negative on that, i.e., those balances will be getting slightly bigger. And we'll probably get a small benefit on inventory as -- with the paper price reduction. So, all of which, as of crisis today, and that's all I can really go on, I would expect a small working capital outflow on the underlying business, so absent the reversal of the energy margin calls. First one is really on pricing. And in terms of box pricing, do you think at this stage, all our full sort of box price increase sort of implemented by the end of this financial year, i.e., sort of nothing rolling into the next financial year? And just sort of following on from that, could you help us think -- how should we think about how the metrics now included in index contracts might be different compared to previous cycles? I appreciate there may be elements of sort of gas pricing, et cetera, in there, but just how should we think about sort of those dynamics or the drivers of pricing as we go into 2024? And just secondly, in terms of M&A thoughts now, you flagged in the presentation you're thinking more around bolt-ons. I just wondered sort of the profile of assets that might be attractive to the group now, and how much does the kind of sustainability initiatives drive your thinking on that? Thank you. No, thank you. So, on the pricing, we've seen -- during H1, we saw quite a significant increase in prices compared to H2 of last financial year and, of course, H1 of the previous financial year. And what we're seeing in H2, we expect prices to increase again, but not of the rate that they increased in H1. And this reflects a moderation in paper prices. As I said, our indexes aren't only on paper, they're on non-paper inflation as well, which, of course, we're still seeing coming through. So, it's the balance of that, that's why we expect H2 price to be better than H1. And therefore, when you look into the following financial year, everything else staying the same, which clearly won't happen. But if it was to, you would see the full year effect of the higher prices, therefore, coming into the following year, because that rate of increase during this year. I said that does depend on paper pricing and lots of other things, but everything is staying the same, that's how we see that. We've been very pleased with our progress on pricing. On the M&A side, there are a number of opportunities there. As Adrian said, there are bolt-ons. It's nothing heroic at all. It's where it really gives us a particular sort of capacity, building our market share, particular sort of assets that we want. It's in Europe, U.S., it's paper packaging, and there were no -- it was all in our core business, nothing outside of that. What we have found is that the quality of assets that we are looking for if they're available on bolt-ons, then we're happy to look at them. But we have found that the solutions that we are developing in terms of new capital, work with our supply base, we can create assets frankly, just aren't out there in the marketplace today. Those two new builds that we have recently -- two new packaging plants we recently opened are just -- it's just way ahead of anything else out there. These new expansions that we are investing in as part of our capital, again, it's using technology that just isn't out there, much, much more efficient, lower energy usage, higher labor productivity, the quality control, that's giving us, I think, a real competitive advantage in the market, and we expect that to continue. Hi, guys, thanks very much for the call. Just following on this paper price questioning, can I just -- during the containerboard price upcycle, you were looking to shorten the lags between the containerboard price increases and the paper price increases. Presumably now you'd be looking to lengthen those legs. Can you touch on that a little bit? I mean, half our customer base is indexed and half is fully negotiated. And I think we've really demonstrated over the last couple of years where we've had a lot of inflation, how we've been able to really effectively manage that in mitigation and pass through to our customers. And now -- and going forward, I think, with our service, our quality, we're very happy with the relationships that we have. In terms of our sort of our pricing, we're feeling that we're in a very good position, supported by the types of contracts that we have. And in the index contracts, it's not just paper, it's also non-paper as well. So, we're feeling in a good position. And then, particularly, on the unindexed contracts, it's very much looking at what the overall inflation environment is as well. So yes. I mean, it's -- I don't think anyone is expecting anything to fall off a cliff. Clearly, when you get into a deflationary environment, if that happens, then there's pressure on the down on price. There's no two ways about it, but we're not expecting anything significant in the medium term. Good morning. Thanks for taking my questions. Three, if that's okay, please. Firstly, just on energy, again, if we step away from FY '23 as a whole, what will energy hedges have saved you for the full year? Secondly, [in your ability] (ph) and, again, up to the 520 million pieces of plastic replaced, can you give us a feel for what that equates to as a percentage of your total volumes? Maybe talk around what the experience has been in converting those customers? Are there differences in contract duration, what they're willing to pay for product, or anything interesting that's kind of transpired? And then finally, on the guidance, and look maybe a little bit unfair, but I'm just trying to piece together everything you're saying. Box volumes in the second half to be better sequentially, pricing -- box pricing continues to rise, paper prices are down ever so slightly, but it is a little bit of a saving, and OCC is down. Would it not be fair to say that H2 is really well underpinned actually, but calling it consistent with the first half, but actually there's quite a bit of upside to maybe to that number, or what should I be thinking to offset that optimism? I mean in terms of the first question, it's genuinely impossible to say and it's not something we'd look at, because in order to say -- we don't look at it in those terms anyway, we look at it at the risk that's been managed. But if you were to make an assumption, you would only ever buy at the highest market price, then clearly, being managed against that, there's been a good benefit. But that's never the case. We've also got energy sales. We also supply electricity where the markets are sensible across Europe to local grids. So, we only ever look at things in the round. And I'll go back to -- at the year-end, we said our cost base would have a headwind of around about £100 million due to energy. That's what's happened. So, anything else, it's really impossible for me to say. And on the plastic replacement, I mean, it's representing around about sort of 2% to 3% over that period of our annual volumes. In terms of revenue, the plastic is actually quite a -- plastic replacement is actually quite a bit better. It's attracting the innovation in there. It's attracting a premium. It's a new product, et cetera, and it is accelerating. That doesn't -- the numbers we've given actually doesn't include some of the very latest, obviously, products that are out there. We talked about the ECO Carrier for the soft drinks industry. I mean, that is looking like a very significant development. And also, in things like laundry liquid, et cetera, now you're starting to see a number of replacement, all those plastic tubs, and we're very pleased with the developments there. And these are all around products that packaging of [indiscernible] or liquids in there, and the way our barrier technology in products, in packaging that's going be sort of in a high humidity environment. We're really pleased with the development there, the number of units, but more importantly, the margin. And I think in terms of our guidance for the full year, all I can say is we wouldn't be so explicit this year unless we were feeling -- as we're feeling very confident about that. I'll just stress, that is not dependent on a big move forward in volumes or anything like that. This is about the value added in our products, about our service, the overall added value we're able to give to our customers. And the margins we're able to earn on that gives us -- really gives us an underpin on the confidence. Now obviously, we'll come back during the year as things develop, but sitting here today, we feel in a good position with our customers. Thank you. Good morning, and thanks for the time, guys. Just to -- I don't know if you could maybe comment or provide any insights into the OCC -- I mean, spots rates [indiscernible]. I think it's obviously great for margins. I don't know, maybe you can just comment, do you think it has reached the floor or perhaps where you're going from here? And then, sort of linked to this, as you mentioned earlier, there's been some light pressure or tailable pressures on [owned comparables] (ph). Just looking, yet again, back on your comments on medium term, not expecting medium-term deflation, [indiscernible] see a kind of sharp correction in H1? And then, just thirdly, around the [push] (ph) in Germany and U.K., you can maybe comment if it's stabilizing or do you think there's more downtime? [The reason is] (ph) it sounds like there was downtime, given you H2 outlook. Thanks very much. Thank you. In terms of the price of OCC, it has come down quite significantly. We've seen the export markets really sort of dry up for this. We've seen consumption of paper production or paper fall as well in Europe, and that's led to a significant reduction in the price of OCC. And I think this is currently running about sort of 11, 12 days of stock across the industry, which historically -- that's a very high figure. It seems to be sort of -- at the moment, it seems to be reasonably stable where it is, but it is a volatile market. In terms of paper, we've seen a lot of downtime there. That's partly why the OCC has gone up and the stocks have gone up. There has been a lot of downtime there. Industry stocks seem to be pretty stable at the moment. And the price, the fall in the price of paper, I think -- going back to what I said earlier, it probably has more to do with the change in the underlying cost base. But I think it will -- our expectation, but this is a volatile market, our expectation is if gas prices go up, I think you'll see some strengthening of the paper price. If they come down, maybe it causes some weakness. It's very difficult to call. But I do think it's responding to the costs rather than anything else. But I do note the considerable downtime that has been taken across the industry. And therefore, the stocks have been on paper relatively stable. As I said at the start, we're very pleased with the start of the year, the first six months, and we're feeling good about the -- about our market position and the prospects for the remainder of the year.
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We will get to the handset part, but I guess maybe I wanted to kind of start. You have had an Analyst Day and then an Auto Day, so obviously, diversification has been the theme. Maybe you could just spend a few minutes on just what that means for QUALCOMM? I mean, we will dig into the different pieces. But, obviously, there’s an auto piece, but maybe you can point us to some other areas that may not be on everybody’s radar and then we will dig into more stuff. So, when Cristiano became CEO about a year and a half ago, even before that, we were, obviously, focused on diversification. But one of kind of the key changes he made to the focus of the company going forward is really transition from a connectivity chip company for the phone to a connected processor company for the edge. And so, it’s a fundamental transition, not just from how we position the company externally, but really how we operate internally, how we make investment decisions and like. And so, the premise is being -- as everything gets connected to the cloud, we have the ability to take the technologies we had created for the phone and apply it to other industries. And so, the premise of the diversification plan is very simple. And if you look at automotive, clearly, the industry is going through a once-in-a-lifetime transition in various ways and the technologies we have in phones become extremely relevant to the auto industry. You look at broader IoT opportunity within consumer edge networking, industrial, the same trend applies, right? And digital transformation, obviously, a very big deal right now and it’s almost like with the macro environment becoming more challenging, digital transformation is actually a tailwind and transitioning from a technology perspective is becoming even more important for industries to survive and thrive. And so, we are in this unique position where we happen to have a technology portfolio that's extremely relevant to a bunch of industries and the plan -- diversification plan is really based on taking that and applying it to different areas. So, that’s the framework. Yeah. We’ll definitely drill into a couple of the pieces. I wanted to obviously go to auto. This pipeline increased substantially during the year, you said $30 billion. Obviously, there’s a long horizon on that as is auto. So, got a couple of pieces. But first, can you just walk us through, from a company that had gateway content for a while that’s grown digital cockpit is, obviously, a spot that’s right in your wheelhouse and then obviously the ADAS and autonomous maybe eventually. Can you just walk us through that content per car? Where you are in terms of adoption of those kind of three different components in market today? Yeah. So, maybe I will start with kind of the history of how we started in automotive and where we are going. So, previously, we have been focused on connectivity as the key set of chips that go into car. And when we talk about connectivity, there’s 4G going to 5G, there’s WiFi, Bluetooth, position location, powerline communications for communication within the car. And so, there’s a whole set of connectivity technologies that we sell into cars. The second is, as the internal experience within the car, both from the infotainment center, the cluster, rear seat entertainment, driver monitoring, smart mirrors, there’s a lot of stuff happening within the car, and then the software assets as well, we have the ability to be the chip supplier and the software supplier for those areas. So that’s the second domain that we have went into. And then the fourth, which came through -- partially through the acquisition of Arriver as a part of Veoneer, is ADAS software and we are getting a team with a lot of safety expertise, a lot of auto-specific software expertise that we are bringing to bear. So, when you put all of these pieces together, you have connectivity, digital cockpit, ADAS, and within ADAS we have both the vision platform and the drive policy platform, hardware and software, we call it the digital chassis, right? That’s -- on the physical chassis, sits on top of the physical chassis, it’s a digital chassis that really if you are an automaker and you are looking for a set of solutions for each of these areas and you want it for the lowest tier car, all the way to the highest tier car and everything being software compatible, you write once and use it across all tiers, you use it across all domains. It’s something that’s unique to us because of the scale of technology that we have, we can bring all of these to bear. And so, when you look at the design win pipeline and we gave the breakdown, we didn’t show the numbers, we showed a pie chart that breaks down the $30 billion, and what you will see is now our design win is very well split between all three domains, connectivity, cockpit and ADAS. So, very excited about where the industry is going. Very excited about what we can bring to bear. You made a comment on the timing of the revenue ramp, which, I think, works out well for us as clearly shorter-term drivers in other areas, and auto coming on the back of it gives us kind of growth opportunity for a long period of time, predictable growth, which is different than the handset market. So, as a part of the portfolio, in my role, I am excited about what it brings to bear. I wanted to ask you about the software piece in ADAS. I guess when you did the deal, you were very excited, and everybody is always excited when they do a deal. But then you announced BMW and made a point that it’s open. So, I think that is a big component of it, but so a couple of pieces of the question, I think. One, why would you win, I think, versus at least two established players? So, that’s the name. But I guess, I think, customers want to have their own imprint on what the experience is going to be. But I guess, I am kind of curious, in terms of your ability to leverage, where is that software stack? I think, your lead customer is going to help push it along. How much can you then transfer that to other customers? Is this something -- because you mentioned that it’s kind of like a 2026 timeframe with that customer. Is that kind of something that needs to kind of still prove out? Or you feel like you are still -- you are in a position where that software stack is mature enough and you can actually get some additional customers to sign on for it? Yeah. So, of the two competitors, we see Mobileye as the incumbent clearly in ADAS. They have been doing this for a period of time. We are the new entrant in the area. So, we have been investing internally in ADAS for a long period of time and -- for several years. But clearly that theme in our mind was not at scale, and did not have the industry-specific expertise that is so important when you start talking about safety. So, when we did the transaction, there were two things we are looking for. First is, obviously, a team that has been doing this for a long period of time. Second is a team that brings auto specific safety and security experience that is so important when you are talking to the OEMs. And then we were able to combine their effort with ours. But the third thing that was most important is the relationship with BMW that was simultaneous with the transaction. And what we are doing with BMW is really bringing our assets to bear for them and commercializing a full ADAS stack together between the two companies and then we have the ability to take the stack and sell it to other customers. So, this gives us, I think, a lot of credibility simply because: first, Arriver had credibility as a result of having been in the industry for a long period of time; second is you are commercializing the stack with a company that is widely respected within the auto industry and a great partner for us. And when you bring those two together, you certainly have significant ability to take that combined solution into other OEMs. And so, we are seeing very positive traction from the OEMs. It’s reflected in our design win pipeline. I mean, as you saw, we were in end of July, when we did our earnings release, we are at $19 billion. By the time we got to Investor Day, two months later, we were at $30 billion, and that is proof of our success. A lot of the execution is spending, right? So, clearly, our focus is now executing on the ADAS software stack together with BMW and then making it available to others. I want to ask you on the -- you mentioned the areas of increased content, the digital cluster, the infotainment, rear infotainment and such. Is there a way to think about -- I mean, obviously, that’s been the hardest thing to pin down in terms of what we see in the auto market. You have EVs as a trend, but then these cars also have tons more screens and they want them to look more like a Tesla, I guess. If you think about your content per car, I don’t know if you were willing to throw any numbers to it, but… So, at our Auto Investor Day, we talked about the opportunity for us, which we think is at $2,000 at the low end, $3,000 at the high end, right? So, there is a very wide range depending on which of the domains someone is buying from us and also depending on the tier of the cars, right? So, typically the way a lot of our conversations with the OEMs work is, if you are an OEM and you have a luxury brand and then you have a low-tier brand, what they want is to be able to write the software one, supply to all tiers of cars. And so, they’ll agree to multiple tiers of chipsets and we have a breakdown of where they are planning to deploy which tier. But I think as we get to ‘25, ‘26, ‘27, I very much suspect that the OEMs are going to end up shifting up in those tiers. Because the importance of having the technology that we are delivering for the OEMs, for the consumers as a competitive tool for them is only becoming more important. And as they do that, I think, we are going to see a shift up in term of content. The one last thing that I should have said earlier that’s unique to us is, at Auto Investor Day, we announced a chip platform where the hardware can be shared between ADAS and digital cockpit. So, it’s unique to us. You can have one piece of hardware do both. And when you are an OEM and you are trying to scale your solution across tiers to have the ability to do that is extremely unique and a pretty significant advantage for our customers. I do want to shift to handsets and if we have time we can go back, but obviously, a lot going on in handsets. I wanted you to think about, I mean, this is -- market has been interesting obviously. It’s been weak for over a year, almost year and a half. I think there is a couple of components to that. So, China, I think, there is a lot going on in China. I think there is been a lot of hope of like opening up. I guess, they have announced some changes. But then, I think when you look overall, 5G adoption is fully penetrated in kind of China and the U.S. I think, Europe is moving slowly. So, I think when you look out, I think, maybe, like, there is regions like India, it’s still adopted, but maybe not the same types of market. So, I mean, we are entering the fifth year of 5G adoption, not sure, even the six years. So, I think, kind of two parts there, how do you think about the overall kind of growth of handset market? And is there any hope that we have hit a bottom and we can see maybe even an up year next year? So, we think of this in two parts. There is a short-term cyclical challenge that the industry is going through, and I will come back to that. And then, there is a long-term secular conversation, right? And so, the easiest way to think about the industry right now is to kind of break it into two, because when wires cross across, you kind of loose the difference there. Short-term cyclical, there is two things happening. One is you have an inventory build that we talked about at our earnings release. And we talked about a couple of quarters as the timeframe that we think it takes for that to go through normalization. The second is just the overall market and the dynamics you outlined, and, clearly, China being a large significant portion of it. The way we think about it is, we will fully admit we don’t have clarity on how the macro-China situation plays out in the short-term. And so, we are trying to give as much transparency as we can around that, and we have shared all the information we had at earning release, and so there is no update to give at this point. And so, we are going to get through that period. Now, when you step back from that, you look at the longer term, there are several things that are happening in the handset industry very important. First is the conversation 4G to 5G very important for us. But if you look at the last three or four years in developed markets, the transition had already happened to 5G, but the content has gone up significantly because -- and we shared this in one of our web slides, I think, couple earnings release ago. A very relatively small portion of our content is now driven by 5G. Most of our chip content is actually the applications processor, CPU, GPU, AI, camera, audio, video, security. And each of these are ramping at a very significant rate in terms of what the consumers are demanding from their phone and then also what the OEMs are demanding. And so, the lot of the content growth that you have seen come through has actually nothing to do with 5G, it’s other capabilities in the phone. And so that has its own curve independent of 4G to 5G transition. Specifically on 4G to 5G, the markets that have not transitioned are really the emerging markets. And especially, India is going to be very significant and as the Prime Minister just announced the few months ago, and we are seeing the operators being extremely aggressive in the transition. So, we are going to have that opportunity as that transition happens. But as I said earlier, for us, the story is really about content increase on the application processor side and there are secular trends on increase within that. And maybe one last point is, when you look at emerging market through COVID, one of the changes that has happened is, the phones have become the primary TV viewing device in emerging markets. So, it used to be one TV, 20 people watching the TV in rural areas. Now that one TV have shifted over to 20 phones and everyone is watching their own content from their own phones. And when that happens, it automatically drives an upgrade cycle on the phones, because next time you buy a phone, you want a more capable device, and that is driving mixed shift, even at the low tier of the market, which is great for us. Just kind of drilling into that a little bit, I mean, obviously, I was eyeing your flip phone, so, I guess, there is a storyline there to some point. But I think, we also saw in other markets, when things are short, OEMs have kind of just produced the highest end, right, because they know that they can push it on to consumer. Consumers got pretty desperate for certain types of products, and we’ve seen things like PCs unwind already. Do you think that dynamic happened during the pandemic and hence that’s where more high-end phones sold through just because that was available, or you think that didn’t happened? There was a part of the phenomena and that I think applies to every industry. It’s not just a handset or PC story. I think, overall, if you are going to be constrained, you are going to be manufacturing higher-end chips. We talked about us doing that within our own supply, where that we were shifting across tiers and selling higher-tier chips in the constrained capacity that we have. So, that’s a clear trend. I would say that, that could -- that would unwind to some extent and you are seeing that happen in the market across the board and not -- again, not the handset market, overall industry, across various things. But again, I go back to the short-term cyclical, long-term secular, and our focus, we can run the business only for long-term secular trends. That’s what we are focusing. In terms of the inventory part, I mean, your business is actually -- you were kind of underperforming the first half of ‘21 and you kind of caught up, so you were kind of countertrend as maybe the RF guys were correcting. So, it’s been hard to kind of match the two cadences together. I think, you are now seeing a correction. So, can I just -- are you shipping -- you are definitely shipping below trend, but have you -- do you have a good sense of what the right run rate was? As you look at the back half of kind of when you started to see acceleration back half of ‘21 into ‘22, there’s some periods there that maybe that was building inventory, because we are now discovering it. But what’s the real run rate that you should get back to in terms of the handset? Well, so one way to think about this is, if you look at our fiscal year, our handset revenue grew by approximately 50%. And to your point, there was clearly some inventory build happening in a portion of it. Now, if you look at the calendar year revenue growth rate, which takes into account the adjustment we are seeing in the December quarter, so the calendar year is more of a -- it takes out the build and a large portion of the bleed away, handset revenue still grew 30% for us in a mature market. So, it is -- that’s the content story we talked about earlier and the mixed shift story we talked about earlier that’s helping us even when you kind of take out a large portion of the noise. What’s the right way to think about the customer that shouldn’t be named, but is it an Android vendor? I mean that’s been the one supply chain that’s been resilient through these corrections. There’s been a lot of news flow about production being disrupted, and you really haven’t seen any semi companies comment on it. I think, do you think that supply chain potentially build inventory like everybody else, or do you think it’s been managed better? And is there anything you can comment on in terms of these recent shutdowns? Well, I mean, rather than talk about our customers, I think, the way I think about it is, there’s going to be -- if there are short-term constraints in manufacturing in a given facility: one, typically, these OEMs have diversification in their manufacturing plants; and then second, I would say is, usually they are pretty good at catching up on manufacturing when they have constraints for some period of time. So, not a new trend. OEMs go through this from time-to-time, and it will normalize. I wanted to ask you a question about customers as well as Samsung. And when you joined, the -- I think the internal modem term view was a lot louder. You said, I think, you and Cristiano were, like, “We were going to execute.” Well, fast forward, you are going to have all the share at Samsung and that transition at Apple has been delayed. So, do you think that internal modem storyline that’s been kind of hanging out there in certain periods of time in the story is gone, or do you think we should, long-term, still think about a balance between customers having their own modems? Well, no change to anything we have said in the past, right? With Apple, we’ve been very transparent. At Investor Day, we said 20% share was our planning assumption for the 2023 launch. Now, we think we have a majority of the share for that launch. And we have said in fiscal ‘25, we expect minimal revenue from them. So, that’s our planning assumption. That’s how we are going to plan our business. Product wise, it’s relatively simple, right? For us, it is always about performance and modem leadership. We’ve been the leaders in modem performance for a long period of time. And there is -- one, there is a very strong pipeline of products coming up. Second, I think you are going to see second half of the decade, towards the end of the decade, we are going to start talking about 6G, and we are positioned to drive both of those ranges. So, we will focus on what we control and deliver the best product. I wanted to ask you about ASPs and gross margins, but I want to wrap it into a little bit of the 5G conversation we had. So, if -- and I know you answered the question that 5G is not the biggest driver, so maybe you already answered it. But I am -- I think people look out there and say, all right, India 5G is going to be the best thing you can point to in terms of the 5G story and the view is those would be lower ASP products. So, when you think about your overall business and over the next couple of years, do you think -- because your ASP is, I think, they are up, from my math, like 35% or something equate, and that’s mix and that’s maybe like-for-like, we don’t know. But you definitely benefited on an ASP perspective and the benefit of gross margin as well. How do you think about that trending particularly as some of these regions that typically are lower end layer in? Yeah. So, I will reiterate the 5G method. I think, at some point, people will realize that there is more technology in the phones beyond 5G or 4G. They use it every day. So, it should have been more obvious. So, I think when you look at the phone, you have 4G to 5G transition remaining in all emerging markets. So, yes, India is one of them, but there’s a bunch of other markets, and we are going to see the benefit of that very early in the 5G cycle. We talked about a 1.5x content increase when you go from 4G to 5G. The second is whether transition happens on RF front-end, we don’t play in RF front-end on 4G-only devices. So, when you go to 5G, that opens up SAM for us. The third is really content on the application processor side and that really is the story for us. That’s -- when you look at the investments we are making, the progress we are making, CPU being a great example, where we have now PC-class CPU performance coming up, and we are going to bring it to phones as well. So, we have this ability to really add an incredible amount of technology. And so, if you are an OEM competing in the premium tier globally, what we deliver to you is performance that allows you to keep your existing market share and grow it, and then take that same technology into all the peripheral devices, whether it’s tablets, hearables, wearables, PCs now. And so, in my mind, the SAM is expanding and just getting caught into the 4G to 5G conversation in phones is actually missing the point on the opportunity in front of us. In terms of that expanded content, I think, last earnings call, you rolled RF into the respective buckets and the answer was, you wanted to -- business is elsewhere big enough that you wanted to put those in there. I think, what are you going to provide going forward in terms of color on RF? Yeah, we have been very clear, right? We had set Investor Day targets for RF as a revenue stream. And as I said at our earnings release, we will give periodic updates against that as well. So, you are still going to be able to measure it alone as you would want to. But the -- I think the key message for us is, RF was a phone story for us in the past. As you look forward, every car goes to 5G, tremendous opportunity for us to win RF. Within IoT, there is the dongles that go into home, 4G going to 5G, Reliance in India, very, very focused on it. There’s an RF opportunity. You go into every other device in IoT getting connected with 5G, there’s an RF opportunity for us as well. So, it really kind of follows and it’s just a product line now into each of those end markets. And so the change we are making just reflects where the business is today. I said I would circle back. You have done a good job answering my questions. The -- I wanted to ask on the IoT side, right? So, people look at this business that had huge growth during the pandemic, and obviously, you have a lot of great drivers. There’s -- I mean, all kinds of stuff in there, metaverse in there, there’s dongles, but then there’s a lot of WiFi and it’s hard to parse through. You have been really good with disclosures. So, you kind of every quarter you come up with a different area. You are going to break out. Right now, you have seen corrections in one part of this IoT bucket. Do you think the rest of that kind of business will see some sort of downturn here? Or -- and kind of where can you point to some areas that maybe you are going to see growth? Yeah. So, again, kind of going to long-term secular before I come back to the short-term cyclical. The long-term secular growth, there’s like four areas that, I would say, and I highlighted at the Investor Day, where we have tremendous growth opportunities. First is in the PCs. You’ve seen the Mac’s transition over from x86 to ARM. I think there’s an opportunity for the PC ecosystem to eventually make that transition. And from our perspective, the one thing that we -- one piece of technology that we required to deliver a solution that exceeds existing options there was to have a CPU that met the performance benchmarks and exceeded it. And so, NUVIA acquisition was important for us, because we got a team that allows us to deliver on that, and so we are very excited about what’s in front of us. And as we go through the next several quarters, we are going to talk about it a lot more, give proof points on performance, on traction. But that’s the first one. The second is metaverse. The way I think about it is, you can debate your view of how this -- how big XR devices are going to be. There are people who say it’s going to be 50 million units. There are people who say it’s going to be 1 billion units. The way I see it is, it doesn’t have to be very big for it to be material for us, because we are leveraging technologies that we develop for phone and so it’s very incremental for us. And the -- really everything QUALCOMM does well is very important for that market. So, it’s really a sweet spot market for us. So, that’s the second one. Third is using 5G for broadband access into homes. It’s not something that the developed world naturally thinks about. But for emerging markets, we really think 5G becomes one of the primary broadband technologies into the home. So, that’s a great opportunity. It just extends what we have, very, very limited incremental cost for us. And then, finally, probably, the longest -- the biggest long-term opportunity for us is, as transformation of industries happen, a great example is retail, where the retailers are looking at tremendous transformation of technology in the store, I mean, it’s not optional anymore. And so, we could be a very good partner for them. And that’s just one industry, and there’s ten of these that we are pursuing. So, very excited about all four. And each one will have its own timeline, each one will have its own cycle. But when you put those together, it’s -- I think the long-term opportunity is tremendous. Only a couple more minutes, but I want to ask, the one area you didn’t mention is data center. I mean, you have had efforts in servers, you have AI efforts. I mean, what’s the status of your data center? I mean, we have always thought of that as upside and opportunistic. That’s not a primary focus for us. If you just listen to Cristiano talk about our strategy, it’s very much focused on the edge, and so we are going to prioritize that.
EarningCall_1570
Good day, everyone, and welcome to Smith & Wesson Brands, Inc. Second Quarter Fiscal 2023 Financial Results Conference Call. This call is being recorded. At this time, I would like to turn the call over to Kevin Maxwell, Smith & Wesson's General Counsel, who will give us some information about today's call. Thank you, and good afternoon. Our comments today may contain forward-looking statements. Our use of the words anticipate, project, estimate, expect, intend, believe and other similar expressions are intended to identify forward-looking statements. Forward-looking statements may also include statements on topics such as our product development, objectives, strategies, market share, demand, consumer preferences, inventory conditions for our products, growth opportunities and trends and industry conditions in general. Forward-looking statements represent our current judgment about the future and are subject to risks and uncertainties that could cause our actual results to differ materially from those expressed or implied by our statements today. These risks and uncertainties are described in our SEC filings, which are available on our website, along with a replay of today's call. We have no obligation to update forward-looking statements. We reference certain non-GAAP financial results. Our non-GAAP financial results exclude costs related to the planned relocation of our headquarters and certain manufacturing and distribution operations to Tennessee, the spin-off of the Outdoor Products & Accessories business in fiscal 2021, COVID-19-related expenses and other costs. Reconciliations of GAAP financial measures to non-GAAP financial measures can be found in our SEC filings and in today's earnings press release each of which is available on our website. Also, when we reference EPS, we are always referencing fully diluted EPS. When we discuss NICS results, we are referring to adjusted NICS, a metric published by the National Shooting Sports Foundation based on FBI NICS data. Adjusted NICS removes those background checks conducted for purposes other than firearms purchases. Adjusted NICS is generally considered the best available proxy for consumer firearm demand at the retail counter. Because we transfer firearms only to law enforcement agencies and federally licensed distributors and retailers and not to end consumers, NICS generally does not directly correlate to our shipments or market share in any given time period, we believe, mostly due to inventory levels in the channel. Before I hand the call over to our speakers, I would like to remind you that any reference to EBITDA is to adjusted EBITDA. Thank you, Kevin, and thanks, everyone, for joining us today. With firearm demand continuing to normalize, our second quarter results once again demonstrated the significant progress we've made over the past several years in creating a highly adaptive and robust business model that consistently delivers strong profitability regardless of market conditions. A comparison back to our fiscal 2020, which was the last period of normal firearm demand provides a great illustration. While top line revenue increased by 6% in Q2 of this year versus FY '20, EBITDA increased by nearly 90%, driven by higher ASPs and lower operating costs. Looking forward to the second half of our fiscal year, while we anticipate more normal demand levels, our seasoned team has effectively managed through these cycles before, and our business model is specifically designed for this, and we expect to continue delivering strong level of profitability even with the significant one-time expenses associated with our move to Tennessee. All of this is thanks to the hard work of the Smith & Wesson team in remaining steadily focused on the long-term success of the business, no matter the conditions. And as always, our appreciation for their dedication cannot be overstated. Turning now to the market. Consumer demand for firearms as measured by NICS was largely consistent from our fiscal Q1 to Q2, tracking below the surge period. The trend worsened in the latter half of our second quarter, as evidenced by the accelerated year-over-year decline in monthly NICS, ending with October only nominally increasing sequentially and representing the lowest sequential increase over September on record. Not surprisingly, this deterioration coincided with the broader consumer slowdown, driven by persistently high inflation, the beginning of the winter heating season across the northern half of the country and rising interest rates. But this said, the most recent data from November NICS released last week indicates a return to more normal demand patterns, and firearm demand does remain healthy when compared to historical levels and remains elevated when compared to our FY '20, which again was the last pre-pandemic period. This indicates that the temporary headwinds are being offset by longer-term tailwinds. As you'll recall, there were more than 10 million new consumers added to the firearms market over the past 18 to 24 months, many of whom are now returning for subsequent purchases. With these new entrants, previous studies indicating that firearms enthusiasts will own an average of seven to eight firearms and recent data showing that concealed carry is on the rise, we believe long-term demand trends remain very healthy. However, with the uncertainty surrounding the current economy and its impact on firearm demand levels, many firearm retailers and distributors continue to take a cautious approach and continue to adjust inventory levels. This is creating a near-term headwind to our business, as we discussed on the last earnings call. Importantly, this is a normal and healthy process and consistent with how we have seen the market adjust in past periods following significant surges in demand. And we note that inventory levels for our products within our distributors and strategic retail accounts are down considerably sequentially and versus prior year, marking the third consecutive quarter of significant channel inventory declines and indicating therefore, a solid pull-through of our products at retail. All of this means we remain in a highly competitive environment and winning profitable market share at the consumer level remains our core focus. With many consumers squeezed by inflation and record prices for household essentials, consumer price sensitivity on discretionary purchases has increased, predictably, leading to increased promotional activity within the firearm space. As we have mentioned before, we take a very strategic approach to pricing and are confident in the pricing actions we've taken to align our ASPs with the power of the Smith & Wesson brand and our long-standing reputation for quality and innovation. We believe we are now well positioned versus competing products across the full feature value spectrum. The resulting higher ASPs have driven strong profitability by helping us mitigate inflationary pressures and also partially offsetting lower volumes. We expect our use of promotional activity in this competitive landscape to similarly remain aligned to ensure we do not erode those gains long term. However, we may increase promotional activity on certain of our core product lines in the second half of our fiscal year to address the realities of the current challenging economic conditions. Additionally, and now more than ever, innovation and new product introductions are critical to continuing our leadership position in the industry. Thanks to the hard work of the Smith & Wesson engineering and product management team throughout the pandemic, we are very well positioned to continue our steady cadence of product launches. Just in the past few months, we introduced our M&P metal, a full metal version of our iconic M&P full-size pistol, our equalizer, a 15-round concealed carry pistol, featuring our patented EV technology, which reduces slide racking force by over 35% and our competitor made by our Performance Center in collaboration with our legendary pro-shooting team of Jerry Miculek and Julie Golob, a full-featured metal frame pistol ready for competitive shooting straight out of the box. These products have been very well received by the market and are exceeding our expectations. And stay tuned, we have several more exciting new products lined up for introduction throughout the second half of our fiscal year. In summary, we continue to manage the business for the long term, ensuring we consistently deliver high levels of profitability regardless of which direction demand is trending. Fiscal 2023 continues to be a year of recalibration an adjustment for our industry and Smith & Wesson. Interest in shooting sports remains strong and participation rates remain above pre-pandemic levels, which bodes well for the long term. Over the near term, the industry is facing the dual challenge of a cyclical downturn and more intense macroeconomic headwinds, pressuring consumer spending, particularly on discretionary items, such as firearms. While this will likely to continue to impact our top line revenue over the balance of fiscal 2023, it is precisely the type of environment for which our flexible model was built, and we expect to remain highly profitable and continue delivering on our commitments to our customers, employees and stockholders well into the future. Thanks Mark. Net sales for our second quarter of $121 million was $109.4 million or 47.5% below the prior year comparable quarter, but $7.3 million above the second quarter of fiscal 2020, the last pre-pandemic comparable second quarter. As we noted in our last earnings call, we expected our second quarter volumes to be roughly 20% to 25% of the full year, and we came in within that range. For the third consecutive quarter, inventory in our distribution channel has meaningfully declined. This ongoing inventory correction, combined with the impact of promotional activity by our competitors and the trading down by consumers to lower-priced products negatively affected our quarterly sales. On a positive note, however, the discipline that we've exhibited in promotions during the current quarter has improved our overall profitability when compared with pre-pandemic levels, reflecting ASPs that were approximately 45% above fiscal 2020. Although gross margin in the second quarter of 32.4% was well below the 44.3% realized in the prior year comparable quarter, the increase in ASPs resulted in a 4% improvement over the second quarter of fiscal 2020. Relocation costs negatively impacted the current quarter gross margins by 1.5% in the comparable quarter last year by 0.5%. The decrease in margins from last year was also due to a combination of reduced sales volumes across nearly all product lines the impact of inflation on material and labor costs, unfavorable fixed cost absorption due to lower production volume and unfavorable product liability and inventory valuation adjustments partially offset by decreased compensation costs. Operating expenses of $26.7 million for our second quarter were $9.9 million lower than the prior year comparable quarter primarily due to a $3.1 million reduction in relocation costs, lower sales-related expenses, such as co-op advertising and freight and decreased compensation-related costs driven by temporarily unfilled positions, we believe, as a result of the relocation. Net income of $9.6 million in the second quarter compared to $50.9 million in the prior year comparable quarter, reflecting lower net sales and gross margin slightly offset by reduced operating expenses. However, when compared to the second quarter of fiscal 2020, net income was $9.3 million higher this quarter due to higher ASPs and lower operating and interest expenses. GAAP earnings per share of $0.21 in the second quarter was down from $1.05 last year, but was $0.20 more than we reported in the second quarter of 2020. Non-GAAP earnings per share of $0.26 was down from $1.13 in Q2 fiscal 2022, but $0.24 higher than in fiscal 2020. EBITDA of $25.6 million represented 21.1% of sales. During the quarter, we used $35.3 million of cash from operations and spent $28 million for capital projects, resulting in net free cash used of $63.3 million. This was consistent with our expectations, given our planned inventory build during the quarter, payment of profit sharing from fiscal 2022 and increased spending on the construction of our new facility in Tennessee. We remain focused on managing the business for long-term profitability, market share performance and capital return to our stockholders. To that end, our board has authorized our $0.10 quarterly dividend to be paid to stockholders of record on December 20, with payment to be made on January 3. Looking forward to the third quarter. Now that we are operating under a more normal seasonal demand model with distributor inventory at more comfortable level, our earlier estimate of 20% to 30% unit volume for the third quarter continues to appear reasonable. We expect that margins will continue to be pressured by costs associated with relocations, inflation and lower volume than the prior two years. In addition, we've begun to increase promotional activities on select products and expect that to continue through most of the rest of this year, which will likely affect ASPs, margins and operating costs. And finally, as show season begins in January, both sales and marketing costs are likely to grow beyond our current quarterly run rate. We remain committed to our long-term financial targets and while the low end is still within reach for fiscal '23, recent industry trends have created additional uncertainty as we are also being impacted by the one-time costs related to the construction of the Tennessee facility and equipping it with state-of-the-art machinery. When you combine these one-time costs with the working capital needs of our business to meet cyclical consumer demand and costs associated with preparing for next summer's move, we will likely continue to experience negative free cash flow during our third quarter even with inventory beginning to decline seasonally. Finally, our effective tax rate is expected to be approximately 24%. I just want to start out just talking big picture on kind of the promotional environment. It seems like it's gained steam kind of around the holidays in Black Friday. It doesn't seem like you guys have followed suit. Is that correct? And then, it sounds like you may be open a little bit more here in the second half to be a little more promotional, but it doesn't sound like you're going to follow what we're seeing from some peers and get overly promotional here in the second half. Yes. That's a good question, I think. So, so far, yes, the answer is we haven't participated to the level of some of our competitors. I think we're taking a little bit as we kind of -- as I said in some of the prepared remarks, we're kind of taking more of a longer-term approach. We don't want to erode those ASPs that we've been able to gain over the last couple of years. We do feel like we're in a good position versus the competition and what the brand should be able to command. With all that said, we're -- sorry, and one more thing. We're also going to try and push a little bit more on new product and get a little bit rather than being totally reactive and just going in straight into promotions, there's some things we can do with new products to kind of drive volume and maybe some bundling with some accessories, et cetera, so a little bit more creative things. All that said, I think we all understand that the economic conditions are what they are, especially for discretionary items like firearms. So, we're kind of going to have to play the hand we're dealt as we kind of go forward here. And so, I think your question of are we going to participate in a more meaningful in promotions in second half, the answer is probably yes. Okay. And it looks like just as we look near term, and I know you don't and haven't given kind of quarterly guidance. But given we saw some handguns 9 millimeters being sold by peers at $200-or-so at retail, plus rebates, I would expect that you're not expecting any significant volume growth here in the near term as peers are overly promotional? Yes. I think Deana kind of gave some comments -- some color to that in her prepared remarks around the percentages of unit volume that we expect for the first half versus the second half. And so, I think we're kind of holding to that. I think you can probably get to where you need to be based on some of the comments that Deana gave on the percentages first half versus second half on unit volume. I mean, generally speaking, Mark, we don't expect Q3 to be terribly different from where Q2 came. The seasonality may change. We'll see how the Christmas season goes and reorders in January. But right now, we're not forecasting it to be terribly different than Q2. And then your Q4, as you know, you've been around a while. Q4 is usually for us, our fiscal Q4 is usually kind of -- you get that pickup in Q4. So kind of go back to historical and expect that same kind of pickup we've had historically pre-pandemic. Yes. And that's just -- I want to walk through just your new product launches and moving to more kind of historical norms and kind of timing of shipments. Within your inventory build at the end of the quarter, can you speak to maybe how much of that was new product as you had some new products that we're launching kind of at the end of the quarter? Not a lot of it. Our new products, just the timing of it we usually load into the channel prior to the actual consumer launch that it's available at retail once we start talking about it. So you'll note that we launched the -- those new products were right at the beginning of November. So, we had really loaded a lot of those in already and then middle of November. So, they were already starting to ship into the channel. So a lot of that inventory build was not associated with new products. Okay. And then as you just discussed Q4 the April quarter, maybe seeing a little bigger build in shipments, is that primarily due to continued new product launches and getting that product into distributors and retailers' hands? Yes, yes. Our second half will continue. You saw the cadence kind of pick up, and we almost had kind of one new product launch every month since September -- end of -- right at the end of October, beginning of September, one then at the beginning of October and -- sorry, end of October, beginning of November, and then one just most recently with the competitor that we do anticipate to kind of continue a pretty steady cadence probably not to that level, but throughout the second half. So, the second half does have a lot of new products included in. Okay. And it might be digging a little bit here just into your plans on launches, but a lot of your products that you have launched recently have been at mid- to higher end of maybe ASPs and price points. Should we expect that going forward? Or is there a chance that you come out with more lower and introductory type products going forward? Yes, I think you are digging a little bit there, but I'll give you a little bit of color. It's -- as I said earlier, I mean, we're managing the business for the long term, and we do believe that the Smith & Wesson brand and our reputation does allow us to kind of play in that mid upper tier. And so, yes, I mean, the new products we're launching, the intent with the new products that we're launching is that we can command full margin for a brand-new product. And we anticipate those products will come in kind of where our ASPs are sitting today and shouldn't materially impact the most hopefully help us to be able to maintain them. But that said, the new products, the detail of it is you're going to span the spectrum between kind of our lower end and all the way up into our high-end products, so as much color as I can give you is that they're not really going to materially impact our ASPs, one way or the other. Okay. The next one, just kind of shifting a little bit, can you just give any more update on relocation as far as timing and costs and anything -- is it still going according to plan? Or have we seen anything shift? No, yes, appreciate the question. Everything is going very well. And yes, according to plan on a timing basis. As we've talked about in previous calls, just with the inflationary impacts across the economy, it is a little bit towards the north end of our range of what we expected, but we are still within our contingencies, and we still anticipate to be able to do it within our budget, although albeit towards the north end. And from a timing perspective, it's going very well. So, the building is right on track, and our personnel out there were actually -- we've got over 60 employees already working out of the area mostly front office personnel working out of the Tennessee, a temporary location there. So, the move from a personnel perspective is going very well as well. Okay. And then another kind of big picture question. Just cash -- the balance sheet has changed a fair amount. We've seen the inventory come up, cash position come down, still debt free. But just looking at expectation that you'll still have some negative free cash flow here this next quarter, has anything changed as far as capital allocation or plans of investment? I'll let Deana get into the detail in a second. But just generally, from capital allocation, nothing has changed in terms of our priorities. I think we said right from the get-go three years ago when we were talking about the spin that our capital allocation priorities would be reinvestment back in our business and then return excess cash back to stockholders, and that remains the priority. So right now, obviously, we're investing back in our business with the facility in Tennessee, which continues to be a fairly significant cash strain, but as planned and anticipated. And once we're done with that, we don't see anything major on the horizon in terms of the cash expenses needed for the business, and we'll be back into returning cash to the stockholders. Yes. And you'll see that our capital spending is higher than it normally is, just in the quarter ever in mind for the full year. Without that, we would have been $30 million to $40 million higher in cash. So we did plan for it. We expect to spend the cash. We went into this knowing that, that was an excellent use of cash for the long-term viability of the business. And unfortunately, that means I don't get to hold the cash that I want to hold. But once we get back to the grand opening of the new facility, that should cover everything that we need to do in the short term, and we'll get back to looking at how can we make more investment to our investors. And then the last one for me, just big picture again. Regulatory environment, we've seen the first kind of piece of legislation or change here in a long time. Can you just give an update on where you guys stand and then in recent legislation nationwide, not state by state, any change that, that had on your business? Yes. We -- as we always kind of answered this question, Mark, we make lawful products and we abide by all the laws and whether it's local, state or federal, and we will always continue to do that. It's one of the things we pride ourselves on is compliance with regulations and running an ethical business. And so that said, the state regulations, we have seen them kind of -- they come and go ebb and flow, and there's, I guess, a lot of noise, if you want to call it there. The Oregon legislation obviously is causing a temporary big spike in that area for folks looking to exercise the second amount of rights while they feel they still can. We'll continue to react to those as they come up in terms of the long-term macro impact to the business. We've just kind of seen -- I mean you look at some of the states that have the most restrictive laws on the second amendment. There are some of our top NICS states. So, those consumers are still willing to exercise their rights even with the respective laws to the impact to our business, it's fairly minimal. You guys launched the M&P 12, the shotgun about a year ago. And about a year -- now that we're about a year into it, Mark, I wonder if you could just go through your thoughts on the category how the law just gone a year into it. And I guess you didn't enter this broad new category of just one model, one SKU that being the long-term plan I would just love to hear your thoughts in terms of how that launch has gone and how you view the category and the response to your product and your plans going forward to the extent that you can disclose. Sure. Thanks for the question, Rommel. Yes, the long gun category and shotguns in general, yes, some opportunity for us, some white space for us in the Company. The M&P 12 that we launched was really more addressed towards a little bit of a niche in that market, which is bullpump shotguns, and it is more of a -- one of the higher end bullpump shotguns. And again, as I said earlier, and we believe definitely commands that higher end price due to the quality and brand reputation that we have. That is, unfortunately, in the recent downturn has been one of those categories, the higher end, more tactical specialty shotguns has been one of those categories that's been kind of more hard hit. The shotgun category still anecdotally here, it's still moving very well, but it's at the low end a lot of hunting shotguns and pumps, et cetera. So long term, as much color as I can give you is, yes, I mean, it's a white space for us and continues to be an area we look at and evaluate. And as I said earlier, new product development is one of those things -- one of those areas, that's a really great lever. We feel we can pull to keep those consumers interested in us and gain more than our fair share of the market as we go forward. So hopefully, gives you line there gives you the information you need. [Operator Instructions] And as there are no further questions in queue, I'd like to turn the call back over to Mark Smith for closing remarks. Sir?
EarningCall_1571
Ladies and gentlemen, thank you for standing by. Good day and welcome to the WD-40 Company First Quarter 2023 Earnings Conference Call. Today’s call is being recorded. At this time, all participants are in a listen-only mode. At the end of prepared remarks, we will conduct a question-and-answer session. [Operator Instructions] I would now like to turn the presentation over to your host for today’s call, Ms. Wendy Kelley, Vice President of Stakeholder and Investor Engagement. Please proceed. Thank you. Good afternoon and thanks to everyone for joining us today. On our call today are WD-40 Company’s President and Chief Executive Officer, Steve Brass; and Vice President and Chief Financial Officer, Sara Hyzer. In addition to the financial information presented on today’s call, we encourage investors to review our earnings presentation, earnings press release, and Form 10-Q for the period ending November 30, 2022. These documents are available on our Investor Relations website at investor.wd40company.com. A replay and transcript of today’s call will also be made available at that location shortly after this call. On today’s call, we will discuss certain non-GAAP measures. The descriptions and reconciliations of these non-GAAP measures are available in our SEC filings, as well as our earnings presentation. As a reminder, today’s call includes forward-looking statements about our expectations for the company’s future performance. Of course, actual results could differ materially. The company’s expectations, beliefs and projections are expressed in good faith, but there can be no assurance that they will be achieved or accomplished. Please refer to the risk factors detailed in our SEC filings for further discussion. Finally, for anyone listening to a webcast replay or reviewing a written transcript of this call, please note that all information presented is current only as of today’s date, January 9, 2023. The company disclaims any duty or obligation to update any forward-looking information, whether as a result of new information, future events, or otherwise. Thank you, Wendy and thanks to all of you for joining us this afternoon. Today, I will begin by discussing our sales results for the first fiscal quarter of 2023. I will also provide you with an update on our growth ambition, our Must-Win Battles, and my strategic priorities. Sara will review some financial topics with you, including our guidance for FY 2023. As Wendy mentioned earlier, we prepared a presentation covering our first quarter results and have posted it to our Investor website. We invite you to refer to that document to review any numbers or results that we don't talk about on today's call. I'm happy to share with you that in the first quarter gross margin improved sequentially by 400 basis points, compared to the fourth quarter of fiscal year 2022. This is due to the pricing actions we've taken over the last several quarters. Sara talk with you in a few moments about gross margin in more detail, but we're confident that our plans to rebuild margin are working. Let's discuss our sales results. Today, we reported net sales of 124.9 million for the first quarter of fiscal year 2023, which was a decrease of 7%, compared to last year. There are several things obstructing top line performance this quarter. Sales volumes are down as expected due to the disruptions caused by the price increases we've put into place over the last few quarters. Changes in foreign currency exchange rates had an unfavorable impact of about $9.5 million on our consolidated net sales in the first quarter. On a constant currency basis, net sales would have decreased by less than 1%, compared to the first quarter of last year. Also impacting our top line results this quarter is our values guided decision to suspend sales of our products to our marketing distributor customers in Russia and Belarus, which negatively impacted ourselves by approximately $5 million. Overall, underlying volumes remain in-line with our expectations and we would expect volume performance to improve sequentially in the second half of fiscal year 2023 as price related disruptions abate. For more information about the impact of price increases on our sales results and the offsetting decreases in sales volume, please see our Form 10-Q for the period ending November 30, 2022, which we have filed earlier today. Now, let's take a closer look at first quarter results in our trade blocks starting with the Americas. Sales in the Americas, which includes the United States, Latin America, and Canada, were up 3% in the first quarter to 58 million. Maintenance product sales in the United States increased 15%, due to strong sales of WD-40 Specialist, WD-40 Multi-Use Product and 3-IN-ONE. The strong sales were driven by the favorable impact of price increases on revenues, as well as increased production capacity and improved availability as our supply chain continues to strengthen. These increases were significantly offset by a lower level of customer orders and promotional programs, due to disruptions caused by price increases. Maintenance product sales in Canada increased 7% in the first quarter, primarily due to the favorable impact of price increases, which were mostly offset by unfavorable changes in foreign currency exchange rates and weaker economic conditions that resulted in lower levels of demand. Maintenance product sales in Latin America were down 31% in the first quarter when compared to last year due to the timing of customer orders. This is because in the fourth quarter of fiscal year 2022, customers were buying products in advance of a price increase, which lowered purchases from these customers during the first quarter of this year. In addition, in the first quarter of 2022, we had a strong comparable period because of significant purchase activity in advance of a price increase, that went into effect November of 2021. Sales in Mexico, our newest direct market, remained constant. Now across the [indiscernible] to EMEA. Sales in EMEA, which includes Europe, the Middle East, Africa and India, were down 29% in the first quarter to 40.8 million. Currency fluctuations significantly impacted our sales results for EMEA trading block during the quarter. Changes in foreign currency exchange rates had an unfavorable impact of over $8 million on net sales for the first quarter. On a constant currency basis, sales would have decreased 15% over the first quarter of last year. As you know, we sell into EMEA through a combination of direct operations, as well as through marketing distributors. Sales in our EMEA direct markets, which accounted for 70% of the region sales in the first quarter, declined by 21% during the quarter, compared to last year, due to the impact of changes in foreign currency exchange rates and reduced demand driven by weaker market and economic conditions. The region has also been impacted by a lower level of customer orders and promotional programs as customers adjust to the price increases we recently implemented. Sales in our EMEA distributor markets, which accounted for 30% of the region sales in the first quarter decreased by 43% during the quarter, compared to last year. More than half of this decline was due to a suspension of sales in Russia, which resulted in decreased sales of approximately $5 million, compared to last year. In March of 2022, we made the values guided decision to suspend sales of our products to our marketing distributor customers in Russia and Belarus and this has contributed to an unfavorable impact on our sales in this region. Now, on to Asia Pacific. Sales in Asia Pacific, which includes Australia, China, and other countries in the Asia region were up 25% in the first quarter to 26.1 million. In our Asia Pacific distributor market, sales were up 41%, compared to last year, primarily due to strong sales of WD-40 Multi-Use Product. These strong sales were linked to successful promotional programs and continued easing of pandemic related lockdown measures. In addition, the increase in sales is partially due to price increases we implemented over the last 12 months, as well as many distributor customers purchasing product net funds of additional price increases that will go into effect later this year. In Australia, sales remained constant in the first quarter. Changes in foreign currency exchange rates have an unfavorable impact on sales in the first quarter. On a constant currency basis, sales would have increased by 12%, compared to last year. These sales increases were due to the favorable impact of price increases, which were partially offset by decreased sales of home care and cleaning products. In China, sales were up 22%, compared to last year, driven primarily by successful promotional programs and the favorable impact of price increases. In addition, sales were favorably impacted by the timing of shipments where I could do some customer orders placed in late fiscal year 2022, which will not shift until early fiscal year 2023. Changes in foreign currency exchange rate had an unfavorable impact on net sales for the first quarter. On a constant currency basis, sales would have increased by 34%, compared to last year. We're taking a proactive approach in China and shipping as much product as we can during times when COVID-related restrictions are minimal. We expect more pandemic-related disruptions in the market over the short-term, but we remain optimistic about our long-term opportunities in China. In addition to volatility in the China market caused by COVID-19, we expect volatility in this market due to timing of promotional programs, the building of distribution, shift in economic patterns, and varying industrial activities. Now, let's talk a little bit about our future growth aspirations. To understand where we're going, it's important to understand where we've been. On Slide 11 of our earnings presentation, you will see 20 years of maintenance product sales adjusted for currency. We have continuously grown our multipurpose maintenance product sales each year except for 2020 when we experienced a modest decline due to the impacts of the pandemic. Following that modest decline, our sales rebounded extremely strongly in 2021 and 2022. We demonstrated substantial resilience in the past, including during the great recession in 2008 and 2009, and that gives us confidence to face whatever volatility, uncertainty, complexity, and ambiguity may come our way in the future. Therefore, in terms of future growth, Sara and I are committed to our long-term revenue growth aspiration, which is to drive net sales to between 650 million to 700 million by the end of fiscal year 2025. The bulk of that growth is expected to come from sales of WD-40 Multi-Use Product for geographic expansion, increased penetration, and premiumization. In terms of growth aspirations by segment, each of our trade blocks have unique long-term growth expect expectations. The compound annual growth rates associated with our segments reflect our long-term growth expectations for the segments and may not always align with shorter-term trends and results. In the Americas, we expect growth between 5% to 8% annually We recently increased our expectations for growth in the Americas, fueled by several factors. In Latin America, over the last couple of years, we've seen very strong sales, largely driven by our newest direct market in Mexico. Despite the softness we reported in the first quarter, we expect excellent prospects for strong continued growth across Latin America in the future. Canada's growth prospects have also been significantly boosted as we continue to roll-out next generation Smart Straw in the region. Strong growth opportunities exist also within the U.S. market in e-commerce, within the WD-40 Specialist brand and within the industrial channel. Our expectations for growth in our EMEA and Asia Pacific segments remain unchanged. Over the long-term, we anticipate sales within the EMEA segment will grow between 8% to 11% annually and sales within the Asia Pacific segment will grow between 10% to 13% annually. Globally, we're targeting revenue growth in the mid-to-high single-digits to deliver against our aspirational $650 million to $700 million 2025 goal. Now, a brief update on our Must-Win Battles. Our Must-Win Battles are the primary areas of action that will enable us to deliver against our revenue growth aspirations. These hyper focus actions are the key drivers of revenue growth. Our largest growth opportunity in the first Must-Win Battle is the geographic expansion of the blue and yellow can with the little red top. Though consolidated sales of our flagship brand were down 12% in the first quarter, with every confidence WD-40 Multi Use Product will return to growth this fiscal year. The decline in WD-40 Multi Use Products was driven primarily by a 34% decline in sales in EMEA, due to the reasons I mentioned a few minutes ago. Our second Must-Win Battle is to grow WD-40 Multi Use Product through premiumization. Premiumization creates opportunities for revenue growth, gross margin expansion, and most importantly it delights our end users. In the first quarter, sales of WD-40 Smart Straw and EZ-REACH when combined, represented 43% of global sales of WD-40 Multi Use Product. Sales of premiumized products declined by 15% in the first quarter, primarily due to lower sales in our EMEA segment. Our Smart Straw next generation delivery system is currently available in the Americas and will be rolled-out globally in fiscal year 2023. Smart Straw next generation supports our objective to grow premium delivery system penetration to greater than 60% of our WD-40 Multi Use Product sales by 2025. Our third Must-Win Battle is to grow to WD-40 Specialist. In the first quarter, sales of WD-40 Specialist were up 23%, compared to last year. The United States saw outstanding growth, reporting an increase of 70%, compared to last year. We're pleased that WD-40 Specialist is fully leveraging our most iconic asset, the blue and yellow brand with a little red top. Our final Must-Win Battle is focused on driving digital commerce. In the first quarter, e-commerce sales rolled back and were up 51%, compared to the first quarter of last year. This was driven by triple digit growth in the U.S. and double-digit growth in Asia Pacific. We believe we are well-positioned to benefit from the significant shift to online behaviors in the post-pandemic world. We're focused on developing a data driven marketing strategy that empowers us to engage directly with end users in meaningful ways online. We expect e-commerce will be the fastest growing retail sales channel globally for the duration of fiscal year 2023. We see a world where almost every transaction in the future will be influenced by a digital touch point somewhere on the path to purchase and we believe we’re well equipped to thrive in that world. Thanks, Steve. Thank you for that overview of our sales results. While our top line results were challenged in the first quarter, you might recall we shared with you last quarter we expected much of our growth to be weighted toward the second half of fiscal year 2023 as we managed through disruptions in the market due to the pricing actions we have taken. This continues to be true. Currency is a significant headwind for us as well. On a constant currency basis, net sales would have decreased and significantly compared to the first quarter of last year. Let's start with the discussion about our 55/30/25 business model. The long-term targets we use to guide our business. As you may recall, the 55 represents gross margin, which we target to be at or above 55% of net sales. The 30 represents our cost of doing business, which is our total operating expenses, excluding depreciation and amortization as a percentage of net sales. Our goal is to drive our cost of doing business over time toward 30%. Finally, the 25 represents our long-term target for EBITDA. The model is being tested right now due to the inflationary environment we continue to operate in. The good news is that we saw a strong margin recovery this quarter driven by actions we have taken as part of our margin restoration plan. Our gross margin target of 55% is a critical component of our business model and Steve and I remain committed to restoring gross margin to our target of 55%. First, the 55 or gross margin. In the first quarter, our gross margin was 51.4%, compared to 50.8% last year. This represents an improvement of 60 basis points year-over-year and more importantly, it represents a reversal of eight quarters of sequential margin declines. Over the last two years, we have seen consistent declines in gross margin, due to inflationary headwinds and the challenges in the global supply chain. This quarter, we reversed that trend and experienced sequential margin growth of 400 basis points, compared to the fourth quarter of fiscal year 2022. While we believe we will continue to see sequential margin improvement for the remainder of this year. I don't believe it will be as substantial as the recovery in the first quarter and we do expect our margins to flatten out in the second half of the year. Now, let's take a closer look at gross margin this quarter as compared to our first quarter 2022 gross margin. Price increases, which have been implemented across all our markets and geographies, positively impacted our margin by 860 basis points this quarter. These tactical price increases that we implemented over the last 12 months took time to embed their way into our reported results. I am very pleased to see the positive impact they had on our first quarter gross margin. Also impacting gross margin was changes in foreign currency exchange rates, which positively impacted our margin by 90 basis points. This impact is due to fluctuations in the exchange rates for the euro against the pound sterling in our EMEA segment. The euro strengthened against the pound sterling, resulting in a favorable foreign currency transaction impact. Finally, favorable sales mix changes positively impacted our margin by 60 basis points in the first quarter. These positive impacts to gross margin were largely offset by changes in major input costs, which include specialty chemical and aerosol can costs. And these costs when combined negatively impacted our gross margin by 690 basis points. Commodity related inflationary headwinds began to significantly impact our gross margin in the second half of 2022. This time last year, we hadn't begun to experience inflation headwinds at the levels that we are seeing today. Higher costs associated with aerosol cans negatively impacted our margin by 360 basis points and the remaining 330 basis points came from higher specialty chemical costs. Gross margin was also negatively impacted by 120 basis points, due to higher miscellaneous input costs, a 100 basis points from higher filling fees paid to our third-party contract manufacturers, primarily in the Americas, and 80 basis points due to higher warehousing and freight costs. We are beginning to see input costs stabilize and are hopeful that this trend will continue, but it continues to be a dynamic environment, especially in EMEA. We remain confident that our plans to rebuild gross margin coupled with the advancement of our margin accretive Must-Win Battles will enable us to deliver on our long-term goals. While it still may take some time, we will continue to take the necessary to restore our gross margin to 55% or higher over the long-term. That completes the gross margin discussion. Now on to the 30, the cost of doing business. In the first quarter, our cost of doing business was 36%, compared to 32% last year. The cost of doing business is primarily comprised of three areas: investments in our tribe, investments in brand building, and freight expense to get our products to our customers. This quarter, our cost of doing business increased by $1.4 million or 3%, due to increased travel and meeting expenses and higher employee-related expenses, compared to the prior year's first quarter. Although our cost of doing business increased, our cost of doing business as a percentage of net sales was impacted more significantly, due to the decrease in revenue this quarter. This brings us to EBITDA, the last of the 55/30/25 measures. EBITDA was 17% of net sales this quarter, which is down significantly, compared to last year, primarily due to lower sales and higher operating expenses this quarter, which was offset by an improvement in our gross margin percentage. We expect to return to historic EBITDA levels as we continue to rebuild our margin and reach our revenue growth objectives over the long-term. That completes the discussion on our business model. Now, let's discuss some items that fall below the EBITDA line. The provision for income taxes was 20.9% this quarter, compared to 19.8% last year. The increase in the effective income tax rate was primarily due to tax shortfalls from settlements of stock-based equity awards, which was partially offset by a one-time tax deductible, charitable donation. Many of you may recall that in 2016, we purchased and subsequently relocated our San Diego based tribe members to a new office building. Our plans had always been to divest of our older San Diego facility. Recently, we made the values based decision to donate the facility to a large regional community foundation and we completed that donation in the first quarter. We believe this donation aligns well with the bookends of our values. Our first value is to do the right thing, and we believe this donation will help to make a positive impact in the communities where our tribe mates live and work. Our last value is to sustain the WD-30 Company economy, which this donation has also enabled us to do. Net income for the first quarter was 14 million versus 18.6 million in the prior year. Changes in foreign currency exchange rates had an unfavorable impact of about $1.3 million on the translation of our consolidated results this quarter. Diluted earnings per common share for the quarter was $1.20, compared to $1.34 for the same period last year. Now, a word about our capital allocation strategy. Our capital allocation strategy includes a comprehensive approach to balance investing in long-term growth and providing strong returns for our stockholders. In addition to investing for future growth, we also focus on our [returning capital] [ph] to our stockholders. Historically, our business model has been asset light, which has typically required low levels of capital investment, roughly between 1% and 2% of sales. As we have previously disclosed, in fiscal year 2023, we expect to invest approximately $9 million in capital projects. Excess capital generated by the business is then allocated to the highest return alternative. Annual dividends will continue to be targeted at greater than 50% of earnings. On December 13, our Board of Directors approved a quarterly cash dividend of $0.83 per share, reflecting an increase of more than 6% over the previous quarter's dividend. During the first quarter, we also continued to return capital to our stockholders by repurchasing approximately 22,000 shares of our stock at a total cost of approximately $4 million under the plan. We are currently evaluating the most accretive use of our excess cash given current interest rates. If it is more accretive to do so, we may elect to slow down our stock purchases under our current share buyback plan and utilize that cash to repay a portion of our current debt. Let's chat about our balance sheet and cash flow statement. Inventory levels continue to have our attention and we are currently carrying extra inventory on our balance sheet. Our inventory levels have gone from 104 million at the end of the fourth quarter to 119 million at the end of the first quarter. We have been intentionally building up certain raw materials, components, and finished goods, particularly in the United States, to ensure adequate supply of our products as we have expanded our aerosol filler network. As a direct result of these choices, we have experienced increases in the capacity and flexibility of our supply chain, which has enabled us to better meet market demand for our products. We believe that right now this is a good use of our working capital. We anticipate our inventory levels will begin to level off in the near term and we expect to see them decrease before the end of the fiscal year. I do not believe that we will be at pre-COVID inventory levels anytime soon as the environment today remains dynamic and requires us to carry higher levels of inventory than we have historically. One other item I liked this quarter was the return of our positive cash flows from operations. Last year, we spent most of our cash flows from operations on building back a more stable supply chain. And as those investments are winding down and the impact of the price increases are flowing in, we are seeing our cash flow from operations return. Now, let's turn to guidance. We expect volume performance to improve in the second half of fiscal 2023 as price related disruptions abate and accordingly today we are reiterating our guidance for fiscal year 2023. We expect net sales growth between 5% and 10% with net sales between $545 million and $570 million. Gross margin for the full-year is expected to be between 51% and 53%. Advertising and promotion investment is projected to be between 5% and 6% of net sales. The provision for income tax is expected to be around 22%. Net income is projected to be between $69 million and $71 million, and diluted earnings per share is expected to be between $5.09 and $5.24, based on an estimated 13.6 weighted average shares outstanding. Our projections for fiscal year 2023 reflect fluctuating foreign currency exchange rates. Without those currency headwinds, our sales growth projections would have been between 10% and 15% of net sales. In addition, we are managing through disruption in the market from our various price increases and still expect much of our growth to be weighted toward the second half of fiscal year 2023. We also want to remind everyone that there are dynamics outside our control that may impact our fiscal year 2023 results, unanticipated inflationary headwinds and other unforeseen events. This guidance does not include any future acquisitions or divestitures. This completes the financial overview. Thanks, Sara. I believe my primary responsibility as CEO is to build on the excellent foundations laid by Gary and Jay. There'll be no fundamental shifts in strategy as there is a very significant runway for growth by laser focusing on our global Must-Win Battles. However, investors will see an increased focus in three key areas. Firstly, we must pivot the company toward a more sustainable future. We see the planet as a key stakeholder and we will be putting the required infrastructure in place over the next 18 months or so to be able to set and then effectively measure progress against environmental targets. In support of this goal, we'll be adding a small number of dedicated tribe mates focused solely on this purpose. In addition, we will be procuring and implementing IT systems that will enable us to track and report our carbon footprint and progress on ESG initiatives to stakeholders. Second, we need to leverage our capability as a global learning and teaching organization. Being learners and teachers means taking every opportunity to make things better than they are today. We don't rest on our laurels. In that spirit, we recently completed a culture survey in partnership with Berkeley Haas School of Business where we identify the strengths and opportunities present within our culture. To address the opportunities we have identified, we've created a global culture squad, made up of tribe mates who are passionate about making our special culture even better than it is today. Finally, we need to realize a huge growth potential present in emerging markets. I believe the long-term global market growth opportunity for WD-40 Multi Use Product is over $1 billion and that the fastest growth will be achieved in our emerging markets. With this end in mind, the new dedicated emerging markets team has been created to drive faster growth in this critical area. So, in summary, what did you hear from us today on this call? You heard that even though first quarter sales results were down, we continue to believe we are positioned to achieve our sales growth guidance for the full fiscal year. You heard that we experienced strong sales of WD-40 Multi Use Product in the United States in our Asia distributor markets and in China in the first quarter. You heard that sales of the WD-40 Specialist were up 23% in the first quarter. You heard that we continue to make outstanding progress in digital and e-commerce where our e-commerce sales have grown 51% in the first quarter. You heard that although we've been experiencing pressure on gross margin from the challenging inflationary environment, we saw a strong margin recovery this quarter, driven by our margin restoration plan. You heard that we continue to return capital to investors through regular dividends and that we raised our dividend last month. You heard that we reiterated our full fiscal year guidance. You heard that Sara and I remain committed to the 2025 revenue growth targets and the 55/30/25 business model. And you heard that I'm very focused on my strategic priorities as CEO and we've identified our first areas of execution. In closing today, I'd like to share with you a quote from Zig Ziglar, “You don't build a business. You build people, and then people build the business.” Thank you for joining our call today. We'd now be pleased to take your questions. Hey, everyone. Thank you for taking my questions. I just had a question on the cash flow statement. I understand you, kind of went through why inventories are up and that makes sense, [indiscernible], but just wondering if these payables went down too, I was wondering shouldn't they be up as well? I'm just wondering why the difference there? Hi, Daniel. This is Sara. So, payables partly is timing. And then the second piece of that is the payout of our incentive program happens in the fourth quarter. So, just depending on the timing of that along with our AP, just normal turns in AP is driving that. It's nothing really significant. Okay. And then you mentioned I think China was up [32%] [ph] of some of that was shipment timing, was there some pull forward there? Because I know in past years it's been fairly lumpy. And I know you're not going to give quarterly guidance, but I was just wondering if you should expect similar scenarios to unfold where there's a strong first quarter if [indiscernible] and then kind of evened out over as we move forward? Sure. Hey, Daniel. So, yes, China, I’d say at local currency, China was up 34%. Now, clearly, there's likely to be a little bit of disruption, kind of ahead in terms of COVID, but we don't see the same, kind of shutdowns that we've seen in past quarters unless things really worsened, situation really worsened. So, historically, I think in the past couple of years, the China business has been kind of front-end loaded a little bit and you've seen that play-out in the first quarter. I think we're being a little bit cautious in terms of how we see things for the next, kind of period of the quarter because of the situation. That situation might exist through until spring. But no, we don't really see any significant variations in the China in terms of volatility outside of further lockdowns or shutdowns. And as we get into the third quarter, obviously, we lap that situation last year where we had six weeks of shutdown and we're hoping we'll avoid that this year. Okay. That's helpful. And then my final question, you also mentioned that there were some lost sales due to – from – disruptions due to price increases that should ease as the year progresses, but I was wondering if those lost sales will be recovered or are they just lost? It depends. I would say that some of them are lost, it's just momentum. So, what happens, we've lost promotional momentum. And I think when you look at the first market to execute the price increases was in North America, and we're starting to see that recovery happen. So, North America is about a quarter ahead of Europe in terms of the price increases. So, yes, some promotional momentum has been lost, some business momentum, but that's roaring back. So, you're seeing that come back in – certainly in the United States, but we think that Europe is probably a quarter behind the U.S. in terms of the kind of the situation here. Hi. This is Cristina Xue on for Linda Bolton Weiser from D.A. Davidson. Thank you for taking my question. So, maybe I'll follow-up from the previous question. Moving or going forward, do you think more pricing is needed to help to restore those gross margin going forward? Hi, Christina. Thank you for the question. So, in terms of EMEA and Americas, which is 88%, 87% of our business, we think we've taken the necessary tactical price action to restore our gross margin. So, we have no further tactical pricing measures. And we revert back to our strategic gross margin enhancement strategies, such as our premiumization, our WD-40 Specialist Strategy, etcetera. We do have price increases planned in Q2 and Q3 within Asia Pacific. So, Asia Pacific hasn’t seen the same level of inflation that the Americas and EMEA have seen, but there are price increases planned within the Asian region, within our Q2 and Q3. So yes, absolutely. Yes. So that was one of the things we spoke about last quarter was just this loss of momentum and that's the real driver of, kind of the volume loss. And so, if you look – if you start with the U.S. we've seen a significant recovery in volume loss. And we expect that to dissipate to virtually zero over a period of time going forward. I just can't tell you exactly when that's going to be, but we have seen a significant improvement as we've re-established our promotional programs with customers. We've already seen a significant enhancement in our volumes over the past couple of months in the U.S. particularly, that has now got to play out in Europe as a follow-on. Ladies and gentlemen, that does conclude our allotted time for questions. We thank you for your participation on today's conference call and ask that you please now disconnect.
EarningCall_1572
Good day and welcome to AstroNova's Third Quarter Fiscal Year 2023 Financial Results Conference Call. Today's conference is being recorded. [Operator Instructions]. I would now like to turn the conference over to Scott Solomon of the company's investor relations firm, Sharon Merrill Associates. Please go ahead, sir. Thank you, Drew. Good morning, everyone, and thanks for joining us. Hosting this morning's call are Greg Woods, AstroNova's President and CEO, and David Smith, Vice President and Chief Financial Officer. Greg will discuss the company's operating highlights. David will take you through the financials at a high level. Greg will make some concluding comments and then management will be happy to take your questions. By now, you should have received a copy of the earnings release that was issued this morning. If you do not have a copy, please go to the Investor page of the AstroNova website www.astronovainc.com. Please note that statements made during today's call that are not statements of historical fact are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on a number of assumptions that could involve risks and uncertainties. Accordingly, actual results could differ materially, except as required by law. Any forward-looking statements speak only as of today, December 7, 2022. AstroNova undertakes no obligation to update these forward-looking statements. For further information regarding the forward-looking statements and the factors that may cause differences, please see the risk factors in AstroNova's annual report on Form 10-K and the other filings that the company makes with the Securities and Exchange Commission. On today's call, management will be referring to non-GAAP financial measures. AstroNova believes that the inclusion of these financial measures helps investors gain a meaningful understanding of the changes in the company's core operating results. It also helps investors who wish to make comparisons between AstroNova and other companies on both GAAP and a non-GAAP basis. A reconciliation of non-GAAP financial measures to their most directly comparable GAAP measures is available in today's earnings release. Thank you, Scott. Good morning, everyone. And thank you for joining us. Let me begin by saying that we are pleased with our Q3 performance, particularly considering the still challenging macroeconomic environment. On the top line, we delivered record revenue of $39.4 million. The year-over-year increase of 37% was primarily driven by our August acquisition of Astro Machine coupled with another strong quarter in Test & Measurement and mid-single digit growth in our base Product Identification business. Inflation, supply chain shortages, and geopolitical volatility have continued to make things tough for businesses in many industries, including ours. But I'm extremely proud of the way our team has continued to navigate those challenges to deliver for our customers. Turning to our segment results. Product Identification revenue grew 36% in the quarter to $29 million, largely reflecting the addition of Astro Machine. To give you some perspective, on our acquisition call in August, we noted that Astro Machine's revenue for the trailing 12 months ended June 30 was about $22 million. And we are tracking slightly ahead of that run rate. Astro Machine is a perfect fit for our Product Identification segment in two specific ways. First, it's a great complement to our label printer business. Label printers currently represent about a third of Astro Machine's revenue, and we can scale that portion of the business by expanding the distribution of those products through a much broader distribution channel. There are also cross selling opportunities between our business bases, as well as product development and acceleration advantages in our R&D efforts with the combined teams. Second, Astro Machine expands our addressable market into the high speed overprinting space, as well as mail and package printing applications. This market accounts for the other two-thirds of Astro Machine's revenue, and is benefiting from the rapid expansion of ecommerce. While technologically similar, it adds new customers and channels, as well as the opportunity to expand business with existing customers. And of course, the recurring revenue stream that runs through both the label printer and mail handling sides of the business is significant. Our engineering and product development teams are working well together. And we have already identified several exciting opportunities for product synergies. It is also advantageous to be adding a second engineering and manufacturing center based here in the US, located near Chicago's O'Hare International Airport. Of course, it's still early in the process as we are now just four months into the acquisition. But so far, the integration is right on plan and the business synergies are exceeding our expectations. Elsewhere in our Product Identification segment, we continue to maintain a steady pace of new product innovation, highlighted by the launch of our entry level QL-E100 full color table top label printer as well as several additional technology innovations. The QL-E100, which we introduced to great customer response at PACK EXPO International in October, is purpose built for customers just beginning to capitalize on the benefits of in-house label printing, as well as large organizations that need multi-unit widespread distribution of their label printing. Turning to our Test & Measurement segment. The segment posted other solid quarter as revenue increased about 38% year-over-year to $9.5 million. The top line would have been even stronger, but for supply shortages, which resulted in about a $2 million of unfilled orders, most of which we expect to ship in the current fourth quarter. The aerospace component of our T&M segment posted its highest quarterly revenue since the first quarter of our fiscal 2021 year. That milestone is certainly consistent with the rebound of the commercial aviation market, which continues to ramp back up from the depths of the pandemic. Segment hardware and service revenue also grew nicely in the quarter. The growth in hardware relates chiefly to the higher production rate of key programs, such as the Boeing 737 MAX and the Airbus A320. The increase in service revenue is indicative of the greater number of planes in the sky and the increased demand for our aviation paper, as well as maintenance, repair and overhaul services. The data acquisition portion of our T&M segment also performed well in the quarter as we continue to see demand grow for our technology in areas such as rocket and missile telemetry, and other defense-related applications. Thanks, Greg. And good morning, everybody. I'll provide a couple of brief comments on the quarter's financial results, including the impact of Astro Machine. Comparing the third quarter this year to last year, we saw revenue growth in all areas, reflecting both the acquisition that Greg highlighted in his remarks as well as the ongoing business. Hardware sales were up 57% for the quarter to $11.9 million. Year-to-date, hardware is tracking 29% ahead of fiscal 2022 at about $30 million. Supplies revenue of $23 million was 27% ahead of last year's third quarter. And through nine months of the year, revenue from supplies is up just over 9% to $57.8 million. Third quarter revenue from service and other was up 42% year-over-year to $4.5 million. Year-to-date, this category is 31% ahead of last year's pace, coming in at $12.7 million. By geography, year-to-date, the US accounted for $65.5 million in revenue or 63.8% of total sales, with the international side making up the remainder $37.2 million or 36.2%. Turning to expenses, we remain focused on really diligently managing those areas of the business that are under our control. Our GAAP results this quarter, I want to note, include $217 million in acquisition-related expenses, relating obviously to the costs associated with getting the Astro Machine transaction completed. For more useful comparison to 2022, I'm going to talk about operating expenses including the acquisition or highlighting the differences, but as always, please review the tables in the earnings release for a reconciliation to GAAP to the non GAAP results. On a total basis, operating expenses in the third quarter were $10.4 million, 3.3% higher than the comparable period last year, but they would have been slightly lower without Astro Machine. Operating expenses on a non GAAP basis have been really very stable for the last several quarters. Non-GAAP operating income in the quarter grew to $2.1 million or 5.2% of revenue from $300,000 or 1% of revenue in the same period last fiscal year. The increases were driven in part by higher revenue in the 2023 period, as well as an improvement from the acquisition. Astro Machine's OEM business model has a lower gross margin profile, but much lower operating expenses, supporting higher operating margins. Overall, the Astro performance is in line with perhaps even a little better than planned at the time of this transaction, as Greg noted. In the segments, Product ID operating profit was up 63% in the third quarter to nearly $3 million, which translated to an operating margin of 9.9%, up 160 basis points year-over-year. Test & Measurement segment operating profits more than doubled to $1.7 million, yielding an 18.0% operating margin, up 580 basis points compared to the same period last year. Turning to the bottom line. Non-GAAP net income for the quarter was $830,000 or $0.11 per diluted share compared to $103,000 or $0.01 per share in the year earlier period. Acquisition-related expenses impacted GAAP EPS by $0.07 per diluted share. Bookings in the third quarter increased more than 8% year-over-year to $35 million, the highest quarterly total since the first quarter of fiscal 2020. Backlog at the end of the quarter. Our backlog as of the end of the quarter increased 46.6% to $39.3 million from %26.8 million at the same period last year. In early August, we funded the $17.1 million acquisition with debt under an amendment to our credit facility. And the terms are all explained in the filings we did at that time and are summarized in the footnotes to the third quarter 10-Q that we're going to file very shortly now. Also, the elements of the Astro Machine balance sheet are in the consolidation disclosed in the 10-Q along with a discussion of the items that are preliminary estimated and subject to change. The inventory balance has grown this year because of our responses to supply chain challenges, and is the other reason for the growth in the debt balance. We're taking a number of careful and measured actions to reduce inventory levels, and thus allow us to reduce our drawings under our revolving credit. And we believe those steps will begin to show effect beginning in the fourth quarter. Thanks, David. In closing, we posted a strong quarter and are confident in the underlying fundamentals and secular trends shaping our business. The integration of Astro Machine is on track, and we are excited about the future potential from this transaction. With a record backlog and a healthy order demand exiting Q3, we are well positioned to continue executing on our growth strategy as we move through the fourth quarter and into fiscal 2024. Great, thank you. Thank you all for joining us here this morning. As always, we look forward to keeping you updated on our progress. Stay safe and have a wonderful holiday, everyone.
EarningCall_1573
Good afternoon, ladies and gentlemen, and welcome to the Resources Connection, Inc. Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference call is being recorded. At this time, I would like to remind everyone that management will be commenting on results for the second quarter ended November 26, 2022. They will also refer to certain non-GAAP financial measures. An explanation of -- and reconciliation of these measures to the most comparable GAAP financial measures are included in the press release issued today. Today’s press release can be viewed in the Investor Relations section of RGP’s website and also filed today with the SEC. Also during this call, management may make forward-looking statements regarding plans, initiatives and strategies and the anticipated financial performance of the Company. Such statements are predictions, and actual events or results may differ materially. Please see the Risk Factors section in RGP’s report on Form 10-K for the year ended May 28, 2022, for a discussion of risks, uncertainties and other factors that may cause the Company’s business, results of operation and financial condition to differ materially from what is expressed or implied by forward-looking statements made during this call. We’re pleased to report continued strong financial performance in Q2 despite ambiguity in the macro environment. Q2 revenue on a same day constant currency basis was almost 6% higher than prior year, excluding the taskforce business, which we divested at the end of May. The growth delivered is on top of prior year growth rates, which were significantly into double digits. Gross margin improved 180 basis points over prior year to 41.1%. Run rate SG&A continues to decline as a percentage of revenue to just over 26% in the quarter. Adjusted EBITDA margin improved 230 basis points over prior year to nearly 15%, representing record performance for a second fiscal quarter. Net income grew to $17.4 million, up from $14.3 million over prior year, which represents the highest level in a decade. These profitability results exceeded our guidance as we grew top line, improved pricing and maintained disciplined cost management. We entered Q3 with one of the highest pipelines in company history and are working tirelessly to convert all the opportunity. Against this backdrop of strong demand, we also note that some clients have paused current initiatives, and others have delayed project starts, so the conversion to revenue may take a bit longer this calendar year. While Q3 always reflects holiday impact, we remain cautiously optimistic as we move further into calendar 2023. I’ll turn now to some of the underlying reasons for our long-term positive perspective. We recently conducted a primary research project on the successes and challenges of executing mission-critical projects in the wake of global disruptions and market volatility. Organizations have taken on more mission-critical projects in the past 2.5 years to keep up with the rising customer and competitive demand. From finance and digital transformation to enterprise-wide operational change and reimagine supply chains, these critical initiatives are imperative to success. Yet, many companies have found it more challenging to execute these strategic projects. A tight labor market, a changing workforce, a distributed workforce, a shortage of in-demand skill sets and new technology demands have made it all the more difficult to balance and execute organizational priorities. This research we undertook informs us as to what leading companies are doing to execute work differently and what lagging companies are missing. We surveyed 400-plus companies in North America, Europe and Asia Pacific, with $1 billion or more in revenue in 4 industries: technology, pharma, financial services and health services. The respondents were functional leaders and above. We also conducted in-depth interviews with 10 large global organizations that have been executing key initiatives with great success. Today, I’m pleased to share a summary of the insights we learned. Fundamentally, most companies have found that executing critical projects is very challenging since the pandemic began, with only 15% reporting all their projects met key goals. Second, project management skills are critical at all levels of an initiative, and most companies lack enough of the necessary talent in their organizations. Third, the management of hybrid, remote and organizationally diverse teams is the number one challenge in execution, which ties to the need for strong project management and change management support. Fourth, the best companies of project execution have a much higher percentage of outsiders on their teams, and they intend to grow the mix. Fifth, a strong project framework supported by great digital collaboration tools is critical to success. These findings strongly support RGP’s focus on project management and specific expert skill sets. Items 4 and 5 are the most significant findings for our business. First, in relation to core RGP, the research reflects the secular trends we have anticipated. Not all talent should be full time, and blending in independent experts improves outcomes. This trend is gaining traction quickly in our global clients and is called organizational workforce strategy or total talent transformation. Finally, the idea of buy, build and borrow is the way forward. RGP is perfectly positioned to provide the needed solutions. We engage with clients to provide project management, change management and subject matter expertise. The majority of our work in our global client base is related to execution of change, transformation, regulation and risk projects. These are the mission-critical projects our clients face today, and they lack all of the skill sets they require. Second, with respect to item 5, we also know that most of the projects in which we engage have a digital element, especially related to employee experience. Digital transformation of the employee experience is the core competency of the Veracity team, utilizing exceptional software platforms like ServiceNow, Akumina and Salesforce. We are currently working in several large global organizations to improve collaboration, manage hybrid and diverse teams, and drive knowledge sharing as companies learn to work differently. Veracity has won significant work in this area, delivering record revenue highs in the second quarter. We will publish the full research report this month. So, please watch for our press release and full publication on our website. In addition, we remain optimistic about our expanding opportunities in Asia Pacific. This region delivered 16% revenue growth on a same day constant currency basis in the quarter, with more to come. Consulting talent is now borderless. As we continue to support global clients who are migrating work to this region, we are increasingly winning partnership opportunities, leveraging our international presence. We are working with marquee clients in the region and expanding our reach within these clients in meaningful ways. The passion of our people and the quality of talent in the region is absolutely outstanding. In addition, we are helping clients in North America and Europe understand the power of diverse and distributed teams who can solve their problems in a differentiated way. Our strategy is to build delivery teams with both, in-country and offshore talent, which we manage with the oversight of our integrated global account teams. And as we upgrade our technology, this truly global approach, which cannot be replicated by the Big 4, will allow us to deliver a quality and value combination that cannot be matched. We are winning more and more work with this strategy, and we believe that our global operations, in particular, in Manila, Bangalore and Mexico City, will be important centers of excellence to support global client account growth. In closing, I’d like to share a story one of our consultants recently shared with me about her experience with RGP, our human-first approach and why she loves our model. She explained that she is bipolar and has always been very open about it. It is relatively managed, but she still has times of significant depression. This past summer, she suffered a fairly severe episode and shared with two RGP managers that she was having trouble. They both immediately asked what they could do to help, and they proactively worked on her behalf. When she expressed concern about shifting responsibilities to others, they both reassured her that all they wanted to do was make sure she was okay. She told her husband that in the 20 years of working at different firms, while her prior bosses have been concerned and hope she felt better soon, this was the first time her boss has immediately acted for her, so she was able to focus on herself. That she said is what makes RGP so very different. We act and care for our people. We don’t just talk. During the second quarter, we saw good revenue growth and operational metrics as well as strong margin performance. Pipeline build and closed deals were strong, and we were able to maintain the revenue momentum we noted at the end of the first quarter, despite increasing macroeconomic uncertainty. Same day constant currency revenue, excluding taskforce, increased by nearly 6%, and the overall demand profile for our services demonstrated continued strength throughout the quarter. Geographic performance was solid across our core business, with strategic accounts, Asia Pacific, North America, healthcare, Countsy and Veracity all performing well, with Europe, the one area of weakness. Overall, we have performed well through the first half of the year but are, of course, weary of recessionary trends impacting our clients. We will continue to work hard at top-of-the-funnel activity as well as ensuring great care and shepherding opportunities from prospecting to deal closure. While our growth pipeline has now reached one of its highest levels in three years, the sales cycle requires more attention and more efforts than it did a year ago. But a lot of opportunity remains as companies continue to shift their focus to co-delivery of important initiatives. Clients increasingly recognize the value of owning their own intellectual property and working with firms to help them execute on key projects. This allows us to run day-to-day operations and change for the future, which has always been our value proposition. As clients work through their workforce plans for the coming year, there is an enduring reality that the pace of change will continue to be relentless. The flexibility of speed required to meet that pace are hallmarks of RGP. And as such, we see real opportunity through the remainder of the year and beyond. One of the fast-moving trends we are currently seeing with our clients in the technology sector is a rapid shift in focus to profitability expressed via reduction in force, division closure and a focus on only the initiatives that are a priority for the enterprise. However, many of these clients are seeing attrition beyond their desires and are quickly recognizing the value we can provide as a flexible solution versus the more rigid approaches of larger firms. As a result, we are getting the opportunity to increase our presence in key projects and, in several cases, entrées into new projects to replace incumbent firms. As an example, at one Fortune 500 technology client, two of the large projects we were to begin working on were initially paused as the company went through significant restructuring and layoffs. But we stayed close to our clients through the uncertainty as many of them were concerned not just about the condition of their projects, but perhaps even the status of their own employment. As circumstances played out, we’ve got more clarity on the timing of the existing projects, which we began to help us shortly thereafter, and we are currently in discussions with them on other projects brought about by the restructuring. Some of these projects are to help provide on-demand talent for gap caused by attrition and others relate to providing expertise and execution around important enterprise initiatives. Another way that we’ve been able to differentiate ourselves is by leveraging our international delivery capability. As an example, a large multinational conglomerate is undertaking several major initiatives related to a global restructuring. We have deployed over 200 consultants around the world to help with these overlapping priority projects. A primary reason that we were selected as a key partner was our ability to support their data cleansing and compliance efforts in Manila, an important center of excellence for our clients. Half of the consultants we have deployed are domiciled in the Philippines. Similarly, a global financial services client has undertaken myriad initiatives, including finance transformation and divestitures. We have nearly 100 consultants supporting these efforts, with a large contingent working out of Mexico. Our ability to execute internationally, along with our presence and capability in Mexico, was the determining factor in our ability to win this work, which is already leading us to additional opportunity to take share from larger competitors. On the candidate side of our business in the second quarter, we continue to attract and retain exceptional talent to our platform. As I noted earlier, many clients have reacted to macro uncertainty with restructurings, layoffs and reductions in benefits as they seek to buffer their bottom line. We have seen in this cycle in particular that talent really values the importance of control and community. Many begin to realize that in traditional employment, particularly during turbulent times, there truly is a lack of control and a dilution of community. For groups impacted by a restructuring and their colleagues who are not directly impacted but affected, RGP becomes an even more attractive alternative to traditional employment. We have numerous examples of this contemplation in the workforce as alumni, newcomers and even former employees of existing clients have decided to work with us versus traditional alternatives. As the labor market remains tight, our talent team, which essentially manages a human capital supply chain, is performing exceptionally. Attrition is in line sequentially and year-over-year, and strong hiring trends persist as we become the premier destination for talent that is daring to work differently. The average tenure of our agile employees approaches five years, and we have learned over time that the highest risk of attrition typically occurs in the first year of employment with us. This continues to be an area of focus for us, and we’re working very hard to provide transparency regarding portfolio of opportunity that awaits each consultant. Additionally, our team envelops new joiners in our culture as we understand that this community experience is a key differentiator for us and helps to underpin the trust that consultants have in RGP. Over the Thanksgiving holiday, I asked the talent team if there were any consultants who are struggling and if there’s anything more we could do to support them. Our Southeast talent team informed me of a consultant who is dealing with a confluence of circumstances, including seriously ill family members and damage from Hurricane Ian. The team had stayed very close to our consultant. And when I spoke to her, she let me know she was fearful that her need for time off to care for her family, but heard her chances to work with us in the future. Nothing could be further from the truth. The team and I reiterated our support and decided that she actually needed a few extra days of time off given the burden she was shouldering. She shared with me that the outpouring and support she received was unmatched in her career and that while she is new to RGP, she had found it professional home. We are proud to be human-first at RGP. Now let me turn back to our second quarter operations. In addition to our gross pipeline nearing a multiyear high, we continue to make progress with respect to pricing as well, increasing billing rates, excluding taskforce, by 4% on a constant currency basis compared to prior year quarter. Pricing leverage will be an opportunity across the enterprise regardless of economic direction. While we are mindful of potential broader impact based on economic conditions, early non-holiday third quarter revenue and operational trends are in line with the solid Q2 trend. Finally, let me touch on operational leverage. In Q2, we continue to focus on controlling fixed costs and operating efficiently, resulting in significant adjusted EBITDA margin improvement over prior year quarter. We will remain especially vigilant about discretionary spend through the balance of the year. We achieved another quarter of strong performance, one of the best second fiscal quarters in more than a decade, coming in near the high end of our guidance range for revenue, exceeding guidance range for gross margin percentage and coming in better than the favorable end of the SG&A guidance range. Revenue for the quarter was $200.4 million, up 6% over the prior year quarter on a same day constant currency basis and excluding the impact of the taskforce divestiture. And our revenue for the first half of the fiscal year was up 11% on the same basis. In addition to strong top line growth, we also achieved record second quarter adjusted EBITDA margin of 14.8% and record second quarter adjusted EBITDA of $29.6 million, representing 19% growth over the same period a year ago. GAAP diluted EPS was $0.51 per share for the quarter, an improvement of $0.09 or 21% over the prior year quarter. Overall, demand remained stable despite uncertainties in the macro environment. While certain client segments have become more deliberate in their spending pattern as they wait for more macro certainty, mission-critical initiatives and projects are still being executed, particularly in our large global clientele, which tends to be more resilient. Revenue from our strategic global accounts grew 6% year-over-year on a constant currency basis. Our core solution areas in finance and accounting, and technology and digital also continued to perform well with 9% and 17% year-over-year growth, offsetting certain other areas that were softer. Despite the Federal Reserve’s effort to address elevated inflation, the labor market remains tight and continues to support our top line performance. Also contributing to the solid revenue growth in the quarter was a continuous improvement in our bill rates, with our ongoing efforts to align pricing with the value delivered to our clients, yielding positive results. U.S. average bill rate rose to $156 from $148 in the second quarter of fiscal 2022, an increase of 5.4%, with both Europe and Asia Pac driving similar improvement. Our ability to improve pricing has and will continue to play a significant role in sustaining our top line performance while also improving our overall operating leverage and profitability. Geographically, North America and Asia Pacific both performed well with 6% and 16% year-over-year growth on a same day constant currency basis, while Europe declined by 5% on the same basis and also excluding taskforce, largely because of delayed client buying patterns due to growing recessionary pressure. The tremendous growth in Asia Pacific was attributable to strong demand from our FDA clients as large global companies continue to shift their service centers to the Asia Pac region. Gross margin in the first quarter was 41.1%, up 180 basis points over the same quarter a year ago and just beating the high end of our guidance range, primarily driven by an improvement in the bill/pay ratio of 270 basis points. Enterprise average bill rate for the quarter was $130 constant currency, up from $127 a year ago, average pay rate was also favorable at $62 constant currency, an improvement from $63 in the prior year quarter. Now turning to SG&A. We remain disciplined with cost management and investment oversight in the business in light of ambiguity in the macro environment. Our run rate SG&A expense for the quarter was $52.7 million or 26.3% of revenue, a 70 basis-point improvement compared to the same period a year ago and better than the favorable end of the guidance range of $54 million to $58 million. As a reminder, run rate SG&A excludes noncash compensation, restructuring charges, contingent consideration and technology transformation costs. Technology transformation costs associated with our system implementation was $2.7 million for the quarter, of which $1 million was capitalized, with the remaining $1.7 million included as non-run rate operating expenses for the quarter. We expect these costs to ramp up in the second half of the fiscal year as we progress through the implementation. Estimated cash outlay in the third quarter is expected to be in the range of $5 million to $7 million, of which approximately $3 million to $4 million would be capitalized. Our implementation is on track, and we anticipate completing the project over the next 18 months. Turning to our liquidity. We generated $23.7 million of cash from operations during the first half of the fiscal year as a result of strong business performance. Our debt level remained low with a leverage ratio of only 0.2x. And we ended the fiscal quarter with $89.4 million of cash and cash equivalents after distributing $4.7 million of dividends and repurchasing approximately 318,000 shares during the quarter at an average per share price of $16.80. We plan to continue to return cash to shareholders through dividends and through our share repurchase program, which has $60 million available at the end of the quarter. I’ll now close with our third quarter outlook. The early third quarter revenue trend has been steady compared to Q2. While clients are evaluating their spending decisions more carefully as the macro economy continues to adjust, our sales metrics remain robust and the pipeline remains healthy, reflecting the favorable secular workforce trends Kate and Tim both mentioned. The long-term prospect of our business remains strong. In the short term, we expect a typical seasonal revenue pattern in the third quarter due to holidays across the globe. In addition, the strength in the U.S. dollar will continue to impact the translation of financial results from our foreign entities. We estimate our third quarter revenue to be in the range of $181 million to $186 million, which would be the second highest Q3 revenue in the last decade despite the sale of taskforce earlier this fiscal year. As with every year, gross margin will also be affected by the holidays, along with the reset of employer payroll taxes at the beginning of the calendar year. Nevertheless, we expect our sustained improvement in pay/bill ratio to partially offset the seasonal impact, yielding a gross margin range of 37.5% to 38.5%, which will be the highest third quarter gross margin over the last 10 years. Finally, we expect our run rate SG&A expense to be in the range of $56 million to $58 million, reflecting higher employer payroll tax expense at the beginning of calendar 2023. Non-run rate and noncash expenses for the third quarter consist of $2 million to $3 million of technology transformation costs and approximately $3 million of stock compensation expense. With that, our Q3 adjusted EBITDA margin is expected to return to the typical single-digit percentage range, reflecting the normal seasonality factors I just pointed out versus prior Q3’s exceptionally strong adjusted EBITDA margin. I would also note that while we have a robust pipeline, and we’ll continue to work to outperform as we always do, the pause in stronger activity that is reflected in our third quarter outlook could potentially continue as we move through calendar 2023, depending on the broader macroeconomic trends that we obviously do not control. Hi. It’s Andrew. I just wanted, Jenn, if you don’t mind, when talking about the revenue target for the third quarter, $181 million to $186 million, could you just give us what that would be on organic constant currency revenue growth basis year-over-year, excluding taskforce? Yes. Sure. Hi Andrew. At the high end of the range at $186 million compared to Q3 of last year, same day constant currency, excluding taskforce, you’re looking at approximately a 5% decline. Right. And you just said same day. So just -- could you just mention what number of days in the third quarter and year ago quarter? Hey. Happy New Year, and it was nice to see the profitability come through for the quarter. I’m wondering with regards to the guidance that you gave, you are seeing really solid growth in North America, and then Asia was really strong. I’m wondering, if we take a look at the overall guidance for revenue, how would that break out from a North America, Asia, Europe perspective? Yes. Sure. The guidance contemplates continued softness in Europe. Asia Pac is expected to hold steady in this quarter, obviously, taking into holiday impact, right, if you were to compare to Q2. In North America, we’re also expecting to be relatively steady to Q2. And to Q3, if you’re comparing year-over-year, we are seeing some slower decision-making overall within our client base. We noted that our pipeline is still very strong. The revenue conversion has slowed down just a bit. So, if you’re comparing year-over-year, we’re seeing some softness in North America as well. So, it should be fully expected by almost everybody. What I’m wondering is when you’re talking about the slower decision-making, could you give us a little bit of a dimension in terms of, hey, typically, when we get engaged or when the timing for decision is typically X number of weeks or X number of months, now it’s getting stretched out to what -- how do we think about that? And to what extent are you seeing some projects being canceled? Hi Mark, it’s Tim. Happy New Year to you. Let me just give you a little bit of color on that. In terms of dimensionality, we kind of measure aging overall. And our aging overall has extended out, I don’t know, 3 or 4 days -- 3 or 4 business days, which is basically tantamount to a full week. But I don’t think that really measures the kind of the full extent of it because when you look at the actual sales funnel, the actual amount of opportunity -- the portfolio of opportunity is actually higher, is at one of the highest levels that we’ve had in a while measured at the end of the quarter. The difference is getting from opportunity identification to qualification is kind of where you have more lengthening. And so, that’s the principal issue. It’s like determining budget, understanding if people have the green light to go -- where people had green light before they don’t necessarily have -- immediately right now, they have to ask for an additional layer of approval. And last comment I would make is, just in general, there’s a lot of our larger companies who are contemplating their overall portfolio of projects. And as a result of that, that creates an additional filter through which decision-making has to happen. So hopefully, that gives you enough color. It’s very helpful. I appreciate that, Tim. And then, can you talk a little bit about -- you have really nice bill rate improvement, particularly as we think about North America. What are you seeing from the Big 4? We noticed some things from E&Y, some chatter there in terms of what they’re doing. Just wondering what you’re seeing out there in terms of pricing and the project pipeline for the Big 4, and how would that impact you? Well, I’ll start. I think Kate can also add some commentary on this. But what I would say is that what we saw early on was that the Big 4 was much more aggressive in terms of raising their prices, and they were slower to lower them going through previous cycles. So, as a result, they have -- their ability to kind of come down from those pricing -- for that pricing if they’d like to price more aggressively, they can. Now, we haven’t really seen that yet. So, what I would say is that what we’re seeing in terms of opportunity is because they have -- they still have enough demand in their pipeline that they can still price aggressively, there’s an ability for us to take on some of the work that they may have done from an execution standpoint and also for our ability to take over from where they’re -- where they’re just kind of toeing the line on pricing, and we’re just simply a better value. And we’re starting to see those opportunities now, particularly in some of those large clients. Yes. Hi Mark, and Happy New Year, too. I’d answer it a little bit differently, too. What we’re seeing in the Big 4, and I’m hearing it directly from clients, is that they don’t have the talent or they’re experiencing quiet quitting in the delivery of the work for clients. So, I think the Big 4 are certainly having talent challenges that aren’t going away anytime soon. And the experience they’re delivering in the client base is an opportunity for us. That’s really interesting. And it certainly sounds like a great opportunity for you. With regards to thinking strategically about your geographic footprint, how would you characterize the long-term opportunities in Asia Pac? How big could that practice be? And then similarly, how are you thinking about Europe? To what extent -- is it macro versus the reorganization and the divestiture of taskforce, how -- is that impacting the kind of the pipelines over there? Yes. Let me jump in, and then I’ll have Tim follow up because I think he’ll have especially some further commentary on Europe. Let me start with taskforce, and then I’ll turn to Asia Pac. Taskforce, strategically, we are looking at building our business with an employed consultant model. We think that the importance of creating that connection and the global community of consulting talent is really important. And taskforce, if you remember, runs more of an independent contractor model. So strategically, we made that pivot, and I would say we’re very pleased that we’ve done that. And we wish taskforce well. There was no animosity with that separation. It’s just a different strategic vision of what we are building globally. I just came back and so did Tim from trips in Asia Pac, and I think we’re both incredibly bullish about our opportunities there, especially throughout Southeast Asia, continuing to build in both, Manila and Bangalore and beyond Bangalore. The ability for us to tap into the right talent and to bring our model to that region, which is new for them, is exciting and, I think, exciting for all of us. I was really struck by how passionate our people are about our business model there and the ability to attract talent to what is a newer or emerging consulting model for that region. I think you’ll continue to see us. We’ve started that practice in Malaysia. There are some other geographies in Southeast Asia that we are looking at in a very cost-effective way. But remember, too, the reason we’re investing in upgraded technology globally is that we want to be able to tap in and capture this borderless consulting talent without the cost structure of 10 years ago. And that’s what we’re prepping the Company for. Yes. I mean, I’ll just add a couple of comments about APAC, and I just -- I’ll make a quick note on Europe. In APAC, I think in addition to what Kate was talking about, a lot of the growth that we’ve seen has been centered around a similar strategy that we’re using in Europe, which is to try to attach our largest and most important clients in our strategic client account program globally. And so there are global initiatives where we would only play in certain work streams, and most of that was done domestically. And what we’ve seen over the last year in particular, and particularly in APAC, is that we -- there are large opportunities for us there, opportunities to work in there -- in centers of excellence over there, places where we have BPO and other setups. And so, we’re taking advantage of that with our footprint. In terms of Europe, I think the one thing to remember, Mark, is that we restructured that with an eye toward profitability and making sure that we could service our large clients there. And as a result of that, our revenue base is a smaller client base, and we’re targeting more project execution projects, which will give us a little more volatility in terms of our run rate. But in the long term, as we continue to invest there, we’ll be able to kind of steady the run rate, and we’ll rightsize the business from a profitability standpoint. Yes. HUGO is progressing as planned. We’re continuing to build talent pools in both the Tri-State and Southern California areas. I think the opportunity for us as we move into the second half of 2023 and beyond is how can we continue to leverage the capability of digital engagement more broadly in our business. I mean, this management team is very-focused on driving efficiency, lowering our cost of sales. And technology and digital engagement will be a piece of it. But so far, everything is going as planned. We don’t break it out separately. It’s not significant enough yet for us to focus on, but we’re very pleased with where we’re headed. Great. And then, Kate, obviously, everybody is talking about the macro environment. The majority of economists are projecting a recession for this year. Philosophically, how should we think about -- if we end up having a mild recession, which seems to be the consensus, how should we think about what the impact would be on the top line? And to what extent -- how should investors think about the level of profitability that you could maintain if we end up going into a mild recession? Yes. We’re very committed, Mark, to maintaining the profitability range we’ve set. We’ve said on an annual basis, we want to be in the mid-teens. That’s different than 10 years ago, and we’re very committed to it. So, while I think a mild recession -- and you’ve started to see in these results, it’s hitting us a little bit on the top line. We’re delivering, we’re continuing, especially in the quarter we’re just reporting record profitability, and we’re not giving that up. I mean we’ve made moves in the business to lower our cost structure, and we’re continuing to do that with upgraded technology and the ability to do more with technology so we can bring headcount cost down. We’ve always said the two biggest costs for us are headcount and real estate, and we’ve made moves on both, and we continue to do so. So, I’m very optimistic that we will continue to deliver results on the bottom line in this business. So, I wanted to -- a lot of my main questions have already been covered, but I did want to touch on -- first of all, I appreciated you sharing and undertaking the test, which sort of going through the survey that you referred to. And I was wondering if you could sort of talk a little bit about that. It seems as though it was pretty extensive, so sort of thinking about a couple of things that came out of that. But could you sort of talk a little bit about maybe the -- were there any of the learnings that you got from that outside of where you thought they would be? And has that led to any changes that you thought you needed to make operationally? And then also maybe just from -- I’m looking forward to actually seeing it, but was there sort of a -- what was the time frame of when you guys did that? We did conduct the survey largely in November. I think we started it at the end of October, but largely completed it in November. We did a preview of our findings in New York City on November 30th. And like I said, Marc, we’ll be publishing the full report in the next two weeks. So, we will issue a press release. I would say the surprising thing for me or the surprising insight is the accelerating use of organizationally diverse teams. And while -- that’s rapidly expanding in the companies that are leading in terms of their own project delivery and recognizing that the talent you have around the table that runs day-to-day operations is not necessarily the talent you need to drive change. And so, I think as more organizations recognize that, that presents opportunity for companies like ours to be the right partner. And finally, companies starting to think about their human capital supply chains very differently, and the advent of technology is allowing them to do it. I think we’ve all learned so many lessons coming out of COVID that is really an interesting time to be in a human capital business because, finally, the world is catching up to our business model, and that feels very good. So, while this upcoming quarter may have some top line challenge, the longer term trends are really moving in our favor. And while we read today in The Wall Street Journal that bosses are demanding people come back to the office, I think it’s still really up in the air whether talent is going to respond to that in the right way. I think talent clearly has choices today, and our business model is one of them. So, the research I think confirmed where we are as a business more than surprised me. Okay. Excellent. And thank you for that. And then, there’s been several comments on the positive bill rate environment and what you’re seeing there. Is there any -- is there much of a change at all as far as business mix that’s helping that, or is that just there has been -- there just continues to be then with the pricing improvement… Hey Marc, this is Tim. I just -- I lost you a little bit there. You kind of -- at least on my end got a little garbled. Do you mind repeating the question? I’m happy to give you some color. Sure, sure. I was asking about sort of the contributions on bill rate and maybe what you see going forward there, whether that was a business mix benefit or is that just sort of just pushing to pricing and the room that we may have for that going forward. I think it’s a good question. I mean it’s a little bit of both. But right now, it’s more really just pricing discipline and less of a mix shift for us. In reality -- Mark asked a question about kind of where we saw the Big 4, like -- I mean, we realize that our pricing value to market, there’s a huge opportunity for us. That’s a big focus for us across the business. However, as we take on more project consulting projects where we’re actually responsible for the deliverable and doing more of that type of work, we will command higher bill rates and higher margins. And we think there’s more opportunity for that now for us to shift share from some of the larger firms as people think about value. Can I just add a comment on bill rate? I mean, if you look at across all of our regions, I mean, they all have increased this year compared to last year, 5-plus-percent in their bill rate. And if you look at it on a weighted average basis, remember, we divested taskforce. Without taskforce, it actually -- taskforce within Europe, it tends to have a little bit more -- higher bill rate. Our overall weighted average rate actually came down a bit because of the mix shift. But if you look at all the regions individually, they have all made really good progress this year in terms of bill rate increases. Thank you. And I’m not showing any further questions at this time. I would now like to turn the call back over to Kate Duchene for any closing remarks. I just want to thank everyone for joining us again today. I wish you a happy and healthy new year, and we’ll look forward to talking to you again after Q3. Thanks, everyone.
EarningCall_1574
Good day, and thank you for standing by. Welcome to the First Quarter Fiscal 2023 Winnebago Industries Financial Results Conference Call. 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 turn the call over to, Ray Posadas, Vice President of Investor Relations and Market Intelligence. You may begin. Good morning, everyone, and thank you for joining us today to discuss our fiscal 2023 first quarter earnings results. I am joined on the call today by Michael Happe, President and Chief Executive Officer; and Bryan Hughes, Senior Vice President and Chief Financial Officer. This call is being broadcast live on our website at investor.wgo.net and the replay of the call will be available on our website later today. The news release with our first quarter results was issued and posted to our website earlier this morning. Before we start, I’d like to remind you that certain statements made during today’s conference call regarding Winnebago Industries and its operations may be considered forward-looking statements under securities laws. The Company cautions you that forward-looking statements involve a number of risks and are inherently uncertain in a number of factors, many of which are beyond the Company’s control, could cause actual results to differ materially from these statements. These factors are identified in our SEC filings, which I encourage you to read. Thanks, Ray. Good morning, everyone. As always, we appreciate your interest in Winnebago Industries and spending time with us to review our fiscal 2023 first quarter financial results. I will initiate the call with a broad overview of our performance during the quarter and then pass the conversion to Bryan Hughes to cover our financial results in more detail. We will then offer some closing thoughts before turning to your questions. Winnebago Industries first quarter results are a testament to the strength, diversification and resiliency of our brand portfolio amid more difficult industry and macroeconomic conditions. As we expected, demand for our premium RV product lineups continue to normalize in the first quarter, lapping a period of tremendous growth for the RV lifestyle in our fiscal 2021 and 2022 years. While we believe many of the underlying drivers of this record setting period are secular and likely to have a significant and positive impact in the long-term, including the introduction of thousands of new, younger and more diverse RV families that could remain customers of our premium brands for many years to come, Winnebago Industries will continue facing difficult comparisons to our fiscal 2022 results as the RV industry stabilizes throughout fiscal 2023. Our performance was also challenged by several macroeconomic factors that we expect to impact our near-term results. This includes a broader economic slowdown, general inflation that while trending lower is still meaningful, higher interest rates and as a result, lower consumer confidence. That said, our outstanding Winnebago Industries' team nimbly managed these challenges in the first quarter. I am immensely proud of our teammates for their arduous work to enhance the agility of our supply chain, increase the efficiency of our operations, and drive an increasingly more balanced portfolio of profit streams that are at various places in the outdoor economic cycle. The result was reasonable revenue stability and solid bottom line results that exceeded most external expectations. While we certainly cannot control the overall size of the outdoor recreation market in the immediate near-term, we can stay focused on strengthening and investing in our golden threads of quality, innovation and experience that will drive our profitable growth for years to come. Ultimately, Winnebago Industries achieved $952 million in net revenues in the quarter, a decline of 18% from the year-ago period. We realized a consolidated gross margin of 16.8%. While consolidated gross margin was down year-over-year, it remains well above pre-pandemic levels, up 240 basis points when compared to fiscal 2019 first quarter, and we delivered adjusted earnings per diluted share of $2.07. While down compared to historic record high levels last year, these results remain strong and reflect the resilience of our operating model, the vibrancy of our products and a more robust organization that we are today. Our results were driven by a few key factors. First, the strength of our premium outdoor lifestyle brands and our innovative product portfolio. Some of you saw our products in action at our Investor Day last month. The best current example of this formula is the Barletta lineup of pontoons. They are simply some of the best premium pontoons on the market today in function and feel, and the marine customers are voting with their purchase decisions. Barletta, which was founded just five years ago and acquired in August of 2021 by Winnebago Industries, has seen its market share begin to approach almost 7% of the market. The growth and profitability of our Marine segment is now a material chapter to our story and becoming a more well-rounded outdoor recreation mobility leader. We remained incredibly focused on the organic competitiveness, health and growth of our business. Our three RV brands, Winnebago, Grand Design, and Newmar, all received the recent Dealer Satisfaction Index awards from the RV Dealer Association, which places a special emphasis on quality. We recently began full production in shipment of our new HIKE 100 FLX travel trailer, which was named the model year 2023 "RV of the Year" by RVBusiness magazine. This product is part of an initiative to expand into differentiated customer segments and drive innovation with off-grid and off-road capabilities. A second key driver of our results in the first quarter was our flexible operating model that compliments a highly variable cost structure and our commitment to operational excellence, which enabled Winnebago Industries to maintain strong profitability despite market pressure on our topline. Our operational excellence initiatives are another example of the shared enterprise capabilities that our individual business units leverage across our enterprise. These initiatives include an outstanding strategic sourcing function, manufacturing best practices, company-wide focus on consumer insights and the consumer experience, and the benefits of an overlapping dealer network with deep, long-term relationships. And finally, certain external factors had meaningful impacts on our first quarter performance as well. The most significant was our supplier Mercedes-Benz AGs recent recall of all model year 2019 to 2022 Sprinter Chassis. As we discussed during our Investor Day last month, this recall prevents Winnebago Industries and all industry OEMs, upfitters, and retail dealers using that chassis from currently shipping, selling, or delivering any of the affected products until a remedy is implemented sometime in the first calendar quarter of 2023. This issue negatively impacted our first quarter top and bottom line results, including inventory levels and cash flow. Notably, despite this impact, we grew our Motorhome segment revenue in the first quarter and delivered solid profitability, reflecting the continued fundamental strength of our operations and margin profile. The second external factor we are actively managing is the dealer demand for our wholesale towables RV inventory. As I have mentioned previously, each of our reporting segments is experiencing varying forms of channel stocking behavior, which in turn impacts dealer inventory levels, backlog and production schedules in diverse ways across our portfolio. We are especially and closely managing Towable RV production levels to align with normalized dealer inventories in this segment. While our Motorhome and Marine businesses work carefully to replenish dealer inventories that remain low in various sub-segments. We are focused on exercising further rigor and a focus on sustainable long-term value by adjusting production across our businesses to calibrate to the needs of our dealers and in consumer demand levels. Our operating model allows us to do that profitably despite some disruption in our supply chain as we adjust our manufacturing to real time market dynamics. We are proud of how our results in the first quarter demonstrate that Winnebago Industries can and will deliver strong profitability and performance through challenging cycles. Furthermore, the benefits of our diversified and more balanced portfolio were evidenced by the growth in our Motorhome and Marine segments helping to offset the decline in towables. Our Marine segment revenues grew 66% year-over-year in the first quarter and accounted for 14% of our revenue, highlighting the tremendous success of our initiatives in that segment, and benefiting from continued strong momentum specifically in the Barletta brand. At the same time, as I mentioned, our Motorhome segment continues its growth trajectory with revenues growing 10% year-over-year as consumers continue to see the value of our products in the market. Our broad portfolio, enterprise synergy and capabilities and commitment to quality, innovation and experience enhance our resiliency and ensure we are well positioned to create long-term value. With that summary, I will now turn the call over to our Chief Financial Officer, Bryan Hughes, to review our fiscal 2023 first quarter financial results in more detail. Bryan? Thanks, Mike, and good morning, everyone. First quarter revenues were $952.2 million, reflecting a decrease of approximately 18% compared to $1.2 billion for the fiscal 2022 period. Our topline performance was driven by a number of factors, which Mike mentioned, including the expected cooling of demand, driving lower unit sales, particularly in the Towable segment. We were also impacted by the Mercedes-Benz AG chassis recall, which prevented us from shipping, selling, or delivering any products included in the recall, and resulted in an estimated negative impact of approximately $50 million in first quarter net sales, as well as related impacts to profitability and working capital, and is expected to have a similar impact in Q2. Gross profit for the quarter decreased 30.1% to $160.4 million compared to $229.4 million during the first quarter of 2022. Gross profit margin of 16.8% was 300 basis points lower than last year, driven by operating leverage, chassis recall-related production inefficiencies, a normalization back to seasonal trends within our Towable segment after extraordinary performance during the prior year period when dealer inventories were at all-time lows, and comparing against the strong Q1 last year where pricing was taken ahead of inflation. Operating income was $85.9 million for the quarter, a decrease of 41.3% compared to $146.4 million for the first quarter of last year. Fiscal 2023 first quarter net income was $60.2 million, 39.6% lower than the $99.6 million recorded in the prior year quarter. Reported earnings per diluted share was $1.73 compared to reported earnings per diluted share of $2.90 in the same period last year. Adjusted earnings for diluted share decreased 41% year-over-year from $3.51 to $2.07. Consolidated adjusted EBITDA decreased 42.0% to $97 million from $167.2 million in the first quarter of 2022. I would like to call out that we adopted a new accounting standard in the first quarter of 2023, which impacted the accounting treatment for our convertible notes. As a result of this required accounting adoption, we no longer recognize a non-cash discount or related non-cash interest expense from the convertible notes. The new standard also requires the earnings per diluted share calculation to assume conversion of the entire amount of shares underlying the convertible notes and interest charges to be added back to the calculation. Prior year results were not adjusted or otherwise affected by the new accounting standard. Our adjustment following adoption of this new accounting pronouncement results in adjusted EPS to be on an equivalent basis with how we have been doing the adjustment previously by removing the dilutive impact of the convertible notes. In this way, we recognized the economic benefit of the call/spread overlay that we implemented when we issued the convertible notes. Accordingly, we will adjust the diluted shares outstanding in the calculation of adjusted diluted EPS until our share price exceeds the strike price of the warrants, which is at $96.20. Now I'll turn to our segment performance, starting with our Towable segment. Revenues for the Towable segment were $347.3 million for the first quarter, down 46.7% compared to the prior year. This was primarily driven by declines in unit volumes as a result of the ongoing softening of consumer demand as well as the impact of our adjusted production schedules due to normalized dealer inventories. Segment adjusted EBITDA was $36.3 million, down 67.6% from the prior year period. Adjusted EBITDA margin was 10.5%, down 670 basis points year-over-year, but only 30 basis points sequentially and similar to historical levels. As we discussed in our Q4 call, we reinstated our traditional fall programming and are comparing against pricing ahead of inflation last year in Q1. Backlog decreased to $434 million, down 76.9% from the prior year when dealers were focused on increasing their inventories. Turning to our Motorhome segment. We delivered solid first quarter revenue growth of 10.1% to $464.2 million compared to the prior year. Our year-over-year growth was the result of the pricing actions we took in fiscal 2022, which more than offset the negative impact from the chassis recall. Segment adjusted EBITDA was $50.3 million, representing an increase of 0.2% from the prior year. Adjusted EBITDA margin was 10.8%, down 110 basis points, primarily due to production inefficiencies tied to the chassis recall. Finally, let's turn to our Marine segment. In the first quarter, revenues for the Marine segment were $131.4 million, up 65.7% from the prior year as a result of strong unit growth across both Barletta and Chris-Craft. Adjusted EBITDA for the Marine segment was $18.5 million, 74.5% higher than the same period last year, and adjusted EBITDA margin was 14.1%, 80 basis points higher than last year. Dealer inventories continued to build towards more normalized levels in the marine space, and our backlogs were up 23.8% compared to the first quarter of the prior year, reflecting the strong demand for our brands. Moving now to the balance sheet. As of the end of the quarter, we had roughly $590.4 million in outstanding debt, representing a net debt-to-EBITDA ratio of approximately 0.6x. Our healthy balance sheet has continued to allow us to execute our balanced capital allocation strategy, which prioritizes strategic investments in our business to drive growth while returning capital to shareholders. For example, we reached a number of exciting milestones this quarter that will enable future growth across our portfolio. In November, we announced plans to develop a new advanced technology innovation center. We also continued to expand our manufacturing capacity for both of our marine businesses to help meet the pent-up demand for those products. As always, we balance these investments with returning capital to our shareholders and continued to pay our quarterly dividend for the quarter, which as a reminder was increased 50% to $0.27 per share during the fourth quarter of fiscal 2022. Thanks very much Bryan. At our Investor Day last month, we unveiled fiscal 2025 strategic targets on net revenue, RV and pontoon market share, gross margin, adjusted EBITDA yield, free cash flow, and our community giving levels. We believe those targets are appropriate and achievable even as the distractions of the near-term market conditions are present. While there will likely be RV industry shipment contraction in calendar year 2023, we do believe market tailwinds will be present again in that segment by the time we reach the fiscal 2025 year. However, a dramatic rebound in RV shipments is not a dominant assumption in order for us to achieve our 2025 financial targets. We also have stated a clear intent to complement profitable organic growth with strategic inorganic investments and continued operational excellence initiatives that cumulatively drive accretive profitability in competitive differentiation during this three-year period. As it pertains to calendar 2023, RV shipment projections, we now generally agree with the recent RV Industry Association forecast, which anticipated a mid-range estimate of 391,000 wholesale sales. This updated expectation is slightly lower than our previous 400,000 to 410,000 forecast we offered in October. In the meantime, we are continuing to execute our strategic priorities and invest in the areas of our business that will create new growth engines. As Bryan stated, we are expanding our capacity in both of our marine businesses to accelerate our market share potential. We announced last month that we have signed a lease for our ATG Innovation Center, which will be dedicated to applying emerging technologies for next-generation products in all our businesses. This includes the strategic imperative to execute a measured, but intentional electrification roadmap within our brands that balances scaled adoption opportunities, superior customer experience, and competitive differentiation. Looking ahead, we are confident that Winnebago Industries has significant long-term opportunity for sustained market share gains and profitable growth across our portfolio, leading to enhanced value for our end customers, dealers, employees and shareholders. Before we open-up the line to questions, I want to touch on the continuing progress we are making on our commitment to corporate responsibility. In fact, this traction was recently validated when we were named one of America's most responsible companies by Newsweek Magazine, a first time honor for Winnebago Industries. On the environmental side, we are working actively on waste, water, energy and product lifecycle targets that we have set for the years 2030 and 2050. On the community side, we are passionately engaged in making the communities our employees live, work and play-in better as well as the health of and the access to the outdoors overall. We are doubling down on our fiscal 2025 giving targets compared to our fiscal 2022 actual philanthropy, and we are off to a great start with our recent community go campaign this fall, collecting $1.2 million, supporting 270 different non-profit organizations. The heart of our company shines through these types of initiatives. Lastly, we just released earlier this week the fourth edition of our corporate responsibility report. Our most substantive report to date, this publication outlines our aspirations on our ESG priorities and shows specific base levels, frameworks, and progress to achieve those ambitions. I am humbled and inspired by the enthusiasm and commitment of our team to both do well and especially do good. That concludes our prepared remarks this morning. We hope all of you have a safe and joyous holiday season. Thank you. [Operator Instructions] And our first question comes from the line of Craig Kennison with Robert W. Baird. Please proceed. Hey, good morning. Thanks for taking my questions. Question on retail for this year and next year for the industry. I'm wondering where you think 2022 will finish for the industry and what is required in 2023 at retail in order to hit the RVIA range that you think is attainable? Good morning, Craig. This is Mike. So let's start with 2023 and then I'll move back to 2022, which obviously has very little time left in it in terms of a calendar year. From a 2023 standpoint, we believe that retail will probably be very similar to the RVIA wholesale shipment forecast for that particular year. Our hope is that it is slightly above. So if I were to put a range as of today, it would be in that 390,000 to 400,000 retail range for calendar year 2023 with the goal being that the industry can, particularly on the towable side, take out a little bit more inventory over the course of next year. So that is our thinking and as you might imagine those thoughts are subject to updates, obviously as we see the market conditions play out in front of us. I would say for calendar year 2022 retail, again, the period that we're going to be completing here in a few weeks, we're probably in that 440,000 to 450,000 unit range with the retail that is left. Obviously SSI has not reported yet on November. We have a decent idea of November for our business and then we're a couple weeks into December. So we're probably in that 440,000 to 450,000 range for calendar year RV – 2022 RV retail. Great. Thanks, Mike. And then a question on ASP for both categories, it looks like your average selling prices are trending up around 20% or a little bit more. How much of that is mix versus pricing action that you've taken? And then if you could just address the affordability impact for your consumer and whether that weighs on your retail outlook? Craig, I'll address the latter part of that question and then ask Bryan Hughes to give you his thoughts on the ASP elements. We certainly are thinking a lot about the affordability of the lifestyle today. My first message would be that the RV lifestyle still compares economically favorably to other forms of travel, particularly for singular trips or longer journeys. The cost of airplane tickets, hotels, rental cars certainly is not going backwards. And in fact, those are experiencing some inflation as well. So – and RV road trip continues to compete very favorably cost-wise for the American consumer with trips of other means. But the affordability is something we're watching both in terms of the retail prices that are in the market and now the higher interest rates from a consumer financing side that are in the market today for consumers to take out a loan to acquire those products. And certainly as a premium branded parent company with five great brands, but all of them arguably positioned in the sort of the better, best part of the market, we are watching that carefully. So something that I'm sure we'll talk more about as we get more into the spring 2023 period where I think we'll have a better handle on how the consumer is reacting to the prices at that time. Yes. I guess, and on the ASP side of your question, Craig. If you look at our segment level information, you'll see that as you pointed out the ASPs are up 22%, 23% for both Towable and Motorhome. That's largely driven. As we've talked about in the past, the inflationary pressures that we've been facing. We did price ahead of inflation a bit in last year's Q1 as we commented at that time. But there's not a lot of mix if you look at underneath or within those segments. It's largely net pricing and mix plays a relatively much smaller role in that ASP increase. I just wanted to kind of follow-up on Craig's question. Your dealer inventory is up quite a bit year-over-year [towables versus] [ph] as well when they reported. And I don't think November and December is going to remove too many units from the dealer channel. So do you think that – would you prefer wholesale outpace retail, or would you prefer maybe wholesale came in a little bit lighter? Yes. Good morning, Tristan. This is Mike. That question really has to be answered, it depends framework. And what I mean by that is, obviously as you're well aware, we have different moving pieces of our business. In the Marine and the Motorhome RV segments of our business, there are still some sub-segments where dealers maybe interested in continuing to add to their inventory position and we have, as you know and Bryan and I both mentioned on the call, a very rare situation here with the Mercedes-Benz recall that has a lot of that Sprinter inventory stuck in place at the present time. But on the towables RV side, I think it would be fair to say that we think both the dealers and probably the OEMs would see little harm in field inventory being reduced a little bit here over the course of the next three to four months and I won't get further than that because I don't have a crystal ball to anticipate the market condition. So if you look at Winnebago Industries RV dealer inventory at the end of our first quarter fiscal 2023 compared to the end of our first quarter fiscal 2019, our turns today on a trailing basis are higher. The real question is on a forward basis, are we in the right position? But our business has grown meaningfully over the last three, four years. And our inventory actually has not necessarily on the towable side over exceeded that retail growth at all. So we definitely feel there's room for towable inventory in the field to get a little bit lower. And we'll see what happens here over the next three, four months as we head into the spring 2023 selling season. Okay. Thank you. And then just a question on the Springer recall, I think you said remedy in Q1 of next calendar year. Is that a bit longer in the timeframe than you expected? And then if it is, what are you going to do it to offset that? Yes. So a little bit of history on the Mercedes-Benz recall, this was something that came to our attention late in the October 2022 time period. And it took us a little while around a week or so to understand even from Mercedes exactly what the issue was and what the implications were to our business and a potential timeframe for resolution. I don't really want to share many specifics about the challenge Mercedes is facing here other than the timeframe for the specific resolution of the product issue has been something that has moved around. And the estimate that we provided in my script today of resolution projected to be sometime in calendar Q1 of 2023 is our best estimate at this time. But you notice, I'm not saying whether that'll be January or whether that'll be March, the timeframe for resolution is still not as specific as we'd like it to be. So we continue to work with Mercedes as a good OEM customer of theirs to see what we can do to help. From a long-term standpoint, we don't view this as a systemic issue. We believe Mercedes will continue to make quality chassis for their OEM and retail consumers and we'll get back to business operating smoothly at some point in the future. The biggest concern with that issue is retail being frozen or lost while they pursue the resolution. And whether that comes back to have a material impact on the total number of wholesale shipments that OEMs like ourselves can ultimately deliver to the market. So we've been transparent with the financial community as to the Q1 impact, certainly this morning. And also that we project there to be a similar impact in Q2. What we cannot tell you, Tristan, this morning is, what that means for Q3 and Q4 once the issue is resolved, that will largely depend on the retail environment at that time. Okay. So it doesn't sound like we're going to try to transition everyone over to ProMaster Chassis, we're just going to kind of stay the course and hope it resolved. Yes. Again, we continue to partner with Mercedes technically on the issue. We continue to work with our dealers to try to provide them other products that they can retail to their consumers that are interested in similar size platforms, but the final details of the resolution program and ultimately the financial impact to ourselves or our dealers is still a work in process at this time. Thank you. One moment for our next question, please. It comes from the line of Scott Stember with MKM Partners. Please proceed. Mike, you were talking about one of the bigger headwinds is deal or inventories for towables and the whole right-sizing process. Could you maybe expand on that a little bit as far as 2022 models that are in the field, and if you guys are feeling any need to have to discount more than normal notably on Grand Design? Yes. Scott, thank you for your question. I'll break my answer down into two parts. First, retail; and then second, wholesale, and I'll start with the latter wholesale. Our two businesses, Grand Design RV and the Winnebago branded Towables in this segment have not provided what I would consider to be abnormally steep discounts to our dealers from a historical perspective to move product at this time. We came to the open house in the September/October timeframe with fall programs that we stated at the time we’re similar to our pre-pandemic fall programs in terms of benefits to the dealers. And we generally used the structure of the fall programs on both of those businesses throughout the rest of Q1 through November to ship product to the market. From a retail standpoint, we are certainly watching retail inventory carefully. The good news is, is that the market was pretty healthy in 2021. And the first probably 1/3 to 40% of 2022 and so subsequently, you did not have significant piles of excess or old inventory that were stuck at retail when the market started to slow down. But as inventories, as we've admitted in the Towables segment are our healthy and ample, we do watch the aging inventory on our products. We have the ability through reporting here to look at inventory in different age brackets in the field. And each of our businesses then determines whether they work with the dealers when aging inventory is excessive. I would not say that at this particular time, the aging inventory in our Towable segment is a major problem. It could certainly turn into that over the course of 2023 if retail conditions are not as we imagined, and we would then have to deal with it at this time. But from a historical standpoint, as we sit here today, we do not have overly excessive aging inventory on towables in the field. But I can tell you that dealers and OEMs certainly have a sense of anxiety with the uncertain economic conditions, and we'll be monitoring that carefully. But Q1 did not include any significant retail support programs for aging inventory from our Towables businesses. Got it. And regarding 2023 orders, we know coming out of Open House that there really wasn't a lot that took place, but dealers are going to have to have some 2023 product on their lots. Can you just talk about whether the order activity has picked up and also in Q2, sequentially, what are we looking like, particularly on towables from a production standpoint? So order activity, like a number of other questions, varies by category. Order activity in the Marine and the Motorhome space has remained reasonable. And what I mean by that is, as dealers are adjusting to the retail conditions in the Motorhome RV and the Marine markets, they are ordering in what we would call a rational reasonable level. And on those two businesses, you still see a healthy backlog as projected by our dealers, which again, we attempt to cleanse as regularly as we can to make sure it has integrity for our production planning purposes. From a Towables RV standpoint, Scott, we have not seen a meaningful difference in probably order taking here in the last 60 days. It remains lower than certainly the last couple of years at this time, which would be expected. And dealers are very cognizant of the inventory they're sitting on. The economic conditions around them with inflation, general inflation and rising interest rates, and they continue to be conservative with their Towable RV ordering pattern. So we really don't share specific information on production planning for current or future quarters that we're in. I can just tell you that daily, if not almost hourly, we continue to discuss with all of our businesses and brands, the rightsizing of our production schedules to the market conditions and the wholesale appetite that our channel partners have. So we are acting accordingly in all of our businesses. Certainly, some more aggressively than others, Towable RV at the top of that list to make sure that we do not overproduce in the future. Got it. If I could just slip one last one in. Looking at the total backlog, it looks like units in absolute value are down about the same amount. So is it fair to assume that on what is being ordered that the pricing is reflecting the realities of what's going on in the market right now? Yes. I would tell you that – and this is a good opportunity, Scott, to talk about inflation that we're seeing or not seen and how it relates to our pricing. Certainly, historically, we adjusted pricing preferably one time a year at the model year change. And then as we got into conditions in 2021 and 2022 with unexpected and rapid inflation. As all of you know, we were forced to take multiple price increases during a model year in order to try to keep up. And as Bryan Hughes has explained many times, there's been a sort of a timing element to that as to whether you're ahead of or behind the inflation that you're facing. We are seeing generally very moderate inflation in our business today with the exception of motorized chassis, which is where we're seeing our most significant inflation still sequentially and overall, in most of our other categories, our inflation is pretty moderate right now. I would not call it deflationary, but it has moderated to a meaningful degree. Subsequently, our pricing actions outside of the model year changes from 2022 to 2023. Our businesses, generally across the board have not felt the need to have to take price increases here recently above and beyond what they've priced at the model year change. We don't share a ton of information for competitive reasons on this call about our pricing behaviors. And so I won't comment on anything we have planned. But I would tell you the wholesale programs, particularly around Towable RVs continue to be sort of framed in the fall program context that our businesses took to Open House. Hey, guys. Good morning. Just wanted to talk about Towable margins, and I think you've said a number of times that kind of – you're seeing a return to normal seasonality. So I guess I'm trying to understand in the quarter, just maybe the year-over-year change in margins. I think you benefited last year from price cost. But maybe talk about the moving pieces and kind of bridging that gap. I think there was a 600 basis point, 700 basis point contraction year-over-year? And then maybe how to think about that over the next couple of quarters, whether that's sequentially or year-over-year? Yes. Good morning, Mike. This is Bryan. I'll address that one upfront and Mike can add on. I'd go back first to our comments last year for Q1, really strong EBITDA margins we had in towables in excess of 17% was certainly an outlier relative to the more typical lower seasonal Q1 that we would report on. And at the time, we had referenced pricing that was probably a little ahead of anticipated inflation. So that was certainly something that elevated the prior year. On top of that, if you take just the deleverage equation when you're based with the topline reductions that we were faced with in Q1 and using that 85% to 90% variable cost structure. That explains the bulk of the difference. So we probably had a little inflationary impact year-over-year relative to pricing because of the timing that we've talked about. And then largely, the rest was that deleverage that we would experience. So those are the two primary drivers. But the end result in EBITDA margin for towables is a more typical Q1 EBITDA margin if you look back into our history and pretty similar to Q4 and also sequentially more in line with each other as well. Okay. And maybe just to clarify, I mean, going forward, the way to think about maybe the margin progression would look similar to what we saw pre-COVID is that just I mean maybe not in terms of magnitude, but just quarter-to-quarter flow. Is that the way to think about it? That's our current expectation, Mike. As Mike was alluding to earlier, we're obviously going to be keeping a very close eye on how retail performs and how dealer inventory is performing as well, including aging. And so our current expectation, though, is that will follow a similar seasonality or quarter-by-quarter low at EBITDA margin. That's our expectation currently. Okay. That's great. Thank you. Another question on margins, just in the quarter, I'm trying to understand, SG&A as a percentage of sales did come in a little above what I had modeled, and I think what most people in the Street had modeled. Was that a factor of just segment mix, i.e., Marine and Motorized outperforming Towable? Or was there something maybe investment related or just cost related in the quarter that elevated SG&A expense? Yes, absolutely both. I think it's fair to say that our Motorhome businesses have in general a greater SG&A fixed component than does the towables. And so you do have a mix dynamic going on there. But then we would certainly also call out, as Mike did in his comments, we continue to make strategic investments that we know to be the right thing to do for the business long-term. And doing our best to hold on those that are most important, while obviously, managing SG&A as aggressively as possible on those things that are less strategic in nature. So I think you hit the two main points that I would have provided in my answer within your question. Hey guys. Thanks for the question. I just wanted to follow-up on some of the ASP conversations. And I guess that you guys have been pricing to offset rising inputs, but is some of those bigger material costs potentially move favorable. Would the plan be to pass that through to the consumer to the dealer? Or sort of, I guess, conceptually, how would you look to treat that? Fred, this is Mike. I'll respond to that. Again, we generally don't share forward-looking pricing strategies or intentions. And we respect that at times, maybe some of our competitors choose to do so. But we've always maintained through the years that we are not a cost-plus pricing business that we are a market-based pricing business and that market-based pricing is ultimately set on a number of elements. Hopefully, long-term, based on the differentiation and innovation we bring to market that consumers are willing to pay for. So certainly, if we were to see significant deflationary elements within our build materials and our COGS, we would consider what that means, not just in the context of those of those costs, but also what our competitors might be contemplating as well and retail conditions. So we won't share specifically this morning any pricing intentions, but you can be assured that our businesses are certainly talking about a variety of scenarios depending on how inflation or lack of affects our business in the future. So our ambition is to always balance market share and sustainable profitability. We're neither overly focused, I would argue, on one to the negative dilution of the other. We try to find that sweet spot where we can drive market share that we think is right for who we are. But we also want to be candidly one of the most profitable OEMs in the industries we compete in as well, so that we can reinvest in our future and continue to create strength. Fair enough. And you guys gave us the chassis recall impact on the topline. Is there a way to sort of frame up the margin impact in the quarter? I mean you guys still posted double-digit adjusted EBITDA margin in the motorized category despite the chassis. I assume that there's a drag baked in there, too, but could you size that for us? I'm sorry. Yes, we prefer not to disclose by chassis or by model there. So for competitive reasons, as you can probably appreciate. On the marine side, could you talk a little bit about the supply chain? I mean, obviously, power availability has been a big issue in the last 18 months. Is that something that is opening up? And I guess, is marine going to see a better first half of calendar. From a supply chain standpoint, on the marine side, over the last couple of years, we've certainly seen issues across different categories. But Bret, as you're probably aware, one of the most important, but also one of the categories that experienced some constraints was the actual engine side of the business. Over the last year, year and a half, we made a very conscious decision to put most of our eggs from a motor/engine standpoint on the marine businesses into the Mercury basket. And that's for a number of reasons. First and foremost, the supply chain challenges that we had with Mercury's primary competitor were very disruptive to our business. Secondly, we really think Mercury has done an excellent job from an engine technology and innovation standpoint and continue to candidly set the pace of competition, particularly on outboards, and that's the category I'm really talking about here, outboard engines versus the others. We have seen Mercury continue to improve as a supplier for a number of different reasons. And so as we enter calendar year 2023, we have a higher level of confidence that the supply chain rhythm related to those components is going to be much more stable than it was in the past year, year and a half. Obviously, we'll take as many engines as the market, though is willing to absorb from us in terms of wholesale shipments relative to retail. But your question does give me an opportunity to state again how pleased we are with the Barletta pontoon business that we acquired now about 15, 16 months ago, how well it's performing and just the reaction that we continue to get from retail consumers to that brand's product line compared to the other choices they have in the market and the profitability of our Marine segment, particularly around Barletta's growth, Bryan and I have been very pleased with as well. So around 15% of our revenues this quarter came from the Marine segment. And I think the profitability was probably closer to 20%. That is a meaningful step forward versus prior first quarters and prior fiscal years in terms of the balance and diversification of our portfolio. And the two things I think outsiders continue to underestimate about our business is our profitability resilience across our entire business, but also our strategic intent and execution to diversify our portfolio. And this was another quarter where the hard work that we've done in the last three, four years has paid off in terms of having a solid quarter in light of market conditions. Bret, I think you'd have to talk to somebody at RVIA on that. I know they produce a range. We chose the midpoint here is what we generally aligned to during this particular release period. But we have representation on the statistics committee, but I can tell you the 391 number for calendar year 2023 is probably not connected to any sort of hard recession in the U.S. economy. Thanks. Hey, guys. Good morning. Just going back to the marine side for a second. It looks like you added about 1,100 units into the channel here in Q1. How long would you expect that pipeline fill opportunity to extend here in fiscal 2023? Joe, good morning. This is Mike. So there's going to be a number of factors which ultimately result in answering that question. And on this call, I won't be able to give you a precise answer, and I'll explain why. Certainly, the overall macro conditions around the marine industry are things we're watching carefully. While the marine industry has been a little healthier than the RV industry in the last year, and certain categories like pontoons, have been trending much healthier as of late than the Towable RV segment specifically. We do not believe, as you would expect, we do not believe that the marine industry nor some of its sub-segments are immune to any of the macroeconomic pressures that consumers are facing. Inventory is building in the marine industry across a number of different categories. And that is similar on the Barletta side. But the positive elements, which make it difficult for me to answer your question are the following. Barletta is a five-year-old business. We have not put the Barletta brand in all of the markets around the country that we believe that we can have a presence in. There are dozens of open markets that we have documented that we believe the Barletta brand can have a presence in today that they still do not have a presence in now. And partly because we prioritize our existing dealers when the supply chain constraints were very real as opposed to setting up new dealers. The other element that's difficult for us to put timing on your question is we are introducing two new lines to the Barletta business. Today, we only go after about 40% of the addressable pontoon market, and yet that business has grown to a top five player with only three existing lines or brands underneath the Barletta umbrella. We are adding a new lower-priced still premium lower priced line called the [ARIA]. And we are also adding a line on the high end called the reserve, both of which have been introduced to the dealer base for the future. And as we stated, we have invested in capacity expansion for that brand, which is ongoing. So we believe that Barletta, and we'll have to do this in a very disciplined way can swim a little bit against the tide as the marine industry normalizes as well because of their market share momentum, their line expansion product-wise and their dealer expansion. And so we're going to be very disciplined, though. We have to watch, obviously, the temptation to overbuild and overstock, but that timing is going to be different than what you'll see in our other segments for sure. That's helpful, Mike. I appreciate that. And then maybe moving over to RVs. It looks like your dealer turns, you mentioned this earlier about 2.8x. You're running about 2x pre-COVID, running about 4x post-COVID. It sounds like you expect that to stay within that 2.5x to 3x range, here in 2023. Is that a fair assessment? So if you look at those numbers on a trailing basis, I would tell you that Bryan and I, we really have thought for some time now that as dealers came out of the frenetic sort of pandemic inspired retail period that they got used to great margins and low working capital. And we have felt for some time that they would try to run their business on the RV side at probably somewhere to a half turn higher and so I think your range is right overall. It does vary by segment, Motorhome versus Towable. But if the industry was running to 2.5 in the past, we do believe dealers are going to try to run at 2.5 to 3 in the future. But that will be dependent, to some degree, as you know, Joe, on the volatility of the of the retail market. So yes, I mean, we expect about a half turn higher when the dust settles and we have to adjust our production planning processes to be able to fulfill the dealers adequately when turns are a half turn higher. But it's still very chaotic today. I'm not sure it has settled yet. Hey, good morning. Thanks for fitting me in here. So really appreciate the comments on both wholesale and retail. I think everybody at this point sort of agrees earnings power for fiscal 2023 is going to be down materially as the industry sort of normalizes versus the last couple of years. I guess my question is, if retail and wholesale for the industry play out the way that you expect, do you think that sets the stage for you to, again, grow the top and bottom lines as we look to fiscal 2024. And obviously, there's a lot of moving pieces there, right? Where are inventories as we finish 2023? How are you thinking about ASPs promotional environment, all of that. But ultimately, do you think we're going to exit the next year in a healthy enough place that you'll be able to grow again? So James, first of all, good morning. Thank you for the question. As you saw at our Investor Day, a month or so ago, we absolutely have ambitions to grow. We certainly put both net sales and market share targets out for our overall business at higher levels than they are today. The path to overall growth will still continue to be a combination of organic growth, and we believe some smart, well-considered inorganic growth as well. The timing of both of those will be very interesting to see how it plays out because the organic growth will be tied largely to two factors; one, market conditions; and second, our ability to create growth opportunities in the business. I mentioned how we could do that on Barletta. I would say on the RV side, it will have to be through new products and innovation, as much as anything. The inorganic timing, as James, I know you know, is hard to predict. So we certainly have higher market share ambitions, as we've stated during our Investor Day presentation. And in order to reach those by the end of our fiscal 2025 year, we will need to make steady progress over the next three years. That element has been a little bit of neutral here as of late for a variety of headwind factors, but we do anticipate that turning back positive at some point down the road. So I just can't comment on sort of when some of that can happen. But we're a very financially healthy company as well, although we stay paranoid about that status. And with Bryan's leadership, we make sure that we're structured in a very careful way. But we have the capability to make some inorganic investments as well strategically to match who we want to look like three to five to 10 years down the road. And so you'll see that happen as well. That's helpful. And maybe to one of the last points you just made there, the sort of market share environment. Obviously, market share has been a big part of your growth algorithm for a number of years now. That's maybe stalled out a little bit here as of late. Maybe an update. I know a big part of that is this whole sort of clearing out of Tier 3 product, where do we stand with that? And is there an opportunity this fiscal year to sort of move beyond that and maybe outgrow the industry or under decline in the industry? I guess this is a better way to put that. Yes. No. Our expectations for our businesses is that over time, we continue to take reasonable market share gains for who we are as a premium OEM. Most of the pressure we've been seeing on market share has been in two spaces. Towable RVs with the, what you cited, James, with the second and third-tier inventory in the field, but also some of the affordability questions that were raised earlier. In the very near-term, consumers are very price conscious. And on the RV side, we've also obviously seen other competition come to the market with Class Bs. We have been predicting that for years that it was going to be hard for Winnebago Industries to hold 45% to 50% share when most of our other competitors years ago were not candidly engaged in that category to the degree they are now. But each of our brands and businesses, both on the RV and the Marine side, have product plans, distribution plans and candidly, marketing and digital plans to make our brands more relevant, more appealing to our end consumers and then hopefully, obviously, with our dealers as well. So again, we watch market share carefully. We don't talk a lot about dollar share because it's very difficult to track. I would suggest that our dollar share candidly, is probably doing better than our unit share here in the more recent past because of our ability in the last year to pass through the pricing increases that we were able to do. So again, it's a balance of market share and profitability that we continue to pursue. Got it. I appreciate the candor here. Obviously, it's a difficult time to predict much, if anything, given the macro uncertainty, but good luck now we're getting. Thanks guys. Thank you, and thanks for taking my question. Wanted to just get your big picture thoughts, Mike. Just when I look at your comments that you talked about retail of 390 to 400 or so for 2023, if look at that shipment number, you take the lower end of the range. To me, that doesn't imply that there's a ton of inventory that is worked down in the industry. So I would just kind of love to understand your logic. And if those numbers kind of shake out? Are we still somewhat elevated going into 2024? I'm just trying to understand kind of some of the logic that kind of goes behind the thought process. Yes. Good morning, John. I would say the logic emanates from a bottom-up point of view in this way. We really look at the Towable RV retail. We look at the Motorhome RV retail. We break it down into fifth wheels and travel trailers Class A, B and C. And there will be categories that we believe over the next year is a stable relatively healthy retail environment persists, which could see some actual inventory climb. I've mentioned many times before, we haven't dwelled on it during this call. That we've been under pressure, as an example, on certain parts of our Class A business from a supply chain standpoint. And we have not been able to be as competitive as we would like to be on shipment share on Class As because of challenges around some certain key components. As that relieves itself, we have a choice in the future to work with our dealers to continue to raise some field inventory on certain elements of that sub-segment. As the Class B business grows, as electric products are introduced to the market. There are various spots where we believe field inventory can actually in the RV industry rise carefully. That then is offset by places, particularly around sort of the mainstream Towable RV segments where we believe dealers would prefer to probably have less of those. So just a reminder that the numbers we give you are always macro and there's various moving pieces to them, and that's our best guess at this time. But we'll see how it plays out. Understood. And then just on capital allocation question. When you look at kind of a 400,000 retail environment, does that make you comfortable – is that environment comfortable enough for you that you guys would look at acquisitions or look at buyback? Or do you scale back those things given the retail environment for the next 12 months or so. Great question. Well, it's going to be a dynamic environment as we've been talking about throughout the call. I have stated before, and I'll reiterate it. Our capital allocation priorities really don't change given the environment. We're going to continue to focus on growth. Organically and inorganically, make sure our liquidity is sufficient, particularly at times like this where there's a higher level of uncertainty we'll target that range of 0.9x to 1.5x in terms of our leverage ratio and then returning cash to shareholders. And it's all dependent on the environment that we're in and our forward view of the environment, which we've talked about throughout the call as to how we allocate. So I think that, that's the primary comments that we would make. We did pay a cash dividend that was up 50% in this quarter. We held back on share repurchases for a couple of reasons. First, Q1 is historically a seasonally low cash generating quarter. And last year was the strong exception to that. But historically, Q1 is relatively lower than it was this year. And then second, as we talked about our free cash flow was impacted by working capital increases driven by continued supply disruptions and Mercedes-Benz recall specifically. So our free cash flow generated in Q1 was certainly something that influence our decisions around share repurchases in Q1 here. So I think that's the context that I would provide as it relates to capital allocation. And Mike, I'll turn it back to you if you want to add anything further. Thank you for taking my questions and fitting me in here. Just quickly on margins, I think you had talked about the margin progression earlier in the call. Historically, it seems like there's – with the exception of last year during 2Q 2022, seems like there's a step up in margins for the Towable and Motorhome segments. Do you think margins have bottomed there? Yes. We feel good about the increases that we've made to the Motorhome business over time, Brandon, we've talked about that in past quarters and how our current expectation is to maintain that double-digit EBITDA margin. And so you can see that over time over the last several quarters now, we've been able to accomplish that and even in more challenged times like what we're seeing now, we were able to maintain that double-digit EBITDA margin in the Motorhome business. So that's where we've seen the most notable change over the last three years now. On the Towables side, I talked about that earlier in our expectation that the seasonally low Q1 here is in line with what we've seen historically and in line with really our expectations. So a bright side to the margin story is certainly marine as you saw in Q1, marine is performing very well relative to the portfolio. And so we're liking everything that we're seeing in the marine and really in line with what we had expected to see when we brought Barletta into the portfolio. So that has played out in line with our expectations and what we anticipated. So a good story there. Great. And just one last one. On the Motorhome side, you had talked about orders being reasonable. It looks like just from the data you provided, implied orders might have been down about 80% versus 2019 levels. Kind of how do you feel – is that reflective of kind of where demand is right now? Or is the channel filling up quicker than expected? Thanks. Yes, Brandon, this is Mike. I guess the term reasonable is in light of the volatility in the world around us. Again, certainly, dealers are paying close attention to their overall inventory levels. I would tell you in the month of November, we got no new orders on Mercedes chassis as an example. And that was certainly different than a year ago. Almost a third of our field inventory on Winnebago-branded Motorhomes is on Mercedes chassis. And so it's hard to take orders when the dealers essentially know that, that's something that they can't really see forward to. So yes, I mean, it is chaotic in the way that a small dealer, a large dealer is looking at a variety of these categories. But again, relative in this order from positive to less positive Marine orders, Motorhome orders, Towable orders is the way that I would rank those. So we'll see what happens as dealers get into the retail selling season. We are coming up on show season here over the next three, four months. That begins in earnest after the holidays with a number of different shows, including the Florida RV SuperShow down in Tampa, I think the third week of January. And so we'll learn a lot in many ways over the next 60, 75 days about our prospects for the rest of fiscal year 2023 and calendar 2023 and subsequently, I think orders will definitely respond to whatever the retail activity is as we make the turn of the calendar year. Thank you. And this concludes the Q&A portion of today's conference. I'd like to turn the call back over to our host. Thank you, everyone, for joining our call today. From the Winnebago Industries team, we wish you and your families a happy holiday season and look forward to connecting in the new year. Thank you.
EarningCall_1575
Good afternoon, everyone, and welcome to PriceSmart, Inc.'s Earnings Release Conference Call for the First Quarter of Fiscal Year 2023, which ended on November 30th, 2022. After remarks from our Company's representatives Robert Price, Chairman, and Michael McCleary, Chief Financial Officer, you will be given an opportunity to ask questions as time permits. As a reminder this conference call is limited to one hour and is being recorded today, Tuesday, January 10, 2023. A digital replay will be available following the conclusion of today's conference call through January 17, 2023, by dialing 1-877-344-7529 for domestic callers or 1-412-317-0088 for international callers and by entering the replay access code 6032359. For opening remarks, I would like to turn the call over to PriceSmart's Chief Financial Officer, Michael McCleary. Please proceed, sir. Thank you, operator, and welcome to the PriceSmart earnings call for the first quarter of fiscal year 2023 that ended on November 30, 2022. We will be discussing the information that we provided in our earnings press release and our 10-Q, which were both released yesterday afternoon, January 9, 2023. You can find these documents on our Investor Relations website at investors.pricesmart.com, where you can also sign-up for e-mail alerts. As a reminder, all statements made on this conference call other than statements of historical fact are forward-looking statements concerning the Company's anticipated plans, revenues, and related matters. Forward-looking statements include but are not limited to, statements containing the words, expect, believe, plan, will, may, should, estimate and some other expressions. All forward-looking statements are based on current expectations and assumptions as of today, January 10, 2023. These statements are subject to risks and uncertainties that could cause actual results to differ materially, including the risks detailed in the Company's most recent Annual Report on Form 10-K, the quarterly report filed on Form 10-Q yesterday and other filings with the SEC, which are accessible on the SEC's website at www.sec.gov. These risks may be updated from time-to-time. The Company undertakes no obligations to update forward-looking statements made during this call. On behalf of myself and our Board of Directors, I would like to express our appreciation to Sherry Bahrambeygui for her leadership during the past four years. Sherry's performance as CEO during some of the most challenging years in the history of PriceSmart has been marked by record revenues and profits, as well as membership growth, club growth and the launch of online shopping. Our Company is poised to build on Sherry's accomplishments. Sherry will remain on PriceSmart Board of Directors, where she will continue to make important contributions to PriceSmart's future success. I'm excited about re-engaging more directly in our Company's day-to-day business affairs. I have a very personal passion for PriceSmart. Our business takes place in countries that have significant economic and political challenges. Since our Company's beginning in 1996, we have been committed to operating our business at the highest standards related to our buildings and equipment, our merchandise and most importantly to providing an outstanding working environment for our over 10,000 PriceSmart employees, serving our members in the 12 countries and one U.S. territory in which we do business. U.S. PriceSmart stockholders can be proud of the investments you have made in our Company. We had another outstanding first quarter with both total revenues and net merchandise sales exceeding $1 billion. Net merchandise sales increased by 8.6% after a negative 2.3% currency impact and comparable net merchandise sales increased by 5% after taking into account a negative 2.1% currency impact. By segment, in Central America, where we had 27 clubs at quarter-end, net merchandise sales increased 10.1% with an 8% increase in comparable net merchandise sales. All of our markets in Central America had positive comparable net merchandise sales growth. In the Caribbean region, where we had 14 clubs at quarter end, total net merchandise sales increased 12.9% and comparable net merchandise sales increased 6.6%. All of our markets in this segment also had positive net merchandise sales growth. In Colombia, where we had nine clubs open at quarter-end, net merchandise sales decreased 8.3% and comparable net merchandise sales decreased 13.1%. The decrease in Colombia during the current quarter was primarily due to the significant foreign currency devaluation that impacted net merchandise sales by 20.5% and comparable net merchandise sales by 19.6%. The comparable net merchandise sales decreased in Colombia contributed approximately 160 basis points of negative impact to total comparable net merchandise sales for the quarter. In terms of merchandise categories, when comparing our first quarter sales to the same period in the prior year, our foods category grew approximately 6%, our non-foods category grew 1% and our other business category grew 10%, primarily from our food service and bakery departments. Membership accounts grew 3.9% versus the prior year to 1.76 million accounts. We continued with strong 12 month renewal rates of 87.9% and our membership income was a record $15.9 million, an increase of 7.5% over the same prior year period. We believe that these membership numbers demonstrate that our members remain pleased with the value they're receiving and appreciate the PriceSmart shopping experience. We remain diligent with inventory management, utilizing strategic markdowns to reduce slow moving and excess inventory in the first quarter, primarily related to home furnishings and apparel. Total gross margin for the first quarter of fiscal year 2023 as a percentage of net merchandise sales increased 20 basis points to 16.2% versus 16% in the first quarter of fiscal year 2022. In total dollars, total gross margin increased $15.5 million or approximately 10.3% versus the same quarter of the prior fiscal year. Total revenue margins increased 20 basis points to 17.6% of total revenue when compared to the same period last year, primarily due to the increase in merchandise gross margins. The team has done a great job of being proactive about selling through overstocked categories. Our focus has been on getting back to our core business that has a more standard inventory balance and customary margin structure. We believe that good sell-through results in Q1 including for our Smart Week and World Cup events are reducing the risk of additional markdowns in Q2. We have transitioned out of Christmas items and are now preparing for spring with water sports, camping and exercise programs, that started landing in December and will bring fresh new merchandise to the clubs. Supply chain disruptions were relatively tempered during this quarter, with our overall supply chain logistics network remaining relatively stable and reliable. Shutdowns in China lessen during the first quarter, but we remain cautious due to the recent COVID outbreaks there. We saw a relief on shipping costs during the quarter on our Trans Pacific freight rates which averaged approximately $6,400 per container during Q1, down from $11,500 last quarter and rates approached $4,000 per container at the end of November. Additionally, transit days for inbound containers loaded with our merchandise from Asia decreased to 51 days on average for the first quarter of fiscal 2023 from 61 in the fourth quarter of last year. Unfortunately inflation continues to be a macroeconomic factor that has a significant impact on the cost of our merchandise, driven in part by rising commodity, input costs, labor, and higher packaging costs. Although we do our best to mitigate cost increases, inflation has resulted in increases in our merchandise selling prices. For the first quarter of fiscal 2023 the average sales price per item increased 10.3% compared to the same period of the prior year. During the same comparative period we have seen the items per basket decreased 4.4%, however transactions grew 3% this quarter versus a year ago. SG&A expenses decreased during the quarter by 40 basis points as a percentage of total revenue, primarily due to the sale of Aeropost and the devaluation of the Colombian peso. Operating income for the quarter increased 20.7% from the same period last year to $55.5 million. Other expense of $4.6 million was driven by $3.2 million of foreign currency losses due to revaluation of monetary assets and liabilities in several of our markets. In addition we had transaction costs of $1.1 million associated with converting Trinidad dollars into available tradable currencies. Our effective tax rate for the first quarter of fiscal 2023 came in lower than last year at 33.3% versus 34.1% a year ago. On a go-forward basis we estimate an annualized effective tax rate of 32% to 33%. We are very proud of our results in this quarter, as our net income and earnings per share were a record for the Company. Net income for the first quarter of fiscal 2023 was $32.9 million or $1.5 per diluted share compared to $30.5 million or $0.98 per diluted share in the comparable prior year period, which included a $0.05 gain from the sale of Aeropost. Moving on to the strength of our balance sheet, we ended the quarter with cash, cash equivalents and restricted cash totaling $281.7 million. From a cash flow perspective, net cash provided by operating activities totaled $30.5 million for the three months ended November 30, 2022 and net cash used in operating activities totaled $13.3 million for the same prior year period. Shifts in working capital generated from changes in our merchandise inventory and accounts payable positions for the three months ended November 30, 2022 contributed $29 million of cash flow compared to the same period of the prior year. This positive change was supplemented by another positive change of $11.3 million in various assets and liabilities, primarily driven by less prepaid VAT and duties as the buildup of inventory was significantly less in the current period comparatively. Net cash used in investing activities increased by $9.4 million for the three months ended November 30, 2022, compared to the prior year, primarily as a result of a net decrease in proceeds from settlements of short-term investments. And net cash provided by financing activities during the quarter increased by $13.5 million primarily due to the $16.7 million increase in long-term debt proceeds, partially offset by net repayments of $4.3 million of short-term borrowings, compared to the same three month period a year ago. Turning now to our growth drivers. Starting with real estate, as we have previously discussed, we currently have two warehouse clubs under construction. In the spring, we expect to open our third club in El Salvador. Additionally, in the summer, we expect to open our second club in Medellin which will be our 10th warehouse club in Colombia. Once these two new clubs are open, we'll be operating 52 warehouse clubs and we are actively exploring additional locations as well. Both of these clubs are applying our smaller club formats. And as we fine-tune these smaller club formats, we're finding operating efficiencies that we believe will allow us to increase our square footage productivity. We believe that one of the quickest and most effective ways to increase sales and profitability is to increase the size of our warehouse clubs and the number of parking spaces in our high volume locations. For instance, we are currently preparing to remodel and expand one of our clubs in San Salvador, El Salvador. As we've mentioned previously, our real estate strategy also focuses on the important role of our distribution facilities to optimize efficiencies and reduce supply chain risk. We continue to actively seek new distribution center options in several of our larger markets to facilitate the frequency and flow of merchandise, maximize selling space in the clubs and create alternatives for e-comm order fulfillment. Turning now to membership value. One of the things that continues to excite members is the treasure hunt in our stores. Our team of buyers curates items from around the world, seeking out great values on fantastic merchandise. This treasure hunt opportunity drives traffic to our clubs and generates incremental sales opportunities. An area that we believe provides exceptional value to our members is our private label products under the members selection banner. During the first quarter of fiscal year 2023, our private label sales represented 25.9% of our total merchandise sales, that's up 230 basis points from 23.6% in the comparable prior year period of fiscal year 2022. Another area of membership value is our wellness offering, which includes optical, audiology, and pharmacy. We currently have 47 locations with optical centers and expect to have 51 opened by the end of the fiscal year. Our optical program provides for four free exams for every membership and we performed over 33,000 eye exams during the quarter. Optical is also an important social responsibility contributor to our local communities. Through our partnership with Price Philanthropies Aprender y Crecer program, we have provided approximately 13,000 screenings, 3,500 exams and 3,100 eyeglasses to local school children since the program's inception. And we are very excited about having the service available to support our local communities. We currently have pharmacy centers in all eight of our warehouse clubs in Costa Rica and have now opened pharmacies in two warehouse clubs in Panama. With respect to audiology centers at the end of November 2022, we operated 14 and we expect to open an additional 16 centers in fiscal 2023. Our third growth driver is our e-commerce channel. During the first quarter, total e-comm sales represented 3.9% of total merchandise sales. Total orders increased 8.1% and the average transaction value increased 11.6% versus the prior year period. So we continue to see encouraging signs with regards to how our members are responding to their online experience with us and PriceSmart.com in general. As of November 30, 2022 approximately 55.1% of our members have created an online profile with PriceSmart.com. We believe that there are significant growth opportunities in our digital channel. 13.6% of our total membership base has made a purchase on PriceSmart.com. The average online purchase on PriceSmart.com in Q1 was 37.8% higher than the average ticket for in-club purchases. We will continue to invest in this part of the business in an effort to provide an enhanced omnichannel experience to our members. It is also encouraging that 8.7% of our membership accounts are enrolled in our auto renewal options. This membership option allows for a component of our income to become more reliable, which is obviously something that is of great benefit in a climate where we are facing a lot of unpredictable variables that impact our sales. Now turning to ESG. The Company's actions and practices aim to responsibly use natural resources and focus on environmental impact and social wellbeing. On the last call, we told you we were planning to open 30 recycling centers this year. And I'm pleased to say our progress has been good, as we have opened more collection centers in Guatemala in December and plan to be fully rolled out in that market this month, as well as opening one in El Salvador. To put our impact into perspective, our initial pilot site in our San Pedro Sula club in Honduras averages on a monthly basis about 15,000 pound of recycled raw material. Additionally, we continue to work with global food banking network where the Company donates non-sellable but safe to consume merchandise to participating through banks. We currently have programs in place in Guatemala and Costa Rica that are fully operational, with the intention to begin in El Salvador, Colombia, Panama and Nicaragua over the next two quarters. We further the philanthropic mission in PriceSmart communities. PriceSmart and the Price Philanthropies Foundation have established the PriceSmart foundation to serve as the philanthropic partner of our Company. The core principles of the PriceSmart Foundation are promoting youth career development and education, supporting economic development and under resourced communities and funding initiatives that strengthen environmental and community resilience. The foundation is a separate and independent legal entity from both PriceSmart, Inc. and the Price Philanthropies Foundation and has its own Board of Directors. PriceSmart has budgeted to provide partial funding that includes in-kind donations of staff time and cash grabs to non-governmental organizations that support its mission and to support the foundation itself. Our commitment to sustainability and social causes remains strong and we're committed to fostering a safe, healthy environment for our employees, members, vendors, communities and the world around us, that we consider to be part of PriceSmart's family. Looking forward into Q2, we are happy to report strong holiday sales with our comparable net merchandise sales for the four weeks ended January 1, 2023, up 10.4%, which includes a negative currency impact of 0.7%. We also want to highlight that as disclosed in our 10-Q filed yesterday, we expect to take a charge in Q2 due to the CEO transition, which will reduce EPS by approximately $0.23. In closing, I would like to reiterate that we are determined to focus on the fundamentals that have characterized the club business since its inception in 1976, including by ensuring we have the right merchandise, at the right price, in the right quantity, in the right condition, in the right place and at the right time. PriceSmart has a unique business model in the markets where we serve, that has embraced by our members and continues to grow. We have a highly committed and talented team at PriceSmart, and I want to thank all of our employees for their continued hard work and dedication to PriceSmart. With that, I will now turn the call over to the operator to take your questions. Operator, you may now start taking our callers questions. Mike, I've got question for you. Listen going back to Colombia, obviously, it's a very difficult situation. Membership was down sequentially, comps were weak. In the 10-Q, you mentioned that you're considering some different strategies over the near term to confront these issues. And one of them was you might hold pricing steady and it could impact the gross margin. I guess two questions. Number one, have you adopted any new pricing strategies yet in Colombia? And if so, how far might you go in terms of holding prices and having a little bit of a negative impact on the gross margins? John, this is Robert. And let me begin, I just want to greet everybody on the call, including, of course, our employees at PriceSmart. I want to thank for all the good work they do. We're taking a very serious look at how we want to deal with the sales situation in Colombia. We've got a big investment there. We've probably put more money into Colombia maybe than any other country we're in in terms of real estate. And I think now is the time for us to try to build that market. And even though the economy there is weak and of course, we also suffer because a lot of our strength is in imports and imports are particularly affected by the currency change. I think we can't be passive. And this is a long road in terms of how we think about Colombia and the future in that country. And so my -- I don't know the exact numbers, but I would expect that there could be some effect on margins, but we also hope that our suppliers are going to support us in terms of more aggressive pricing, particularly on imports so that we can begin to build sales volume at this time. So I don't think it's going to be a major thing in terms of margin impact, but I don't -- I think we're going to be more aggressive about how we build sales in Colombia. Well, we're doing more -- we haven't implemented anything yet, but we're doing more than thinking. We're really actually making plans and working with John Hildebrandt, our new President; and Ana Luisa, who is our Chief Merchant to try to develop a strategy that -- and we'll do it incrementally. We're going to test things out and make sure that what we do really impacts. The other thing to keep in mind is we have a second location opening in Medellín, and we want that location to open well. So what we'd like to do is begin to implement some more aggressive merchandising strategies in advance of that opening. Okay. Okay. Secondly, you mentioned that your December comps were up 10.4%, which is a little bit ahead of what they most recently have been last quarter and so on. Did you see a similar improvement in the comps in Colombia in December? Hi, thank you. Thank you very much for the opportunity and also for your time. I wanted to know about the surprises being over the CEO position, how many transition will it be? How much time do you think it could take and how difficult would it be defined an appropriate candidate to fill in? And it's more likely that this person might be an outsider to the company or from within? Hi Hector, we're having a lot of trouble hearing you, it's coming little garbled, but I understood your question being related to the CEO transition. And I think how long we expect the interim position to last and what the strategy is for replacement, is it something along those lines? Yes. Yes. Thank you. And if it's -- and if you believe it's going to be more likely an outsider to the company or from within? Okay. So this is a very, very important question and a very important matter for the company. So what we have been -- our approach is going to discuss this with the Board and take our time to be sure we come up with a good answer, because the Board needs to be involved and this is a key responsibility of the Board is the leadership of this company and the resolution of this has to be done in a way that's really going to be good because there is a very challenging issue to make transition in CEO. And so we're going to take our time, we're going to make sure we do it right, but it will be a Board responsibilities. Thank you. And on that note, I also wanted to know long-term strategy for the business could be changing with this movement and considering the implications of the appointment of David Price as Executive Vice President and Chief of Staff? Sorry, I caught something about David Price and EVP, but I didn't catch the rest of it. Hector, I'm sorry, we're having a lot of trouble. Yes. Sorry. If there are long-term strategic views for the business that could be changing, considering the appointment of David Price as Executive Vice President and Chief of Staff? So, the question is, there will be changes in the business because of appointment of David Price, is that your question? He's my son, you know, and he tells me on a regular basis that I'm too old to understand technology, so he's got to educate me in technology. So that's one thing that I expect from these young people that they're going to be able to provide much more relevant and knowledgeable information on technology than an old timer like myself. Got it. Thank you. I don't know if I heard the answer correctly because I'm having issues here, probably on a prior one. Thank you. And the last question would be an operational question. If you could give us more color on the other expenses categories mainly on our FX impacts throughout these [indiscernible] if we believe that substantial review [indiscernible] level. Thank you. I'm just -- no, I think it's the communication line. I think it's more about the communication lines, he is just coming across were garbled. Try one more time, Hector, please? Sorry. About the extensive category, mainly the FX impact the closest line. We saw that they were substantial versus historical levels. So what's the technology to give us more details on that? I heard something about FX and something about expenses, is that the question about the level of FX expenses below operational income? Is that it? Okay. Yes, good question. The primary component, the biggest component of that of the FX line continues to be the Trinidad FX premiums that we've been talking about for probably three years now, as being a significant component. The other component is actually related to an unusual circumstance we had this quarter versus other quarters where we had actually the big appreciation in Costa Rica, actually worked against us. You may recall, we've had some similar circumstances in the past, where we have a large dollar balance outstanding, which over time is the Costa Rican colón devalue as you would expect that to add more value to us. But particularly in this quarter we had a significant 8% devaluation. So that hurt us in Costa Rica. At the same time, we had the non-depreciation in Colombia, which where we have a liability position. So we do protect all of our long-term financing is protected through swaps in local currency loans, but our working capital tends to be fluctuate between dollars and local currency. So we had just kind of a perfect storm there of the Trinidad premium Colombia devaluation, also devaluation in Dominican Republic. And then the counterintuitive appreciation in Costa Rica kind of all worked against us during the quarter. Michael, you did a pretty good job on the expense line, the operating expenses. And one of the things you've said in the past is you're going to continue to invest in technology and so on. And did that spending moderate at all in the quarter relative to some prior quarters? No, I wouldn't say it moderated. I mean, obviously, when we've talked about this before, when sales are going up and as a percentage of sales, it doesn't distort things as much as when sales are growing a little bit slower. But no, I wouldn't definitely not say that we've moderated. Okay. So to the extent that revenues grow, let's say, mid-single digit, you think those expenses -- that expense -- technology expense might grow at a lower rate? I'd say, TBD, Jon. I mean, we've got a lot, Robert alluded to it earlier. We've got a lot to do in the digital area and we've got commitments to continue along that path and that's the constant thing the revaluation within management and within the Board to the track and the pace. So lot of things to do and so we're just doing our best to balance that out, but sometimes you can imbalances as far as the sales growth versus our stated goal will continue down that path. This concludes our question-and-answer session. I would like to turn the conference back over to Michael McCleary for any closing remarks. Okay. Thank you all for joining us today and we look forward to talking to you next quarter. Take care. Bye-bye.
EarningCall_1576
Good afternoon. Thank you for attending The Duckhorn Portfolio First Quarter 2023 Earnings Conference Call. My name is Matt, and I will be your moderator for today's call. [Operator Instructions] Good afternoon, and welcome to The Duckhorn Portfolio's first quarter 2023 earnings conference call. Joining me on today's call are Alex Ryan, our President, CEO and Chairman; and Lori Beaudoin, our Chief Financial Officer. In a moment, we will give brief remarks followed by Q&A. By now, everyone should have access to the earnings release for the fiscal quarter ended October 31, 2022, that went out at approximately 4:15 Eastern Time. The press release is accessible on the company's website at ir.duckhorn.com. And shortly after the conclusion of today's call, a webcast will be archived for the next 30 days. Before we begin, I'd like to remind you that today's discussion contains forward-looking statements based on the environment as we currently see it, and as such, includes risks and uncertainties. If you refer to Duckhorn's earnings release as well as the company's most recent SEC filings, you will see a discussion of factors that could cause the company's actual results to differ materially from these forward-looking statements. Please remember the company undertakes no obligation to update or revise these forward-looking statements in the future. We will make a number of references to non-GAAP financial measures. We believe that these measures provide investors with useful perspective on the underlying growth trends of the business and have included in our earnings release a full reconciliation of non-GAAP financial measures to the most comparable GAAP measures. In addition, please note that all total US food consumption data cited on today's call will refer to dollar or unit consumption for the 12-week period ended October 30, 2022, and growth versus the same period in the prior year, unless otherwise noted. Thank you, Sean, and good afternoon, everyone. We really appreciate you joining us today to discuss our continued strong first quarter financial performance. Following my opening remarks, Lori will walk us through our quarterly results and also provide an update to our fiscal 2023 outlook. Then we will open the call for questions. In this period of uncertainty with significant inflationary pressure and mixed economic indicators, we have continued to show strong growth well in excess of the luxury wine sub-segment. Irrespective of the backdrop, the sound and consistent execution of our sales strategy as well as our powerful brand equity are further strengthening deep connections with customers and we are well positioned to sustain our outperformance of the fastest growing sub-segment in our industry, with a focus on our execution and the momentum we seek to accelerate every day, I would like to begin today's call by offering a few highlights from the quarter. First, Q1 marked another all-time high in quarterly net sales, with particular strength observed in October. Organic net sales growth was up nearly 4%, which adds to a strong 14% growth rate comparison from the prior year period. This performance is even more remarkable when you consider the fact that Kosta Browne Single Vineyard release was included in Q1 of the prior year, but will shift into Q2 beginning this year and remain in Q2 in all future fiscal years. Second, net sales were almost entirely driven by a 9% volume growth and continued to be led by our Duckhorn Vineyards and Decoy winery brands. Moreover, our wholesale depletions growth was even stronger into the high teens, another example of the robust demand of our high quality luxury wines. Third, the interconnectivity of our brands and our one-stop luxury wine shop go-to-market strategy, continue to win as top line growth remained broad-based. Excluding the impact of Kosta Browne's new shipping schedule, which removed all Kosta Browne's Single Vineyard series release shipments from Q1, we realized strong performance that was balanced across the entire portfolio in all channels and across all key distribution metrics, cases, account sold and points of distribution. Fourth and further reinforcing the strength of our portfolio and how well it resonates with our core luxury consumer consumption, trends remain very healthy. Within the fastest growing sub-segment of wine, $15 per bottle and above The Duckhorn Portfolio was once again the fastest growing amongst the top 15 suppliers up mid-teens in both dollars and units and reflecting consistent rate of market share gains that is nearly 2x greater than any other supplier in luxury wine. And fifth, in spite of shipment cadence headwinds from Kosta Browne, a winery that carries a higher gross margin than the company average, we delivered a consolidated adjusted gross margin that was up versus the prior year period, a testament to our ability to keenly manage cost of goods and take price where appropriate. Our calculated pricing actions, which primarily took place in early September through a combination of optimizing trade spend and thoughtfully increasing frontline prices are increasingly flowing through the system. Thus far, we have not seen any dampening effect on demand and no sign of trade down within our portfolio, a likely reflection of our more affluent luxury consumer's ability to absorb modest and thoughtful price increases for our fine wines. Our performance this quarter showcases our continued ability to successfully execute on a multi-faceted growth strategy. Beginning in wholesale, we recognized double-digit depletion growth in both on and off-premise channels, reflecting positive contribution from all key sales metrics with particular strength in total account sold, which was up double digits in the quarter. As we discussed on our last earnings call, increasing new accounts is our primary focus for further penetrating the considerable wholesale distribution white space opportunity we have in front of us and within this focus on new accounts, we believe our greatest growth opportunity is in the off-premise channel, which represents the majority of our current wholesale business. In addition to double digit account growth, off-premise depletions were also bolstered by solid gains in both points of distribution and velocities per accounts. While off-premise sales were the greater driver of Q1 growth by channel, I am particularly proud of our team's on-premise execution against a significant year-over-year comparison, the on-premise channel still grew depletions by double digit, highlighting continued strong sell through for a high quality luxury wines, particularly as fine dining remains resilient. We believe we are well positioned for ongoing share gains in the channel given our scale and distribution leverage, reputation as a reliable supplier within luxury wine and our trade partner's confidence that our brands will sell. In addition, much like we have in the past, we will continue to make the strategic investments that we believe are needed to advance our growth agenda and fortify our competitive position. I'll now turn to our high margin direct-to-consumer business, which is also performing well. In spite of shipment cadence headwinds for a Kosta Browne, we see healthy trends in our wine club sales as we continue to impress our most loyal customers with new innovative offerings by providing each visitor an exceptional luxury wine experience. As we move into the second quarter, we feel good about how the direct-to-consumer channel. Is shaping up Kosta Browne's impeccable track record of demand outpacing supply, continues into the present with our Single Vineyard series released providing the latest example of this dynamic. Now, for a moment, let me touch on one of my favorite areas, product innovation. I'm really excited about several of our new releases, including Decoy Brut Cuvée and Canvasback, Red Mountain, Merlot as well as the solid pipeline of new product innovation coming to the market in the next few months. We have a rich history of successfully innovating within the luxury sub-segment. It is a strategic pillar that allows us to continue to outpace the industry and we are confident that these new product introductions will be an important aspect of our continued growth. Before I turn things over to Lori, I want to comment on another important development today. As discussed in the press release this afternoon, Lori has announced her intention to retire as our Chief Financial Officer next spring. Lori's professionalism, intelligence, warmth and moral character have been an inspiration to me and all of us at Duckhorn over the past 13 years. She is a strong leader with a clear vision and she will leave this company strong and eager to take on the next set of opportunities. We would not be where we are today as a leading platform for high quality luxury wines, if not for Lori's sound leadership and dedication over her career with the company. She has truly been instrumental to the success of Duckhorn Portfolio and we are tremendously grateful. We are conducting a national search for our company's next CFO and we expect Lori to continue as CFO until our new CFO joins us to ensure a seamless transition over the next few months. Lori also plans to serve as a Senior Advisor to the company after the transition to afford her thoughtful counsel into the future. With that, I'll now turn it over to Lori to discuss our first quarter performance and updated fiscal year '23 outlook. Thank you, Alex. After a career spanning more than 40 years, I can unequivocally say that my time at The Duckhorn Portfolio has been the proudest period of my professional career. I am honored to have partnered with the immensely talented and dedicated team we have at this outstanding organization. Over the course of my more than 13 years here, we have grown this business tremendously and realized countless achievements. We have built on the foundation established by Dan and Margaret Duckhorn to make The Duckhorn Portfolio America's premier luxury wine company. Given the advantage position in which we sit today and because of the innovative spirit and growth oriented mindset shared across the entire company, I could not be more confident that the Duckhorn Portfolio will remain a driving force within luxury wine and continue to deliver profitable growth for years to come. With that said, my focus remains steadfast on the quarters ahead of us and I plan to work diligently with Alex, the rest of the executive team and my eventual successor to ensure a seamless transition. Turning to our first quarter results, and beginning with our top line. Net sales were $108.2 million, a 3.8% increase in organic growth compared to the prior year period. These results reflect 9.2% growth in volume, as continued execution in the on-premise and off-premise channels led to strong wholesale case growth, partially offset by negative 5.4% price mix. The decline in price mix was primarily a result of the previously discussed timing shift in the Kosta Browne shipment and to a lesser extent, the continued outperformance of our leading Duckhorn Vineyards and Decoy Winery brands relative to our other winery brands. And as Alex noted earlier, first quarter depletions outpaced shipments as a number of key metrics; account sold, points of distribution and velocity per account, all contributed nicely to our growth. Let's focus for a moment on net sales performance by channel. Wholesale to distributor was our greatest contributor to growth, increasing 15.8% versus the prior year quarter, both on and off-premise were up double digits in the quarter, once again highlighting the strength of our portfolio and the consumer's continued desire for our high quality luxury wines in all settings. In addition to our strong business fundamentals, we looked at the timing of shipments, particularly in October, and believe our outperformance relative to internal expectations reflects some pull forward from the second quarter. I will discuss this in greater detail shortly. The California direct-to-trade channel was up 0.7% versus the prior year period. While this marks a moderation in trend, I'd point out our challenging year ago comparison as first-quarter fiscal 2022 recognized a material benefit from California's substantial reopening as the pandemic subsided. The direct-to-consumer channel was down 46.3% compared to the prior year quarter. This decline was entirely related to the Kosta Browne DTC shipment timing shift that we've noted a few times on the call already. To put this shift in context, if we excluded Kosta Browne shipments from last year's Q1 performance, DTC net sales would have grown nicely in positive territory, underscoring solid performance in our clubs and of our tasting rooms. First quarter gross profit was $54.7 million, an increase of $2.3 million or 4.4% versus the prior year period. On an adjusted basis, gross profit grew to $55 million or 4.2% compared to the prior year period. This represents a 50.8% adjusted gross margin, up approximately 20 basis points year-over-year as negative channel mix from a decline in our higher margin DTC business was more than offset by margin improvements within our wholesale channels. Total selling, general and administrative expenses were up $2.5 million or 10.9% versus the prior year period. The increase was in line with our expectations and driven primarily by increased growth investments to support the pursuit of our considerable wholesale distribution white space opportunity and continued execution against our overall long term strategy. On an adjusted basis, which excludes transaction-related expenses and non-cash equity-based compensation, total operating expenses increased by $4.6 million or 25.7%. Net income was $19.8 million and diluted EPS was $0.17 per share compared to net income of $21.3 million and $0.18 per diluted share in the prior year period. Adjusted net income came in at $20.5 million and adjusted EPS was $0.18 per diluted share compared to $23.5 million and $0.20 per diluted share in the prior year period. Adjusted EBITDA for the quarter decreased 6.4% to $35.7 million. This represented 33% of net sales compared to 36.6% of net sales in the prior year period. The reduction reflects planned growth investments in the quarter as well as the timing shift in Kosta Browne DTC shipments out of Q1. At the end of the quarter, we had cash of $5.3 million and total debt of $206.2 million, resulting in a leverage ratio of 1.6 times net debt. Regarding our outlook, we are reaffirming our guidance for fiscal year 2023, which calls for net sales of $393 million to $401 million, reflecting approximately 5.5% to 7.5% organic volume led growth. Adjusted EBITDA of a $132 million to $137 million and adjusted EPS of $0.62 to $0.64 per share. We are making a few updates to certain assumptions underlying our full year guidance though, namely, interest expense and adjusted gross margin. For interest expense, given the continued rise in interest rates, we now expect approximately $13.5 million to $14.5 million, up from $11 million to $12 million previously. To reflect our first quarter outperformance, we now expect adjusted gross margin for fiscal 2023 to be flat to down approximately 50 basis points, an improvement from our prior guidance of down 50 basis points to 100 basis points year-over-year. There are no other changes to our margin assumptions. We still expect planned pricing to cover inflation and a greater year-on-year contribution from our other winery brands on one hand will be offset by continued outperformance in growth from The Duckhorn vineyards and Decoy Winery brands on the other hand. There are no changes to our strategic growth investment plans for fiscal 2023. Our current set of investments should enable us to continue to execute against our multi-year wholesale distribution opportunity and scale profitably over time, further expanding our competitive moat and cementing Duckhorns' leading position within the luxury wine industry for the long term. Aside from the full year guidance offered on our last call, we also provided detailed quarterly net sales guidance given a new delivery cadence for our ultra-luxury high margin Kosta Browne wines. As we sit here today, we are on plan with Kosta Browne shipments and remain confident that we can produce outsized growth embedded in our guidance for the second half, both in wholesale and DTC and particularly in Q4. That said, and as we signaled in September, variability in monthly wholesale performance can influence any given quarter, particularly during times of economic uncertainty. Based on stronger than anticipated growth observed late in the first quarter, we do believe a portion of net sales outperformance was pulled forward. As such, we are tempering our net sales growth expectations for the second quarter to up low to mid-single digits from up mid-to-high single digits. However, our guidance for the full fiscal year remains unchanged. Overall, we are very encouraged by the first quarter and we look forward to continued success throughout fiscal year 2023. Thank you, Lori. We are off to a great start to the year and on pace to meet our fiscal year '23 guidance. Regardless of external factors, we are delivering strong results and executing upon five strategic growth priorities. First, we are procuring ample supply of high quality fruit that meets the standards for our luxury wines through a highly diversified supply chain. Second, we are leveraging our scaled Omni channel platform to engage with consumers and continue to build brand awareness. Third, we are deploying our differentiated one stop luxury wine shop sales approach to meet the fine wine needs of all trade partners. Fourth, we are thoughtfully innovating to continuously refresh the portfolio and deliver exciting new offerings as a means to ensure strong, consistent growth and fifth, we are investing from a position of strength to drive sustainable penetration of our considerable wholesale distribution white space opportunity, which should support continued outperformance of the fastest growing sub-segment of wine luxury, as well as our long term target of high single digit organic net sales growth at highly attractive margins. Hi, this is Noah on for Kevin. Could you guys comment on trends you've seen more recently in October, November, with Nielsen suggesting some slowdown as well as comment on general trends for premium wine in the category more broadly, thanks. Yeah, Noah, sure. I'll take that. Think back a little bit, just to look at that data represents largely about one-third of our overall business. So we need to take that in the context. The category is slowing a little bit. We've all seen the same data. So let's just identify that. We continually are progressing significantly higher than the category and the competitors within the category. So we feel we're an advantage position there. And frankly, the three-year trends are a lot more stable than the short term trends. I just don't -- we can't look at two year trends and call the industry. So we still are confident. We're going to continue to outperform. Hit our growth rates and stay in front of our competitors on that. So I hope that gives a little context of how we're looking at it. Do you have a follow up on that? Thank you for your question. The next question is from the line of Peter Galbo with Bank of America. Your line is now open. Alex, I found your comments on the on-premise pretty interesting, still at kind of a double digit depletion, even with some of the slowness we've seen, particularly at the high end of fine-dining. Can you just kind of tell us what you're seeing because that would seem to break trend with a lot of the other data? And I don't know if that's -- you guys have obviously taking a lot of share in the on-premise, so if it's more of that or if there's something else that you're seeing in that on-premise business? Peter, we're seeing we're seeing success, right. We've been meeting with our customers where they want to be met. The brands taste good, they’re priced correctly. We've been very aggressive in making sure we position ourselves with the right partners and our wines are selling. So there's a confidence both on-premise and off-premise. I think it applies equally. We kept investment up in our on-premise sales teams throughout the pandemic. So we were really well poised when things came back to be front and center of our customers and we take that responsibility really seriously and I think what you're seeing is success in that focus. Great. No, that's helpful. And then maybe just as a follow-up, Alex, give you a little bit more time to o talk about some of the innovation that the Canvasback and Decoy just when we might start to see that roll out more in retail, how that much -- that's embedded in your growth plans now? Is it incremental to this year or is it more of a fiscal '24 event? Just any more color you can provide there. Thanks very much. No, I wouldn't call, we try not to make silver bullets. We try to make a combination of really successful pieces to the puzzle, so you should expect to see those impacts in the -- really in the second half and then continuing beyond that as we grow, they're not incremental to our plan. We planned for and we knew we were making and we strategically made them. So they're not -- they're not outliers. They're embedded in the overall plan but I think most of the impact this year will be second half and into the future. And remember, as you know we've talked about many times, innovation keeps the -- keeps our customers excited, keeps my employees excited, keeps the market excited. So that is a just as innovation is a long-term strategy to excite and bring up the average bottle price of our customers going forward. So this is just -- this is just -- this year's implementation of that. Yeah, Peter, hi, this is Lori. I just might add. We've been releasing our Decoy Limited over time several releases of those varietals and we've seen great success with that. When we release a new wine, especially a wholesale wine, we anticipate it will take about three years to completely be integrated and reach what we're thinking as a point where we won't be seen significant year over year growth. So we continue to reap the benefits from these new product innovations for years into the future. Thank you for your question. The next question is from the line of Andrea Teixeira from JPMorganand. Your line is now open. Hey, this is Drew Levine on for Andrea. Thank you for taking the questions and Lori, our congratulations as well. So I wanted to ask on the guidance. Clearly, the first quarter came in better than expected and you noted some potential pull forward from October, but on the other hand, I think Alex mentioned wholesale depletions were running high teens. So I'm just curious, is there anything, I guess I would seem to suggest that distributor inventories are being depleted faster. So I'm curious why some more I guess conservatism on the second quarter, is there anything you're seeing from a consumer perspective, it didn't sound like that but just any more thoughts on the guidance there. Thank you. Sure. Yeah. So as you mentioned, we are -- we did see for Q1 was a volume driven growth and we're estimating that about half of the outperformance is pulling into Q1 from Q2. So we're -- the outperformance really was a function of strong direct to distributor depletions and then price as well. So when we were originally doing our planning, we were thinking in our price increases, which were really effective mid-quarter that those would not really impact a quarter much at all. We figured our distributors would bring in heavy prior to these changes taken into effect and that's not what we saw. We saw distributors buying at their normal cadence. We've seen depletions really exceeding our expectations and then the distributor's really ordering heavy towards the end of the quarter and that's what's giving us really the thought process that some of that pulled forward from what we had originally planned to ship in Q2. So we're not seeing any decline in demand at all. We're seeing great, as I said, depletions continue. So no concern at all from the price changes that we implement. And keep in mind that there is always some level of variability in the timing of wholesale sales. So we're cognizant of that just as Lori mentioned as it relates to Q1 that can occur again as we get to the border over the next Q2 into Q3. So we want to be cognizant of that and how we look at things. Thanks so much for the color and then just as a follow up on the California direct to retail channel, not taking anything away from the performance, obviously against a tough comparison, but the three year did decelerate a bit in the quarter. Obviously a more developed market for Duckhorn. So just curious if there's anything else from a consumer perspective that you're seeing, maybe in California relative to the rest of the United States. Hey Drew, that's a great question and I think we had reported this on some earlier reporting. We had a bulk wine shipment, a bulk wine sale built in to the quarter of the prior year. It's unusual, we don't normally do a lot of bulk wine sales, but from time to time to manage quality, we will do that. If you exclude that somewhat unique item, we were up high-single digits in the State of California, the largest wine consuming state in the union. So just to put a clarifying point on that, I think our results in California were really, really healthy for the luxury bottled wine sales that were -- that we typically -- that we do as our core business. Thank you for your question. The next question is from the line of Greg Porter with Evercore. Your line is now open. Hey guys, thank you for taking the call. I was wondering if you could provide any more color on how you're thinking about the CFO search internal versus external and just kind of any more color you can provide there. Thanks. Yes, as you would expect, first of all, Lori is going to remain in the CFO position until where you've hired someone and integrated. So there's no lapse in anything. So we're very confident that we have full support and coverage until that time. We've hired a national search firm and one of them significant items are going to be looking for is public company experience, a solid public company experience to help us take this company for the next several years into the future. So I think we've covering all the important parts that we need and that the market's going to need from us. Great. And then just one other quick follow up. So I saw in the press release that the underlying price mix without the impact from the Kosta Browne shift was flattish. Is there any more color you can provide, I guess I got another track channel numbers have been around 2%. Is that sort of what you're -- what you're seeing and do you think that level of pricing is going to sustain through the end of the year or do you expect that to kind of ramp or decline kind of based on the cadence that you have planned out? Yeah. So Greg, we don't really break out price separately from brand. So we have price mix we did see in the quarter. So as we had anticipated the DTC would impact our margins for sure and that's actually what we saw. We didn't have -- our margins didn't decline to the extent that we thought they would mostly because of we experienced a little earlier benefit from the pricing changes than we anticipated as I mentioned earlier and then also we had really strong brand mix, which helped offset some of that that we hadn't anticipated. I think another point to take into account is that we've seen zero pushback on our pricing changes into the first quarter and the beginning of this fiscal year. So, we're confident that we made the right ones at the right time and we do expect those to continue to flow through the -- flow through the performance for the year. Thank you, everybody. Lori, congratulations and thanks for all your help, especially around the IPO. I don't think any of us on this call were that easy on you and you obviously managed it well, appreciate all the effort and so maybe I'll just start with a with a CFO question as well on margins. I believe you said that you saw improving margins within specifically the wholesale channel. Can you maybe just talk about what's going on there and how you are kind of able to improve margins on that part of the business and then maybe just some context on what the perhaps the spread looks like on your California business versus your wholesale business. Yeah. So Kaumil, so what we saw is we saw more sales in our wholesale channel than we had anticipated and what I was referring to with regard to the spread was more so that we had anticipated our distributors would bring in heavy prior to our price changes and the price changes were effective mid quarter. We didn't see that behavior. We saw kind of business as usual but then we also saw heavier buy-in towards the end of October, the end of our quarter. So we recognize greater benefit from that in the quarter than we had anticipated. And recall how we implement our pricing changes, right. We have multiple ways we can do it. One is through reducing trade spend and one is through changing our frontline price and so the majority of this price changing was implemented through changing our trade spin. I was curious, would it -- I was curious what it looked like or what it looks like now the price margin differential between your direct or your of California business versus your wholesale business. Oh, sure. Yeah. So as we've been talking for the past two years our direct to trade in California is our second highest margin business, right? Direct to consumer is the highest margin business we have then within California or direct to trade is the second highest margin and then the direct to distributor coming in third, but then also remember as we talk about, we have different operating expenses across those three channels as well with the highest operating expense being in our DTC business. The second being in California because we have a lot -- a lot more people out selling our wines than with the other 49 states. So when it comes right down to contribution, that is quite some more in terms of contribution to the bottom line between those channels. Thank you for your question. There are currently no further questions registered. [Operator instructions] There are no additional questions waiting at this time. So I will pass the conference over to the management team for any closing remarks. All right, I want to thank you again for joining us today to review our first quarter performance and our updated outlook for the remainder of the fiscal year. I look forward to speaking with you again in early March when we report our second quarter 2023 results and until then on behalf of the entire Duckhorn Portfolio, I'd like to wish you a safe and happy holiday season. Take care and talk to you soon.
EarningCall_1577
All right. Good afternoon, everyone. My name is Alex Klar. I'm one of the Application Software Analyst here at Raymond James. Very pleased to have Alteryx here with us. Mark Anderson, Chief Executive Officer and Kevin Rubin, Chief Financial Officer. We're going to be doing a fireside chat and I will open up questions from the audience here about halfway through. So just as a background, Mark, Alteryx has really evolved as a company since you joined a little over two years ago, broadened product portfolio, revamped go-to-market. So just as a kind of an intro for the audience, can you give us a quick overview of the company and with that, the key value propositions for customers particularly in the current macro? You bet. And thanks for the opportunity, Alex. We -- two years ago, we were a company that was largely focused on selling to users, the analysts that sit outside of the CFO's office or the Head of Supply Chain's office. And the entire company was focused on delighting those users. We make great software. But I think when I came on board, I really felt there was a strong need to build more around use cases and the value propositions that drive real value for the enterprise. And that requires -- instead of a bottoms-up sales motion, it requires much more of a top-down one. So you're articulating very defined returns on investment for use cases that typically are in the office of the CFO or any of the functional areas that need transformation. And really what our software does. I think in this world where everyone is rushing to try to digitize and transform their business, automate their business. We've, over the last 25 years of being a business, we've made what I think is the hardest part of that journey possible, and that's getting going. We allow users to take data from almost infinite sources and then cleanse, prep and blend that data so that it can be a pipeline to a data location like a Snowflake or a Databricks. And if you want to check out how much our customers love us go visit our community site, they talk -- they are zealots for Alteryx, they talk about putting Alteryx tattoos on the biceps and name their kids middle names Alteryx. And our goal is to -- today, we have roughly 400,000 members of that community. I want there to be 4 million one day and 40 million down the road because it will be really transformed output for those employees and it's something very personal to the people themselves. Got it. So some of the very topical investors right now, the overall demand environment the macro. Third quarter was a strong booking for you, ARR was up, you had $1 million ARR, customers was up, you [Indiscernible] your largest ACV deal to-date. So how would you characterize the overall demand environment exiting 2022? Yeah. Well, firstly, I'm glad that we transformed from selling to analysts to selling to CFOs. CFOs really are minders of the treasury now and they are the ones that are really driving the prioritization of spend and clearly spending is narrowing. So I'm glad we're not nice to have. Everything that we do, we do to help customers run a tighter ship, to really be able to predict inflation and the impact of the recession on their businesses by being able to use data from anywhere to make better data-driven decisions. So I think what we've seen at worst has been an elongation of sales cycles often manifested in an extra step or two in the process. And we've been teaching our now largely transformed sales team, many of them come from $1 billion or greater companies, come with more than 15 years of experience. So often, it's not the first crisis that they've managed through. And we're teaching them how to demonstrate that value upfront. And I think we're have to have, not a nice to have. So you kind of hit on the kind of switch to selling towards to the CFO. I want to hit on the go-to-market. That's been a big kind of revamp under your leadership and bringing in Paula on the go-to-market side. So seeing -- we saw a kind of a really big increase in sales and marketing head count, not just kind of direct sales reps, but the entire organization. How do you feel about kind of the overall coverage and capacity of the go-to-market as you see it today? And then with that kind of overall productivity trends? Yeah. Well, firstly, this will be my ninth quarter, I think, at the end of this quarter, and we've grown productivity every single quarter. So we really are enabling our people better and again hiring better people that have stage experiences that the next few legs of the journey, which I think is pretty important. Bringing on a great leader like Paula Hansen, super important as well. She's a very special leader. I got great experience managing thousands of people and billions of dollars. So she's seen the movie a few times herself. But I think it can't just be salespeople. It's got to be the people that support those salespeople that make them more productive. So we've actually started to spend a lot more money on post sales. So customer success organizations has more than quadrupled in the last two years. These are people that go in and help us stick the landing of an implementation so that the customer is up and running and getting to the breakthroughs that they're paying for. And then that earns us permission to go in and ask for more. So you said our net retention rate was 121%, up 1%. But for our large customer cohort, it was up 1% to 129%. And so we can plan a pretty darn good fiscal year by leveraging these resources to drive that retention and expansions, sorry. Got it. Aside from the overall demand environment, profitability a much bigger focus now. Kevin, 2022 has kind of been -- has been a big investment year. Given kind of the overall macro, how are you thinking about like the levers to drive margin expansion? And kind of help kind of think about the path to profitability back to profitability. Yeah. Thanks for the question. So I want to emphasize the point that Mark made. We made the intentional decision over '21 and '22 to really invest in the go-to-market and to a lesser degree, but also important is R&D to really put the infrastructure in place to be able to have an enterprise capable sales organization to have the capabilities from a customer success and a customer's support perspective to really support these larger enterprises. And that investment was largely done towards '21 and '22. We feel very comfortable with the infrastructure and the foundation that we've set for the business going forward. So as we think about '23 and beyond, it is really how do we now get leverage and productivity out of these investments that we put in place? When I think about levers of margin expansion, having the enterprise go to market that we have today is a pretty powerful lever as we think about what that's able to capture going forward. It's obviously less expensive to continue to serve your existing customers. And so we have a very good infrastructure around that to help drive leverage. Partners are becoming more and more important to the model and partners are a great way to be able to continue to scale in a more efficient way. And then we have cloud, right? So as we think about -- we've spent a lot of time innovating the platform. We launched the analytics, the Alteryx Analytics Cloud. And 2023 is really the opportunity for us to start to see some meaningful momentum from a cloud perspective. And so all three of those dynamics are all levers that we would expect to realize from a leverage perspective. Got it. Definitely want to hit on the partners and cloud here in a minute. I did want to touch on just the overall -- you kind of alluded to this, but the product portfolio has kind of really broadened versus even where you started the year. So can you just give us an update on where the platform stands today? And how you see the strategic positioning of the product in terms of like opening up a broader base of users? Yeah. Well, we acquired a company called Trifacta, early part of this year, and that was really what we felt was by far the best and most available replatforming option. We -- our product was primarily a Windows-based [big] (ph) client prior to this. And I tell having a cloud presence would reduce friction from the idea or from the journey from ideation to provisioning and using fingertips on keyboard. So really important to have much lower friction on the beginning of the journey part for us. And that integration is going really well. We're knitting together the Alteryx applications designer cloud. We're in a customer trials right now. We -- it will be fully productized and available on the Trifacta platform next quarter. Alteryx auto Insights, which was a result of another acquisition Hyper Anna that we acquired about year and half years ago. That's doing really well. That's hitting the Trifacta platform. And then Alteryx auto machine learning, which allows Alteryx customers, designer customers to be able to have some preconditioned machine learning models so that they start to experience with machine learning themselves as general knowledge workers. And so I think over time, you'll see us add more and more capability organically but also inorganically onto that platform. We think there's -- nobody is really stepping up and building a proper platform in the space, it's a very fragmented vendor landscape. And we think who better than us to go build this platform because we made the hardest part of the journey easy with designer. And I know it's still early days. A lot of the products have only come on this year, but are you seeing that kind of multiproduct adoption like you would have expected today that's been kind of even faster or - just curious on how that's kind of -- Yeah. It's early days. So the vast majority of our revenue comes from designer and server, the two premise-based products. But as we start to get the capabilities of these cloud products to be high value, we'll start to see a much greater uptake. For example, just in the last quarter, we talked about 1 customer, a large U.S. airline that did an ELA with us last year. They doubled the number of users that they used in the ELA just one year later. And then they brought on two more cloud-based products to become a greater than $1 million ACV customer, all just in the span of a little over a year. And so we do see salespeople wanting to have more quivers in their arrow, and that's certainly what these additional products represent. They solve -- important to solve problems that will be -- will be a future kind of cornerstone of our platform. And just maybe to extend on that, you may recall, earlier this year, we launched cloud ELA SKUs. And so the whole intention of the cloud SKUs is that they marry very nicely with be on-premise ELAs. So over time, they're very plug and play. So for customers that have elected the ELAs that are on-premise technology, we have a pairing, if you will, of a cloud ELA that they can just attach to. So the ability to cross-sell over time is only going to get stronger. So I do want to ask about the ELA. So it's been a new introduction. It's only been a little over a year. So what have you talked about in terms of kind of penetration in your base that's adopted one of those? What kind of utilization are you seeing from customers that are on the ELA versus maybe a more legacy contract? Kind of curious, -- and then is that at all increasing your visibility in terms of kind of like the upsell potential? It is for sure, Alex. Yeah, the ELAs we started in Q3 of 2021. And this airline customer that I mentioned was an early cohort of an ELA user. These are -- it's not rocket science, but we made these ELAs burstable. So a lot of software companies will penalize you if you go over your user count. We think what we do is so important. We want to motivate customers to do more and go faster, so we give the ability in our ELAs to burst upwards of 50% more licenses. And customers have really taken that up. We said on the last earnings call that of the early cohorts of ELAs that we did, over 40% of them were already in their burst capacity. So that's a real tell. We look at the telemetry from all of our usage when they're already in their burst capacity in the first couple of quarters. It's a really good tell a, that they're going to renew and b, that they're going to renew at the higher amount. And I think that's happening because of the sales and marketing investments we made, the majority of that investment went into these customer success or subject matter expert resources that help customers get up and running faster. Got it. And so on that kind of -- you kind of alluded to this already, 40% are in burst capacity. You have a bigger renewal quarter, I think, coming up in fourth quarter. You talked about 2023 as a big renewal year in general. Just given what the NRR is, what you're seeing on the burst capacity, like how should we think about kind of the renewal opportunity for upsell broadly? I mean, generally speaking, we've been pretty open that the best opportunity for us to upsell customers is in the year of renewal. And if you dig deeper, it's in the quarter of renewal. So guidance for Q4 certainly suggests what our feelings were relative to the Q4 opportunity as we think forward into 2023. So first of all, we expect to have a significant -- we expect to have a significantly larger renewal base available to us. We're going to have a larger concentration of ELAs that hopefully have been well into their burst. So that provides a tremendous amount of visibility to us. Not to mention, we've got a whole host of new products that we can actually offer these customers. So I think there's a lot of good momentum going into '23 as we think about what that will look like. And as we do get through '23, is that kind of -- are we through most of kind of the -- to kind of replacement to ELA structure? Is that kind of the last milestone to lap? Or there'll still be more of that kind of longer tail in the years to come? Well, I think we're in a cadence now where we have a larger concentration of one year cohorts, and those are going to come up every year. If we're successful in being able to renew those each year at higher levels, you should see the renewal base continue to grow year after year. I think we're well behind any of the prior behavior and discounting in particular that we talked about a couple of years ago. Customers are making decisions on duration based on their specific purpose. It's not being motivated by higher discounts. And so it's a very healthy renewal base that we continue to see. Got it. So shifting gears for a second. Use of cash, and you've got a good deal of cash in the balance sheet. You've been acquisitive historically, but you've got some converts coming due, certainly not unique in software with the converts -- with having issued converts over the past several years. But how should we think about kind of free cash flow generation, use of cash and the opportunity to address those converts? Yeah. So we have $85 million coming due in 2023 from the initial converts we did. We have $400 million coming due in '24 and then another tranche in '26. We obviously have more than enough cash to address the '23s without any issue. We have a number of attractive options that we are evaluating as it relates to the '24 notes and evaluating which of those options is best for us and shareholders. So more to come on that. In terms of use of cash, we still have ample of cash to be able to run this business highly effectively as well as entertain other inorganic activities of some size and scale. And so a top priority for us is getting the leverage in the business that we talked about as we think about going forward, which free cash flow will then follow that component and then taking any pressure off the capital structure. Got it. So I kind of want to go back to something we were talking about earlier, but the launch of kind of the browser-based offering broadly -- more broadly next year. How do you think -- how should investors think about that from an addressable market perspective? So not everyone is obviously, although most probably could junk on the Global 2000, but not everyone is a Windows company. So is that a real TAM expander from you as -- is that the right way to think about it? Yeah. I really think it is, Alex. I think -- the objective for us, it's a different product than designer desktop. Designer Desktop has been the product of 25 years of continued innovation. We've been at Designer Cloud for about a year. And still learning a lot from our customer deployments that are there now. But think of it as a subset of the connectors, so a subset of the data sources and a subset of the analytical tools that you can apply to the data. And we think it opens up new personas that we can sell to. Understand the elasticity of pricing on the longer term basis. Obviously, it's a premium product, but do you feel give the ability to kind of where pricing and overtime how do we think about that in terms of a quick number? Just real quick. The question was around price elasticity and longer-term potential is pricing for -- as a growth as a growth driver? Yeah. I think if we think our future state long-term, there's going to be dozens and then ultimately, hundreds of apps that will be made available on our cloud-based platform. And there'll probably be hundreds of use cases that we'll be able to monetize independently for someone that just wants to buy a use case, maybe not necessarily a net of Alteryx. So I think long term, the revenue growth is going to come from different form factors of revenue than just license revenue and then also different personas to whom we can sell. So one of the things we talked about earlier when the go-to-market was creating -- you've created a lot of templates and the idea of use case selling. And I'm curious, as we think about kind of enablement broadly, what's kind of been the results of that kind of more use case selling? I'm just curious how that's driven kind of results so far? Yeah. Well, I'm not sure about your CFOs, but I know my CFO here, he doesn't think about buying licenses or products. He thinks about getting something in return for the capital or operating expense we spend. And it's usually tied to a business outcome. And so use cases are really just templated business outcomes. And I think they dovetail very nicely with a kind of a large top-down enterprise selling type approach. I think -- to me, I think being able to prove it out with the value engineering resources that we have and with the ability to help them quickly get to the realization of the application or the use case. If you go to our website today, there's hundreds of different use cases that we've chronicled in a use case Navigator, really just showing the possibilities that it really helps setting up an appointment and saying, "Hey, you're not saying I'd like to sell you some Alteryx licenses. You're saying, I read from your annual report that you're having issues, making sure that people that are now living in different states are paying the right taxes and we're withholding the right revenue taxes. Well, we've got an application for that and we can help you and we can sell that. And then once we deliver that, we can validate the innovation was consumed and they got the return. And that earns us permission to go sell more. So the other thing on the enablement side, also kind of go-to-market related, but the partner network. And you've seen ramping kind of contribution from the partners already, PwC global kind of expansion, KPMG I think you partner sourced ACVs up pretty meaningfully. So can you just talk about what you did to the partner program over the past kind of couple of years? And how you expect those benefits to play out? Yeah, I've spent a career working with partners as a sales leader, and you've got to really invest. And to be frank, two years ago, we didn't really have much of a partner organization. So number one, you have to have an organization that's designed to work with partners to help make them productive, teach them provide programs that motivate them and curate the relationship with them so that they feel cared for and loved and ultimately rewarded with leads and margin. The other thing you have to do is you have to have the kind of people in the field that are motivated to work with partners, right? We have really made a wholesale transformation in the quality of the people that we have. And they're people, not too dissimilar to me that come with an average of 15 years or more of experience. They've worked for $1 billion-plus companies like VMware or Palo Alto Networks. They've seen that long-term result on a very, very long TAM -- long-tail TAM. And they're used to working with partners and getting leverage on our partners. And so I think we did both. We transformed the team who are comfortable sitting in the office of the CFO with a partner from PwC. The other thing that we did is we really started to get much better at being a proper technology integrator with technology partners, partners like Snowflake, Databricks, Google BigQuery, AWS. These are becoming important influence partners for us. And so whenever these two products are being used by a customer, the integration work that we've both done together, technical integration work that we've done together makes the use of Alteryx and Google BigQuery, much more seamless, much easier. Same thing with Snowflake. We've built really strong field integrations with most of these companies as well so that salespeople can sit down at a Starbucks on a Monday, compare their territories, build campaigns together to go try to sell more of each. And then if you just look at LinkedIn, almost on any given week, we're doing a tiding a webinar with one partner or another. And at the end of the day, I think of all of this is we're trying to drive relevance up in the community, right? We're trying to be very easy to use and deploy, very successful and a high correlation to value when you do deploy us. And we're trying to be more relevant to the community, to partners as well as to customers Got it. So maybe just kind of as a wrap up question here. What do you think are maybe one or two kind of underappreciated aspects of the Alteryx story today that investors are going to have a greater appreciation for 12 months from now? I think it's -- we can only control the things that we can control. We can't control the demand environment, I would say, more and more customers are using us to do more with less and that can be interpreted in a number of different ways, all of which I think are meaningful during times where spending gets narrowed. They need to run tighter ships. They need to see around corners and they need to make better data-driven decisions. And that's why people do business with us. The other thing, I think, is by using Alteryx, you're building workflows that are basically automating previously onerous and manual processes and you're putting them into something called a workflow that gets embedded into business process. And some of our biggest customers have thousands and thousands of workflows. If spending gets really tight and they want to stop spending, you can't replace those workflows with Google or a brother you can't just do cut and paste from the logic that's been put into those workflows and use them with anybody else. It's a very, very sticky product, which is why our expansion rate has been so, I think, world class. So I think we're looking to build on all of that, build this proper platform that, of course, has to be in the cloud. And we think there's permission for an independent company like us to go, hoover up 10%, 20%. And that's 10 to 20x from where we are now. And the decisions we're making are really long term in the manifestation. We think of this as very much a long game from my own experience, growing companies from $100 million to billions of dollars. You do all the right things at the different stages. You hire great people, you orchestrate their output. And the shareholder values will in the long run come. And I hope for those of you that are shareholders, we're not happy with a $40-something stock price. But those of you that are prospective shareholders, we're all working really hard to leverage this incredible innovation. I would just add to all of what Mark says. I think the last piece is the actual earning power of this business, right? We have an incredibly sticky product. We have demonstrated historically the ability to drive significant profitability. We've made some very intentional investments in the last couple of years to put us in a very enviable position today as we go forward. And this business has the capacity and the ability to be a highly profitable business.
EarningCall_1578
Good morning. Welcome to the Wendy's Company Preliminary Earnings Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Thank you, and good morning, everyone. Today's conference call and webcast includes a PowerPoint presentation, which is available on our Investor Relations website, irwendys.com. Before we begin, please take note of the safe harbor statement that appears at the end of our earnings release. This disclosure reminds investors that certain information we may discuss today is forward-looking. Various factors could affect our results and cause those results to differ materially from the projections set forth in our forward-looking statements. Also, some of today's comments will reference non-GAAP financial measures. Investors should refer to a reconciliation of non-GAAP financial measures to the most directly comparable GAAP measures at the end of this presentation or in our earnings release. On our conference call today, our President and Chief Executive Officer, Todd Penegor; and our Chief Financial Officer, Gunther Plosch, will briefly review our preliminary Q4 and full-year 2022 results and provide an update on our capital allocation actions. From there, we will open up the line for questions. Thanks, Kelsey, and good morning, everyone. I'm pleased to speak with all of you a bit earlier this quarter to announce our preliminary fourth quarter financial performance and revisit our capital allocation policy. Before diving into our strong results, I did want to take a moment to comment on Trian Partners amended 13D that was filed this morning. We look forward to continuing our partnership with Trian Partners with a shared goal of delivering value for all shareholders. Wendy's continues to make meaningful progress against our three strategic growth pillars, and we are pleased with Trian Partners confidence in our growth strategy. Today's call will be focused on our preliminary fourth quarter and full-year 2022 results and the capital allocation actions we announced earlier this morning. I look forward to sharing the detailed drivers of our 2022 results and providing our 2023 and long-term financial outlook as part of our full earnings release on March 1. Now let's turn to our preliminary fourth quarter and full-year 2022 results, which highlight the strength and resiliency of the Wendy's brand as we continue to deliver compelling growth. 2022 global system-wide sales grew 6.8%, supported by a second consecutive year of double-digit two-year global same-restaurant sales as well as over 275 new restaurants we opened across the globe. This sales strength, along with the step-down in inflationary pressures, underpinned the almost 300 basis point improvement in company-operated restaurant margin over the course of the year. This momentum alongside the hard work and dedication of our restaurant crews, franchisees and support center staff drove our full-year adjusted EBITDA of approximately $498 million, a 6.6% improvement versus the prior year. The strength we are driving in the business alongside our robust liquidity position supports the capital allocation actions we announced this morning. We have achieved our 12th consecutive year of global same-restaurant sales growth, which is a streak we plan to keep alive in 2023 and beyond. 2022 also marked our second consecutive year of double-digit global same-restaurant sales on a two-year basis, which is truly remarkable. This growth extended across the globe with double-digit two-year same-restaurant sales in both our U.S. and International segments. Our sales results have enabled the Wendy's system to weather the unprecedented headwinds over the last few years and set us up for further growth next year. Our sales momentum picked up even further to close the year as our two-year same-restaurant sales results accelerated in Q4 versus the prior quarter. Our international business continued to achieve outstanding results supported by growth across all our regions. This sales strength further bolsters our confidence in accelerated international expansion in the coming years. The acceleration in our U.S. business, same-restaurant sales was supported by our strategic mix of craveable innovation and compelling price points across a variety of occasions. We launched the decadent Italian Mozzarella sandwiches and garlic fries, delivered another exciting extension of an iconic product with the Peppermint Frosty and continue to promote our ownable $5 Biggie Bag. At the breakfast daypart, we enticed trial with our $3 croissant promotion and continue to see our French Toast Sticks resonate with customers. I'm excited to share more about our strong sales results, including updates on our breakfast and digital billers at our full earnings call in March. I am proud of the new net unit growth our team was able to deliver in 2022 despite ongoing development challenges across the industry. We opened over 275 new restaurants globally, reaching 2.1% net unit growth and marking a second consecutive year of net unit growth acceleration. This growth was spread across the globe with the U.S. and International segments making up approximately 40% and 60% of our net unit growth, respectively. Turning to the UK. We have grown the market to a footprint of almost 30 restaurants and well under two years. As of year-end, this includes 12 company-operated restaurants as well as our first traditional franchise-operated restaurant. We are excited for all the growth that's ahead for this market in 2023 and beyond, including our first drive-thru restaurant expected to open in the coming weeks. Finally, our focus on franchise recruiting has paid off with nearly 40 new franchisees joining the Wendy's family across the globe in 2022. This signals just how much excitement there is in the investment opportunity of the Wendy's brand. In addition to the new development commitments that come along with these new franchisees, we are excited by the wealth of experience and growth mindset that they bring to the system. We are committed to bringing Wendy's to more of our fans and are excited about the strong foundation we set for further growth ahead. We remain committed to driving accelerated growth across our three strategic pillars, building our breakfast daypart, accelerating our digital business and growing our global footprint. Before turning it over to GP to walk through our capital allocation updates, I want to take a moment to comment on the redesign of the company's organizational structure that we communicated this morning. The redesign is being made in an effort to better support the execution of our long-term growth strategy by maximizing organizational efficiency and streamlining decision-making. Following this change, we intend to embark on a broader redesign of our organizational structure as we see an opportunity to operate as a fully global brand with a unified voice, approach and operating model. We anticipate that our 2023 and 2024 G&A will be relatively flat versus 2022 despite elevated inflationary pressures as a result of the redesign, we are now beginning in service of accelerating our growth even further. Thanks, Todd. As Todd mentioned in his opening remarks, our Board of Directors recently had the opportunity to revisit our capital allocation plans in order to address our cash balance, which remained elevated at approximately $780 million as of year-end 2022. Our capital allocation policy is unchanged and our first priority remains investing in the business for growth, which we will continue to do while remaining true to our asset-light model. Second, we are committed to maintaining an attractive dividend. Our continued business momentum, supported by the large investments in our strategic growth pillars over the last several years, and our strong liquidity position support a 100% increase in our quarterly dividend to $0.25 per share. We expect the full-year dividend to reach $1 per share and anticipate similar strong dividends moving forward as supported by our expected strong free cash flow growth and other factors subject to the discretion of our Board of Directors. Lastly, we will utilize excess cash to repurchase shares and reduce debt. We announced today a new $500 million share repurchase authorization expiring in February of 2027. This replaces the previously approved $250 million share repurchase authorization, which was set to expire in February of 2023. Additionally, we repurchased $20 million of our debentures so far in the first quarter under an existing Board authorization. We will continue to assess opportunities to reduce our debt in alignment with our capital allocation policy. We continue to deliver on our simple, yet powerful formula. We’re an accelerated, efficient growth company, and we are committed to returning cash to shareholders as the momentum in our business continues to grow. Thanks, GP. Please note that we plan to report our audited fourth quarter and full-year earnings on March 1 and host a conference call that same day. At that time, we will answer questions regarding our 2022 results and share our 2023 and long-term outlook. As we transition into our Q&A section, please keep questions focused on the capital allocation actions that were announced this morning. Additionally, due to the high number of covering analysts, we will once again be limiting everyone to one question only. Certainly. [Operator Instructions] Our first question comes from the line of Brian Bittner with Oppenheimer. Brian, your line is now open. Thank you. Good morning. Good morning and thanks for the question. So as we focus on the capital allocation strategy and clearly, the significant increase in your capital returns to shareholders that you've announced this morning. It seems like a pivot from the last couple of calls, GP when it sounded like you were pretty focused on putting capital towards deleveraging the balance sheet. So could you just talk about how the Board came up with this balance and to increase the dividend so dramatically? And on the buybacks, it's a long tail on the buybacks going out to 2027. But can you talk about maybe the near-term buyback strategy? Are you looking at doing some sort of ASR, particularly with that cash balance being so heavy still? Thank you. Good morning, Brian. There were a lot of questions in there. So again, the first and most important point is our capital allocation policy is unchanged. Yes, what we have definitely decided with the elevated cash balance we had of around $780 million it's obviously time now to put this cash to work and return it back to shareholders. Our second most important priority was always to issue attractive dividends. So we felt with the high cash balance we have, the high visibility we have in growth, the high visibility we have in future strong cash flow growth, that it is the right action to actually be a little bit more attractive on the dividend side. We are balancing that with our third priority, which is returning cash to shareholders through share repurchases and to debt reduction. On the share repurchase side, the $500 million, you're right, it goes out for four years. We're not going to comment how that is going to phase out annually. You can expect for us that we're at least going to spend about $70 million a year to manage our dilution. The rest is going to be on our discretion. We will see how things develop over the next couple of years. Great. Thanks. I know the lines of questions you want to be capital allocation related. But Todd, I was wondering if you could help contextualize your strong 4Q U.S. sales results relative to QSR for category dollar share you typically do that with earnings calls and just given your released 4Q comps, I think that would be helpful. My other question, though, just on capital allocation was for GP. And could you just speak to your ability in meeting your growth priorities while reducing or limiting G&A, keeping those dollars flat from 2023 and 2024 and just your confidence and your ability to really reach – achieve your priorities, while keeping those dollars flat. Andrew, on the sales front, I'm a little too early to have all of the fourth quarter share data. So we'll share a lot of our share performance as we get together on March 1 with our full earnings release. But when you look at the momentum that we had in the third quarter and the step-up in momentum that we had on a two-year basis into the fourth quarter, both U.S. and international, my sense is we performed very well relative to competitors within our space. I mean we had a strong calendar. As I said on the prepared remarks, our breakfast business behind the continued momentum on French Toast Sticks, the $3 breakfast deal to drive trial. We did all of that lapping the $1 Biscuit promotion from a year ago to put those strong numbers in place. And then you look at the rest of our day calendar, very balanced with the $5 Biggie Bag on the value side, iconic Peppermint Frosty out there, and the continued success of Made to Crave with the Pretzel Bacon Cheeseburger and Italian mozz have done a nice job balancing that calendar and QSR continues to be placed – place to be, and we're performing well within that segment. GP? Yes. So on your G&A question, yes, we are confident that we can keep G&A relatively flat versus 2022 in both 2023 and 2024. I mean there will be some inflationary pressures. As you know, we are an efficient company. We ended 2022 with about 1.9% of global sales. And I think with the redesign actions to streamline our decision-making, I will give us enough tailwinds in our G&A to offset our inflationary pressures and keep as a result of it, G&A relatively flat over the next two years. Great. Thank you. Another one that maybe strays a little bit from capital allocation, but just wondering if you'd be able to speak a bit more to the organizational restructuring and any kind of additional detail on some of the benefits that you spoke to as it relates to streamlining decision-making and sort of how that enhances growth potentially going forward, guys. I'd appreciate it. Thank you. Great news is we're starting from a position of strength, right? We got a lot of momentum in our business to finish the year. We feel like we have strong plans in place that we'll share as we get into the March 1 discussion around 2023 guidance and our longer-term guidance. But as you think about where I wanted to go to evolve the org structure, it was really around how do we actually think more global in all we do. How do I really make sure that we're focused on driving global unit growth? Are we driving more of a focus on digital activation leveraging our technology with a global mindset? And as you take some layers out of the organization, it allows us speed of decision-making, it can drive focus, it will drive efficiency, it will drive productivity. And as GP just commented, also helps us on the G&A front, too. But ultimately, the way the resources will be reallocated and focused, it is around driving traditional new restaurant development without any distractions and things that we chase during the course of this past year. Continue to drive more digital demand and really raises the bar on the operational excellence of everything we do at the restaurant level, while we continue to build our breakfast business. So it's as simple as that. Hi. Thanks for the question. Could you expand a bit more on your latest thinking on the long-term development outlook? And then would you expect the org redesign to result in any changes to the development strategy, pacing or targets? I think you touched on that a little bit, Todd, just now, but any other further details would be great. Thanks so much. Yes. On the long-term development outlook, unfortunately, we'll have to wait until we get guidance put out there on March 1. So we'll talk through that in the context of our guidance for 2023 on March 1. We will give you a little more flavor on an update to our long-term targets as we get to that date also. But as we think about the org redesign, we did test and learn in a lot of places during the course of this year. We've looked at REEF Kitchens. We did some things around hamburger stands and frosty cards. What I really want to do is make sure that we got a dedicated focus to drive the U.S. development plan, drive the international development plan with most of our time energy effort on traditional new units with our global next-gen 2.0 design, which we're really excited about. Great. Thank you very much. Just following up on that org structure redesign, similarly encouraging to be the whole G&A flat in this environment over the next few years. But Todd, I presume this means you'll be more intimately involved perhaps in the day-to-day as you're removing a layer of management in there. I'm just wondering if you could share any color in terms of any changes expected in terms of primary focus or initiatives or what we can expect from that perspective as you presumably streamline the global structure. Thank you. Great question, Jeff. As we sit around the table operating as a senior leadership team, the last couple of years, I had two business unit presidents that had a lot of autonomy that were driving their business. And it served us well. I mean we've got a lot of success in the U.S., a lot of success in international. But we do need to have that global mindset, and it will put me a lot closer to the business. And as we sit around the table as a senior leadership team, having a global marketing mindset, talking about operations with a focus on the U.S. and international, it will help speed to decision-making. We'll make sure that we got one message to the entire organization, both U.S. and international. And I do think it will make us a lot more effective, so we can go faster to continue to drive and accelerate the results that we've seen behind our key strategic growth pillars that we've been very focused on the last couple of years. So I see a lot of benefit from all of that. Hi, good morning. I was just wondering if you can comment on the timing of the announcement. Essentially, your comps are still continuing to see outperformance. The G&A seemed to be relatively more relevant compared to last quarter. But I'm wondering what was propelling your decision to announce the organization redesign today when you're seeing kind of sales continue to be elevated. I think just a function of how we're looking at managing our business moving forward. As we start the year fresh here in 2023, but I personally thought it would be good to have a fresh look on how we operate as a leadership team. And as we embark on some of the work to make sure that we can hold our G&A relatively flat in 2023 and 2024, as GP just alluded to, having the senior leadership design in place certainly helps enable that work. So as we work through what that next layers look like, how does the org design flow out, what does our G&A actually come out to look like, we'll have all of that work done to be able to share with you as part of our 2023 guidance and our longer-term outlook when we reestablish that on March 1. Thanks. My question is regarding the capital allocation. The companies use more capital to repurchase stock and pay dividends on average, I guess, over the past several years that looks like it's going to change going forward. Could you talk a little bit about how the company came to this decision? And then I had a follow-up. Good morning, Chris. Yes, it's obviously an active dialogue with our Board of Directors. There's different point of use that we discussed in terms of what options do we have to return the excess cash that we currently are sitting on to shareholders. And at the end of the day, what I think we decided is in line with the capital allocation policy. Number two is an attractive dividend. Now obviously, at the stance we are taking on dividend is very, very attractive. And we want to signal to the financial markets that we have high confidence in growth, high confidence in high cash flow generation, and that's basically a little bit the adjustment that we made on the dividend side of things. Again, all combined, if you do the calculation, you're getting to capital returns over the next several years of more than $1 billion. So we are signaling that our cash flow generation is going to stay very strong. Hi, thank you. The question is on the comp, if I can, in the fourth quarter. I mean, can you talk about how much of that was price? How much of that was ticket if you are kind of seeing different consumers behave different ways with the brand, if you think there's anything really instructive in the data that you're seeing in the fourth quarter specifically? And I guess I'll be a little cheeky and see if you'll address this. I mean, can you talk about what you think your average pricing will be for 2023, if you think you might take more pricing? And there have been so many movements in commodities since we've last spoken if there's even a soft update that where we can kind of consider commodity inflation relative to pricing for 2023, if you're willing to address that. Thanks so much. Hey, John, a lot of good questions in there, and I won't address those today. We'll save a lot of that detail and discussion for our March 1 release when you start to think about where we are on price, where we are in customer counts, what we're seeing on mix. How we're looking at the health of the consumer. I mean we continue to see a consumer that's a little more strapped. We're in the right segment of the restaurant business. QSR continues to place – be the place to be. There is continued trade down into our category. And as you see from our results on a one- and two-year basis, we're competing and performing very well. So we're happy with that. Yes. Just to add on this, John, right? And we are really happy about quarter four, right? We told you in quarter three that we're going to grow double-digit on a two-year basis across all segments. And we have done that actually exceeded that with more than 13% growth on a two-year basis in the fourth quarter. Hey, thanks for the question. I just had one on the unit growth on the U. S. side. It looks like you guys had a bit of outsized closures. I mean, is that something we should read into on a go-forward basis? Or was there anything specific to the quarter just in terms of – I think it was the first quarter in a while with net closures during the quarter. Just figure out and I ask the question. Thanks. Good morning, Greg. Yes, we are happy with our outlook EBITDA performance on the units, right? We told you it’s going to be 2% to 2.5% for this year and we ended up in that range. Secondly, I would say the split between growth is 40% in the U. S., 60% in international. We kind of told you, as we worked ourselves through the year, that we will have elevated closures this year. We told in the past between 130 and 140, which is definitely elevated versus what you have seen in the past from us. That’s what basically happens this year. As you might remember, a lot of it has to do with REEF and cleaning that adventure up for us. I’m not going to comment on closure rates on a go-forward basis. We do that beginning of March. Thanks. I don’t know if you’ve mentioned this, but what is your leverage target now? And then I’m just curious how you perhaps weighed using cash for buying back stock against debt reduction or other sort of business-related spending, perhaps incentivizing unit growth or even if that cash is used on an expense basis, I’m wondering how you weighed those options? Thanks. Good morning, David. From a leverage ratio point of view, we haven’t really issued a target. As you know, at the end of the third quarter, we were about 5x levered. We’ve gone to do the final numbers once we issue the full audited results. From a debt structure, as you know, we have securitized debt that is really nicely levered. The first time we need to get into kind of refinance mode is probably in 2025 or 2026. So we have some time to think about it. Optimistically, we definitely are taking debts down in line with our capital allocation policy, right? You’ve seen it. We have bought back in the quarter already $20 million of our debentures. As you know, they are due for repayment in December of 2025. So there is $70 million to go. And we’ll see whether we can reduce debt on a go-forward basis. It’s the balancing act between the share repurchases and debt, because I think we are demonstrating that we are doing both. Hey, thanks for the question and good morning. I’d like to ask what about sales if I can. One of your biggest competitors has been on air quite a bit lately. It's been mostly brand messaging, but also a little bit of value. And from your strong fourth quarter results, it does seem like it didn’t have much of an impact or perhaps even benefited from the higher level of media attention on the category. So maybe if you can comment on how you think the heightened competitive messaging affected your business in the fourth quarter and what it can mean for the trend going forward in 2023? Yes, I think we continue to do a great job of having a very balanced calendar. When you think about what we continue to do on $5 Biggie Bag to bring folks in for affordable great tasting food, that’s a great offer. The news we continue to bring on Made to Crave continues to allow folks to trade up and through their purchase cycle in the course of the month, you can buy on the low side of the menu and the high side of the menu. And things like bringing Peppermint Frosty into the restaurant really is something that drives our iconic Frosty brand, but actually a great halo to the rest of Wendy’s. There is a lot of activity, a lot of folks out on air, no different than we’ve always seen. We’re out there on air actively at the moment. We’ve got strong messaging going on as we start the year. So we feel like we’re really well positioned to continue to compete, both from the perspective of where our momentum was as GP just commented on the fourth quarter. But with the plans that we have in place moving forward, we feel really strong that we’re well positioned to continue to win in the category. Hey, thanks. Good morning. Just looking for any additional color on the org redesign, so on the timing, what led the realization that there was a more efficient path. I’m sure there’s something continually you’ve been reviewing and then back on the confidence you can contain the cost, if you could just reflect on where you stand now with building up the teams and capabilities to deliver on the digital and growth plans, just comfort that you’re sort of cresting the peak of investments here? Yes, back to – as I said a little bit earlier, the timing was one that we had to make some of the senior structural changes first to get that out, so we can continue to do the work to look at the organizational redesign that we said we were embarking on to make sure we can lock down our plans over the next 30, 45 days. So we can kind of share all of that outlook as part of our 2023 guidance and have that thinking factored into our longer range targets. But we’re absolutely committed to holding our G&A relatively flat in 2023, 2024. We think we can reallocate a lot of those resources to ensure that we’ve got the right focus on traditional net unit development across the globe. We think we can leverage a lot of our great marketing thinking even better across the globe. And clearly, we can continue to drive digital with a global mindset, which we’ve had to date, but I think we can be even more focused on it. So I think all of those things set ourselves up to build off of a very strong foundation and a business that has a lot of momentum to take us to a whole new gear of growth. Great. Thanks for taking the questions. I was just curious within the context of the new capital plan, how you think about carrying your cash balance going forward? Obviously, we can work through the implications for the share buyback and the dividends. But just curious as you think holistically or maybe philosophically, just about the amount of cash that you would like to carry on your balance versus historical periods? Good morning, Josh. Right. As you know, the last several quarters, obviously, we are very elevated from a cash balance point of view. As I said in the prepared remarks, we ended up this year with about $780 million. Obviously, with the actions that we are taking now that cash balance is going to get reduced, it will take a little time to kind of work this down. As you know, we can run our business very conveniently at about $300 million of cash. Definitely believe that we’ll stay a little bit elevated over the next couple of months. Why is that? We’re heading into kind of uncertainty and volatility from a macroeconomic point of view. So we definitely believe to be a little bit more prudent on cash balances is appropriate. Thank you very much. Thanks for the time. My question is on the organizational restructuring keeping G&A flat. Are the efficiencies primarily going to be realized through headcount? Are there any other projects or investments you might pull back in? Are you considering things like more outsourcing of technology? Thank you. Yes, Lauren, a lot of work to do on the org redesign. And we had contemplated several investments that we would put in place the last of years and we’re thinking about an investment posture on some of the G&A for the next few years. But as we ran into this economic cycle, we’re relooking at where we’re placing some of those resources. We’re looking at some of the existing headcount in light of the org changes that were announced this morning with the senior team on the U. S. side and with a few folks moving on. All of that is yet to come. So we got a lot of work to do now to really define how do we get to those savings, how do we make sure that they’re structural, so they stick and hold us relatively flat on the G&A in the next couple of years. But most importantly, we got to make sure our resources are focused where they matter the most as I continue to say driving traditional new unit development, driving our digital demand, raising the bar on operational excellence and continuing our momentum in breakfast. Great. Thanks. Thanks for taking the question. Just two quick ones. I want a clarification. Just want to clarify that the G&A guidance is for flat dollars going forward in 2023 and 2024? And then just on CapEx, any color on CapEx in 2023 and 2024, is there any – are there any expenses that we should be expecting to be shifting out of G&A into CapEx? Or is CapEx relatively consistent on a go-forward basis as well? Thanks. Good morning. So as you know, we finished G&A in 2022 at $255 million. We are saying flat, relatively flat. So we’re not saying flat. So there’s going to be a little bit of inflation there is the one clarification I have. On capital, I’m not yet ready to give you any color on it. As you have noticed, we actually not yet done with even the cash flow for this year. So that needs to settle and we’ll purchase that one and beginning of March, we’ll give you a little bit more color how that number develops. Great. Thanks for taking the questions. And I have two follow-ups, which I hope just equal one question. The first is, could you just give us an update on where you stand with the REEF closures? I’m wondering how many closed for instance maybe in 2022 or the fourth quarter and how many you expect to close in the next year? And then I had a question on the dividend payout. So as I calculate, it looks to be about over 100% payout. I think, GP, you made the comment that this is going to be a consistent given. So I think that would mean that you’re going to grow it from here. But if you could just comment on the targeted payout things obviously but double as I’m kind of calculating what you had previously talked about? Good morning. So on your REEF questions, we finished the year with about 50 REEF units across the globe kind of equally split roughly between the UK, Canada and the U.S. Again, as we said, the partnership is [Life and Active]. You will hear more how that develops at the beginning of March when we do our unit guidance. In terms of dividends, again, the exact payout ratios and what have you, we’re obviously going to declare when we issue our guidance for next year. And as you note, it’s clearly well north of 50%. I also want to make sure that people absolutely understand that this is not a special dividend, it’s a regular dividend increase. And again, you can also expect that dividend will annualize to $1. And you can also expect that similar elevated dividends will be paid out in the coming years. Obviously, that is all subject to the discretion of the Board of Directors. Thank you. Obviously, just given the long tail on the buyback through 2027, how are you thinking about the timing across, I guess, the next four years or so? Is it going to be relatively balanced? And then also what was the unit level margin ex the UK? Good morning, Nick. So yes, you’re right. The authorization is for four years. It gives us a little bit flexibility. As I said, at a minimum, you can expect us to spend $70 million a year just to simply manage dilution in terms of how we then manage the rest, which I would call discretionary share repurchases is going to be the function in terms of what is our outlook on the fair value of the company. What is the timing when it makes sense for us to make the share repurchases. So we are going to make that decision on a quarterly basis and decide together with the Board how we’re going to pace and sequence those share repurchase programs. I didn’t fully understand. So can you repeat that one, second part? Thanks for the question. I wanted to follow-up on the cash balance issue. You mentioned about a $300 million minimum cash level necessary. How has that changed? And given the lower G&A spend and the stronger sales, shouldn’t that start to narrow or improve going forward potentially freeing up more discretionary cash flow for share repurchases? Yes, Jim, you’re not wrong, right. If you step back, pre-COVID, if you go back to a balance sheet pre-COVID, you would manage the company at around $200 million in cash and obviously COVID happened. Remember, we had to do the famous relief, working capital relief package for franchisees and we realized maybe we’re living in the volatile world and basically say, you know, what, we want to be a little bit more prudent and try to target around $300 million. If volatility comes down, we’re moving through something between $200 million and $300 million to comfortably manage what we need to manage is definitely an option and you’re absolutely right. I think clearly means there is a little bit more cash available for capital allocation actions. Great. Thanks for the question and squeezing me in. You kind of mentioned it, but just wanted to get a sense of on the dividend. Was there a discussion around doing a special dividend in the fourth quarter and the first quarter here? And maybe how you came to the decision to increase at a 100% versus maybe doing a special? And then just a quick follow-up on the company-restaurant margins. Maybe you can help frame where you saw a little bit more favorability in the quarter? Was it lower beef costs, better labor? Just any incremental color on the line items there would be helpful. Thanks so much. Good morning, Jared. Yes. So I don’t want to get into the details of the working discussions on Board level, special dividend versus regular dividend versus share repurchases. I think collectively with the Board, we landed on a very attractive, I think, capital allocation action basically increasing the dividend to 100% and making this regular dividend action and do the famous $0.5 billion of share repurchases. So yes, I don’t want to get into the discussions around all the details how we got there. But I think the outcome is positive. On the restaurant margin, really happy. As you have seen in the consolidated numbers, we are landing flat on prior year. If you actually peel this back a little bit, the U. S. company restaurants landed actually at 15.2% and they were actually favorable, so up versus prior year’s quarter by about 20 basis points. So that went well. So that tells you we are really starting to truly approach pre-COVID margin levels. I might remind you that was in 2019, our U. S. company-restaurant margin was 15.5%, and that despite really still relatively elevated inflationary pressures we had in the fourth quarter. More detail in terms of what happens to labor, pricing mix, we’ll give all of that out when we are fully analyzed in detail our results beginning of March. Thank you, Jared. That was our last question of the call. Thank you, Todd and GP, and thank you, everyone, for participating this morning. We look forward to speaking with you again on our call in March. Have a great day. You may now disconnect.
EarningCall_1579
Good morning, and welcome to our Half Year Results. I'm joined by our new CFO, Dominique Highfield, and we will update you on our progress to create a profitable and scalable business. In terms of agenda, I will give you a brief summary of the second half, followed by an update on our financial performance from Dominique. And then I will finish by giving you an overview of the progress we're making against the various initiatives that support the delivery of our plan and to return us to a profitable business in the second half. Our performance was largely in line by plan. Instructions and fees have remained stable despite the significant turnaround the business is going through. Instructions held steady at 21,205. However, revenue was down 16% due to the lower conveyancing volumes we saw at the end of last year. Our total fee income was broadly flat at £34.4 million. ARPI held well at 1,624 and the low interest [ph] conveyancing volumes were offset by the price increases that were implemented in July and the improved attachment rate for the Pro package. Our work to improve conversion in the living room continues, and we're up 170 basis points since financial year 2022. The cost-cutting work we started in the summer is yet to flow through to the adjusted EBITDA, which was a loss of £8.4 million, reflecting lower revenue and gross profit margin. We remain laser-focused on cash, which sits at £31.3 million. I am pleased with our progress in the first half. We took £13 million out of our cost base, and this has now increased to £17 million of annualized savings, enabling us to invest in strategic priorities and drive revenue streams. In August, I committed to diversifying revenue, and we have launched our financial services business as of the 1st of November following the FCA approval. To ensure we return to profitability, I committed to ensuring that all of the areas in which our sales business operate are profitable. And I'm pleased to say that today we are operating in areas where we can achieve profitable, targeted and sustainable growth. In October, we reset our brand going back to chartering [ph] about our low fixed fee. Our famous Commisery campaigns are once again deterring people from the High Street. We launched our new campaign in October against a backdrop of political and economic chaos. Our brand awareness remained as strong as ever over 90% awareness during this time. Consideration increased by 6 percentage points. This really does prove our proposition has never been more relevant with the cost of living being at the forefront of consumers' minds. I am confident that our new campaign and our go-to-market strategy will have the required impact to grow instructions in the second half. Not only have we welcomed some fantastic talent into the business in the first half, but we also welcomed two new Board Directors, Adrian Gill and Gareth Helm, who both bring a wealth of experience from the sector and already adding value supporting me and my team. I shared at year-end, some of the quick actions I have taken in the first quarter, and I have continued to work at pace taking necessary actions to turn the business back to profitability. This includes a further £4 million in costs being taken out as we continue to focus on our cash burn. I will share more detail on other actions we have taken after Dominique shares the financial performance. Thanks, Helena. Good morning, everyone. I joined very recently being impressed by the caliber of the people I met and a strong believer in the proposition. In my short time here, I have been so impressed by the dedication and the pace of everyone in the business to deliver sustainable and profitable growth. Helena and I share the belief that Purplebricks has great potential, and I'm excited by what we can achieve together, including, but not limited to, creating a cash-generative and profitable P&L. On the face of it, the half year '23 results are as expected, which is not flattering, but our financial results are yet to evidence the progress made by the actions we've taken to our operations and to our culture. These results are one of reset and of investment. And what you'll see is a more effective cost base, a sales line that has weathered short-term disruption in our transformation, a business poised for future profitable growth. As Helena has already mentioned, in the first half of this year, we have invested in the future growth of the Purplebricks business, and this has impacted several of the group's core performance measures. That said, our instructions held up well year-on-year despite the material organizational changes that took place. ARPI reduced marginally. We did see our customers accept the increase in our pricing and continually choose more of the expensive Pro package, meaning the true underlying ARPI increase of 10%. However, that isn't what's reported due to the mix of conveyancing income year-on-year. So flat instructions and a marginal reduction in ARPI has led to a total fee income for the half, reducing by 1% to £34.4 million. Gross margin percentage is down on the prior period, but this is in line with our expectations being a result of the well-publicized move to the employed model. This is an investment into margin. But once the revenue line has grown, we will see not only the benefit of improved service levels, but of a more impressive gross margin percentage. Flat revenues, a restrained gross margin percentage and further investment choices translated into an adjusted EBITDA loss of £8.4 million. We closed a 6-month period with a cash balance of £31.3 million, a reduction of £11.9 million compared to the opening position. Stabilizing and generating cash remains our priority. Starting with trading, we delivered slightly higher net instructions in the first half of the year due to the increased conversion rate from a better field performance. Total fee income, which represents business won in the living room, was £34.4 million, a 1% decrease year-on-year as mentioned, because of the mix of conveyancing income, partially offset by our price increases and an increase in the number of Pro packages sold. You can see that despite instructions remaining relatively flat year-on-year and fee income down only 1%, reported revenue has decreased by 16% year-on-year. This, again, is in line with expectations with the reduction versus the prior period happening as a result of the movements on the balance sheet, with deferred revenue from instructions growing and with accrued revenue from conveyancing declining. These are the IFRS accounting adjustments to make sure that our revenue is recognized over the correct accounting period. And the reason our P&L has been impacted as it has with these balance sheet movements is essentially because conveyancing income reflects the reduced pipeline having been flattered previously from the hangover of the stamp duty holiday period, and the instruction revenues are increasing as a result of price changes. So more is held on the balance sheet to account for this growth versus last year. Lettings revenue was down period-on-period from £3 million to £2 million as the business moved to an employed model in half one within lettings, temporarily rationalizing our focus as a result. Conveyancing income was down from £8.8 million in half one '22 to £5.8 million in half one '23 driven by the timing of cases referred to our partners. Other revenue was relatively flat at £2.7 million in half one '23. Moving on to gross margin. The majority of cost of sales is the amount paid to our sales field. Cost of sales increased by £3.2 million or 21% year-on-year, driven by a higher fixed cost base. For four of the six months in the last year comparative, we were operating on a different model, being commissions paid to self-employed local property experts. But as you know, from September 21, we moved to an employed sales field model. And so now our cost of sales has represents both salary and commission costs paid to employed agents. So the largely fixed nature of these costs has led to a reduction year-on-year in gross profit margin, being 47% compared to 63% in the prior year. This margin percentage is in line with expectations, being an investment into our field teams, into our data available and in the service standards delivered. That said, we have recently taken action to reduce these fixed overheads through further cost-saving activity. This benefit will flow through in the next half of this year. Moving on to operating expenses. Operating costs reduced by £1.2 million [ph] versus last year to £24.6 million. And whilst we drove a 28% decrease in marketing costs, this was partially offset by a 14% increase in support costs. We have reduced our marketing investment, focusing on effectiveness and channel mix on our target customer segments. We saw the benefit of this come through in our cost per instructions. Half 1 '23 was £490, much more focused and much more effective than the cost per instruction of £686 in half one, '22. Support costs increased by £1.7 million due to additional investment in our operational capability, including the digital function and our customer contact center. Moving on to earnings. Lower revenue and lower gross margin, combined with movement in deferred revenue has resulted in a fall in adjusted EBITDA to minus £8.4 million from a loss of £0.8 million in half one '22. The operating loss of £11.7 million includes exceptional costs, as guided to previously, were the main items relating to restructure activities. The letting provision remains unchanged at £2.8 million, being suitably conservative and against a backdrop of a very low claims rate to date. Turning to cash. We have seen an unacceptable level of cash outflow for this business, which we have been addressing in the first half of the year as a priority. Our cash position at the end of the first half of FY '23 is impacted by our trading performance, but we have reduced the burn rate with a total outflow of £11.9 million compared to £15.7 million in the previous half. The cash burn is slowing. The first half of the year saw us make a marketing investment and costs go through the P&L, which have since been cut. The second half of the year will see the cash trajectory changed significantly off the back of these actions, as well as key trading initiatives in play ready for deferred [ph] cash generation in the first half of FY '24. As you can see from the slide, going left to right, the main drivers of this cash outflow are the P&L items that we've already covered and the extent to which they have been paid by the end of the period. You'll see that we have a £2 million difference between cash and adjusted EBITDA relating to deferred revenue and the cost of sales prepayment that I mentioned earlier. As many of you know, we're required to recognize our revenues and cost of sales over the expected period during which we provide the customers the service. As a result, the timing of cash flows is different from that fee accounting recognition. Turning to profitability. Here, you can see our path to EBITDA breakeven by the end of half two, a significant turnaround in profitability to achieve consensus. We will achieve this through three key steps. First, our go-to-market strategy, which Helena will share more detail on shortly. This is the work that we'll see our volumes grow through improved field performance and higher demand. Secondly, in line with previous guidance, we will continue to achieve cost savings across the field, marketing and head office with these weighted towards half two. We have attacked the cost line to create a cost-conscious culture as well as a lean and efficient cost base on which to grow. We have cut into fat and not muscle. I am incredibly clear that cost-cutting will only get us so far in turning this business into profit and generating cash. These activities have been done in conjunction with a focus on the customer and building our new revenue channels. Finally, the full impact of the price increase we implemented in July will be demonstrated by ARPI growth in half two. What this half two breakeven performance demonstrates is the benefit of the actions in half one flowing through, but importantly, it positions us successfully for profit and cash generation in FY '24. So to summarize, there are a lot of moving parts for this half. The results are representative of a business going through change of consolidating its cost base and preparing for growth from new trading initiatives. Our decisions and actions have given us a healthier cost base and a shift in cost culture. And as I turn to guidance, I can confirm that the full year outturn [ph] is in line with previous guidance, which means a consistent revenue performance into half two and a much stronger EBITDA performance than half one. Stabilizing cash while we reposition the business to grow is mine and Helena's shared priority. I am confident with the actions being taken we will get there in the time as communicated and with significant cash resources until then. Helena will talk to us now more about these actions. Back to you, Helena. We remain the most relevant brand in our sector. We consistently outperformed the competition in multiple areas that matter most to our customers. We are number one in the industry for sales exchanged. We achieved 80% against the industry average of 68%, and our largest high street peer achieved 65%. This 17% differential shows the commitment and skill of our agents to sell homes. Of the 20% of homes that don't sell, 15% withdrawal from the market and less than 5% lift with other agents. We are the second fastest estate agent to get your sale agreed, taken on average 33 days. We are 21% faster than the whole market. Our largest peer takes 45 days. Our speed to achieve a sale agreed is a great USP for us. Our brand remains unrivalled. We remain the largest brand in the sector. And as I mentioned, we saw a 6 percentage point increase in consideration following the launch of our Commisery campaign. I set out a clear plan in August to cut costs and stabilize cash, grow instructions, diversify revenues and raise standards. And I'm pleased to say that we are making progress in all areas. Dominique has covered where we are with our cost reduction plans so I will talk to you about where we are with the rest of the plan. Diversifying revenue is vital if we want to protect our business from being solely reliant on a buoyant sales market. We are working towards having a greater proportion of our income from lettings, mortgages and conveyancing from FY '24 onwards. In lettings, we are focused on retaining our portfolio and growing in our four key cities. We have not received any further claims following the breaches last year. There are significant growth opportunities in lettings, which we are exploring as part of the broader strategy review, which will be shared with you at the year-end. I am pleased to share that we have launched our mortgage business five months ahead of plan. We are now an appointed representative which means we own the end-to-end customer journey and employ our own advisers who can access mortgage deals through the MAB [ph] platform. This change in our model means that we can achieve up to three times more revenue per mortgage written, as well as selling additional products such as insurance. We also have a significant opportunity in the remortgage space in the future. We will be scaling our mortgage business in a compliance-led and disciplined way. Conveyancing, as you know, accounts for 17% of our revenue, and this is largely from the seller's customer base. In Q3, we will launch our digital solution to capture the buyer customer segment. Ahead of the digital launch, we implemented a manual process. The success of this exceeded our expectations with 25% of buyers contacted accepting a quote. We are therefore confident that we will see higher revenue volumes once the digital solution is live, targeting 100% of our buyers. The key to us returning to profitability is ensuring that all of the areas in which we operate are profitable. Previously, we had a flawed understanding of our demand drivers, and this prevented us from achieving predictable and sustainable growth, which resulted in Purplebricks not being a profitable business. Our go-to-market strategy uses demand drivers such as market headroom, resource requirement and profitability to inform where we operate. We have modeled the potential EBITDA impact of performance optimization and process standardization, and this shows a material uplift in EBITDA. We have segmented our sales footprint into three groups. Group one is performing and profitable. These areas have limited headroom for growth. And whilst they are profitable today, we believe there is room for further profit to be achieved through standardization and workforce efficiency. Group two, our growth areas have significant headroom for growth, which will be achieved through targeted marketing and the right fuel capabilities. Group three, the unprofitable areas from which we will be divesting, largely due to lack of opportunities and less cut through the proposition as it is today. We were able to define these segments by understanding the characteristics and the areas which we have historically performed well in. We then identify the areas with the same characteristics and where our performance was not as strong, indicating a significant growth opportunity for us. The graph on the left shows the number of properties which we have identified as being potential Purplebricks customers. The average house price is the x axis [ph] and the size of the bubble reflects the density. Approaching our field in this way has removed significant waste and allows us to target our marketing efficiently. In the second half, we expect to see further efficiencies through the standardization of our processes. We continue to improve conversion since the launch of our recovery plan. And you can see from the graph that we have consistently improved conversion is going employed by 170 basis points. Underpinning our go-to-market strategy is the commercial excellence work. Through this, we look at consistency of process, adoption of technology, use of data and improvements to the customer journey. This will not only support conversion further, but it will also optimize the end-to-end customer experience. It has been a very busy first half. We are laser focused on cash. We have reset the brand. Our go-to-market strategy leaves us well placed to grow instructions in a profitable way. And we have started work to diversify revenue streams by launching our mortgage business, and we continue to raise standards across the business. And amongst all of this, we have made significant progress on defining the strategy for FY '24 and beyond, which I look forward to sharing with you at year-end. I have built a strong team who like me are energized by the challenge to return Purplebricks to a profitable business and quickly. Thank you. We are available to take any questions, should you have any, we'll stay on the line for a few minutes longer. See if any questions come through.
EarningCall_1580
Good morning and welcome to the Star Group Fiscal 2022 Fourth Quarter Results 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 do note that this event is being recorded. I would now like to turn the conference over to Chris Witty, the Investor Relations Adviser. Please go ahead sir. Thank you and good morning. With me on the call today are Jeff Woosnam, President and Chief Executive Officer and Rich Ambury, Chief Financial Officer. I would now like to provide a brief Safe Harbor Statement. This conference call may include forward-looking statements that represent the company’s expectations and beliefs concerning future events that involve risks and uncertainties that may cause the company’s actual performance to be materially different from the performance indicated or implied by such statements. All statements other than statements of historical facts included in this conference call are forward-looking statements. Although the company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. Important factors that could cause actual results to differ materially from the company’s expectations are disclosed in this conference call, the company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2022, and the company’s other filings with the SEC. All subsequent written and oral forward-looking statements attributable to the company or persons acting on its behalf are expressly qualified in their entirety by the cautionary statements. Unless otherwise required by law, the company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, after the date of this conference call. I’d now like to turn the call over to Jeff Woosnam. Jeff? Thanks Chris and good morning everyone. Thank you for joining our year-end conference call. It's amazing how time passes so quickly and here we are concluding another fiscal year and at the start of a new heating season. Looking back, fiscal 2022 was certainly a year full of unique challenges including warmer than normal temperatures, product cost volatility, and higher operating expenses but one in which I believe the range of Star’s offerings, depth of our resources and dedication to customer service set us apart from our competition. During fiscal 2022, we experienced temperatures that were on average 9% warmer than normal, saw heating on oil costs on the New York Mercantile Exchange that range from a low of $2.06 per gallon to an historic high of $5.14 per gallon and paid premiums over NYMEX prices to ensure prompt delivery of heating oil product. Our product cost drove greater expenses in areas such as bad debt reserves, credit card fees, and fuel for our vehicles. In addition, like so many businesses, we face rising wage and related inflationary pressures. Despite these headwinds, we were able to deliver 110 million in adjusted EBITDA and we're successful in reducing overall net customer attrition to levels slightly below last year. We also repurchased 3 million common units during fiscal 2022 as part of our ongoing stock repurchase plan, which we believe further enhances long-term shareholder value. In addition, our acquisition program remains an important component of our growth strategy, and in total we completed five separate transactions during fiscal 2022, adding nearly 8 million gallons of heating oil volume annually. While no acquisitions were completed during the fourth quarter, we closed on two small heating oil companies after the end of the fiscal year, one in October and another in November. We've also taken steps to better position Star for the future. As part of our ongoing evaluations of our operations in core markets and the resources and capital required to optimize the company's potential, we sold our heating oil and propane assets in New Hampshire and Maine during October. Our business in these markets was small and somewhat geographically detached, making it difficult for us to achieve certain operational efficiencies and a desired level of profitability. We ultimately decided it was best to divest ourselves with these assets and direct our internal focus and capital in areas that produce greater and more consistent returns. Our long term goal of expanding our heating oil and propane business, both organically and through acquisitions, remains unchanged. To that end reducing net customer attrition continues to be a critical metric for our team. While there's still much progress to be made, I believe that this past year's net customer attrition further validates the investments we've made in improving the overall customer experience as well as the strength and appeal of Star's product offerings. I'm very proud of the way our team navigated through the external market forces we faced in fiscal 2022. Given our strong operating platform and recently expanded credit facilities, we believe Star is prepared and well positioned for the heating season ahead. So with that, I'll turn the call over to Rich to provide additional comments on the quarter and year-end results. Rich. Thanks Jeff and good morning everyone. For the fiscal 2022 fourth quarter, our home heating oil and propane volume decreased by 1.5 million gallons, or about 7% to 19 million gallons as the additional volume provided from acquisitions was more than offset by the impact of net customer attrition and other factors. Our product gross profits decreased by $2 million or 5% to $35 million due largely due to lower volume of liquid products sold. Delivery branch and G&A expenses increased by $1.4 million or just 2% to $79 million. Our net loss increased by $27 million for the quarter to $50 million as an unfavorable non-cash change in the fair value of derivative instruments of $35 million and an increase in the adjusted EBITDA loss of $3 million more than offset an increase in the company's income tax benefit of $12 million. The adjusted EBITDA loss rose by $3 million to a loss of $31 million reflecting lower sales volume, a 2.4% decline in home heating oil and propane per gallon margins, and an increase in operating cost of 2%. For fiscal 2022, our home heating oil and propane volume decreased by 10 million gallons or 3% to 296 million gallons at slightly warmer temperatures, net customer attrition, and other factors more than offset the impact from acquisitions. Temperatures in Star’s geographic areas of operations for the fiscal year were about 0.5% warmer during the prior year comparable period and 9% warmer than normal. Our product gross profit increased by 9 million or 2% as an increase in home heating oil and per gallon margins and higher motor fuel gross profit more than offset the impact from a decline in liquid products sold. Operating expenses did rise by $26 million, reflecting a $2 million lower benefit recorded on the company's weather hedge program, additional costs from acquisitions of $5 million, and an $18 million or 6% increase in expenses within the base business. As mentioned on previous calls, higher petroleum costs drove an increase in credit card fees reserved for doubtful accounts and higher vehicle fuels totaling $9 million in the aggregate. Higher medical expenses accounted for an increase of $2.5 million and other areas in the base business rose by $6.5 million or 2%. Net income declined by $52 million to $35 million as an unfavorable again, non-cash change in the fair value of derivative instruments of $53 million and a decrease in adjusted EBITDA of $17.6 million was only slightly offset by decrease in the company's income tax expense of $20 million. Adjusted EBITDA for fiscal 2022 declined by $17.6 million to $110 million as lower home heating oil and propane volumes sold and an increase in operating expenses more than offset the impact from higher per gallon margins. And now I'd like to turn the call back over to Jeff. Thanks, Rich. At this time, we'd be pleased to address any questions you may have. Joe, please open the phone lines to questions. Hi, thanks for taking my question. Can you just speak to how product margins are impacted by the absolute price level, do you see as prices rise, the ability to take more margin is diminished? No, not necessarily. It, for the most part, rising energy costs for us become a little bit of a challenge because there's greater price sensitivity, customer price sensitivity in the marketplace. So, in times like these it's very important that we employ very strong margin management. I think we've done that this year. And, I'd just like to add, even though the margins were down in the quarter, a couple of pennies, they were up for the year, which is more than -- more important they're up by $0.056 per gallon and you get into a summer quarter where you don't sell very much volume. You can easily get a $0.02 or $0.03 increase or decrease in margins. [Operator Instructions]. And this concludes our question-and-answer session. I would like to turn the conference back over to Jeff Woosnam for any closing remarks. Well, thank you for taking the time to join us today and your ongoing interest in Star Group. We look forward to sharing our 2023 fiscal first quarter results in February. In the meantime, have a wonderful holiday. Thank you everybody.
EarningCall_1581
Welcome to CalAmp's Third Quarter 2023 Financial Results Conference Call. My name is Heena and I’ll be your moderator for today’s call. [Operator Instructions] As a reminder, this call is being recorded. I would now like to introduce your host for today's conference call, Joel Achramowicz, Managing Director of Shelton Group, CalAmp Investor Relation firm. Joel, you may begin. Good afternoon, and welcome to CalAmp's fiscal third quarter 2022 financial results conference call. I'm Joel Achramowicz, Managing Director of Shelton Group, CalAmp's Investor Relations firm. With us today are CalAmp's President and Chief Executive Officer, Jeff Gardner; and Acting CFO, Cindy Zhang. Before we begin, I'd like to remind you that this call may contain forward-looking statements. While these forward-looking statements reflect CalAmp's best current judgment, they're subject to risks and uncertainties that could cause actual results to differ materially from those implied by these forward-looking projections. These risk factors are discussed in our regular SEC filings and in the earnings release issued today, which are available on our website. We undertake no obligation to revise or update any forward-looking statements to reflect future events or circumstances. Jeff will begin today's call with a review of the company's recent operational highlights, and then Cindy will provide details review of the financial results followed by a question-and-answer session. With that, it's my great pleasure to turn the call over to CalAmp's President and CEO, Jeff Gardner. Jeff, please go ahead. Thank you, Joel. And thanks to all of you for joining us on the call. Our third quarter revenue grew 8% sequentially to $78.9 million, which exceeded the high end of our expectations. This higher-than-expected revenue resulted from additional components which we secured in the spot market to meet our customer commitments. This created significant margin pressure in the quarter. But the fulfillment of these orders accomplished several objectives for both CalAmp and our customers including the avoidance of business disruption for customers affected by Verizon 3G network shut down, and it allowed the fulfillment of aged order demand for other customers. Given the unpredictable nature of component availability and pricing in the spot market, as well as the strategic importance of the conversions, the team felt it necessary to absorb the margin pressure in order to fulfill these orders. We view this situation as transitory with some continued impact in Q4, but to a much lesser extent, and then return to a more normalized level of gross margin in early next fiscal year. Cindy will discuss the financial impact of this in more detail in a moment. Turning back to our progress in the quarter, our sales team has been working very hard to convert customers to recurring contracts, while also setting the framework for securing new customers to drive our future growth. Our software and subscription services revenue in the third quarter increased 11% sequentially to a record $49.3 million. Remaining performance obligations also increased by 20% sequentially to $252 million, and the software and subscription subscribers increased 12% sequentially to 1.5 million. Notably, we converted two large customers, Michelin and Navman to recurring contracts in the quarter, along with a number of other customers. As the quarter end, we have cumulatively converted approximately 75% of eligible customers to recurring contracts, and are on track to substantially complete the conversion process for remaining customers by fiscal yearend. Other software highlights during the quarter included a software and subscription services renewal contract with our large parcels shipping customer, which is a multiyear multimillion-dollar commitment. This customer has approximately 130,000 trailers outfitted with our edge devices and industry leading telematics software platform, CalAmp Telematics Cloud. We also secured Ford, North America as a major news subscription customer during the quarter. And we launched our new GPS based vehicle tracking solution, developed in collaboration with BMW in Europe. We expect to see increasing revenue from this partnership in the quarters ahead. Much of the recent business development success has been due to the focus between our sales and marketing groups to improve our go-to-market activities led by our CRO and our CMO, this joint activity has resulted in the implementation of a lead generation program that's enabled expanded opportunities for the company sales team. This work is setting the foundation for systematically building the sales pipeline and securing new recurring customers. On the product development side, I wanted to tell you about an exciting upcoming release that will represent a major milestone for our transportation logistics strategy. Soon, we released cargo insights for tracking shipments in our CalAmp application. This will be an innovative new user experience that will be simple to use, and will make tracking and protecting assets even easier to manage. As we have shared for a long time, our industry leading CalAmp Telematics Cloud platform aggregates data from our large portfolio of edge devices and sensors installed on tractors and trailers, including those from our recent partnership with Hyundai Translead. We offer a plethora of trailer sensors for tire pressure, cargo door control, extreme temperature monitoring, tilt, shock, light and other environmental factors. The CalAmp Telematics Cloud makes it easy to access data from these many sensors through API's with 99.9% uptime in the cloud. But our new cargo insights application goes a step further, it will provide an industry first experience that presents all this insight data in a single multisided application. One that will appeal to all functional departments across the transportation and logistics industry ecosystem. CalAmp’s cargo insight is visibility into the cargo on the trailer, the vehicle and the driver. It adds critical accountability to the customer for protection against insurance claims to maintain compliance with regulations and to keep informed as each trailer of precious cargo proceeds down the highway. This new release brings our strategy to life for the benefit of our customers. Before I hand the call over to Cindy Chang, our acting CFO, I would like to take this time to thank her for her support during our CFO transition. Cindy and her team have done an exceptional job and ensured that our financial operations have been maintained with a tremendous level of detail and attention. At the same time, I'd like to welcome our new CFO, Jikun Kim who will be starting on January 9. He has a long, successful track record in executive financial management at various tech companies, including most recently as CFO of Momentus, a NASDAQ listed space infrastructure company. Prior to Momentus, he served as CFO at tech firms Formlabs, EMCORE, Merex Group and AeroVironment. Jikun received an MBA from Columbia Business School, an MS degree in electrical engineering from UCLA, and a BS degree in Electrical Engineering from the University of California at Berkeley. He'll be joining Cindy and me for the Needham Growth Conference on January 10. So those of you planning to attend that event will have a chance to meet him, even though only a few days after his start date. With that, I now pass the call over to Cindy. Thank you, Jeff. My commentary will include reference to the non-GAAP financial measures of adjusted basis net income, adjusted EBITDA and adjusted EBITDA margin, a full reconciliation of these non-GAAP measures with the closest to the corresponding GAAP basis measures is included in the press release, announcing our fiscal year 2023 third quarter earnings that was issued earlier today. As Jeff mentioned, we had a strong revenue growth in the quarter, increasing 8% to $78.9 million compared to the prior quarter, and up 15% compared to the same quarter a year ago. Software and subscription services revenue was $49.3 million, up 11% sequentially and up 35% from the prior year, representing 62% of our consolidated revenue. Both the sequential and the year-over-year growth in the software and subscription services business reflect the progress we are making converting eligible telematics device customers two recurring subscription contracts, which have contributed approximately $20 million to revenues in the quarter. At the end of the third quarter, we've converted approximately 75% of our total eligible telematics device customers and anticipate to substantially convert the remaining customers by the end of our fiscal year. In terms of performance metrics for our software and subscription services business, remaining performance obligations in the third quarter was approximately $252 million, up 20% from the prior quarter, and up 72% from the same quarter a year ago. During the quarter, our subscriber base increased to 1.5 million, up 12% sequentially, and up 44% year-over-year. Telematics products revenue in the third quarter was $29.6 million, which represented a 5% increase sequentially, and an 8% decline year-over-year. Our largest customer representative $13.2 million of revenue for the quarter, which was up from $12.4 million last quarter, but it down from $14.4 million in the same quarter a year ago. Our backlog with this customer remains solid. Consolidated gross margin in the quarter was 33.7% compared to 39.8% last quarter, and a 40.7% in the same quarter a year ago. As Jeff mentioned earlier, we had aged backlog of demand. As essential components became available in the spot market, we made a decision to incur additional costs to secure these components to fulfill critical backlog, including for those customers requiring an upgrade to 4G ahead of Verizon 3G network sunset. Some of these costs were passed on to our customers with the balance, putting short term pressure on our gross margin. This negatively affected the gross margin in quarter three by $5.7 million, or approximately 700 basis points. We anticipate gross margin to improve meaningfully in the fourth quarter driven by lower levels of spot buys and to return to normalize levels early in the next fiscal year. In the quarter, we continued our efforts to manage operating expenses and achieve operating efficiencies. As a result, third quarter non-GAAP operating expenses decreased by 6% sequentially, and a decreased by 10% over the prior year. Adjusted the EBITDA in the third quarter was a $4.7 million compared to $4.8 million in the prior quarter and $3 million in the same quarter last year. Adjusted EBITDA remained a flat sequentially reflecting lower operating expenses offset by gross margin compression. In terms of our overall liquidity position, at the end of the third quarter, we had the total cash and cash equivalents of approximately $45 million as compared to $48 million last quarter. The sequential decline in total cash and cash equivalents was due to an increase in deferred billings or unbilled receivables as a result. At November 30, 2022, there were no borrowings outstanding under our $50 million revolving line of credit, total net borrowing capacity on this line, based on eligible accounts receivable and inventory at November 30, was $36 million. Our aggregate outstanding debt is approximately $232 million, including $230 million at the 2% convertible senior notes due August 2025. In reference to our outlook for the fourth quarter of 2023, the company is maintaining its policy of not providing detailed quarterly guidance. However, given the significant volume of shipments in the third quarter, the company expects fourth quarter revenue to be relatively flat sequentially. With that, I’ll turn this call back over to Jeff, to provide some final comments. Jeff? Thank you. Cindy. And I'm proud of our team for continued progress we have made towards achieving our goal of converting all eligible customers to recurring software contracts by fiscal yearend, while continuing to secure additional new logos around the globe to drive our future growth. With that, we will now open the call to your questions. Operator? Okay, great. Thank you. Yes. Congrats on the strong revenue results there. Question on the guidance for the fourth or the notion that revenue would be, say, flat sequentially in the fourth quarter, and you talk about converting the rest of your software and subscription customers. So going from 75%, up to almost 100%. To me, that would imply some growth, at least on the software and subscription side. So should we think about software subscription growing sequentially, and the rest of the business down a little bit? Or how should I think those two, kind of -- ? Yes, thanks, Mike. Good question. So, I mean, the way we looked at it, if you look at our second half, consensus was $152 million, the spot buy allowed us to pull in some orders into the third quarter. So that's why we're talking about flat sequentially. We've done a lot of the heavy lifting on the conversions, we've just got a couple of our big customers to do in the fourth quarter, and then it would be most of our smaller customers. So in terms of the fourth quarter, we said that it would look a lot like the third quarter. But when you look at the comparison to our revenue production in the second half versus consensus, it's up quite a bit. So we're really happy about, I think two things I would also add on our new contracts for the conversions, we're getting our cash up front, which is important for long term cash flow. And put us in a better position. Remember, with all of these contracts, we're getting three-year minimum commitments from each of our customers. So really pleased that salesforce has been extremely focused on that. And long term, our goal was to build a company here that has much more predictable recurring revenue, and I think we're on track for that. Okay got it. And then, on the software subscription EBITDA margin, can you provide what that was in the quarter? I think it will, at least near 10-Q now and then what do you view as a normalized EBITDA margin for your software and subscription business? Yes, I'll start that and maybe Cindy can jump in. First of all, this is an unusual quarter with the spot buys. So looking at our gross margin this quarter does not give you a good picture of what it's going to look like long term. Longer term, all of our software and subscription businesses we believe is 50 plus percent gross margin. And when you combine that with our equipment business, which is shrinking, that we believe in the long term, we're going to move more towards that 50% range. That's our long-term goal. So again, Cindy talked about some of the expense cuts that we made in the quarter, we continue to improve the efficiency as the business as we move more towards a software company. And I think you'll see long term the margins grow from historically in the 40% range closer to the 50% range, which still remains our long-term goal. Hi, guys, thanks very much. I guess I was just curious about the backlog metrics in the company. I know you guys don't explicitly guide to backlog or talk to backlog, but maybe you can kind of give us a sense for what happened. I assume it was down sequentially. I'm just wondering if there is significant backlog left here or you've worked most of it down kind of where are you with that? And then also, I was just curious about sort of the impact you're getting from the Verizon 3G sunset, any sense for how much incremental telematics revenue you might have gotten this quarter, just as you're shipping against that opportunity? And with that, stepped down it might look like once we kind of get past that sunset. Thanks. Yes. Thanks for the call, George 0:22:17.8 or the question. In terms of our backlog, we were finally able to fulfill some of our backlog, we finally were in a position with the spot buys that I mentioned earlier, to take some of these older POs for our customers, and many of those were to support them as we move toward the Verizon transition. I think that as we -- the rise and transition being a high point for revenue, I don't really feel that way because we've been fulfilling against that for the year, there was some incremental demand this quarter. But again, I think as we convert our business, convert our existing customers to 4G, it puts our salesforce in a better position to sell our software and subscription services revenue. So I don't feel like we had some, a natural demand driven by the 4G, we've been filling against that all year. And we're anxious to get our transformation step one was to convert the base. We're almost there. We're going to get there in the fourth quarter. And then I'm really excited about our ability to fill against our transportation and logistics and enterprise fleet opportunities, which are more full stack solutions with higher ARPU in 2024 and beyond. Hi, this is Clay Williams on for Jerry. Just a going back to the long-term target of 50% gross margin. Can you kind of help us think about the timing and trajectory to get there as you continue to expand the install base? Yes, Clay, we're going to make significant progress next year, when you look at, look at the fact that we did 62% S&SS, this quarter. And at the same time, as we're seeing that growth in software, and subscription services, we're seeing very good improvement in our costs. We've been really working hard on our cost structure. I believe Cindy talked about 6% down sequentially, and 10% down year-over-year. That's a reflection of this company transforming into a software company. And so I think that it's hard to get, to give you specific guidance as to when we get the 50% but we definitely think we'll make significant progress, we are well set up for that to make progress towards that goal in fiscal year ‘24, which begins in March of 2023. No, thank you. And a quick follow up on the -- on subscriber growth. As you mentioned, we are going towards that are coming to the end of the conversions here at the end of the year. How should we think about subscriber growth longer in ‘23, annual and longer term. Thank you. Yes, So, yes, it's been a banner year for subscriber growth. And a lot of that's had to do with our conversion to a subscription model getting our customers on our device management platform. That's been really good. I think what our investors have to look forward to is maybe slightly slower growth in 2024, in terms of absolute subscriber growth, but much higher growth in terms of ARPU, as we add more full stack solution customers, enterprise fleet, transportation logistics, what I'm excited about is when I talked to my sales leader, Brennan Carson, who's brought in a lot of domain expertise in terms of transportation, logistics, and enterprise fleet, why we're doing these conversions, we're building a really excellent pipeline for future growth, and those are at much higher ARPU. So again, I think you'll see slightly slower growth in terms of absolute subscribers, but at much higher ARPU. Yes, Jerry, this is Cindy, I just want to add that in the SaaS conversion deals, right, multiple deals actually are three years based, and we have a minimum guarantee with the customers. So we would, as Jeff mentioned, that we would still expect good growth in terms of a number of subscribers in the next year, next several years, right within the current arrangement. And we hope there will be more to come in the future. So we have a good confidence on the number of subscriber growth in the years to come. Hey, good afternoon. Thanks for taking my questions. And I apologize for my earlier technical difficulties. Hey, a couple of quick clarifications, I'm not sure if I heard an OEM mix number. I heard a Caterpillar number. But I was wondering if there was a total OEM number that you provided. And then also within the software and subscription services, big number this quarter, you did sign some other extensions on some existing customer contracts. I am wondering if there were any larger one-time benefits in there. If you could break that out, then I had a couple follow ups on gross margin front. You can handle the rest. So, Scott, the OEM in the past, like in the past a couple of years, we had multiple customers there, Caterpillar is one of the biggest one, we actually successfully converted some of the core OEM customers into a SaaS business already in the past one year. So the leading customer or almost the major customer in this OEM category is caterpillar. So the Caterpillar revenue is honestly is very, very representative of the total OEM business revenue. So specifically, for quarter three, the total OEM revenue was about $13.5 million with a Cat added $13.2 million there. And as we mentioned, the demand with this customer remains solid, and we do hope we can continue to grow the business when our supplies continue to support. And then, yes, thanks, Cindy. That was great answer. And on the software side, we did have some big conversions. We had a very successful quarter, getting Micheline and Navman. Two of our top six customers converted so that helped a lot. We also in addition to the large parcel delivery company that we mentioned, multiyear, multimillion dollar contract. We also signed another extension for Commonwealth of Pennsylvania, another large enterprise fleet customer that delivers millions, multimillion dollar revenue each year. So, I mean, you're, I think you're seeing some very good things with respect to Brennan Carson, our Chief Revenue Officer has been here for about six months. He ceded his sales leadership with an extensive amount of domain knowledge. And I can see our pipeline growing each and every quarter. So, yes, you It was a great quarter with good numbers. But, I mean, we want to keep putting up those kinds of numbers going forward, Scott. And that's really what this transformation is all about. Hey, Jeff, but just to clarify in terms of that $49 million, are there one time software sales in there, or any sort of large component that's one time that we should not expect to be recurring as we go into future quarters? I don't believe so. I mean, it's pretty much our normal mix. So, yes, I don't think there's any large one time in there, that would be unusual that we need to call out so that you can model going forward. Okay, very helpful. Lastly if I could on the gross margin front, I want to make sure to clarify a couple of numbers, I thought it was $5.7 million, in terms of the negative cost related to the product fronts of 700 basis points overall, from a gross margin standpoint, just want to clarify that number. And then the recovery. It sounds like you're recovering in the immediate quarter. Can you give us some idea as to the magnitude of that recovery? And you talk about normalizing I think, in most last two to four quarters normalized, I think has been more in the 28% to maybe 30% plus range on the product front. Is that where we're going to in the first half of fiscal ‘24? Thanks. Yes. I mean, what was unique about the third quarter, we had an unprecedented level of spot buy opportunities. How should investors think about that, I'll tell you how we think about it as the supply chain continues to improve. The first sign of that is the spot buy opportunities, right. So these are customers who didn't use their full allocation who sold their product to these brokers and made it available in smart market. So I think long term, what we see and into the first quarter, as we look at our forecast, that our allocations are improving, we're seeing our vendors really step up in terms of providing extra capacity. Both we've got one of our contract manufacturers, expanding their production into Vietnam, bringing on new capacity, and we got Texas Instruments building some capacity in the US, which is also going to allow us to source more in the normal markets, not with a spot buy opportunity. So that means good things in terms of margin. In terms of the fourth quarter, I think the recovery, we said we're going to see a significant or meaningful recovery in the fourth quarter. That means on two fronts, because when you talk about the spot buy there's two parts of it. One is how much do we pass on to our customers, and what are the spot buy opportunities, so we believe our spot buy activity will be much less even as much as half as much as the first quarter. And we'll be able to pass on more to our customers as we've kind of worked through this, we were under an extraordinary amount of pressure in the third quarter because of the impending transition. So now that's going to be falling away, we're in a much better position to work with our customers on this to find the best way to bring on this additional volume. What I'm really pleased about I think we earned a tremendous amount of goodwill for our key customers, some of which had orders that were as old as six or nine months outstanding, to deliver 4G product to them in advance to the January 1, Verizon shut down. Hey, Jeff, quickly, if I could follow up on the front, it looks like you added about 150,000 customers sequentially, which is a pretty big number. Part of that is the ongoing 3G to 4G migration. I want to say that the existing base that we needed to be converted over was somewhere in the ballpark of 200,000 or so. Is that correct? And so then, kind of using straight line math, maybe rounding a little bit, that non 3G upgrade customers are somewhere in the 50,000 to 75,000 plus kind of net additions in the quarter. Is that the way to think about the non-end of life 3G contribution? Well, we think the customers that we delivered, that's a complicated question. But we believe that I believe the numbers were something like 80,000 to 100,000 of product that we delivered to serve our customers who needed to do the 4G transition, or in other words, they needed to get that product before the Verizon cut over so the balance would be more traditional. We, our shipments increased about 25% in the quarter. And so most of that was not this 3G. I mean, some of it was the incremental part but still had very strong shipments across the board to our customers as supply Chain improved. Now it improved because of the spot market this quarter. But we expect that improvement to continue into the fourth quarter in fiscal year ‘24. Scott, I want to add, yes, I just want to add a little more color. Well, we made a decision to do spot buys in quarter three, actually majority of the spot buy expenses, which was support our telematics products business, right, as you can see from the 10-Q, we filed our actually, TS, telematics product business gotten harder on gross margin. So when we report our number of subscribers, it was -- it's actually more related to our SaaS business. We think the SaaS business, actually, in terms of the subscriber growth, we can still talk about the 80:20 rule, right? 80% of the subscriber growth is driven by the SaaS conversion, 20% is driven by new logos and renewals, et cetera. So the point is, the 3G, 4G that impact actually was more towards our telematics products, but in our subscriber business, it is actually more very active support to the new customers, we just converted. There are no additional questions waiting at this time. So I would like to turn the call over to Jeff Gardner for any further remarks. Well, thank you. And thank you for joining us on the call today. And for your continued interest in CalAmp. As I mentioned earlier, we will be attending the Needham Growth Conference again in January in New York, but this time in person, so that'll be nice. So please feel free to schedule a meeting with us if you're planning to attend. We look forward to sharing our progress with you during our fourth quarter of 2023 earnings calls in April of next year. We hope you all have a wonderful holiday season and appreciate your time today. Operator, you may now disconnect the call.
EarningCall_1582
Welcome to the Liquidity Services, Inc. Fourth Quarter of Fiscal Year 2022 Financial Results Conference Call. My name is Carmen and I will be your host for today's call. Please note that this conference call is being recorded. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. On the call today are Bill Angrick, Liquidity Services' Chairman and Chief Executive Officer; and Jorge Celaya, its Executive Vice President and Chief Financial Officer. They will be available for questions after their prepared remarks. The following discussion and responses to your questions reflect Liquidity Services management's view as of today, December 8, 2022 and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact the financial results is included in today's press release and in filings with the SEC, including the most recent Annual Report on Form 10-K. As you listen to today's call, please have the press release in front of you, which includes Liquidity Services' financial results as well as metrics and commentary on the quarter. During this call, Liquidity Services management will discuss certain non-GAAP financial measures in its press release and filings with the SEC, each of which is posted on its website. You will find additional disclosures regarding these non-GAAP measures, including the reconciliations of these measures with the comparable GAAP measures as available. Liquidity Services management also use certain supplemental operating data as a measure of certain components of operating performance, which they also believe is useful for management and investors. The supplemental operating data includes gross merchandise volume and should not be considered as substitute for or superior to GAAP results. Good morning, and welcome to our Q4 earnings call. I'll review our Q4 performance and the progress of our business, and next, Jorge will provide more details on the quarter. We delivered strong EPS and adjusted EBITDA results during the quarter despite macro challenges, which limited the supply of vehicles in our marketplace. This performance reflects our efficient business model and diversified client portfolio. During Q4, the strength of our buyer liquidity and a recessionary environment was on display as the number of auction participants and registered buyers on our platform grew 34% and 24% year-over-year, respectively. For the full year fiscal 2022, we generated a record number of auction participants and completed transactions on our platform, which provided outstanding results for our sellers. We estimate that the lack of vehicles for our customers' fleet replacement cycles reduced our GMV by $10 million during the quarter. This combined with abnormally low conversion rates on share of sales in our government real estate vertical resulted in lower than expected GMV during Q4. While these are currently headwinds, we expect these trends to normalize and boost our business as we move through 2023. For our full fiscal year 2022, we're proud of the focus and execution of our team. We continue to advance our strategic and operational objectives, which translated into a record $1.1 billion of GMV, up 29% over the prior year, GAAP net income of $40.3 million and $42.7 million non-GAAP adjusted EBITDA. We also grew our registered buyer base to a record 4.9 million reflecting strong interest in our circular economy platform during this inflationary environment. As we commence fiscal year 2023, we remain focused on expanding our mindshare and position with commercial and government clients as the most trusted marketplace to manage value and sell surplus assets in the circular economy. Despite near term headwinds in vehicle supply, we have a strong business pipeline and continue to see opportunities to reach $1.5 billion in annualized GMV and expand our technology enabled asset-light services to drive long-term shareholder value. Our expertise in diverse sectors, strong buyer base across numerous asset categories and global reach are continuing to provide advantages for our clients as they navigate this current volatile macro environment. Let's take a closer look at the progress of each of our segments and how we are driving market share expansion. Our GovDeals segment is making excellent progress in expanding the growth in activity of customers on its marketplace. We continue to grow the number of new accounts and number of assets sold in the mid to high-single digit percentages each quarter despite the current headwinds of lower vehicle supply. In fact, we set new records for these metrics during Q4. Additionally, we continue to make progress penetrating our GovDeals customer relationships as a one stop solution for all asset sales, including their highest value assets. For example, since fiscal '20, our GMV per seller and a number of assets sold per seller on GovDeals have grown 44% and 19%, respectively. We're also committed to the relentless improvement of our platform and we'll be launching the next generation of our GovDeals marketplace in 2023. The beta version of our new GovDeals marketplace was shared with select bidders in Q4 and was extremely well received, resulting in a 2 times increase in our customer net promoter score. This bodes well for the future and we expect our modernized GovDeals platform and introduction of more data driven features will increase our recovery rates and lift GovDeals' GMV materially over time. As client vehicle replenishment cycles normalize, federal infrastructure spending takes hold and we continue our pace of account acquisition, we see the opportunity to significantly grow the size of our GovDeals business over the next three to five years. In our Retail segment, our flexible service offerings have been well received by the marketplace as customers utilize both self-directed and fully managed solutions, leveraging our distribution center network to reduce supply chain costs and the sale of returns and shelf-pulled goods. Whilst some clients have held onto returned inventory to offer customers compelling early holiday deals, we have a strong new business pipeline and have won several new programs in the big box, omnichannel and pharmacy sectors, which has continued to diversify and grow our business portfolio in the Retail segment. Our Retail segment has a large market opportunity driven by strong secular growth in the volume of return merchandise as customers continue to embrace online retail. For example, according to the National Retail Federation, retailers expect about 18% or $158 billion of merchandise sold during the holiday shopping season to be returned. Our value-added services, in particular, have been highly prized by our Retail segment customers as they help our clients reduce their supply chain costs. Current results reflect that we are still early on and fully leveraging the investments we have made in three new distribution center facilities. We expect retail segment margins to improve as we further leverage this added operational capacity and drive productivity gains. Our CAG segment continues to play the role of a trusted global market maker for a high value equipment in the industrial supply chain. Our ability to support cross-border transactions and financial settlements among counterparties has been increasingly valued given the broad application and demand for the industrial assets we sell. For example, in a recent auction for biopharma assets in Europe for multiple Fortune 500 clients, we had over 100 bidders from 27 countries, including 17 bidders from China, where 60% of the assets were ultimately sold. Our global reach was critical to getting our sellers the best execution. Indeed, our CAG solutions are well positioned to help industrial companies who are in a cost savings mode, manage through the current recessionary environment. We anticipate growth in the energy, biopharma and automotive verticals, in particular, and we have landed new mandates with major companies in these areas. As COVID restrictions loosen in China, we have attractive growth opportunities in the APAC region, which have been limited recently. Finally, our CAG heavy equipment fleet category has strong upside potential. We grew our consignment heavy equipment vertical 36% year-over-year in fiscal 2022 and finished the year ahead of plan for signed contract, new sellers, transacted opportunities and net new revenue. Finally, our Machinio segment continues to scale nicely with expanded coverage in more equipment categories and related services such as financing. We believe our Machinio digital advertising and storefronts solution offers business customers cost savings and convenience that are well suited to a recessionary environment. We have recently launched a self-directed auction for smaller dealer customers to list their equipment directly on the Machinio marketplace and we're also offering transaction based services to Machinio customers to unlock valuable liquidity for sellers. Finally, we've opened a new Machinio sales office in China and believe there is a significant growth opportunity for our Machinio classifieds marketplace and storefront platform in the China market over time. In conclusion, we are focused on executing multiple drivers to create value for our shareholders over time. We've continued to enhance our brand awareness in the marketplace and plan to double our core business over the next three to five years, which will be aided by the normalization of supply chains and our leverage of the fixed investments we've made in sales, branding and marketing, technology and operational capacity. Moreover, our capital efficient business with a strong operating cash flow, $98 million in cash and zero debt, provides us with ample flexibility to execute our plans. We've increased our authorized share repurchase capacity to $15 million and we will continue to deploy our capital on organic growth initiatives, share buybacks and tuck-in acquisitions. In closing, we thank our team members across Liquidity Services for their dedication to our mission to power the circular economy to benefit sellers, buyers and the planet. Good morning. We completed the fourth quarter of fiscal year 2022 with $283.3 million in GMV, which was up 16% from $244.4 million in the same quarter last year. Revenue for this fiscal fourth quarter was $75.2 million, up 7% from $70.3 million in the same quarter last year and includes the completion of a high purchase transaction volume by our CAG segment. As a reminder, for our business model trend, higher growth of consignment, including growth in the real estate sector will lower our ratio of revenue as a percent of GMV and cause revenue to grow at a slower rate percent than GMV. This trend can be impacted in the reverse in any period where higher purchase transactions occur. Specifically comparing segment results for this fourth quarter to the same quarter last year, our GovDeals segment was up 20% on GMV and 8% on revenue, including Bid4Assets. Our Retail RSCG segment was up 10% on GMV and up 6% on revenue. And our CAG segment was up 13% on GMV and up 6% on revenue, reflecting an increase in sales conducted with partner organizations that are fully reflected in GMV. Machinio revenue was up 18%. GAAP net income for this fourth quarter was $8.3 million resulting in diluted GAAP earnings per share of $0.25. This includes a $4.5 million, or $0.14 per share non-cash gain from the reduction in fair value of the Bid4Assets earn-out liability as the expectation of the timing of real estate asset flows continued to shift outside of the earn-out period. Non-GAAP adjusted EPS for the fourth quarter was $0.19, including approximately $0.03 of unfavorable impact to tax expense in the quarter for estimates of stock-based and other variable compensation. The total year 2022 effective tax rate was 15% on GAAP net income reflecting the non-taxable earn-out gain and 32% for adjusted net income. Non-GAAP adjusted EBITDA was $12.3 million, up from the same quarter last year, primarily due to the higher revenue and reduced variable compensation expense versus the fourth quarter of last year to close out fiscal year 2022. This was partly offset by a lower average segment gross profit margin in CAG on its higher mix of purchase activity this quarter and the increased sales operations and technology expenses compared to a year ago. We hold $97.9 million in cash, cash equivalents and short-term investments. We have generated operating cash flows of $44.8 million and performed $25.4 million of share repurchases on a trailing 12 month basis. We have zero debt and $25 million of available borrowing capacity under our credit facility. In the near term, our quarterly results can experience uncertainty in predictability as the current macroeconomic environment lends itself to hesitation by sellers and buyers in the timing of transactions for surplus assets in any given period. As clarity over the direction or severity of global economic challenges unfold, we would anticipate having better visibility on growth in the short-term. As a company, we are confident in our business model and strategic direction. Our results in terms of revenue, profitability and cash have remained solid even during these turbulent times. Our first quarter of fiscal year 2023 guidance range for GMV is above the same period last year with year-over-year growth expected across our segments. Relative to the fourth quarter of fiscal year '22 sequentially, seasonality is a factor as GovDeals' GMV may experience a seasonal decline sequentially going into this next fiscal first quarter. Despite the expected year-over-year improvements in volume and buyer and seller activity, we also expect CAG GMV to decline sequentially on lower purchase transaction volume completed during this last fourth quarter of fiscal year '22. GovDeals is also experiencing continued headwinds from vehicle sales in both volume and pricing given constraints on sales of new vehicles that are resulting in a dampening of availability of used vehicles for sale. However, heavy equipment assets in both GovDeals and CAG remain robust. The Retail segment expects to continue to diversify its seller base, transitioning product flows in terms of sellers and categories. Overall, the company sees opportunities to gain market share across our segments. Our profit guidance for the first quarter of fiscal year 2023 reflects expected year-over-year top line growth with higher labor costs and inclusive of increased sales technology and operations expense to support growth during 2023 across our segments. We expect that our effective tax rate overall during fiscal year 2023 will remain at approximately 30%. Management guidance for the first quarter of fiscal year '23 is as follows. We expect GMV to range from $265 million to $295 million. GAAP net income is expected in the range of $1 million to $4 million with a corresponding GAAP diluted earnings per share range from $0.03 to $0.12 per share. We estimate non-GAAP adjusted EBITDA to range from $7 million to $10 million. Non-GAAP adjusted diluted earnings per share is estimated in the range of $0.09 to $0.18 per share. And the GAAP and non-GAAP EPS guidance assumes that we have between 33.5 million and 34 million fully diluted weighted average shares outstanding for the first quarter of fiscal year '23. Hi. Good morning, everyone. Hey, Bill. Couple of things here. Number one, you talked about the GMV being less than or being hit by headwinds on the vehicle side $10 million, and then you mentioned lower conversion rates on real estate. Is that a function of higher rates and sellers -- buyers and sellers not coming together on an agreed upon price? I mean, was the potential flow through of real estate where you thought it was going to be or the potential GMV post transaction completion? Regarding the comment on the government real estate vertical, what we've observed, Gary, is that local counties have made decisions to defer share of sales in part due to consumer friendly advocacy, which is highlighting some residual COVID policies to allow people to get back current with their real estate forbearance or current recessionary pressures giving policy positions to defer some of these sales. We think that is likely to normalize and reverse in 2023, and, therefore, the sales will happen. So it's not a bid ask spread issue. It's really a policy position where people have held back the sales to allow them to become pay-off by the individual borrowers or owners. The other thing I would note in the real estate area is, we have a very good pipeline and we have contracts that have been awarded that just haven't been implemented yet, and I think there has been somewhat of a backlog and how government agencies have been able to process their business. So again, part of a larger picture for us is that we do think these things, this logjam will clear out in 2023 and that will give us more visibility and actual GMV traction in the real estate vertical. The vehicles is a well-known industry wide phenomenon. We've had conversations with our government clients, our commercial clients. There is significant backlog in how OEMs have been working their backlog down. According to a municipal fleet agency, they have said to us, there is at least 5 million orders on the books for vehicles that have been backlogged industry wide. So it gives you a sense of the order of magnitude that agencies and commercial owners, they want the vehicles, they have the money for the vehicles, it's just they're not being produced at the rate that fulfill their demand. And so as that flips from a headwind to a tailwind at some point, we think we'll benefit from it. Okay. And then, could you talk a little bit about this next generation launch for the GovDeals business? What is different in that new, I guess, it's a new product website that you planning out there? Yeah. No, that's a great question, and I think it's a very important thing. The GovDeals user experience on the front end has been largely intact for over a decade, and there's a lot of functionality there, but it is not at the same level responsive design and data driven search and one-to-one marketing as you would see on our AllSurplus platform. And therefore, it's really about the front end user experience, it's about the taxonomy and the path to purchase being improved, it's about putting artificial intelligence tools in place like we have in our AllSurplus marketplace to guide buyers to the right assets quickly. We think it's going to improve better participation and we think it's going to improve the ultimate GMV realized, all things equal, for everything we sell and the leverage there is meaningful because it's a good-sized marketplace. And we've got our beta in the hands of our test customers already, phenomenal feedback. As I mentioned, our net promoter score for those that have used the new site more than doubled, which is rare. So we think as that unfolds in 2023, it's just going to improve the path to purchase and the bidding activity and will improve pricing realized for the assets we sell for our government clients on GovDeals. Thank you. Bill, I'm curious, as you look at your retail segment, what is the ideal economic scenario for you to see success there in your view? Well, in terms of the macro trends, one, you want to have robust growth in online sales -- online retail. We think that's a well-entrenched habits among consumers and we think that as a secular growth area in the economy. And that is the catalyst for our business, because the more that's sold online, as I noted, the NRF data, the more that's going to be returned, so over $150 billion of return system in the holiday season. So that's a good thing. I think bargain hunting kind of environments are the good thing on the buyer side. So when we have a little bit of a ripple around recession, buyers are looking for deals. So they're going to be looking to save money and our buyer base has been very active, as I noted on our metrics. I think that's a positive. In terms of the retailers themselves, I think retailers are kind of balancing wanting to have good deals and stock and we all got emails probably in October for holiday sales. So they pulled forward a lot of those Black Friday concepts earlier in the year. So they were holding some inventory maybe that they would have otherwise liquidated. But I think as you get out of the holiday season, you're going to see normalization of flows into our reverse supply chain, and I think retailers are going to be looking to be continuing to invest in omnichannel experiences, continuing to invest in convenience through their core e-commerce platforms. I think the consumer -- the Bank of America data that came out says that consumers still have more savings than they had pre-pandemic. So it seems like the consumer is holding up. I think that's net positive for the retail environment. And ultimately, we think that's helpful for us, the more spending on goods, the better we -- we have commented, George, how during the course of 2022 people have shifted their behavior from buying goods to buying services and experiences. So that affected retail at large in some of their same-store sales activity. And I commented earlier in the year that we feel like that's going to reverse and people will normalize their spending behavior in 2023.So I don't have the crystal ball, are we going to have a soft landing as the Fed tightens or something that's a little harsher. We would like to see more of a soft landing. We'd like to see the consumer continue to have discretionary savings and continue to normalize to where they were in early 2022. But even in the recession environment, our bargain frugal buyer base is a very strong competitive advantage. And I think if retailers have to cut costs and hollow out their corporate resources, they'll be more reliant on value-added services and facilities that Liquidity Services offer. So we think we're well positioned there. Looking at the vehicles supply side, in a very hypothetical admittedly scenario of Carvana, which could end up liquidating, not making a prediction just it's a scenario suggestion, what would that potentially do for your business? Correct. If there is a whole lot of additional vehicles all of a sudden on the market from a supply perspective, what would that do for you? Well, we -- yeah, well, I can tell you that we've had conversations with wholesale automotive dealers who are looking, in many cases, for the first time to utilize our marketplace platform and create a new channel for Liquidity. If vehicles are sitting unsold, that's not a good thing for these automotive wholesale dealerships. So we present our marketplaces another avenue for that asset class to be monetized, and we sell, as you know, a lot of vehicles in the used market and that Liquidity is an asset for anyone looking to manage their balance sheet in the vehicle industry. Got you. And last question, I don't know if it was simply a throwaway line in your text, but you mentioned expanding mindshare with customers this year and that being a focus. Could you walk through how you're planning to expand that mindshare? Give us a little bit of a sense of the marketing plans. Sure. Well, we've invested in expanding our corporate communications team to do, I think, very targeted brand awareness campaigns with these large corporate clients, and in many cases, government organizations to bring them the receipts, if you will, on the work that we've done, the actual transactions that we've completed. the case studies, the recovery that we generate. And so its content that's created and then delivered through very targeted communication to influencers and decision makers that may not necessarily be direct clients of ours, but have oversight of the supply chain, operations, the CFO's office, the compliance office within global manufacturers, global retailers, government agencies and that might be delivered digitally, and it might deliver you to a case study or landing page and allow you to learn more. We also have industry specific insights that we're delivering, for example, in automotive, energy and biopharma that gives you I think relevant data on the market making activity in those areas. So if you're CFO, I think it's really helpful to know what amount of balance sheet can I monetize to raise capital in a period where maybe we have to pull back some of our spending. I think that's been well received. We also have presence as a thought leader and speaker in a number of government industry associations. We have national cooperative arrangements directly as a result of these efforts. So we are really just linking the data of our marketplace with insights and delivering that in a scalable way through a lot of digital marketing activities and we do have recognition happening, George, through sustainability awards, through vendor excellence awards with many of our clients, and those are shared through more of a traditional corporate communications, press release format. So just to be clear, and just my final question, relative to spending for this objective, none of this sounds expensive. This seems simply leveraging of your existing data more so than anything. There was no needing to walk into Jorge's office for more dollars to achieve this. Hi. Just a couple of questions picking up on that last thought process. I mean, last year, you said, you were going through a -- another kind of spending investment on sales, technology et cetera. Is that really about over in terms of having to add more people, put more power behind your technology initiatives? I mean, your sales were up 8% last year. If you back out the reversal of the earn-out, it looks like your overall expenses were up about 11%. So I just want to get an idea as we go forward, can we expect to see more of an equilibrium or even maybe sales growth that would be in excess of the OpEx expenses in fiscal '23? In terms of the investments in expanding staff and operational capacity, you're correct, we took a step-up in fiscal '22. We will not see the same step function growth in the period in 2023. I mentioned, we have three new facilities that we funded essentially over a 12 month period to support demand in the Retail segment in terms of the sales team and coverage. We still feel like we're under penetrated, Gary, in many regions of the country. And it is an e-commerce platform, but we also know that having access to our team and our insights, that's helpful in attracting new clients and organizations, both in the government market and the commercial market. So areas like Florida, Southeast region, which has had a huge migration in terms of population, and therefore, flush with municipal revenues, that's an area that's under penetrated for us. So we are going to continue to find ways to serve those areas. But we don't -- in terms of rate of growth of spend, that will moderate. And when I talked about the GovDeals monetization, we're leveraging technologies that we've already deployed to other places within Liquidity Services. So it's not a massive undertaking for us in terms of costs. And it's an interesting time when you look at the amount of technology talent that's now in the marketplace. You've had massive layoffs in many of the big tech world. So we're always looking to be prudent and acquisitive if we can get great engineering talent through direct hires or outbound hires, but we don't see structurally any major step function increases in our spending. Thank you. And I'm not showing any further questions at this time. Thank you, ladies and gentlemen. This concludes today's call. Thank you for participating and you may now disconnect.
EarningCall_1583
Good morning and welcome to the Worthington Industries Second Quarter Fiscal 2023 Earnings Conference Call. All participants will be able to listen-only until the question-and-answer session of the call. This conference is being recorded at the request of Worthington Industries. If anyone objects, you may disconnect at this time. Thank you, Chris. Good morning, everyone and welcome to Worthington Industries second quarter fiscal 2023 earnings call. On our call today, we have Andy Rose, Worthington's President and Chief Executive Officer; Joe Hayek, Worthington’s Chief Financial Officer; and Geoff Gilmore, Worthington’s Chief Operating Officer. Before we get started, I’d like to remind everyone that certain statements made today are forward-looking within the meaning of the 1995 Private Securities Litigation Reform Act. These statements are subject to risks and uncertainties that could cause actual results to differ from those suggested. We issued our earnings release yesterday after the market close. Please refer to it for more detail on those factors that could cause actual results to differ materially. Today’s call is being recorded and a replay will be made available later on our worthingtonindustries.com website. Thank you, Marcus and good morning everyone. I will go over the consolidated results and provide some additional color on the building products, consumer products and sustainable energy solutions businesses and then Geoff Gilmore will go through Steel’s results. Geoff, as many of you know, is our current Chief Operating Officer and will be the CEO of the Steel business when we complete the planned separation of our businesses. In Q2, we reported earnings of $0.33 a share versus $2.15 a share in the prior year quarter. There were some unique items that impacted the quarterly results, including the following. We incurred pre-tax expenses of $9 million or $0.14 a share related to the planned separation of our steel processing business, which we expect to complete by early calendar 2024. We will quantify those costs each quarter going forward until the contemplated separation is complete. We also recognized incremental expenses of $0.01 per share related to our recent acquisition of Level5 tools and the earn-out associated with that acquisition. And finally, we benefited by $0.04 a share due to restructuring gains associated with the divestiture of our WSP joint venture’s last remaining steel processing facility. This compared to restructuring gains of $0.03 a share in the prior year quarter. Excluding these unique items, we generated earnings of $0.44 a share in the current quarter compared to $2.12 a share in the prior year. In addition, in Q2, we had inventory holding losses estimated to be $53 million or $0.81 a share compared to inventory holding gains of $42 million or $0.61 a share in the prior year quarter, an unfavorable swing of $95 million, which is $1.42 a share. Consolidated net sales in the quarter of $1.2 billion decreased 5% from the prior year, primarily due to the lower average selling prices in Steel Processing, combined with lower volumes partially offset by the inclusion of Tempel Steel. Our gross profit for the quarter decreased to $106 million from $185 million in the prior year and gross margin was 9% versus 15% primarily due to the swing from inventory holding gains to losses in steel processing. Our adjusted EBITDA in Q2 was $64 million down from $168 million in Q2 of last year and our trailing 12-month adjusted EBITDA is now $455 million. With respect to cash flows and our balance sheet, cash flow from operations was $133 million in the quarter and free cash flow was $108 million. We have generated over $360 million in free cash flows in the last 12 months. During the quarter, we invested $24 million on capital projects, paid $15 million in dividends, received $24 million in proceeds from asset sales, and received $55 million in dividends from our unconsolidated JVs. Like in Q1, the dividends we received from our unconsolidated JVs exceeded their equity earnings during the quarter as their working capital levels have normalized, allowing them to payout earnings that were not distributed in the prior fiscal year. Looking at our balance sheet and liquidity position, funded debt at quarter end of $699 million decreased $7 million sequentially and interest expense was down $1 million also on a sequential basis. We are operating with low leverage and our net debt to trailing EBITDA leverage ratio is roughly 1.25x. We also have ample liquidity and ended Q2 with $130 million in cash and $675 million in availability under our revolving credit facilities. Yesterday, the Board declared a dividend of $0.31 per share for the quarter, which is payable in March of 2023. We will now spend a few minutes on each of the businesses. In Consumer Products, net sales in Q2 of $154 million, up 9% from $141 million in the prior year quarter. The increase was driven by higher average selling prices, which were partially offset by lower volumes. Adjusted EBIT for the consumer business was $13 million in the quarter and EBIT margin was just under 9% compared to $18 million and 12.5% last year. There were two primary drivers for the decline in consumers’ profitability. First, retail sales slowed, not materially, but it is clear that consumers are watching their discretionary spending. In addition and more impactfully, our retail customers reduced their inventory levels during the quarter. The result was a significant decline in customer orders, which led to lower volumes and lower fixed cost absorption. In addition, the quarter was negatively impacted by $1 million of expenses related to our acquisition of Level5, including the write-up of inventory to fair market value. While the quarterly results for the consumer business were not as strong as we would have liked, our team continues to do an excellent job of managing through a challenging environment. Additionally, we have started to see customer inventory levels stabilize, which we believe will lead to more seasonally normal volumes going forward. Building Products generated net sales of $142 million in Q2, up 17% from $121 million in the prior year quarter. The increase was driven by higher average selling prices, which were partially offset by slightly low overall volumes. Adjusted EBIT for Building Products was $41 million in the quarter and adjusted EBIT margin was 29% compared to $55 million and 45% in Q2 of last year. The decrease in EBIT and margin was primarily driven by lower equity earnings in our ClarkDietrich and WAVE joint ventures, which were down $11.4 million and $3.4 million respectively compared to very strong results in the prior year quarter. This softness was partially offset by improvements in our wholly owned businesses, which saw operating income increase $1.4 million or 31% year-over-year due to higher average selling prices and a favorable product mix. Similar to what we saw in Consumer, many of our product lines in Building Products saw customers decrease their orders due to higher-than-optimal inventory levels. In 2021 and early 2022, when supply chains were uncertain and tight and demand from end users continued to grow, many of our customers ordered at or above their expected demand levels. And those same customers are now rationalizing their on-hand inventories while demand has moderated with the economy. While the demand outlook is unique by end market and will be impacted by the broader economy, our team continues to execute at a very high level. And we believe that as customer inventory levels stabilize, we will see a return to more seasonally normal demand trends. In Sustainable Energy Solutions, net sales in Q2 of $38 million were up 15% compared to $33 million in the prior year quarter due to increased volumes and higher average selling prices. The business generated adjusted EBIT of $1 million in the current quarter, which was up slightly from the prior year as the favorable impact of higher average selling prices was partially offset by higher production costs. Despite a continued challenging operating environment in Europe, that team continues to do an excellent job executing, we remain very optimistic about the hydrogen and alt fuels ecosystems and our SES business. Thanks, Joe. In Steel Processing, net sales of $842 million were down 10% from $938 million in Q2 of last year, primarily due to lower average selling prices and lower volumes, which were partially offset by the inclusion of the Tempel Steel acquisition. Steel prices peaked in the latter half of 2021 at over $1,900 per ton. And recently, we’re trading under $700 per ton. Our total shipped tons were down 13% compared to last year’s second quarter, driven primarily by lower tolling volume with the mills and the exit of our consolidated JV, WSP. Direct tons in Q2 were relatively flat compared to the prior year quarter and were 54% of the mix compared to 47% in the prior year quarter. From a demand perspective, we continue to see stability and signs of growth in automotive, but did experience some weakness in our construction end market demand, which has been impacted by the slowdown in both residential and non-residential construction. In Q2, Steel reported an adjusted EBIT loss of $17 million compared to a $72 million gain in the prior year quarter. The large year-over-year decrease was driven by lower direct spreads, which were negatively impacted by the inventory holding losses that Joe mentioned earlier, estimated to be $53 million in the quarter compared to $42 million last year, an unfavorable swing of $95 million. Though steel prices have stabilized because of lag in price indices, we anticipate we will see moderate inventory holding losses in Q3, which could approximate or be slightly lower than the loss we reported in Q3 of fiscal year 2022, which was $25 million. It’s been 1 year since we purchased Tempel Steel, and it continues to prove to be an excellent addition to our steel processing business. The Tempel leadership team is doing an outstanding job managing the business and executing on strategic initiatives to meet the growing demand for increased electrification in many of our markets. Lastly, I am, so, proud of all of our teams as they remained focused on keeping our people safe and running efficient operations, all while doing an excellent job delivering for our customers. Thank you, Geoff, and good morning, everyone. Our fiscal second quarter was somewhat challenging, driven by significant steel price declines and inventory destocking at several of our larger consumer and building products customers that stockpiled product to offset supply chain challenges. These short-term trends appear to be waning. And we are optimistic that this quarter represents a trough in earnings and we will enter calendar 2023 with some solid momentum. End market demand remained steady across most of our products and markets despite the continued debate around where the economy is headed as a result of the Federal Reserve’s continued rate hikes. Higher rates will clearly impact some markets, but recall there is another $1.3 trillion of approved government investment spending from the Inflation Reduction Act, the Chips and Science Act and the Infrastructure Investment and Jobs Act underway. Some of this money will almost certainly benefit our various businesses, although the extent is hard to quantify. I want to express my gratitude for our employees who continue to go above and beyond to deliver for our customers despite the ebb and flow of input costs and supply chains. As evidence of our hard work, Worthington received three outstanding awards during the quarter. Investors’ Business Daily voted us as their top ESG Company of 2022. Newsweek named us to their list of America’s Most Responsible Companies for 2023 and Computerworld named us as the Best Place to Work in IT for 2023. All of these accomplishments reflect the strength and quality of our golden rule culture and the hard work and dedication that our employees bring to work every day. Congratulations, and thank you. Last quarter, we announced an exciting plan to separate our steel processing business into its own public company. We are calling this initiative Worthington 2024 with the goal of standing up two financially strong and strategically well-positioned companies to unleash their full potential. Our team is working hard. And we are on track to make that happen. Once complete, we will have a market-leading business in consumer products, building products and sustainable energy poised to capitalize on key trends in sustainability, technology, construction and outdoor living. With higher margins and lower asset intensity, this business should benefit from premium sector multiples. Worthington Steel is and will continue to be a best-in-class steel processor with excellent growth opportunities in automotive light-weighting and electrical steel laminations, positioned to take advantage of fast-growing trends in electrification, sustainability and infrastructure spending. In anticipation of the planned separation in early 2024, we have been strengthening our balance sheet by building cash, so that both companies have financial flexibility to maximize their potential. We do not anticipate any material changes to our modest leverage and ample liquidity mindset for both companies. And we are likely to continue with similar capital allocation strategies once the planned separation is complete. Both businesses will be run with our philosophy and golden rule principles and utilize the Worthington business system of transformation, innovation and acquisitions to drive growth and shareholder value. So while the quarter was challenging, primarily due to the rapid decline in steel prices, we are well capitalized and poised for a return to better results. Demand is solid. And when combined with our market strength and excellent teams, our future is bright. To all of our customers, suppliers, employees, shareholders and other stakeholders, I hope you share in our excitement for where we are headed. Question firstly is just on seasonality. You pointed out that there was some sizable destocking in your recent quarter, notably in your consumer businesses and then to some extent, in construction. I think the third quarter from a volume standpoint is typically a little lower than the November quarter, if I’m thinking about that correctly, or pretty in line with it. So you’re saying relative to the second quarter, we should expect that those similar seasonal patterns should play out versus where you’re at right now? I think that’s fair. I think some seasonality returns. And we do think that not 100%, but most of the destocking is done and so sequentially, we see a little bit of upside. Sorry. So seasonality is relatively flat. But consumers saw more destocking earlier. It’ll building products might take a little more time because the seasonally normal growth there on the wholly-owned businesses certainly is more like March, April, May. That makes sense. And then on the inventory swings this past quarter, you guys have called out a $50 million headwind, maybe a little bit more versus neutral. And then the impact is going to be less than half of that in the next quarter? Did I hear Geoff correctly there? Yes, Phil, this is Geoff and you heard me correctly, $53 million headwind this current quarter. And I think this quarter, probably very similar to what you saw last year, Q3, and that would be approximately $25 million. So half, thank you. And then, the last one, this is just around the separation cost this quarter, $9 million pretax, I think $9 million, $10 million. Is that the level of spend we should see over the next three or four quarters, does that take or up – take or down? Does that go up? And what are those costs largely covering right now? I think, Phil, that’s a reasonable estimate. I mean those costs are out-of-pocket, advisory fee, transaction-oriented fees. And we think those costs will be in the neighborhood, ultimately. And it will ebb and flow a little bit between now and the end of the potential separation. But $35 million to $45 million there is a good range. And then there might be some other costs associated with things that will happen down the line in terms of software, etcetera. But those shouldn’t be all that material in addition to those numbers I gave you. One cost, Phil, Joe didn’t mention is there may be some financing costs down the road, too, once we determine the capital structures of the various companies and how that might go forward. First, can you talk a little bit about what – how you see the margins developing and the non-steel processing business over the next quarter or two quarters, please? So, margin-wise, in the Consumer Products business, again, when you have destocking and you have volumes as low as they are, it’s harder to outrun your fixed costs. And so I think it should be sequentially no worse likely better than it was in Q2, although in Q3 of last year. In Consumer Products, we had some – we had different input costs for steel in particular. So, probably won’t be as high as they were in Q3 of last year. And then Building Products, it’s really the same story when Andy talked about trough in terms of revenues. It’s going to be helpful there, just sort of seeing those things continuing to get a little bit more volume back. But we don’t expect a V-shaped recovery by any means. But we do expect some sequential improvement in the Building Products space as well. Okay. And then, maybe quickly on the CapEx, I think you previously said it’s going to be up 10% to 20% year-over-year. Does that still stand, or can you provide an update on that? Okay. And then just lastly, on the separation, what are kind of the next steps we should expect from you, or what will we see next? Yes. So, we have actually made a lot of progress in the current quarter, really focused in two areas, current state analysis and then starting to think about future state analysis for both companies. Probably the next major step for us is to start to populate the teams of both companies. And so that’s likely there will be some announcements on that after the 1st of the year. Got it. You are welcome. And just to add on one thing, we have said early 2024, we are tracking to be at or slightly ahead of that pace, so more to come. While you are working on that when I see there is no buybacks for two straight quarters. Is there a legal restriction on buying back stock because of the separation, or is there something another explanation? There was a legal restriction up until the point of announcement. As of today, we are under kind of normal trading windows. So, there is no reason that we cannot be buying back stock. I will tell you that we have consciously made a decision not to purchase stock at least up to this point because we wanted to build our cash balance in anticipation of making sure that both companies are very well capitalized and can get the best credit rating that they can achieve out of the gate. I don’t think that necessarily means we won’t buy stock, but that’s been our bias up to this point. I will also say that I think at quarter end, we had built upwards of $130 million of cash. We continue to build cash. And a lot of that is driven by the decline in steel prices as we replace higher-priced steel with lower-priced steel, but also we continue to earn pretty good money. So, that the combination of those two things is helping us build that cash. And John, just to circle back to your first question, you scared us for a minute there. The assets held for sale, it’s $5 million. I think you might be off one line on your printer there. It’s $5 million it’s just a building that we have for sale. Was the reason for the sale of the Worthington specialty products in Michigan that U.S. Steel shut Great Lakes and at the old rouge plant, they’re running the melt, but not the hot strip mill. So, the sources of steel aren’t the same. That’s not the reason for it, John. I mean we have a rigorous capital management program. And we are always looking at our businesses and do like they fit our strategic portfolio. Is it something that we want to remain in long-term, and that was a business we just didn’t feel like fit the portfolio strategically any longer. So, it seemed in the best interest of shareholders to sell that versus continuing to run it. Thank you. Looking at the on-balance sheet, inventory accounts, the middle account for work in process inventory fell a great deal with steel prices as one would have expected. The raw materials accounted at $305 million stayed very large and the finished product inventory at $190 million stayed very large. Should we assume that either you accumulated, unfinished steel inventory this year because the price was cheap or else you didn’t have enough a year ago? And that with the finished products, are the customers buying a little less quickly now with the economy is slowing down, or just give us a little flavor for the movements or the lack of movements in the raw materials and finished inventory accounts. Yes. So, I think some of the answers to your question are embedded in your question. But the real sort of driver there on the raw side is we do have some seasonality. And you get ready and January tends to be a pretty big month on the steel processing side. Steel prices were going up and then coming down and you are buying in different buckets. And then, on the finished goods side, John, what you had there is really in the – more driven by the Consumer and the Building Products side of things. I mean a year ago, we couldn’t keep any inventory. We were – had more orders than we could satisfy. And so we were literally setting things out the door as soon as we could make them. And so inventories just have returned to more normal levels, especially seasonally relative to where they were a year ago. Thank you. Thank you. And I don’t know what those advisors are charging you for $3 million a month. But it’s a hell of a lot of money to tell you what you already know. It is definitely an expensive process. But we are very happy with the teams that we have helping us. And we are really happy with our own teams and the work that we have done thus far. [Operator Instructions] It appears that we have no further questions at this time. I will turn it back to the presenters for any closing remarks. Alright. Well, thanks everyone for joining us today. We wish everybody a Merry Christmas, a terrific holiday season and a Happy New Year. We will talk to you in 2023.
EarningCall_1584
Hi everyone and welcome to the Fourth Quarter and Full Year Result of Ericsson 2022. Before starting, I just want to say that we have some issues with the streaming of this conference call, so we are focusing on the audio right now. So, everyone joining on audio, you will be able to listen in now, but we might have some issues with the streaming. With that said, I will also welcome our CEO, Börje Ekholm and our CFO, Carl Mellander. As usual, we will have a presentation and then we will have a question-and-answer session. In order to ask question, you will need to join the conference by audio, as I said, and the details for that is to be found on our press release or on ericsson.com. But before handing over to Börje and Carl, I would like to read the following. During today's presentation, we will be making forward-looking statements. These statements are based on our current expectations and certain planning assumptions, which are subject to risks and uncertainties. The actual results may differ material due to factor mentioned in today's press release and discussed in this conference call. With -- we would like to encourage you to read about these risks and uncertainties in the earnings report itself, as well as in the annual report. Thank you, Peter, and good morning, everyone, and thank you all for joining us. So, today we're excited to present another quarter of good progress towards our strategic and financial goals to -- that we have outlined to you at our Capital Markets Day about a month ago. From a financial perspective, 2022 was one of our best years in the company's history. With our fourth quarter results, we're on track to deliver on our long-term EBITA target of 15% to 18% by 2024. Target achievement is supported by cost savings, growth in our IPO revenues, portfolio changes, and that includes, of course, reaching breakeven on cloud software and services, but also to exit some loss-making businesses, and we are executing on these initiatives. We made significant progress despite macroeconomic headwinds during the quarter. I am truly excited about Ericsson's future as we continue to execute on our strategy and we have full confidence in our long-term development. As we also said during our Capital Markets Day last month, we expect and plan for overall mobile networks market to be flattish in the next few years and the lower now predicts a slight growth outside of China. But as we also said, during the Capital Markets Day, we expect 2023 to be rather choppy with near-term uncertainties and macroeconomic headwinds that will likely impact operator CapEx. So, as expected, during Q4, we've seen some operators slowing the pace on network investments and that includes front-runner customers in many markets. We expect operators to continue to sweat the assets in response to the macroeconomic headwinds. In addition, we expect the operators to adjust inventory levels as supply situation eases. These trends started to impact networks in Q4 and as we expected, it impacted sales in North America. We expect and plan for these trends to continue during the first half of 2023. And after that, it's -- we believe the inventory adjustment cycle is starting to get through and development normalizes again. But in addition to this, longer term, growth in data will drive network investments and data growth remains at very high levels, and that will return mobile networks market into more of the flattish development that we're predicting over a number of years. Looking ahead, it's important to remember that we're still in the early stages of the 5G rollout and actually, of the cycle of widespread enterprise digitalization. To address the near-term outlook, we're taking several actions. Most notably, we're taking cost savings initiatives that we expect to take full effect by the end of 2023 and with the impact starting to show during Q2 of 2023. In cloud software and services, we're executing on our revised strategy. And of course, there are seasonality in that business, but we expect to see and plan for breakeven of operating profit for full year of 2023, and with gradual improvements in profitability thereafter towards much more attractive levels. We as a company, are at the epicenter of a very powerful trend and that's really that anything that can go wireless will go wireless. And we are investing to retain our leadership in 5G, but we're also working to shape the future industry structure and how the industry will expose, monetize and consume advanced network features that 5G networks can provide. And this will allow us to transform into a platform company. Going forward, our enterprise business will be a major driver of our long-term growth and profitability. I would already now would like to thank all my colleagues for their efforts at delivering on our long-term plans and create long-term stakeholder value. Our achievements would not be possible without them. But let me now go through some highlights for 2022. With our fourth quarter result and what we have executed on during the quarter, we're on track to deliver on our long-term EBITDA target of 15% to 18% by 2024. As we conclude the year, we have established a clear leadership position in mobile networks, and we've taken important steps towards building a high-growth enterprise business. Based on technology leadership, we have increased our market share in RAM from about 33% in 2017 to 39%, excluding Mainland China. And we've established a global leadership position in 5G core. Our strategy is extending our leadership in mobile networks and expand into the enterprise segment with the objective to maximize value across all stakeholders. The Vonage acquisition, which we which we completed during last year, gives us the foundation to transform Ericsson into a platform company and executing on this strategy remains a top priority for us. In 2022, organic sales grew by 3%, driven by a 4% increase in Networks and 16% in Enterprise. EBIT margin, excluding restructuring charges, was 10.1%. However, if we exclude Vonage that we -- and the previously announced charges during the year, EBIT margin was 12.9%, reaching our 2022 target of 12% to 14%, as we said and we committed to when we announced the Vonage acquisition. We remain fully committed to continue building a culture of accountability and integrity, and we continue to invest heavily in those areas. We recognize that we can only be a true industry leader if we're both technology leader, but also a leader in how we conduct our business. As you saw during the quarter, we took the decision to extend our monitorship. This is the right decision to take to ensure that integrity is fully embedded into our culture. I'm convinced that a best-in-class compliance program will give our company a competitive advantage and establish us as a true industry leader. Let me go through some key events during the quarter. In December, we announced the signing of a multi-year IPR agreement. This contract is of strategic importance to our 5G licensing program. This positive outcome positions us well to capture further 5G license agreements. And that's, of course, among previously unlicensed handset manufacturers, but it's also in new areas such as consumer, electronics and IoT. Based on this, we expect significant IPR revenue growth over the coming 18 to 24 months, as we said at our Capital Markets Day. Group organic sales grew by 1% year-over-year, of which IPR revenues contributed by five percentage points. And we saw an EBITA of SEK9.3 billion, corresponding to a margin of 10.8%. During the quarter, we had a strong focus on breaking the curve on the inventory development, and we executed on that, and we were able to significantly lower our inventory levels. This contributed to cash flow before M&A of SEK16.9 billion. In the quarter, our Networks business grew in India on the back of significant market share gains. As we said at Q3, as well as our Capital Markets Day, the growth from share gains in several markets could not fully compensate for reduced operator spending and inventory reduction in other markets, including North America. As is always the case and we've said in the past, market share gains result in higher service revenues from large rollout or higher share of service revenues as a result of large rollout contracts. These contracts are profit accretive. However, they are initially margin dilutive. And of course, these contracts are important for us, and we took them consciously because they strengthening our strategic market position and build the scale to be competitive long-term. Gross margin came in at 44.6%, which is mainly due to the change in business mix. And we expect gross margin to be 40% to 42% in Q1 of this year, due to the changing business mix. In Cloud Software & Services, we saw sales growth in North America, mainly from 5G core contracts. But this was offset or was more than offset by declines in other market areas. The performance in this segment has clearly not been satisfactory historically. And at our Capital Markets Day, we introduced an updated and revised strategy to turn the segment around, which included priorities to limit subscale software development, accelerating automation to lower deployment and maintenance costs and changing focus from market share gains to profitability as well as realizing cost synergies from combining the two prior segments. So in the quarter, we started to execute on this strategy, and that included to exit some subscale businesses. And we're confident that the business is on path to reaching operating profit breakeven for the full year of 2023. In parallel, in our core mobile infrastructure business, we're continuing to execute on our enterprise strategy. This is organized around two pillars, each leveraging our strength in mobile networks. First, Enterprise Wireless Solutions focused on capturing the multibillion dollar enterprise market opportunity for 5G. I need to get some water. So, first of all, Enterprise Wireless Solutions focused -- so Enterprise Wireless Solutions is focused on capturing the multibillion dollar enterprise market opportunity for 5G optimized networking and security solutions. And the second pillar is the global communication platform business, where we will be able to monetize 5G in new ways by transforming how network features such as speed, latency are globally exposed, consumed and paid for. During Q4, sales in the Enterprise segment represented 8% of total sales. Enterprise is a growth engine for Ericsson, and we continue to fine-tune our portfolio to maximize profitability. And this included an agreement to divest our loss-making IoT business. After this divestiture, our emerging technology area is expected to be profitable. We are investing in building up a strong go-to-market organization for enterprises, and we're investing to broaden our product offerings as well as bringing network APIs to the market. These investments are a foundation for profitable growth after 2023, but they will weigh clearly on profits in the coming year. In the quarter, we also announced a SEK2.3 billion provision related to a potential resolution with the US authorities regarding the previously announced deferred prosecution agreement breaches or breach notices. The provision also includes costs associated with the extension of the compliance monitorship that we announced in December. While we're now in a position to make a sufficiently reliable estimate of the financial penalty, we have not yet reached a resolution with the DOJ and discussions are ongoing. Separately and with respect to the past matters described in the company's 2019 Iraq investigation report, we continue to thoroughly investigate the fact in full cooperation with the DOJ and the SEC to determine if there is any merit to the allegations. But it's not appropriate for me to comment further as this is an ongoing investigation at this point in time. We continue to focus on building a culture of ethics and integrity throughout our business and our company. And that includes the Board and remains a top priority for Ericsson. I will now share a little more detail about the development in our market areas. So this high-level summary slide highlights how sales increased significantly market areas, Southeast Asia, Oceania and India. In Europe and Latin America, sales remained stable. We saw a decline in other market areas as operator CapEx were reduced due to macroeconomic pressures, but also from operators' slowdown of rollout plans. And in addition, we've seen supply chain easings that enable some operators to optimize their inventories. Digging a little bit deeper into this, I'd like to highlight a couple of things. As you can see in market areas; Southeast Asia, Oceana and India sales increased by 21%. Of course, as you are aware, this was primarily driven by 5G market share gains in India, which, of course, we're extremely happy with. We did though experienced a slowdown of investment in certain other countries in Southeast Asia, which negatively impacted sales. In market area Northeast Asia, sales declines after the elevated 5G investment levels we've seen for the first three quarters of the year. In market area North America, we saw a 7% decline year-over-year. And as stated in our Q3 report, as well as at our Capital Markets Day, we have during the year seen accelerated CapEx investments, but we've also seen customers holding relatively large inventories. During Q4 our operator customers guided around reducing the CapEx investments. This is further compounded by the need to optimize inventories as supply constraints actually eases. Market area other primarily includes IPR revenues -- IPR licensing revenues and a major part of our segment enterprises. And growth here was mainly driven by the acquisition of Vonage, impacting the quarter by SEK4.1 billion and the retroactive part of the IPR licensing revenues for unlicensed periods. Thank you, Börje. And I'm glad your voice recovered as well. I'll try to do the same here. But -- so good morning, everyone and thank you for joining the call. I wanted to start by coming back to some of the one-offs that we have recorded in the quarter. First of all, of course, we landed this major IPR agreement, which meant retroactive revenue from the expiry of that agreement, which was in early January 2022. And all of that revenue was recorded in the fourth quarter, which brought IPR as a total up to SEK6 billion of revenue in Q4. Second of all, we agreed with a buyer or acquirer to divest our IoT business. And we took a related charge there of SEK1 billion in the quarter related to that, and that impacts the Enterprise segment. Then in Cloud Software & Services, we decided also per the strategy that we have in turning around this business. We decided to exit certain subscale businesses. And here, we also recorded a charge in the fourth quarter amounting to SEK0.8 billion. And then finally, also as Börje mentioned, last week, we announced that we were now in a position to reliably estimate the financial penalty from the DOJ regarding DPA breaches. And hence, we made a provision, then amounting to SEK2.3 billion in the quarter for that, including the extended monitorship costs. I also wanted to reiterate around what we see happening in the market and the market shift. So in the Q3 report, the call back then, but also even more at this Capital Markets Day in New York in December, we discussed this mix shift that we expected to start in the fourth quarter, but also continue into the first half of 2023. And we really see, and I'm reiterating a bit what Börje explained, but I think it's valid point here, that some CSPs in, especially front-runner markets, are now taking down their CapEx in some cases, from record levels previously and some are also adjusting down their inventory levels. At the same time, of course, we ramp up in other markets where we have gained significant market share, which often comes with a large services share in big rollout projects. And altogether, we expected this to impact both top line, but also gross margin in the networks. And this came through as anticipated in the Q4 numbers. But with this overall intro, I'd like to dive into the numbers a bit more than for the quarter to start with and then a bit later into the full year. But in Q4, we reached sales of SEK86 billion, which is actually the highest sales for Ericsson in a single quarter ever. And the organic growth here, as you see, is 1%, supported by catch-up IPR revenue, which drove growth by about 5 percentage points, if you look at the total IPR revenue. And we saw South East Asia, Oceania and India grow, and you saw the market area slide that we presented before. This is a result of those market share gains that we talked about. Europe and Latin America flat, and the other three market areas declined notably than in North America as expected. Gross income, excluding restructuring charges, grew by SEK4.6 billion year-over-year to SEK35.7 billion. Of course, supported also again by the IPR revenue growth of SEK6 billion from SEK2.4 billion in Q4 last year, but also the addition of Vonage into the Ericsson family. But the margin and gross margin, of course again excluding restructuring charges, while supported by IPR declined still by 200 basis points then to 41.5% year-over-year, primarily due to the business mix shift that we talk about in the networks, but also related to this previously announced charges for contract portfolio exits in Cloud and Cloud Software & Services. R&D increased. You know that investment in technology leadership is absolutely key for Ericsson, increased to SEK13.2 billion. The FX effect year-over-year is approximately 45% of that increase. So quite big impact from FX. But other than FX, the increase is really a result of the decision or decisions we make to invest in our 5G portfolio and offering across the company, but also includes investments in Enterprise Wireless Solutions as well to enhance the offering there and bring 5G into that, not least, but also the addition of Vonage, of course. Other operating income, just to highlight that was negative SEK2.8 billion. And there is where you find provisions and charges related to DOJ monitorship and IoT. So all in all, EBITDA then, again, excluding restructuring charges, declined by 27% to SEK9.3 billion. That corresponds to a margin of 10.8%. Again, as a result of the charges of around in total SEK4 billion, but also increased expenses then not at least in the enterprise side, which in turn comes from bringing Vonage a full quarter into our business. Obviously, they were not part of Ericsson Q4 2021 So from that overall view on the group, let's look at the segments. Here, we can start with Networks, where Q4 organic sales grew by 1%, supported by IPR, of course again. And the double-digits growth that we saw in market areas, Southeast Asia, Oceania and India. Gross income in networks, excluding restructuring, increased, primarily driven by retroactive IPR licensing revenue. And the gross margin then a similar pattern on the group level, of course, decreased to, in this case, 44.6%, caused by again this business mix shift that we talked about and that we had anticipated and mentioned at the CMD, not least. EBIT came out at SEK12.5 billion. This is an EBIT margin of 21.4. Then moving over to Cloud Software & Services. Organically, we grew by 2% here. North America grew, as Börje said, while sales in other market areas were down, and that has mainly to do with the timing of project milestones and similar, but also some contract de-scoping in the managed services part of that business. Gross income increased following the higher sales volume. But again, of course, negatively impacted by the charges that we have talked about several times already. EBIT in Cloud Software & Services, SEK0.7 billion, stable EBIT margin of 3.4%, again impacted by one-off charges. Finally, then Enterprise on the right side here. The total share of total Ericsson sales at Enterprise stands for now is 80% in the quarter. We saw a strong growth here in several parts of this business. Organically, we grew by 15%, of course, reported much more to 65%, but that obviously has to do with the addition of Vonage contributing with SEK4.1 billion in sales in the quarter. Gross income increased by SEK2.1 billion to SEK2.9 billion in total, and that's again driven mainly by the Vonage acquisition. That leads to an EBITDA level in enterprise, excluding restructuring of negative SEK1.7 billion. You can compare that with SEK0.6 billion the previous year, mainly due to the charges related to the IoT divestment that we talked about, but also growing investments in R&D and SG&A, not least in enterprise wireless solutions. That's about the quarter. And now if we zoom out and look at the -- excuse me, 2022 full year numbers instead. Sales of SEK271.5 billion, which is up close to SEK40 billion year-over-year, if we look at the reported numbers, not considering currency in this case. But if we do adjust for comparable units and the currency growth was 3% year-over-year for the full year. Gross margin, excluding restructuring declined to 41.8%, impacted again by the same items. I will not repeat all of those again. And here, you can also see the R&D expense increase is about SEK5.3 billion in increased R&D, and one-third of that is FX movement related. In networks, where we add investment is really in the cloud run area, but also in what we call Ericsson silicon or our ASICs. Also enterprise saw an increase in R&D. So EBIT margin here, as you can see, you can see the numbers here. But excluding the one-offs and the non-organic or the Vonage acquisition, we came out at 12.9% in EBIT margin, again within the range for 2022, the target range that we had put up earlier of 12% to 14%. Gross margin is a metric that many follow in our industry, and let's look at that here. You can see the gross margin development from Q1 2020. And we decided to start this graph there. But of course, earlier, we have shown also development from 2016, 2017 when gross margins were at 30%, and we remember that time as well. Now we have surpassed 40% since some time. And now on a rolling four quarter basis, gross margin is 41.80%. So the improvement you can see in the blue line here from 2020 is really driven by the investments in technology leadership and competitiveness. And as you know, this -- the improvement you see there in the blue line is really also accompanied by market share gains over the same period. Now we see a certain decline in gross margin and it comes as a result of, of course, inflationary pressure and this business mix shift that we talk about in the networks. And specifically in the fourth quarter, and I mentioned this already, we saw that this shift, as expected impacted our gross margin. When it comes to inflation, I would say that we have managed well to offset that in the quarter with commercial initiatives like product substitution. And of course, without inflation, you could say that this, call it, operational leverage coming out of technology leadership as well would have contributed to a stronger gross margin. But in this quarter now, we have managed to offset that inflation. So aside from those effects that I talked about, of course, we again had these one-off charges that we should not forget when we look at this to better understand the underlying business and the one-off charges here affecting gross margin amounted to 0.6 percentage points on group level. So from there, let's move into how our earnings have converted into cash flow. And of course, as you know, free cash flow before M&A is a key metric for us. We came out at SEK16.9 billion in the quarter and SEK22.2 billion for the full year, which is 8.2% of net sales. As you know, we have a long-term target of 9% to 12% of net sales. So, we came in just below that range now for the full year 2022. But there, I think we should remember that this was a year with significant global challenges when it comes to supply chain. And of course, that has impacted our working capital. And I think it's in this context we should see the year-over-year development of free cash flow. 2021 was a very strong cash flow quarter for us, where free cash flow before M&A reached even 14% of net sales. So that creates a bit of a tough comparison when we look at 2022. But we can also see this over the two years. And then in average, we have generated free cash flow of SEK27 billion between the two years on average per year. So what happened in the quarter was that now as the supply chain situation globally is easing up, we were able to reduce the inventory just as we said would happen, exactly that happened as well. So that's good, both in component, but also in project inventory. And so this improvement in inventory, together with very strong cash collection, including the collection from the IPR licensees, where we have the new agreement, delivered a positive contribution from working capital and therefore, generated a strong free cash flow in the quarter. I can add also that, of course, there is an impact from currency between quarters and over the years. But if we look at the reported numbers, this cash flow of SEK16.9 billion is actually the highest that we have delivered at least during the last seven years in Ericsson's history. We continue with the focus on working capital, of course. It's a big important drive in our company, and we continue that with full force. I said before, though, the large rollout projects that we are happy to have won tend to build up working capital initially at least, and that's normal and expected as an effect of winning a business of that nature so that we believe will continue. However, the inventory side should still continue down. So on the back of the strong cash flow then, we managed to increase the net cash position by SEK10 billion. Now it's a bit more than SEK23 billion of net cash. And this is after having paid out, of course, the second dividend installment of SEK4.2 billion, gross cash now of SEK56.2 billion. And then the proposed dividend from the Board of Directors at SEK2.70 per share corresponds to a total amount of SEK9 billion and is proposed to be paid out in two installments, just like previous years as well. Now before I hand back to you, Börje, I just wanted to present a couple of key data points for the future. So my last piece for today here covering the outlook for the first quarter and also the full year 2023, to some extent. Well, first, some specific comments regarding first quarter then starting with top line. And we look at average seasonality for networks and the cloud software and services. For networks, this is minus 23% on average historical numbers. And for cloud software and services, this is minus 35%. I'm talking now about the delta, the difference between Q4 and Q1. And for networks then, we expect that the seasonal decline Q4 to Q1 will be more pronounced in Q1, even when adjusting then for the retractive EPR licensing revenue in Q4. And for cloud software and services, we expect a normal seasonality to play out in the first quarter when adjusting for the retroactive IPR again. So next, when it comes to gross margin for Networks, we are specific now in the guidance for the first quarter, where we say that given this change in business mix resulting from market share gains and what we have explained now and earlier, we expect to see a range of gross margin in networks between 40% and 42% in the first quarter. And then when it comes to operating expenses in Q1, there is a typical decrease in our company, if you look at historic averages, by SEK3.3 billion from Q4 to Q1. I believe this is a good indication also this time. And just so I have said that, of course, there might be large variations between the quarters. Then amortization of intangibles is expected to be around SEK0.9 billion per quarter for the Ericsson Group in 2023, of which SEK0.8 billion in the Enterprise segment. And lastly, for Q1, we expect EBITDA for the group to be somewhat lower than EBITDA last year same period, but then with an improvement during the rest of the year as a result of declining margins in networks that we guide for due to the changing business mix. Thank you, Carl. So to sum up, we took several important steps during the quarter in achieving our strategic and financial goals during the last quarter. And in a choppy world, I would say we focus on manage what we can manage. And this includes, of course, saving costs of SEK9 billion that will have full effect by year end of 2023. And we expect to start seeing the reduced cost to come through during the second quarter of 2023. We're also executing on the plan for cloud software and services that will allow us to improve profitability and reach breakeven for the full year 2023. We see great traction in our expansion into enterprise, and we'll continue to invest in broadening our product portfolio and build a strong enterprise go-to-market organization. These investments will create a strong platform for profitable growth going forward while weighing, of course, on the costs in 2023. And we expect to be able to showcase what we can do with the global communication platform during the coming quarters. So I encourage you to stay tuned for Barcelona this year. Our basic premise for our business is basically that anything that can go wireless will go wireless. I'm truly excited about Ericsson's future as we continue to execute on our strategy. As we go forward, the investments in and growth from our enterprise business will be a major driver of Ericsson's long-term growth and profitability. And we remain committed to reaching the lower end of our long-term EBITDA target of 15% to 18% by 2024. I would like to thank everyone, each and every one of our customers, partners and employees. This has truly been a team effort. Thank you. Finally, I would like to welcome all of you to our Annual General Meeting at the end of March. And as you have seen and Carl described, the Board is suggesting a dividend of SEK2.70 per share, split into parts as it was the past year. Thanks, Börje. As we're a little bit late, I will give you actually five minutes extra for Q&A. So we'll have some. So it's now then time for the Q&A session. [Operator Instructions] So, let's look here who we have on the first part of the question. I would like to welcome, Andrew Gardiner to ask the first question. Hi, Andrew from Citi. Good morning, Peter. Thanks very much for taking the question. So really, my question comes down to the unusual approach you're now taking or at least unusual for you guys in terms of giving near-term guidance, right? So been quite quantified in terms of what you're telling us in 1Q for margins, in particular. I think to many of us on the call, that's going to be quite appreciated. It's been a long time decade since Ericsson has done that. And hopefully, it helps us find a floor in terms of our estimate revisions here given the near-term challenges. But of course, for that to be a floor, the estimates need to be conservative enough. I was just hoping you can give us a better sense as to how much you have risk-adjusted those 1Q targets, sort of worst-case type modeling to give us conviction that this indeed is hopefully the final cut in terms of the estimate. Can you give us some color around how you set those near-term targets? Thank you. Should I start Börje? Thanks for the question, Andrew. I would say we wouldn't express it in this way if we weren't -- if we didn't have the confidence about it. And as we provide a range also 40 to 42, we think that different scenarios can be covered in there. And with the visibility we have now on customer demand, on project rollouts, on our own cost situation, et cetera, in cost of sales, we deem that this is the level where we expect to land in the quarter. So we have confidence then. I think that's -- we recognize, Andrew, the repeated questions about near-term guidance. So we felt this may be the right thing to do. So we took that step. So it was really to help. But we've been, I would say, as Carl described, trying to be providing you with the best estimates we can do. At the same time, there are, of course, always developments, but this is based on an assumption of the inventory adjustments in networks. And I think that's important to remember, we're taking a rather conservative look on that. What we feel is conservative today. So I feel very good about the estimates that we provide you. … I just have a quick specific follow-up. In terms of the first quarter EBITDA guidance of it to be quite somewhat below last year, just so that we're getting the reference point correct. I mean you are referring to the SEK5 billion of EBITDA reported in Q1 2022. There's no – are there any sort of one-offs or things that we should be aware of? Or is it just below SEK5 billion is what you're guiding to? Thanks, Andrew. That was the first question. So we are now ready to go ahead with the second question, and that is from Aleksander Peterc from Societe Generale. Hello, Aleksander? Great. Yes. So I'd just like to come back a little bit on margins again following up on Andrew's question earlier. So, can you give us a sense of whether margins will bottom out in the first quarter of the year, that 40% to 42% range or should we model broadly speaking, a similar range for the second quarter because you said these pressures will persist and then we'll see an improvement. And then just broadly speaking, do you think that networks can longer term return to a 44% to 46% gross margin range, which you saw in previous quarters towards that an artificially high level of gross margins as a result of a particularly favorable business mix, which is not expected to prove the longer term just in broad terms. Thank you very much. Yes, I can start on that. It's -- as we have said, it's -- the first half is really where we'll see the sizable inventory adjustments that impacting primarily from runner markets and their front runner markets around the world. So, we think that those effects are going to be there for the first two quarters. And from there, you'll start to see an improved market environment during the second part. And the reason why we believe the market will improve is actually the underlying traffic growth. So that gives us the comfort. And this is what we've seen, by the way, previous swings you've had in CapEx. So, when you've had those big adjustments, operators can sweat assets for a couple of quarters, but it cannot be done for much more because simply traffic grows fast underneath. So that's why we're -- what we are seeing is a gradual improvement in the second part of the year. So that's the way we try to model it. Yes. Can I just ask you -- can you give us an annual run rate of IPR and our quarterly run rate now that your main deals have been renegotiated? Could you provide us with an estimate at this stage? Thank you. Yes. So, current portfolio is around SEK9 billion. As you know, we ended up with 10.4% now during 2022. What we have also said, as you know, and we expanded on that at the Capital Markets Day is that we expect IPR to grow significantly. There are more device players in the ecosystem that are currently unlicensed, especially for 5G. So, we're targeting those now on the back of the large agreements that we have just signed. But there's also other growth opportunity there, consumer electronics, IoT, as we have mentioned before. So, we believe that we cannot talk exactly about the timing because this is about negotiations, obviously, with the licensees, but we expect it to grow over time. Thank you, Aleksander. So we are now ready to go further in the Q&A queue. So, the next question I have here is from Andreas Joelsson at Danske. Hi, Andreas. Hi and good morning. A question on Vonage, please. If you could elaborate a little bit how the business model is actually working. Is it a subscription-based model? Is it a license-based models for getting sort of access to the APIs? Or how does that work really? Thanks. Well, if you look at the current model in Vonage, you have both on a subscription-based model, that's the UCaaS, CaaS solutions, but you also have a transaction model on the CPaaS. Over time, as we launch now the new part, call it the network APIs, there are still more work to be done on the business model. So right now, the focus is to make sure that we technically solve the issues and that we can actually present those type of network APIs on the CPaaS platform. And that's why I said, you'll see announcements during the year. And hopefully, we can start to display also the business model that we intend to see there. But so far, we need to continue the work we're doing together with our operator partners to be able to launch those APIs and show them to the market. So stay tuned for announcements on that, Andreas. Thanks, Andreas. Thanks for that question. So we will move further with the next question. And I'll have the next question from Sebastien Sztabowicz from Kepler Cheuvreux. Hello, Sebastien. Yes. Yes. Hello, everyone, and thanks for taking my question. I've got one question on the mix because Dell'Oro I know this RAN market in the US declining in the mid-single-digit range in the coming year. So, the scale effect will play negatively there. But do you see any room for any capacity of grade cycle building up in some advanced markets and including the US? So how do you see your mix shifting in the coming years with the capacity upgrades and maybe some rollouts in emerging markets? And the second one is on the RAN market specifically. It is gradually slowing a little bit declining right now. Have you seen a change in the competitive landscape or the pricing conditions in the RAN market today or not so far? Thank you. If we start with the overall RAN market. And as we said at the Capital Markets Day, we expect a flattish, call it, mobile network market as well as RAN market over the next few years. That has not changed. And I would say Dell'Oro is now forecasting slight growth outside of China and a slight decline if you include China, then we see this inventory adjustment happening now that I think we have to expect to work its way through the system. When everyone normalizes inventories, we do the same thing. That's why we also are able to reduce inventory. So you see that is in the supply chain. I think those will, as we see it now work its way through the next few quarters, one, two quarters or Q1, Q2. Then after that, what will drive the cycle in the US, but it applies also to other front-runner markets. It's two things in reality. One is the underlying traffic growth that we're seeing already. That continues at very healthy levels. So, we expect to see a, call it, normalization of the RAN market also in front runner markets, and that's why you reached the overall flattish market. The other part, which I think is very interesting is new applications. We're starting to see some come through. First use case probably is fixed wireless access and fixed wireless access today may be used in mid-band. But over time, that's probably going to migrate over to millimeter wave and provide also support for the market. So, when you look at this shifts that we are seeing, you will see these type of individual years have negative or positive numbers. But over time, we expect this more flattish market. So that will start to help the mix again as you move forward beyond 2023. Pricing environment, we are in a competitive industry. This is why we're focused on leading on technology. And when we lead on technology, we help our customers both improve performance in the network, but also lower the OpEx. And what we see is that we can win those deals at attractive gross margins. And that's why you see us even though we're fairly substantially changing the business mix in the company achieving compared to historic levels, a very attractive gross margin. So I feel quite good about our competitive position, and that's ultimately the driver of the gross margin you can realize. Thank you. We will then move to the last question of this session today. And the last question I have from Terence Tsui at Morgan Stanley. Hello, Terence. Yes. Thank you. Good morning, everyone. A question on networks as well, please, and just around the strong growth in India. Can you just give us maybe a flavor of the margin profile in India versus the other regions? And maybe give us an idea of how your profitability should evolve as revenues start to pick up in the region? And then a real quick follow-up just on a topic that we haven't asked on so far, just around the provision you made for the DOJ. Just wondering, are there any updates on the investigations being conducted by the other authorities? And shall we expect maybe a single settlement that covers all of the investigations in the future? Thank you. If we start with the provision, yes, we set aside the provision for the bridge notices. And that was because we could, as we say, provide a reliable estimate of the financial consequences. Besides that, we have, as you know, not reached any agreement with them or with anybody else. So that's why at this point in time, there are ongoing investigations and discussions. So we cannot update you in any shape and form right now. India. We will not comment on individual markets and our margin profiles there. But what I can say is that when you look at the guidance, we've given for Q1 on gross margin in Networks, and you can there see that we expect a decline in the US quite substantial as well as a growth in new market share contracts. That is not only India, it's other market share contracts as well. And you still see a longer-term healthy gross margin. If you compare to what we had five years ago, it's still a very healthy gross margin. So we have factored in a lot of those swings. But the most important one here, when we talk about mix is actually the -- that when we take a market share gain, the contract by nature has a lot more service content than a normal, continuous business. And when that happens, we have lower margin. They're all positive margins, but it will dilute gross margin, but that's all factored into the 40% to 42% gross margin. Thanks Terence. That was our last question. I see that I still have some questions in the queue. IR is clearly open, you can call in and ask a question to us. Carl Mellander will be in London on Tuesday, meeting some of you, both the sell side and the buy side. So, that's another opportunity. And as Börje said, we have the event in Barcelona coming up, and I know that a lot of you are traveling down there as well to meet with us. So those are opportunities near-term to meet the management. With that said, I would like to conclude this call. And thank you all for dialing in and asking questions. Thank you.
EarningCall_1585
Hello, and welcome to the Fourth Quarter Earnings Conference Call for Amphenol Corporation. Following the presentation, there will be a formal question-and-answer session. Until then, all lines will remain in a listen-only mode. At the request of the company, today's conference is being recorded today. [Operator Instructions] Good afternoon, everyone. This is Craig Lampo, Amphenol's CFO, and I'm here together with Adam Norwitt, our CEO. We would like to wish everyone Happy New Year and welcome you to our fourth quarter 2022 conference call. Our fourth quarter 2022 results were released this morning. I will provide some financial commentary, and then Adam will give an overview of the business and current trends, then we will take questions. As a reminder, during the call, we may refer to certain non-GAAP financial measures and make certain forward-looking statements. So please refer to the relevant disclosures in our press release for further information. In addition, all prior year comparative data discussed during this year is on a continuing operations basis. The company closed the fourth quarter with sales of $3.239 billion and GAAP and adjusted diluted EPS of $0.82 and $0.78, respectively. Fourth quarter sales were up 7% in U.S. dollars 11% local currencies and 8% organically, compared to the fourth quarter of 2021. Sequentially, sales were down by 2% in U.S. dollars, 1% in local currencies and 2% organically. Adam will comment further on trends by market in a few minutes. For the full-year 2022, sales were a record $12.623 billion, which were up 16% U.S. dollars 19% in local currencies and 15% organically, compared to 2021. Orders in the quarter were $2.884 billion, which was down 12%, compared to the fourth quarter of 2021 and 8% sequentially, resulting in a book-to-bill ratio of 0.89:1. This was driven by lower bookings in the communications related markets. For the full-year, orders were $12.925 billion, resulting in a book-to-bill ratio of 1.02:1. GAAP and adjusted operating income were $666 million and $676 million, respectively, in fourth quarter of 2022. GAAP and adjusted operating margin were 20.6% and 20.9% respectively in the fourth quarter. On a GAAP basis, operating margin increased by 100 basis points, compared to the fourth quarter of ’21 and decreased by 10 basis points, sequentially. GAAP operating margin for the fourth quarter included approximately $10 million of acquisition related costs. On an adjusted basis, operating margin increased by 80 basis points, compared to the fourth quarter of ’21 and decreased by 10 basis points sequentially. The year-over-year increase in adjusted operating margin was driven by strong operating leverage on the higher sales volumes, as well as the benefit of ongoing pricing actions. On a sequential basis, the slight decrease in adjusted operating margin reflected normal downside conversion on the lower sales levels. For the year 2022, GAAP operating margin was 20.5% and adjusted operating margin was 20.7%, when compared to 2021, adjusted operating margin increased by 70 basis points, which was primarily driven by normal operating leverage on higher sales volumes, as well as the benefit of pricing actions. Given the overall cost and supply chain headwinds we experienced in 2022, we are very proud that our adjusted operating margin equals our previous full-year record operating margin set in 2018. Breaking down fourth quarter and full- year results by segment, in the harsh environment solutions segment, sales were $795 million and $3.107 billion in the fourth quarter and full-year of 2022 respectively. Compared to the prior year fourth quarter, segment sales increased 10% in U.S. dollars and 12% organically. Compared to the full-year 2021, segment sales increased by 13% in U.S. dollars and 15% organically. Segment operating margin was 25.7% and 25.8% in the fourth quarter and full-year of 2022 respectively. In the Communications Solutions segment, sales were $1.436 billion and $5.652 billion in the fourth quarter and full-year of 2022. Compared to the prior year fourth quarter segment sales increased 1% in U.S. dollars and organically, compared to the full-year 2021, segment sales increased by 17% in U.S. dollars and 13% organically. Segment operating margin was 22.2% and 22% in the fourth quarter and full-year of 2022. In the Interconnect and Sensor Systems segment, sales were $1.008 billion and $3.863 billion in the fourth quarter and full-year of 2022. Compared to the prior year fourth quarter, segment sales increased 14% in U.S. dollars and 17% organically. Compared to the full-year 2021, segment sales increased by 17% in U.S. dollars and 18% organically. Segment operating margin was 19.2% and 18.5% in the fourth quarter and full-year of 2022. The company's GAAP effective tax rate for the fourth quarter was 19.2% and the adjusted effective tax rate was 24.5%, which compares to 18.8% and 23.8% in the fourth quarter of 2021 respectively. For the full-year 2022, GAAP effective tax rate was 22.3% and adjusted effective tax rate was 24.5%, which compared to 20.6% and 24.3% in 2021. In 2023, we expect our adjusted effective tax rate to be approximately 24%. GAAP diluted EPS from continuing operations was $0.82 in the fourth quarter, an increase of 14%, compared to $0.72 in the prior period. Adjusted diluted EPS was $0.78, an increase of 11%, compared to the $0.70 in the fourth quarter of ’21. This was an excellent result. For the full-year, GAAP diluted EPS from continuing operations was $3.06, a 22$ increase from $2.51 in 2021. Adjusted diluted EPS was $3 in 2022, a 21% increase from $2.48 in 2021. Operating cash flow in the fourth quarter was a record $705 million or 147% of adjusted net income and net of capital spending, our free cash flow was a record $613 million or $127% of adjusted net income. We are pleased to have delivered a cash flow yield at these strong levels. For the full-year 2022, operating cash was a record $2.175 billion or 117% of adjusted net income and net of capital spending our free cash flow for 2022 was a record $1.796 billion or 96% of adjusted net income, a very strong result. From a working capital standpoint, inventory days, days sales outstanding and payable days were 86, 73 and 54 days respectively. During the quarter, the company repurchased 2.3 shares of common stock at an average price of approximately $75, bringing total repurchases during 2022 to 9.9 shares or $731 million. When combined with our normal quarterly dividend, total capital return to shareholders in 2022 was more than $1.2 billion. Total debt at December 31 was $4.6 billion and net debt was $3.1 billion. Total liquidity at the end of the quarter was a very strong $4.1 billion, which included cash and short-term investments on hand of $1.4 billion plus availability under existing credit facilities. Fourth quarter and full-year 2022 EBITDA was $798 million and $3.1 billion, respectively. And at the end of the fourth quarter of 2022, our net leverage ratio was 1 times. I also wanted to make a few comments on interest expense. As I mentioned last quarter, due to the rising interest rate environment, our interest expense had increased primarily as a result of our floating rate convertible paper, which represents approximately 14% of our total debt outstanding at the end of the year. Based on current and near-term expected interest rates and debt levels, we expect 2023 quarterly interest expense to be approximately $40 million, which is reflected in our first quarter guidance. I’d now turn it over to Adam, who will provide some commentary on current market trends, as well as the recently completed acquisition this month. Well, thank you very much, Craig. And welcome to all of you to our first earnings call of 2023 and I hope it's not too late to wish as well all of you a Happy New Year and to those of you celebrate the Lunar New Year, wish you all a happy year of the rabbit. As Craig mentioned, I'm going to highlight our fourth quarter and full-year 2022 achievements, including some discussion about the acquisitions that we mentioned in our press release. I’ll then discuss our trends and progress in our served markets and then make some comments on our outlook for the first quarter, and of course, we'll have time for questions at the end. Looking to the fourth quarter, our results in the fourth quarter were stronger-than-expected. Exceeding the high-end of our guidance in sales and adjusted diluted earnings per share. Sales grew by 7% in U.S. dollars and 11% in local currencies, reaching $3.239 billion. On an organic basis, our sales increased by 8% and that was driven by robust growth in the broadband, commercial air, automotive and military end markets. And I'll give some more details about those markets in a few moments. The company booked $2.884 billion in orders in the fourth quarter, representing a book-to-bill of 0.89:1, and this negative book-to-bill was driven by order reductions in several of the communications related markets as certain customers adjusted demand in light of excess inventory that they had built up throughout 2022. We're especially pleased to have delivered another quarter of resilient and strong profitability with adjusted operating margins reaching 20.9% and 80 basis point increase from prior year. We achieved these results despite the continued wide range of challenges around the world. Adjusted diluted EPS, as Craig mentioned were $0.78, representing robust growth of 11% from prior year and that's another excellent reflection of our organization's continued strong execution. Finally, the company generated record operating free cash flow in the quarter of $705 million and $613 million, respectively, clear reflections of the quality of the company's earnings. I'm extremely proud of our team around the world and our results this quarter once again reflect the discipline and agility of our entrepreneurial organization as we continue to perform well amidst the challenging and dynamic environment. We're also pleased to announce that we closed the acquisition of Control Measure Regulation Group or CMR just here in January. CMR is based in France and has annual sales of approximately $75 million and they're a manufacturer of a broad array of cable assemblies and complex interconnect assemblies for the industrial market with a particular focus on heavy equipment engine applications. This acquisition further expands our offering of high technology, value-added interconnect products in the diversified industrial market. In addition, we're pleased to have signed an agreement for the acquisition of the North American hybrid and fiber optic cable and cable assembly, as well as the global infrastructure antenna business of RFS at the end of the fourth quarter. Based just down the street from us here in Meriden, Connecticut, RFS is a provider of Interconnect and Antenna products for the mobile networks market with expected sales of approximately $100 million in 2023. This acquisition, which we anticipate will close by the end of the second quarter and thus is not included in our guidance, expands Amphenol’s product offering and presence with mobile network service providers, who are continuing to invest in their next generation 5G networks. As we welcome the outstanding CMR team to Amphenol and look ahead to welcome the RFS team once that transaction closes, we remain confident that our acquisition program will continue to create great value for the company. Our ability to identify and execute upon acquisitions and successfully bring these new companies into Amphenol remains a core competitive advantage for the company. I just want to make a few comments about 2022. And I would just say that 2022 was another very successful year for Amphenol. We expanded our position in the overall market, growing sales by 16% in U.S. dollars, 19% in local currencies and 15% organically reaching a new sales record of $12.623 billion. In fact, over the past three very dynamic years, we're proud to have grown our sales by more than 50% from our 2019 levels, actually 53% to be exact, a great reflection of the company's diversification and agility in these truly dynamic times. Our full-year 2022 adjusted operating margins reached 20.7% and that was an increase of 70 basis points from 2021. This strong level of profitability enabled us to achieve record adjusted diluted EPS of $3. Finally, we generated record operating and free cash flow of $2.175 billion and $1.796 billion respectively, clear confirmations of the company's superior execution and disciplined working capital management. Our acquisition program again created value this year with two new companies added to the Amphenol family in 2022 and one added here already in 2023. CMR, NPI and ICA Holdings have expanded our position across a broad array of technologies, particularly in the industrial market, while bringing outstanding and talented individuals into the Amphenol family. We're excited that these acquisitions, as well as the RFS acquisition, which we expect to close at the end of the second quarter, represent expanded platforms for the company's future performance. We also bought back in 2022 almost 10 million shares under our share buyback program and increased our quarterly dividend by 5%, representing as Craig detailed a total return of capital to shareholders of just over $1.2 billion for the year. Finally and really importantly, especially in this today's dynamic environment, we come out of 2022 in a uniquely robust financial position with the lowest leverage and highest liquidity and availability we've seen really in modern times. And while there continued to be a high level of volatility in the overall market environment in 2022, as we enter 2023, our agile entrepreneurial management team is confident that we have built further strength from which we can drive superior long-term performance. I'd like to spend a little bit of time to talk about our trends and progress across our served markets, and I would just comment that we remain very pleased that our balanced and broad end market diversification continues to create real value for the company with no single end market representing more than 25% of our sales in the year of 2022. We believe this diversification mitigates the impact of the volatility of individual end markets, while continuing to expose us to leading technologies wherever they may arise across the electronics industry. Turning first to the military market, this market represented 10% of our sales in the fourth quarter and 9% of our sales for the full-year. Sales in the quarter grew strongly from prior year, increasing by 11% in U.S. dollars and 13% in local currencies and on an organic basis sales increased by 12% with broad-based growth across virtually all applications, but particularly military vehicles, space and airframes. Sequentially, our sales increased by a better-than-expected 11%. For the full-year 2022, sales grew by 4% in U.S. dollars, 6% in local currencies and 4% organically, reflecting our operational execution, as well as strength in space related unmanned aerial vehicles, ground vehicles and avionics applications. Looking ahead, we expect sales in the first quarter to grow slightly from these fourth quarter levels and we continue to be excited by the strength of the company's position in the defense market, where we offer the industry's broadest array of high technology Interconnect products. As the geopolitical environment has become more dynamic, militaries around the world are expanding their investments in next generation technologies, thereby increasing the demand potential. We look forward to supporting this increased demand with our expanded range of Interconnect and Sensor products, as well as our significant investments in new capacity that we have made in recent years. The commercial aerospace market represented 3% of our sales in the fourth quarter, as well as for the full-year 2022. And in the quarter, our sales grew by very strong 33% in U.S. dollars and 38% in local currency and organic. As we benefited from the continued recovery in the commercial air market. Sequentially, our sales grew by 13% from the third quarter, which was well ahead of our expectations coming into the quarter. For the full-year 2022, sales increased by 36% in U. S dollars, 40% in local currency and 36% organically, reflecting our strong design in positions on a broad range of platforms, as well as the ongoing recovery in demand for aircraft. Looking into the first quarter of ’23, we expect now a modest sequential moderation in sales. I just want to say how grateful I am to our team that's working in the commercial air market. Over the last three years, they performed really well amidst a truly volatile demand environment. And with the ongoing recovery in travel and thus in demand for jetliners, our team's efforts to strengthen our breadth of high technology Interconnect and Sensor products, while diversifying our market position, including into next generation aircraft are now paying real dividends. We look forward to realizing the benefits of this in 2023 and beyond. Industrial market represented 25percent of our sales both in the fourth quarter and for the full-year and sales in the quarter grew by 7% in U.S. dollars, 12% in local currency and 7% organically from the prior year fourth quarter. This growth was driven in particular by sales into alternative energy, battery and electric heavy vehicle, factory automation, oil and gas and medical applications. On a sequential basis, sales were down by just 1%, which was a bit better than our expectations. For the full-year 2022, sales grew by a strong 14% in U.S. dollars, 19% in local currency and 13% organically, and we really had broad-based growth across virtually all segments of the global industrial market. And looking into the first quarter, we expect sales in the industrial market be roughly at the same level as we achieved here in the fourth quarter. Our outstanding global team working in the industrial market continues to find new opportunities for growth across the many segments of this exciting market. I remain confident that our long-term strategy to expand our high technology Interconnect, Antenna and Sensor offerings, both organically and through complementary acquisitions, has positioned us to capitalize on the many revolutions happening across the industrial electronics market. To that end, the addition of CMR further strengthens our position, particularly in the important heavy equipment segment. And we look forward to realizing the benefits of this strategy for many years to come. The automotive market represented 21% of our sales, both in the fourth quarter and for the full-year and we had another great quarter in automotive sales growing by a strong 21% in U.S. dollars and 31% in local currency and organic. Our growth was broad-based, but was once again particularly robust in hybrid and electric vehicle applications. On a sequential basis, our automotive sales increased by 5%, which was above our prior expectations. For the full-year 2022, I'm very pleased that our sales increased by a strong 22% in U.S. dollars and 29% in local currency and organic, reflecting broad strength across our automotive markets, including in particular in next generation electronics, including electric and hybrid drivetrains. Looking into 2023, we expect a high single-digit sequential moderation of sales in the first quarter from these high levels, driven especially by a seasonal moderation of sales in Asia. I remain extremely proud of our team working in the automotive market. They continue to manage through a dynamic overall environment all while remaining focused on driving new design wins with customers, who are implementing a wide array of new technologies into their vehicles. In particular, our long-term efforts that expanding our range of next generation Interconnects incorporated into electric and hybrid electric vehicles has enabled Amphenol to expand our position with a broad range of customers and thereby created further potential for the future. The mobile devices market represented 12% of our sales in the quarter and 11% of our sales for the full-year 2022. Our sales in the quarter declined from prior year by 11% in U.S. dollars and 7% in local currency and organically, and this was driven by reduced sales of products incorporated into smartphones, laptops, tablets and wearables. Sequentially, our sales declined as we had expected by 10% as demand was impacted by a pull forward of demand into the third quarter as we it discussed 90-days ago. For the full-year 2022, sales in this market increased by 3% in U.S. dollars and 5% organically, as growth in smartphones and wearables was somewhat offset by a moderation in tablets coming off the higher levels of the pandemic. We are pleased with this performance amidst the market with generally muted demand in 2022. As we look into the first quarter of ’23, we anticipate a seasonal sequential decline of approximately 35%. And while mobile devices will always remain one of our most volatile markets, our outstanding and agile team is poised as always to capture any opportunities for incremental sales that may arise in 2023 and beyond. Our leading array of Antennas, Interconnect products and mechanisms continues to enable a broad range of next generation mobile devices, which positions us well for the long-term. The mobile networks market represented 4% of our sales in the quarter and 5% for the full-year 2022. Sales in the quarter declined from prior year by 8% in U.S. dollars, 6% in local currency and 12% organically as we experienced the pause in demand from operators after a number of quarters of strong growth. Sequentially, our sales declined by a higher-than-expected 17%. For the full-year ’22, sales grew by 8% from prior year and 3% organically as we saw increased demand for products used in next generation 5G equipment. Looking ahead, we expect a high single-digit sequential reduction in sales in the first quarter as operators continue to moderate their investments. Our team continues to work aggressively to realize the benefits of their efforts to expand our position in next generation 5G equipment and networks around the world. And as customers continue their investments in these systems, we look forward to benefiting from the increased potential that comes from our unique position with both equipment manufacturers and mobile service providers. We're also excited by the pending acquisition of the hybrid and fiber optic cable and antenna assets of RFS, which will further broaden our product offerings for this important market. The information technology and data communications market represented 19% of our sales in the quarter and 21% of sales for the full-year. Sales in the fourth quarter declined by 6% in U.S. dollars, 5% in local currency and 8% organically from prior year as many customers reduced their demand after five consecutive quarters of robust double-digit growth. Sequentially, our sales declined by 11% as we had expected coming into the quarter. For the full-year 2022, our sales in the IT datacom market grew by a strong 18% in U.S. dollars, 19% in local currency and 14% organically as we continue to benefit from our leading technology solutions and design and positions across a wide array of applications. Looking ahead, we expect a roughly 20% sequential decline in sales in the first quarter as our OEM and web service customers continue to moderate their demand levels. Regardless of this current demand pause, we remain encouraged by the company's outstanding position in the global IT datacom market. Our team has done an excellent job developing leading high speed, power and fiber optic Interconnect products that are enabling our OEM and web service provider customers to continue to drive their equipment and networks to higher levels of performance. We look forward to realizing the benefits of that leading position in this important market for many years to come. Finally, the broadband market represented 6% of our sales in the quarter and 5% of our sales for the full-year 2022. Sales increased by a very strong 79% in U.S. dollars, 82% in local currencies and 64% organically as we experienced a significant increase in demand from cable operators for a wide range of our products. On a sequential basis, sales grew by a much better-than-expected 19%. For the full-year 2022 sales grew by 62% in U.S. dollars and 38% organically, as we benefited from strong demand from broadband service operators, who are both upgrading and expanding their data networks, as well as from the Halo acquisition completed last year. Looking ahead, we expect sales to decline in the low double-digits from these levels, due to seasonal adjustments from customers. We remain encouraged by the company's expanding position in the broadband market and we look forward to continuing to support our service provider customers around the world, all of whom are working to increase their bandwidth to support the proliferation of high-speed data applications to homes and businesses. And in certain cases in furtherance of government programs to expand broadband. Now just in summary, I want to comment on our outlook. The current economic environment remains highly uncertain. In addition, as we did discuss earlier, we have seen certain customers in the communications markets reduce their demand as they normalize inventory levels. Assuming market conditions do not meaningfully worsen and also assuming constant exchange rates. For the first quarter, we expect sales in the range of $2.840 billion to $2.900 billion and adjusted diluted EPS in the range of $0.65 to $0.67. This would represent a sales decline of 2% to 4% and adjusted diluted EPS of flat to down 3%, compared to the first quarter of ’22. I remain confident in the ability of our outstanding management team to adapt to the many opportunities and challenges in the current environment and to continue to grow our market position, while driving sustainable and robust profitability over the long-term. And finally, I'd like to take this opportunity to thank our entire team around the world for their truly outstanding efforts here in the fourth quarter and for the full-year of 2022. Thank you. The question-and-answer period will now begin. [Operator Instructions] Our first question is from Guy Hardwick with Credit Suisse. You may go ahead. I think I'll leave the questions on guidance to callers after me. But Adam, just when I speak to investors about Amphenol, they push back initially, if they don't know the company that well, that's why isn't this company exposed to commodity price deflation if it's selling components to the electronics industry. What was your -- what would be your pushback on that? And maybe if you could talk about some of the content drivers in connectors and other products? Yes. Well, thanks so much, Guy. And I think what you're referring to is, kind of, Moore's Law, which says that over time, whether it's every 18-months or some approximation thereof, that electronics tend to get a doubling of the performance for the given price. And I think that, that is true in electronics that if you look at what we -- the devices that we use today, the networks that we use today, we get so much more out of those things given the increase or even in certain cases, not increase of what we pay for those things today. And so it comes down then to innovation. And are we, as a company, innovating, developing products that are enabling our customers' applications and allowing our customers to sell value. And so you mentioned commodity. And we don't view our products as a commodity. Actually, we view them as a very precious piece of jewelry almost that the Interconnect products that we make from connectors to value-add Interconnect, Sensors, Antennas, these are highly critical components that go into very complex systems, everything from mobile devices all the way up to fighter jets and everything in between. And they represent also a very high risk and relatively low value as a percentage of the total bill of materials. And thus, if you can embed technology, if you can embed value, if you can be there for your customers, well, then your customers will be willing to share with you some of the value that they're able to realize on the sale of the end product. And so the difference between, kind of, a standard commodity is something that you see the price trading on an exchange somewhere, and ours is just a chasm of distance between them, because our products are enabling technology. They're very much application specific. We're selling hundreds of thousands and millions of different products to tens of thousands of customers and millions of different applications around the world. And if our product doesn't work, that small little thing in the system, then ultimately, the system itself doesn't perform for its customers. And so it's up to us to develop innovative new technologies on a consistent basis to be able to execute on behalf of our customers to do that with high quality, high reliability with a breadth of products so customers can come to us all at once. And if we can do that consistently, then we're able to realize good margins while also controlling the cost on our side. And that's another piece of this, which is that at the end of the day, margin is price minus cost. And so we have to control the price by selling value to our customers. We have to control the cost by ensuring that every element of cost is controlled and treated as it was coming out of our own pockets. And that comes really from the entrepreneurial organization, the 130 general managers around the world, who all treat the company's money as if it were their own. And the fact that we don't have cost centers in the company, we have a tiny little headquarters. And so that control on cost together with selling value through technology ultimately allows us to realize robust margins on a consistent basis. Thanks for taking my question. I feel, I guess, Adam, I'm hoping you can just maybe talk a little bit more about the March quarter guide. You folks are talking about revenue being down double-digits sequentially. And I don't want you to repeat all these segments discussion, but you sort of talking about 2 times normal seasonality. Perhaps you just talk about what are the one or two segments you think that are performing worse than what you would expect them to do in the normal seasonal environment? And then to the extent this weakness that you see in March, do you think it's more demand weakness? Or is it more inventory adjustment by our customers? Thank you. Thanks so much, Amit. There's a little bit of static on the line, but I think I heard the question well. Look, our guidance that we've given here, and I think I talked a lot about by each segment, but let me just put a finer point on this. If you just take two of our end markets and the guidance that I discussed and that's mobile devices and IT datacom, which are two of our largest communications markets, those represent about two-thirds collectively of the implied sequential reduction in sales from the fourth quarter to the first quarter. And I think we talked about in IT datacom that we clearly see a, sort of, reduction in orders from customers, because of elevated inventory levels. And there may be some demand layered into that, as well as our customer -- as the end customers, kind of, pause their build-outs, but we shouldn't forget one thing about IT datacom. We shouldn't forget that this is a market, first of all, that since 2019, we've grown that market by more than 70% during that time period that our customers have had to increase their output and their construction of their networks in order to satisfy a true explosion of demand for the Internet. And I think the underlying drivers of that, whether that be a video over the Internet or the use of certain tools that we didn't ever use before, the data traffic on the Internet is not dropping. I think what we are seeing is maybe a pause and a kind of realignment because these companies went real gangbusters for a number of years. But the structural increase of data traffic over the Internet in the broadest sense, that's something that we believe, and I think we're in good company believing that we'll continue for a long time to come. On mobile devices, I think we talked about the fact that during the course of the pandemic, there was a real surge in mobile device demand, as people had to detach from their offices and go home, things like tablets, things like computers, upgrades of phones and the like. Let alone the fact that everybody had a lot of disposable income to buy new things in their ears and on their wrists and otherwise. And I think there's been some relaxation of demand that's well reported, and you yourself have talked a lot about that in a variety of reports here in 2022. And regardless of that, our team did a fabulous job this year, driving 5% organic growth in 2022. But we're reacting to the demand that we hear from our customers. We're not losing share. Quite the contrary. But the demand expectations of our customers here in the first quarter really result in the guidance that we've given. So I would maybe point to those two markets, most particularly, which represent just roughly two-thirds of the sequential decline in our outlook. Yes, thanks. Good afternoon and Happy New Year, everyone. Adam, it's just a question regarding the industrial markets. In addition to your acquisitions, you've been growing really well organically. And there was some concern that those industrial markets typically lag some of the other markets like consumer and datacom. There's also concerns about inventory build, but it sounds like you're relatively optimistic in terms of the drivers across those diversified markets. So any color you can give on your outlook there would be great? Yes. Thanks so much, Matt, and Happy New Year back to you. No, look, our industrial market has a real bright spot for us over these three years. And I just mentioned how IT datacom since 2019 has grown by 70%. Our industrial business has actually grown by more than 90% during that time period. And we've added some amazing acquisitions across Interconnect and Sensors, but we've also driven really strong organic growth. And I think, last year, we grew by 13% organically. In ‘21, we grew by 27% organically and really on a wide swatch of the industrial market, which is very, very diversified inside it. This industrial lag consumer and datacom, I don't have a really good opinion about that, I think they're quite different markets. You have a lot of very different demand drivers. And if you think about what are the underlying drivers of demand in industrial, well, think about the things that are in the headlines today. Things like investments in infrastructure, things like electrification, things like decarbonization, which includes everything from infrastructure to support electrification, which includes things like alternative energy generation, which includes things like natural gas conversion and pipelines. And we've actually seen funny enough, like strong performance in both our alternative energy business, but also our oil and gas business. Both of those are really showing really strong momentum right now. And I wouldn't think that any of those correlate necessarily to a consumer or a datacom world. Is there inventory in the supply chain of industrial? I don't have good evidence to say, yes or no to that. I'm sure if you looked at a variety of publicly traded balance sheets, you may see some evidence of and some evidence of not. We do look in our distribution channel in there. I think inventories are healthy. They're not crazy. I mean, they may be up a touch or two, but not out of whack to the overall demand environment. Look, industrial is going through a true revolution. And when you think about everything from electrification, electronification, all the underlying drivers that I talked about, I think we've done a fabulous job, and our team in that area has done a fabulous job, both organically, as well as identifying and bringing to the Amphenol family great companies like CMR this quarter and many others over the last three, four years that put the company in a strong position going forward. Hi, Adam. Hi, Craig. Thanks for taking the question and Happy New Year. I guess the question I had was more on the margins. You had pretty robust margins in the fourth quarter. But as you're sort of looking in terms of the end market outlook and some of this sub-seasonal sort of trajectory starting off the year. How should we think about the puts and takes on the margin and also in relation to some of the acquisitions that you've done recently? What sort of impact on the margin will that have? How resilient are these sort of margin levels at this point? Thank you. Great. Thanks, Samik, and Happy New Year to you. Yes, I think that if you think about our margin, I mean, I think I'd start off by just saying how proud we are of the margins performance that we've had in 2022. We really have, ultimately -- I mean, throughout 2022, we really done, I think, a great job of just expanding our margins, even sequentially converting, kind of, higher than our normal conversion with the cost actions, with the pricing actions we've had to take. And thus -- and really hitting our 21% in Q3, which is kind of a timing of record and really 20.9% in Q4 and then 20.7%, which matches the record of 2018. So I'm really happy with certainly achieving those. And as we guide here into the first quarter, we're guiding down, I'd say, above seasonal and then we talked about -- Adam just talked about that in response to a previous question. And I think if you, kind of, look at the markets, we've always said that our markets don't really drive kind of our margins. So we don't have significant margin differences of a significant range within our markets, except for broadband, we've talked about before, which was our old cable business. But other than that, I think the markets are similar operating margins and drive similar conversion level. So I wouldn't really talk about that as being a place where it's driving a change in the way our overall conversions would look. We talked about decrementals and kind of that close to 30% range. We're kind of seeing a little -- even slightly less than that as we're guiding here into the first quarter. And I think that just goes to the management team and how well they have done in regards to responding to some of these areas where we have seen some headwinds from a demand perspective in IT data, which is declining at above normal rate typically. And then in the first quarter, they're taking great actions that obviously are reflected in our guide and not necessarily impacting our normal conversion. And mobile devices, they're used to these types of decrementals and headwinds in terms of their first quarter and certainly, they're taking them. So I think that -- and this is really not a different story than we've had over many years where we're able to manage, you know, regardless of the demand environment, we're able to manage their operating margins and really do a great job of expanding our margins when we see demand increases, which we've done here in 2022. And then here in Q1, where we see a little bit of headwind in certain of our markets, taking the actions that really need to be taken in regards to protecting our bottom line. And I think that agility of the organization is really going to -- shining through again. And I think that's just no different from what we've seen historically. And I wouldn't expect any difference in terms of whatever comes here in 2023. And regardless, I think I feel really comfortable with how the team will perform. Yes. Good afternoon and thank you very much for taking the question. Could you speak please to what Amphenol has seen in the China market, both how it's been tracking recently, given the COVID dynamics and also whether you're expecting demand in China to pick up materially over the course of this year given reopening? Yes. Thanks very much, Mark. And look, I'm glad you bring off China, because I want to just give a real shout out to our team in China. Q4 in China was a funky quarter. You came in with zero COVID and you left with 100% COVID. And that created a lot of challenges operationally. And the fact that we were able not only to deliver on our commitments in the quarter, but to actually exceed our guidance in the quarter was just a real testament to our entire global organization, but in particular, to our team in China, who just manage through this well while protecting our people as best you can in a country where basically everybody got COVID, it was really phenomenal And I'm just so proud of what they were able to do during that time period. Look, our business in China, we have a great business in China. Our China business is very much a business for the local region, for the customers, who want to buy in those regions. And we've done such a great job over the years despite geopolitics and all of that of being a truly local company, and this gets to kind of our organization, which I think, I've used the term before that we have an organization that's really purpose-built for whatever the world order is going to be. And that's an organization of people who are made up of local nationals all over the world, people from India in India, people from China in China, people from France in France. And that allows us to really tailor our operations to the requirements of that region and of that country. And we've certainly done that in China over these last several very dynamic years. In terms of whether we expect a kind of a demand rebound in China, I don't know, I think it's a little early to say that. But whatever comes will come. And I think we're poised and positioned that if there is some rebound, if there is an increase in consumer spending or whatever on whatever kind of products, there's no doubt in my mind that our team will be there to capture more than our fair share if that should so occur. I mean, they demonstrated here in the fourth quarter that nothing can stop them. And I'm very confident that whatever comes along, we'll take full advantage. And if risks materialize, if some impediments should come along, I mean, this is a team that's pretty battle hardened. So I'm pretty confident they'll do a great job. Hi, good afternoon and Happy New Year. I was just wondering, Adam, if you could talk a little bit more about the business, you're acquiring from RFS. It seems like it's a bit of a game changer for you guys in terms of product and how you might be able to compete against some larger players in antennas, et cetera? Yes. Well, thanks so much, Steven. Happy New Year to you as well. Look, we're really excited about this business. I mean, we have a business in fiber optics, we have a business in hybrid cable, we have a business in antennas. But no doubt about it, RFS brings us a much, much stronger position from a technology perspective, from a capacity perspective and from a channel into certain markets. And we've always been really excited about the mobile networks market. And one of the unique things about Amphenol is, I think I've said this many times, is that we sell to the OEMs. We're one of the leading interconnect suppliers to the world's leading OEMs who make mobile networks equipment, but we also sell to the service providers and to the operators. And that actually is an evolution of our long-term position with the broadband service providers where we know how to work with service providers. And today, we work with service providers in broadband, we work with them in the IT datacom market, we work with them in broadband -- I mean, in mobile networks. And anywhere where now providers are our customers and not just OEMs making equipment. And I think RFS really allows us to take a step function growth in the strength of our position there with service providers. And doing that at a time where we're still, I believe, in the early innings of the 5G investments in the network, let alone what happens when 5G exists for all of our other markets. And we're big believers on the kind of structural potential of both the build-out of the 5G networks that are happening around the world, as well as what it means to have low latency, ultra-high bandwidth ubiquitous data traffic for all of our end markets. And after 5G will come, 6G and then there will come 7G, and you and I will probably still be floating around when we're talking about 10G one day, Steve. But now, we're really excited about RFS and look forward to them. I look forward to getting to the regulatory process. And again, we expect to close it at the end of the second quarter. And thus, it's not in our guide here in the first quarter, but it is certainly in our long-term strategy. Hi, Adam, you and your team have been through many similar cycles. And I wanted to focus a little bit on the communications commentary you gave about a little bit of inventory digestion or some pauses or things like that? Just curious, in past cycles, have you seen these last kind of one to two quarters or multiple, multiple quarters from when you sit there, it seems like this is one segment that is taking a little bit of a downshift, not that structurally you're losing share problems with it, but more of a cyclical nature if I understand your comments correctly? Thank you. Well, thanks so much, Jim. I would love to be able to extrapolate from sort of past experience to today. But I would tell you that I don't know that at least in my history, which is, by the way, 25-years this year in the company, to live through a time period like we've just gone through in the last three years and what that has done to the dynamics of the market from a pandemic to a supply chain crisis, to an explosion of data traffic that came out of the pandemic and shutdowns and work-from-home and all those various things, the transformation of how people consume, entertainment and media and information. So I don't know that there is a good template for kind of the -- what has happened in the IT datacom market over the last three years. And thus, it would be hard for me to say, do I expect this to be a one quarter, two quarter or whatever kind of an adjustment? And thus, we don't run our business that way. The fact is it is what it is right now, and we adjust in real time our resources to accommodate the level of demand that we see from each of our operations. We have 131 operations around the world right now, roughly. And each of them have their own set of customers. Some of whom have demand that is growing and others of whom and that includes those who work in this market, where maybe demand is moderating somewhat. They don't make a guess and say, well, is that going to be a one, two, three quarter thing, and thus, what should I do? They just say, my customer needs this much, and I'm going to go out and adjust my resources in real time. And that real-time reactivity and agility that Craig mentioned earlier, which, by the way, was reflected in our margins in the fourth quarter and is also reflected in our margins in the first quarter, that's how we run the business. We'll react to whatever the demand environment is, and we're not going to try to trip over ourselves trying to guess how long it is. But what I know is this, long-term, the demand for data, the demand for our products, leading edge, high-speed fiber optic power products, that's going to be a very robust demand long-term. And so we will come through this adjustment that our customers are going through, and we will come out of it a stronger company than ever, and we will continue to have a very robust technology position in the future. Good afternoon. Thanks for taking the question and Happy New Year from me as well. Adam, your auto business is underlying production now by an extremely strong level each of the past two years. And I know it's always hard to parse up, but do you get the sense that channel inventory of your products has influenced that outgrowth at all? And maybe just more importantly, as you look forward, what do you see as the key factors plus or minus versus history that could influence your ability to grow strongly above market again in 2023? Thank you. Well, thanks to you and Happy New Year as well. Look, you said it, I mean, we have definitely outperformed in the automotive market for a pretty long time period here, quite a number of quarters, and I'm just really proud of our team. There weren't always easy years, I mean, clearly, 2020 was a tough year. Even 2019 was a challenging year. But we never kind of threw in the towel during that time period. We never said let's go cut back on new product investment or let's retrench, let's reorganize, quite the contrary. In fact, we continue to work with customers around the world on next-generation applications. And those next-generation applications, everything from passenger connectivity and power applications to high-voltage applications in the car to communications around Antennas and the like. we are now really realizing the benefits of that over the last couple of years. And in terms of the channel, we don't really see the channel and the inventory in the channel as being a big driver of the demand. I think the driver of the demand has been the rapid adoption of new electronic systems, in particular, electrification of cars, but not exclusively electrification. And so when I think about the key factors that can be plus or minus in the future, well, sure, at some level, the number of cars being sold matters. But more importantly is the content of electronics and the content of new systems in those cars in the future. And if that content continues to move up and to the right and if we continue to do a pretty decent job of getting some or more than our fair share of that, then I think there's good potential for our automotive business in the long-term. I would not get out in front of my skis here and tell you that 29% organic growth is going to be our perpetuity or 41% that we achieved in 2021. But we're very confident in our -- in the strength of our position. Great, thanks. I'd love to hear about how the backlog changed during the quarter, and in particular, the duration of the backlog and perhaps it relates to lead times somewhat, whether you're seeing customers still place orders in excess of lead times to the degree that has been a pattern? Thank you. Thanks so much, Will. I mean, look, we obviously had in the fourth quarter a lower book-to-bill of 0.89. But I would just point out that over the course of this year, we still have a positive book-to-bill of 1.02. And if you look over the last two years, we've actually booked in the last two years, $25 billion in orders and we've shipped $23.5 billion in sales. So we've added $1.5 billion to our backlog during that time. And we have, today, still a very robust backlog. I think we talked about last quarter that we probably saw about a three-week expansion of our backlog. And I think we're probably still roughly in that ballpark right now, somewhere around a three-week or so beyond what maybe it was in the past. And when I say the past like 2020 and maybe year-end. And that's a really strong position. At the same time, there's no doubt about it that the kind of acute phase of the supply chain crisis and the kind of multiplicity of pressures that was put on our customers across really all of our markets, I think we're beyond the acute phase of that supply chain crisis. I'm not going to tell you like it's totally in the rearview mirror, like there's still little things that people have to deal with. But I would not be surprised if our customers, kind of, normalize a little bit more their lead times across the board. And one of the things that happened during the course of the pandemic and the supply chain crisis that came thereafter, is we were doing a great job. I mean, we supported our customers through the time. We did not meaningfully have to extend our lead times, but customers were sort of taking a one-size-fits-all approach in several of the markets. And that led, I think, them to certainly in the communications market, to maybe end up ordering a little bit more than they were going to do. I would also point out one other thing out here just in the fourth quarter, with our relatively low book-to-bill, compared to historical levels, actually, that was really concentrated in our communications markets. And we saw a book-to-bill outside of the communications market, which was basically 1:1 in the fourth quarter, which also gives us some confidence that there's still a robust demand for our products. But I don't think in terms of the normalization, I would expect some normalization. That whole cliche of just in time versus just in case, maybe customers long term will have a little bit more order windows. But I think we sit in a really good position here. Thank you. So the company has taken a lot of share coming out of the pandemic. And there has been a heightened focus on resiliency and connectivity from the customer base, again, coming out of the pandemic. I'd just be interested to hear how you think about those two drivers as the macro seemingly will normalize here at some point? Thank you. Yes. Thanks very much, Chris. I mean, look, resiliency connectivity, I think there's been a lot of things that have shifted. We've just been through a once in a several-generation pandemic. Hopefully, we are sort of at the tail end of it. I know our team in China certainly hopes that in the fourth quarter. But I think it has changed everything. It's touched everything. Let me say that, whether it's dramatically changed everything. But no doubt, resiliency and ability of a company to be there for its customers regardless of what comes along. That is definitely more in the consideration of our customers than ever before, and that plays very well into our approach. Our approach has never been to put all our eggs in one basket to build these massive campuses. We have 250 facilities around the world. Some people think we're crazy to have that many factories, but part of it is risk. Part of it is making sure that we're close to our customers, and we're not putting all of our eggs in one basket. And we have a pretty fragmented manufacturing footprint all over the world with low-cost operations in all three of the major regions in continents. And I'll tell you that, that enabled us during this time period to take share from maybe some of our competitors, who are either smaller or more concentrated and thus, we're stricken by these kind of unpredictable impediments that came along during the pandemic and the supply chain crisis. And relative to connectivity, and I'm going to sort of put a little stab on what your implication is there, I mean, communications, the Internet, the ability to stay in touch with people, that has clearly been a dramatic shift in this pandemic. And we look at our position in our communications markets and the phenomenal growth that we've had, and I mentioned the IT datacom market for us growing 70% during that time period. But also, mobile devices grew by nearly 25% over those same three years. And that's just a reflection of this kind of now demand for people to have a multitude of ways of communicating and connecting with each other. And that's something as we seek to sort of enable the electronics revolution, that's the phrase I always use, there's no doubt about it that we're living in revolutionary times. And that creates a real structural and long-term opportunity for Amphenol. Thank you. Hey, Adam, notwithstanding the comments you made on IT datacom earlier that might also apply to mobile devices. You specifically called out mobile device kind of mean reverting from abnormal COVID-driven level. So does that imply we should expect some seasonal growth for 2023? And more broadly, is visibility, maybe ex mobile devices, beginning to improve at all in your markets? Yes. Thanks very much, Wamsi. I am not going to get out in front of my skis on trying to give an estimate of what mobile device demand is going to look like this year. You know, well, I'm bad at guiding it even for the 70 or so days that we try to give guidance in a quarter let alone to make some estimate of what it's going to look like in the course of the year. It's hard for me to do that. What I do know is there's a lot of new devices, they're wonderful. I'm addicted to mine, and we have a strong position. And so I don't take a position otherwise on whether mobile devices is going to have a worse or better performance seasonally going through the rest of this year. I mean, we tried to give some guidance here in the first quarter. We'll see what happens there, and then we'll try to give some guidance on the second quarter 90 days from now. Relative to visibility in general, look, it's still a fairly uncertain world. And so I don't know that there's a dramatic improvement in visibility. I mean, we're not giving full-year guidance. We don't think it's prudent at this time, because there is still a lot of dynamism, a lot of uncertainty in the world today. And so we'll see. I mean, I certainly hope that as we passed the three-year mark on the anniversary, I think -- it's actually three years from day after tomorrow that Wuhan was shut down. I remembered it very, very well. And you hope that after three years, it renormalizes. There's a saying in Chinese that a pandemic doesn't last more than three years. It's a famous old saying that, I think, a very old saying in Chinese. And hopefully, that is really the case, and there can be a little bit more normalization. But I think there's still a lot of uncertainty in the world today. Hey, good afternoon, Adam and Craig. Maybe a question on the input cost environment. We've seen certain commodities pull back in certain areas. Energy and labor costs remain elevated and then maybe pricing pass-throughs might get tougher in 2023. But if we take a step back, can you just talk about the Amphenol cost opportunities in 2023? Yes. Thank you, David. I think that, certainly, the cost environment is, in some ways, a little bit different than it probably was as we, kind of, entered the year here. I think there are certain places where it has improved, there’s other places, honestly, where it probably hasn't improved. But I mean, certainly, on certain commodities, we've seen some level of relief in certain parts of the business without a doubt. But places like energy, places like the labor, certainly, logistics has gotten a little better, but I would say energy and labor is certainly very -- sill continues to be a headwind in many places. So I'd say, on balance, it probably has made some improvements from a commodity perspective. I think that what does that mean from a cost perspective in 2023? It's tough to tell our margin perspective. I mean, there's no doubt that in a normal environment, you would expect some pricing headwinds from your customers. And whether or not they will start in certain places to try to come back to pricing, we'll certainly do our best to -- as we always do to -- as we add value to our customers to ensure that we're keeping that fair margin. But as costs come down, I would expect in some places for pricing to have some headwind. But I would expect that ultimately a balance to happen where we were able to protect our margins and continue to have strong margins. It really wouldn't -- I wouldn't think change from a profitability perspective. And in a normal environment, prior to the pandemic when inflation was kind of at a normal pace and the demand environment was normal, that's -- you did have that kind of normal balance. And I expect that, ultimately, over time, we'll see that again. And whether or not that happens in ‘23, that's a little bit too early to predict. But I think we are in a better place, both on the price and a cost perspective, than we certainly were a year ago. Happy New Year. Thanks for taking my question. Could you just quantify the impact of price in 2022 overall? And if there's any areas that were strong in particular? And what are your expectations for the upcoming year? Yes. I was kind of I was saying before, I mean, certainly, we did have some pricing kind of momentum in 2022. Honestly, I couldn't even tell you what exactly the impact the price was on our top line. We don't -- unfortunately, our systems aren't capable of even providing that information. I would say it's somewhere kind of in maybe low single digits, but it's a very difficult thing to even have to provide. So -- and honestly, it really wouldn't provide us with any help in regards to how we run our business. So it's not something we're necessarily focused on. But certainly, there was some pricing in 2022. We've talked about that and without a doubt there was. I mean, again, as I mentioned before, in a normal environment, pricing would be, I would say, more of a headwind than a tailwind and ‘22 was a slight tailwind, I would say. And I know it's tough to say whether we'll be in 2023 as the cost environment maybe levels off a bit. But ultimately, whatever it is, I know I'm really not so concerned. I think that the team has continued to do a great job of managing cost, managing price and ultimately ensuring at the end of the day, we're getting paid for the value we provide to our customers. Well, thank you so much. And again, we'd like -- Craig and I would like to, on behalf of our entire team around the world, express our gratitude to each of you for the confidence you put in us. And we wish you all the best and look forward to speaking with you just a short 90-days from now. Thank you, everybody. Happy New Year again, and stay safe.
EarningCall_1586
Good morning, ladies and gentlemen. And welcome to the CSPI’s Fourth Quarter Fiscal Year 2022 Financial and Operating Results Conference Call. At this time, all participants have been placed on a listen-only mode and we will open the floor for your questions and comments after the presentation. Thank you, Matthew. Hello, everyone. And thank you for joining us to review CSPI’s fiscal fourth quarter and full year results, which ended September 30, 2022. With me on the call today is Victor Dellovo, CSPI’s Chief Executive Officer; and Gary Levine, CSPI’s Chief Financial Officer. After Victor and Gary conclude their opening remarks, we will then open the call for questions. Statements made by CSPI’s management on today's call regarding the company's business that are not historical facts maybe forward-looking statements as the term is identified in federal securities laws. The words may, will, expect, believe, anticipate, project, plan, intend, estimate and continue as well as similar expressions are intended to identify forward-looking statements. Forward-looking statements should not be read as a guarantee of future performance or results. The company cautions you that these statements reflect current expectations about the company's future performance or events and are subject to a number of uncertainties, risks and other influences, many of which are beyond the company's control that may influence the accuracy of the statements and the projection upon which the segment and statements are based. Factors that may affect the company's results include, but are not limited to, the risks and uncertainties discussed in the Risk Factors section of the annual report on Form 10-K and the quarterly report on Form 10-Q filed with the Securities and Exchange Commission. Forward-looking statements are based on the information available at the time those statements are made and management's good faith belief as of the time with respect to the future events. All forward-looking statements are qualified in their entirety by this cautionary statement and CSPI undertakes no obligation to publicly revise or update any forward-looking statements, whether as a result of new information, future events or otherwise after the date thereof. Thanks Michael, and good morning, everyone. This morning we reported an exceptional finish to our fiscal year 2022. We were able to ship a sizable portion of our record fiscal Q3 backlog, which contributed to revenue growth of 67% in the fiscal fourth quarter compared to prior year quarter. At the same time, the TS business segment hit on all cylinders and we achieved $0.31 per diluted common share in earnings for the fiscal year fourth quarter while continuing to generate new orders. As a result, we finished the year with the backlog at a near record level and $24 million in cash, a solid momentum across all product lines and services offerings as we entered fiscal 2023. When we last talked with you in August, I made a comment that our team had started to turn the corner on meeting the challenges presented by ongoing supply chain inflationary pressure. While we still have challenges in our supply chain, we've been able to work around some of them. During the past year and a half, the supply chain challenges have been a big factor behind the growth in our backlog and some of our critical components for our product and systems have taken a full year to be shipped. The fact that we have not lost a single order from our backlog during the period is a testimonial to the unique features and exceptional performance of our solutions, as well as critical role they play for our customers. As our team work to elevate some of the most critical supply chain issues, we were able to accelerate deliveries and revenue growth. Our revenue growth during the fiscal fourth quarter was driven by technology solutions or the TS business and its managed service practice. We generated revenue of $15.8 million, an 80% increase from the prior year quarter. We are winning new customers while earning increased business from existing customers. The managed service practice or MSP revenue grew 24.6% from the prior year quarter and was driven by a customer's increase and use of our implementation, installation and training capabilities. The managed service practice growth during the quarter came from existing customers who rely on CSPI to meet critical systems needs. During recent quarters, we have experienced modest growth from existing customers, so expanding business from -- there's critical component is both welcome and exciting. At the same time, we also generated MSP revenue growth from our new customers who are initiating relationships with our team and this contribution to our financial performance is also highly valued. While our view of the cruise line business remains unchanged from the prior quarter, any upside during the year will be seen as a boost to the overall performance in our internal goals. We remain ready to pursue new opportunity as they arise, as we have maintained the staffing need for this business as they have been reassigned to other projects within CSPI. Regarding the UCaaS practice, we secured additional UCaaS orders during the quarter and the current pace is encouraging. Before I move on, I want to congratulate the TS team as CRNs, a brand of the channel company named Technology Solutions to its 2022 solution provider 500 list. CRN's annual solution provider 500 ranks North America largest solution providers by revenue and serves as a gold standard for recognizing some of the channels’ most successful companies. Our high performance products, or HPP segment, which also impacted by ongoing supply chain issues during the quarter reported revenue of approximately $0.9 million, above fiscal Q3 and below the year ago fiscal Q4 amount. However, the story with the segment is momentum as we expanded the segment’s backlog, and we believe we have entered a phase of increased customer interest and activity. We believe fiscal 2023 is going to be an exciting year for the segment. During the quarter, we added two new ARIA customers, a consistent level of performance over the past few quarters. I mentioned earlier that our new business pipeline continues to build and we finished with a near record backlog at the end of the fiscal year. We had one large sale with a financing arrangement in the fourth quarter with a total payment of $12.8 million to be received in three installments with the last occurring in fiscal 2024. This revenue was recorded net. As a testimony to the strong balance sheet of the company, we will realize sizable portion of the $24 million in cash at September 30, 2022 for the cost of the sale in fiscal 2023’s first quarter. We have successfully executed similar type of orders for this customer. A key objective for our team is to continue the migration of CSPI's revenue to higher margin product and services. For the full-year, we executed this goal as evidence of by our gross margins of 34.6%. Our gross margin for the fourth quarter was 36.2%, which resulted from a strong 24% revenue growth of our managed service practice and mix of business. Our overall revenue growth was the chief driver behind our net income for the quarter of $1.4 million or $0.31 per diluted share. We also benefit from a favorable currency exchange, which Gary will review in a few moments. Back in August, we noted the pressure being put on our cost by inflationary forces in the tight labor market. This pressure led to increased wages in employment incentives. During the fourth quarter, we began to experience some relief from this pressure. Don't get me wrong, it's still there but the upward pressure has abated somewhat, and we have been able to meet our staffing needs within our business model. To summarize, we had a great finish to our fiscal year. Our strategy of focusing on higher margin product and services that met customer demand is yielding solid progress each quarter. Despite converting some of the older backlog revenue, we increased the backlog from the third quarter. This demonstrates the strength of our offering, yet, it also highlights our continued engagement and customer loyalty during this period since we have not lost a single order from the backlog. We have successfully transitioned our business during the unprecedented period and today we are an active player in the high growth and margin business, and we believe we have the resources withal and the strategy to realize our potential. Thank you, Victor. As Victor mentioned in his opening remarks, our fiscal fourth quarter revenue was $16.7 million, a $6.7 million or 67% increase over the year ago fiscal fourth quarter. We reported gross profits of $6 million or 36.2% of sales compared to $4.2 million or 41.7% of sales in the year ago fiscal fourth quarter. Service revenues grew 25% compared to the year ago fourth quarter and was up from our fiscal third quarter, which is a combination of the growth in the MSP as well as a higher average selling price. Our engineering and development expenses for the fourth quarter were $865,000 compared to $700,000 in the year ago period. As we have discussed previously, the increase is primarily due to higher personnel costs, which include outside consultants. Our SG&A expenses in Q4 was $4.8 million, up $1 million from the year ago fiscal fourth quarter due to increased variable compensation and bonuses from hitting key operating objectives for the full year. We reported net income of $1.4 million in the fiscal fourth quarter or $0.31 per diluted share common compared with our net income, which was net income of $0.8 million or $0.19 a share -- per diluted share for the fiscal 2021 fourth quarter. The 2022 fourth quarter results reflected a $0.9 million gain from the impact of foreign currency exchange rates while the prior year period included a gain from the sale of discontinued operations of $0.5 million or $0.11 per diluted common share. We ended the fourth quarter and full year with cash and cash equivalents of nearly $24 million as of September 30, 2022, which was an increase of $4 million from September 30, 2021, primarily due to the receipt of an installment payment for a large financing order in the fiscal 2022 fourth quarter. During the fiscal year 2022, we purchased 22,000 common shares from the stock repurchase program. We have authorization to buy an additional 172,000 shares of CSPI Common Shares as of September 30th, 2022. We continue to believe the shares at the current price level represent value, especially when you factor in the margin expansion we are generating and the growing backlog. I also want to highlight that the Board of Directors approved a quarterly dividend of $0.03 per share payable January 6, 2023 to shareholders of record on the close of business on December 21, 2022. Before I conclude my remarks, I want to highlight what Victor mentioned earlier, how we have had an opportunity to leverage the strength of the balance sheet to offer CSPI financing for customer orders. This is twofold benefit for us. It will enable us to accelerate the top line growth while attractive interest rates will allow us to achieve greater profitability. However, I want to stress this will not change our prudent expense management and we will be vigilant to ensure that we have the resource to execute the multi-year growth strategy of transforming to a cybersecurity, wireless, and managed service company. I hope things find you well. I got a couple questions. I wasn't able to keep up with that installment payment. So I got the balance sheet side of it, the income statement side of it, that was -- sales was booked in the fourth quarter? The first installment payment will be in Q1, hit Q1, and then the remaining will be year two and three. So it'll be a month 13 and then month 25, let's say. No, we had to pay it in full -- that 60, and then the next October will be the next payment, and then the following in October will be the final payment. The ARIA products, I know that there's still some kind of supply chain impact. Did that impact the shipments of those or is that finally starting to ease. And do you have a ballpark of what the backlog on that is? We talking a couple of million, we talking 8 million? And you know, you said you're going to ship in Q1. Does that mean that's all the product you have available to ship right now, or that's just what’s scheduled to ship in Q1 and you're going to be able to ship additional in the remaining quarters of the year. You had a very good first quarter here or last quarter, last year. A couple of quick questions. One, on the last conference call, you talked about expecting delivery or an October delivery timeframe for that large $1.8 million government cybersecurity order. Is that still inline for October or -- we’re past October, but was that delivered in the first quarter, or is that being delayed? So it wasn't in the fourth, it’ll be reflected in the next report then the next -- the fourth quarter. Okay, that's great. Interesting point was your comment about the -- you're expecting an exciting year in the HPP division this year, hopefully. Am I assuming correctly that some of the assignment is generated from that webinar you did with NVIDIA back in June and maybe some progress on the amount of interest you had from that webinar? I think it's a combination of a lot of sales activities that we're doing, not just from the NVIDIA. The stuff with those large organizations as you know, Joe, take a while to get embedded into their product line. So we're making progress but it's slow, but it's moving forward. So you’re still working with on that -- from that webinar. Some -- the lead group with that, it’s just that takes a lengthy period of time is what you're saying… Yes. They're NVIDIA’s customers that we're talking with. So they're pushing the sales cycle more than we are. So we're just a piece of the overall solution. Well, that's all right. NVIDIA’s got a lot of customers. Again, in last conference call you mentioned about adding some channel partners or you're progressing on that level. Have we added any additional partners since that last conference call? Not exactly sure, but I would say probably three to five new ones that we've been talking with and I think three signed. And just I guess in the last conference call you also mentioned that you thought that the E2D royalty revenue would be included in the last quarter, the fourth quarter of last year. Was that the case or are we expecting any in the first quarter of this fiscal year? So you're expecting more down the road. Well, that's pretty good. Sounds pretty exciting. Hopefully, if we can solve the backlog the quarters going forward will be a lot better than even this report, which was a very good quarter. So thanks a lot again, guys. And again, have a good holiday. [Operator Instructions] Thank you. That concludes our Q&A session. I will now hand the conference back to CEO, Victor Dellovo for closing remarks. Please go ahead. Thank you. As always, I want to thank you, thank our shareholders for the continued interest and support. Fiscal 2022 was not without its challenges, pandemic supply chain issues, inflationary pressure, and yet we grew revenue and gross margins, while ending the year with a record backlog and strong enough balance sheet to secure orders that will further drive our revenue and gross margins. Gary and I look forward to sharing our progress and fiscal 2023 first quarter operating results in February. Until then, enjoy the holiday season. Be well, stay safe. Thank you, ladies and gentlemen. This concludes today's event. You may disconnect at this time, and have a wonderful day. Thank you for your participation.
EarningCall_1587
Please note that certain statements made during the call constitute forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Act of 1995 as amended. Such forward-looking statements are subject to both known and unknown risks and uncertainties that could cause actual results to differ materially from such statements. These risks and uncertainties are described in the Company's earnings press release and its filings with the SEC. The forward-looking statements today are made as of the date of this call, and the Company does not undertake any obligation to update the forward-looking statements. Good afternoon, everyone. I want to begin by acknowledging the dedication and focus of the teams managing our stores, fulfillment centers and e-commerce platforms. As the holiday season begins, they are going the extra mile and working exceptionally hard to deliver for our customers. I also want to take the opportunity to acknowledge our stockholders who continue to demonstrate unrivaled enthusiasm and support. As we work to transform the Company and do something unprecedented in the retail sector that sustained passion is a major tailwind for us. Similar to last quarter, I'm going to spend some time at the outset of this call, recapping where we've been, where we are now and where we're looking to go. Throughout 2021 and 2022, we were extremely focused on repairing our decayed foundation, reestablishing a culture of operational intensity, and setting the right long-term priorities. This translated to building a strong balance sheet, modernizing a crumbling infrastructure, and putting together teams that are now able to operate with the nimbleness and efficiency our stockholders and customers expect. Today, we're in the process of aligning corporate costs through our go-forward needs after completing the majority of necessary upgrades to our systems, fulfillment capabilities and overall foundation. A large portion of our cost cuts will stem from reductions in corporate headcount that have been made during the back half of this calendar year. In some cases, individuals who helped us complete key initiatives have left on their own accord and are not being replaced. In other cases, we've made the decision to eliminate or streamline parts of the organization where we can leverage the work completed over the past 18 months to operate with increased efficiency. We now have a firm understanding of the resources required to pursue opportunities in gaming as well as high potential growth categories like collectibles and pre-owned businesses. Looking ahead, we have two overarching priorities: achieving profitability in the near term; and driving pragmatic growth over the long term. Now that the necessary investments have been made and we have identified the aforementioned opportunity set, we're going to be very judicious with respect to how we allocate capital to the core business. Maintaining a sizable cash position will maximize our optionality and keep us strong against the challenging economic backdrop. If a strategic asset or complementary business becomes available in the right price range, we want to be able to explore those acquisitions. As a result of these steps and our planning, we believe GameStop is well positioned, heading into 2023. We stand to benefit from our strong cash position, lack of debt, healthy inventory mix, shrinking cost structure and disciplined focus on categories where we have competitive positioning. We are also fortunate that the Company's exposure to digital assets has been very modest, thanks to risk management efforts. The Company has proactively minimized exposure to cryptocurrency risk throughout the year and does not currently hold a material balance of any token. Although we continue to believe there is long-term potential for digital assets in the gaming world, we have not and will not risk meaningful stockholder capital in the space. Net sales were $1.186 billion for the quarter compared to $1.297 billion in the prior year's third quarter. Approximately $50 million of the decline is attributable to FX. Sales attributable to new and expanded brand relationships remained strong. Likewise, sales in the collectibles category remained strong on a year-to-date basis. SG&A was $387.9 million or 32.7% of sales compared to $421.5 million or 32.5% of sales, in last year's third quarter. Notably, SG&A as a percentage of revenue was down on a sequential basis from 34.1% in Q2 of this year. We've also taken additional steps in recent weeks to further reduce SG&A on a go-forward basis, now that significant improvements have been made to the core business. We reported a net loss of $94.7 million or $0.31 per diluted share compared to a net loss of $105.4 million or $0.35 in the prior year's third quarter. As with SG&A, we saw a healthy reduction in our net loss on a sequential basis versus Q2 of this year. Turning to the balance sheet. We ended the quarter with cash, cash equivalents and marketable securities of $1.042 billion. We continue to maintain a strong cash position while sustaining strong in-stock levels for the busy holiday season. With respect to inventory, we have strengthened our position in recent months by divesting a small percentage of merchandise that was acquired late in 2021 and early in 2022. Divestitures occurred in categories seeing soft customer demand over multiple quarters. Inventory was $1.131 billion at the close of Q3 compared to $1.141 billion at the close of the prior year's third quarter. At the close of the reporting period, we had no borrowings under our ABL facility and no debt other than a low interest unsecured term loan associated with the French government's response to COVID-19. Capital expenditures for the quarter were $13 million, up $0.5 million from last year's third quarter. We anticipate CapEx will remain at similar or reduced levels now that the Company has largely completed its period of heavy investment. In the third quarter, cash flow provided by operations was $177.3 million compared to an outflow of $293.7 million during the same period last year. In terms of an outlook, we're not providing formal guidance at this time. It is worth reiterating, however, that our goal is to achieve profitability in the near term. I want to finish by reiterating what we've said in the past. We're attempting to accomplish something unprecedented in the retail sector. We're seeking to transform a legacy brick-and-mortar business that was on the brink of bankruptcy into a retailer that meets customers' needs through our stores, e-commerce properties and emerging sales channels. This path carries risk and is taking time, but it is the path we are on. With that said, GameStop is a stronger business today than at any time in the recent past. I'll leave it there for this quarter. Thank you.
EarningCall_1588
At this time, all participants are in a 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. As a reminder, today’s conference call is being recorded. Some of the statements made during our prepared remarks and in response to your questions may constitute forward-looking statements made pursuant to and within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, as amended. Such forward-looking statements are subject to both known and unknown risks and uncertainties that could cause actual results to differ materially from those that we expect. Please refer to today’s press release and the company’s most recent Form 10-K with the SEC for a discussion of known risks and uncertainties. Investors should not assume that the statements made during the call will remain operative at a later time. We undertake no obligation to update any information discussed on today’s call. Thank you Mark. Good morning and thank you for joining us on today’s call. Our new CEO, Jacquie Ardrey, and John Enwright, our CFO both join me today. Jacquie joined the company in November after most recently serving as President of Grandin Road with previous experience at Harry and David and Hanna Andersson. She has jumped right in and we are excited to have her leading the company into the future. First, let me make a few comments on the quarter. We delivered a year-over-year improvement in non-GAAP EPS largely driven by implementation of our targeted expense reductions. Total revenues of $124 million were modestly above overall expectations and we began to experience some stabilization in our gross margin rate as supply chain challenges moderated and strategic price increases help offset increased raw material and freight costs. As in past quarters, we are continuing to experience bifurcation in the spending of our customer base. Vera Bradley’s direct full price channel customers with higher household incomes remain more engaged and continue to spend more than customers with lower household incomes, especially in our Vera Bradley factory channel where inflationary pressures impacted traffic and discretionary spending. However, our Vera Bradley indirect channel experienced its third consecutive quarter of year-over-year growth. At our Vera Bradley brand, we are continuing to fuel our innovation pipeline and build on our lifestyle merchandising focus in the core areas of travel, back-to-campus, everyday, and collaborations. In the third quarter, we continued our powerful product collaborations with Disney and Harry Potter, launched a new rain gear collaboration with Totes, introduced our VB Cloud casual footwear collection, expanded our family sleep and loungewear collection, and made our debut in the metaverse with our NFTs to celebrate our 40th anniversary. While stores will continue to play an important part of our Vera Bradley distribution strategy going forward, we continue to rationalize our store base, closing underperforming stores as leases expire. We have closed 10 full line Vera Bradley locations this year. Pura Vida’s ecommerce revenues continue to be affected by social and digital media effectiveness and higher costs. This year, we have lowered Pura Vida’s year-over-year marketing spend until we can determine the best ways to maximize the marketing effectiveness, which has had a negative impact on sales. In the third quarter, we did begin to reinvest more marketing dollars than we spent in the first and second quarters, and we saw a positive impact on ecommerce sales trends, although still negative compared to the prior year; however, at the same time we experienced a negative trend in Pura Vida’s wholesale revenues. Our number one priority is to build a more diverse, innovative, effective and performance-based marketing program to drive Pura Vida ecommerce sales. We are in the process of implementing a comprehensive customer data platform for Pura Vida to build a single coherent, complete view of each customer so that we can better target and personalize marketing and become less reliant on third party marketing. This should be complete by early next year. In the meantime, we are continuing to work with our micro influencers, expanding our TikTok presence, launching impactful ads on connected TV, optimizing SMS, and aggressively exploring other methods to effectively reach our customers. We opened our new Pura Vida full price stores at Broadway at the Beach in Myrtle Beach, South Carolina in August and at the SanTan Village in metro Phoenix in September. Stores can play a key role in driving new customer acquisition as we continue to diversify our marketing platforms, and they demonstrate the power a retail presence has in driving digital sales, omnichannel loyalty and spending. So far, all of our Pura Vida full price retail stores are trending to exceed their first year sales projections. On the Pura Vida product front, we continue to build customer excitement and engagement through collaborations like Disney, Harry Potter and Hello Kitty, partnering with key influencers and continuing innovation like the expansion of our demi fine and stone jewelry collections and extension of our apparel offerings. Thanks Rob. Although I’ve been with the company just a few short weeks, I’m convinced that both our Vera Bradley and Pura Vida brands have untapped potential in the marketplace. While I expect the macro environment to remain unpredictable, our teams are focused and our cash position and balance sheet remain solid. I look forward to working closely with our leadership teams to develop and execute solid growth plans, leverage our many opportunities especially in the areas of merchandising and marketing, and deliver consistent, sustainable growth and value to our shareholders over the long term. I look forward to talking to you more about our go-forward plans during our year-end earnings call in March. Thanks Jacquie, and good morning. Let me go over a few highlights for the third quarter. The numbers I will discuss today are all non-GAAP and exclude the charges outlined in today’s release. For a complete detail of items excluded from the non-GAAP numbers as well as a reconciliation of GAAP to non-GAAP numbers, please reference today’s press release. Consolidated net revenues totaled $124 million compared to $134.7 million in the prior year third quarter. Consolidated net income totaled $6.3 million or $0.20 per diluted share compared to $6.2 million or $0.18 per diluted share last year. As Rob noted, the increase in EPS was primarily attributable to expense leverage due to the cost reduction initiatives. Vera Bradley direct segment revenues totaled $80.1 million, a 7.6% decrease from $86.6 million last year. Comparable sales decreased 9.6% in the third quarter. Vera Bradley indirect segment revenues totaled $22.3 million, a 6.7% increase from $20.9 million in the prior year third quarter, reflecting an increase in certain key account orders partially offset by a decline in specialty account orders. Pura Vida segment revenues totaled $21.7 million, a 20.3% decrease from $27.2 million last year. Third quarter gross margin totaled $65.6 million of 52.9% of net revenues compared to $72.3 million or 53.6% of net revenues last year. The current year gross profit rate was negatively affected by higher inbound and outbound freight expense, deleverage of overhead costs and channel mix changes, partially offset by price increases. Third consolidated SG&A expense totaled $57.6 million or 46.4% of net revenues for the current year third quarter compared to $63.7 million or 47.3% of net revenues in the prior year. As expected, current year expenses were lower than prior year primarily due to cost reduction initiatives and a reduction in variable related expenses due to lower sales volume. The company’s third quarter consolidated operating income totaled $8.2 million or 6.6% of net revenues compared to $8.7 million or 6.5% of net revenues in the prior year. Now let’s turn to the balance sheet. Total quarter end inventory was $178.3 million compared to $148.3 million at the end of third quarter last year. Total current year inventory was higher than prior year primarily due to approximately $17 million in incremental logistics costs burdening overall inventory, as well as incremental Vera Bradley factory inventory related to lower than expected revenues. Cash, cash equivalents and investments as of quarter end totaled $25.2 million compared to $75.3 million at the end of last year’s third quarter. The company had no borrowings on its $75 million ABL credit facility at quarter end. A key reason for our lower cash position is due to the inventory build of $30 million over last year. We will continue to take a conservative approach to cash, particularly in this volatile and challenging environment. Now let’s shift to our fiscal 2023 outlook. We expect the fourth quarter macroeconomic environment to continue to be unpredictable. The Pura Vida business will continue to be challenging, inflationary pressures will continue to impact Vera Bradley’s customers with lower household incomes, particularly in the factory channel, and there will be continued pressure on gross margin. All forward-looking guidance numbers that I will discuss are non-GAAP. For the fourth quarter, we expect consolidated net revenues of $136 million to $141 million compared to $149.6 million last year, and a consolidated gross margin rate of 49.5% to 50.5% compared to 50.9% last year. The expected decrease is primarily associated with incremental targeted promotional activity and deleverage on overhead costs, partially offset by price increases and lower year-over-year freight expense. Consolidated SG&A expense of $61 million to $63 million compared to $67.1 million in the prior year. The reduction is primarily driven by cost reduction initiatives and lower variable related expenses due to expected sales decline. Consolidated EPS of $0.16 to $0.20 compared to $0.17 last year. For the full-year, our updated expectations are consolidated net revenues of $489 million to $494 million compared to $540.5 million in fiscal 2022, a consolidated gross margin rate of 51.9% to 52.1%, compared to 53.3% in last year. The expected year-over-year decrease is primarily related to incremental inbound and outbound freight expense, incremental targeted promotional activity, and deleverage on overhead costs partially offset by price increases. Consolidated SG&A expense of $242 million to $244 million compared to $258.8 million in fiscal 2022. The reduction in SG&A expense is being driven by cost reduction initiatives and variable expenses. Consolidated diluted EPS of $0.22 to $0.26, compared to $0.57 last year. Net capital spending of approximately $10 million compared to $5.5 million in the prior year. Hi, good morning. Hi Jacquie, Rob, David. Rob, as you think about channels, could you tell us a little bit about the right-sizing of full price? Also, as we look ahead to factory, you’ve been experiencing that pressure with that customer - what are your thoughts on the evolution of that, and indirect had a nice number as well, would love thoughts if that momentum can continue. Jacquie, I was curious about what attracted you most to Vera Bradley, and also as you embark on your initial weeks and months there, what are some of your key priorities? Finally Rob, on the inventory number, you gave a lot of great detail. Maybe you can help us understand how to model going forward inventory growth relative to sales. That would be great. Thanks everybody. Thanks Oliver. I guess a couple things. Let me hit some of the channel conversation questions that you asked. Full price, we’ve been talking about that we see the full price store count consolidating this year, which we’ve been doing, making sure that we’re really right-sizing it. We do believe that continuing to leverage the ecommerce business, our indirect business, and really looking at our full price business as a way to get to the customer in the most efficient way and in the place where she shops, so I think that you’re going to see that rationalization kind of continue through this year. The factory channel right now, we do believe that the big factor for us has really been what’s been going on in the general economy and this inflationary pressure, and the tightness that we’ve seen kind of across retail in more -- what I’ll call more the semi-opening price areas, right, the non-luxury areas that we’re seeing just some reduction in that customer. We’re just going to kind of fight through these near term economic pressure points, but we still believe that long term, factory is a really important part of our business. The indirect channel has been very encouraging to see, and really the power of expanding our ecommerce businesses within our indirect channel, that they’re really where we’re seeing the strength, so again we just think that continuing to leverage that ecommerce space will be important. I think maybe I’ll turn it over to Jacquie a little bit to talk about what attracted her, and then we’ll hit the inventory comment at the end. Yes, thanks Rob. I was certainly drawn to the opportunity here. I love the fact that both the iconic Vera Bradley and Pura Vida brands were built from an entrepreneurial spirit. We have devoted, emotionally connected and multi-generational customer bases, high brand recognition, socially conscious, purpose driven, and have enormous untapped potential in the marketplace. I’m really working now with the leadership team and the board to build upon the company’s heritage and leverage our opportunities, particularly in merchandising and marketing, which is where I’m spending a lot of my time right now to really drive the long term profitable growth for both brands. Since joining over just about a month ago, besides relocating here to Fort Wayne, I’ve been really immersing myself in the business, working with Rob, spending time meeting with the corporate Vera Bradley and Pura Vida teams, visiting stores, meeting with our board of directors. It’s been a really busy but great, exciting month, and really my key priority right now is just evaluating our go-forward strategy so that we can have some really exciting things to talk about in March. Oliver, I’ll hit on the inventory question. As we kind of work through inventories a little bit higher than we would want it to be, we expected this also would be a little bit different when we started this year, so inventory built. As we detailed, a lot of the build is associated with just the cost to get inventory from Southeast Asia to Indiana, so as we think about next year, we anticipate -- and obviously we’ll come out with our guidance for next year at the next earnings release, but we anticipate by the end of next year getting inventory back in line to where we would normally be, and so ultimately we would expect to see some free cash flow benefit next year associated with that and a reduction in inventory. Okay, thank you. Rob, as we think about the consumer, in the industry we saw a pretty volatile October with a weaker October and then shoppers shopping later. Are you seeing that as well, if you could help characterize some dynamics there. Second question to this is on the gross margin line. You called promos in the prepared remarks, but you also are undertaking strategic price increases. What should we take away between those two dynamics in how we’ll model or consider gross margins? Thank you. Yes, so I think from a consumer standpoint, you’re right, Oliver, that we saw weakness in October, and as we got towards Black Friday, we saw the consumer begin to pick up during Black Friday and that momentum has continued past Black Friday. What we have definitely seen, though, is the importance of promotional activity as part of that stimulation, that the consumer definitely is looking for the deal, is kind of returning to that historical Black Friday mentality. We’ve been -- you know, we’ve added some promotional deals into the brand and the consumer has responded, so we expect that as we move through fourth quarter that it will continue to be promotionally driven, targeted promotions but promotionally driven nonetheless, and so I think that’s part of the balance as we kind of move in the year ahead, is just how to balance that promotional environment for the consumer and finding opportunities to offset that expense through other ways, whether that’s through product cost or whether that’s through general SG&A. I think that probably talks a little bit about that gross margin number because we do think there will be some promotional pressure on that gross margin number. The international logistics long term will really help us as that has come dramatically down, but the domestic logistics costs are remaining, I would say high, and we’re not seeing the reduction on that side, but the international logistics costs will be a tailwind as we move forward. Yes, I’d just add to that, I think obviously we’re not giving out guidance for next year, but as a tailwind into next year will be international logistics getting back to more normal pre-pandemic levels, which will obviously benefit our P&L. Okay, thank you. The last question, at Cowen we’ve done a lot of work on fungible tokens and NFTs, and also the metaverse and what’s happening with decentralization and Web3. Why did NFTs make sense for Vera Bradley, and are you seeing any interesting trends with the customer profile there and any thoughts on plans ahead? Thank you. I think one thing that’s been so important for us of getting in the NFT world is, one, we’ve always been a company that’s been innovation-driven and we wanted to get into that space, learn from that space, begin to experiment in that space and stay relevant with the younger customer especially, so we thought it was a great opportunity. We thought we could use it as a leverage for our foundation and a leverage for just the collectability of our patterns, and so it’s something that we’ll continue to experiment around. It’s not a huge commercial opportunity yet, but it’s one of those areas we want to make sure that we’re exploring and learning and kind of growing as that space grows in the years ahead. I wanted to start off on Pura Vida -- you know, we’ve talked probably for a year now about the digital trends, and I know you’re looking at putting together the database. What really needs to happen here before we can start to see some improvement in that business? It just seems to be taking a long time to, I guess, figure out where to go next on that side, outside of opening the retail stores. I think that’s a great question, Joe. A few different things, right? One thing that is underway is the customer data platform, the technology. There’s a lot of technology pieces the team’s been working very hard on over the last quarter. We’ve had success with all of these platforms at Vera Bradley, so we’re working through and getting that learning, so we do think the first party data will be part of that. But the other piece of it is just a real diversification in the marketing platform. One thing that I think is exciting with Jacquie coming in and her leadership with her merchandising and marketing background is getting a fresh set of eyes to look at it, because we do need to find a new way of acquiring customers that is not as dependent upon our old channels, and that obviously has not been an easy transition but it’s one that we think we can get through. Stores have shown that the consumer still remains engaged. It’s improved our ecommerce business, so when we get in front of the consumer, we’re seeing a positive uptick. I think it’s going to be really mixing. As we’ve seen a lot of these direct-to-consumer businesses have started to become more omnichannel, opening up stores, diversifying their marketing, and I think that we need to be doing the same. We’ve had a -- it has not been an easy transition at Pura Vida to kind of re-platform the business, but I think we’re making some progress and I think with Jacquie coming on board, we can accelerate that progress in the months ahead. Okay, and speaking on the retail stores, I know we’ve talked about in the past you have the San Diego store, I think it’s now anniversarying. How is that performing, how are those comps looking year-over-year for the San Diego store? It’s great news on the new ones, that they all seem to be performing above expectations. What I would say about the stores at Pura Vida is it’s still early innings, right, so the good news is with all of our four full price stores that have opened up, they’re all tracking to exceed first year expectations, that’s really encouraging. The second part of it that’s very encouraging is we’re seeing a significant uptick in the ecommerce business in those metro areas, and again just showing the power that stores have not only as a four-wall revenue and profit center, but also just for the franchise overall. I know it’s one of these areas that Jacquie’s looking at as she plans the go-forward strategy, is just how to diversify the Pura Vida platform so that we can get that business growing again. I know I’m speaking a little bit for her, but we’ve had so many conversations over the last 30 days that she really sees some excitement and potential around that brand, and so I think we’ll see improvements as we move through next year. Okay. One more, if I may. Just on the guidance, I was wondering if you could give us a little more color. Last quarter, the gross margin guidance was 53.7% to 54.1%, and you’ve increased the range for revenues for the full year guide but significantly reduced gross margins down to 51.9% to 52.1%. Even with freight expense declining and some of the other things that you’ve discussed, just maybe give us a little more color into how that gross margin estimate declined so dramatically. Yes, so Joe, we talked a little bit about some more tactical discounting that we had probably initially built into our forecast at the beginning of quarter three, so really that is the more significant driver. Obviously that helped us drive a little bit more revenue, we’re expecting to drive more revenue based on that but at a rate difference. From a profit perspective, we’re neutral to positive on that, so we think it’s the right thing to do. It helps us be competitive in the marketplace - you know, she’s out there, she’s looking for more of a discount than I think we initially anticipated when we put together our guidance at the beginning of the third quarter. Good morning. Could you talk a little bit about product categories you’ve expanded? In the Vera Bradley chain, you’ve expanded the product categories significantly now in the outlets with your shoes to both the outlets and the full price stores, outerwear the last years before. As part of the overall looking at this, how do you feel about the categories you’re in and are there categories that should be de-emphasized or emphasized for you going forward? I think a couple things, Eric. First of all, I think the product innovation expansion in the categories just again shows the power of the Vera Bradley brand and our heritage in prints and color and fun and casual, so I think that that’s an underlying piece that stitches it all together. I do think that part of what Jacquie’s evaluating is just overall the merchandising strategy and how to balance that strategy, both in terms of what is the overall offering as well as what is the offering by channel. I know that that’s one area that she’s really digging into and we’ll be looking at that over the months ahead. Yes, and I would add that although it’s really too early to make a judgment about any product categories that we might exit, I’d say the team was already going through a SKU count reduction exercise which I completely support, and I obviously believe that travel, back to campus, everyday are kind of the key franchises for the Vera Bradley brand and we’ll continue to collaborate with strategic partners going forward. Great, and if you look at -- just thinking about expansion in terms of Pura Vida stores, you’re at four now. Do you look upon next year as another year to continue to expand the brand, or do you want to sit here and wait and get a little bit better data from those stores as they start to anniversary - as you mentioned previously, San Diego just anniversaried. How should we be thinking about expansion for Pura Vida stores next year? It’s a great question, Eric. I think first of all, there definitely is a learning and gathering the learnings from the stores, so I know that the team is actively doing that right now and so we are learning a lot, and that will make us better as we move forward. I think that’s another key area that Jacquie is really looking at as she’s thinking about the next go-forward strategy is kind of what is the role that stores play in Pura Vida, what are the first things she really wants to attack to get that business back on track. Again, I think she’ll have more information on that in March. Okay, and last question here, so in terms of collaborations, you’ve gone through the full cycle with Harry Potter. The collaboration, I would assume are more solid margin player because they’re not discounted, even on the sales here. How do you look at the need and desire to have more or less collaborations in both Vera Bradley and in Pura Vida going forward, and how do they fit into this overall world here? Yes, I think that our collaborations have been really powerful in attracting new customers to the business, and that’s really been one of the key points, and I think that you will continue to see opportunities around collaborations. At the same time, it is really important that we keep it fresh, we keep it measured. I don’t think that you would see us overall expanding big in terms of having more collaborations than we’re having today. I think it’s really about dialing them in. We’ve learned a lot as we’ve worked through the franchises at -- Disney is a great one, right, when we talk about our Disney collaborations, there’s a lot of different franchises within Disney that we’ve worked with, and some of them have really worked well, particularly the ones that kind of fit with the Vera Bradley DNA, and so I think we get smarter and smarter over time, but I think it will continue to play a role but it will be a measured role as we move forward. Yes, that’s definitely a focus for me in terms of how much of core and how much is partnerships for both of these brands, so that’s definitely something that’s on my mind. Good morning everybody. I know that you are not providing any sort of guidance for next year, but maybe at the highest level, can you talk a little bit about your planning? Do you think it will be a tale of two halves, or maybe just even at the very littlest can you talk a little bit about the cost initiative programs, just remind us what the size was originally, what was captured this year and what is expected to be captured next year? Thank you. Thanks, Steve. Yes, we do think next year is going to be a tough year, so I think a lot of people are thinking about a recession next year and as we’re finalizing our plans, we’re taking that into consideration while we finalize our plans. In regards to expense reduction target, it was $25 million, was kind of what we committed to, and a lot of that commitment is going -- we’re going to achieve a lot of that commitment in this year, so ultimately we’ll have gotten a lot of that through the P&L this year and ultimately then we’ll lap it next year. We won’t continue to grow from kind of -- we’ll have that in our base next year, the $25 million compared to where we expected to be this year, so. I think we’re not finalized with the plans. We have to get through holiday as we think about next year, so that’s why we can’t be really committal on what we expect for next year, but we’ll be able to give a much more detailed, thorough answer in a couple months. I think the only thing I would add, Steve, just from kind of a big picture market standpoint, the way we’re looking at it is we think the positive for next year, which John spoke about earlier, is the reduction of international logistics expenses, right? That’s going to be a positive on the P&L next year and a tailwind, which is good news. On the flipside, we do expect the macro environment to continue to be challenging, and as long as there’s this recessionary pressure, that that will be pressure that we’re facing next year, and then the company will just continue to be very disciplined on the SG&A line as we move through, making sure that we’re controlling SG&A well to manage through the recessionary environment. To me, those are kind of the three big levers that we’re looking at next year, but we’re obviously still finalizing our plans. That’s really helpful, Rob, and you actually just touched on something I wanted to follow up on from a logistics standpoint. Can you remind, if the numbers are handy, what that incremental was in ’21, what the incremental incremental was in ’22, and those two numbers would be helpful because I know that that is not going to 100% roll-off because inventory needs to work its way through the system, but at the very least knowing those two numbers would give a benchmark for what could be in the ultimately earnings power standpoint. Thanks. Yes, I can handle that question. In ’21, it was about a $6 million increase, roughly about that number, and in ’22 it’s about $7 million, so if you go back to logistics expense from pre-pandemic level over ’21, it’s about $12 million to $13 million. That does conclude the question and answer session. I’ll now turn the conference back over to Rob Wallstrom for any additional or closing remarks. Great, thank you. I’ve enjoyed being with this amazing organization for the last nine years. I could not have been surrounded by a more dedicated, collaborative and committed team, and I have enjoyed being part of the company’s special and powerful culture. I’m especially proud of the innovation, tenacity and resilience that our teams have demonstrated to overcome challenges as we stayed focus as a customer-centric and purpose-driven organization. Forbes names us as America’s number one best midsized employer for a reason. It’s an exciting time as Jacquie leads the company into the next phase of the future. We have a portfolio of two iconic lifestyle brands, multi-generational customers with amazing loyalty and devotion, remarkable brand recognition, a solid balance sheet, and incredible team. With Jacquie’s leadership and strategic direction, I believe the company will deliver meaningful growth and value to our shareholders over the long term. I look forward to following the company’s continued progress and wish everyone much success. Thank you for joining us today, and I know Jacquie and John look forward to speaking with you in March on the year-end earnings call.
EarningCall_1589
Good morning and welcome to FuelCell Energy's Fourth Quarter and Fiscal Year 2022 Financial Results Conference Call. All participants are in a listen-only mode. After the speakers' presentation, we'll conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference call is being recorded. I'd now like to turn the call over to Tom Gelston, Senior Vice President of Finance and Investor Relations. Thank you. Please go ahead, Mr. Gelston. Thank you and good morning, everyone, and thank you for joining us on the call today. As a reminder, this call is being recorded. This morning FuelCell Energy released our financial results for the fourth quarter and fiscal year 2022, and our earnings press release and our annual report on Form 10-K are available in the Investors section of our website at www.fuelcellenergy.com. Consistent with our practice, in addition to this call and our earnings press release, we have posted a slide presentation on our website. This webcast is being recorded and will be available for replay on our website approximately 2 hours after we conclude the call. Before we begin, please note that some of the information that you will hear or be provided with today will consist of forward-looking statements within the meaning of the Securities and Exchange Commission Act of 1934. Such statements express our expectations, beliefs and intentions regarding the future and include without limitation: statements with respect to our anticipated financial results, our plans and expectations regarding the continuing development, commercialization, and financing of our fuel cell technology and our business plans and strategies. Our actual future results could differ materially from those described in or implied by such forward-looking statements because of a number of risks and uncertainties. More information regarding such risks and uncertainties is available in the Safe Harbor statement, in the slide presentation and our filings with the Securities and Exchange Commission, particularly the Risk Factors section of our most recently filed annual report on Form 10-K. During the course of this call, we will be discussing certain non-GAAP financial measures. And we refer you to our website and to our earnings press release and the appendix of the slide presentation for the reconciliation of those measures to GAAP financial measures. Our earnings press release and a copy of today's webcast presentation are available on our website at www.fuelcellenergy.com under Investors. For our call today I am joined by Jason Few, FuelCell Energy's President and Chief Executive Officer; and Mike Bishop, our Executive Vice President and Chief Financial Officer. Following our prepared remarks, we will be available to take your questions and be joined by other members of the leadership team. Thank you, Tom. And good morning, everyone. Thanks for joining us on our call today. Since we met last quarter, we achieved some exciting accomplishments on our journey to enable the world to be empowered by clean energy. Today, we announced our best annual revenue since 2015 as a result of strong execution of product sales and continued progress on our Powerhouse business strategy. More on that in a few minutes. But before getting into the business results, I always like to give an overview of FuelCell Energy on Slide 3, for anyone who might be new to the FuelCell Energy story. In operation for over 50 years, FuelCell is a leader in developing stationary fuel cell energy platforms. Our goal is to leverage our proprietary technologies to decarbonize power and produce hydrogen. We operate in North America, Asia and Europe. And we are focused on entering more markets around the world as we commercialize and scale our technologies. Our manufacturing facilities are currently located in the United States, Canada and Germany, which creates an efficient distribution network, leverages our centers of expertise, and helps us to meet local content requirements. We have 95 platform installations in commercial operation, which we believe demonstrates the commercial feasibility of our energy platforms. Our first commercial platform was deployed in 2003 in Japan, where we demonstrated our fuel flexibility using biofuels produced on-site. For the full fiscal year 2022, we reported revenues of over $130 million across four revenue categories: Product, Service Agreements, Advanced Technologies and Generation, which together represent diversified sources of recurring revenue under multiyear contracts. In fiscal year 2021 and 2020, we had no revenue from product sales, but they returned to our revenue mix in fiscal year 2022 with orders for 20 molten carbonate fuel cell modules from Korea Fuel Cell. We have delivered these modules Ex Works to Korea Fuel Cell to service its installations in the South Korea market, generating new product sales in South Korea as well as other Asian markets, select countries in Europe, the Middle East, Africa and North America is a priority for us. Starting January 1, 2023, the limitations in our settlement agreement with POSCO Energy and we can work directly with existing POSCO Energy KFC customers to provide new long-term service agreements for the existing installed base in addition to KOSPO where we already provide 20 megawatts directly. It is also important that we keep our sights on our company's purpose, which is shown on Slide 4. Across our company, we are committed to a shared purpose of enabling a world empowered by clean energy. As world events have recently shown us, every industry will be meaningfully impacted in the future by the energy transition. We believe FuelCell Energy is well positioned to be part of that solution by assisting customers on a safe, secure and practical path to carbon-zero, and this purpose drives our strategic focus and our passion for our work. Next, let's turn to the key business developments during the quarter shown on Slide 5. Over the fiscal year, we continued to execute against our strategic agenda, delivering projects in our backlog, completing and delivering product orders and making tangible progress toward commercialization of our new technologies. As I mentioned, we delivered eight more modules Ex Works to Korea Fuel Cell during the fourth quarter, completing the initial two orders for a total of 20 modules placed earlier this year. We are continuing to scale our commercial organization in Korea in anticipation of developing a pipeline of opportunities in Korea and other Asia markets. Importantly, as I previously stated, starting January 1, 2023, we will regain full access to the Korea market, including legacy customers that were previously solely serviced by Korea Fuel Cell. On December 16th, we announced that the platform at the U.S. Navy Submarine Base in Groton, Connecticut achieved commercial operations. We entered into an amended and restated power purchase agreement with Connecticut Municipal Electric Energy Cooperative, or CMEEC, to allow the plant to operate at a reduced output of approximately 6 megawatts, while a Technical Improvement Plan is implemented over the next year with a goal of bringing the platform to its rated capacity of 7.4 megawatts by December 31, 2023. In conjunction with this project reaching commercial operation, we have closed on a previously announced tax equity transaction with East West Bancorp. We continue to expect this project to highlight the ability of FuelCell Energy's platforms to perform at high efficiencies, while advancing the U.S. Navy’s sustainability objectives and contributing to the reduction in Scope 2 emissions. Incorporation of the fuel cell platform project into a microgrid is expected to demonstrate the capacity of FuelCell Energy's platforms to increase grid stability and resiliency, while supporting the U.S. Military's efforts to fortify base energy supply. Next, we recently announced the important milestone that we are accepting orders for our solid oxide platform for both power generation and hydrogen electrolysis applications. We have also entered into our first contract for our solid oxide fuel cell with a repeat customer Trinity College in Hartford, Connecticut. We continue to invest in our internal R&D activities as we focus on full commercialization of our patented solid oxide platform. More details on this in just a minute. Additionally, we have announced our intent to deploy our solid oxide electrolysis platform integrated with NuScale’s Small Modular Reactor to produce hydrogen and ammonia in Ukraine to support energy security and agriculture. We believe this will be an important application for solid oxide technology and are excited about this opportunity. The timing of the project will be predicated on further resolution of the unfortunate conflict in Ukraine and other factors. We continue to hope for the restoration of peace in Ukraine, while offering our prayers and support to the people in that region who are suffering greatly. Next, we're continuing to progress toward commercialization of our Advanced Technologies for carbon capture. Under our joint development agreement with ExxonMobil Technology and Engineering Company or EMTEC, we recently completed a joint marketing study to define application opportunities and commercialization strategies that Exxon and FuelCell Energy will pursue in collaboration. In addition, we have now extended our joint development agreement until August 31, 2023 to further the technology and prepare for demonstrations. Together, we will continue to identify partners for commercial trials or demonstration projects as we pursue carbon capture across a broad landscape of industrial application. My fourth key message is that we're encouraged by developments in global policy support for decarburization, including the Inflation Reduction Act in the U.S., a Carbon Tax in Canada, and an overall policy support across Europe, Asia, Africa and the Middle East. We believe we are well positioned to capitalize on the evolving global energy landscape with a portfolio of solutions that aim to decarbonize power and produce hydrogen. On Slide 6, we wanted to illuminate that we believe our company is well positioned for future growth as a result of the Inflation Reduction Act or IRA. As a U.S. manufacturer, and a company that has demonstrated a long-term commitment and practice of sourcing U.S. materials, we find the IRA to be a very meaningful and supportive domestic policy. We believe that the various policy mechanisms within the IRA as highlighted on this chart will provide FuelCell Energy with the long-term market and tax certainty needed to support our continued investment decisions in hydrogen, carbon capture and manufacturing expansion as well as team members passionate about our purpose. With this legislation, we believe that FuelCell Energy and customers of our fuel cell technology will be able to take advantage of investment tax credits, production tax credits for clean power and hydrogen, and carbon capture utilization and sequestration credits, which we have summarized on Slide 6. To illustrate how we believe the IRA may work, I want to highlight two examples. First, even though the fuel cell investment tax credit expires in two years, given our molten carbonate platform's fuel flexibility to operate on biofuels or a hydrogen blend, and our solid oxide platform's ability to operate on a 100% pure hydrogen, the green power generation investment tax credit or Section 48E is expected to extend incentives which benefit the sale of our platforms through 2032. The second example relates to our carbon capture platform under development, where we expect to benefit from Sections 45Q and 48C as a U.S. manufacturer. Across the board, we believe that these are important centers to achieve three critical objectives. First, building and deploying more clean energy assets across the country, ensuring that the United States leverages its rich natural resources. Second, decarbonizing our most challenging sectors without deindustrialization. And third, supporting U.S. manufacturers in rapidly scaling capacity, thereby driving down unit costs and creating favorable economics for global deployment of U.S. manufactured clean energy technologies, such as FuelCell Energy. The investments FuelCell Energy is making in our business are well aligned with these policy goals and constructive energy transition policies around the world. Next, on Slide 7, I'd like to go into further detail about our solid oxide platform, which has progressed far enough in the design cycle and commercialization process that we are now accepting customer orders. Over the past several quarters, we have provided you with specific updates, including photographs of our prototype units. In recent months, the technology has undergone independent lab testing at Idaho National Labs or INL. And their teams validated that the FuelCell’s stack has performed well in test in a broad range of conditions and unexpected events. This independent validation has allowed us to move forward with our first order from Trinity College in Hartford, Connecticut, for a 250 kilowatt solid oxide fuel cell. We are very excited about potential opportunities for a sub megawatt power generation platform and our targeted geographic markets in addition to the sub megawatt power generation platforms we currently offer across the European Union and the UK. In support of future production we are expanding our facility in Calgary, Canada, with additional dedicated manufacturing space as part of the first phase of increased solid oxide capacity. We will provide more insight on our expansion plans as they progress in conjunction with reevaluating our market opportunity in light of the IRA and other favorable developments around the world. Next, on Slide 8, we highlight the specific advantages of FuelCell Energy’s solid oxide fuel cell, and solid oxide electrolysis cell technologies. There are many characteristics that make our technology attractive, including fuel flexibility, efficiency, reliability, and a small footprint for easy colocation. The most important factor is the cost of electrolysis-produced hydrogen, however, is the cost of electricity. Efficiency is one of the most effective ways to lower costs, and we believe FuelCell Energy’s solid oxide platform is among the most efficient electrolysis technologies available. Therefore, among competing technologies, we believe our solid oxide platform offers one of the best chances of achieving the $1 per kilogram levelized cost of hydrogen targeted by the U.S. Department of Energy by 2050. We believe solid oxide presents the best opportunity for hydrogen production facilities to minimize the overall costs, while maximizing efficiencies, and that this platform will give more organizations the option to implement a flexible energy strategy. In addition, with the renewed focus on nuclear energy, extended operational dates and the recognition that nuclear energy is an excellent source of power for hydrogen generation utilizing electrolysis, we believe our high temperature solid oxide electrolysis platform is well positioned to capitalize on this developing opportunity. And now, I will turn the call over to Mike to discuss the financial results for the third quarter in more detail. Mike? Thank you, Jason. And good morning to everyone on the call today. Now that you've heard from Jason, I will provide some details regarding our financial results. For the fourth quarter of fiscal year 2022, we reported total revenues of $39.2 million compared to $13.9 million in the fourth quarter of fiscal year 2021, an increase of 181%. Looking at revenue drivers by category. Product revenues were $24 million in the quarter compared to no product revenues in the comparable prior year quarter. Product revenues are the result of module sales to Korea Fuel Cell Company or KFC, for which the company recognized $24 million on the Ex Works delivery of eight fuel cell modules from our manufacturing facility in Torrington, Connecticut. Service agreement revenues decreased to negative $1.1 million from negative $0.1 million. The decrease was primarily a result of a reduction in service revenues due to higher future cost estimates related to future module exchanges compared to our prior estimates, which more than offset revenue recognized in the quarter. Generation revenues increased 30% to $8.8 million from $6.7 million primarily due to the completion of the Long Island Power Authority or LIPA Yaphank project during the three months ended January 31, 2022, and the higher operating output of the generation fleet portfolio as a result of module exchanges and continuously improvements during fiscal year 2021. Advanced Technologies contract revenues increased slightly to $7.5 million from $7.3 million compared to the comparable prior year quarter, Advanced Technology contract revenues recognized under the joint development agreement with ExxonMobil Technology and Engineering Company were approximately $1.8 million lower, offset by an increase in revenue recognized under our government and other contracts of $2 million. Gross loss for the fourth quarter of fiscal year 2022 totaled $15.2 million compared to a gross loss of $8.4 million in the comparable prior year quarter. The increase in gross loss was driven by higher manufacturing variances, $8.7 million of costs that cannot be capitalized related to the construction of the Toyota project, lower service margin as a result of higher future cost estimates related to future module exchanges and lower Advanced Technology contract margin. These were partially offset by favorable margins on module sales to KFC. Operating expenses for the fourth quarter of fiscal year 2022 increased to $27.5 million from $14.2 million. Administrative and selling expenses increased to $15.3 million from $10.7 million due to higher sales, marketing and consulting costs as we invest in rebranding and accelerating our sales and commercialization efforts, including increasing the size of our sales and marketing teams, which resulted in an increase in compensation expense from additional headcount. R&D expenses increased to $12.2 million during the quarter, up from $3.5 million in the fourth quarter of fiscal year 2021 reflecting increased spending on ongoing commercial development efforts related to our solid oxide platform and carbon capture solutions. Net loss was $42 million in the fourth quarter of fiscal year 2022 compared to net loss of $24.2 million in the comparable prior year quarter, driven primarily by the gross loss and higher operating expenses. Additionally, the provision for income tax was $0.3 million higher compared to a negligible amount in the fourth quarter of fiscal year 2021. Adjusted EBITDA totaled negative $36.1 million in the fourth quarter of fiscal year 2022, compared to adjusted EBITDA of negative $16.9 million in the fourth quarter of fiscal year 2021. Please see the discussion of non-GAAP financial measures including adjusted EBITDA in the appendix at the end of our earnings release. The net loss per share attributable to common stockholders in the fourth quarter of fiscal year 2022 was $0.11 compared to $0.07 in the fourth quarter of fiscal year 2021. The higher net loss per common share is primarily due to the higher net loss attributable to common stockholders, partially offset by the higher number of weighted average outstanding shares, due to share issuances since October 31, 2021. Please turn to Slide 11 for additional details on our financial performance and backlog. The chart at the left hand side of the slide graphically shows some of the numbers we just reviewed in the fourth quarters of fiscal years 2021 and 2022. Looking at the right hand side of the slide, we finished the quarter with backlog of approximately $1.09 billion, a decrease of 15.4% since October 31, 2021. The primary driver was the reduction in generation backlog due to the decision in the fourth quarter of fiscal year 2022 not to move forward with the development of the 7.4 megawatt and 1.0 megawatt Hartford projects given their current economic profiles. On Slide 12 is an update on our liquidity and ongoing investments in project assets. As of October 31, 2022, we had total cash, restricted cash and cash equivalents of approximately $481 million. This total includes approximately $458.1 million of unrestricted cash and cash equivalents represented by the darker blue bar on the chart in the center of the slide and $23 million of restricted cash and cash equivalents represented by the lighter blue bar. Looking at the right hand side of the slide, there is a chart illustrating our total project assets which make up our company-owned generation portfolio. We intend to continue to develop, construct and grow our portfolio of project assets with a clear focus on only those projects that will drive long-term value to FuelCell Energy and our shareholders. Investments to date reflect capital spent on completed operating projects as well as capital spent on projects currently in development and under construction. As of October 31, 2022, our gross project assets totaled approximately $262.4 million, which excludes accumulated depreciation. As detailed on Slide 21, in the appendix of this presentation, our generation portfolio totaled 63.1 megawatts of assets as of October 31, 2022. This includes 36.3 megawatts of operating assets and 26.8 megawatts of projects in process. As projects in process begin commercial operation, they are expected to contribute higher generation revenue. Additionally, as these projects in process reach mechanical completion and/or achieve commercial operation, we expect to seek additional tax equity financing, as well as long-term back-leverage debt transactions to further reinvest capital back into the business. Turning to Slide 13, I will introduce our projected investments that we expect to make in fiscal year 2023 in order to drive future growth. The three primary target areas for investments are: capital expenditures, research and development, and continued build out of our generation portfolio. Capital expenditures are expected to range between $60 million to $90 million for fiscal year 2023, which includes expected investments in our manufacturing facilities for both molten carbonate and solid oxide production capacity expansion, the addition of test facilities for new products and components, the expansion of our laboratories and upgrades to an expansion of our business systems. The solid oxide production capacity expansion is underway in our Calgary, Canada facility and is expected to increase manufacturing capacity of the facility from 1 megawatt to 10-megawatt per year of solid oxide fuel cell production and 4 megawatt to 40 megawatts per year of solid oxide electrolysis cell production by the middle of fiscal year 2024. In addition FCE is currently evaluating the potential for additional manufacturing facilities to complement Calgary and support the growth that we anticipate. Looking at research and development, our R&D efforts continue to be focused on commercialization of our hydrogen technologies, including long duration energy storage. We estimate that full year R&D expenses for fiscal year 2023 will be in the range of $50 million to $70 million. As projects in our generation portfolio begin operation under long-term power purchase agreements, we expect this to translate into growth in recurring revenues. As of October 31, 2022, we had 26.8 megawatts of projects under development and construction. And to build out this portfolio, we estimate the remaining investment in project assets to be in the range of $45 million to $65 million, down from our prior estimates, due to the removal of the Hartford projects that I previously mentioned. At our Investor Day in March of 2022, we presented long-term revenue targets, whereby we expect revenues to exceed $300 million by the end of fiscal year 2025 and for revenues to exceed $1 billion by the end of fiscal year 2030. As Jason discussed, we see favorable tailwinds from the recently passed Inflation Reduction Act, or IRA. And as a result, we expect to revise our long-term revenue targets during fiscal year 2023. Thanks, Mike. I feel it’s important that each quarter we remain grounded with our summary of the Powerhouse business strategy which serves as our guiding strategy toward achieving long-term growth. Shown on Slide 15, the first tenant is grow. We are working to optimize our business for achieving growth in markets where we see significant opportunities for our technology. The second is scale. We plan to scale our existing platform by investing in, extending and deepening our leadership in total human capital across the organization. Across our operation, we are making progress in optimizing capacity for our molten carbonate platform with the goal of achieving 100 megawatts of annualized integrated on-site manufacturing, and conditioning capacity. And third, innovate. Over our 50-year history, we have never stopped innovating. We believe our technologies and our culture enable our participation in the growth of the hydrogen economy and carbon capture, and drive us to deliver on our purpose. We are developing diversified revenue streams by delivering multiple products and services that support the global energy transition. At the beginning of the year, we published our first Sustainability Report. Today, I want to reaffirm our dedication to achieving net-zero which remains in the forefront of FuelCell Energy's priorities. We reiterated our commitment to achieving net-zero on Scope 1 and 2 emissions by 2030 and Scope 3 emissions by 2050. We are aligned with the leading standard organizations and the United Nations Climate Action goals that we believe we can impact. In addition to commitments to our environmental objectives, we are focused on the safety of our employees, the people in our communities in which we work and live, and are maintaining a diverse, equitable and inclusive organization. Before moving to Q&A, I will conclude my prepared remarks with some takeaways on Slide 17. We have a strong balance sheet, which positions us to fund projects in development as well as commercialization activities to execute on our growth strategy. We have multiple sources of funding, including well established relationships with financing providers. We have expanded our sources of liquidity through tax equity transactions, such as the recent transaction with East West Bancorp. These provide flexibility to scale our operations by allowing capital to be recycled as projects reach completion. We have over $1 billion of backlog with recurring revenues from long-term contracts. We have a rigorous and thoughtful approach toward allocating capital, so that the next phase of growth is aligned with the addressable market opportunity. Our solid oxide platform adds sub megawatt power generation and high efficiency electrolysis to our product portfolio. And we are investing in capacity expansion to capture this strong market opportunity. Global policies to support the energy transition are gaining momentum, as evidenced by the passage of the Inflation Reduction Act in the United States. We believe our technologies have an important role to play in helping society achieve our global sustainability goals. We're making investments in capacity, capability and global talent, which we believe will position FuelCell Energy to capture market opportunities over the coming years, and deliver enhanced shareholder returns over the long run. Congratulations, guys. A lot of positive developments here. The next leg of development LCC obviously is the commercialization of both the fuel cell and the electrolyzer on the solid oxide side. So, help us walk us through some more details on how you're achieving that. How confident are you that you can actually start getting more electrolyzer orders or fuel cell orders from solid oxide cells in the future? If you could just talk about that? Manav, thank you for the question, and thank you for joining the call this morning. This is Jason Few. I'll maybe start and then some of the team members may jump in as well. With respect to our solid oxide platform, as we indicated, we have advanced the commercialization process far enough, where we have started to take orders and in fact have secured our initial order with Trinity here in Connecticut for 250 kilowatt platform. We're excited about that opportunity, because that really opens up the aperture for us quite a bit on smaller scale opportunities in the U.S., which for the most part with our molten carbonate platform at 1.4 megawatts, those are opportunities that we previously could not pursue at least domestically. On the solid oxide electrolysis side, it's the same platform that we're utilizing to deliver electrolysis and the work that we've been doing to demonstrate our capabilities, both internally with respect to our efficiencies and the work that we've already done with INL has demonstrated really strong performance for electrolysis. So right now, where we are, as a company, is really focused on scaling our manufacturing capabilities to meet what we believe is going to be demand for our platform giving our efficiency and differentiation. So we feel very confident about where we are, about the commercialization progress we've made, and our ability to scale manufacturing for that platform. Perfect. My very quick follow-up here is, there is a little bit of increase in CapEx '23 versus '22. And if that should be the case, IRA is a game changer. Help us understand how you will be spending this money and whether this is a good run rate for the next couple of years as you commercialize all these new businesses? Good morning, Manav. And thank you for joining the call. And as Jason hit on, we are investing in solid oxide manufacturing. We have -- in our 10-K, we indicated that we are expanding the size of our footprint in Calgary. So with that, will come capacity expansion. So a large chunk of the expenditures in fiscal '23 are going to that. In parallel to that, we're also looking for additional facilities, potentially in the U.S. as we think about growth in the future around both electrolysis and solid oxide power gen. We're also investing in the carbonate technology capacity expansion as well, thinking about automation in our facilities in Torrington, and then also preparing for the large opportunity around carbon capture with the carbonate platform as well. And looking at implementing CapEx related to that, so that we're prepared for that growth as well. So that's where the chunk of CapEx is coming from for fiscal '23. I would say this a meaningful investment that the company is making in '23 to be able to capitalize on this growth. We'll obviously evaluate future expenditures around CapEx later in fiscal '23 and as we go into fiscal '24, but this gives us confidence in being able to hit the growth plans that we've laid out in the future. And just to maybe add to that, I mean, if you think about what we laid out in our Investor Day, a $2 trillion market, which we intend to relook at in light of the IRA. If you just think about the opportunities around carbon capture, we tag that at about $1 trillion total available market between now and 2030. And then if you take distributed hydrogen and energy storage, that's another $550 billion or so that we viewed in our outlook. And so that capital that we're deploying is to aggressively go after those opportunities. And when you look at IRA, you look at Canada's response to IRA, and you have to believe that the EU is going to do something similar to IRA, and then you certainly have the same kind of programs happening in Asia. We think those are smart investments for us to make to pursue those opportunities. Thank you for the detailed response. And thank you for taking the questions and just want to let you know a lot of people are hoping and cheering that you succeed, the world does need to decarbonize and you guys are making a difference. Thank you. So just maybe first on the backlog in -- from Hartford, could just go into a little bit more detail of what happened and how we should think about that going forward? Yes. So, maybe I'll start and then I'll ask Mike to pick up here a little bit. So as we looked at Hartford, there's a couple of factors that we evaluated in terms of our decision around that program. One is, as we looked at the PPA and the timing of the PPA, the questions around interconnection and timing became a risk factor in terms of interconnection being able to be done in times to comply with the PPA. It's a project where we had exposure to gas prices. And as we looked at when we originally did this agreement to now, there's been a pretty significant shift in gas prices. And so as we looked at our ability to manage the gas price risk and that exposure, the risk around interconnection, we made a decision that right now this program didn't make sense for us to continue to move forward. That being said, we will continue to have conversations and look for ways to restructure that PPA. And if we can, we'll look to bring that back into the backlog. But for now, we've made the decision to not move forward. And we've had very little capital expenditure on that project, which we reflected in our financials this quarter. Mike, do you want to add anything? I would echo what Jason said. Particularly the larger Hartford project was signed at a different time. We have not invested much in that project. We took a small charge in the quarter for about $800,000 related to that project. And really, we want to be investing in our capital that will have a return for the company and to shareholders, and just evaluated these projects, and made the decision to stop at this point and reinvest that capital back into growth investments. And just as a follow-up. Wondering if you could give us any more detail about the trigen platform in Long Beach. It seems that you gave a little bit of detail around progress there. But anything more? And also if there are other potential customers looking at the trigen platform to deploy as well? Yes, George. So on that, where we are right now is we've started the commissioning phase for that platform, for the trigen project in Long Beach with Toyota. We are making progress consistent with our plan at this point. We think, overall, the opportunity for the trigen type platform, whether it be port applications, or purely just distributed hydrogen applications where the utilization of fuel is an acceptable way of producing hydrogen as we are in this case using RNG. So we're producing green hydrogen, carbon-neutral power and water. We think there's opportunity for this platform at ports. We think there's opportunities for initial distributed hydrogen, especially when you're in a market where the infrastructure or midstream infrastructure is behind where the technology is in terms of the ability to deliver that hydrogen in a very efficient way. So we think distributed hydrogen has a big opportunity. And we also think where you're going to have high energy prices, this platform creates a great opportunity, because if -- part of the goal on hydrogen is to bring the cost down to somewhere in the $2 or even as low as $1.50 a kilogram. And in a high energy price environment, that's going to be difficult. But even with that, we think that's where our electrolysis platform comes in because of the high efficiency. So we really see this platform as where we can help a customer make the best economic decision for how they produce hydrogen and we can deliver that hydrogen, whether it be from fuel or through the electrolysis process. I have a couple of questions. I was wondering if you could touch on the upcoming year, which facilities will be repowered or what the expectation is for repowering in service revenue? Jeff, thank you. Good morning, and thanks for joining the call. Mike, do you want to talk a little bit about our service program and how we do stack replacements? And then maybe even we can speak a little bit around what we see for Korea as well. Yes, Jeff, good morning. This is Mike Lisowski. Thank you for the question. Our generation portfolio has assets that are replaced at the end of life according to the degradation schedule. And that's really according to the overall product technology that we have installed. We have a number of five-year life platforms that are coming to replacement. Those are happening on a quarter-by-quarter basis. We keep a rolling view -- now that we have deployed our seven-year technology, we keep a rolling view on those replacements work to optimize the performance of those plants over the life of those assets. And then we replace them according to the times frames and schedules that we’ve forecasted. So although we haven't put guidance out yet to the fact that when and the quantity of those modules that will be replaced, I can say that we are on schedule and on track for fiscal '23. And Jeff, this is Mike Bishop, just to dimensionalize a little bit more. If you look at total service revenues that we had in fiscal year 2022, about $12.8 million, going back to '21, we were in the $20 million range and back to '20 in the $25 million range. So '22 was certainly a light year from a service replacement perspective. And if you just look at the history, the KOSPO project, for example, was installed around five years ago. So that is up for module replacement. So you would expect to see higher service revenue during the course of this year, just from that one project alone. And as Mike mentioned, there's a number of other sites that are coming up on that transition as well. Can you articulate -- my second question is. You alluded to the issues with your Korean partner being alleviated on January 1st. Can you articulate what that service revenue potential would be or do existing sites need to wait for their existing agreements to expire before potentially signing up with you folks? So it was a bit -- you were alluding to some potentially positives to be shown in backlog, it sounded like after January 1st, but it was unclear what that is. Yes, sure, Jeff. So in the settlement agreement that we reached with POSCO, a couple of things happened. One, we regained access to the market, and that access to the market related to new opportunities. And as we've talked about before, the Korea market is largely an RFP market. So in those opportunities, we will be able to compete with those and have been able to do so since the settlement. One of the factors that have really impacted the volume of RFPs in the Korea market to date has been the GENCOs waiting for what they call the clean hydrogen portfolio standard to be released by MOTIE or the Korean government, which really sets what the framework for pricing is in the in the Korea market. The second part of that though related to the settlement was for the existing fleet that's in Korea. For those customers that were sold to by POSCO Energy, we were not able to work with those customers on extending their LTSA up and until the end of this year, December 31, 2022. At the expiration of that provision in the settlement agreement, which will be January 1, we now have the opportunity to work with those customers on those LTSAs. That potential replacement module market in terms of based on what's already been replaced from a module replacement standpoint versus kind of what's coming up over the next couple of years is about 116 megawatts of opportunity. The other key point that I would make in the settlement, maybe the third dimension of that, is that in that settlement, POSCO no longer retain the right to manufacture our modules. So rather FuelCell Energy does that LTSA or KFC or POSCO does that LTSA, those modules must be provided by FuelCell Energy. So we see this as a great opportunity for us. Now, we need to work with those customers starting January 1 to really understand where they are from a platform perspective, what their intentions are around an LTSA. So I would suspect by our next quarter, we'll be able to provide some more color to that after we've had an opportunity to more fully engage directly with those customers. I wanted to talk about gross margins and maybe get a better sense from you guys. What are the biggest factors or the most impactful items that can take them higher year-on-year? I mean, you've called a number of already but maybe the -- I mean is it the non-capitalizable costs with Toyota project or stronger product sales, which should absorb more fixed costs or anything you can call out there? And then, I mean as we look forward fiscal '24, maybe once you're commercializing more solid oxide products, is that when you see gross margins really inflect and enter the positive territory? Good morning, Sam. This is Mike. I will take that question. So maybe at a high level, I'll describe how the company has historically thought about gross margins, and then hit on a few of the things that you brought up there. So from, so the company has four lines of revenue, from a product revenue perspective we’re typically targeting margins in the 10% to 15% range; service, long-term agreements, we're targeting margins north of 20%; generation, we really think about EBITDA contribution there if you look at our financial statements, and you mentioned this. Currently in our financial statements, we're taking charges for non-capitalized costs related to the Toyota project. And we also have depreciation coming through. But when you back that out, the company really targets margins in the -- EBITDA margins in the 20% to 40% range. And then of course, from Advanced Technologies, that's research and development. You've seen strong margins there in the 30% to 45% range over time. So, we would expect Advanced Technologies to continue at that level. But from kind of a high-level perspective, those percentages that I just laid out are what the company is targeting when we're either putting new deals together or how we think about the business over the long-term. Okay, certainly helpful. One other thing I noticed was that in generation it seems like a project or two kind of fell out of the in-service portfolio. Looked like Triangle Street was one of them and then UCI. The other -- just curious if you could give any color on what happened there and how any sort of assets might be recovered or redeployed? Sure, good question and thanks for that observation. The Triangle Street project is a project here local in Danbury, right down the street from us. We've -- over the past couple of years, that project has evolved to more of an R&D type project where we're using it to essentially test out certain aspects of our platform, that's the high efficiency fuel cell. So, have evolved that from just a generation site where we're taking revenue to more of an R&D project. So it felt appropriate to remove that from our generation backlog. On the UCI project, that project reached the end of its term. We entered into an agreement with the owner of the project, the UCI Medical Center. They are going through a capital expansion at the UCI Medical Center. So essentially worked out an arrangement where we -- they paid us to essentially remove that asset. Parts of that asset are able to be redeployed in our service fleet. For the JDA with Exxon extended to August, can you talk about some of the next milestones that you guys would like to hit that would help move that closer to commercialization? Sure. So the way that this project continues to move forward is there are technical hurdles that we continue to demonstrate with our platform to show that we will be able to achieve the -- not only the capture targets but the power generation targets and cost targets, leveraging our technology as a way in which to really address the carbon capture market opportunity. Going through August, there are a couple of things that we'll do. We started a marketing study, we completed that marketing study. And as a result of that marketing study, we will now begin to look for customer opportunities to do demonstrations with the technology collectively between Exxon and FuelCell. The other thing that we'll do is continue to the optimization work on the technology that will ultimately set up for the decision that Exxon will make with respect to the Rotterdam project where we'll actually demonstrate the technology as well at an Exxon facility as part of this. And so working through August, it's our view that all the technical questions will largely be answered. And that we’ll begin to transition from more of testing and demonstrations to start to work toward commercialization. That's the goal that we have as a company and thus the extension of the agreement. And then just one more on the solid oxide order with Trinity, how should we think about project timing there? And then maybe more broadly, the ramp up in solid oxide revenue over time? So the Trinity project is slated as a 2023 project. And we are, as we speak, expanding capacity for our facility in Calgary. We're also doing work here locally in our Torrington unit facility, in Danbury around that technology. We have taken on a lease for larger space to expand our manufacturing capabilities. And so, we are very focused on manufacturing expansion in '23. And as we said, we're taking orders now. And so, we would expect there to be more volume in 2024. So I was wondering, could you just give us an update? I know previously, you had thought about, I believe the number was 14 potential module sales to KFC by year-end. And then as you mentioned, those replacement modules to that market would likely come from you. So maybe how you think about module sales going forward as we get into calendar year '23? Sure. Good morning, Eric. This is Mike and thank you for the question and the observation. And you're correct to your point. In the settlement agreement that we laid out with POSCO Energy and KFC, there was a provision by which KFC could order an additional 14 modules. We had a fixed price and a fixed agreement around warranty provisions. That option is available to KFC until December 31st. As of today, that option has not been exercise. We have not announced that. And as Jason mentioned, going forward after January 1st, the company can go out and talk to customers that are that are currently customers of POSCO Energy to potentially capture the opportunity in Korea, as Jason mentioned, over 100 megawatts of module replacements currently available will certainly happen over time. So getting prepared for those discussions and expect to be in Korea in earnest to work through that the beginning of '23. And then maybe second one. Just on the generation portfolio, I know a lot of moving parts. In the past you had provided kind of where you saw breakeven. And at the time, I believe it was 60 megawatts. And so just curious, whether there's a specific number you can give or ways that you think about that as they play out here in '23 and then going forward? Sure, Eric. I'll take that one as well. And I think so when you think about breakeven from an EBITDA perspective as a business, I think in the past we had pointed at generation portfolio could potentially get the business to EBITDA positive, if you're at that 60 megawatt level. Since then the company has done a bit of a pivot, given the energy transition that's here and the strong market opportunity that Jason talked about. So we've increased investments. So our R&D expenses and our SG&A expenses have gone up as we're taking advantage of the market opportunity, and also commercializing our solid oxide. So I wouldn't look at just the generation portfolio at this point leading the company to break even. I would look at the totality of the revenue opportunities that we've been talking about here, whether it be increased product revenues coming from Korea, and opportunities elsewhere in the U.S. and Europe, whether it be contributions from service as the fleet continues to grow. And also, obviously contributions from generation with the Groton project coming online, you will now see further increase in our generation revenues as we go into 2023. So if you look at kind of where that portfolio has come from, this past year, we did about $36 million of revenue compared to $24 million in the prior year. So you've seen nice increase and contribution coming from the generation portfolio. And of course, we can look forward to Toyota coming online in 2023 as well. So that's how I would sort of characterize the business and the breakeven opportunities as we go forward, Eric. I was wondering if you could elaborate on your long-term plans for the solid oxide electrolyzer that you're developing. I guess, what kind of applications could you pair this with? And would it work with an intermittent power source like wind and solar? Or would it need to be paired with a more ratable power source like what you're doing in Ukraine for maximum efficiency? Praneeth, thank you for joining the call and good morning. Yes, so when we think about our solid oxide platform for electrolysis, it is a high temperature, high-efficiency electrolysis platform. We think one of the core applications in way it will be used is as a way to either firm up capacity of intermittent resources like wind and solar, and then producing hydrogen that could then be used in reverse to actually do power generation when those intermittent resources are not available. We've done a few different things with respect to managing the thermal properties of our platform as a high temperature in the way in which we use and store water from a heat perspective to keep our platform in a situation where we can fast ramp around intermittent resources in addition to the ability to use small trace amounts of electricity to continue to keep those thermal property sets. So we feel really confident about our ability to leverage intermittent resources as a way to generate hydrogen through electrolysis. With respect to baseload resources, as an example, like nuclear, like the small scale nuclear reactor for the Ukraine or large scale nuclear platforms that exist today, we think that the differentiation is even greater there because of the fact that we're high temperature, highly efficient. And not only from a, the ability to convert that electricity but to use the waste heat from nuclear which is abundant and be able to operate at an efficiency of up to 100% electrical efficiency in converting that hydrogen. And that's a significant difference between our technology and then low temperature technologies like PEM and Alkaline, which can't take advantage of that waste heat, anyone without the waste heat already operate at a material difference between efficiency. And so, we feel very confident about our ability to operate not only with a -- in a nuclear type application, but also with intermittent resources. And we think that that's -- we think that electrolysis and hydrogen, and using hydrogen as an energy store is incredibly important. And we think that that's actually a much better resource than mineral-based resources. Because your ability to store hydrogen very similar to like you store natural gas today in salt caverns, it is regenerative. It is locally produced. It doesn't have the same challenges potentially that exists with lithium-ion batteries, both from a mining, geopolitical, rare earth minerals and other issues tied to that. So we feel pretty excited about that opportunity. I'll just start with the last topic. When you're talking about integrating hydrogen as a storage medium, integrating that with intermittent energy sources, the software piece of that, the EMF, is that proprietary technology you're developing in-house or are you envisioning integrating with third-party technology on that piece? Yes. We are developing that software in-house. We are, for example, right now, operating a reversible system that is alternating between hydrogen production and consumption, just like we demonstrated electrolysis in our lab and now we've evolved that into our standard product design. We're at that phase with energy storage right now where we're working through the algorithms actually operating a system, learning what works best, and that will be our proprietary control technology. I did want to just step back for a second to the experience of Groton, clearly, a long path there, was including some of the slog as far as the implementation processes, within Navy's on procedures and so forth. Any lessons learned with the benefit of hindsight that are particularly applicable to other implementations you have ahead? No, in every implementation, we do, one of our practices is to really look at lessons learn, how we can improve, everything from the core technology itself to the EPC process that we use to construct a project in terms of how we engage on site with the host of the platform. And so there's certainly a lot of lessons learned with our implementation in Groton, and we will certainly put all of those to work. In addition to that, through this process, we've obviously made improvements to the platform in terms of how we deal with thermal management. We've taken all of those lessons and we'll continue to look at how those lessons apply across our fleet, rather it's the existing fleet, or on the work that we're doing around new technologies and innovations for our new platforms. And so, certainly a lot learned. And we're glad that we're at COD, and we're going to continue to do things to optimize that platform, as we've indicated. And just last one for me. With the Exxon JV and you talked about having been through a marketing study, could you maybe drill down a bit as far as what you've learned as far as types of customers that you think it will be kind of prospect for the markets that they might be in? Anything like that would be great. Yes, sure. So the work that we did really looked at the industrial sector, and that industrial sector cut across everything from food and beverage to oil and gas to petrochemical. And what we learned through that work is that there was clearly demand for carbon capture, there's a lot of customer interest and willingness to deploy technologies, certainly, when you look at 45Q and how that got enhanced in IRA to go to $85 a ton for sequestration, that certainly gets a lot of people very interested in the economics of the opportunity. And we see across the industrial landscape, where you -- if you just think about industrial boilers, for example, there are thousands of industrial customers that use that across a number of different segments, and that all represents opportunity. And I think the study confirmed the interest and the need. And so, I think we're pretty excited about that. Julian, thank you. And thank you again for joining us today. We will continue to execute on our Powerhouse business strategy working to deliver growth and optimize returns. The FuelCell Energy team is excited about our work to deliver on our purpose of enabling a world empowered by clean energy. We wish everyone a happy and joyous holiday season. And thank you for joining and have a great day.
EarningCall_1590
Yeah, perfect. I am kind of like I think people are probably to come -- going to come in, Tom, good to have you here, connect in person. Just you had really good solid results yesterday. Maybe we start a little bit like on a quick summary of that one and then kind of we go into kind of deeper into C3 more from an industry perspective like to get everyone on the page like what were the highlights for you from yesterday's results? What's kind of a big picture? I guess we're about a roughly a third of a billion dollars business. We're a computer software company. We're growing at a -- the idea was to build a platform and a set of applications that would allow organizations to apply elastic cloud computing, big data, internet of things and predictive analytics to build enterprise applications. So we built a family of 42 enterprise applications that provide predictive analytics for their own gas industry, the utility industry, health care manufacturing, aerospace, defense, intelligence and we started in January of 2009. Today we employ about 900 people and operate in any number of cities around the world and in this space of building turnkey enterprise AI applications, I think we might be the largest company in the world. Yeah. And then if you think about the -- like everyone is asking about macro, where do you see customers and customer's priorities around like what you're offering, how high is that on their kind of mindset at the moment? Well, if we look at enterprise application software, so I was there when we started that industry, okay and what we did is we took relational database systems. We built tools on top of relational database systems, so we could build forms and reports and then we built ERP and manufacturing and supply chain and CRM and that is roughly a half a trillion dollar business today and turned out to be a pretty good idea that would be Oracle, PeopleSoft, SAPC and what have you. Now, we use those applications. Without those applications, it would be impossible to operate enterprises and we use those applications to report both for managerial purposes and regulatory purposes with perfect 20-20 hindsight what happened 30 days ago or 180 days ago, what inventory levels were, what customer churn was? Ok. What cash levels were, what was what -- what was a failure rate of devices okay. Now enter this idea of predictive analytics okay, that promises to be a $600 billion software market in a few years. All that is, it's really simple, but when we take this large installed base of SAP, Oracle PeopleSoft and what have you and we make these applications predictive, which is what we do. Okay, in addition to telling Boeing, how many parts they have in their supply chain from Bremerton, Washington or South Carolina, all the way to Shenzhen and a Boeing 777 got a million parts and then we got 7767. 757, 747, 737, 707, etcetera, so there's a lot of parts and a lot of bins and you need to report what they all are very, very accurately. So rather than report, so this is for a roughly last time I checked a $60 billion aircraft manufacturer or we can tell them what their customer churn was or we can tell them what the failure rate of their equipment was. Now, when we make these applications predictive, we can tell Boeing, Dave Calhoun exactly how many parts he needs in each bin in the next six months to meet his demand function, which oh, by the way, Boeing is not doing a very good job of that's why they're not shipped in airplanes, or we can tell them rather than simply tell them what they're -- where their breakdowns in the supply chain were, we can predict breakdowns in the supply chain, so it can mitigate, get the right part of the right place, the right time in Renton or South Carolina wherever it is and deliver the product OTIF on time in full to Southwest Airlines or me or whoever it might be, rather than to report to him what the -- what his customer churn was, in the last period, we can tell him which customers are going to leave in the next year, so you can do something the same. This is what happens when we make these company -- when we make these applications predictive and I will argue that this is in five years there is no board of directors that is going to tolerate a CEO standing up and tell them where the supply chain broke down. Okay, not okay or what our customer churn was. I'm sorry that's not going to be that CEO will be gone. So it's not a 100% replacement market for enterprise applications, but it addresses all of the problems that we addressed in enterprise application software and we're making them predictive and that's what we do at C3.ai. Yeah. Okay, perfect. And then when I first looked at you, I kind of forward like, is this like a AI platform or if you talked about all the applications that you have, like when you started out the business where -- how did you think about it. Was that like as it was the idea to build a platform business or was the idea to have like, help customers with kind of solutions. Great question. The first application we started in January 2009 and the idea was to build an application okay, and the application was what you can think of today is like ESG on steroids. So we wanted this is -- this was like the ultimate clean tech play. We want to take an organization the size of a General Motors without chemical, United States Army and be able to characterize their energy and carbon footprint in real time and report on it any number of formats. In order to do that, we had to build a platform. So he spent a billion dollars in 10 years a billion. This is not like some sequoia dollars or government dollars. This is like real money. Okay, this not Sand Hill Road dollars. This is real money, and building a software platform that basically allows us to build any kind of predictive analytics application for any industry. First, we applied it to energy, then we applied it to oil and gas and then we applied it to oil space -- or aerospace, financial services, health. So we do have a platform and people do license the platform from us, but on top of that, we have 42 turnkey applications that address the value chains of oil and gas utilities, manufacturing, banking, what have you. Now we've seen something so in the last 10 years, our primary competitor was some combination of the hyperscalers, cloud era, pivotal, the apache open source tax, data tricks, robot blocks and all this kind of crip crap that's out there where people wanted to some CIO was going to take 20,000 programmers in Bangalore and try to build this himself with some these huge science experiments. I think my friend Jamie Diamond is spending a billion dollars right now trying to do this. Well, no way, no how, he's going to fail. Everybody fails and we had a kind of a secular change in this market in the last month when all of the hyperscalers, Google, Thomas Korean, AWS, Adam Selipsky, okay? And Azure Scott Guthrie came out and said our customers are telling us loud and clear, they don't want tools anymore. They don't want tool goods. They want turnkey application. So if you want turnkey applications that address supply chain, demand chain, supply chain optimization, customer churn, predictive maintenance, that run on the Google Cloud, AWS, Azure, Oracle or Bare Metal or on the Edge on the Video Box, this is exactly one doorbell in the world that you can ring on that, you can ring, that's right down the road in Redwood City and it says right above it’s a C3.ai, that's what we. Like so how do you see that evolving over time? Like do we -- is there like a critical loss? Is there like diminishing returns at some point, like how do you think about that number? Well, you have supply chain, you have supply network risk, you have demand chain, you have a customer churn, you have fraud detection. Now that's pretty much applied to all industry. Supply chain to get into the DOD they call logistics, okay. Fraud, they call it fraud okay, now -- but these applications applied to telecommunications, they apply to pharmaceutical or chemical, oil and gas and so it becomes a pretty big matrix of probably 300 turnkey applications before we're done, Sibyl I think when we built Sibyl Systems, I think we had almost 300 different applications that we brought to market, different variants of CRM. for call center, field service, customer service, internet self-service, sales automation for all the industry segments. And so it was it was -- it was about 300 products in the matrix. And then if you think about that building and out of like, where the SI is fitting in there? Like, on the one hand, like, it is -- I'm an old SAP guy like to so if you want to go deeper into certain verticals and kind of understand the process better and kind of work on that, you kind of need it as part of that. Where are you working with them? How many… We are in Washington, DC we work with Raytheon. We announced this morning of strategic partnership with Booz Allen, we do work with PWC, we do work with Accenture. So we kind of work with everybody. Well, in the case of Booz Allen, Brazilians building kind of a very large practice to serve the needs of the defense intelligence community. I expect that, PWC and Accenture will be doing the same thing. Okay, perfect. Then the -- we talked about the -- you're building an application like the other change that where that happened was that you kind of -- we kind of went from a kind of there we went to a different pricing model like a consumption. Can you talk about kind of realization of maybe actually the world's moving consumption and I need to change that about that a little bit. Well, historically, we sold on a subscription-based model where we would have three, four, five year commitments. So our average transaction value might be any given quarter $20 million. So for that to be true, we had to be doing -- our deals were five, 10, 20, 50, $100 million at a time. Now that's good work if you get it and it is -- and it makes you to see you can finance the business without having to bring any door bells up sand hill road and I particularly enjoy bringing doorbells on sand hill road. So that enables this to build a base very, very viable business without walking around hatman and begging for money all the time. And now -- but then as our product became more mature and we had a partner ecosystem and a developer community and much richer documentation, online training and whatnot, that enable us to transition to a consumption-based pricing model and in the cloud in the 21st century, a consumption-based pricing model just is the standard, is the standard GCP, AWS, Azure, Snowflake, you name it. And so we made that transition beginning last quarter where rather than selling multi-year subscriptions, we just allow people to buy the product and kind of pay as you go, let's say, $0.55 per CPU hour without having a gut wrenching conversation about the $50 million or $75 million or $100 million upfront licensing agreement. That makes a lot easier to do business where you do business within any given quarter with say an order of magnitude more customers. And if you look at the revenue that we'll get from any given customer over say, 10 quarters, 12 quarters, it's actually revenue neutral without having to go through what is an unnatural act today in cloud computing, no question. The cloud computing standard is this consumption based pricing, it's really gone well. It's like, like because you have been in the industry and I admire you like for so many years, if you think about the evolution towards that consumption model, when you back then obviously, with Siebel it was like seat-based, etcetera, if you think about that… Right, yeah, exactly, that was all, that was perpetual as well. If you think about that, that consumption model, do you think there is certain parts of the industry or is that like something that the whole software industry probably have. I think it goes -- we need to be able to be the standard in all industry segments. Now that being said, if somebody was to say they really want to go big like Shell, the United States Air Force, as somebody likes wants to go all in, they're going to drive up in their Mercedes and send of the guys and like cut and they're going to want some sort of enterprise license agreement. It'll be on whatever terms they want and it'll be for a sufficient amount of money that a reasonable person will agree to their terms and that just happens. That's the black swan. You can't model it, but you guys could work what happens. You take -- on that node you had, what's the baker use is like one of the big guys for you their commitment rewards towards you, but also like, changing themselves as a company has been amazing. If you look at the dollar amount there… That is very large. And where do you see I remember when that deal happened, it was like a big wake up moment for a lot of the other guys like, oh shit, this is like over equipment or equipment company that just kind of spend that much on definitely… It repositioned them in the oil services market, there are gas services market, their competitors are Slumber J and Halliburton and as it relates to Digital, they look like dinosaur as compared to baker heels. And did you notice like a pick up like in terms of other segments that you have they are you kind of focusing on lighthouse customers that kind of could be that next speaker used for a different industry or was that just you need at the time? The honest answer is it wasn't very sophisticated. It was really coin operated. When a CEO walks in the door with a management team, a mandate and check that CEO is an aerospace business, we're in the aerospace business okay, if you happen to be running a large year in the European utility, we're in the utility business and we're having a world of shell or the oil and gas business or if Lorenzo and walks in from Baker Hughes with roughly a $0.5 billion offer, we're in the oil and gas business. Now in the long run, there is no industry that's not going to -- no board that's not going to mandate that their CEO see around corners and identify problems in the supply chain before they happen, not wine to the board about why you can't ship cars because war broke out in Southeast Asia. I'm sorry, not an excuse. We got to ship cards. No fair enough. And last few minutes, I wanted to talk a little bit about the like one of the focus areas for this conference was that people realized I need to think about more returns and think about more about my growth profile and how I'm growing. How profitable I'm growing. Talk a little bit about your mindset in terms of like growth, profitable growth. Where are you on that life and then. Our internal business. Okay. Well, we went public in December of 2020. We raised about a $1 billion and the purpose of that was and back in December of 2020, all of the analysts from all of the banks, it all went to the Massachusetts School of Management, okay, and I would come in and explain that you're not spending enough money time. You're not spending enough money. You're not investing in a market. You're not investing in the market. And honestly, Raimo, between you and I, almost all of them, graduated from business school after 2008 okay, and they've never seen anything but market that went up every day. So we didn't pay a lot of attention to that. That being said, when we went public, the purpose that we -- for which we raised the money was to build market share and to invest in technology and that's what we did. Now clearly the pendulum has swung okay and again, the markets are demanding that companies like us have a path towards profitability. Now we operate at an 80% gross profit margin. So come on, we've been in the software business and operating 80% gross margin, how hard is it to run a profitable business. I can be profitable this quarter okay, I only have one cost, but it's human capital. So I do a big laugh and I'm cash positive and profitable. Would that be -- would that be in the best interest of our shareholders, no freaking way okay. We be training our future growth to make some analysts a one shareholder happy. Now, but if you look at what we're doing, last year I spent 29% on marketing and branding. Who spends 29% of revenue on marketing. That would be nobody okay. 46% on R&D. Who spends 46% on R&D to Salesforce, does Oracle, does SAP, no way. no how, we were not even close okay. We spent a 23% on sales okay, that's reasonable. We spent 15% on F&A, maybe that's a little hot, okay, but so our model is very simply we take -- we're operating a roast browser of 80%. We keep marketing down to 11%, sales will go up to about 24%, R&D will kind of come naturally down to scale to about 23% of revenue, which is a big number for R&D already F&A down to 12%. I haven't done the fast math, but the net of that should be like about a $1 profit okay, in the fourth quarter of '24 and then we grow up from there. And so I see this as basically a 20% operating margin business. It'll be throwing off cash, I think as this consumption model kicks in, in the next few quarters and about the same time and I don't know whether this happens in four quarters, you can tell me when the fed decides to take a foot off the break, you're going to looking at a company that's going to be a leader, if not the leader in enterprise AI software, growing at north of a 30% compound annual growth rate, operate at a cash positive profitable business with a ton of cash in the bank and so I think that's probably a product that equity markets will find quite attractive when equity markets kind of recover from the current state of kind of chronic depression. From you, you've seen this game before and you saw, we had it at Sibyl and Oracle before. Like if you think about the noise coming from the financial markets in terms of like, oh no, you need to grow. No, you need to be like, the guy that needs to kind of show me profitability, etcetera. Like for you as someone needs to take more longer term, like what's your north star in terms of like that balance between growth and margins? I don't know how to tell you this, Raimo, but I'll still be here when that analyst has gone, okay? I've seen them all come and go and I'll still be here. And so our North Star is run a cash positive, but yes, at Siebel, ran a cash positive profitable business from the day we shipped a product okay? And we had 80% market share in CRM. We created the CRM market, right? 80% market share globally. When I sold the company to Oracle, I think our revenue at the time was roughly $2 billion. Marc Benioff, a guy who I hired at Oracle, okay, out of USC, studied business administration, okay, and have never seen a computer in his life. Their sales was about -- were about -- it's true, okay. They're just $180 million, we're here about $2 billion. But -- so same story. I am committed to run at a cash positive profitable business, okay? We're committed to running a rapid growth business, and our goal is establishing a maintain a market leadership position in this market. The market leader is going to have about 50% market share. Number two, we'll have 15% market share. Number three, we'll have 10% market share. And then in expansive markets like a few years ago, there's another 20 companies out there once the market -- the music stops, all those guys kind of go out of business. So I think a lot of these guys are about to be gone. But that's our North Star. We're going to be a leader in the field, will be a great place to work, have satisfied customers, establish and maintain market share in Asia aerospace, banking, telecommunications and that's the game. It's kind of funny, like the -- how do you think about these investment levels? Because I just interviewed the sales first guy and the they're like, "Oh, we could get sales of marketing below 35%. It was like, dude, you're only growing 10. Like how does that work? Like -- so if you think about the likes -- putting the foot down more on sales versus not putting the foot down like, is there a healthy level in terms of growth? Because the other thing is also, if you grow overinvest and the wheels are coming off all the time, you lose the culture in the organization, etcetera. Like is there like -- I'm asking you because you've been around for longer than most of the other guys that are meeting there. Like is there a level that you think is like a healthy level? I think that we will be investing about 40% in sales and marketing, okay? I'm confident we can be -- we can grow it. We can do that while growing the top line okay, north of 30%. And in a steady state, be drawing off, okay, 20% operating margins. So that is exactly where we're going with the model. We've done it before. We know how to do it. It's not rocket science. When -- if you have 80% gross margin business, it's not that hard to make money.
EarningCall_1591
Good morning. My name is Chris, and I'll be your conference operator today. I’d like to welcome everyone to the Express, Inc. Conference Call to discuss Third Quarter 2022 Earnings, as well as the partnership with WHP Global. 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, and welcome to the Express earnings conference call and webcast to discuss the announcement of our third quarter 2022 results, as well as our partnership with WHP Global. Our third quarter 2022 earnings release and presentation and the press release and presentation relating to the partnership with WHP Global can be found in the investor relations section of express.com. These items will be archived and our call will be available for replay. I'd like to open by reminding you of the company's Safe Harbor provisions. Today’s call may contain forward-looking statements. Any statements made during this conference call, except those containing historical facts may be deemed to constitute forward-looking statements within the meaning of the federal securities laws. Actual future results may differ materially from those suggested in forward-looking statements due to a number of risks and uncertainties, for a description of the risk that could cause our results to differ materially from those described in forward-looking statements. Please refer to our 2021 Form 10-K, third quarter Form 10-Q, and other filings with the SEC. These risks and uncertainties are further detailed in our earnings press release and the press release announcing the partnership with WHP that we issued this morning. These statements represent our current judgement and are subject to risks, assumptions, and uncertainties. Express assumes no obligation to update any forward-looking statements whether as a result of new information, future events, or otherwise, except as required by law. We have two separate presentations on our investor relations website this morning. One for our third quarter 2022 earnings release and another standalone presentation for the partnership announcement. The consummation of the partnership is pending lender consent, regulatory approvals, and customary closing conditions. Our comments today will summarize the detailed information provided in both press releases and both investor presentations. In addition, we may refer to certain non-GAAP measures. You can locate a reconciliation of any non-GAAP measures discussed in our comments to amounts reported under GAAP in our earnings release. We will also be providing financial comparisons to prior fiscal periods and our prepared remarks today, refer to 2021 unless otherwise noted. Please see explanatory notes in the earnings release for additional details regarding the definition of certain items. With me today are Tim Baxter, Chief Executive Officer; Matt Moellering, President and Chief Operating Officer; Jason Judd, Chief Financial Officer; and Yehuda Shmidman, CEO and Founder of WHP Global. Thank you, Greg, and good morning, everyone. I'll briefly review our third quarter results before turning to the strategic partnership with WHP Global that we announced this morning. Q3 was tougher than we anticipated and that is reflected in our results. The macroeconomic, consumer and competitive environments were extremely challenging and became more acute as the quarter progressed. Across the industry, we saw widespread aggressive promotional activity. Our strategy to elevate our brand through higher average unit retails and reduced store-wide and site-wide promotions, which has driven steady growth for the past five quarters, came up against the consumers reduced spending in discretionary categories and increased appetite for deep discounts. At the same time, we had some misses in our women's business that further impacted our performance. We did however post our sixth consecutive quarter of positive comps in our men's business. Despite these results, we remain confident in our ability to achieve our stated goal of long-term profitable growth in the Express brand. We are already working to realign our assortments based on customer purchasing behavior, recalibrate our opening price points, and address opportunities in our women's business. We are also taking decisive actions to right size our cost structure and improve our profitability. This morning, we also announced some incredibly exciting news. We have entered into a mutually transformative strategic partnership with WHP Global, a leading brand management firm to advance our EXPRESSway Forward strategy, scale our Express brand, and accelerate the growth of our company through brand acquisitions. Through this partnership, we begin a bold new chapter, one that we expect will drive greater shareholder value. Let me talk you through the key components of this partnership. First, we will leverage our fully integrated omnichannel platform and operating expertise to acquire operate and grow multiple fashion brands. Second, we will establish an intellectual property joint venture with WHP to scale the Express brand through category and global licensing expansion. And third, we will immediately strengthen our balance sheet with $260 million in gross proceeds from the WHP investment. When combined, we expect these components will lead to accelerated long-term profitable growth and increased shareholder value. Let me provide some additional detail on each one. First, our platform. This model furthers our transformation from a mall-based specialty retailer to a fully integrated omnichannel platform with the capability and reach to operate multiple brands. We expect to be well-positioned to take advantage of anticipated retail industry consolidation by pursuing brand acquisitions in partnership with WHP. Through these strategic acquisitions, we will leverage our platform to accelerate our growth, generate operating margin expansion, create cost savings, and drive profitability. Second, the intellectual property joint venture. This will enable us to scale our multi-billion dollar Express brands through new licensing agreements with international partners and in non-core categories. Today, the awareness and profile of the Express brand are larger than its category and geographic footprints. And now, with the partnership, expertise, and reach of WHP, the intellectual property joint venture can help to unlock its untapped potential. To be clear, EXPR will continue to operate the Express brand in the U.S. exactly as we do today through a 100-year license agreement with the new intellectual property joint venture. I have said many times that we are transforming Express from being known as a store in the mall to a brand with a purpose powered by a styling community and that remains true going forward for the Express brand. Third, the balance sheet. WHP will invest a total of $260 million into this partnership. 25 million will be through a common equity pipe investment to acquire 5.4 million newly issued shares of Express common stock at $4.60 per share. This represents an approximate proforma ownership of 7.4%. The intellectual property joint venture is valued at approximately $400 million. WHP will invest $235 million for a 60% stake and EXPR will maintain a 40% stake. These cash proceeds will strengthen our balance sheet allowing us to pursue compelling synergistic brand acquisition opportunities, upgrade our platform capabilities, and eliminate our high interest rate term loan. As we do so, we will maintain our disciplined approach to capital deployment. This is a bold and innovative partnership and realizing its full potential would only be possible with a highly experienced and equally committed partner. I have known Yehuda Shmidman, CEO and Founder of WHP Global for many years. I have great respect for the WHP model and their expertise and for Yehuda’s personal and professional integrity. Thank you, Tim. I'm very excited to be here with you today. First and foremost, I share your enthusiasm for our new partnership and I am 100% aligned with the vision you outlined. I believe strongly that it truly will be transformational for both of our companies. WHP Global is a leading brand management firm with significant capital backing and a strong portfolio of global consumer brands that includes TOYS"R"US, BABIES"R"US, ANNE KLEIN, JOSEPH ABBOUD, JOE'S JEANS, and more. Today, we have a global network of more than 125 licensees across North America, Asia, the Middle East, Europe, and Latin America, and we are thrilled to partner with EXPR as we look to leverage our expertise to help drive growth for both Express and new brands to be acquired in the future. We believe that Express is an incredible brand with a powerful brand purpose and meaningful untapped growth potential, especially in major regions outside the U.S. Furthermore, our belief is that by aligning our respective capabilities, we can significantly enhance the value of our companies by growing Express together and by acquiring additional fashion brands in the future. On behalf of the entire WHP Global team, I'd like to thank Tim, Chairman of the Board, Mylle Mangum, the Board of Directors, the management team and all of the EXPR stakeholders. We are thrilled to join forces with the team and confident that we will accomplish great things together. Thank you, Yehuda. Together, We partner a multi-billion dollar brand with high awareness and a steadily growing base of loyal customers with a forward thinking brand management company that has a proven track record of unlocking brand value on a global scale. Together, we build a portfolio of fashion brands and expect to deliver accelerated long-term growth. In addition to the mutual opportunities and benefits of this partnership, a number of industry dynamics makes us an opportune time for such a bold move. Over the last few years, the retail apparel industry has been negatively impacted by a scarcity of capital, high SG&A expenses, which have led to operating margin pressure and ever increasing expectations around the customer experience. The financial results and pace of growth for our company and so many others in our sector have certainly been affected by these conditions. As I said earlier, we will continue to operate the Express brand in the U.S. just as we have been doing and we'll build upon everything that is working. We will continue to drive growth in modern tailoring, denim, chinos and tops. Through our fleet optimization strategy we have had great results in our [indiscernible] pilot stores. We've opened six new Express Edit concept stores in the last five months and will continue to drive growth here. Our UpWest brand had a remarkable quarter with sales up 40%. We opened our 14th store in SoHo, launched our first wholesale partnership with Nordstrom and will also continue to drive growth here. UpWest remains separate from our partnership with WHP and will continue to operate as usual. The EXPRESSway Forward strategy is grounded in four foundational pillars: product, brand, customer, and execution. These are the fundamentals of any sound and scalable retail apparel business and every brand we bring into the fold in the future will be guided by our relentless commitment to putting products first, developing a relevant and compelling brand positioning, engaging existing customers, and attracting new ones, and ensuring seamless omnichannel execution. This mutually transformative strategic partnership with WHP will advance our EXPRESSway Forward strategy, scale our Express brand, provide WHP access to a fully integrated omnichannel operating platform, and accelerate the growth of both of our companies. Through this partnership, we begin a bold new chapter and expect to drive greater value for our shareholders. I appreciate your interest in our company, and I'll now turn the call back over to the operator for your questions. Good morning. So, I guess a couple of questions. I do want to dive into just the quarter and the trends. You guys are one of the last to report. So, if you could talk a little bit just about your own trends, what was tough in the quarter? You mentioned that women's, you had a couple of misses. I'm curious also if you saw challenges in your denim business? And then if you could just talk a little bit more broadly about how you're seeing the consumer respond to product to promotion? Is traffic down – your outlet stores were still flat. So, I'm curious what you're seeing overall away from what you're seeing specifically? Absolutely. So, look, I think the quarter, as I said, the challenges in the quarter got more acute as the quarter progressed, which I think is very consistent with what we've heard from many of our competitors who reported earlier. And for us I think the challenges were somewhat different. We have, as I said, driven five consecutive quarters of growth over our pre-pandemic levels through elevating our average unit retails and reducing store-wide and site-wide promotions. So, those two things, you know, we've had average unit retails up in the teens for many quarters in a row. And those things Marni came in direct conflict with the consumers desire to spend less in discretionary categories and their desire for deeper discounts. So, the strategy which has worked really very well for those five quarters, just really came in conflict with the consumer's behavior and the consumer's mindset. And so, the outlook that we provided for the year gives you some indication of how the fourth quarter is playing out. I would expect those same dynamics to be in play in the fourth quarter. That being said, I also mentioned, we had some misses in our women's business and specifically in women's tops. That is a category that as you know is one of the most price sensitive, it's also one of the categories that drives the most new customers into the brand. And so, in that category in particular, I think we saw really increased pressure based on those market dynamics that I just described. We also got a little out of balance. The versatility of our tops assortments and women's wasn't where it needed to be. And we are making those corrections and expect to have that business back on track as we move into the first quarter based on the corrections we've made. Yes, specifically about denim. I think Denim is certainly a category that has slowed, did slow throughout the third quarter where we were seeing tremendous growth in denim through the second quarter and where we were grabbing market share. On this call, last quarter, I talked about grabbing a tremendous amount of market share in denim. I'm fairly confident that we will still – when we see all the data that we still will have taken market share in denim, but it is not a category that's driving growth right now. In men's, the denim business is being completely offset by our incredible chinos business, but in women's, there doesn't seem to be a casual bottoms offset to that drop that we're experiencing in denim. Not yet. Not yet. The biggest success we've had in bottoms in women's has been in the re-launch of our Editor pant, an iconic – obviously an iconic pant for us and you'll see an expansion of that as we move into the first quarter, but she is not buying a cargo from us yet. And then can you just – I just want to clarify one thing, I think you said Express will have 40% ownership, WHP 60% ownership, is that of EXPR in total or of the new shares? And then… So, that's a great question and one we should definitely [indiscernible]. So, there are two things, let's start with the IP joint venture that we have formed together. WHP is investing $235 million for a 60% stake in the joint venture – in the intellectual property joint venture, and we will maintain a 40% stake. The second piece is they are investing $25 million for 5.4 million newly issued shares of common stock at $4.60 per share, which represents a 7.4% proforma ownership of EXPR. Okay. So, they're going to own 7.4% of EXPR and then they will own 60% of the joint venture and you guys will own – and the EXPR will own 40% of the joint venture? Got it. Okay. Just want to clarify that. And then last question, I'm sorry, but you touched on AUR. If you could just think forward to 2023, obviously, 2022 is wrapping up a little tougher, but there is prices to bring merchandise over [you] [ph] freight costs and things are down even though freight costs in the U.S. are still high, can you just talk a little bit about opportunities or pressure you see going into 2023? And what the outlook looks like for AUR? Are your AUCs down in 2023 at all. So, is there room to, kind of pick back up on that conversation? Yes, absolutely. So, as we move into 2023 and specifically in our women's business where we've seen the greatest price sensitivity. As I said, Marni, and as you know in tops very specifically, we have – we are recalibrating our assortments to reintroduce more opening price points, more price points that are more in-line with where we have been historically. The reintroduction of some very powerful fashion mix. I think what – so I do – our average unit cost, yes, will be going down in specific categories. In other categories like jackets where we've seen exponential growth in both men's and women's, we're winning in modern tailoring. We've seen very little price resistance actually there because the value we offer in those categories is so extraordinary. So, we will not – we're going to continue to push forward putting products first and we'll get the right product. And in modern tailoring, we exist in a very powerful [value bands] [ph]. But in the tops business specifically, we are recalibrating that. We're reintroducing opening price points into the mix. We're going to drive fashion very differently. We're going to have much more versatility and much [bigger breadth] [ph]. We also got actually a little tight on our SKU counts, a little focused, too focused perhaps and needed greater breadth in our top assortment. And so, all of the work we're doing, we believe we'll get the women's top business back on track as we move into Q1. And yes, there will be lower price points throughout the assortment. Good morning. I want to ask a small question about current and one about the WHP. Inventories, so you made some progress in the inventories. How should we be thinking about inventories end of the year and going forward? Yes. Sure, Eric. This is Jason. Good morning. With regard to inventories, we've been very consistent with our language around the purpose for why the inventory balance was escalated at the beginning of the year and how we were going to work through that balance and have it more in-line with our sales trend by the end of the year that still absolutely holds. That should be where the expectation is for the end of 2022. And as we work into 2023, the expectation is that we continue to be on this trend of being in-line with sales or growing slower than sales as we push for efficiencies there. Obviously, balanced with the comments that Tim just had around the work that needs to be done in balancing out the assortment, but that is again into a mix of different price points and cost points, but the trend that we're on right now is the trend that you should be modeling. Okay. And for the acquisitions now, what is going to be your criteria for acquisitions, I guess, both operationally and financially? And when you look at it, are those acquisitions going to be in EXPR and then paying the royalty to the joint venture or is it envisioned they're going to be inside the joint venture? Well, it's a great question, Eric. A really good question. So, I'll start with the first, which is the criteria. We're going to be exploring multiple opportunities, and we're going to be very, very focused on those opportunities that we believe will provide us with the most top and bottom line growth. That is, put simply, those are the two most important criteria. Will this be accretive to our top and bottom line? Can we drive growth through these acquisitions? And so, it's more than just about the revenue and it's more than just about whatever brand it is. It's got to be able to drive both top and bottom line growth for us. The bottom line growth would obviously be driven through synergies that we believe we could create. And we also believe that as we look at these brands, we'll be able to identify very significant opportunities for top line growth because of our expertise in brand management. So, those are the two most important criteria. ‘Full stop’. The second piece to your question, we have formed an intellectual property of JV for the Express brand and Yehuda and I are aligned that we will form intellectual property, joint ventures for future brands. And yes, any brands that we would be operating just like Express under a license agreement with the IP JV. Great. Thank you so much. Tim, I know you touched on this a little bit, but just want to understand a little bit the trends that you've seen here in December, because [lapping] [ph] Abercrombie from last year, maybe weather compares a little bit easier and there's some inventory challenges across the mall last year related to supply chain. Is what you're seeing now, sort of just a change versus your expectation. Are you actually seeing the consumer get a little bit weaker? And where is it going? I think somebody asked a question about next year, just how are you thinking about the trends that you're seeing now from the consumer next year? And maybe connect that to how you're, sort of buying inventory at this point for what you're thinking about next year? Absolutely, Jay. So, the outlook that we provided for 2022 clearly indicates that we're seeing the same behavior in the fourth quarter from the consumers that we saw in the third quarter. And so that is slightly different than our expectation. Coming into the fall season, our previous outlook we did expect to see improvement in the fourth quarter based on Omicron and the impact of that last year and all sorts of other factors. The macroeconomic environment and the consumer sentiment that I described earlier, spending less on discretionary categories like apparel, and looking for deep-deep discounts that still seems to be in play in the quarter. And I would say the discount side of that is even more in play in the fourth quarter as it is typically a more promotional quarter anyway. Thinking, you know going forward, we have not shared an outlook for 2023, yet we will do that when we share our fourth quarter results, but we are approaching 2023 with conservatism, particularly in how we're buying merchandise. And we have a great go to market process that as the supply chain challenges and bottlenecks have, sort of evened out, we're going to be able to get back into chase mode, which is something that works very, very well for us. So, we are testing things right now in the southern part of the country that will influence product we chase into for the [indiscernible] first quarter and the second quarter. So, we're going to approach it with conservativism and we have the mechanisms and the ability to chase into trends as we see consumer behavior rebounding. Got it. And so, maybe just a follow-up on that. I mean, is your [chase ability] [ph] comparable today to what it was pre-pandemic? I mean, can you just talk about how much lead times have shrunk from like, sort of like the worst of the supply chain issues like the last couple of years versus where they are right now? Yes, Jay. So, what I would say is they are getting better. They're not to pre-pandemic levels yet, but they're getting closer. There is a lot of capacity available out in the – out of the factories right now, which helps out a lot. We're still and the logistics is getting better, supply chain, timing is getting better. So – but it's not back to pre-pandemic levels. So, we're still being a little cautious about that to make sure we get the product in on time, but everything is definitely improving. And as it's improving, we are increasing our ability to chase into product, which is obviously really important for a fashion business. And Matt, do you have visibility into when it really gets better? Is it sort of depending on China and lockdowns ending or what does getting back to really pre-pandemic levels of lead times really depend on? I think once we get into the first half of next year, we're going to be in much better shape. We've already started to shorten our lead times based on certain [course] [ph] getting better. As it relates to China for us specifically, we had low double-digit exposure to China this past year. We're down to single-digit exposure in product next year. So, we feel good about our positioning and China will have limited impact on us specifically. There obviously could be a knock-on effect as people move out of China into other geographies if necessary, but we feel good about where we're positioned right now. Okay. And then maybe one last one for me. Just on the promotions that you're seeing and the consumer looking for value, last year was, sort of an exceptional year for a full price selling across the mall and this year feels like more of a normalization return to normal clearance levels, normal types of activities, not necessarily as deep promotionally as it was in 2019 and 2018, what is your sense of where the mall is at? I mean, in terms of what the promotions have gone back to? Is it more of like – more of like just, kind of a reversal of last year or are we really seeing like a deepening of promotions getting back to 2019 with maybe potential for more potentially if the economy is weaker next year? I think that throughout the year, we've seen significantly increased inventory levels in many of our mall-based competitors that were different than our increased inventory level to be honest. We've talked for the past year about how we aggressively actually front-loaded receipts in the year in all of our core categories that don't age, so that to mitigate all the supply chain challenges and be sure that we had inventory in those categories. And so, we're seeing now that step down related to that. So, we didn't need to pull the trigger on aggressive promotions in order to drive that inventory down. It was very strategic. In many of our other mall-based competitors, I think we saw much more aggressive promotion certainly than in 2021. But even, I would say, as high in many cases as pre-pandemic levels 2019 because there were such cost of inventory throughout, based on all the challenges from the pandemic, all the supply chain challenges, all the reasons that there were so many inventory glut. I do think that as we move into 2023 across the industry we're seeing much better inventory management, much more normalized levels of inventory. And I believe that's going to allow for less promotion actually as we move into 2023 because there won't be a necessity or promotion to actually liquidate inventory. The promotion will actually be more offensive again versus defensive. So, I actually believe that as we move into 2023, we're going to begin to see less promotion again, a more normalized level of promotion versus the heightened level we've been seeing. Hey, guys. Thanks for taking my question. Just on the [indiscernible], I know you've kind of – not to beat a dead horse, and I know you touched on this, but maybe looking at same-store sales on a three-year basis, it looks like they’re decelerating pretty substantially. Can you just discuss in more detail the cadence of the quarter and then perhaps what you're seeing quarter to date from a comps perspective? Sure. As I said, the challenges that we faced in the third quarter became more acute as the quarter progressed. So, started off much more in-line with our outlook and obviously ended where it ended, which drove the miss to the outlook that we had provided, which came primarily in the back half of the quarter. In the back half of the quarter is where we really began to see very aggressive promotions from many of our competitors. We were still staying very true to our commitment to being a less site-wide and store-wide promotional store. We did end up at the end of the quarter pushing some site-wide and store-wide promotion that was not anticipated in our outlook, which also drove our bottom line outlook miss as we reacted to the competitive environment. I think that – and as I said, as we've moved into the fourth quarter, the outlook that we've provided for the year we are seeing that same consumer behavior, less spending on discretionary categories like apparel and much, much, much increased appetite for deep discounts. So, where we are promoting, we are doing it strategically. And that's when we get competitive and when we see the improved results. So, we are – as we move into [2023] [ph], as we finish out the fourth quarter of this year certainly, and as we move into 2023, we will continue to be very strategic in our promotions, but in this environment, we've learned that we absolutely have to be competitive with what's happening around us. The customer is choosing, absolutely choosing based on really not just value, which is what had been driving our increases, but on promotion specifically. So, that's, sort of the state of the union. As we've gone – if you look back at the five consecutive quarters where we actually drove growth versus 2019. It was driven actually through significantly higher average unit retails, which was both – and that was driven by significantly improved product, mix of our assortment, and less promotion. So, the strategy that had been working for us for so long just truly became in direct conflict with what consumer behavior and consumer sentiment was. So, as I said, we're making those adjustments. We're recalibrating our assortments. We're reintroducing opening price points. We'll continue to be very strategic in how we promote. And so, expect to see improvement as we move into the first quarter of next year. Got it. And maybe one more for me. As far as your customers go, where are you seeing – are you seeing different spending patterns between income levels, gender, and different channels? Can you maybe just touch on those dynamics? We're certainly seeing differences by gender. Our men's business, as I said, just posted its sixth consecutive quarter of positive comps. So, our men's business remains very strong. We continue to gain a market share very aggressively in our men's business. So, we're certainly seeing a very disparate performance by gender. In terms of price point, we don't have all that data from the quarter yet. So, I don't want to share any of that other than to say, it certainly appears as though our lower income consumer is the most challenged. About a third of our consumer base makes over $100,000 a year, two-thirds make less. So, it does – it would appear based on everything that's happening around us that that consumer base is much more significantly challenged. [Operator Instructions] And it appears there are no further questions at this time. Mr. Baxter, I'll turn the call over to you for any closing remarks.
EarningCall_1592
Good day, ladies and gentlemen. Thank you for standing by. And welcome to the EHang Third Quarter 2022 Earnings Conference Call. As a reminder, we are recording today's call. Hello, everyone. Thank you for joining us on today’s conference call to discuss the company’s financial results for the third quarter of 2022. The earnings release is available on the company’s IR website. Please note, the conference call is being recorded and the audio replay will be posted on the company’s IR website. Today, EHang’s management team, which include Mr. Hu Huazhi, Chief Executive Officer; and Mr. Xin Fang, Chief Operating Officer; and Mr. Richard Liu, Chief Financial Officer, will successfully give prepared remarks. Remarks delivered in Chinese will be followed by English translations. All translation is for convenience purpose only. In case of any discrepancy, the management team’s statement in the original language will prevail. A Q&A session will follow afterwards. Before we continue, please note that today’s discussion will contain forward-looking statements made pursuant to the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involves inherent risks and uncertainties. As such, the company’s actual results may be materially different from the expectations expressed today. Further information regarding these and other risks and uncertainties is included in the company’s public filings with the SEC. The company does not assume any obligation to update any forward-looking statements, except as required under applicable law. Also, please note, all numbers presented are in RMB and are for the third quarter of 2022, unless stated otherwise. [Interpreted] This is the English translation of the CEO's remarks. Hello, everyone. Thank you for joining our earnings conference call today. Since EHang submitted the EH216-S Certification application to the CAAC, which is the Civil Aviation and Administration of China at the end of 2020. We have been continuously committed to the efforts to actively promote EHang 216 certification progress in the past two years. In airworthiness certification, it's not only a safety certification and pre-requisite for official commercial aircraft operations, but also the crucial path for EHang to move forward in its strategy of becoming an Urban Air Mobility platform operator and thus the key catalyst and the driving force for the company's business growth. Here, we'd like to thank our investors, customers, regulators and partners for their long lasting attention and support. Every member of the EHang team value the support given to EHang and are wholly dedicated to meet the expectations of our stakeholders. As an innovative project, the airworthiness certification process is full of tremendous challenges along with the continued impact of the pandemic in China. Our technology, product and the certification teams have tirelessly worked days and nights to overcome difficulties in a collaborative synergy. Additionally, they have walked to enter close cooperation with the CAAC expert team and we are about to greet the victory [indiscernible]. At present, all of our certification plans has been officially approved by the CAAC expert team. In other words, the means of the compliance for all the trial specified airworthiness review subjects have been confirmed. Including aircraft, their performance and flight, structural strengths, design and configuration, ground control station, airborne human-computer interaction, continued airworthiness, etcetera. As a result, the EHang 216 certification process has already completed the phases of Concept Design, Requirements Definition, and Compliance Planning and incurred the ongoing final phase for Demonstration and Verification of Compliance. We have completed in the most demanding and complicated work across the most difficult obstacles and overcame many challenging uncertainties. What we are doing next is to implement all the plans that we made. Besides, we are fully confident in the final phase of airworthiness certification, which is specifically about conducting verification reviews through laboratory tests, ground tests and inspections, flight tests, and data analysis that is CAAC expert team in EHang, in accordance with the approved certification events. EHang 216 have accumulated more than 30,000 safe flights and data records over the years, which could be solid support to the demonstration of compliance. The proof of passenger-carrying AAV test drive records as well as the test flight in extreme weather environment such as the high altitudes, typhoons, deserts and heavy fog. We have accelerated the process of a verification of the compliance. On this basis, we are carrying out some supplementary test and a flight test for verification, so as to complete the type certification process. We are fully confident to complete the world's first airworthiness certification for the human-carrying unmanned aircraft system. Our confidence is not only derived from strengthen innovation our AAV technologies, but also from the open and innovative spirit of the Chinese government, the CAAC and the aviation industry, as well as their interest, support and guidance. All of these empowered the high degree of innovation, breadth, deeps and a speed of the EHang 216 certification project, which are at the forefront of the emerging industries across the globe. In September and November this year, EHang was honored to be invited by the ICAO, which is the International Civil Aviation Organization to attend the 41st ICAO Assembly, Innovation Fair and RPAS Symposia at ICAO’s headquarter in Montreal, Canada and shared the exploration and practice on EHang 216 airworthiness certification project and innovative results with global aviation regulators. In particular, the CAAC as the first class member of ICAO introduced the China's first airworthiness certification standard for human-carrying unmanned aircraft system at the ICAO Assembly, providing a reference for countries in formulating related regulations. It is not easy to be a first mover and a pioneer. Even so, over the past eight years, EHang has always been committed to its steadfast emission, which is to make safe, autonomous and eco-friendly Air Mobility accessible to everyone. So this, we have and always will adhere to the principles of safety first boarding innovation, careful analysis and prudent verification, contribute to the formulation of relevant industry standards and norms, with the experience and the expertise we have accumulated over the years and lead healthy and continuously improving development of the emerging eVTOL industry worldwide. Meanwhile, driven by leading innovative buyers like EHang, we are pleased to see that China has taken more and more new policies and measures to continuously support and promote the development of Urban Air Mobility and Unmanned Civil Aviation. In August, the CAAC released the Unmanned Civil Aviation Development Roadmap 1.0, which set the short, medium and long term development stages and goals for 2025, 2030 and 2035. These are significant in how they clarified the direction for the new industry development. Meanwhile, the CAAC also proved the seven new Unmanned Civil Aviation experimental zones in addition to the first batch of 13. Currently, there are a total of 20 pilot cities in China to put the policies into actions. In some of these zones, EHang received a strong support and preorders from the local government and customers. We are actively building UAM operational trail pilot basis and supporting infrastructures to bring the integrated development of air [indiscernible], air logistics and smart city management industries as well as provide further grounds for the operations and practical applications of EHang AAVs. And like other development industries, we need to create new regulations to build up this new industry and we made it, which expect to be followed by explosive growth. Against such a strong and promising backdrop, we have the reasons and confidence that EHang will achieve significant growth results and meet our strategic goals after completing a diversification to provide a better returns for our shareholders and partners, while continuously promoting their sustainable development of the emerging UAM industry. Next, I will turn the call to our Chief Operating Officer, Mr. Xin Fang, for business results in Q3. Thank you. [Interpreted] This is the English translation of the COO's remarks. Thank you, Mr. Hu. Hello, everyone. In the third quarter, we remained focused on EH 216 and airworthiness certification project and continued to explore domestic and overseas markets to fully prepare for post-certification commercial operations. Since October, the COVID-19 resurgence has a swap of course many cities across China, especially Guangzhou, where EHang is headquartered. Although, we are facing serious challenges from pandemic control measures, we will continue to drive our efforts in a low altitude aerial tourism, when our AAV targeting markets following Guangzhou City in Guangdong Province, and the Jishou City in Hunan province. Since the third quarter, we have been exploring more potential opportunities in Qingdao City in Shandong Province and the Huangshan City in Anhui Province and integrating local resources to actively develop a broader and diversified UAM ecosystem. EHang formally launched the 100 Air Mobility Routes Initiative last year. So far, we have completed over 6,800 operational trial flights with EH 216 in practical aerial sightseeing scenarios at 15 operation spots across China, to accumulate valuable experience for post-certification commercial operations. These operations spots cover first-tier cities such as Guangzhou, Shenzhen and Shanghai, as well as other tourist destinations. In addition, EHang self-developed AAV operational system has been put into use across all operation spots. The current internal test demonstrated positive results, which will significantly improve AAV operations management efficiency. In October, we established our partnership with HAECO Group, a subsidiary of Swire Group. HAECO Group brings over 70 years of experience in maintenance, repair and overhaul and as aftersales maintenance service system and network across the globe. We believe that the potential cooperation opportunities in manufacturing and assembly continued airworthiness, digital platforms, aircraft maintenance and talent training will have further solidified foundation for EH216 commercial operations in the future. On the international front, we have made meaningful progress in two key regions, Asia and Europe. Since the beginning of this year, we have achieved the fruitful results in developing Asian markets, including Japan, Malaysia, Indonesia and Thailand. And have received a total of 210 pre-orders for passenger grade AAVs. In the third quarter, with the support of our Japanese customers EH216 completed a demo flight tour across four cities, leaving footprint in up to six Japanese cities to date. This flight tour not only demonstrate the use cases in aerial sightseeing over the sea, and mobility and smart logistics, but also include the over the sea flight and point to point flight for the first time of an eVTOL aircraft in Japan. It was also an excellent showcase for participation opportunities at Expo 2025 Osaka, Kansai, which will further strengthen preparations for subsequent business expansion in Japan. Furthermore, EHang played an important role in many European Union's UAM projects. For instance, the EH216 trail flights in October verified and validated the UAM concept of our operations, which completed the AMU-LED project objectives. In November, EHang participate the SAMVA project initiated by the European Union Agency for the Space program to deployed the EGNOS, which is the European Geostationary Navigation Overlay Service of the EH216 operations and to support use space integration across Europe. 2022 is coming to an end, but we continue to see impact from the COVID-19 resurgence and a pandemic control measures in China, which brings considerable challenges to our original airworthiness certification process and a business development plan. We have adjusted our guidance based on the current situation and the outlook for the fourth quarter. The company expected total revenue for 2022 to be in the range of RMB55 million to RMB65 million. Nevertheless, remain optimistic and confident about achieving the company's long-term financial growth and the development momentum based on our core competencies, including the leading technological advantages, EH216-S TC process entering the final phase, and increasing UAM marketing demand with preorders for more than 1,200 passenger grade AAVs in hand, and sufficient preparation for commercialization and industrial chain deployment and also favorable regulatory support, especially in China. Based on that and our consistent execution of the corporate strategies, EHang is well positioned for a promising future. I will now turn the call over to our CFO, Richard Liu for financial results. Richard, please go ahead. Thank you. Thank you, Xin. Hello, everyone. Before I go into details, please note that all numbers presented are in RMB and are for the third quarter of 2022 unless stated otherwise. All percentage changes are on a quarter-over-quarter basis unless otherwise specified. Detailed analysis are contained in our earnings press release which is available on our IR website. I will now highlight some of the key points here. Our third quarter performance reflects impacts from the COVID resurgence in China. However, it continue to enhance our cost management to improve operational efficiency despite these near-term challenges. We maintain our focus on the development of areas that can deliver long term growth as we continue to execute our strategy towards becoming an integrated Urban Air Mobility operator. Turning to our operating results in Q3 2022. Total revenues were RMB8.2 million compared with RMB14.6 million in Q2. This was due to the unfavorable market impact, mainly from the pandemic resurgence and related control measures in China. The EH216 AAV delivers in Q3 were 4 units compared with 8 units in Q2. That said, demands for AAVs remained strong, notably with preorders from the Southeast Asian market this year. As we are focusing on completing the final phase in the Type Certification process of EH216-S. We are also stepping up our efforts in preparing for its commercial operations by expanding our market presence and our partnership network at home and broad, coupled with other strategic initiatives. Gross margin was 65.9% in Q3, a slight decrease of 1.2 percentage points from 67.1% in Q2, but it remains at a high level compared to those of other new energy mobility products such as electric cars. These are tests to see EHang competitive strengths and fresh mover advantages in the global UAM and eVTOL industries. In Q3, our adjusted operating expenses, which are operating expenses excluding share-based compensation expenses were RMB59.7 million representing an improvement of 5.9% from RMB63.4 million in Q2. The decrease was mainly attributed to decreased professional expenses as well as fluctuated R&D expenses related to different processes in product development and the ongoing certification process. With that in Q3, our adjusted operating loss was RMB52.9 million compared with RMB51.2 million in Q2. Our adjusted net loss was RMB55.1 million in Q3 compared with RMB50.8 million in Q2. As for our balance sheet, we continue to maintain relatively healthy cash, cash equivalents, restricted cash and short term investment balances of RMB208.8 million as of the end of Q3, which was attributed to our continuous management of operating expenditures and cash flow. Additionally, we will be moving to a new headquarter office in Guangzhou to embrace the new phase of growth that the company is expecting to see following completion of the type certification. Nevertheless, we have been sticking to a prudent cost control strategy and taking effective measures to optimize new office rental expenses. It is expected to give us a cost down estimated by around 20% compared with those of our current office. Given the latest pandemic resurgence in China, we expect such headwinds would probably remain a challenge in the near term. But we believe that for the longer term, we will be able to capture the great growth potential of the UAM industry with a leading technologies and comprehensive strategies. We remain committed to providing a safe autonomous and sustainable and mobility experience, while creating values for our shareholders and stakeholders. Ladies and gentlemen, we now begin the question-and-answer session. [Operator Instructions] The first question comes from the line of [Technical Difficulty]. Thank you for taking (ph) my questions. I have two questions. My first question is regarding the progress of Type Certification. As we enter into more in-depth rate these days. Can we bit expand that EHang still can receive Type Certificate by the end of this year? And my second question is that in light of recent COVID lockdown, have we encounter any hiccups in terms of production, component sourcing, Type Certificate [indiscernible] and delivery schedules. And do we see any risk limit delay in timetable of resilience on TC and how should we think about the revenue cadence into 2023? Thank you. Do we have the management in the [Technical Difficulty] in the queue? Thank you. Unmute your local line please. Ladies and gentlemen, please stand by. [Technical Difficulty] Thank you. Thank you for the answer. We may have the management translation, please. Perhaps management for the translation line, would you like to rejoin again if you can’t hear us. Everyone please stand by. We are trying to address the issues. [Technical Difficulty] Okay. We can hear you now. Please carry on, please. As our CEO, Mr. Hu mentioned earlier, the EHang 216 Type Certification has entered into the final phase. Specifically to complete the compliance demonstration and verification work according to the certification hence approved by the CAAC expert team. The practical data that EHang has accumulated over the past few years provides a solid support. And together with the support of the CAAC and the expert team, it will help to accelerate the final phase of the process. As we are the world’s first, we are facing a lot of uncertainties, but when it comes 216 Type Certification is one of the key projects of CAAC for this year, which was originally scheduled to complete by round out December this year. Specifically, the CAAC code for the members of the TC expert team to get together at the EHang site in [indiscernible] to work closely with us. However, the recent epidemic resurgence in Guangzhou made it difficult for all the members across the country to come together. That's the timetable might be delayed, but it will not be too long because most recently, as the COVID restriction measures have begun to ease by steps in China. The related impact is expected to gradually decrease. So our expectation may be around January next year. This is all about the translation of the first questions. [Interpreted] Okay. This is the English translation of the answers above. Regarding your second question, the epidemic has had a significant impact on our business development and the original projected trends since the beginning of this year, just like other Chinese companies. In terms of the business development, the tourism industry is our initial main targeting markets for our AAV product applications. Well, it is one of the industry’s severely affected by the epidemic. However, we have been exploring more potential opportunities in Zhaoqing City in Guangdong Province, Jishou city in Hunan province, Qingdao City in Shandong Province, and the Huangshan City in Anhui Province, et cetera. And despite the strict pandemic inflammation, and we received adequate trust, support and cooperation from local governments and customers. In addition, the epidemic has no significant product on our production and supply chain. And our last year's revenue expectations both depending on the timing of obtaining Type Certificate and the recovery of the economy and the tourism industry after the epidemic situation gradually subsides in China. And ideally, the potential customers in the market above will be able to place orders while we could gradually deliver the product. So that we are likely to achieve significant revenue growth next year and return to the high growth trajectory. And for more details, please wait for our guidance next year. And this is all about the translation of the answer. Thank you very much for the questions. Allow me to proceed with the next question. One moment, please. Our next question comes from Jiahui Wu from Goldman Sachs. Please proceed. [Interpreted] Okay. I will translate for myself. Yeah. Thanks management to take my question and congratulations on the results. I have two questions. The first one is from EHang 216. Could you please share us this aircraft the pump costs breakdown, especially the battery, the model, the battery management part and who are the support [Technical Difficulty] can we take the view that this EHang model above cost breakdown is similar at the EV? And second one is how many the preorder and the decrease we have so far? And in terms of scenarios apart from the [indiscernible], what types of passenger transportation scenarios are we penetrating to? Thanks. Thank you for the questions. This is Richard. Let me take your first question and then I will let our COO, Xin take your second question. So basically, the cost structure of the EH216 AAV can be divided into three major portions. First, the power and propulsion system; and second, the fuselage infrastructure; third, the electronic components and others. And from a new energy mobility product perspective, the major composition of the propulsion system of an EH216 AAV can be regarded similar to that of an EV. It mainly includes electric motors -- motor drivers and batteries together with the battery management system or BMS. In respect of percentage each portion as mentioned just now cost us roughly one-third of the total cost more or less. In respect of suppliers, most of our qualified suppliers whose long term relationships are those located in South China, more especially in the Per River Delta area, which known as a world leading manufacturing hub and where our headquarter is. So this give us an easy access to a large number of high quality suppliers and the competitive edge in respect supply chain, in terms of costs and efficiency as compared to our peer companies in other countries. [Interpreted] Okay. This is the translation of Mr. Fang's answer. So far this year, in addition to the over 200 units of EHang AAV preorders in Asian markets. We have potential orders from many domestic customers in pipeline, such as Qingdao districts in Guangdong city, Guangxi Province, and [indiscernible] to Jishou City in Hunan Province. They are very interested in deploying EHang AAV’s in the local areas to develop the low altitude tourism industry. And the potential orders in Zhaoqing include 60 units [indiscernible] AAVs, which are expected to be placed and delivered gradually after obtaining tax certificate. In addition, 5 units of EHang 216 has been delivered to [indiscernible] to developing an aero sizing project. And this customer intends to purchase additional 25 units as the project evolves. And apart from the low altitude tourism market, we are also in contact with the customers who have needs for firefighting and emergency transportation, such as the Qingdao fire department and some hospitals which has a potential order about 6 units of EHang 216 by our fighting model. Given that our initial primary target market is the low altitude tourism, which we invest more resources. The revenues from this market will be the most significantly in the near future. And followed by the firefighting and the emergency aero transport use cases. This is the all of the translation. Thank you for the answers. One moment for the next question. The next question comes from the line of De Lu from Tianfeng Securities. Please proceed. Thank you management team for taking my question. My first question is recently, we see that U.S. has issued a series of export bans on the high end trips. I'm just wondering, will there'll be any potential impact on EHang supply chain? And my second question is, we noticed that China's domestic epidemic prevention policy is experiencing some softening, especially in Guangzhou. If these policy continue to ease in the future, what will be our new outlook on the future, for example, like TC approval and market demand and et cetera? Thank you so much. This is Richard. Let me take your questions. First of all, we are not using those U.S. ban chips in our products. That's as you can imagine, there will be no potential impact on our supply chain. But we will be mindful of this when we further implement our R&D and supply chain strategies. Additionally, we adopt a strict mechanism to review any sure quality and stability of our supply chain. And we always seek to fully engage with our qualified suppliers to establish long standing and strong partnerships. In respect to your second question, yes, we have been experiencing the optimization or even the easing of COVID prevention and control measures recently. As you mentioned Guangzhou, where we have headquarter has initiated doing so since just two days ago. And it seems more cities gradually following the suit. So this is a very good sign to the market. Given the COVID prevention measures can be further loosened, travel can be back to normal. So when this challenges are ease or is further eliminated, it is expected to have positive impacts on the business. For example, in respect of type certification, the inspectors will be able to travel without difficulties to allocations to conveying and check on-site thus facilitating the process. In respect of markets, you will help the tourism industry, which we initially target back to normal. Thus facilitating the relevant tourism operating customers to complete orders. So coupled with TC soon to be obtained, it is expected our business would rebound next year and we believe our efforts will allow us to capture this market growth opportunities going forward. Thank you. Thank you for the questions. Seeing no more questions in the queue, let me turn the call back to Ms. Chi (ph) for closing remarks. Thank you, operator, and thank you all for participating on our today's call. If you have further questions, please contact our IR team by e-mail or participate our following investor events through the calendar information provided on our IR website. We appreciate your interest and look forward to our next earnings call. Thank you.
EarningCall_1593
Good morning, my name is Devin and I will be your conference operator today. I would like to welcome everyone to the TD SYNNEX Fourth Quarter Fiscal 2022 Earnings Call. Today's call is being recorded, and all lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. At this time, for opening remarks, I would like to pass the call over to Liz Morali, Head of Investor Relations. Liz, you may begin. Thank you. Good morning, everyone, and thank you for joining us for today's call. With me today are Rich Hume, CEO; and Marshall Witt, CFO. Before we continue, let me remind you that today's discussion contains forward-looking statements within the meaning of the federal securities laws, including predictions, estimates, projections or other statements about future events, including statements about strategy, plans and positioning as well as our expectations for future fiscal periods. Actual results may differ materially from those mentioned in these forward-looking statements as a result of risks and uncertainties discussed in today's earnings release, in the Form 8-K we filed today and in the Risk Factors section of our Form 10-K and our other reports and filings with the SEC. We do not intend to update any forward-looking statements. Also, during this call, we will reference certain non-GAAP financial information. Reconciliations of GAAP to non-GAAP results are included in our earnings press release and the related Form 8-K available on our Investor Relations website, ir.tdsynnex.com. This conference call is the property of TD SYNNEX and may not be recorded or rebroadcast without our permission. Thank you, Liz. Good morning, everyone, and thanks for joining us for our first earnings call of the new calendar year. We are pleased with our strong fiscal Q4 results, closing out what was truly a phenomenal year for TD SYNNEX. We began the year with a lot on our to-do-list relative to the merger and integration activities and ended the year having met or exceeded our objectives. As I've mentioned along the way, this merger has gone very well. Today, TD SYNNEX is a $62 billion company with over 23,000 co-workers, serving 150,000 customers across 100 countries. I judge the success of this merger from a few different perspectives. First, from the point-of-view of our customers and vendor partners, our teams continued to provide consistent and uninterrupted service to our partners post-merger. And the financial results we delivered are confirmation of the strong value proposition that we are delivering to the market. Next, from the perspective of our co-workers, we have largely completed our initiatives focused on harmonization of benefits and compensation and recently undertook our first TD SYNNEX global co-workers survey, which indicated a high-level of engagement, an accomplishment that can be hard to achieve in the first year of a large merger. Finally, looking at the merger through the lens of our shareholders, we exceeded the fiscal '22 financial targets we set. For fiscal '22, we achieved revenue of $62.3 billion, up 9% year-over-year, adjusting for FX impacts and merger-related accounting policy alignment, which was above the 6% to 8% range we anticipated. Non-GAAP operating margin was 2.8%, also above the targeted range of 2.5% to 2.7%. And we delivered non-GAAP earnings per share of $11.94. $0.29 above the high-end of our guidance range we provided for FY'22 on our September earnings call and $0.74 above the high-end of the original guidance range provided January of last year, despite higher-than-forecasted FX and interest expense headwinds. Finally, we returned $240 million to shareholders via dividends and share repurchases during the fiscal year, representing progress towards our medium-term capital allocation goals. With regard to the merger integration, we set the ambitious goal of achieving $100 million in cost synergies by the end of year one and we overachieved on that goal by 45%, realizing $145 million in fiscal '22. One of the largest integration project is the consolidation of Tech Data's Americas ERP systems into CIS, the legacy SYNNEX ERP platform. We have made excellent progress on the Canadian migration which we transitioned first and our U.S. transition is well underway having recently completed another major milestone. I'm happy to report that more than 45% of the legacy Tech Data U.S. SAP business has now moved over to CIS and is executing well. We will continue transitioning the remainder of the business throughout the fiscal year and are on track with our plan to largely be complete within two years of the merger close date. Let me now talk about the trends we saw in fiscal Q4 from a market perspective. In short, we experienced a continuation of many of the themes that have played out over the past several quarters. Advanced Solutions continued to experience robust growth in the quarter above expectations, with strength in servers, networking and infrastructure. Endpoint Solutions gross revenue was modestly down year-over-year as the PC market and related peripherals, continued to see a normalization from last year's pandemic-related highs. Several areas of Endpoint Solutions saw solid growth including printers and mobile phones. Our services in specialized solution businesses also experienced solid growth in the quarter. Rounding out our portfolio, our hyperscale infrastructure-focused business Hyve delivered a record quarter with continued outsized robust revenue and profitability growth as we continue to fulfill strong demand from our CSP customers. We also experienced operating profit above expectation from the Hyve business, which Marshall will provide additional color on in a few minutes. From a regional perspective, all three regions delivered strong revenue growth on a constant currency basis, with operating margin expansion on a global basis. We continue to accelerate our revenue in high-growth technologies as the markets we are targeting grew faster than the market projections we provided at our March Investor Day. We achieved greater than a 20% year-over-year growth in gross billings for the quarter and for the full-year 2022 in these areas which include cloud, security, data analytics and hyperscale infrastructure. This growth was in excess of our expectation and high growth technologies represented $16 billion of our total gross billings in fiscal 2022, up from $13 billion in fiscal 2021. We saw improvement in the supply-chain during the quarter with a meaningful reduction in our backlog. Despite decreases in both Endpoint Solutions and Advanced Solutions, our total backlog level remains elevated when compared to historical norms. Our customers are living the reality of a more uncertain and volatile macroeconomic environment with inflation, higher interest-rate and a competitive market for talent. This need for talent is particularly relevant in the IT sector, where the increasingly complex technology landscape and ongoing shift to cloud-based multi-vendor solutions requires an even greater level of knowledge and experience to serve the needs of the market. For these reasons and others, the value proposition that TD SYNNEX brings to the market resonates with our customers. On the vendor side, our utility has a variable-cost route-to-market also becomes more valuable in times of economic uncertainty when vendors desire to lower their cost. During the quarter, we were privileged to receive further recognition from our partner community, including being named the 2022 North America Partner of the Year by CDW; the 2022 Global Distributor of the Year by Palo Alto Networks; the EMEA Distributor Partner of the Year by AWS and Lenovo; and the Americas Distributor of the Year by Nutanix. We also continued to progress on our ESG journey and expect to publish our first corporate citizenship report this quarter. In addition, we recently received a grade of awareness from the Carbon Disclosure Project, a strong achievement in our first year of combined reporting. We look forward to continuing to share updates on our continued progress in this space. As we think about fiscal 2023, the critical nature of technology as an enabler of customer experiences and co-worker collaboration, keeper of cyber safety and a tool to realize cost optimization and efficiency cannot be underestimated. And for these reasons, we believe IT spending will continue to outpace GDP growth in 2023. We are prepared and well equipped to continue executing on our growth strategy and are targeting above-market growth rates as we leverage our industry-leading portfolio of products and services and broad global footprint to bring world-class service and innovation to the market. We enter fiscal '23 even more confident in our strategy being capable of capitalizing on the trends shaping the IT industry and the opportunities ahead. Lastly, I want to thank our 23,000 plus coworkers around the world for their exceptional efforts in making TD SYNNEX's first fiscal year a great success. Our financial accomplishments in fiscal 2022 were significant, with adjusted year-over-year revenue growth of 9%, surpassing the high-end of 6% to 8% target we provided earlier this year. Our operating margin performance also came in above the high end of our expectations at 2.8% for the fiscal year, representing a 14% improvement over the prior year and above our 2.5% to 2.7% target. These results demonstrate the power and reach of our business model and the strong value proposition that TD SYNNEX is bringing to the market. Please note that comparisons versus the prior year full-fiscal year are on an as combined basis, which assumes the merger occurred at the beginning of the period. Moving now to our fiscal fourth-quarter results. Worldwide revenue for fiscal Q4 was a record $16.2 billion, up 4% year-over-year and up a 11% in constant currency. When normalized for the revenue recognition policy alignment relating to the merger of $500 million, the year-over-year growth was 14%. Currency impacts, primarily driven by the Euro devaluation, accounted for approximately $1 billion headwind year-over-year in fiscal Q4. Revenue was at or above expectations across all regions and in both End Point Solutions and Advanced Solutions in fiscal Q4. Additionally, Hyve delivered strong results in Q4 driven by better-than-expected demand and timing-related margin recoveries related to services performed in prior quarters. Non-GAAP gross profit had record quarter of $1.08 billion, our first quarter greater than $1 billion and non-GAAP gross margin at 6.63%, up 44 basis points year over year. The improvement in gross margin was driven by mix shift to high growth technologies as well as the Hyve margin recoveries which approximated 25 basis points. Total adjusted SG&A expense was $582 million, representing 3.6% of revenue. Non-GAAP operating income was $496 million, up $88 million or 21.5% year-over-year, and non-GAAP operating margin was 3.05%, up 44 basis points year-over-year, driven by revenue growth, Hyve performance, the aforementioned of margin recovery, cost discipline and merger synergy execution. On a constant currency basis, non-GAAP operating income increased 26% year-over-year. Excluding margin recovery in Hyve, the year-over-year increase was 16%. Q4 non-GAAP interest expense and finance charges were $78 million, $18 million above our outlook due to higher borrowings and interest rates. For fiscal Q4, the non-GAAP effective tax rate was approximately 21%, below the forecasted 24% rate due to the mix of locations where earnings were achieved. Total non-GAAP net income was $330 million, and non-GAAP diluted EPS was $3.44, above our prior guidance of USD2.70 to USD3.10. Note that the previously mentioned Hyve margin recoveries contributed approximately $0.33 per share of non-GAAP diluted EPS for the quarter. Removing these, non-GAAP EPS would have been $3.11, slightly above the high end of our prior guidance range, despite headwinds from elevated interest expense. Now turning to the balance sheet. We ended the quarter with cash and cash equivalents of $523 million and debt of $4.1 billion. Our gross leverage ratio was 2.3 times and net leverage was 2 times, in line with our investment-grade profile and approaching our previously communicated target of 2 times gross leverage ratio. Accounts receivable totaled $9.4 billion, up from $8.1 billion in the prior quarter and inventories totaled $9.1 billion, down $689 million or 7% from the prior quarter. Net working capital at the end of the fourth quarter was $3.8 billion, a decrease of approximately $35 million from Q3. The cash conversion cycle for the fourth quarter was 23 days, flat from Q3, and cash from operations in the quarter was $302 million. From a shareholder return perspective for the current quarter, our Board of Directors has approved a cash dividend of $0.35 per common share, which represents a 70% increase from the prior quarter. The dividend is payable on January 27, 2023, to stockholders of record as of the close of business on January 20, 2023. For the full fiscal year 2022, we returned $115 million to shareholders via dividends, reflecting a 1.2% dividend yield. We also continued executing on our share repurchase program in the quarter, repurchasing $42 million of our stock and approximately $125 million in total during fiscal '22, which exceeded our $100 million target for the year. Earlier today, we announced that our Board of Directors approved a new $1 billion share repurchase authorization, which expires in January 2026 and replaces our prior authorization. We expect to increase our share repurchases year-over-year in fiscal '23 as we progress towards our medium-term capital allocation target. Before I move to discussing our financial outlook for Q1, I wanted to provide an update on our merger-related cost synergies. As Rich had mentioned, the teams did a phenomenal job of identifying, tracking and realizing synergy opportunities in 2022, allowing us to achieve our year-one target more quickly than anticipated. We achieved $145 million in cost synergies through fiscal Q4 and continue to expect to achieve an additional $35 million in fiscal '23, with much of the savings coming from the completion of our ERP system migration, which is on track for the second half of 2023. Once we are fully integrated on one ERP system for the Americas, we expect to continue to find optimization opportunities and generate revenue synergies. Now moving to our outlook for fiscal Q1. We expect total revenue to be in the range of USD15.2 billion to USD16.2 billion, which equates to year-over-year growth of around 5% on a constant-currency basis at the midpoint. This outlook reflects the impact of year-over-year foreign exchange headwinds of approximately $500 million and interest rate movements of $33 million. Our guidance is based on a Euro-to-Dollar exchange of 1.05. Non-GAAP net income is expected to be in the range of USD248 million to USD287 million and non-GAAP diluted EPS is expected to be in the range of USD2.60 to USD3.00 per diluted share. Based on weighted-average shares outstanding of approximately 94.8 million. Interest expense for Q1 is expected to be approximately $73 million and we expect the tax rate to be approximately 24%. As we enter 2023, I wanted to provide a few modeling points to assist you. As Rich mentioned, we believe IT spending will continue to outpace GDP growth in 2023 and estimate our revenue growth to be 3% to 5% on a reported basis. From an operating margin perspective for the year, we expect a range of 2.6% to 2.8%, with improvements in distribution margins, offset by lower year-over-year contribution from Hyve. Hyve working capital is expected to improve throughout the year, which is expected to reduce the recovery of carrying costs associated with these programs. While it is a challenge to forecast interest expense with precision in the current rate environment, we would anticipate trending toward our guidance for fiscal Q1 at $73 million per quarter, at least through the first half of fiscal year, and then slightly declining in the second half. We expect our non-GAAP corporate tax rate to be approximately 24%. From a cash flow perspective, we continue to expect to generate in excess of $1 billion in free cash flow-in fiscal '23 and anticipate working capital to be a source of cash this year despite topline growth and supply chain constraints continue to ease throughout the year and our inventory position improves. We are committed to progressing towards a medium-term capital allocation framework, targeting approximately 50% of free cash flow returned to shareholders via dividends and share repurchases, as best demonstrated by today's announcement with the other 50% targeted to reinvestment in our business and M&A. In closing, I'd like to thank all our co-workers for their focus and hard work in fiscal 2022, helping to build a cohesive company dedicated to providing best-in-class support and partnership to our customers and vendors. Hi, thanks for taking my questions and congrats on the strong quarter. Rich, the PC OEMs have talked about elevated channel inventory levels. Can you talk about how you see PC channel inventory trending both commercial as well as consumer and when do you think that gets worked off? Are you seeing additional promotional activity and rebates from vendors? And specifically, what have you factored in for TD SYNNEX PC revenue growth in fiscal '23? Well, good morning, Ruplu, and thank you for your question and Happy New Year to all of you. So first I'll comment that when we think about our inventory that it might be marginally ahead of our profile, but nothing out of the bandwidth of what I would call the norm. When we look at the backlog for the PC ecosystem category, I would say that it's generally at profile. So sort of consistent with the serviceability requirements that we had seen in the presort of COVID time. Yes, there is some I'll say traditional activity pre-COVID activity in terms of promotions and rebates et cetera, that are underway, but I kind of think about it as, as I said earlier, is returning to sort of the pre-COVID, if you will, sort of ebb and flow of the business. Okay, thanks for that. For my next question, maybe I'll ask a question on regional performance. It looks like in 4Q on a constant currency basis you saw the strongest growth in Asia, followed by Europe and then Americas. As we look to fiscal 1Q, should we expect a different relative performance by region, given we have the Chinese New Year holidays coming up. And when I look at Europe margins, they are the lowest amongst the three regions. Is there something structural that causes Europe margins to be lower and what can you do to improve margins there? Hi, Ruplu, this is Marshall. So your question in regards to Q1, even though we're not forecasting on a regional basis, we still expect to see on a constant currency basis, modest growth in Q1. And then in terms of Europe and the question in regards to being structural, we still believe that we're going to have a good quarter for Europe in Q1. Yes, as it relates to Europe margin profile, if I could, there are two callouts, first is that traditionally the margin profile in Europe has been lower, there is more cost of doing business in Europe related to the country complexity and then the second thing is the profile of the business, well, where we for example have mobile phone distribution tends to have a bit of a lower margin profile. However, those areas with lower margins have great working capital attributes. So the ROIC on those businesses that have sort of lower margin profile are attractive. Okay, thanks for all the details there, if I can just squeeze one more in. I think for fiscal '23 you suggested a 3% to 5% reported revenue growth. As we look at your high-growth technologies and specifically cloud, how levered is that to overall cloud CapEx spend. So if cloud CapEx is still strong, but lower in fiscal '23 versus '22, do you think that TD SYNNEX cloud revenues can still grow mid-teens as you've done in the past? So any thoughts on cloud revenues would be great. Thank you so much. Yes, I'll start Ruplu and then Rich can chime in. We still feel that the high-growth technology, cloud space industry growth will be mid-teens. And that's an industry comment. I think the various services and products within that segment. We will reflect that as I said in my prepared remarks in the Hyve area, we'll see more modest growth in fiscal '23, but in terms of our overall longer-term thoughts on hyper technologies in cloud, we think it's going to be meaningfully above we'll call it the average growth rate for the business. Just speaking about your question in regards to CapEx, just as a reminder, CapEx is one correlation, but it's not the only correlations to the services that we provide to our hyperscale customers. Hi, good morning guys and thanks for the questions. First one from me. Some of your partner OEMs have highlighted longer decision-making tightening the purse strings, among other things from end-customers and they appear to be seem to be cautioning around the IT environment -- spending environment. I guess that, are you guys seeing a similar environment from your end-customers? And if so, what is driving you guys to be more optimistic around the IT spending environment. And more specifically your growth outlook for fiscal '23, and then I have a follow-up. Thank you. Sure yes. Joe, this is Rich, let me handle that first. So, if we think about the back-half of last year, I think, our reported growth rates in both the third quarter and the fourth quarter at constant currency, and then adjusted for the accounting difference during the merge, were double-digit -- mid double-digit teens, if you will. And when you take a look at Marshall's comments relative to our preliminary thoughts around the year, he is talking about 3% to 5%. So, from my point of view, there is a pretty material, if you will, change in that trajectory overall. The way we kind of think about it, we obviously looked at many, many different sources as we look to plan our business, the one that we most have the best correlation or had seen the best correlations to are GDP. Without getting into all of the details, our business is very concentrated in the Americas and Europe. And if you take a look at the GDP for those two regions is it's near as flat. I think the Americas are up a couple of tons and Europe is down a couple of tons. And over the 15-year average, I see outpaced GDP by about three points. So this is based on -- this is a theory that we use when we think about the likely outcomes for our business in the coming year. And every quarter, we take a look at what are we hearing in market as it relates to GDP. I would say that it had been somewhat volatile. So we continue to look at that metric as the greater macroeconomic scene sort of plays out in front of us. Got it. I appreciate the color there. And then my second question, if I look at your revenue guidance for the February quarter, it's actually in line with what you were expecting for the November quarter, however, the earnings guide is a bit softer. It sounds like from your commentary that it's largely driven by interest-rate headwinds and some FX. How are you -- just want to confirm there that you're not seeing any other material pressures like areas of the P&L like gross margins and maybe even more specifically, are you expecting gross margins to improve going into next quarter as you continue to benefit from the mix-shift that you saw this quarter? Hi, Joe. So as you think about as we think about '22, there was some benefit to the pricing environment, we call that out 5 to 10 basis points on gross margin. I would expect that to abate or normalize in '23 and I think the other influencing factor about Q1, it's just the mix-shift as we talked about earlier. Distribution, we expect to continue to grow well, hyper technologies, specific to the hyperscale Hyve business will decline slightly. So the mix itself is probably the last piece of trying to triangulate the margin profile for Q1. Yes, if. I could just add on to the comments. You know, the fundamentals of the execution of our businesses are quite good. And so I kind of think of three buckets relating to I think you called the softer guide from an earnings perspective. Three points, number one is interest, by far the biggest, a year-to-year. Then second is, there is some currency overhang. Presuming a more stable Euro that sort of a base as we move into the future. You know that FX discussions. And then the third is the mix in particular, lesser growth in Hyve in that overall three to five guide and it's those three factors. But we're very-very pleased with the fundamentals and the profiles of our businesses. Hi, this is Sameer Kalucha calling in for Ashish Sabadra. Thanks for taking my question. I was wondering if you can provide some more color on the inventory normalization, do you think there is any pull forward of demand over here or does it just supply-chain normalization happening as I've heard from partners? And when do you expect the supply chain on the Advanced Solutions side to normalize? Yes, Sameer. Thank you for your question. So a couple of things, number one is, hopefully I'm going to answer your questions here, but number one is, certainly, you know, the reduction of the backlog benefited our overall sales growth that 14% when normalized for constant currency as well as the accounting 606. When we think about the backlog, to give you a little bit more insight as I said earlier, the backlog for the PC ecosystem businesses generally are at profile and serviceability levels that we had seen pre-COVID. We're still elevated in Advanced Solutions and my crystal ball says with maybe some minor exceptions by the time we get to the mid -- at the midyear point that we should probably make our way near profile and have sort of pre-COVID serviceability for the majority of the Advanced Solutions categories. So I do see in Q1 and Q2 a bit more of a backlog run-off in that Advanced Solutions category and hopefully by the mid of the year will be at profile. Got it, thank you. And just a just a quick follow-up. We all hear from partners and industry players saying cloud spending is being more rationalized and companies are looking at their spends more carefully than they have been in earlier times. How do you see that slowdown in Hyve staying out? Do you think it's a very short-term in one or two quarters kind of thing? What do you think is there's little bit something more structural to look in the say, mid-term, when companies try to re-architect their applications, which will likely take longer. So any thoughts you can provide on that? Sure, Sameer. I'll start first. We're used to pencil sharpening. I mean it's part of the business of always trying to create an event ways of providing more value. So, whether it's distribution, whether it's high-growth, those areas over time will feel pressure from just the competitive environment from a pricing environment, but I think the majority of what we're seeing in fiscal '23 as it relates to cloud service providers and their thoughts is, how can we continue to provide more end-to-end solutions beyond just data center fulfillment. But we're seeing that breadth of portfolio play out. And it's upon us to continue to kind of create new value that creates more premium and ultimately more margin for us. Rich. I think, anything else you want to add to that. Yes, just two thoughts and I want to break this between core distribution and Hyve. First, on core distribution, remember that our client base is more towards small, medium size clients overall. And when new technology gets deployed, like cloud, it's very-very much enterprise first and then makes its way down through the rest of the customer as offerings become more efficiently packaged. So, my guess is that if we look at the customer segmentation around cloud, you'll see that the growth rates are more robust in the SMB space because of the evolution of technology, maybe versus the enterprise. So you know that, that sort of relative to the total picture, should be beneficial for us. As it relates to Hyve and that business as you know it services the CSPs. I'd share two thoughts with you. Number one is I do believe that the long-term view for hyperscale will grow at mid-teens, if you will. And then just recall within our portfolio, we have the opportunity of customer expansion. And we're feeling good about our customer prospects, if you will, as we move through time and really taking advantage, if you will, of expanding our customer portfolio. Thank you. Can you go over a little more detail a little bit about the Hyve profitability changes, and was it purchasing timing, true-up? And why is it sustainable? Or just why the volatility there and the profitability? Thank you. Hi Jim, it's Marshall. Yes, as we disclosed or discussed in our prepared comments, quite often within Hyve, and we do this in distribution as well, we have programs that we performed throughout any given cycle or year for which once we perform the service, the cost plus margin gets recovered. And when we close those out or do the refinement review, we tend to get some final settlements or final margin associated with those programs. So we wanted to call that out because it was a meaningful in Q4. It happens in distribution as well as we're working with partners and customers and refining and making sure that the margins that we agreed to receive are achieved and recognized. So it just isn't as visible. We wanted to demonstrate that, that was part of the strength in Q4. It wasn't the only reason why we outperformed, but it was one of those. And then, Jim, as I think about '23, Hyve, we expect will continue to perform well. The strong '22 is just a tough compare and the margin profile itself was very, very exceptional for '22. Yes. Jim, I just would maybe provide a little bit more clarity. When I think about the over performance to the midpoint of the guide, I would share with you a couple of thoughts. So first of all, there's two pieces to Hyve. One is, as Marshall talked about, the margin catch-up and we tried to provide the clarity on that. Second is the incredible performance overall in sort of the base business. We always talk about the lumpiness of our Hyve business. Then an over -- we actually overperformed our expectation within core distribution. And then kind of -- as an interest expense. So it would be those four elements, the core distribution, overperformance, significant overperformance in Hyve, the Hyve margin recovery and then the interest expense giveback. Okay. And then earlier in the question -- or Q&A, you talked about the PC market and things like that. Just curious on the mobile phone market, there were some supply disruptions. How is mobile phone demand and kind of channel supply from what you see, but most importantly, demand from what you're seeing for mobile phone? Yes. So to make sure everybody understands, we have mobile phone distribution in Europe only. The channel dynamics of Europe are different than they are within North America. So it's sort of in that theater. We saw very good demand for mobile phone. I would say that, yes, we tactically have seen some issue relative to the volatility out of some of the Asian markets, but we fully anticipate that supply to catch up really rapidly. Thank you very much. I was wondering, as you look at 2023, can you talk about what you see are the biggest pockets of growth? And I'm wondering if you can talk both from end demand as well as -- I guess there's just so many questions out there about what's happening, right? So end demand and then also backlog fulfillment. So if you go through some of your product lines, you mentioned, I think, on the call, strength in printers. I assume some of that is basically catch up from backlog during the pandemic. But if you could just go through maybe categories that you would point to that we can watch as we look at '23. Thanks. Yes. Thank you, Shannon. So I'm going to embellish a little bit more here. When we run this call last year, we had informed that we had a point of view that said that the first half of the year or actually the entire year, we would see a moderating PC. But in the second half of the year, we would see a robust sort of data center market. And in fact, we were talking about it yesterday. The year played out exactly as we had envisioned it from a category perspective. Obviously, if we take a look at the first half of this year, we believe that PCs will be a challenging category as most of the market had -- or most of the vendors had projected, with the expectation that there will be a recovery in the back half of the year. And I know that you're well informed in the PC ecosystem market, but it's things like operating systems transitions, as well as more premium devices given the worker profile is different than it previously had been. And then there was even comments around the net useful life of laptop, which is more prevailing these days is shorter than sort of a desktop. All of those things, I think, are anecdotally, feel right to me. So I do believe it's going to be a bit of a slow PC category in the first half with that opportunity in the back half. And then I think that will continue to run off backlog in Advanced Solutions in the first half and then see a more moderating Advanced Solutions in the back half. So those are sort of the big themes that we think will play out. Obviously, things will ebb and flow based on the economic circumstance or the reality is the move -- the year moves forward as well. But those are the big thoughts for this year for us. Thank you. And then can you talk about what this -- I don't know if it's a transition, but at least it's somewhat of a shift, from transactional to devices and service infrastructure as a service. Pretty soon nobody will own anything. But the shift of purchasing from CapEx to OpEx. How are you seeing that play out? And do you feel like it's still a push from a company perspective versus a pull from a customer perspective? And how should we think about it running through your P&L over time? Thank you. Sure. So let me start with the infrastructure as a service thought. We see that as material and meaningful in building. And a lot of the -- obviously, we have the traditional Infrastructure as a Service, Platform as a Service, that is virtually delivered today, and those are very, very meaningful business, but we also see the on-prem as a service and infrastructure. And we're engaged with many contracts relative to that space. So I see that one sort of developing and ramping. Candidly speaking, although we provide Device-as-a-Service offerings as well, those discussions had begun arguably as many as five years ago, we haven't necessarily seen a -- the ramp or that monetize the way it has been envisioned. We do participate in, I'll call it more niche sort of activities around that space right now. We continue to work with vendors to see if that promise will play out. But I would have to say of the two, the infrastructure one has more momentum right now than the Device-as-a-Service one. Great. And then just my last question is on cash flow. Is there any -- maybe Marshall, are there any working capital levers that you can pull for 2023 beyond getting the inventory levels down to drive incremental cash flow? Shannon, if we think about '23 and the comments we made around cash flow being at $1 billion plus, we certainly understand that earnings itself will be a big component of that. We certainly expect that the inventory decline due to supply chain constraints will be a benefit. And then the last piece is we do also expect us to become more efficient in our working capital management. One of the things just to remind everyone is that in many parts of the U.S., we still have duplicative warehouse systems. And so with that comes some inefficiencies that as we integrate into one ERP, some of that goodness will be felt in these working capital efficiency comments I made. Yes, Shannon, the way I think about it is the inventory is -- if you want to use the 80-20 or the 90-10 rule kind of think of it in the context of that. There are some other working capital efficiencies to be gained. But by far and away, the inventory is the big one. Good morning, guys. Just circling back to Hyve, I just want to make sure I understand the margin benefit you got in the fourth quarter. Is this really just more of a timing difference, that recovery from the third quarter, which had probably a lower margin on Hyve business than we expected, just kind of offsetting, but for the full year, you're exactly where you'd expect it to be? Yes, Keith, it's more timing within the year. But the first piece was the strong outperformance on Hyve in Q4. So revenue was better than expected and from that came better expected margins. Got it. Got it. And then, Marshall, interest rates, I believe, obviously, are still continuing to go up, especially if you listen to the Fed. How are you thinking in terms of the interest rate for the entire year? I'm assuming your guidance here is based on where interest rates are today. But assuming they go up, does that change, I guess, your target for your leverage and how you think about prioritizing the payment down of debt? Yes, Keith, near in, we are modeling another 50 bps in Q1. So we'll see if that -- hopefully, that's inaccurate, and it's lower than that, but we modeled that in to get to our guide of $73 million for Q1. And then I think that will stay around that range for Q2. And then given the cash flow benefits, working capital efficiencies we spoke to, I think it starts to come down a little bit in the second half of the year. But it will be elevated, and it will be a headwind year-on-year. Okay. I appreciate that. And then if I can sneak one more in here. Obviously, the -- working down the backlog has been a benefit here for you. But as you're thinking about the first quarter, it sounds like order flow is exactly where you'd expect it to be for where we're at today and that gives you confidence you have in your guidance? Yes. There's nothing that's materially different than the order flow than what we were anticipating with the guidance. Obviously, it's early in the quarter, but that's sort of our view. Okay. Yes. First one, I wanted to just clarify with Marshall, on the fiscal '23 revenue guidance, you said 3% to 5% reported. What is that in FX and accounting adjustments of the adjusted growth? Yes, Adam, at least for Q1, it's as adjusted, constant currency about 5%. It's difficult to figure out where we think FX will go. Right now, it's probably going to end up being somewhat of a push because we're lapping a declining euro year-on-year. So as we progress through this year at $105 million, I think it will end up being somewhat flat, plus or minus $200 million or $300 million quarter two, three and four. All right. Good to know, Rich. On that Q1 outlook, that 5% growth in constant currency. I looked at the last year, I think that like-for-like comparison was about 6%. So looking at a similar growth rate at this time last year, but the environment seems a lot worse from a PC perspective, in particular. Maybe you could just give us any confidence that you have, especially talk about how you're feeling here relative to that plan based on what you're seeing here on January 10. Okay. So a couple of things. First, when we look at or think about Q4, our Endpoint Solutions segment was marginally down year-on-year. As we think about the first quarter, I would tell you the following. First, we -- as we've talked before, this -- our forecast process builds bottoms up. So we go to country to region to global and so we have that visibility. And usually, the teams have a pretty good feel as to what's going on, on the ground. It is certainly a more volatile environment now than usual. So obviously, we pay attention to that. As of January 10, I would say that the theme of marginally declining PC segment, our Endpoint Solutions segment and sort of a growing Advanced Solutions segment and the specialized businesses contributing growth as well is the way we think about it. Got it. And just the last one, Rich. You mentioned revenue synergy upon completion of Americas ERP. Just an early look at any sort of timing, ballpark quantification of this do you think that's going to come from vendors or customers? What do we have to look forward to in terms of revenue synergy when that materializes? Yes. So first of all in our prepared comments, we talked about moving over 45% of legacy Tech Data SAP on to CIS. So in the rounding, roughly two-third to 70% of our business now is on the strategic CIS platform in the Americas. So it's a good chunk that's now in there. We have begun Adam, to see some of the vendors which were complementary to one side or the other start to take off in those sales lanes, if you will. We think of it as sort of a build, which will grow and grow as we move throughout the year. But we aren't prepared to comment relative to what the quantification of that is. And we're in a way to past a couple of more metrics and/or milestones before we provide that visibility. But right now, I kind of view it as the sales teams, as I said, we see real transactions occurring, are getting up to speed with regard to product details, sales plans, et cetera. And we'll see how that goes moving forward. Thank you, guys. Thank you for taking the questions. Happy New Year. Just a couple, if I could. Is there just sort of mix outlook on the year? And I guess, super simplistically, the guidance for Q1, the revenue was sort of totally right in line and bracketing Street. The EPS guide is a little bit softer. And so Marshall, it sounds like a little bit of that is interest rates. What are the other components as well? Or you think Street was just maybe sort of inappropriately set with the -- When you compare Q1 to Q1 for us, it's $33 million higher for interest expense. And then the FX impact is about $500 million, which $0.10 to $0.12. So those two largely contribute to, at least the compare and the discussion year-on-year. And then when we think about our thoughts on mix outlook for '23, distribution, we expect will continue to show momentum. And we think that the majority of high-growth technology will continue to show momentum with the commentary we had around the hyperscale infrastructure/Hyve, just having a real tough compare to '22. But still, we expect Hyve to grow. But when you take those into consideration, the mix plays out the way we guided for Q1. All right. That's super helpful. And then are you guys thinking about getting active on M&A again? And I guess where an M&A kind of in the stack would you get active like tuck-in versus sort of medium-sized? I'm assuming you wouldn't do anything big because of the debt and we are in the integration with each other. But where in M&A will you get active this year? Yes. Ananda, thanks for the question. As you had stated a transaction that the size of the merger of the company is not necessarily on the radar or something that I would forecast. But as is usually the case, we're always prospecting and have a pipeline around M&A and predominantly looking to -- looking at targets that would allow us to accelerate our strategy. And so they come in sort of two categories. The first one being the traditional one, so I won't spend a lot of time explaining that. Then we also are very interested in accelerating the capabilities in our cloud platform. And if we find the right IP investment that would allow us to accomplish that, we would consider that along the way. And then as it relates to our interest strategically. Obviously, Europe is less consolidated. Asia Pacific is even less consolidated. So something were to appear in those theaters, they would be of interest. So that's how we think about the M&A pretty consistent with what we talked about previously. Thanks, and good morning, everyone. Just a couple of questions for me. One, just on the pricing environment. Last year, we saw price increases across all your hardware product categories, including Advanced Solutions and PCs. We're hearing about pricing pressure on PCs, particularly as memory and other component costs come through. What's your take there? And how does that flow through in terms of your top line or any impact on your business? Yes, Matt, thanks for the question. So with the overall supply chain profile sort of returning to pre-COVID levels for the PC ecosystem, I would suggest that we're going to see those dynamics in pricing sort of return to pre-COVID levels. As someone had mentioned earlier, I believe that there's ample supply in PC. And to the extent there's shorts, some longs, that's going to dictate what will happen in the overall pricing environment for that PC ecosystem category, if you will, going forward. My view is, is that there may be some, but a bit more limited pricing activity within Advanced Solutions when compared to last year. But I would suspect that by the time we get to the mid of the year that those dynamics would return to normal. Just one last point of note. In Q4, on a year-to-year basis, we had commented that the Endpoint Solutions segment was marginally down. I would say that with the backdrop of that, actually, ASPs were up in both the Americas as well as Europe, even in Q4. But I think there's a point in time where that lapse and then we're kind of over it. I would speculate that maybe there's still some stability in ASP in the first quarter, but we get back to traditional dynamics after that would be my crystal ball. Okay. Thank you. And then regarding the cost synergies, you're ahead of plan. You've got $60 million left. How should we think about how that flows through your P&L this year? Is this more back-end loaded because of the ERP implementation? That's correct. The ERP is expected to complete in the second half. And then with that comes two elements. One is the system-related costs that should go away. And then two is the duplicative costs around supporting two systems, and that efficiency should also play through primarily in the second half of '23.
EarningCall_1594
Greetings and welcome to Limoneira’s Fourth Quarter Fiscal Year 2022 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, John Mills with ICR. Thank you. You may begin. Good afternoon, everyone and thank you for joining us for Limoneira’s fourth quarter fiscal year 2022 conference call. On the call today are Harold Edwards, President and Chief Executive Officer; and Mark Palamountain, Chief Financial Officer. By now everyone should have access to the fourth quarter fiscal year 2022 earnings release, which went out today at approximately 4:00 p.m. Eastern Time. If you have not had a chance to review the release, it’s available on the Investor Relations portion of the company’s website at limoneira.com. This call is being webcast and a replay will be available on Limoneira’s website as well. Before we begin, we would like to remind everyone that prepared remarks contain forward-looking statements and management may make additional forward-looking statements in response to your questions. Such statements involve a number of known and unknown risks and uncertainties, many of which are outside the company’s control and could cause its future results, performance or achievements to differ significantly from the results, performance or achievements expressed or implied by such forward-looking statements. Important factors that could cause or contribute to such differences include risk detailed in the company’s 10-Qs and 10-Ks filed with the SEC and those mentioned in the earnings release. Except as required by law, we undertake no obligation to update any forward-looking or other statements herein, whether as a result of new information, future events or otherwise. Please note that during today’s call, we will be discussing non-GAAP financial measures, including results on an adjusted basis. We believe these adjusted financial measures can facilitate a more complete analysis and greater understanding of Limoneira’s ongoing results of operations, particularly when comparing underlying results from period to period. We have provided as much detail as possible on any items that are discussed on an adjusted basis. Also, within the company’s earnings release and in today’s prepared remarks, we include adjusted EBITDA, adjusted net loss per diluted EPS, and diluted EPS per common share which are non-GAAP financial measures. A reconciliation of adjusted EBITDA, adjust net loss, diluted EPS and diluted net loss per common share to the most directly comparable GAAP financial measures are included in the company’s press release, which has been posted to our website. Thanks, John and good afternoon, everyone. I am pleased to report that our diversified portfolio of revenue drivers enabled us to achieve record revenue in fiscal year 2022, growing our top line by 11% to $184.6 million and generating $11.9 million of adjusted EBITDA. Our seasonally soft fourth quarter also saw growth over the prior year, with revenue increasing 18% to $39.7 million. We realized strong full fiscal year 2022 growth in both our avocado and orange revenues, driven by increased demand and pricing, almost double the prior year. It was an extraordinary year in avocados, with volume and pricing increasing 44% and 73% respectively over the prior year. Fresh lemon volume also grew. However, the pricing environment remained difficult for most of the year as domestic and global lemon markets continued to work through a surplus of inventory. This overall pricing pressure has continued into fiscal year 2023 due to the oversupply in the global marketplace. However, we expect seasonal price increases beginning in our stronger second and third quarters. We are working to help insulate ourselves from the volatility of commodity pricing by expanding our third-party fruit supply, whether it be packed, marketed, and distributed by Limoneira or just marketed and distributed by Limoneira. We are a leading global producer, packager and marketer of citrus. And our expertise, along with the investments we have made in technology to provide growers insight and transparency into their operations and the investments to our supply chain, have made us an attractive partner to outside growers. Today, roughly 60% of our source volume comes from third-party fruit and our goal is to increase that to 75% as we pivot toward an asset-lighter model. This will help reduce the impact of pricing volatility and rising farming costs. Another prong of our strategy is monetization of certain assets. One monetization project that we have – has been underway for some time is our Harvest at Limoneira development project. We closed Phase 1 at the end of fiscal year 2021 and are currently on hold for Phase 2. The good news is we have a minimal amount of debt on this project and we are in talks with the City of Santa Paula to expand from 1,500 total residential units to 2,000 units. We received $8 million in cash proceeds from Harvest in the fourth quarter of this fiscal year when we closed the sale of a 17-acre property. The land will potentially be used to develop an additional 200 or more residential units within Harvest. We have increased our cash proceeds projection by over 20% to $115 million and updated our timeline to include both the Harvest Development and the Harvest Medical Pavilion across the street, which I will discuss in more detail at the end of the call. In addition to Harvest, we have identified over $150 million of assets for monetization as well. We own over 15,400 acres of rich agricultural real estate properties and water rights in California, Arizona, Chile and Argentina that have been acquired over the past 130 years since our company was founded. There is a meaningful difference in the current fair market value of these assets compared to the book value because many of these assets were acquired many years ago at low cost basis. In October, we announced the sale of our Oxnard packing facility for $20 million. And shortly after, in early December, we announced another asset sale, our Sevilla property, for $2.6 million. The proceeds from these sales have been used to reduce our debt and right-size our balance sheet. We will continue our transition to an asset-lighter business model, which includes streamlining our operations, improving consistency of earnings, and increasing EBITDA and dividends per share once the transition is complete in the next 12 to 18 months. Lastly, I’d like to provide an update on our ESG initiatives. This past year, we increased our focus on governance, with a refresh of our Board, appointment of new chairs of our committees, and we worked methodically through governance and compensation approaches. This, combined with many other initiatives, enabled us to improve our ESG score by 40% from an average of 7.6 to now 4.6 as of December 2022. One area I’d like to highlight that has changed in the past year is our shareholder-mandated claw-back policy, which has been updated to better align management with our shareholders. This includes minimum holdings for executives, compensating executives directly for modernization initiatives, aligning executional performance with shareholders to maximize gains on asset sales. Thank you, Harold and good afternoon everyone. As a reminder, due to the seasonal nature to our business, it is best to view our business on an annual, not quarterly, basis. Historically, our first and fourth quarters are the seasonally softer quarters, while our second and third quarters are stronger. For the fourth quarter of fiscal year 2022, total net revenue was $39.7 million compared to total net revenue of $33.5 million in the fourth quarter of the previous fiscal year. Agribusiness revenue was $38.2 million compared to $32.3 million in the fourth quarter of last year. Other operations revenue was $1.4 million compared to $1.2 million in the fourth quarter of fiscal year 2021. Agribusiness revenue for the fourth quarter of fiscal year 2022 includes $13.1 million in fresh lemon sales compared to $7.8 million during the same period of fiscal year 2021. Approximately 680,000 cartons of fresh lemons were sold during the fourth quarter of fiscal year 2022 at a $19.33 average price per carton compared to approximately 390,000 cartons sold at a $20 average price per carton during the fourth quarter of fiscal year 2021. The company recognized $16.4 million of brokered fruit sales in the fourth quarter of fiscal year 2022 compared to $17.4 million in the same period last year. Approximately 583 cartons of brokered fruit were sold during the fourth quarter of fiscal year 2022 at a $28.13 average price per carton compared to approximately 941,000 cartons sold at an $18.44 average price per carton during the fourth quarter of fiscal year 2021. The higher average price per carton in fiscal 2022 is from the addition of higher margin fruits, including mandarins, grapefruits and limes. The company recognized nominal avocado revenue in the fourth quarter of fiscal years 2022 and 2021. The company recognized $2.7 million of orange revenue in the fourth quarter of fiscal year 2022 compared to nominal orange revenue in the same period of fiscal year 2021. Approximately 86,000 cartons of oranges were sold during the fourth quarter of fiscal year 2022 at a $31.22 average price per carton. Specialty citrus and other crop revenues increased to $5.5 million in the fourth quarter of fiscal year 2022 compared to $3.2 million in the fourth quarter of fiscal year 2021. The increase was primarily due to increased brokered fruit and wine grape sales in the fourth quarter of fiscal year 2022. Total cost and expenses for the fourth quarter of fiscal year 2022 were $41.5 million compared to $40 million in the fourth quarter of last year. Operating loss for the fourth quarter of fiscal year 2022 improved to $1.9 million compared to a loss of $6.5 million in the fourth quarter of the previous fiscal year. Net loss applicable to common stock after preferred dividends for the fourth quarter of fiscal year 2022 was $2.8 million compared to a net loss of $5 million in the fourth quarter of fiscal year 2021. Net loss per diluted share for the fourth quarter of fiscal year 2022 was $0.16 compared to a net loss per diluted share of $0.28 for the same period of fiscal year 2021. Adjusted net loss per diluted EPS for the fourth quarter of fiscal year 2022 was $5.7 million compared to a loss of $4.5 million in the same period of fiscal year 2021. Adjusted net loss per diluted share was $0.32 compared to adjusted net loss per diluted share of $0.26 for the fourth quarter of fiscal year 2021. A reconciliation of net loss attributable to Limoneira Company to adjusted net loss per diluted EPS is provided at the end of our earnings release. Adjusted EBITDA was a loss of $3.8 million in the fourth quarter of fiscal year 2022 compared to a loss of $3 million in the same period of fiscal year 2021. A reconciliation of net loss attributable to Limoneira Company to adjusted EBITDA is also provided at the end of our earnings release. Adjusted EBITDA in previous periods did not exclude stock-based compensation expense, which has now been excluded as we believe it is a better representation of cash generated by operations and is consistent with peer company reporting. Adjusted EBITDA for prior periods has been restated to conform to the current presentation. For the fiscal year ended October 31, 2022, revenue was a record $184.6 million compared to $166 million in the same period last year. Operating income for fiscal year 2022 was $2.2 million compared to a loss of $6.3 million in the same period last year. Net loss applicable to common stock after preferred dividends was $737,000 for fiscal year 2022 compared to a net loss of $3.9 million for 2021. Net loss per diluted share for fiscal year 2022 was $0.04 versus a net loss per diluted share of $0.23 in fiscal year 2021. For fiscal year 2022, adjusted net loss per diluted EPS was $1.3 million compared to a net loss of $2 million for fiscal year 2021. Adjusted net loss per diluted share was $0.08 compared to adjusted net loss per diluted share of $0.11 for fiscal year 2021 based on approximately 17.5 million and 17.6 million respectively, weighted average diluted common shares outstanding. We recorded for fiscal years 2022 and 2021 an income tax provision of $800,000 and a benefit of $300,000 – pre-tax income of $300,000 and a loss of $4.2 million, respectively. The tax provision recorded for fiscal year 2022 differs from the U.S. federal statutory tax rate of 21% due primarily to foreign jurisdictions which are taxed at different rates, state taxes, tax impact of stock-based compensation, non-deductible tax items, and valuation allowances on certain deferred tax assets of foreign subsidiaries. For fiscal year 2022, adjusted EBITDA was $11.9 million compared to $9.9 million for fiscal year 2021. Turning now to our balance sheet and liquidity, long-term debt was now down over 20% as of October 31, 2022, to $104.1 million compared to $130.4 million at the end of fiscal year 2021. This is the lowest level it has been in the past 4 years, and we expect further reduction of our debt in fiscal 2023 as we continue to strategically monetize certain assets in fiscal 2023. Now, I’d like to turn the call back to Harold to discuss our fiscal year 2023 outlook and longer-term growth pipeline. Thanks, Mark. Initial crop reports for lemon suggest industry-wide production is expected to be down 10% to 15% in fiscal year 2023 from Mother Nature. However, due to the planned expansion of our third-party fruit, we are expected to increase volume and increase our market share in fiscal year 2023. We expect total lemons sales volumes to be in the range of 5 million cartons to 5.4 million cartons for fiscal year 2023. This is up from 4.9 million cartons in fiscal year 2022 and 4.4 million cartons in fiscal year 2021. For the first quarter of fiscal year 2023, we expect to experience continued pricing pressure but believe the industry-wide lower production will lead to higher prices beginning in the middle of fiscal year 2023. Also, during the first quarter of fiscal year 2023, Chilean lemons underperformed due to high transportation costs and low pricing, which will be reflected in our first quarter results. We expect avocado volumes for fiscal year 2023 to be in the range of 4 million pounds to 5 million pounds. It’s important to note that while fiscal year 2022 was a record year for avocado revenue, the California crop typically experiences alternating years of high and low production due to plant physiology. This, along with adverse weather conditions, is contributing to the year-over-year decline. We experienced unusual high temperatures in early September and a wind event in November that knocked fruit off our trees and will have a negative impact on our 2023 avocado crop. In addition, we now expect to receive $115 million compared to the previous estimate of $95 million from Harvest at Limoneira. And the addition of the Harvest Medical Pavilion spread out over 7 fiscal years, with proceeds of $8 million received in the fourth quarter of fiscal year 2022. You will notice a portion of the cash flow projections have been pushed out approximately 18 months due to the higher interest rate environment, which reduced the current number of new home starts as Phase 2 of the Harvest at Limoneira is on hold. We believe the new breakdown will be as follows. Fiscal year 2022 generated $8 million of cash to Limoneira, fiscal year 2023 is expected to generate $5 million, fiscal year 2024 is expected to generate $8 million, fiscal year 2025 is expected to generate $17 million, fiscal year 2026 is expected to generate $25 million, fiscal year 2027 is expected to generate $30 million, and fiscal year 2028 is expected to generate $22 million. And lastly, as previously stated, we have identified $150 million of certain assets for sale. We have made great progress thus far executing against our plan with the sale of $30 million in the past 3 months and expect to have similar announcements in fiscal year 2023. Thank you. [Operator instructions] Our first question comes from the line of Ben Bienvenu with Stephens. Please proceed with your question. So, I want to ask first about the cadence of the debt paydown. It’s been substantial thus far already and kind of congruent with realization of proceeds from asset sales. I assume the same should be true as we move through this next year. But could you talk a little bit about how we should be thinking about kind of the quarterly cadence of debt paydown and then kind of where you hope to be as you exit 2023? Yes, I think the cadence is exactly as you just referenced. I think we’re ahead of our plan thus far with the modernization exercise and actually have been very pleased with the levels of appreciation on the assets we’ve identified for monetization. So, I think to be conservative, we believe the cadence will continue through 2023. But we actually think in the first two quarters of the fiscal year will be the majority of the 2023 events. Okay, great. My second question is related to avocados and, in particular, the volumes, recognizing that there is, alternating bearing plant physiology. We’ve seen numbers bounce around quite a bit. What do you think about kind of on a – should we see kind of, the average between 2022 and 2023 as a normal amount to model? Or how should we be thinking about what the trajectory of those volumes do kind of over a multi-year basis just from your own production standpoint? So, I think the internal goal is 10,000 pounds per acre, taking into sort of consideration the maturation of younger trees and sort of the production of some of our older trees. And so, as we are at about 900 acres of planted volume, I think 8 million to 9 million pounds should probably be a safe average as we move forward. And then, as we’ve stated before, we have plans to actually convert some of the older lemon production land into avocado production land of about 250 acres in the next 3 years. So, you’ll actually see our avocado production begin to increase. But as you know, it takes time for some of those trees to actually become full bearing. So, we will continue to update as we go. But I think an 8 million to 9 million pound average between years is probably a safe assumption. Okay. And then, last one, quickly for me is you have pretty good line of sight, it seems, to asset sales. I know the step-one priority is deleveraging the balance sheet. But what is your line of sight to asset purchases or asset investments? At this point, we are set up to have our next round of strategic planning and road map update with our board at the end of February, the first part of March. The one thing we do know is that we will need to increase storage capacity in Santa Paula due to our sale of our Oxnard lemon facility. As you may recall, we actually leased back for 3 years lemon washing and storage capability that keeps us operational. But within the next 3 years, we will need to deploy capital to expand our wash capabilities, which will drive greater efficiency in our operation here in Santa Paula. We’ve mentioned that we’re also exploring increasing packing capacity in Chile as a next step. And we continue to explore integrating forward into the avocado space, but with no clear path other than that just directionally, as a placeholder we are exploring that right now. And I think that’s really what we will be looking at. But I think once we delever significantly the balance sheet, the game plan will just continue to keep our foot on the gas with expansion of our – the increase of our grower partner business and our agency business, providing marketing and sales services for other suppliers. No, it is really, really cold here.It’s like minus 30, 40 windchill here today, oh my goodness. It’s pretty bad. So, I’m staying… Just a couple real quick questions. Number one, Harold could you give us a little bit more color on kind of the, the fruit oversupply? Is it because of some of your Asian food service markets still haven’t opened up as much like Japan and maybe Asia, China or is it just purely your demand has kind of gotten back to normal and there is just pure oversupply for production? Can you give us a little more flavor of how that is working out? Absolutely. So, I think, unfortunately, it’s the latter, Eric. I think demand is back to pre-pandemic normals or levels. We have seen a little bit of pullback in food service demand, driven by inflationary pressures and cost of living increases, higher interest rates, higher gas prices, things like that. But the real issue we’re wrestling with is just overplanting and oversupply of lemons, not only here in California, Arizona, but also in the Southern Hemisphere in Argentina and Chile. Now, we’re beginning to see acreage beginning to be rationalized. You’re seeing acres get pulled out. Just here, locally, in Ventura County, we’re seeing acreage being pulled out. And that, in combination with a smaller tree crop, Mother Nature-driven, I think you’re going to see improvement in pricing probably beginning in the second and to the third quarters because of just less lemons in the marketplace. The sort of the – the silver lining of higher logistics costs is – reduced the levels of imports from the Southern Hemisphere shipment – shippers into the U.S. market. So, I think that has actually bolstered pricing as well. But as the returns have been less than growers had become accustomed to in prior years, it’s accelerating people converting their acreage from lemons into other crops currently. And that will lead to pricing improvement as we move forward as well. Okay. So, kind of the next question, and it’s a little bit of a follow-up on this, does this delay in any way kind of how you’re going to plant your 1,000 acres of lemons? And I know that there is a 3-year lead time before you plant? And they are really truly fruit-bearing trees. Does it change the dynamics of how you put some of your production or some of your land into production? So the thousand acres that we currently have are non-bearing, which will come mature over the next 3 to 4 years. So, those are already all in the ground. Some are specialty lemons, but that’s in the north of about 1 million cartons. The 250 acres that we’ve mentioned in the past, 200 to 250, most likely, we are looking at avocados right now. We’ve secured trees for about another hundred acres next year. And then, we will continue to evaluate using land that was either old tired lemons or something that was suitable to be avocados all the time. And so, that’s where we are with that today. And I think as you see, our footprint is not really going to get a whole lot smaller. The increase in our capacity and our outside growers is where that growth is going to come for us. Okay. And then, kind of the sort of the final question, so, you’ve already sold, probably 30 million or so of sort of kind of non-strategic land and assets. And you’ve got another 150 million to go. Even if you just – I’m assuming that most of that property is not an interest-bearing – or is not an income-generating or interest-bearing properties today. So, just if you put that cash into, let’s say, the money market, we actually can almost get 3% money markets these days, it’s going to certainly improve your ROIC. Do you have any ROIC targets or goals that we could maybe start looking at or is it too early to kind of give us those types of metrics? That’s a great question, Eric. So, internally, as we have struggled in the past with ROIC and how the metrics look, we have always – you can’t consider embedded value increases as we have gone along the way, and some of our properties, being either new or redevelopment, have had struggles to meet that overall metric. As you go forward, and perfectly said, that our ROIC will be going up relative to that. And I think internally, we are in that I think 1% to 2% range now and sort of getting 5% to 7%, and then back above 7% or 8% is the goal. I think that takes probably 2 years to 3 years. And depending on how the monetizations work, our weighted average cost of capital traditionally had been about 6.5%, 7%. So, anything, north of that is obviously our goal. And we are working hard to get there. And I think one other comment, Eric, that the thing that will accelerate the return on invested capital will be the actual realization of some of these monetization events that will unlock a lot of the capital appreciation that was embedded in the appreciation of the land and the water assets that we have invested into. So, that’s going to really accelerate the return on invested capital sort of analysis. And then when you layer on the asset-light growth of serving grower partners and serving other suppliers that doesn’t require capital to grow. I think you will see as the business continues to transition, you will see a lot more growth in our return on invested capital. Alright. Thanks for taking my questions. First, I have a question on the – on your growth plans in the context of the asset monetization strategy. For several quarters in a row, it has been a very common theme on these calls, and your answers to your plans have been very consistent. And I am curious about how your thought process here has evolved over the last year in the context of the interest rate environment and the kind of volatility within the avocado space and all the other just macro challenges of the day. Your plans have been very consistent, and I am wondering how you are factoring in these macro considerations as you think about the long-term growth options? Yes. That’s a great question, Ben. And they have evolved and continue to evolve. But certainly, the shift towards an asset-lighter model, the monetization of specific assets, targeted assets, the retirement – reduction and retirement of long-term debt, and the strengthening of balance sheet, it not only is consistent, but the timing is perfect, given the rising interest rate environment. So, that hasn’t changed at all. We are laser-beam focused on execution and executing these plans and de-levering and paying off the company’s debt. So, that remains the same. Now, as we look forward into other opportunities, we remain steadfast in our belief that the long-term future of avocado consumptions continues to grow. And so, we are continuing on our belief that expansion of our avocado production in this part of California, where we have more certainty of our supplies of – long-term supplies of water availability, makes our transition into increasing our avocado production the right move. The exploration of adding value to avocados beyond production into packaging, marketing, and selling, that continues to be an ongoing analysis. I would say that there are some excellent avocado handlers out there already. The dynamic of how California avocados put together with Mexican, Colombian, Peruvian, and Chilean supplies, that’s changing is a very dynamic situation and is giving us more sort of pause to be very cautious as we consider moving forward into the avocado supply chains. And we continue to analyze that and look at that. That’s the area, I think that’s changed the most over the last call it 24 months of analysis. But we will continue to study it and move forward. But we will move forward with greater avocado production. Okay. Very helpful. Thank you, Harold. Another one for me, you mentioned water, I didn’t hear much on the call today in your prepared remarks about your water assets. I believe your fallowing program in Arizona is now entering its second year out of 2 years. Wondering if you can, one, update us on the thought process around, further fallowing initiative. And two, on a bigger picture, any updates on potential around water rights modernization on a bigger scale? Yes, absolutely. So, yes, as we noted, we fallowed 400 acres in the summer and turned around that acreage from being $1 million loser to $1 million winner. So, $2 million swing in that. We noted in this late summer that the Federal government mandated specific amount of acre feet to come off the river between all states that are taking water, with Arizona having the primary piece of risk in that. As you recall, we are Class 3 Colorado River water rights. And Arizona – central Arizona project and Las Vegas are all below us toward Class 5. So, we will continue to be opportunistic there. Our district did present a new fallowing program to the Federal government to try to represent the whole and give concepts. And at this point, it’s still being evaluated as to what the best roadmap is for that. So, I imagine in 2023 and depending on how the winter goes, and we have already had a reasonable start in California, but the Colorado River is structurally broken due to the demand itself. So, we don’t have any specific on the table, but we continue to believe that that asset is worth north of $100 million in the right situation, which we are 50% up. Okay. Very helpful. And, Mark don’t – at this time last year, the outlook was pretty good as well. So, let’s hope the snow keeps coming. One more for me, and then I will get back in line on, you commented on challenges of shipping out of Chile, no surprise there. I am curious though, if you can just kind of update us on if you have seen any observable improvement in the area of international shipping and to what degree you see the light at the end of the tunnel in terms of getting the export business back to some kind of normalized level? So, just anecdotally, Ben, we are seeing far less congestion in the ports. We are seeing turnaround times in the ports of berthing back to sort of pre-pandemic levels. And as a lot of that congestion has worked itself through the system or out of the system around the world, we are beginning now to see decreased – decreases in containerized shipping costs. Not back to where they were pre-pandemic, but certainly directionally moving in the right direction. So, we think the combination of quicker turnaround times at the ports and decreasing containerized shipping costs bodes well for our future imports into the U.S. and especially as it relates to our operations in both Argentina and in Chile. [Operator Instructions] There are no further questions in the queue. I would like to hand the call back to Harold Edwards for closing remarks. Ladies and gentlemen, this concludes today’s teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.
EarningCall_1595
Thank you for standing by, and welcome to the Northern Star Resources December 2022 Quarterly Results Conference Call. All participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session. [Operator Instructions] Good morning and thanks for joining us today. With me is Chief Operating Officer, Simon Jessop; and Chief Financial Officer, Ryan Gurner. I am pleased to present our December quarter results marking the midpoint of FY ‘23. We have continued significant progress on our growth projects in line with our profitable growth strategy to 2 million ounces per annum. Our December quarterly production of 404,000 ounces at an all-in sustaining cost of A$1,746 an ounce demonstrates their capability to operate at $1.6 million ounces per annum. And for the second half higher forecast production is expected to drive unit costs lower as Thunderbox delivers expanded nameplate capacity and grade improves at Pogo. We maintain our full year guidance of $1.56 to $1.68 million ounces at an all-in sustaining cost of A$1,630 to A$1, 690 an ounce. Our safety performance is sector leading with a lost time injury frequency rate of 0.9, but we continue to see numerous incidents. So our concerted focus on training competencies and safety leadership is ongoing. This is reflective across the sector with staff turnover and skill shortages continuing to challenge improvement in safety performance. Simon will speak to the Australian operations shortly. At Pogo, we're continuing to make the mill throughput rate of $1.3 million tonnes per annum, with an increased percentage of stoping tonnes now at 72% of the blend. Overall grade improved quarter-on-quarter, but some stock mining dilution on the margins of the deposits or reduced average mill grade and ounces sold at 65,000 for the quarter at an all-in sustaining costs of US$1,362 an ounce. The second half focus at Pogo is improving mined grade to deliver a full year guidance. While it is very pleasing to see unit cost improve at Pogo and the operation generated mine operating cash flow of US$30 million in the quarter, we have more optimization work to do at Pogo in the remainder of the year. During the quarter, we released an exploration update highlighting continued new discoveries as well as in-mine extensions across the group. The new Joplin deposit at Kanowna Belle underground provides mine life extension there and the regional drilling at Red Hill discovered significant mineralized system providing growth optionality for the Kalgoorlie region. The Wonder North and Golden Wonder discoveries are in close proximity to the newly expanded Thunderbox plant. And in Alaska, we continue to extend the Goodpaster deposit beyond the existing high grade resource. Our financial position remains very strong, which Ryan will talk to shortly. And we are well leveraged to capitalize on the strengthening gold price with fully funded growth commitments advancing. We have growing cash earnings, which enables prudent capital allocation including organic growth, dividends and share buybacks, all with a focus on delivering superior shareholder returns. In regards to the Fimiston mill expansion study, our team continues to evaluate the most compelling design options and actions to derisk its execution to present the case towards final investment decision. Thank you Stuart. For the Kalgoorlie Production Center, including KCGM, Carosue Dam, Kanowna Belle, in South Kalgoorlie, we sold 210,000 ounces of gold at an Australian all-in sustaining cost of A$1,738 an ounce, down on gold sales from the September quarter while A$24 an ounce lower on costs. This production delivered a mine operating cash flow of A$177 million, while we spent A$99 million on significant growth capital projects. Of this, major growth capital total A$62 million was spent on KCGM open pit mine development. At KCGM, open pit material movement increased to 21.1 million tonnes, in line with our material movement plan. Pleasingly, truck hours increased 13% as we take advantage of the new open pit fleet. Grade of mined ore was higher due to increased volumes and higher grade ore from Golden Pike South. The open pit physicals have now delivered 41.5 million tonnes of total material movement for H1, which is delivering into our strategic goal of 80 to 100 million tonnes per annum of annualized movements. This is an amazing effort from the team. Progress in the East wall remediation area continued and remains on track for reestablishing FY ‘24 access back into Golden Pike North high grade ounces. Underground Mining volumes for the Kalgoorlie region increased 5% compared to the September quarter to deliver 115,000 ounces. KCGMs underground Mt Charlotte operation lifted volumes by 19% to 470,000 tonnes as access to greater stoping areas came online. This was very pleasing and it's part of growing this operation to 3.5 million tonnes per annum by FY ’26. Carosue Dam increased ore tonnes while grade was lower due to sequence constraints in Karari. The Porphyry underground mine commenced during the quarter and is well established after three months of development. Kalgoorlie operations, Kanowna Belle and South Kalgoorlie produced consistent volumes quarter-on-quarter, while all-in sustaining costs reduced to A$114 an ounce with margin focus was a key driver for the team. Processing volumes in the Kalgoorlie region was 4.8 million tonnes or 2% higher than September quarter despite no processing activities at South Kalgoorlie mill, which was moved into care and maintenance during quarter one. The revised processing strategy of three plants and the Kalgoorlie Production Center has been successfully established, grade and recoveries consistent quarter-on-quarter. At our Yandal Production Center, including Jundee, Thunderbox and Bronzewing, we sold 128,000 ounces of gold at an Australian all-in sustaining cost of A$1,591 an ounce, up 26% on gold from September quarter, and flat on all-in sustaining costs. This production delivered a mine operating cash flow of A$112 million, up 38% from September quarter, while we spent A$56 million on growth capital projects, A$11 million lower quarter-on-quarter. Bronzewing spent A$8 million on major growth capital during the quarter as we developed this mine for the expanded process plant. Our Jundee operation achieved a new record quarterly underground ore mined with a 39% increase in all at an average mine freight of 4.1 grams per tonne. As a result mined ounces increased 93,000 ounces for the quarter, up 31% from the September quarter. Total jumbo development for this operation was steady at eight kilometers to the quarter and will continue to be a key enabler both on drill platforms and increased stoping areas. Processing throughput was steady at 740,000 tonnes back to nameplate volumes. Thunderbox underground operation continues to increase the stope mining fronts with 503,000 tonnes of ore mined in the quarter. All tonnes mined from both underground and the open pits increased to 1.7 million tonnes, up 30% on September quarter and exceeded the processing volume by 50%. Open pit mining volumes more than doubled to 4.6 million BCMs mined during the December quarter. The substantial increase in material movement is very pleasing and will provide future access to ore sources at Thunderbox. The total mined ounces were 62,000 ounces, increasing 15%. Processing volumes in the Yandal region increased significantly quarter-on-quarter to 1.95 million tonnes. As previously mentioned, Jundee was steady with the throughput growth coming from the Thunderbox mill expansion. The new process plant continued to successfully ramp up, milling 1.2 million tonnes for the quarter. We will systematically be ramping up processing volumes as it stabilized running the new plant over the course of the second half. It is pleasing to see spring capacity at or above nameplate run rate of 6 million tonnes per annum already, while our focus is on bedding in the new operational processes for this expanded plan. The Thunderbox project remains a key focus in the second half as consistent throughput will drive lower costs. Thanks, Simon, and good morning, all. As demonstrated in today's quarterly results, Northern Star remains in a robust financial position. Our balance sheet remains strong as set out in Table 4 on Page 8, with cash and bullion of $495 million at 31 December. And we remain in a net cash position of $145 million with corporate bank debt of $350 million. The company has recorded strong cash earnings for the first half of FY '23, which is estimated to be in the range of $460 million to $475 million. A reminder is that our dividend policy is based on 20% to 30% of cash earnings. Pleasingly, all 3 production centers generated positive free cash flow with capital expenditure fully funded. Figure 6 on Page 9 sets out the company's cash and bullion and investment movements for the quarter with key elements being the company recording $354 million of operating cash flow. Looking ahead to the remaining quarters, this is forecast to rise with TBO positioned to operate at an annualized rate of 6 million tonne capacity during the second half of FY '23 and stronger margin from Pogo through higher-grade stope contribution across the remainder of the year. Quarterly investment in sustaining capital, growth capital and exploration are tracking to plan. Growth capital investment during the quarter included waste material movement at KCGM, establishment of Porphyry Underground at CDO, Ramone underground at Jundee, Orelia open pit development, Otto Bore pit development and TBO mill expansion. In respect of the company's on-market share buyback. During the quarter, 9.4 million Northern Star shares totaling $82 million were purchased and canceled. Since initiation, 42% of the 300 mil program has been completed with 15.5 million units being purchased at an average of $8.21 per share. The 12-month program remains open until September 23. On other financial matters, depreciation and amortization are in line with company guidance provided of $600 to $700 per ounce. First half depreciation is at the upper end of the guidance range at approximately $680 per ounce. And for the quarter, non-cash inventory charges for the group are $57 million or $140 per ounce. As mentioned previously, the majority of these noncash inventory charges relate to the milling of acquired stockpiles at KCGM. And for FY '23, this charge will likely be approximately 50% to 60% higher than FY '22. In respect of costs, our business, like all others, is experiencing pressures. The size, scale and flexibility within our portfolio positions us to maximize efficiencies and productivities in the business, which provide opportunities to reduce costs. In addition to this, our fleet investment program at KCGM and planned expansion at TBO, which is now complete, means we are well placed to navigate the current challenging cost environment. We remain confident in a stronger second half of the year in terms of both production and costs from maintaining mining and processing volumes at Pogo with a focus on high-grade stope delivery, ramp-up in throughput at Thunderbox to 6 million tonne per annum and increased ore volumes from Mt Charlotte and greater contribution from the lower cost ounces of Golden Pike at KCGM. Lastly, in respect to hedging, Table 5 on Page 9 sets out the company's committed hedge position at 31 December. During the quarter, the company delivered 174,000 ounces into contracts and placed 145,000 ounces in FY '26 at an average price of $2,954 per ounce. The overall hedge book being 1.28 million ounces at an average price of AUD 2,673 per ounce. Morning. Morning, everyone. Happy New Year. Thanks for the call. Just a question on the KCGM plant expansion FID. Can you just update us on timing there? And just remind us around the - I think in the last press release, you mentioned a three-year build from FID. Is there any change to sort of timing and scope on that? Thanks Levi. So yes, we're still working into the final detail. And the two elements of that is getting much firmer engineering final designs for the expanded case and the tighter accuracy on that pricing. And the second part is that derisking elements for the execution phase. So ensuring some of the long-lead items and/or frameworks could be advanced or progressed. So we haven't given a date as to what when FID would be reviewed, but we're certainly in the second half, charging ahead with the information in light of our Board to give consideration. So I think it's more likely in the next guidance year for us to look at what we're doing there. But it's still very compelling and still advancing. Right. Thanks, Stuart. And just on the South Kal mill, a few clients are telling me that gold is going up much higher in the next few months. What is the sort of status there? Is there - is it about people? Or if you're comfortable that gold's a couple of $100 an ounce higher by the end of the year? Can you turn it back on? Is it really an optimization game? Or is it still constrained by people? It's probably linked to your first question in that if we move it from – Fimiston from 13 million to 24 million times, the catch up capacity for that extra million that SKO offers, we'll get gold up a lot quick, right? So it's not about trying to go on for 1 million tonne in fortune, it’s the margin in cash because it was one of our higher cost mills in the region. And as you point, people, get back to three mills at Kanowna, Fim and obviously Carosue,. they've got great ability, full teams, good focus. And as far as divesting it - otherwise, it's happy for it to sit there not operating because it doesn't compete with us, as well. So it's certainly contributing to the cash generation in the region not my advice to turn it on anytime soon. Hi, Stuart and team. You just highlight Golden Pike access being steadily regained in FY ‘24. Is that going to be material in terms of all access? Or is it merely just a steady growth over time from FY ‘25 onwards? Thank you. Yes. Thanks for that. Daniel, Simon here. In terms of access back into Golden Pike North, that’s part of our growth in ounces at KCGM, up to 650,000 ounces in FY ‘26. So Golden Pike North is a key driver of those increased ounces over the next few years. So we're remaining on track with with a wall in terms of that capital to pull that down. And during FY ‘24, we’ll start to regain access back into Golden Pike North. So totally in the current plan, as we've outlined with the growth in ounces of KCGM. Okay, thank you very much. Just switching to Pogo and the grade, which was 6.6 in the quarter. I know it was telegraphed that you'd be a lot weaker in the first half and stronger in the second. What are your expectations on grade in the next couple of quarters if you could go on to that, please? Yes, thanks, Daniel. So north of eight grams is, obviously, the reserve grade at 8.5. That's our ultimate landing point. But with what we're seeing in the near-term plan, this is my dilution in those stopes that we’re addressing some of the legacy development in that place. But yes, we’re certainly just looking at where that is. But our current plan forecast that we can deliver into the guidance that’s there for the full year to achieve that. There is some capacity to mil a bit harder than the 1.3, but that's more linked around the shutdown timings and essentially above eight grams delivers that. So it's a real focus on quality over quantity, but the real impressive thing at Pogo is really the unit costs keep coming down and there's still plenty of work to optimize that in the second half of the term we are focussing on. Okay, thank you. And an accounting question. When you define cash earnings, one element of that is cash tax paid. I presume that stamp duty payments that I think were made in September quarter is not included in that. Can you just confirm? Congratulations Stuart and team. Just a quick one on Thunderbox. Just on the path of that 6 million tonnes per annum, right, do we get that from pretty much now? Or did that rate more like the final quarter of 2023? Maybe you can just provide us with an estimate of the exit rate into the end of 2022? Yes, thanks. Al. Simon here. Obviously, last quarter, we started the commissioning and changeover and did the major tie-in. So that was a big quarter for us. During the second half, we’ll progressively ramp up the process plant. So it's just getting in everything to consistent high utilization, high run rates. So our plan is that the exit rate of FY ‘23 is at nameplate. Thanks, Simon. And just looking at the buyback, obviously, the cadence picked up in the quarter, I was just wondering to understand whether that can be sustained. I assume there's a few blackout periods into reporting. And just how you guys are thinking about, I guess, the returns from a buyback? I mean, obviously, the average price you've achieved so far has been pretty good. And the stocks now trading a fair bit higher. What our options are there to deploy that capital over the stated dividend policy, but is there any upside to special dividends or any other things we should think about from a capital management perspective? Yes, thanks. So you're right in as much as 40% of that buyback is complete, but we averaged it at $8.21. So we're still looking at it all of these things, those instruments through the lens of superior returns. So when we compare to exactly that -- your dividend calculated at 20% to 30% of cash earnings, decisions to come up in the year round Fimiston expansion, capital allocation, those types of things, we weigh it all up. So yes, we're in a black out at the moment on the buyback. It’s open through till September this calendar year. So these things also fly where gold price is at and where valuations sit. So it's an instrument in the toolbox. And we'll keep it alive and keep evaluating returns on it. Hi, good morning all. Simon, I've got a couple on Thunderbox. Just firstly, can you give us an indication of the volume and grade profile you are expecting in the second half from the open pit? Yes, thanks, Matt. Yes, fairly consistent. You're not going to see, you obviously got increasing volumes. So you're not seeing huge changes in the grade profile and the reserve profile for the Thunderbox operations is 1.6 grams per tonne. Last quarter, we milled 1.5. So it's not going to change a great deal over the journey. It’s more increased contribution from the Thunderbox underground. D zone we're starting to get into slightly better grade as we get deeper into the into the pit there. So it's, it's fairly consistent around what we delivered in the last in the last quarter. That's helpful. Thank you. And then just secondly, you mentioned you're testing the spring capacity of the mill as you're commissioning it. Has this given you any early indication what throughput rates you think the mill could settle on a more sustained basis relative to the 6 million tonne nameplate. We certainly have seen short periods where we're in excess of 6 million tonnes. But our real focus is just around getting that consistency at that rate. And then obviously, like most process plant over time, you optimize things and gradually push it up. So first, first, first focus for us in FY 23 is just bedding in at the exit rate at nameplate. And then over the next 6 months we’ll really stress test that as to going into FY ‘24 and beyond. Okay, that's great. And my last question is just going on to Pogo. Stu you mentioned with maintenance you can push that mill beyond 1.3 million tonnes. And I guess last few quarters you've been able to reach nameplates of the expanded mills. But do you feel this is the ultimate capacity? Or is this going to push it harder if you can deliver the higher mining grades? And if so what does that involve in terms of permitting and sort of any sort of upgrades in front of the mill? What would you look to do? What do you see 1.3 has really been the sweet spot here? Yes, so we haven't -- there's no permitting constraints really on tonne throughput things that you see, like in Canada and otherwise. But it's in that regard, it's it's available, drives that target of capacity, all of those things are there to run it. It really comes down to I don't necessarily want to fill it up at 1.4 or 1.5 add a lot of grade. The reserve grade is 8.5. We’re focused on the quality. That will get us the best unit costs. So that's, that's really key. But I guess we're giving the confidence that for the second half, part of it can be fruitful part of it can be great. But it's around timings and shutdowns and that uptime on that plant. We kind of know where its Achilles heels are so that when things – where it’s bottlenecks basically stop it from that throughput. So some of the things are oversized some of the things right at the limit in pumps and motors, those type of rating side of things. Hi good morning, Stuart and team. So my question is on really the trending costs for the business and whether you think that they have peaked now? And then how sticky you think higher industry costs could be? Whether you're seeing any downward pressure yet in any of the cost elements of the business? And maybe within that, if you could provide some color, I guess, on WA labor pressures and current staffing levels Yes, thanks. So probably the only cost we've seen come off is in fuel, and all the rest are fairly steady, fairly sticky. And it really depends on, I guess, what all the commodities are doing in the same space. So we've seen some relief in staff turnover and stability there post sort of COVID border opening. But we certainly haven't -- every quarter we even ask ourselves if have we peaked, is it coming down. We don't see material signals for it to -- those unit costs to come down. So yes, we've relate it against our strategy, which is growing profitably, the unit cost derived by economies of scale, the larger plants on same fixed cost base. That's really how we're getting our unit cost down. But the inputs we haven't seen lining up with your materials and/or your labor. Okay, thanks. And then maybe I had a similar question actually on Thunderbox and the profile going forward. Specifically, maybe, I guess, on -- in terms of the open pit material, because you're currently processing around a gram, but the reserves for sort of Otto and Orelia were a lot higher. So is it still correct that we should start to see that open pit material grade going into the mill? Is that sort of the larger function, I guess, of the expanded capacity start to lift and come up? Yes, Dave it’s Simon. You will see the grade sort of start to come up, just depending on which parts of the pit you're accessing. So Otto Bore is a higher grade. Thunderbox is -- D Zone is better grade at depth. And then really a grade will come in sort of FY '24 and beyond. So yes, you'll see some better grades from the open pits as we get deeper into the pits, but it's not going to materially move on the large volume. So you might see 0.1, 0.2 gram sort of changes over some quarters or halves. Just a couple of questions on Jundee power plant upgrades or potential power plant upgrade leaving some pretty handy emissions reductions by 2030. Is that also expected to bring our costs down? Or is that is that purely an ESG exercise? Well, it should -- depending on what energy costs do; it certainly could give us that saving. But I guess we're working with the incumbent energy provider that provides that gas-fired power, and we'll be able to switch between -- that gas is a backup and then the solar with battery storage and eventually wind turbines. So it will derisk energy costs. At the moment, it's probably neutral on operating costs. But the way gas prices have gone, it will certainly protect us from escalation in energy costs. And remembering there's limited capital there. It's all related to the PPA. And that there just a provider putting that capital in. And obviously, in terms of mine output at Jundee, a big uptick quarter-on-quarter and obviously a record for the mine itself. Is that just a function of scheduling? Or is that sort of 2 million tonne per annum rough underground output looking a little bit low now? Or will that turn back down back to that 2 million tonnes per annum in the near future? Yes. So look, it was a fantastic result for the team. And you know, Andrew, with Jundee, it's got those moments where you've got -- it's probably heading for the stoping fronts. And obviously, the team trying to do it, deliver it. And we build the stockpile for future milling. But essentially, it's the same -- similar -- the last question on Thunderbox in the South is keeping these 2 centers at sort of 300,000 ounces, Jundee in the north, 300,000 ounces; TBO on the South for that 600 at Yandal. There's always different sources that are underground open pit that feed into that mine plan, that milling throughput. So you have 2 million tonnes coming from Jundee underground, adding 1 million to 1.5 million of open pit material on top of that, to get to 300,000 ounces from satellite pits. And the same thing at Thunderbox. There's different sources, different grades. But ultimately running at that 6 million tonnes gets you 300,000 ounces. And that's the go forward plans. Hi, good morning, Stuart and Ryan. A quick question for Ryan, can you just remind me how we think about cash tax for the half? Are there still some receivables or refunds to come through? Hi, Kate. Yes now look for the half it's, it's going to be pretty light. So we're going through our FY ‘22 tax return now. So looks like it's probably going to be neutral to a small refund. So you won't see if there's not much cash tax paid payable this half. Okay. Perfect, crystal clear. Perfect. And if you will, Simon. At KCGM, 80 to 100 million tonnes target. Still an effort to get that TMM up above 80%. What are the key levers to pull now to go higher? Is it purely access to bases here, fleet utilization, optimization? Yes. It's really around opening up Fimiston South area. So as we're really leveling out that part of the open pit, we're getting bigger benches, more access and the efficiency -- the efficiencies then go up on our deals as well as utilizing the new fleet. So Golden Pike South takes a lot of trucking hours to move that in the deepest part of the pit. You'll see that finish over FY '23, and then we'll gradually ramp up in FY '24 into Golden Pike North. But it's really around better access to larger bench space higher in the pit. So it's using the new equipment. And we'll get an increase in material movement just where we are on the schedule over the next few years. Correct. Yes. We finished that at the end of FY '22. So really, we've had sort of 6 months so far of the full fleet embedded. And it's just continuing to increase those trucking hours, get more material movement and realize the efficiencies of a fleet that's new versus 20 years old. Thank you, team. Just one quick question for me just with regards to the KCGM mill study. I guess that's on-going. But I thought we would have had that quite now. Can you remind me when that's due? And is the fact that you're continuing to study it because the return metrics don't stack up, which sort of would surprise me? Or is it that you're waiting for certainty of inflation sort of peaking? Or is it a third factor that I haven't considered? Thankfully, we hadn't forecasted it would be out by now. It's really the work to be done this year, and we're still continuing on those final engineering designs. So it's really getting into the nuts and bolts of the final design and getting the engineering companies to give us hard numbers on all of that work. So yes, from what was produced last June was pre-visibility level. Now we're going right down to the feasibility level to make a final investment decision, and that's continuing at the moment. So there's been no retraction on timing or effort to get this done as prudently as it can be. Obviously, we're watching what's happening out there in the market in regard to other projects and timing and execution risks. But at the moment, we don't see that as a reason to not do it. Financial results are still very compelling. It's derisked by the large stockpile that's sitting there. We've got great visibility of the mine plan going forward. So it's a really important enabler, but it's not currently in our 5-year plan. But we'll make a decision this year on what we'll do there. Good morning, gentlemen. I'm interested in just the more specifics on what's happening underground at Mt Charlotte out here in Kalgoorlie. There's some sort of -- you've got some sort of project going to ramp up production from underground. Can you just give me a few details about how far through that is when you expect it to reach its objective and what production figure do you have in mind for that? Thanks, Neil. Yes. So essentially, the Mt Charlotte operation when we acquired it, it had a very short mine life. It was producing at about 1.2 million to 1.4 million tonnes per annum. So we've been moving it towards 2 million tonnes per annum, running at 24/7 and building out the volumes, re-establishing drill platforms at the bottom levels and really proving up the extension of mineralization in that system. It's a significant operation, and we see huge opportunity to be able to grow volumes from Mt Charlotte to 3.5 million tonnes per annum over the next couple of years. So the plans at the moment continue exploration, drilling, conversion of that resource to reserve, the development activity to open up those stoping fronts and obviously start to increase volumes that basically get trucked to the super pit and then haul with the big trucks to the mill. Essentially, at those rates now at the $2 million and some fuel truck haulage. And for the next couple of years is really the ramp up in the volumes. Yes. So in terms of how that contributes to the overall sort of super pit type operation, how does it fit in to the -- what's happening in the open pit? Obviously, you're expanding there as well. It's all sort of part of -- did I understand correctly that you're aiming for about -- what was it? -- about 650,000 ounces out of that whole sort of -- is that just a super pit? Or is that Mt Charlotte as well? Yes. So all of the -- the whole, what we call, KCGM operation by FY '26, that 650,000 to 700,000 ounces to -- that 480,000 to 500,000 ounces presently, growing it out to 650,000 to 700,000 ounces by FY '26. That usually comes from the super pit, Mt Charlotte Underground and the stockpiles. So that's the answer to that. And so we see a huge opportunity in growing Mt Charlotte. It presently doesn't have an underground on the super pit, and there's an opportunity there. And that's part of what we're considering when we evaluate the Fimiston mill expansion study for those new portals and drill drives that we put in a couple of years ago, what we're proving out there. We've got 5 million ounces of inferred resource under the super pit, and that's a potential future large underground. Hi, gentlemen, I'm just wondering really the safety record. You know better than me that mining safety in WA particularly has become a bit of a community and political issue. I'm just wondering if you could just flesh out why that safety record is still not where you want it to be. And just perhaps is it more around the training of peps? You can't get the pep, you've had to dig deeper for staff. Appreciate any sort of comment? Thanks. Yes, thanks, Sean. Look, our lag indexes sort of sit around half or below half of the state averages. So we're pleased with that performance. But it did deteriorate in the quarter-on-quarter and we're still seeing high potentials and misses in that regard, which is reflective of dilution of skills, a high turnover, and ultimately, those vacancies across the last couple of years. So it will take a number of years to restore that. So in the meantime, it's increasing supervision, having patients and prioritizing and slowing things down in the operations to make sure it's done well once -- well and safe. They are the things that all of the industry are focused on to ensure that we're not harming people. Okay. Thanks for joining us on the call today. As you've heard this morning, our growth projects are progressing well to deliver strong production in half 2 with unit cost reduction underway as we deliver growth across Pogo and Yandal in the near term and obviously KCGM over the subsequent years. Have a good day.
EarningCall_1596
Okay. Good morning, everyone. We hope everyone had a first – a productive first day of the NASDAQ Conference here, and I hope the second day is equally as productive. My name is Brian Nowak, I'm the Head of U.S. Internet coverage here at Morgan Stanley. We are thrilled to have David Goulden here, the CFO of Booking Holdings, to sort of talk through everything that's going on at Booking Holdings, the macro space, the state of travel. We were just talking about China reopening, walking in. So there's a lot to cover. I have some disclosures I have to read to get the party started. Please note that all important disclosures, including personal holdings disclosures and Morgan Stanley disclosures appear on the Morgan Stanley public website at www.morganstanley.com/researchdisclosures. Some of the statements made today by Booking Holdings may be considered forward-looking. These statements involve a number of risks and uncertainties that could cause actual results to different materially. Any forward-looking statements made today by the Company are based on assumptions as of today, and Booking undertakes no obligation to update them. Please refer to Booking Holdings Form 10-K or 10-Q for discussion of the risk factors that may impact actual results. I want to sort of start with macro a little bit. I thought it was really interesting on the third quarter call. You talked about sort of sustained demand, in some cases, even accelerating demand, pretty good demand trends even to start the fourth quarter. So maybe just sort of talk about those demand trends. What are you sort of seeing at a high level? And if you want to sort of get into the regional breakdown, I think it's really interesting to sort of hear about the state of travel through your eyes. Sure. Thanks, Brian. So yes, we saw strong demand through October. Room night growth was up 12% versus 2019, which is higher than it was in September and higher than it was in the third quarter. The third quarter average was 3% – sorry, it was 8%. So we feel that is good because it shows that customers have a strong desire to travel. A lot of questions about the macro and different markets. In October, U.S. was up 35% versus 2019, very strong growth. A lot of questions around Europe. Europe was up high-single digits versus 2019. And obviously, the consumer in Europe in October is in a different position than the consumer was in, let's call it, in January and February in Europe and yet, we're seeing strong and increasing demand from those customers. So we see that people are prioritizing travel, even though the macro has certainly tightened a little bit since then, they are prioritizing travel. And the other thing that we're seeing across all our markets is that customers are not trained down in terms of the start of a combination that they're going to, and they're not reducing their length of stay, which is the usual two kind of early indicators that we look for. When things are going to slow down, those tend to be the canary in the coal mine type indicators for us. And we're not seeing that in Europe, and we're not seeing that in our business globally. So just to complete the picture. The other bit of good news for us in the September, October time is that's when Asia came back to growth for the first time. So Asia was about 20% of our business pre-COVID. That has been down a lot during COVID, despite the fact that China outbound, which has been the most important part of China business for us is not yet back at all. We got back to a recovery in September. And by the time we got to October, we were also high single-digit recovered in Asia compared to 2019 as well. So if you look at it, that's a really good picture. The final piece of kind of what we talked about on the call for disclosure is to give people a view as to what we're seeing into the future is we also said that we see a nice build of our book of orders for Q1. We said that looking into Q1, Booking.com in euros, we were 25% higher in bookings than we were at the same time in 2019 looking into 2020, even though we got a shorter booking window, which would actually brought that number down. Right. And those – I think it's an important definition as for everyone. When you talk about the regions, Europe versus 2019, U.S. versus 2019, that's people in Europe booking? Okay. And then talk about ADRs a little bit. I mean, it's been quite a ride for ADRs as you just sort of think about pre-COVID, through COVID troughs and now ADRs have shot up pretty quickly across the entire travel space. You talked about how you're not seeing any of the star trade downs or any of the issues around shorter stays. Some other OTAs have talked about some trade downs on price. Have you seen any trade downs in price? And how are you sort of thinking about ADRs into 2023 and strategies you can use around discounting just to make sure you're hitting the right point on elasticity? Yes. So ADRs have been very interesting, and it would have been difficult to sit – beginning of COVID and predict what's going to happen to ADRs. Because historically, when there's a slowdown in demand, ADRs go down, and they stay down until you get back to occupancy levels that you were before. And industry-wide, we're not back to 2019 occupancy levels. ADRs for the longest period of time, and the ADR increase happened early in the recovery cycle and has accelerated, particularly into this year. So we had a 26% constant currency ADR increase year-on-year, excluding mix impacts in our business in Q3. Now we talk a lot to hoteliers and to property partners, and what they're telling us is they are passing on their cost increases. Their energy bills, particularly in places like Europe are going through the roof. They downsized their labor force in COVID. They can't get the same people back at the same rate. In some cases, they can't get the same people back at all, and they're paying a lot more for their staff. So what they're telling us is this is basically inflation impacting their business, and they're passing those inflationary costs on. That's what we hear. And that's what we believe is the primary driver of the ADR increases right now. And again, we're talking about three years. We're talking about 2022 compared to 2019, right? So you've got a few years of compounding cost increases built into that. So it looks like a very big number, but if you kind of – if you grow into that over the last three years, it wouldn't seem quite so crazy. So we really believe that the primary driver for what's going to happen to ADRs right now is going to be kind of what happens to the macro environment around pricing and inflation. And I don't think people are talking about deflation. Obviously, if there was deflation, there could be some reduction in ADR associated with that. But people are really talking about what level of inflation we're looking at. And therefore, based upon what we are hearing and seeing is it really is tied to that compounding inflation over a few years of impact, and of course, the different dynamics of the labor market. Got it. Okay. Let me sort of take a step back across the CASM of the years. If we go back to pre-pandemic, 2017, 2018 you were growing bookings at a double-digit clip. But then in 2019, the business did start to slow to high single-digit growth. Then we go through COVID, and online penetration and travel is probably higher than it was before COVID. How do you think about sort of one or two of the keys to maintaining double-digit bookings growth into 2023 and 2024 and not going back into single digits as you were? Yes. So we have said, and continue to say that coming out of the COVID, we expect to grow faster than we did going into COVID. Faster on the top line, faster on the bottom line, and of course, the two have a level of connectivity. And why is that? Well, going into COVID, we absolutely were slowing. And a lot of that was to do with our business model. Booking.com, our biggest brand, we were almost entirely an accommodations focused business and entirely dependent upon the agency model where we did not touch customer money, right? We did basically made a booking, passed it on to the property partner and the booker, and the property partner manage the payment flow. Very scalable model, being very successful for us. But wasn't quite as differentiated by the time we got to 2019 as it was in 2014. So that really explains the majority as to why things were slowing down. So what have we been doing about it? Well, we've been building out a lot of new capabilities and a lot of new tools. So we've been building out a payments platform. Payments platform is now 40% of our gross bookings value of Booking.com. The payments platform reduces friction in the traveler, booker experience, but also increasingly gives us the ability to merchandise. So to your point, we can now participate in – we were a merchandiser who couldn't merchandise, or retailer couldn't merchandise. We relied upon entirely upon what we got from our property partners to give us great rate because it's still primarily what we do, but we couldn't participate in those more targeted pricing promotional activities, and now we can. We have started out building new capabilities on the journey towards the connected trip. So flights is now an important business for us at Booking.com, growing from a small base, but growing rapidly, now up in over 40 different countries. Six million tickets booked across the company in the second quarter, over 20% of all the customers are getting in Booking.com in our flights business or brand users we've never seen them before. So you start adding these things up. So we've obviously got the strength of the business that we had before, we've got new capabilities, we've got payments, we've got merchandising, we've increased our alternative accommodation inventory. All the things that we've done give us many more levers to grow the business. And that's why we believe that with the additional capabilities, the additional tools in the toolkit we didn't have before in 2019 that we have increasingly will build upon more in the future, they give us many more levers to grow the business. Got it. Yes. It's a great segue to the next question I want to sort of get into, flight payments. Even the way to think about the margin profile of the company, and I think payments – so first is sort of maybe give us an update on how we should think about payment profit contribution this year? And what about in 2023? What sort of happens with payments and profit contribution next year? Yes. So payments profit contribution, operating margin contribution is basically breakeven right now. And I talked about why because it's just a good accelerant for the business. Think of it as it have a nice lubricant oil that helps the rest of the business go faster. One simple example I gave is, whilst we didn't use the due payments, perhaps our single biggest source of customer service complaints was for payments. Customers call and say, the property charged me the wrong time, the wrong amount. And of course, we're in the middle of that. By definition, we made the booking. So we're going to have to go off and solve that problem. We don't have to when it’s ourselves, right? We solve the problem ourselves. So there's a good reason why we're running at a breakeven. We will start to make some contribution from payments next year in 2023. That will be the first year. If you remember, up until this year, we've said that we've actually been investing in payments that we've been building up. So we'll go from investment pre this year, breakeven this year, and start making some contribution margin from payments next year from the base payments platform itself. And then we'll also, you’ll see us starting to introduce some payment-related travel services. So things like paying your own currency. We're working with partners, but we can offer that to our customers. Our FX-related services, paying your own currency, things like that, where we can actually provide value to our customers over and above just the ability to process the payment itself. So those will start to rollout next year, a little bit more than you see them now, and they will also start adding to contributions. So looking forward, we see some contribution margin from the base payments platform and from some of the things we can build on top of it. Okay. I think that, that multi-year way to think about payments is helpful for investors. Maybe let's try to do the same thing on flights. I know flight has a lower take rate. You've been investing in building up flight supply and flight integration. How should we think about the flight contribution or headwind to profitability? And how long can it be before flight gets to be a profitable business? Yes. So obviously, we're investing in building flights right now, as you said. I think the way to think about flights is to kind of think out into the medium term. So we've got flights up and running at scale, and it's tens of billions of TTV and then you kind of look at the P&L underneath that. The P&L underneath a flight's OTA is very different from the P&L underneath the accommodation of OTAs and certainly not a 39-point EBITDA business, right? And I've been telling people just in a way to think about the framework and how it works is think of flights as maybe a mid-single-digit EBITDA business once we stopped investing it, and we rolled it out. But I also think of flights and payments as incremental to the core accommodation offering and complementary, but purely from a financial point of view, think of them as incremental. So they're producing EBITDA dollars we wouldn't have before. So with flights and payments, EBITDA and gross margin, EBITDA dollars and EPS dollars grow faster than they did before. But obviously, there's a margin compression impact because you're adding these two lower margin businesses to the existing kind of core higher margin business. But as I said, the incremental and they're supportive because I explained how payments make the accommodation business more competitive. Well, flights also makes the whole business more competitive because we can solve a bigger piece of the customer problem. They go to the connected ship, but also it brings a source of customers. So I think people get a little bit sometimes wrapped around the axle saying, well, yes, you may have lower margin rate? Well, yes, mathematically, we'll have a lower margin rate, but we'll have more EPS dollars that are growing faster than they were before, and we'll have a stronger and more competitive business. I think it's a very important point. We always use in the past, we've talked about how flights are sort of the milk to get in the grocery store and the travel journey, and then I booked a hotel later. Have you already started, or sort of do some of that upselling where if I book a flight through Booking.com, you're already sending e-mails and having an impact or people are booking hotels and you're getting a larger direct mix from that? Or is that sort of still on the come in 2023 and beyond? We are starting to see some of that. I'll break flights into two segments. So obviously, right now, the majority of flights we're booking to existing customers because that's who we're marketing to it. We haven't really done much marketing of flights to new customers yet. We are participating in some of the kind of flight metasearch platforms a little bit. But dominance of what we're doing right now is to our existing customers. So in that cohort, it's great because we're seeing those customers, probably because they came to us first when they booked a property then booking flights. But some of those are coming in booking flights and booking hotels. But obviously, there, there's a pretty good attach rate because they were used to buying a hotel from us. So if they're buying a flight from us, there's a high likelihood they're also buying a hotel or some form of accommodation, alternative accommodation, et cetera. The good news is in that new cohort I mentioned, the over 20% who are brand-new to us, we're getting, I'd say, an encouraging conversion rate of them who are also buying a combination for us. And then in both classes, we know that the more the customers buy from us, the more likely they are to come to us back directly, it's kind of back to the connected trip. The connected trip means we're solving much more of a travelers problem. We're going from circa 2019 being a kind of book-and-go transaction engine to something that's actually providing a real complete solution for our customers' leisure travel problem. We know that the more things that they buy from us, we have good data on this, the more likely they are to come back to us directly again in the future. And that sort of changes the way you can manage the merchandising and the performance marketing mix in the overall business. So as we – in 2022, we've been doing some incremental merchandising, performance marketing has been coming as the regions are opening. How should we think about merchandising and performance marketing as a percentage of bookings into 2023? Yes. So it's quite interesting. If you look at them as a combined number, now in 2022, it's about 6% of our total bookings we're spending on those two marketing engines. And that was about 5.5% back in 2019. So we really have stepped on the gas, so to speak, but we told people to start the year that we would. And then you kind of again look at our room night growth in October at 12% versus industry occupancy rates probably down high-single digits and you see there's a big spread between those two, and we're absolutely gaining market share. So you can see the benefit we're getting from that incremental marketing and merchandising. We believe right now, we don't need to do – we don't need to further deleverage those into 2023. We're spending at a level at which we gain share. And exactly how much we spend will be a function of how much growth is remaining in the industry because we've been spending into growth this year, and growth recovery and still recovery in the industry. And then, of course, what happens to the macro environment and what the total demand cycle is. The more demand there is out there, the more likely we are to keep that engine burning higher. Then of course, beyond 2023, in the medium term, we will plan to lever on those line items. Again, because as our direct mix increases, we have to spend less of the business on paid marketing. A great example of that would be just go back and look at 2019 where things were in a more steady-state environment, we weren't talking COVID and all the rest of it. We basically kept our ROIs about the same in 2019 as we were in 2018. Because of the direct mix increase in 2019, you saw we got about 20 basis points improvement on leverage on our marketing spend compared to gross bookings about 120 basis points compared to revenue. So you see what happens when direct mix increases and how that flywheel helps the investment in that area move down with mix. Okay. I want to talk about the individual regions a little more in U.S. versus Europe versus Asia. But maybe just to sort of follow on that last question. Are there any differences by region where you find performance marketing is more effective, merchandising is more effective, Genius is more effective? Like are there any differences in acquisition channels where you made more or less progressed by region? They're all are very important. And you mentioned Genius, we haven't spoken about it. I mean, Genius is something that we've really expanded a lot in the last few years as well. Something else in my list of tools that I could, or should have mentioned earlier in terms of what's different. And now we have three tiers of Genius customers. And the nice thing about Genius is now if you're a logged on user and you haven't booked with us before, you get the Genius Level 1 benefits, which are often a 10% discount on the property, which is not to be sneezed at. And then Genius Level 2 and Genius Level 3 customers are gaining more benefits. That also comes back to the kind of segmentation and the potential inside of the business to really make sure we really work with our most loyal customers. We talk about averages a lot in these businesses. The average direct share is X. The average app user is Y. But you go to the more loyal customers, and they have a much higher percentage of direct share, much higher percentage of app users, et cetera. So that's another tool in our equation. So you're right, when we kind of looking at these marketing tools, you've got marketing, you got merchandising, of course with the marketing. You've got brand, you've got paid marketing, and then you've got things like Genius and they all – so those marketing mixes all exist in all of the regions. And I'd say it's kind of more of a tweak between the differences. I wouldn't say they're fundamentally a lot different. Europe is, of course, the market we've been in the longest, where we have the highest recognition. So you can play that into account. In the U.S., we still recognize, whilst we're gaining lots of share, we have some brand awareness try and build, so we hire our brand there right now than – higher mix of brand spend in the U.S. and more concentration on brand in the U.S. than we had done historically. You saw us last year, I think for the first time in the history of Booking.com, run a truly integrated brand campaign that started off with the Super Bowl and ran throughout the entire year with very consistent creative messaging, that was a big investment for us. And one that we're actually getting from the awareness data, some decent results from and it shows up in our financial results. So I'd say it's more tweaking the mix based upon our position in the region. The Asian marketplace is much more generally geared to some of the merchandising type activities, merchandising and pricing and incentives and cash back and [indiscernible] all those things are very prevalent in the Asian marketplace. And of course, the benefit there is we have two brands. We have Booking.com. We have Agoda, and Agoda is very good at those things. It has been for a period of time and competes well with the regional players like Traveloka, et cetera. So we have the ability to play with – to use both brands and kind of use their respective tools to kind of play in the marketplace. And you mentioned prior to pandemic, 20% of the business was Asia. Have you ever broken out how much of that was China outbound, or like domestic people in China booking? We basically said – you are right, the 20% pre-COVID was Asia. We said that no single market was more than mid-single digits of that. China would have been one of those bigger markets. Now within China for us, though, pre-COVID very little exposure to the domestic travel. Most of our focus was on outbound where, again, we use our two brands, Agoda and Booking, and both have good reputation with the China outbound traveler. We also use partnerships – partnership with [Mesh1], where we provide most of their outbound inventory for the outbound travelers. And we still have a partnership with Trip.com, Ctrip, where they use some of our outbound inventory as well. So through partnership and through our direct brands, that’s how we kind of tapped into that China outbound marketplace, and we're all looking forward to it rebounding when it does it. So we're saying it's been – it will be three years plus for those travelers. And of course, they were very active travelers pre, and I'm sure they will be very active travelers post. So many topics I'd love to ask you about it. Actually, the point on the loyalty and the power users, it bring – it makes me think of business travel and sort of all of us being back, and sort of business travel continuing to come back at different levels. In the past, you've spoken about what percentage of the overall business you think is associated with business based on people checking the box. Is that another potential tailwind to your total company-wide business as you go into 2023? Or where are you on business travel? Yes. We participate in what we call the unmanaged business travel segment. We don't do any corporate managed travel. And that's different industry, and one we don't have aspirations to move into. We're basically a leisure platform. We're very proud and pleased with that. But to your point, we do have people self-disclose if they're using it for business. And of course, it's a pretty good tool if you're a small and medium-sized business, get all your travels to book in one platform, you've got a consistent records, we can help you with invoicing, et cetera, et cetera. That has not recovered as well yet as leisure travel. I'd say, based upon what I read about corporate and managed travel, it's done, it's recovered a lot better than us, but it's somewhere between those two. So that is definitely an opportunity for us. I think we still put most of our focus on that leisure segment, so we kind of look into the future at things like additional flexibility in the workplace from a work environment. Most companies are not bringing their employees back five days a week. They're bringing them back in some kind of hybrid model. That creates the ability to have more extended weekend travel. That's right in our sweet spot. Also, a lot of companies are giving their employees the ability to work for a different state or a different country for a certain number of years. Booking.com, we let our employees work from another country for up to 20 days a year. Well, what happens then? They will probably extend their summer vacation or the winter vacation work from somewhere else approach. Again, that's in our sweet spot. So those are the things that we're very excited about coming out of COVID we think is different because definitely, the workplace has changed, and that will create more opportunity for people to travel. So we're excited about that. Got it. The other part that does seem to have hit an inflection point is your U.S. and your North America business. I remember 10 years ago, writing a note called a Party in the U.S.A., referencing the great Miley Cyrus, all about the U.S. opportunity, but it didn't really ever hit a stride I feel like until a few years ago. So maybe talk to us about what has driven the inflection in the U.S. business? And what are sort of the keys to continuing to take share in that travel market? Yes. So a lot of things came together at the same time for us. We've been investing in the U.S. for a few years before COVID. And COVID were the horrible thing to happen, but it did kind of reset travel back to zero just about. And then when you're rebuilding from zero, you have a chance to kind of assess where you are and what you're doing. And we – and the things that we have been investing in really kind of came together as travel rebounded in the U.S. marketplace. So we've been investing for quite some time in our relationship with the big chains, the chains are very important to chain-centric market in the U.S. And as the COVID market recovered, we were able to kind of really work those relationships. So we have a more – a better understood symbiotic partnership with those chains. We were able to back that up with spending in brand and marketing that helps everybody because we are creating demand on our platform as we kind of refine and fine-tune those tools a little bit prior to COVID. We got much more granular in terms of how and where we are marketing, treating states to states and not the U.S. is a big state and things like that. We also have payments coming out live in the U.S., which is important for alternative sector because that's a key capability we didn't have before. We started launching flights. So a lot of the things I talked about generally really kind of all start to come about in the U.S. at the same time. Of course, we have our two brands. We've got Priceline, and we've got Booking again. Some of the examples that I gave you for Asia, and both brands have participated well and done well in our U.S. growth. And we've done much more work to proactively position those complementary and kind of stop bumping into [indiscernible] where we can and try and position them as two brands in the same family. So it all kind of work together. We've been adding to our alternative inventory in the U.S. It's still underway compared to where we were, but more than we used to have. So a lot of good things happening. And as we talked about, from a growth rate point of view, 35% in October compared to an industry that hasn't fully recovered in the U.S. from an occupancy rate point of view, obviously, shows we're doing very well, and we're pleased about it. And there’s more to do. That's the good news is we're doing well. We've got much more to do. I'd point to the alternative space, and the U.S. as an area where we're still underway compared to our global average, but we're doing a lot of work to enhance our product, to bring out new capabilities. We brought out liability insurance for partners. We've brought out damage deposit mechanism for partners. We've enhanced our payment offering to handle the professional sector, all at their request to make sure we can have more complete and more capable, and we've been adding properties. And we plan to continue to do that. And then at some point in time, we can then work on the last piece a bit because in the U.S., both of our platforms are really viewed as more hotel booking sites whereas I think in Europe, people don't think of us as a hotel booking site. They think of us as a place to book accommodations, and then we need to kind of turn that piece of the engine on in the U.S. as well. How do you think, that point on alternative accommodations in the U.S., how do you think about the competition for supply and sort of getting more of those individual hosts to list on Booking.com as well as the competitor? So we think there's a really good phenomenon, and I think it's happening in the U.S., perhaps more and elsewhere from a supply point of view. There is definitely a professionalization of supply going on in the U.S., and in some ways and particularly in that single property owner home. So you have a nice second home, it's in a nice vacation area. But you don't live there. You live somewhere else. Do you want to be your own booking agent? Do you want to manage check in and check out? Do you want to manage payment? Do you want to manage maintenance and cleaning? Probably not. What about the property manager happens to be in the same town, same village, does that for 20 other properties, all high-end homes like yours and takes care of it as if it was their house? Well, that's what a lot of people are doing. So by signing up those property managers, we really get – we get access to faster inventory, but also to inventory that people really want to monetize. So somebody wants to just rent the house for a week, a year and live in the rest of the year, that's probably not the right customer for our platform. Maybe somebody else can take care of that for them. But we like the people who want to get a bit more yield. But if you turn to a property manager, you probably also don't want to rent your place for week or year either. You want to rent it for a bit more and get some income from it. So there's a nice convergence there that is giving us access to that high-quality, single-property owned inventory, but also kind of fits our platform because those property managers are looking for yield and volume as well and they know how to work with a demand platform like ours. Yes. I wanted to end with Europe because we think it's your biggest business. We think Europe makes up about 55% of your overall business. It's certainly one of your oldest ones when we think about booking and active hotels and bookings BV bringing them together. It's big and it's doing well. I would just be curious to hear about some examples of still existing low-hanging fruit and improvements you think you can make in Europe just to sort of continue to drive outsized growth versus the overall travel industry in the next few years? Sure. I go back, first of all, to quantify the kind of impact of yours. Yes, it's our biggest business. It's over half of our business. But go back to 2019, just from a penetration point of view, we look at all the rooms on our platform, we look at the theoretical sell-through capability. And in 2019, we sold about 7% of all the rooms available on our platform globally. In Europe, that was high, but it's still only 11%. So there's a lot of headroom. Now within that, even though we have much more awareness and much more capability in Europe, that's really where the connected trip is aimed because let's just assume that we do have a strong customer base that use us, again, for that book and go transaction machine, right? We said that on average, pre-COVID, our average customer, we get about 25% of the travel budget. Now obviously higher and lower. But if we're only getting 25% of the travel budget, it means we're getting roughly half the spend on accommodation then none of the spend broadly on anything else. Then even for existing customer base, that's where the connected trip increases the share of wallet we can get from those customers. There's also a lot of things that we don't do as well as in Europe, things like beach ski vacations and things where we can tune – fine-tune our capability. And also families versus couples, again, things we don't do quite as well. So there's a lot of tactical things, a lot of share potential. And that's really where the connected trip is going to make, I think, the biggest difference in the shortest period of time.
EarningCall_1597
Hello and welcome to the Tokens.com Year-End Financial Review Conference Call. My name is Sheryl and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] Please note that this conference call is being recorded. Thank you very much and welcome everyone. On the call today from Tokens.com is myself, Andrew Kiguel, the CEO, Martin Bui; our CFO; Deven Soni is our COO and Jennifer Karkula, our Communications Head. So in terms of reviewing the year, I mean, 2022 has been a frustrating year on many counts. It's been frustrating for sure on the share price, although as a company, I feel like we've achieved quite a lot. And unfortunately, that's always overshadowed by which has been generally a bad year in Cryptocurrency and in the markets as a whole. Today, I do believe we're a better company than we were a year ago and we had close to a $400 million market cap. And in terms of things, we can control such as reducing our overhead building good businesses, I think we've been successful in areas that we can't control such as Crypto price, our share price and macro events, we've obviously suffered through that. But with that, maybe let's just dig into some of the key things of the year for stakeholders and shareholders to understand. In terms of our year-end cash and Crypto balance is approximately $13.1 million or CAD80 million. That's equivalent to $0.13 or CAD0.18 per share. One of the questions that I always get asked is, what is the capitalization of the company and we've seen so many bankruptcies in the space that people are always very concerned about everything going on there. And some people are well capitalized, we have an inventory of liquid tokens plus cash. I don't foresee us requiring any capital next year, so companies will capitalize. In terms of total assets, CAD20.1 million or close to CAD28 million that is CAD0.20 to CAD0.28 per share. And I left these out because that last week we're trading at around $0.08 per share or something like that U.S. or at about CAD0.11. So certainly feel we're undervalued and that the intrinsic value in the audited statements for some of our businesses is reflected. Our startup subsidiaries, Metaverse Group and Hulk Labs both became revenue positive this year. Not seen champers yet. But again, these are nascent businesses in areas that we're continuing to grow and build and innovate. Some of the key highlights of the year Metaverse Fashion Week which was hosted in digital land owned by Metaverse Group attracted over 100,000 visitors over 60 brands. Hulk Labs was only launched at the beginning of this year, the player or gaming sector which could we've made a lot of great inroads and they're doing some really exciting things there. Metaverse Group has had a really great year. Lots of big tenants such as Forever 21, Skechers, UPS Store and there's a whole bunch more they're going to be announced in the New Year that the company has landed and is working on. They host a digital version at the Miami Fashion Week, entered into an exclusive or into a partnership with AIR MILES. So lots of positive things there. The Hulk side, that continues to grow. We entered into an exclusive partnership with the Democratic Republic of Congo. There's now a workforce of over 1,000 players we did the acquisition of Playte Group, which is a proprietary software tool that we'll use to integrate potential investors and Playte earn into the gaming economy. And we did a completion of a small strategic investment grounded Hulk Labs in the U.S. in pre-money, which works as an $11 million post money. Again, Hulk Labs on our balance sheet is carried I believe it is almost zero Yes, the market sees us as the interest being much higher. When I look at some of these years, it's been a really frustrating market. You know, I struggle with the fact that there's been so many disappointed shareholders and they're trying to respond to everybody. Obviously, I can't control the share price and I note that while we fall in a lot, we've fallen in line with other Crypto companies especially that small cap ones. Management remains aligned, we own 25% of the company and the management and the board and we have a view as they say in the press releases with creating value in the long-term and what do I mean by that is I have always tried to be careful stewards of capital, there is no [indiscernible] what they talk about, we have been approached by the seven different other public Crypto companies that are looking to merge or buy us. Nothing has resulted anything, no one really scratched the surface. Everybody sort of looks at us and expect cash, they're interested in because we are so well capitalized. Although we're in what is considered a second into the area and being Crypto, the Metaverse gaming, we have been adults at the table here. We've tried to manage things carefully. We haven't gone out and blown everything that shows up on our balance sheet. I'll mention again, 2022 mark, you look at our income statement, it's marked with a lot of losses, most of those are non-cash repeat, we have to revalue our Token inventory quarter-to-quarter and our NFT inventory quarter-to-quarter. So what that means and if we buy something in dollar, and it trades to $2, you can show gain of dollar, if it drops back to the dollar next, we have to show that. Again nothing changes in terms of what we're holding, that's always reflected as these non-cash assets, which again don't impact the growing businesses that we have, but certainly makes a concerted look fairly unattractive. In terms of the market have already talked about, this has been one of the worst years in terms of the S&P and the NASDAQ on the record. There has been a ton of macro factors, including seven interest rate hikes in the United States, high profile bankruptcies and failures, fraud places like FTX, Becerra, Luna, it's been a bad year, and whereas 2021, I would say was full of overvalued assets, which was really a result of the economic stimulus that the governments added into the system post-COVID. Everything sort of came back and sort of went the other way. And so whereas simply may have been overvalued towards the end of 2021. Certainly, things from the other way that significantly undervalued today. In terms of our operations, going to say this, I'll move it over to Martin. We've been an early mover in lots of areas such as the Metaverse, gaming, these are all areas that we remain highly confident are going to be impactful in the future. Again, we've been overshadowed by the poor performance of Crypto credits this year and high profile dealers in sector, we're still feeling quite confident, we're in the right areas. We do have an long-term, it's a struggle for us, and it's frustrating to see people disappointed in our share price. Again, we're looking at this with a long-term perspective. We did recognize that the 2022 Crypto prices were volatile to the downside. Our ownership of Cryptocurrency inventory resulted in some significant non-cash losses related to the revaluation of assets, we'd have taken steps post the quarter to sell down some of those crypto assets and holding cash. Right now our Crypto inventories primarily in the form of Eth. The reason why is we just don't know where the markets going to go. There's talk about finance potentially having issues and other things. So we just want to make sure that the company is well capitalized regardless of what happens in the Crypto market. We've taken a lot of steps to reduce corporate overhead to preserve capital. As I said, again as of September 30, we apply for the cash renewing from crypto tokens, respectively for $2.1 million in terms of what I would call cash or cash equivalents, and approximately CAD18 million in cash and equivalents. I'll note again, we're not a crypto exchange, we don't engage in performance enhancing derivatives or leverage products. We do not custody assets for other people. There's no room here for things like embezzlement or anything else. We only custody our own assets. We don't have external clients for whom we manage assets for. And as we look forward again, there's more information in the MD&A regarding Metaverse, we can help that and rest of these businesses, but we're really focused on positioning these businesses to be leaders in the space, I continue to be excited about what we're building in those areas. We did pivot a little bit away from just being a pure staking company. I think that's a positive thing. I don't think that these new businesses are adequately reflected in our financial statements or in our share price. But over time, we think this will benefit our shareholders. So with that, maybe I'm going to turn it over to Martin to give a quick review of the financial statements and then we'll open it up for Q&A. Great, thank you Andrew. And hello everyone, thank you for attending the call today. I understand this is not really the best time of the year for a call. So I promise, I'd be quick, so that we can turn over to Q&A with Andrew. So like I said, I won't be going over the financial statements in details. I believe the shareholder and support of the company, which we're always grateful for, understand these periodic revaluation of our Cryptocurrencies and other items such as warrants, which create these non-cash accounting gains or losses, every reporting period, that really do not matter to our operations. So I won't go over those. But I'm happy to take any questions regarding the financials later. So before I proceed, I want to remind everyone that the numbers presented are in U.S. dollars, unless otherwise stated. So our revenue for the nine month was $678,000 compared to $1.1 million for the 12 months of last year. So if we annualized our nine month revenue, you get very close to last year, despite the markets have changed significantly. This is because of the two new revenue streams that we added throughout the year from our two subsidiaries, Metaverse Group, and Hulk Labs. Our operating expenses for the nine months are $2.7 million, a 60% decrease from the 12 months of last year's of $6.3 million, excluding shares based compensations, our real expenses come to about $2.5 million. So we look at what the cash balance at the end of the year is, of almost $6 million, and high level debt we have, this shows that again, Tokens.com is capable of paying for our overhead and cash expenses for the next 14 to 20 months without a need to raise capital. And this is excluding the revenue that we earn with the Metaverse Group, which is 100% in cash, the liquid tokens that we have available to sale and management is always looking for ways to reduce our overhead. So again, I just want to point out there are few highlights that really matter to our operations. And I'll turn the call back to Andrew. Thank you everyone for listening in. Thanks, Martin. So just before I open it up to questions, again, my view is I think we're a better company today than we were 12 months ago, although we are much larger market cap 12 months ago. Why, I think we have more cash, a straightforward business, I think our business compared to other public Crypto companies is a lot better than most of them out there. And again, why because we've been good stewards of cash, our businesses have more growth potential, we're not involved in highly regulated businesses, or have to custody other people's assets. So, again this has been a year of struggle on the capital markets for us. We're working hard to try and continue to get our story out there. And we're hoping that 2023 has better things in sight for us from a public market perspective. So operator with that, I can turn it over to questions. Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Josh Zoepfel from Capital Markets. Your line is now open. Hi, good morning, guys. And thank you for taking my question. So just wanted to ask first obviously with the market kind of being away, it is just kind of an FTX issues and maybe potentially mine. I guess noticing something, anything in the regulatory market and what that might mean for you guys? Nothing for us. Most of the regulatory oversight involves protection of people's assets. We don't custody assets for anyone. If you go through our businesses on the staking side, we are staking our own assets. They remain in our custody and we earn a yield for helping them validate blocks on the Blockchain. And the Metaverse Group side, our books being done there, it's almost turning into what I would call sort of this marketing agency business where we're landing big Tier 1 clients and dealing with the marketing departments that these clients and these people aren't necessarily concerned with the prices of Crypto, they're like what can we do here to create something immersive as a way of interacting and becoming better ways of interacting with our clients and the Hulk Labs, similarly, we're using our own assets. We have the player network that are playing games on our behalf, and earning revenue for us. So there's nothing really that we're doing to get regulated to answer your question. Okay, yes, perfect. And so I know you guys obviously have a lot to deal with Decentraland. But I know you guys kind of own also other like just Metaverse parcels. Can you guys provide us an update just on those? Sure, so Metaverse Group owns now in 12 plus different Metaverses, a lot of the attention does go to Decentraland. And I think it's 40% or 50% of the digital real estate owned is in Decentraland. But Decentraland has the advantage of being somewhat more advanced than some of the other players. And so the Metaverse function, and then Decentraland has come under some criticism in the last few months over. The number of people that are in it are visitors. But we hope our events, we've been able to attract people to fashion show, in fact about 108,000 visitors, we recently did a Music Festival, they believe attracted over 10,000 people. So it's just an easy place to do that. So in terms of Metaverse Group, the idea is to remain Metaverse agnostic. And the new installations are being done there, being done across several Metaverses and trying to get them to do things like Twitch and YouTube and areas like that. To create a broader presence, it could be more sort of touch points with potential clients or brands. Okay, perfect. Thank you for that. And so obviously, you guys mentioned earlier in this call, and also on the MD&A. And news release how you guys are just lowering overhead, so I'm guessing when looking at it is this year, it's like CAD800,000 and professional fees. And roughly say like $400,000 in management fees, is that a kind of a good number to look at going forward? So my target is that outside of like, things that show grants and [indiscernible] the board, looking for the cash spend. I'd like to get everything below CAD1.5 million for 2023. So including salaries, fees, audits, legal fees. Okay, and then you also mentioned just how you guys were not needing to basically raise capital in 2023. And so how do you really kind of plan on just kind of investing in additional assets over this next year? So the business is more than investing in FX. On the staking side for surely that means we're not going to be applying new capital into staking. That remains there as a reserve and in particular was 6.6% or 6.9% was the yield for us in our staking assets of 2022. Metaverse Group and Hulk Labs are self-sustaining. They don't need new capital to grow. And the growth in those businesses is more dependent on gaining customers. And so the Metaverse is a a B2B play. There's a fairly large pipeline of businesses. There's work being done for those installations will be announced in the New Year. But the investments in those businesses are really driven by their revenues. Same thing with Hulk Labs, Hulk Labs, there's no assets investment requirement there. I would say, the markets became blanked again, in our share price was just $3 or $4, we would certainly consider raising capital speaking, but as of right now, the key thing is make it through the winter. I think we can more than adequately do that. But sure, that might mean at the expense of going into a whole bunch of new capital or new businesses. Okay, thank you. And then last before I go back in the queue is I know that now since you guys are now seeing positive revenue in both Hulk Labs and just your Metaverse divisions. So you guys have any kind of foresight to how maybe next year how those revenues will look for both of what your play to earn in Metaverse? Well, we do but I don't want to provide guidance. Yes, I think we're too small in the area that there's some volatility. But I would say internally, we certainly have robust forecasts within each of the businesses. But at this time, I'm not prepared to give guidance on revenue or earnings. So my first question is regards to the decrease in staking revenues for the period. Obviously, asset prices came down in the quarter. But wanting to get a little bit more color on what management was doing during the quarter, that may have also contributed to the decrease in staking revenues? My understanding is that you liquidated a substantial amount of the portfolio or a substantial amount of tokens following the quarter. Were you guys trying to unstake a lot of these assets in the third quarter, just given the lag in getting those tokens back after unstaking, and if you can share some color on what proportion of the portfolio is staked to today versus unstaked? Sure. So in terms of the question, staking is it's somewhat of a passive business, and so the issue on the revenue and why it's more is last year for staking Eth, which is primarily what we're staking now, and you earn an Eth, I think Eth hit a high of like $4,800 or something, your revenue accounts is $4,800. This year Eth is trading at around $1,200. The staking, the amount of tokens that you've staked doesn't increase, because we're staking and getting paid in the native token. And so we're receiving a yield of whatever it is 6.9% or close to 7% in Eth, that we receive an Eth. And so whereas the revenue last year would have been $4,800 for every Eth staked this year, it's only $1,200. So it's not necessarily anything that management has done to decrease the revenue. Like I said, it's somewhat of a passively operated business. Frankly, it's just the price of Crypto came down. And so the value what we've been thinking was not that dissimilar to maybe a mining company where if you don't mind, can Bitcoin last year versus technically this year, same amount of Bitcoin, you've mined, same amount of work, but the revenue is going to be far less. In terms of few other questions question disposal, we didn't disclose that much. And we put out a press release, and it was CAD1.4 million. And it was just a decision to say there was a whole bunch of other smaller tokens that we were staking like Oasis and NFTX and some other things that we said weren't necessarily poor to where we wanted the business to be going into the New Year. And the idea is, if there has to be another, what I would say another failure in the sector from one of the big exchanges or something, there's another college shoe to drop, we wanted to make sure that the tokens we own that were most susceptible to decreases in losses are going our favor, we're really just removed from our books in favor of holding additional cash. And part of that, because we had so many companies calling us up asking to see if we were interested in sort of doing a merger or being acquired and everybody was really interested in cash. And it's not that the company is up for sale, but I just started realizing, hey, if we're going to survive here, and we want to be able to survive here from one, two years, it was fired, holding on to somebody smaller typing, necessarily in a way to balance. If this month turns, we think it's going to turn in favor of things like Bitcoin and Eth. And certainly the Eth right now, you'll get substantial upside in that turn, while also preserving our cash balance in the event that it doesn't or goes down further. And just to add to that, I think one of the things here, it's good to focus on the assets. But I think one of the things that management has done relatively well is we've managed to grow two businesses that I think are not even adequately, their intrinsic value is not reflected on our balance sheet. And we've managed to do that while preserving a fair amount of cash. Whereas I think, if you look at the balance sheet of a lot of our peers, they don't have a lot of cash left. So I think that's been a good task of balancing those things. Great. Yes, I mean staking revenues did come down sequentially quite a bit. But just moving on, the OSC decision resulted in Cryptocurrency assets moving from current to non-current, can you provide a little bit more light on terms of the reasoning behind the decision as from my understanding that that results in that's likely due to the results of the portfolio being staked? Is that correct? I will let Martin weigh in on this a little bit. But the one thing that I said that decision he submitted, this was way back, we have submitted a Shelf prospectus, I'm going to say six or seven months ago, for review by the OSC if it's publicly filed in SEDAR and the idea there was in the event that we were looking to raise capital in the future to streamline it, and also to make sure the OSC was familiar with our business. After a lot of like, back and forth, the OSC asking a lot of questions, we had a lot of really positive conversations, and they really looked at our business with a magnifying glass over the course of several months. At the end of all, that the only key item that they sort of had recommended to us is if we wanted this to be the tokens that we held. So this is not the NFTs with a digital land and Metaverse Group, but just the tokens that we held from the current to long-term, we get pushback on it, because we said, hey, as we showed up posted this last quarter, we can turn around and sell some of these assets where we need to, we were in favor of cash. They were fairly limited. This is the treatment, they wanted to see the balance sheet and we didn't want to create any issues. And so we actually asked for that. And that's why it's shown like that. Martin, I don't know if there's anything else you want to add as to that why? Yes, for sure, I think the result of the OSC review is to give a better presentation of our digital assets to shareholder and reader of the financial statements. So for example, so one thing we also do, we break down between the NFTs, the NFT's and the cryptocurrencies. And we move both of them to non-current assets, which makes sense for NFTs because these are assets that we want to hold on and to build business and revenue upon. The cryptocurrency is a little bit trickier. Because they are given our strategy of staking and then holdings these tokens over a long period of time. It makes sense to move, move it over to non-current, but operation wise, those tokens are available to us to liquidate if we need to, so yes. Yes, the positive thing is that we started off making certainly wasn't like the OSC came and said, hey, we had extensive conversation with them around our business. And I think there was an earlier question about regulation in our space. After a lot of back and forth the fact that at the end of those conversations, if this is really the only issue that concern them. And in my opinion, it's a fairly benign issue. And it doesn't change any of the numbers. There was no restatement of financials acquired, I think that's a pretty good sign. Great, thanks for that. Just moving on to a couple other questions. I wanted to touch a little bit more on that earlier question on operating expenses, it appears that cash OpEx would have come down sequentially. Had it not been for that doubling of professional fees in the quarter, can you shed some light and you know, it's great that you guys are trying to cut cost on a go forward basis, just given the challenging market environment, but can you shed some light on what caused that uptick in professional fees? And how should we look at that expense line going forward? Thanks. Yes, Martin, I don't know if you want to talk a little bit about it. I mean, I have to go back and check Martin probably has some more details on it, but I would change. Some of the things are things that would be pre-committed to. So professional fees, I believe that might include some things like legal costs. I think earlier in the year and especially, we have been engaging in some marketing programs, different IR programs and things that I think over the course of time, we just decided we didn't need. And so that's why today, our overhead is pretty low. It's basically the four people here. And from a corporate side, it's the four people here on the call. There are payments that come up to us from the subsidiaries as well. So each of the three subsidiaries is self-sufficient in terms of its costs. And, there's like some small things that we outsource on a monthly basis that can be terminated with 30 days notice if we needed to, but overall, this is the league of the businesses again, I think in its history. Yes, because we remain to be pretty well capitalized, but Martin, I don't know if you have specifics on those professional fees. Sure, yes, I think the obvious the most significant change from last quarter is the addition of Metaverse Group and Hulk Labs. So these are the degrees, this increase is primarily just additional costs incurred within the Metaverse Group and Hulk Labs, which has to be consolidated into Tokens financial statements. So I think that that is the reason why there's an uptick there from last quarter. I think to your question Bill, between Hulk Labs and Metaverse Group might have been the only two technology companies this year who are actually hiring people and growing. And what I mean by that, it's not like we weren't grossly out in hiring a ton of people. But certainly there's like, three or four people at Metaverse Group that were hired, and two or three that were hired to Hulk Labs throughout the year, as those businesses continued to grow and have more demands in terms of human resources. Okay, great. And then last one, just before I head back into the queue is can you share some color in terms of the player onboarding at Hulk Labs? Subsequent to the quarter, you announced that more than 1000 players that are onboarded, where does that number sit today? And you previously gave guidance of trying to ramp it up to I believe, 10,000 players, how's that looking? Any color you can provide on that is great. Sure, so on the Hulk side, I think we're still kind of dedicated to growing the player base in the capital efficient way as possible. A few of the games we were playing during last few quarters were heavily reliant on couple of Token ecosystems that did not definitely not fare as well over the last couple of months and critically Solana. So, Solana based games obviously are denominated in price of Solana, which has taken hit more than other crypto tokens. So because of that, they temporarily some properly changed a bit. So we took an active decision to slow down player acquisition, because we're also really envisioning a bunch of really Top Tier mobile kind of mobile friendly play to earn games coming out in Q1. So the next three months, that we're kind of wrapping up for building tooling for so, the players today are higher than the 1,000 press release, lower than 2,000. But I think our goal really is the tooling is built for us to scale very rapidly from that sort of mid-range 1,000s to 10,000. The player demand is there, we're really just waiting for the right titles to jump into. So as those kind of appear, hopefully kind of in mid-Q1, that's where we're going to see sort of an uptick. Thank you. And at this time, I show no further questions in queue. I will turn it back to the presenters for closing comments. Yes, I mean thank you very much, everyone. I thank investors for their patience, certainly this has been, for myself as the largest shareholder has not been a fun year. We're working way, we're trying to build value in the company. I think if there's any further questions from anyone, please reach out to us. I think everyone has the ability to access us either contact tokens.com or me directly, and we can respond to further answers. But again, fingers crossed for 2023 is a better year and we'll keep an eye on that, so we have some exciting things in the works. Hopefully the market will recognize next year. Thanks.
EarningCall_1598
Okay. Good. We'll get started. Same thing. How about the Eagles, how about those birds. So guys, thanks for joining us today. Ryan MacWilliams, mid-cap Software Analyst here at Barclays. Welcome to Twilio, it's Jeff Lawson, Founder and CEO. Jeff, just had to say we talked about the Eagles, but I'm glad for your Michigan Wolverine… I know nothing about the NFL, but I'm a Michigan fan, and this is the best year in my recent recollections. Yes, good luck from there. So we'll be taking questions directly from the audience today. But if you do have questions, please e-mail me at ryan.macwilliams@barclays and get those in. So Jeff, I want to talk today about the tough macro environment. But I think an interesting story from your early years when you sold some wedding gifts in order to fund their early days in Twilio. How can we think about how it's looking to get back to that scrapping mindset in like the current present situation? Thanks. Yes. I mean I think that's a lot of what the current situation is about. Being frugal is one of our values. And at times, it's -- you think about frugality versus enterprise software and those things don't tend to think of those two together, right? And so that's been a little bit of a conflict. But for us, let me define what frugality mean, because a lot of people think, I mean don't spend money. Obviously, we need to spend money to make money. But frugality means really focusing on the ROI and making sure that all of your investments are actually worthwhile and being pretty rigorous about that. The example that I gave about frugality to employees from the early days of the company was when we had, I don't know, $100,000 in the bank, we're doing our first run of T-shirts for developers. And we had a choice between Hanes T-shirts, Hanes BCTs or like the American Apparel soft stuff, right? And Hanes costs $3 and the American Apparel cost $9 or whatever, or we did the American Apparel shirts and to me, that was frugal. Why? Those shirts got worn everywhere, every day, developers are asking, can I get another one? I’ve worn mine out. I would rather spend $9 and have something to get a huge ROI out of and $3 like that get sort of the trash. And so I give that example, which is to say frugality is about measuring the ROI. And to be frank, I think we grew pretty fast. And when you're growing as fast as we were, it is hard to have as much focus on ROI. And so now we've curtailed hiring, you saw that we did a risk back in September. And this is a period of time now where we're getting back to the fundamentals, not just like values and culture and things like that, but actually of the dollars and cents and measuring ROI of all those investments and the ones that don't make sense cutting and the ones that are making sense, we obviously keep doing. And that's the financial discipline that you want. I think we've been good stewards of capital. Historically, I do think the last couple of years, the growth did get pretty accelerated, but now we're really pulling it back and looking at those fundamentals every single day. Yes. I think you've seen definitely a pull forward in some of the growth in the messaging business. And I'm most surprised by the scale, right, in size and the momentum you've seen even as you doubled and tripled volumes there. So what -- about this business, particularly the unit economics make the core SMS business like so compelling? Yes. We have a communications business. We have a software business, we're building on top of the communications business. And the conversation with investors over the past several years has always been about like the size and scale of the communications business, how sticky that is, the gross margin of it and then the software business, which is how big is that, how fast can we grow it, et cetera. And at our Analyst Day last month, we did open up a bit more about the details of the communications business. And in particular, the conversation with investors over the past two years where we have seen a gross margin decline because of the rapid growth of our messaging business, in particular, our international messaging business. And investors have been concerned at the decline in gross margin. And so what we wanted to do is unpack it a little bit and talk about the unit economics, because the unit economics, we believe, matter here. And it's not an excuse to say we are not focused on building the software business. We are. But the challenge is when you just look at the gross margin of the company and you try to solve for like a monotonically increase in gross margin. In the quarter, where we have a $3.1 billion communications business and a $400 million software business. And the communications business keeps growing. And so in order to actually kind of predictably say like, yes, every quarter, the gross margin of the company is going to march upward, we would have to say, okay, we're done. We're not selling communications anymore. Like we just have to like zero out the new customers or not allow customers to grow and all that and you're like, well, in what universe does that make sense? Well, it will make sense if we don't make gross profit on those customers, once we want to open up and say like, look, this is a good business. So we opened up the unit economics. Domestically, in the United States, we make about quarter of a penny per message sent, that's the gross profit. Internationally, we make about half of penny per message, twice as much. And importantly, over the last two years, domestically, we've increased that gross profit by 10% and internationally, we've increased it by 25%. So there's been a lot of concern like, if gross margins are declining are you guys -- are your gross profit compressing, are you making less, is competition eating your lunch, like those kinds of questions. We want to show like, no, actually, we make half a penny in every message we send internationally, and that's actually increased by 25% over the last two years. So we don't see a reason to artificially curtail this business. But what we do need to do, while we continue to grow that, we do need to make that business profitable and grow that profit, get leverage on it, make it more and more and more profitable because it's a scale business and because it is one with a lower gross margin profile, there's even more scrutiny on the profitability of that business, great, like we are going to relentlessly focus on the profitability of the communications business, but we're not going to apologize for like adding yet another international SMS to the mix where we just made another half penny. Like, we think that's fine as long as we do that profitably. Flip side is we're going to put a lot of that growth energy of the company into the software business. And we already have -- we've been doing that for multiple years. $400 million software business is good. We think it can be a lot better. We'd like it to be growing faster. And so we talked about a number of changes that we're making in order to drive an acceleration of the software business while really focusing relentlessly on the profitability and the continued leverage growth of the communications business. Perfect. And I definitely want to get to the software side. But just sticking with the Communications business. I'm more surprised even in your early days how quickly you spread internationally, and how many customers you had and like all the different people in the world that were using Twilio. But from your perspective, like as you try to drive more profit out of that business, right, we're talking about growing in a healthier way, right? What can you do to maybe like more streamlined go-to-market there or just be able to better invest in so far? You know it's interesting, the roots of the company were really in product-led growth and in a very efficient distribution of our products. And in recent years, we did see an ROI of adding more sales capacity and of growing the sales cost, and so we did. Now I think that what we're looking at now is the way we are getting more efficient is really turning our energy of the company back towards product-led growth for communications. Really -- like, I think we are probably applying sales resources where they may not be needed to get the growth, because I think we see so much demand for the product. I mean you talk to sales reps that flies off the shelf. Like, great. What am I paying you for? Like just to be a little flippant. Obviously, our sales team does a lot of great work with customers. But when you've got a product that is flying off the shelf, really lead on that product-led growth. While the distribution calories in the company are really put towards that software stack, contact center, CDP, our engagement products like those are software products, they're sold to C suite members, and those are more what you traditionally think of as a B2B SaaS sales cycle. Great. Let's put our sales calories more there and lets -- let the Communications business lean on what are really the roots of the company anyway, product led growth, very efficient distribution, and that's the way that we're progressing the go-to-market function of the company. And Elena, our President of Revenue, talked about this transition at our Analyst Day last month. So you guys had price increases this year. And one thing I've thought about a lot is how you have this long tail of customers, right, that rely on Twilio and never think about going anywhere else. But do you think there's an opportunity there to maybe monetize the long tail customers better or improve margins there? You know I think there is. I think the energy of the company right now is probably more focused on the software selling and pulling the software products through. We've got the leading CDP product in the market, and the market is red hot for CDPs. We've got Flex, the contact center, which, from my perspective, four years in, is doing really well. It's at $100 million basically of ARR and for a SaaS product four years in, I think that's pretty good. I think it can be better. But I'd say the energy of the company is a little more into driving the software growth of the business. I think there are opportunities. I think we can get better. I think when we focused a lot of our energy on making the sales team successful in communications, there were product investments that we forgo because we're investing in actually sales. And I think now with a more product led growth focus, we can put those calories back towards some product improvements that can drive margin from long tail that can do a better job of cross selling the long tail in ways that when we put those calories towards sales, we may not have focused as much on. I think you guys did a great job in your Investor Day about explaining that shift, right, about focus on the go-to-market from communications to software, and how maybe it's better if you kind of separate that go-to-market and have dedicated resources. Can you talk about where we are in that shift and how you think that can really drive growth in the software business? Yes. Well, I'll talk about why I made the decision to change the go-to-market motion there. Because prior to midyear of this year, we had generalist reps who had everything in the bag and then we had overlay salespeople who could help with expertise in a contact center or the CDP or one of these other areas, but primarily, you had a generalist to own the sales cycle end to end and they had a lot of flexibility in terms of what products they were going to sell into in particular accounts. And the philosophy there is a rational economic engine to close deals and so they will pursue the opportunity inside of each account that makes the most sense for the company to grow revenue, grow the customer base. It's a good philosophy. But the thing it didn't account enough for was that we value software more than we value communications, just to be blunt, right? And our growth and our strategic objectives are in software and we did not torque the incentive plan enough to account for the fact that the communications products were basically flying off the shelf. And so -- and you also look at it, though, and you're like, well, the skills required to sell a contact center and a communications or sell a CDP, there is a lot of training. And there's only so much training a rep can have on different products. And while we did do that enablement and while we did torque the comp plans, we just realized it wasn't enough. We weren't getting the outcome that we wanted. And so what I decided to do midyear was to, first of all, make some changes in the sales leadership and second of all, was to go to a model where you've got reps who all they can do is sell Flex, the contact center. All they can do is sell segments in Twilio Engage, which is the CDP and our marketing automation platform and then you've got reps who can sell communications. And they can create leads for the others. But the reps who sell Flex and the reps who sell Segment, all they can do is close those numbers, they run those cycles from beginning to end. And we can control the outcome of how much Segment we sell and how much Flex we sell by how many AEs we put into those groups as opposed to the reps having more control over deciding which product they're going to sell to make their number. And that's a big change for the go-to-market and I think it's the right change after we analyze the dynamics that are happening in the field. I mean reps are excited about these products, but then push came to shove, if I've got a number to make and I can make that number with a large SMS deal, maybe I'll just do that and that's the dynamic we're running into. Yes, right. In 2021 was a year of a lot of growth. The pandemic saw a lot of demand for communications and our software products, by the way. But it's just like the messaging products we're selling quickly, the sales cycles are short, the ASPs are high and there's a lot of demand. And if I'm a rep, what am I going to do, right? It makes sense. And we thought we were accounting for that. And one of the things was -- I'm a software developer, right? So when I think about what is core to software world, it's agility, it's the ability to move on the fly, right? Sprint after sprint. And one of the frustrating things I found about sales compensation models is you can't change it on the fly. I kind of wish you could, I go, yes, that's not working. Let's change it next week. No, there's stability in those models. I get it, it is people's compensation and deal cycles take a while. So you can't just torque those things. And so we would continue torquing them year-over-year more towards software and do enablement, and all that kind of stuff, but we just realized it wasn't happening fast enough for our liking. So we made a structural change to saying, look, we have a dedicated team, a dedicated team. And now we can size and we actually move our sales capacity over to these products to continue to grow the capacity to sell them. And that is our mechanism to be able to control the -- and accelerate the growth of software and control that growth, which I think is much better than what we had before. And so that's why I made the decision. Yes. And I think people were surprised to see just 300 upsells of your core communications you've had based into things like Flex or things like Segment. But it also kind of works the opposite. Like if you attach Segment and Flex, you can get usage on the back… Yes, of course. So that 300 number was just the last couple of quarters. It's not like all time. But the other thing I will say is when you've got a big denominator of almost 300,000 customers, you're like, oh, my god. Well, when do we get to 200,000 contact center customers? I'm like, look, it's not a quantity game for like selling contact center or CDP, it's a quality game. And I look at some of the deals that we have announced on earnings the last few quarters. Fortune 100 insurance company, eight figure contact center deal, 20,000 agents, Fortune 100 retailer, eight figure Flex deal. I mean these are enormous ones. Fortune 100 Bank, these are substantial contact center deals, right? And so when you talk about 300 out of 300,000, you're like, oh my god, what's going on. And I'm like, what matters is that we're selling the right deals, the large deals, strategic deals into the right kind of customers and that's what I see happening. And greater than $10 million CapEx under deal, I mean that was a big take away for me for the Investor Day. I mean as a contact center guy, I can say nothing happens fast there, right… Yes, right. It takes -- and by the way, the revenue from those deals is basically unrealized because you close the deal, they implement, they go live. So that's not even represented in revenue numbers yet. Yes, and the usage that comes from along that. Just sticking with the Investor Day, I think people were surprised that there weren't targets for next year, they're expecting. And I understand what's the usage based model into a macro. But can you talk through that decision maybe not to provide those? And if there's anything today that's like unexpected about the macro at the back of your business? You know, we've talked about with the usage based model, there are some industries that have seen usage slow, these are the ones that have seen usage grow, right? And so like a classic trade off that we see in our business is we've got crypto customers, we also have traditional financial services customers. The crypto customers, usage is not looking so good but the financial services customers, usage is looking great. Why? Because in a dynamic market environment, people are checking their stocks a lot more, they're making trades a lot more, they're moving money a lot more, they're worried about this stuff, right? And so there's more usage of traditional financing, less usage of crypto, good for you all. I probably -- or maybe not, maybe you guys are doing crypto. But that's like a classic trade off that we're seeing. Retail, we were seeing a little bit of softness in, in terms of consumer buying. So we have some visibility into that. We've got some impact of the usage patterns. What we've generally seen, though, is that they often offset each other, right? Because when changes go out in the economy, it's usually not everything is down, it's like some things are down, some things are up. We saw this early in COVID, right? Early in COVID, ridesharing, not looking so hot, right? But then deliveries went through the roof, an offset, right? And so this is what we're seeing in our customer base today. We've talked about it, we talked about now for two quarters, and we'll keep updating investors on the trends that we're seeing sector-by-sector. And I think that just gives us pause like give big bold 12-month guidance when we are in a dynamic economy, it's just that doesn't feel like the right time to start giving longer term guidance, that would seem like we'd fill the IQ test if that was what we did. However, we have definitely heard, I just want to acknowledge this. We've definitely heard the feedback from investors that you want firmer targets on our profitability goals. So I just want to let you know, like we've heard the message and understand why you want more visibility and firmness on that. Like you want a number, not just the greater than zero profitability target. So understand the ask. So during COVID, I think that's a good example of like there are pockets of weakness, pockets of strength, but the overall digital economy search for in that period. I guess that would be helpful for investors now, like you're not seeing anything from the digital economy side of like kind of like the hangover effect from that or like broad weakness there. What I think we're seeing, investors have asked like, like was this just a pull forward of revenue, but like you're going to see -- and I'm like I don't think that COVID represented a pull forward. Like when I think about digital transformation projects that got accelerated by the pandemic, it's not like those projects go away. We have a usage based model. So once you've built these capabilities, whether it's more e-commerce, more delivery, more herbicide hiccup workflows, more telemedicine, all these kind of stuff. The grand scheme of things is like those use cases, the building of them got accelerated but now they're live. And then people keep building on top of them, right? What's next in these workflows, what's next in these things? And so I don't think the notion of -- like instead of a software sale, where you have a onetime sale, like think about on-prem software. I sold it today, therefore, I can't sell it to that same customer again for five years. In a usage based model, if we pulled forward them implementing a use case, well, great. Now we get that in perpetuity as long as that use case is still running. And now with the foot in the door, we get to go sell the next use case and the next and the next. And this is where our progress in becoming a more strategic partner of our customers, growing these accounts over the last two years, I think, is really important because, look, we talked about it at our Analyst Day, we've grown the number of customers that spend $1 million or more a year on Twilio. Two years ago, that was about 125 customers. Now it's more than 425 -- or 150 and now it's 425. $5 million or more. That was 17, now it's $65 million. $10 million or more. That was 7. 10 years ago, we had seven customers spending $10 million more. Today, 27 customers, right? So all of these metrics of large customer adoption of Twilio have grown substantially in the last year. And so to me, that's the benefit that the pandemic provided, not that there's benefits to a pandemic. But getting us in front of our customers in a time when building these things was incredibly strategically important. Yes, and doubled the penetration of Global 2000, but the number of substantial accounts we have has just grown tremendously over the past two years, and that is a great resource. Now in a period of time, you might see a little fluctuations. And Elena did talk about that in the current economy, we are seeing some slowdown in buying cycles in some of the software categories as I think a lot of software companies are seeing. So that's probably not unexpected in an economy and economic environment like this. But at the same time, what we are doing is pivoting our message to those customers of look, Twilio is going to save you money. Like this isn't a luxury item, this is actually a necessity in an environment like this, and we've correlated the use of our products with lowering customer acquisition costs and increasing lifetime value. And we have data point after data point after data point from our customer base to show how using customer data really well with the CDP allows you to actually lower your customer acquisition costs. We have amazing stories, Domino's Pizza, lowered their cost of customer acquisition and increased the return on ad spend. The ROAS went up by 700% after they put in a segment. So those are the stories we're leading with now, right? Yes, that makes a lot of sense. And just look, covering Twilio from a stock perspective for many years, right? It's always like what could political traffic be this year, and then like how bad is the comp the year after, right? But for this quarter, it seemed like there was a decision to step away from the nonopt in political traffic. Can you just kind of like talk about like what went behind that decision? Absolutely. So I made that decision after the 2020 election. Look, I was a big fan of this use case actually at Twilio for a long time. I saw -- Twilio was board in 2008, a presidential election year, we saw as a younger person, I was very involved in like phone banking and knocking on doors. And it's just like, to me, that's part of democracy. Reaching out to your neighbor and saying, this is what I believe, and like trying to convince people of ways that we can change our society through free and fair election. I mean that's just like fundamental. And when I saw customers starting to use Twilio, first for phone banking in like 2010 and then messaging starting in 2012, I was like, this is a great digital extension of democracy. I'm proud that Twilio being used in this way. Unfortunately, it works too well. And so in 2014 and then in 2016 and then in 2018, every year, the amount of traffic that political campaigns we’re sending with Twilio was growing and growing and growing. And the problem is they got to carve out when the laws were passed like TCPA that said politicians, candidates, they aren't subject to that law, kind of like that's an interesting carve out for you. And then they use that then as the excuse to say, we don't need to get opt in to text messages, we can just buy voter list that have a phone number and just go spray text messages. And unfortunately, the medium works too well, they were getting an ROI in terms of like outcomes, boats, donations, things like that. And as a customer -- as a consumer, I don't know about you all, my phone is blowing up now every two years, ask me to give money to candidates that are like running for things 4,000 miles from where I live. I'm like, what's going on here. We’re just buying this list. Consumers hate it and carriers have it. So creative friction with our carrier partners. It created friction with consumers. If consumers start saying, you know what, I don't want to text messaging anymore. I'm going to move it all of it like Facebook or WhatsApp or signal or one of those, like, well, that will be net negative for our business, right? And so in some ways we just made this decision that we want to help preserve the integrity of the channel by curtailing this activity, and we want to improve our relationships with our carrier partners. Because like the CEOs of carriers were getting these messages and sending it to their team has been like WTF, make the stop. And then they would just say, well, Twilio come on, and we'd say, the law is what it is, and we're kind of stuck in the middle. And we just said, you know what, we can get out of it. So despite the fact that I was actually proud of this use case for a while after 2020 change for mine and said, look, unless they prove to us that they're getting opt in, that's a different story. If you say I want to engage with this campaign, I want to give money to this cause, I want to do this, like, great." But the idea that you can just spray and pray to try to raise money or to get people to vote, that's not okay. And I think it was the right decision, still a lot of it went on in the recent election, they just switched to some other companies. And I'm kind of like, well, you know what, let those companies now go pick fights with carriers and consumers and all that, while we actually build a better platform as a result. As a [indiscernible] surprise but as a consumer with the PA phone number of Purple States, and I was getting like 10 a day, I was like this makes a whole lot of sense… And we've actually had an infrastructural later, started to put up more ways to ensure that there's only that good traffic. So that even if someone goes to another vendor, like we've got the exclusive toll free channel in the US. So if you want to use a toll free phone number, you have to go through Twilio. And so we can actually set the rules of engagement there along with our carrier partners. And so I think that corralling this into a more sensible world is a really good idea. It makes sense for the SMS channel on the health of that. Just you've talked -- you're pretty early coming out about SBC and how that was going to change in software. But with $4 billion in cash and cash equivalents on your balance sheet, like any thoughts there about strategic actions you guys can do or maybe help offset some of that dilution. Like how are you thinking about your strategic position here? Well, look, we raised the money primarily for M&A opportunities. Now I would be -- I think I would fail the IQ test if I didn't say if we went out and did some big M&A activity right now, our investors will be super excited about that, right? So look, I think we're realistic that we've got a lot to chew on. We're still integrating Segment in SendGrid even. And look, this isn't the environment for large M&A. So with that amount of cash, the question is what do you do with it. I think all options are on the table. Excellent. And we'd love to hear about some of your like signs of early momentum around Engage, right? And what are kind of your expectations for that for the next year? Yes. Well, we just launched the TGA a month and half ago, great early customers already. I was just out yesterday in the field, meeting with a big insurance company talking with them about Engage and Segments. And look, I think that we've got a great product here and the reason why Engage for anyone who doesn't know, Engage is our marketing life-cycle automation product. So basically, it takes in everything a company knows about a customer and designs a customized marketing journey for you using all the real time signals that a company can see about you and then using all the channels that they have to engage with you. Whether that's on the Web site personalization, mobile, text messaging, e-mail, advertising, every channel available brings it all into one tool. And the reason why this is so killer is that it starts with the data. There's been no shortage of software out there in the world that is like let's you design a marketing campaign and hits that. Obviously, that's been around for a long time. But as those solutions get more sophisticated and the buyers get more demanding, what do they need, they need more understanding of the customer. So people try to bolt on like data about customers. And they do these batch, then all we can batch upload your customer data once a week or we can ingest data with an API, but it takes us nine hours to make sense of the data. And Segment is this real time global Internet scale data ingestion and profile building engine. We have one customer, FOX Sports, who uses a Segment during the Super Bowl to understand those customers. They ingest 1 million events a second for FOX Sports. That's just one example. That's the scale. And then resolve those data points about each one of us, what we're clicking on, what we're viewing when we had paused when we -- whatever and turn that into a profile of us. We likely a sport channel. We are not a sports channel. We should -- we sold an upgrade to be a subscriber for the next 12 months or whatever else. That's the whole goal of taking those data points, turning them into profile insights about each one of us in real time that while I'm still on the site, still in the mobile app, you can take actions to personalize and try to make me a better customer. That's what Segment does. So the actual step of them saying -- and now take an action once you have one of those profiles changed with a new attribute, that's what Engage does. So Engage is so powerful because it started with the data, right, and a real-time Internet scale data ingestion and profile building engines and then buy an ad, send a text message, send an e-mail, right, do a personalization. That's the easy part. The hard part is adjusting that quantity of data at scale and driving insights from it. That's what we already had solved. And so that's why we're so excited about this product, because we've solved the hard problem. Now, the relatively easy part of like design e-mail and have get triggered, that's what we added with Engage. So really excited to bring this product to market. We'll say it's only six weeks into its GA. So we are still at the very early stages, but I think both our large Segment customer base can drive adoption of Engage because you've already got these customers with the data -- of the data there and the profile is there, so adding the next step is relatively easy. I also think Engage will then draw a lot of Segment purchase. Because you have to have a Segment to use Engage. So it's another vehicle and another buyer to go get to go pull in CDP in the company. So I think it's -- we're heading that from two sides. Yes. And another great product to move into more enterprise customers. right? So guys, we’re over time but appreciate Twilio being here. Jeff, thanks so much.
EarningCall_1599
Good day ladies and gentlemen, and welcome to the Raytheon Technologies Fourth Quarter 2022 Earnings Conference Call. My name is Latif, and I will be your operator for today. As a reminder, this conference is being recorded for replay purposes. On the call today are Greg Hayes, Chairman and Chief Executive Officer; Chris Calio, Chief Operating Officer; Neil Mitchill, Chief Financial Officer; and Jennifer Reed, Vice President of Investor Relations. This call is being carried live on the Internet, and there is a presentation available for download from Raytheon Technologies' website at www.rtx.com. Please note, except where otherwise noted, the company will speak to results from continuing operations, excluding acquisition accounting adjustment and net non-recurring and/or significant items, often referred to by management as other significant items. The company also reminds listeners that the earnings and cash flow expectations and any other forward-looking statements provided in this call are subject to risks and uncertainties. Raytheon Technologies' SEC filings, including its Form 8-K, 10-Q and 10-K provide details on important factors that could cause actual results to differ materially from those anticipated in the forward-looking statements. Once the call becomes open for questions, we ask that you limit your first round to one question per caller to give everyone the opportunity to participate. [Operator Instructions] You may ask further questions by reinserting yourself into the queue as time permits. Thank you, Latif, and good morning, everyone. I hope you've all had a chance to review our press release this morning. Before we get into the highlights, I'd first like to welcome Chris Calio to the call. As you know, Chris has been our Chief Operating Officer for the last year, has been responsible for our business units as well as our operations, engineering and digital functions. Effective March 1, Chris has been elected to the position of President and Chief Operating Officer of RTX. Chris has been instrumental over this past year in driving our focus on operational excellence and delivering for our customers in a very challenging environment. So welcome, Chris. Okay. Let's go to the webcast slide for Slide 2. We'll talk about some of the highlights for 2022. I don’t need to tell anybody that 2022 was an incredibly dynamic year. And I'm pleased to say that we were able to achieve, despite facing a number of significant challenges, including transitioning out of Russia, managing record levels of inflation as well as supply chain and labor constraints. With all that as a backdrop, we still delivered $67.1 billion in sales for the full year, which was up 6% organically and adjusted EPS of $4.78, which was up 12% year-over-year. We also returned almost $6 billion of capital to shareowners, which included $2.8 billion of share repurchases. And more importantly, even with the $1.6 billion headwind from the R&D tax legislation, we generated $4.9 billion in free cash flow, which exceeded our expectations. At the same time, we continue to position the business for sustained profitable growth. In 2022, we captured $86 billion in new bookings, resulting in backlog growth of 12%, a book-to-bill of 1.28 and a near record backlog at the end of the year of $175 billion. Additionally, we were granted over 2,600 patents last year. This places us in the top 10 of companies in the United States for the second consecutive year. While we invested $9 billion in R&D and CapEx, this allowed us to bring new technologies to our market and drive further automation and digitization through each phase of our product lifestyle from design, through development, through manufacturing and product sustainment. Our investment in recent awards supports our mission to create a safer and more connected world, which was especially true in 2022. Our products and technologies have been instrumental in helping the people of Ukraine defend itself. From the Stinger, Javelin and Excalibur to NASAMS and now Patriot air and missile defense system, we remain in lockstep with the U.S. government to ensure we can continue to support our allies. On the commercial side of the business, we saw continued advancements on our path towards leading the future of sustainable aviation with the start of development flight testing of the GTF Advantage engine, which, as you know, further enhances the GTF's position as the leader in fuel efficiency and CO2 emissions. Importantly, we also completed the first engine test run for our regional hybrid electric flight demonstrator. This system integrates a 1-megawatt electric motor, which was developed by Collins with a highly efficient Pratt & Whitney fuel burning engine, specifically adapted for hybrid electric operations. This new engine will reduce fuel burn and CO2 emissions by 30% compared to today's most advanced regional turboprop aircraft. These types of investments along with strong demand across both the commercial and defense end markets will position us for continued growth as we head into 2023. We're particularly proud that RTX outperformed among all companies in the Russell 1000 for local U.S. job creation in 2022. RTX leads the industry in employee giving and volunteering, which is a testament to the impact our workforce has in the communities where we work and where we live. Before I turn it over to Chris, I just want to spend a minute to talk about the status of our integration and the next steps as we evolve as a pure-play aerospace and defense company. As you know, in 2020, we brought together two great companies, UTC aerospace business and Raytheon. With combined strength, scale and capabilities that makes us uniquely equipped to innovate and deliver game-changing technologies and solutions for our customers. As we approach the third anniversary of this merger, we've accomplished many of our objectives, including exceeding our original synergy commitment, and we see even more opportunities ahead. So today, we're starting the next step in our integration and evolution. Our plan is to streamline our structure to a customer-centric organization with three focus segments: Collins Aerospace, Raytheon and Pratt & Whitney. This will better align us with our customers' needs and allow us to better collaborate on next-generation technology. There is still a lot of work to be done to make this happen, but let me turn it over to Chris to give you some of the additional details of this transformation and some additional business updates. Chris? All right. Thank you, Greg. It's great to join today's call, and I'm looking forward to engaging more with everybody. I'm starting here on Slide 3. Over the past year, I've been focused with our team on driving operational performance and program execution as well as identifying ways to improve our cost position and to ensure alignment between our investments and our strategic priorities. As Greg noted, our merger integration is nearly complete, having realized gross cost synergies of $1.4 billion. And so we are now in the process of realigning RTX into three business units. Let me give you some additional color around our thinking on this. At its core, this move is about enabling us to better coordinate with our customers, aligning with their needs and collaborating more effectively across our businesses, all of which is feedback we've received from our customers. All of this will ultimately enhance performance, make us even more competitive and allow us to capture additional revenue synergies in areas such as connected battle space. For example, just this past year, we were awarded a phase of the JADC2 effort known as TITAN, where RIS and Collins are working together to deliver this cutting-edge solution to ensure our joint forces have one common operating picture of the battle space. Additionally, this realignment will allow us to better leverage our scale so we can optimize our footprint, improve resource allocation and reduce costs for both RTX and our customers. Now we don't have a number for you today in terms of cost savings as we are in the early stages of that analysis, but we do believe there are additional material opportunities to be realized. Commencing with this reorganization, Roy Azevedo, President of RIS business, informed us of his plan to retire. Roy will, however, stay on as an adviser over the next several months to help us with this important transformation. Shawn Mural, currently the CFO of RI&S, has been made acting President of RIS, effective February 1. While organizational changes like this are never easy, we have demonstrated our ability to successfully execute on these types of initiatives in the past. And many members of the team involved in this process have experience from our recent portfolio and merger transformations. The exact timing of this change isn’t final yet, the current plan is to make it effective during the second half of the year. Until then, we'll manage the business under our current structure. We'll provide updates on our progress over the coming months. Before I turn it over to Neil to discuss our results for the quarter and the outlook for the year, I want to turn to Slide 4 to share some of our critical assumptions for 2023 and the areas where we're focused to ensure we execute on our commitments. As Greg mentioned earlier, customer demand for our products and services continues to grow. In Commercial Aerospace, we expect global air traffic to fully recover to 2019 levels as we exit 2023 with continued strength in the U.S. and Europe. This is pretty consistent from what we're all hearing from the airlines. And like everyone else, we're keeping a close eye on China, which historically has represented about 14% of global air traffic. Our working assumption today is that China's lifting of COVID restrictions continues to be manageable and its traffic levels will remain robust. We also assume traffic in other parts of the world remain resilient. We are, therefore, expecting commercial aftermarket revenue growth across our aerospace businesses to approach 20% in 2023. Commercial production rates are also quickly accelerating. We expect commercial aircraft volumes will be up around 20% year-over-year. On the defense side, our backlog is expected to continue to grow given the heightened and increasingly complex threat environment. In the U.S., we continue to see strong bipartisan support as evidenced by the adoption of the Defense Authorization Bill and the Omnibus Appropriations Bill with a budget of $858 billion, which is up about 10% from 2022. In overseas, the EU is targeting a €70 billion increase in defense spending over the next three years and Japan will increase their defense budget by 26% this year. Given our current backlog and this continued strength in demand, we remain extremely focused on execution, and I see four key actions that will position us to be successful on this front. One, we continue to grow production capacity to deliver on this backlog as we move through 2023 and 2024. For example, we've made investments in key strategic locations like Asheville, North Carolina, for turbine airfoils, the Kinney, Texas for RF and EO/IR products and Bangalore, India to expand the Collins India manufacturing strategy. Second, we, of course, need a skilled workforce to execute our development and production programs. Labor availability remains a constraint. We've made some progress across RTX in Q4 through reduced attrition and other strategic retention and recruiting initiatives. Third, we need to continue restoring health within our supply chain. We've actively maintained a physical presence at close to 400 supplier sites. We continue to qualify additional suppliers on key programs. We secured sources of supply for critical commodities. While we are broadly beginning to see our supply chain improve, it is not yet at the levels we need, we are assuming a recovery as we move into the back half of the year. And lastly, we are taking a number of actions to deal with the elevated levels of inflation that everyone is experiencing. For perspective, we are expecting roughly $2 billion of labor and material inflation in 2023. And we are targeting to more than offset this headwind through higher pricing and aggressive cost reduction actions across all RTX. Some of these actions in the category are blocking and tackling, such as continual process improvement and some are more strategic in nature, such as driving productivity through increasing the amount of connected equipment and automated factory hours. There is no doubt, we've got a lot of work in front of us, but I think we all believe we've got the right actions identified, and more importantly, the right team in place to do it. So with that, let me turn it over to Neil to look at our financial results and outlook for 2023. Thank you, Chris. Let's turn to Slide 5. I'm pleased to see how we finished the year where we continue to see solid growth in organic sales, and adjusted earnings per share and robust free cash flow in the quarter. Fourth quarter sales of $18.1 billion grew 7% organically versus the prior year. This growth was primarily driven by our commercial aerospace businesses as the continued recovery in commercial air traffic more than offset the supply chain and labor challenges we saw during the year. Adjusted earnings per share of $1.27 was in line with our expectations and up 18%, led by the commercial aftermarket at Pratt & Collins, which more than offset the impact of lower productivity in our defense businesses. On a GAAP basis, earnings per share from continuing operations was $0.96 per share and included $0.31 of acquisition accounting adjustments, restructuring and nonrecurring items. It's worth noting that both GAAP and adjusted earnings per share had a tax benefit of about $0.06 associated with legal entity and operational reorganizations, which were completed during the quarter. And finally, we had free cash flow of $3.8 billion in the quarter, bringing our total cash generation for the year to $4.9 billion which exceeded our commitment as a result of stronger collections, particularly in international areas across the portfolio. With that, let's turn to Slide 6, and I'll get into the segment results. Starting with Collins. At Collins sales were $5.7 billion in the quarter, up 15% on an adjusted basis and up 16% organically, driven primarily by the continued recovery in commercial aerospace end markets. By channel, commercial aftermarket sales were up 21%, driven by a 32% increase in provisioning and a 25% increase in parts and repair, while modifications and upgrades were up 5% organically in the quarter. Sequentially, commercial aftermarket sales were up 6%. Commercial OE sales were up 20% versus prior year, driven principally by the continued strength in the narrow-body. Military sales were up 5%, driven primarily by improved material receipts, higher volume and new program awards. Adjusted operating profit of $743 million was up $274 million from the prior year as drop-through on higher commercial aftermarket volume and lower R&D expense was more than offset by higher SG&A expense. So shifting to Pratt & Whitney on Slide 7, sales of $5.7 billion were up 10% on an adjusted basis and up 11% on an organic basis, with commercial OE sales growth in large commercial engines in Pratt Canada as well as higher commercial aftermarket volume. Commercial OE sales were up 37%, driven by favorable volume and mix within Pratt's large commercial engine and Pratt Canada businesses. Commercial aftermarket sales were up 11% in the quarter with growth in both legacy large commercial and Pratt Canada shop visits. Adjusted operating profit of $321 million was up $159 million from the prior year, driven primarily by drop-through on higher commercial aftermarket, which included a favorable contract adjustment that was partially offset by higher SG&A and R&D. Turning now to RI&S on Slide 8. Sales of $3.5 billion were down 8% versus prior year on an adjusted basis, driven by the divestiture of the Global Training and Services business in the fourth quarter of 2021. On an organic basis, sales were down 5% versus prior year, driven by command, control and communications, cyber training and services and sensing and effects. Adjusted operating profit in the quarter of $278 million was down $122 million versus prior year. Excluding the impact of divestitures, operating profit was down $96 million, driven primarily by unfavorable mix, lower net program efficiencies and lower volume. RIS had a $2.9 billion of bookings in the quarter, resulting in a book-to-bill of 0.92 and a backlog of $16 billion and on a full year basis, RIS' book-to-bill was 0.96. Turning now to Slide 9. R&D sales were $4.1 billion, up 6% on an adjusted basis and up 7% organically, primarily driven by higher volume in Naval Power programs including SPY-6 production, higher volume in Strategic Missile Defense, including Next Generation Interceptor development and higher volume and advanced technology programs. Adjusted operating profit of $418 million was $68 million lower than the prior year, driven by unfavorable program mix and lower net program efficiencies, partially offset by drop-through on higher volume. RMD's bookings in the quarter were $6 billion for a book-to-bill of 1.48. And for the full year, RMD's book-to-bill was 1.37, resulting in a record backlog of $34 billion. So with that, let's turn to Slide 10 to discuss the financial outlook for the year. At the RTX level, we expect full year 2023 sales of between $72 billion and $73 billion, which represents organic growth of 7% to 9% year-over-year. From an earnings perspective, we expect adjusted earnings per share of $4.90 to $5.05, up 3% to 6% year-over-year. And we expect to generate free cash flow of about $4.8 billion. I should note, we are not assuming the legislation requiring R&D capitalization for tax purposes will be repealed in our outlook. And as a result, in 2023, we'll have a cash payment of about $1.4 billion related to the current law. While there are more details on the cash flow walk in the appendix, let me share a few of the moving pieces. First, we are expecting segment operating profit growth. Offsetting that will be increases in working capital, capital expenditures as well as a lower pension cost recovery. Additionally, we're expecting to buy back approximately $3 billion of RTX shares in 2023, of course, subject to market conditions. Now getting into the details around the earnings per share walk, starting at the segment level, we expect strong operating profit growth of about 20%, which results in about $0.77 of earnings per share growth at the midpoint of our outlook range. And as Chris noted earlier, this overcomes about $2 billion of material and labor inflation. And with respect to pension, although markets have improved since we spoke in October, pension will still be a substantial year-over-year headwind. Based on actual 2022 asset returns and where discount rates ended the year, that headwind will be about $0.22. Our tax rate in 2023 is expected to be approximately 18% versus the 14.4% we saw in 2022, which will result in a $0.22 headwind. This change is primarily driven by benefits recorded in 2022 that likely won't repeat in 2023. And to wrap things up, we see about $0.14 of net headwind year-over-year, primarily driven by higher interest and corporate expenses, and all of this brings us to our outlook range of $4.90 to $5.05 per share. So with that, let's go to Slide 11 for a little more detail on the segment outlooks. At Collins, we expect full year sales to be up low double digits, primarily driven by continuation of the commercial aero recovery. Military sales at Collins are expected to be up mid-single digits for the year as well. We expect Collins adjusted operating profit to grow between $750 million and $825 million versus last year, and this is primarily driven by drop-through on commercial aftermarket, higher OE production ramp and increased defense volumes. At Pratt & Whitney, we expect full year sales to be up low to mid-teens versus prior year, principally driven by higher OE deliveries in both Pratt's large commercial engine and Pratt Canada businesses, as well as continued growth in legacy large commercial engines, GTF aftermarket and Pratt Canada shop visits. Military sales at Pratt are expected to be flat, driven by higher F135 sustainment volume, which will offset lower F135 material inputs. We expect Pratt's adjusted operating profit to grow between $200 million and $275 million versus last year, primarily on higher aftermarket volume, which is partially offset by a higher large commercial OE delivery impact. Turning to RI&S, we expect full year sales to be flat versus the prior year and adjusted operating profit to be up between $75 million and $125 million, driven by improved net program efficiencies. And in R&D, we expect sales to grow low-to-mid single digits versus 2022 as the effects of the supply chain constraints ease in the back half of the year and for adjusted operating profit to be up between $175 million and $225 million versus prior year, driven by improved net program efficiencies, which will be partially offset by continued mix headwinds. And finally, higher intercompany activity will increase sales eliminations by about 10% year-over-year. And it's also worth noting, we've included an outlook for some of the below-the-line items and pension in the webcast appendix. Okay, Neil, thanks very much. So we're going to close out on Slide 12 and take a quick look at our priorities. Obviously, there is no surprises here. As we head into 2023, I would tell you the future remains bright for RTX, especially with a $175 billion backlog and strong demand in all of our end markets. We also know the challenges that we saw in 2022 will continue, and we'll keep working to mitigate the big three that we continued to focus on: supply chain, labor and inflation. And although we're monitoring the macro environment, we remain optimistic on the economic outlook as the demand drivers for our businesses remain incredibly strong. As Chris mentioned, we're actively preparing for the demand ahead by expanding capacity, investing in digital solutions and leveraging automation to unlock efficiencies across our value streams. We have the right team in place, and we're making the right investments. And we're also taking proactive actions to mitigate the risks we see today and to ensure success not just in 2023 but beyond. The streamlining lining of our businesses is just the next step in our journey on leveraging the unique scale and capabilities of RTX to deliver value for our customers and our shareowners. Right now, it's all about program execution and managing costs. We have the backlog, we have the demand, and we have the technology and our balance between defense and commercial aero will help us navigate into the future. We will, of course, continue to stay disciplined in capital allocation, and we’re going to generate strong free cash flow this year and beyond, all of which enables us to return significant value to our shareowners. Most importantly, we remain confident in our ability to achieve our 2025 targets. We’re going to provide an update at our upcoming Investor Day, which will be on June 19 at the Paris Air Show. Before I close, I really want to say a special thank you to Roy Azevedo for his many contributions to Raytheon over these past 34 years. Roy has been a key member of our senior leadership team at RTX for the past three years, and we wish him nothing but health and success as he moves into the next phase of his career. Greg, just like to follow-up on your final comment there on your confidence in 2025, whether there’s confidence has been shaken anyway by this change in the R&D tax legislation but also the supply chain challenges because you basically have to double the cash flow between now and then to get to your target. Rob that is a great question, one that we have been working through over these last couple of months. We obviously thought going into the end of 2022 that the tax legislation, the R&D amortization would get eliminated. Unfortunately, that didn’t happen. That cost us $1.6 billion last year. As Neil said, it will be another $1.4 billion. And as we go into the 2025 time frame, that drag will still be about $1 billion, about $800 million of that is actual net R&D deferral and there’s a couple of hundred million dollars of additional interest expense and financing our little loan to the government. So is all that being equal, we still see – and we had always talked about a $10 billion free cash flow in 2025. Realistically, I think that number is going to be $9 billion. Now most of that growth from, let’s call it, $5 billion this year to $9 billion is going to come from segment operating profit. We should grow between 2022 and 2025 by about $5 billion. And that just assumes an execution on the current demand that we have in backlog, right? That’s – there’s nothing else magic about that except the continued return of people flying and the defense budgets remaining very robust. So we see a path to the $9 billion. I don’t see a path to the $10 billion today because of the R&D. But it’s a long time, maybe we hope that people in Washington will understand that they’re making a very, very bad tactical decision here and not allowing us to deduct R&D, but it is the reality that we face today. Hi, good morning, guys, and thank you. Maybe a little bit more focus on 2023. You mentioned 400 suppliers in the supply chain. How are you expecting the supply chain to unravel across both the commercial aerospace and defense segments? And you mentioned $2 billion of inflation headwinds. Can you talk about the impact of pricing on a net basis and across the businesses, maybe where you’re seeing the most impact? Hey Sheila, it’s Chris. I’ll start with this one and then invite Neil and Greg to chime in. So let’s talk about supply chain for a minute. Maybe start with the positive, which was – saw some stabilization as we exited the year last year. If you look at R&D, material receipts were up 30% Q3 to Q4. Supplier delinquencies were down. At Pratt, we saw some uptick in casting deliveries. So those are some of the green shoots that we saw at the end of the year. But I’ll tell you, it’s not where we need to be, especially for the back half of 2023. The kinds of things that we’re focused on, candidly are the things that we can control. We’ve got the people on site, as you mentioned, and they’re responding to engineering and quality issues, giving us better visibility of what’s going on. We’re leaving bottlenecks and also finding issues earlier than perhaps we were previously giving us more time to react. We qualified some additional suppliers and negotiated additional LTAs. I think we did about 400 agreements last year with about $1.8 billion in annual spend. So again, giving our suppliers better visibility into our demand and what we’re doing. And then candidly, we’re taking some actions in our own house to better enable supply chain performance, small things like reducing the time it takes to place a PO to perhaps more complex things like engineering changes to improve the yields on some of our complex parts and ensuring we’ve got sort of a stable configuration as programs move from development into production. So those are all the things that we’re focused on continue to drive health and supply chain. But you’re right, we’re going to need it to perform to hit these numbers we’ve got here in 2023 and beyond. So Sheila, the other question you had there was on inflation. And I think, again, we – the $2 billion of inflation is a real number we saw it last year. We were able to overcome it through cost reduction as well as some additional pricing. And again, we will see pricing benefits again in 2023, especially on the commercial aftermarket side. Keep in mind also on the defense side about 1/3 of our business is cost type, cost reimbursable and so some of that inflation gets passed automatically along to our customer at the Department of Defense. As I think about that $2 billion, right about $1.2 billion I think Chris said is product related and about $800 million of that is people cost. And that is a real number. We’ve got roughly $20 billion in compensation costs across RTX that’s about a 4% increase year-over-year for $800 million. It’s a big number. But again, we’ve got plans in place for cost reduction both in the supply chain and in the factories as well as in the back office. And some of this transformation activity that Chris mentioned with the realignment of the businesses will also present us an opportunity to get after some of that cost. So it’s real, but we’ve got plans and I think we have more than provided for that in the guidance that Neil covered. Good question for you about this restructuring reorganization, I guess, in the defense business in Raytheon. I think we all understand that you’ll get cost synergies out of it. But if you look at RIS in the quarter with the sales down 5%, how does the reorganization boost sales synergies. I think that that’s the first question. And then the second question is, I mean it’s really – I mean, how do you boost that? And then the second question is, is there some restructuring that actually has to go on in that portfolio? Because are there some businesses in there that are just structurally lagging? Hey Ron, it’s Chris. Maybe I’ll take a crack at the sales synergy. So again, as we kind of said upfront, this is about taking the organization to the next level, right? You got a tremendous defense backlog, something like $70 billion RIS R&D. And this is really about enhancing customer alignment and coordination. We’ve had customer feedback throughout the last couple of years about the need for us to figure out how to better integrate some of our solutions, providing mission solutions to the customers, coming in with a unified narrative and an investment story. All of these things, I think, will enable us to work better and frankly, collaborate better across businesses. In large organizations like ours, you won’t be surprised to hear that sometimes there’s some friction there, and we think this will help remove some of that friction and again, provide better solutions to the customer. So thus far, the customer feedback, those that we’ve spoken to sort of see that potential and it’s up to us to execute on it. As of the portfolio, I think, again, RIS has a very strong portfolio. Book-to-bill was 0.96 not necessarily where we wanted. We had some campaigns push out of the year, but feel really strong again about the portfolio, and we’re going to continue to invest in it. Ron, let me just jump in and add to that. As we look at this reorganization, this is not just about putting RIS and RMD together to recreate the old legacy Raytheon Company. We’re going to look to take the entire portfolio of RIS, Collins, RMD and move the pieces where they most appropriately align from a technology and a customer standpoint. So you may well see pieces, especially related to JADC2 moving into the Collins business. We’ll see how all of this evolves over the next several months. I would tell you by the time we get to the end of the first quarter, we should have a really good understanding of what the new organization is going to look like. We’ll share that with everybody at that point. It’s going to take us longer than that to actually do the rewiring that’s why we’re talking about kind of a mid-year. But I agree with Chris. I think the portfolio that we have across the legacy Raytheon and Collins business is really quite strong. And the book-to-bill we’ll be – we’ll get better at some of those legacy RI&S businesses, especially in the Space segment. I would also tell you that the performance in Q4 was not great, but it was really program – legacy programs from many years ago that we still have not completed. So there’s some work to do there. But I would tell you the portfolio is not broken or the business is not broken. Good. Recognizing that there’s multiple top line inputs that are out of your control at the moment, which of the 2025 segment margin targets hold and which do not at this point? Because in the two aerospace segments, the 2024, 2025 incrementals required to get there are a lot better than 2023. And then obviously, on the defense side, it requires a pretty big step up. So help me with that math? And I guess, just what’s the latest medium-term outlook for each of the segment margins? Yes. Noah, let me take a stab at that one for you because as you look out to 2025, clearly, we’ve had in 2022, some supply chain and labor impacts that have kind of caused us to come in a little lower than our initial expectations. However, when you think about that backlog that we’ve been talking about, it’s $175 billion at the company level, $69 billion, $70 billion within the defense. We have a lot to deliver ahead of us. And so I think there’s going to be some puts and takes as we look at the segments on an individual basis as you get out to 2025. But as I step back and look at the totality of RTX and where we projected to be and where we’re aiming to go and with that backlog, we feel confident that we can get there. We can get the sales growth, get the earnings growth and Greg already hit on the cash flow pieces there. So some things have changed since we’ve talked in 2021. We’re certainly dealing with a lot more inflation, but we’ve also got the situation in Ukraine that has given R&D some tailwinds. So when we get to June, we’ll be able to lay out that in more detail. It also be aligned with the format of our new operating segments at that time. But I think there’s going to be some puts and takes, but we’re all focused on driving margin improvements and making the right investments to drive that automation in the factory and digitization. I should add to Greg’s comments earlier about the free cash flow walk. We’ll probably see about $0.5 billion of capital headwind between 2022 and 2023. So making the right investments. I’m really focused on earnings growth and conversion to cash and so we’ll see where the margins land, but I do think we’re going to get that earnings growth. Is it your anticipation that you’ll have a few hundred basis points of defense segment margin expansion over the next few years? And is that all cost or is that mix? Or is it not dealing with supply chain? Or how do you do that? It’s – I would tell you, it is a combination of all of those things. It’s supply chain getting better, which allows us to see productivity in our factories. It’s also – as we move from these LRIP contracts, initial rates of production on LTAMDS and SPY-6 and others to full rate production to see an improvement in margin on the production side as well as the mix of DoD versus international sales. Today, we’re actually at a low point of about 30% at RMD of international versus DoD sales that actually transitions back towards a more historical level 40%, 45% as we do more exports, especially around LTAMDS and some of these new systems. Greg, I want to say in RMD. You’ve just up low to mid-single digits on an organic basis. Just in the backdrop, it seems like it should be potentially better than that. Obviously, wondering if you could just kind of parse out how much is being impacted by the supply chain. And if – just when we think about all the DoD potential replenishment activity, plus you’ve got strong demand from NATO allies. Just a lot of opportunities for the space, it feels like you should be having a more potentially sustained top line growth. Maybe just your thoughts on that over the coming next couple of years. Thanks. Peter, I think you’re spot on. I think as we look at 2023 and then 2024, there is more growth potential at RMD than there probably is any business outside of Collins just because, again, the backlog is so strong. I would tell you, given the challenges that we saw in supply chain last year and driving material in, I think we’ve taken a more conservative view of 2023 performance there. I think total material inputs at RMD last year were around $6 billion. This year, we’re looking at about $6.5 billion. But quite frankly, the demand is out there for more. So that $6.5 billion should also drive some productivity, $100 million to $150 million. Again, I think that’s actually light by historical standards, but we’re – I hate to say that we’re conservative again and again. But really we set these targets. So we think we can absolutely deliver. We’re not going to have to go back and relook at these in the middle of the year. But there is certainly the demand out there for higher top line and that would result in higher bottom line. But most of that growth, I think, will come in 2024 when we really see supply chain back to where we had seen it pre-pandemic. And that is the key for RMD. They’ve got the orders. We’ve got the capacity. We just have to bring – drive the material in and that $6.5 billion that we see next year is going to have to continue to grow significantly to meet the demand out there that we see. Thanks. Hey, good morning. And Greg, just a follow-up first. I think you just said RMD might have the fastest growth outside of Collins. And I just wanted to clarify, is Pratt still the faster growing of the two? Or is Collins now faster growing? From a bottom line perspective, it’s going to be Collins, right? I think, again, top line, you’re going to see – what is the number, Neil, for 2023 here for Pratt? For 2023, they’ll be up low to mid-teens. So very substantial growth for 2023. And sort of as you look out over the next several years. These – all four businesses are in the same ZIP code of high single-digit type of sales growth on a CAGR basis. Got it. And maybe a more detailed question on Pratt. If you can just give a little color on where GTF is in the aftermarket composition where legacy higher-margin aftermarket is in that composition? And how those two play out over the next several years? And also how the GTF aftermarket is trending versus your sort of assumptions of profitability on those long-term contracts? Myles, this is Chris. Maybe just as a step back for a minute on GTF. Demand remains really, really strong. As you know, we continue to do the block upgrades to drive improved time on wing obviously, improve time on wing helps with their contract profitability. We continue to incorporate upgrades to sort of improve the customer experience. On the aftermarket side, in 2022 turned slightly positive. And so from this point, it’s about accelerating those margins. You’re going to see that through some better contract mix as we talked about back in Investor Day in 2021. You’re going to see that through increased time on wing through some of these upgrades. And so the GTF aftermarket profitability is something that is of high focus at frac given the growing installed base, get about 2,500 engines out there and a very large backlog. So GTF aftermarket is a huge driver. And maybe I’ll just put a couple of financial numbers around that to help out a little bit. But at Pratt for 2023, we think the aftermarket there will be up between 20% and 25% from a sales perspective. So think about the legacy shop visits being about 15% to 20% up year-over-year. On the OE side, that would imply about a mid-teens sort of a sales growth there. So we see strong growth, obviously, in the commercial business. And I guess while I’m on Pratt, I’ll just throw out a couple of the Collins numbers just so everyone has them. In their aftermarket business, think about that as being up sort of low double digits to low teens, sequentially kind of growing in the low single-digit percentage kind of range. And on the OE side, up low to mid-teens year-over-year. So again, with all that OE growth that we see across the narrow and wide-body platforms, you’ll see that both at Pratt and Collins. Greg, I guess following up on that. Could you just comment where you are on, I guess, across mainly Collins, but also touching on Pratt, where you are relative to the manufacturer stated rates, I guess, in particular on the MAX in the low 30s, A320 in the mid to high 40s and 787 around two a month. Thanks. David, it’s something we focus a lot on. Obviously, we are, I would tell you, at Collins and at Pratt in lockstep with Boeing and Airbus in terms of their production rates. Obviously, some of the challenges that we’ve talked about at Pratt on the supply chain with structural castings is limited, I would say, some of our ability to meet some of the demand out there. That’s starting to ease. And again, we are working very closely with Airbus on the A320 production rate. As far as 737, that’s really a Collins story. And we – the outlook that Neil talked about, that assumes those rates that you talked about around 31 aircraft or so a month on average. I think they were a little light on that in the fourth quarter, but we think we’ll get back to that. They still have roughly 200 aircraft that be delivered that are in inventory, too, from when the line was shut down, which, again, also is part of Collins’ upside for the year. As far as 787, we see that, as you said, I think it’s one a month going to two a month and perhaps up to three. Again, I think that’s – that will all depend upon Boeing’s ability to continue to get the aircraft out the door. But we are working with them on a daily, weekly basis to make sure that we can support them. But we don’t see anything in our supply chain today that would prevent us from delivering either at Boeing or Airbus to the rates that they need. Great. And Greg, could you just comment on the interiors business, how that’s doing? Is that – if you’re starting to see a pickup there from the widebody side? Thanks. Yes. It’s – David, it’s one of those things, it is probably the slowest recovery of all of the Collins businesses to your point because it is primarily widebody. And as the airlines were conserving cash for these last couple of years, we saw sales down significantly. We don’t expect a recovery in the interiors business, literally over the next three years. So it gets better, but it’s still not back to what it was pre-pandemic. It’s – it will remain a challenge. Yes. Thank you so much. So cash flow – in the fourth quarter, you had a $900 million uptick in payables, a huge uptick in contract liabilities and yet inventory where you normally get a benefit in the fourth quarter were actually up a bit. Maybe comment on some of those trends and how that translates to a flat year in 2023. Thanks, Cai. Good morning. Let me start on 2022 and where we ended the year. You’re right, the inventory was up. I would say most of that was at Pratt and Collins as you think about the backlog, the growth rates we just talked about on the commercial aerospace side and the supply chain issues that we’re all working to overcome. We were pretty strategic in our thinking around making sure we're bringing the materials and so that we can deliver and meet the customer commitments. You pointed out the accounts payable growth there. So not all, but a large portion of that inventory growth was sort of offset by the payables to kind of go along with that. On the advances side or the contract side, really that was driven by some – a couple of large international advances that we received in December. That contributed to our overdrive of free cash flow, which was about $500 million relative to our expectations. That will be a drag on working capital as you get into 2023. And as I look at the 2023 free cash flow, we see a little bit of headwind on the working capital, in part because of some of the advances that we got at the end of 2022. And I'd say in part because we're going to continue to be pretty strategic about making sure that we bring in parts and materials where we need them and where there's constraints and bottlenecks in the supply chain value stream right now. So on balance, we're always targeting to take that inventory balance down, but we want to be smart and make sure we have the products so we can deliver it. We will be seeing improved velocity through our factories as we go through 2023. So I'd expect the turns to improve here. But all eyes on the inventory management for sure, and then managing through the collections as we get into 2023 at our international customer sites. Greg and Chris, hey, following up on the supply chain what issues did the same versus 2022 versus what issues are different, I mean considering the strengthening visibility on demand, I would have assumed that we've seen a lot more improvement by now. So what's the root of the problem? And can you provide more details on the actions you're taking to get this resolved by the second half of the year? Hey Kristine its Chris. So I would say the constraints are those that we've talked about previously. I said that we saw some improvement on castings, but it's not where it needs to be, so casting is still there. Rocket Motors continues to be a pacing item at R&D. And microelectronics, while the lead times have stabilized, they haven't come down and back to 2019 historical levels. And so those are sort of the three main areas that I talked about. We've talked about in the past that continue to be a headwind as we're moving into 2023. In terms of the specific actions, I talked about a few of them earlier. But again, some of this is what I would call blocking and tackling in the factories, whether it be ours or our supply chain. And I mentioned that before in some cases, we'll try to make an engineering change to improve producibility and ultimately yield. In other places, we just need to be in with our customer answering quality questions and making sure we can help them relieve bottlenecks. On microelectronics, a lot of that was about really the supply base, understanding our demand and then working some interesting agreements, negotiated agreements on making sure that we had our priority place in line and we made sure that we had our right allocation. With what you're seeing on the consumer side in terms of microelectronics coming down, we expect to see our allocation get better in that area, but again, still not where it needs to be here in 2023. We are assuming a back half recovery. So certainly not all is lost, but it will be the man-to-man defense here to get to that point. Thanks Chris. And Greg, maybe a follow-up; you mentioned on your commentary on commercial large structural casting. It sounded more constructive today than your commentary in previous quarters. I was wondering what changed in the supply chain that you're seeing to make you more confident? How much of that is the OEMs walking away from, like Airbus walking away from the 75 per month versus you're seeing that ease through investments they're making or maybe labor easing? Well, I think, Kristine, if you think about the structural casting issue, we're not out of the woods, as Chris said, but it has certainly gotten a lot better from where we were a year ago today. And we continue to work with the suppliers there, primarily around the requirement side, making sure that the specifications that we're flowing down are actually producible in the supply chain. So that's giving us this confidence. But as Chris said, it's going to be the end of 2023 before we see structural castings back to 2019 levels. Again, we've got confidence they have been bringing people on, they have been training people. We have folks out there helping them. But all of that would support the OE rates that we need to support for 2023. No. I would just support you said, Greg, that our supply chain is bringing in labor, they're starting to see more success on that front. But in some cases, like take casting, this is a pretty complex process. And there's a learning curve for folks that you bring in and take some time to come down that learning curve to get to a level of productivity that we need to see for the improvements here; but again, focused on that in the back half of 2023. Thank you. Good morning. On Pratt, you're talking about 15% to 20% growth in the aftermarket and the legacy programs this year. One of the things that we've been concerned about has been capacity constraints just it's taking longer if they get a V2500 into a shop for an overhaul and longer to get it through. When you look at that upside you're forecasting, how are you thinking about the capacity issue labor availability? And is there potentially further upside from that if you can actually get – have more success there? Doug, let me start with that, and maybe Chris will add. So as we think about the outlook, you're right to say that we see the large commercial engine – legacy commercial engine shop visits up 15% to 20%. Think about the Vs being up around 20%, and if you think about the math there, we were a little over 700 or so as we exited 2022. So that puts us in the mid-800s, kind of a range expectation for 2023, which is a level we've been at before. So as it relates to capacity, we have that level of capacity for the legacy shop visits. And it really then comes back to the conversation we've been having here for the last hour about ensuring that the supply chain is there and ready to support that level of shop visit inductions, which again, we've been planning. These expectations are in line with the numbers that Chris put out there back in May of 2021. So again, the supply chain, I think expects this level of an uptick in our shops to as well. In terms of – is there upside as you think about retirements of this aircraft, for example, it was 21 aircraft in the last year got retired that V2500 powered. So I'm not going to get ahead of ourselves. But I think that when you look at the dynamics around OE deliveries today of new aircraft, we think the V2500 still has a lot of life left in it. About a third of that fleet has yet to see its first shop visit, and so I'm cautiously optimistic that we will see that fly for a longer period of time at these elevated levels. Doug, I would add that you're right, turn times have been elevated on V and other platforms. And so we don't see as many supply chain constraints there, perhaps as we do in other areas. I would say the labor is stabilizing. Again, you bring in people off the street to do MRO, there is a learning curve associated with that individual becoming a productive technician and maintenance personnel. But we believe we've got the plan in place there. In terms of upside, I mean, again, if you listen to lessors and others out there today, and Neil kind of referenced this, given the supply chain challenges we're having on perhaps new production, you're seeing airlines hold on to older assets longer, signing up for longer leases. So again, it kind of goes to the life of the V2500 maybe being some upside there. Great. Thanks. Thanks for the final question. Guys, I wonder if we could dig in a little bit more on the GTF. And you talked, Chris, a little bit about the time on wing. What we've been reading lately from comments from some of the leasing companies and comments in the press is the time on wing on new generation engines has been falling short of expectations. And so a) kind of to what degree do you share that perception and kind of where does it need to get; b) what specifically in the engine do you need to kind of improve to get it there; and then the last part is, I think you mentioned the GTF aftermarket profits were positive for the first time. And just with a relatively young pool of engines and maybe some time on wing challenges, how do profits get to positive? So I would say that I generally agree with the sentiment that you're hearing, time on wing, and we've been pretty open about this. And very open dialogue with our customers, a lot of time on wing – on newer platforms, not necessarily being where we wanted them to be when we launched the program. We have done a number of block upgrades. As I said, we've got a block upgrade going in now through MRO that increases time on wing. On average, about 20% just based on the geography that you're in. And we've got some other, I'd say, durability and reliability hardware and software fixes that we put in as well. So we want to – we obviously want to get to the contractual levels that we have promised, and we've got a plan to go do that with these upgrades, Seth. I will tell you, keep in mind, you've got the GTF advantage that's going to start cutting in 2024. As you know, that's the next generation of the GTF, more thrust, better fuel burn, start flight testing in Q4 with Airbus, and we remain on track there in – for 2024 EIS. That takes all of the lessons learned we've had on the, what I call base GTF program and some enhanced testing. And we think that that's the next generation that will get to the levels of performance and time on wing that our customers are anticipating. But even on the – what I'll call the existing fleet today, we've got upgrade plans to continue to push that time on wing higher and higher. Our customers are demanding it, and our contracts are dependent on it. So we're aligned there. Okay. Thanks, Seth, and thank you, everyone, for listening today. As always, Jennifer and her team are going to be available today, tomorrow, the rest of the week to answer any follow-up questions that you have. Thank you for listening, and take care, everyone.