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Greetings, welcome to the REV Group Fourth Quarter 2022 Earnings Conference Call. At this time 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. All right, thank you, Sherry, and good morning, everyone. Thanks for joining us. I apologize in advance for any rough voices itâs the cold and flu season here in Brookfield, Wisconsin. Earlier today, we issued our fourth quarter and full-year fiscal 2022 results. A copy of the release is available on our website at investors.revgroup.com. Todayâs call is being webcast and a slide presentation which includes a reconciliation of non-GAAP to GAAP financial measures is also available on our website. Please refer now to slide two of that presentation. Our remarks and answers will include forward-looking statements, which are subject to risks that could cause actual results to differ from those expressed or implied by such forward-looking statements. These risks include, among others, matters that weâve described in our Form 8-K filed with the SEC earlier today and other filings that we make with the SEC. We disclaim any obligation to update these forward-looking statements which may not be updated until our next quarterly earnings conference call if at all. All references on this call to a quarter or a year are to our fiscal quarter and fiscal year unless otherwise stated. Joining me on the call today are our President and CEO, Rod Rushing, as well as our CFO, Mark Skonieczny. Thank you, Drew, and good morning to everyone joining us on today's call. This morning I'll provide an overview of this yearâs commercial operational and strategic achievements including full-year financial highlights and our consolidated fourth quarter performance. I will then turn it over to Mark for detailed segment financials. Throughout fiscal year 2022, we continued to advance strategic agenda that we put forth during our Investor Day presentation in April 2021. During our Investor Day, we highlighted product development and simplification as a driver to unlocking shareholder value in our business. We stated that we have intermediate and long-term opportunities to simplify and commonize the design of our products and improve our designs for manufacturing, while maintaining the brand identity and differentiation that our customers value and expect. In the past 12-months, the REV Fire Group consolidation of fire apparatus businesses as long as the new commercial chassis platform that leverages our Spartan chassis business as a center of excellence across the Fire Group brand portfolio. As we move forward, a greater percentage of REV Fire apparatus will be built on the Spartan commercial chassis than before. In 2022, we developed an integrated product roadmap across our Fire Group brands to enable platforming and simplification. This will lead to the standardization of subassemblies and in addition having centers of excellence for subassembly production. We will do this while retaining differentiation of our brands and our customer's ability to customize. We expect a portion of the FY â23 fire bookings will benefit from the standardized design with continued momentum into 2024. Within the commercial segment, our ENC municipal bus business introduced its next-generation transit platform with over 90% commonality between the battery electric and the hydrogen fuel cell models. This platform will offer municipal fleets flexibility with multiple links and multiple propulsion systems. The new platform design will not only reduce complexity and production costs for our business, but it will also lower the end usersâ training and maintenance costs. These early wins within the Fire Group and the Commercial segment are examples of our work in progress across the enterprise and will serve as enablers in our journey to double-digit EBITDA margins. We continue investing in our people with formal on-the-job training of operational disciplines, by the close of fiscal year 2023 roughly half of our workforce will have achieved a broad screen or black certification -- lean certification. Together, these teams will build a pipeline of over 1,500 active cost savings projects, designed to increase throughput and delivery efficiencies. Each of our businesses is now utilizing an integrated reporting and project management system that provides managers at all levels the ability to monitor progress and assist in the completion of this work. We have expanded our purchasing engineering capabilities by engaging offshore resources to support our internal teams. Within purchasing, we are finalizing qualification for multisource solutions to the top five key components that created the greatest challenges to throughput in fiscal year 2022. We expect these efforts will be completed by the end of the first calendar quarter and will enable improvement in throughput within our Fire Group and our Commercial segment for the remainder of the year. We engaged our business with two offshore engineering firms to accelerate and advance our engineering capabilities. This work is progressing on two fronts. First, we are documenting our designs and approving the engineering documents that we present to our manufacturing floor. The completeness and accuracy of our bills and materials has been another direct issue in the past, has been problematic for production during the supply chain challenges we have been working through. Secondly, we are collaborating with an offshore firm to supplement our application engineering. This will improve the quantity and quality of the engineering documents that are released to the floor and reduce the engineering cycle time, enabling to build engineering buffer before production execution. Over the past year, many of our businesses delivered or introduced new zero-emission products. Our battery electric portfolio includes the first North American-style fire truck, Type II ambulances, Type A -- and Type A school buses. Terminal trucks and municipal transit buses are offered in both battery electric and hydrogen fuel powertrains. These efforts have been driven by voice of the customer and supported by partners and suppliers that offer leading-edge technology. They demonstrate our commitment to leading in the developments for the markets we serve by delivering solutions that fulfill our customers' needs while reducing the carbon footprint of our fleet of vehicles. Fiscal year 2022 was challenged -- was a challenged operating environment with the continuation of external headwinds we faced in exiting 2021. Chassis supply remained inconsistent with unfulfilled allocation in the first quarter followed by a trough of just 10 receipts per week from a major OEM in the second quarter. Late in the third quarter, we began to receive an anticipated deliveries and the mix of chassis that was not aligned to our master production schedule. As we exit the fourth quarter, chassis supply has improved our visibility to future deliveries and mix of vehicles to be received remains uncertain. Most recently, a well-publicized recall was issued by a top luxury van OEM that is preventing unit shipments at this time. On the material side, we did experience dual supply chain improvement as we exited the year. However, the shortages of key components have continued and in some cases, they're constrained as we entered the fiscal first quarter of 2023. An example of this is the leading HVAC provider [indiscernible] Group in commercial segment ceased operations in the fourth quarter and we are currently managing through this transition with a new supplier for HVAC requirements. Finally, like many manufacturing companies, we've experienced the impacts of the constrained labor market, we built specialized and highly customized vehicles and scale that limits the opportunity for automation. Availability of the workers and the times restricted our ability to achieve our target line rates. We have improved onboarding, employee tooling, and employee training to reduce employee attrition and position our associates for opportunity for advancement. The momentum of our lean training products mentioned earlier is also expected to help our business improve efficiency and reduce the labor required per unit to complete the vehicles. Despite the challenges noted, we exit fiscal 2022 with a record of $4.2 billion. Our bookings remained strong throughout the fourth quarter and that included additional price increases being implemented during the quarter. We had another successful year of converting earnings to cash with full-year free cash flow conversion of 136%. We returned a total of $82 million of cash to our shareholders in the form of dividend and share repurchases and exited the year with a strong financial position. Total liquidity under our ABL credit facility was $308 million, which provides significant flexibility and opportunity to continue to pursue our strategic agenda. Turning to slide four, I'd like to present a few highlights for the quarter. Previously, I shared that our ENC municipal bus business announced the development of the next generation zero emission products, the Axess battery electric bus and the Axess hydrogen fuel cell electric bus. ENC announced its first order of products from the Dallas Fort Worth International Airport. BMW ordered four active EVO battery electric buses along with 22 Axess [C&G] (ph) powered buses. The new fleet of buses is expected to be delivered to the airport in December of 2023. We believe emissionâs free buses will attract significant municipal interest as state, local governments pursue low and no emission transit buses under FTA grants. As we noted on our third quarter earnings call, the FTA announced a $1.7 million of grants for low and no emission buses. These are the first awards related to the bipartisan infrastructure theyâll -- which provide a total of $5.5 billion over five-years to help state and local government authorities by release zero emission or low emission transit trucks. In September, we were pleased to see the return of the RV dealer open house at Elkhart with strong new demand and enthusiasm. REV recreation group brands combined to showcase more than 60 models, including new and updated designs, new products on display at the open house included the brand new in fleetwood, Frontier, GTX, Class A, Diesel, Luxury Motorhome that features an industry first dedicated office. Lance Camper debuted itâs Enduro overlaying concept unit, which is designed for off grid camping and the active outdoor sports. The Fleetwood GTX 37RT received several awards, including, RV of the Year and best in the model, while the Enduro 1 RV of the Year and the [indiscernible] . Within the fourth quarter, we announced the appointment of Dan DesRochers as the President of the Rev Fire Group. Prior to joining Rev Group, Dan served as the President and Chief Operating Officer at Morgan Truck Body, a division of JB Poindexter, where he led a team of 2,500 and oversaw 14 plants. Over his 30-year career Dan has held leadership with Morgan Olson, General Electric, United States Can Company and Federal Signal, and comes to us with a strong history of operation performance. I'm very pleased that Dan has joined our team and I look forward to the impact he will have improving advancing our Fire Group business. Turning to slide five, fourth quarter consolidated net sales increased 5.7% versus prior year. The increase was primarily the result of higher sales in commercial recreation segments, partially offset by lower FNE sales related to chassis and supply chain constraints. Adjusted EBITDA increased by $2.4 million, the increase was primarily a result of increased sales and profitability in the recreation segment, partially offset by lower contributions from FNE and in commercial segments. The fourth quarter marks a point where our year-over-year comparables reflect supply chain constraints. As was the case throughout fiscal 2022, the operating landscape continues to change. As I previously mentioned, it's exiting the fourth quarter, we received a recall notice from an OEM partner that is expected to delay shipments and ship revenue in fiscal year 2023. While we continue to face and address supply chain challenges, we are confident that the initiatives that we have put in place will improve our throughput and our financial performance. Thanks, Rod, and good morning, everyone. Please turn to page six of the slide deck as I move to review of our fourth quarter segment results and full year consolidated performance. Fire and Emergency fourth quarter segment sales were $253 million, a decrease of 9%, compared to the prior year. The decrease in net sales was primarily due to fewer shipments of fire apparatus and ambulances, partially offset by price realization of trucks shipped within the quarter. Within the Fire Group, completions of shipments continued to be impacted by shortages of critical parts such as radiators, wiring harnesses, and axles, as well as lower than expected line rates in our holding facility, which continues to integrate the production of KME and for our branded units. The result was a 9% decrease in unit shipments versus the fourth quarter of last year. Sequentially, unit sales improved versus the third quarter reaching the highest level of fiscal 2022 with increased shipments from several fire plants. Although below expectations, we did see sequential improvement in shipments from our Holden facility. The Holden team remained focused on balancing feeder lines to increase production levels with recent success of telling its cab & chassis and body lines to be aligned for final assembly. Within the Ambulance Group, we continue to experience unpredictable OEM chassis deliveries framing production planning challenges that resulted a 9% decrease in shipments versus the prior year. As Rod noted earlier, although we have been receiving a greater number of chassis from our OEM partners, the timing and mix of units remain varied. The ability to plan production as well as align component parts supply begins with the expected receipt date on a specific chassis. If the chassis delivery date is delayed or a different model is received, it has a downward impact -- downstream impact on the value chain. In addition to the disruption this caused to our component inventory, we have continued to experience material shortages related to supply chain constraints. Despite these challenges, unit completions improved late in the quarter with shipments increasing compared to the third quarter. Turning to EBITDA. F&E segment adjusted EBITDA was $1.9 million in fourth quarter 2022, compared to $10.1 million in fourth quarter 2021. Adjusted EBITDA margin of 0.8% decreased 280 basis points, compared to last year. The decrease was primarily the result of supply chain disruptions, labor inefficiencies, increased inflationary pressure, and costs related to Hurricane Ian, partially offset by price realization. As we mentioned earlier, production at the Holden facility have not supported the shipments of units at the rate we anticipated entering the fiscal year. In addition, slower completion of units that were booked prior to the recent inflationary environment resulted in a price cost headwind in the fourth quarter, which is the first occurrence this year. Full-year segment and consolidated price cost remain positive, but production of aged backlog remains a headwind entering fiscal 2023. Total F&E backlog was $2.6 billion, an increase of 73% year-over-year, the increase in backlog was a result of strong unit orders and pricing actions taken over the past year. Fire apparatus orders were a quarterly record and increased 23% versus last year's quarter, while orders for ambulance increased 14%. Looking into fiscal 2023, we expect typical first quarter seasonality within the F&E segment with an approximate 10% revenue decline. As our multi-sourcing initiatives take hold in the fiscal second quarter, we expect sequential revenue growth throughout the year. Segment margins are expected to remain in the low single digits as we continue to complete aged units within backlog. The midpoint of guidance anticipates that manufacturing efficiencies and more favorable pricing will begin to improve segment margins in the second half of the fiscal year. Turning to slide seven. Commercial segment sales of $111 million was an increase of 17%, compared to the prior year. The increase was primarily related to the higher sales of school buses, terminal trucks, and street sweepers, partially offset by lower sales of municipal buses. Commercial segment sales in the prior year were impacted by a five-week suspension of school bus production due to limited chassis availability. Although school bus shipments were higher than previous year [Technical Difficulty] was limited by shortages of wiring harnesses and HVAC equipment, resulting in a 29% sequential decline in unit sales. HVAC supply will remain a headwind to throughput in the fiscal first quarter while multi-sourcing initiatives are expected to improve supply in the second quarter. Within the Specialty Group, terminal truck shipments increased for the 12 consecutive quarter and street sweepers sales increased for the fifth consecutive quarter, each setting a unit sales record. Municipal transit bus shipments were limited by continued supply chain constraints of key components, primarily wiring harnesses. Commercial segment adjusted EBITDA of $3.3 million decreased 42% versus the prior year. The decrease in EBITDA was primarily the result of an unfavorable mix of municipal transit buses and rework inefficiencies related to supply chain constraints that impacted school buses and municipal transit bus completions, partially offset by increased contribution from the specialty businesses. An unfavorable mix of municipal transit buses is primarily the result of low-margin units sold during the highly competitive bidding cycle related to COVID. In the Specialty Group, efficiencies related to improved production velocity result in a three-year high margin performance despite challenges related to supply of key components. Commercial segment backlog was $526 million at the end of the fourth quarter, which reflects pricing actions taken throughout fiscal â22 and increased orders of municipal transit buses. Due to the chassis constraint that impacts the school bus industry, we have seen an increase in the number of school bus plus chassis orders rather than body-only conversion orders. This change in order patterns not only requires us to procure more chassis directly from OEMs, but also impacts the margin profile of the business as chassis costs are essentially treated as a pass-through and therefore is margin dilutive in the segment. We expect segment margins to trough in the first quarter of fiscal 2023 and we continue to ship low margin municipal transit buses. We expect segment profitability to improve sequentially throughout the year as we build through the municipal transit backlog. Multi-sourcing of wire harnesses, as well as the resourcing the HVAC equipment supplier mentioned earlier is expect to alleviate the supply chain headwinds within the second quarter benefiting line rates in all businesses in the commercial segment. Turning to Slide 8. Recreation segment sales of $260 million were up 19% versus last year's quarter. Increased sales versus the prior year were primarily results of increased shipments of Class B and Class C units and pricing actions, partially offsetting the increase in lower sales in towable units related to supply chain and labor constraints. Our plan to maintain the regular production schedule within the quarter as dealer inventories on our brands remain approximately 50% below pre-COVID levels exiting the year. Recreation segment adjusted EBITDA of $35.3 million was an increase of 13.6% versus the prior year. The increase in EBITDA was primarily results of price realization, volume leverage, and favorable mix, partially offset by material inflation and labor inefficiencies in the towable business. Segment backlog of $1.1 billion, decreased 9% versus the prior year. The decrease was primarily due to continued production against backlog and lower orders across product categories. Class B and Class C unit net orders have normalized to pre-COVID levels and backlog through these businesses remain at approximately one-year production. Class A and towable backlogs extend beyond fiscal 2023 at the current production volumes. We did receive a small number of cancellations in these categories but expect to regain a portion of orders and to convert to the following model year of orders. We do expect recreation segment backlog to decline throughout the year as we maintain production to a more normalized level. As Rod mentioned earlier, the timing of revenue and EBITDA in fiscal â23 will be impacted by global recall from a low -- luxury van OEM that prevents us from selling units. We do not expect these sales will be lost, but the timing of approximately $40 million to $50 million of revenue is expected to shift from the first to second fiscal quarter as the OEM recall fix is received and units are delivered. Turning to slide nine. Full-year consolidated net sales decreased 2.1% versus fiscal 2021. The decrease was primarily the result of decreased sales within the F&E segment, partially offset by increased sales within the Commercial and Recreation segments. The decrease in F&E segment sales was primarily due to lower unit shipments related to supply chain constraints and chassis shortages and inefficiencies related to the transition of KME production to our Holden facility, partially offset by pricing actions. As a result, full-year F&E net sales decreased 15%, 13% lower unit sales versus the prior year. Within the year we successfully repriced a portion of F&E backlog that was booked prior to today's inflationary environment. However, lower throughput segment limits our ability to realize pricing actions that were taken in fiscal â21 and â22. We expect greater contribution from these pricing actions in the back half as we exit fiscal year 2023. The increase in Commercial segment sales was primarily the result of increased production of school buses, terminal trucks, street sweepers, and pricing actions. The increase in the Recreation segment sales results from favorable mix and pricing actions that resulted in record Recreation segment sales. Full-year consolidated adjusted EBITDA decreased $36 million or 26% year-over-year. The decrease in EBITDA was primarily the result of decreased contribution from F&E and Commercial segments, partially offset by higher contribution from the Recreation segment. The decrease in F&E segment EBITDA was primarily due to lower unit volume and inefficiencies related to supply chain constraints and the transition to KME production from our Holden facility. The decrease in the commercial segment EBITDA was primarily due to the completion of a large municipal transit bus order earlier this year, which resulted in an unfavorable mix of units in addition to increased costs related to inefficiencies associated with supply chain constraints and rework needed to complete units. Full-year Recreation segment margin of 11.6% was a record and benefited from pricing actions and higher mix of diesel units for certain categories and opportunities to batch-build units to fulfill elevated demand. We do not expect to repeat this margin performance in 2023. The contribution from towable and gas units increases the opportunity for batch building decreases. Turning to slide 10. Trade working capital on October 31 was $348 million, a decrease of $20 million, compared to $368 million at the end of fiscal 2021. The decrease was primarily the result of increased accounts payable, customer advances, partially offset by an increase in inventory. The increased inventory balance includes an increase of $37 million in the third-party chassis and an elevated level of work in process as unfinished units wait for key components in order to be completed. Full-year cash from operating activities was $91.6 million. We spent $8.9 million in capital expenditures within fourth quarter and a total of $24.8 million for the full-year resulting in full-year free cash flow of $66.8 million, which represents a cash conversion rate of 136%. As Rod mentioned earlier, we returned a total of $82.4 million of cash to shareholders. Net debt as of October 31 was $209.6 million, including $20.4 million of cash on hand. We declared a quarterly cash dividend of $0.05 per share, payable January 13 to shareholders of record on December 30. At quarter end, the company maintained ample liquidity with approximately $308 million available under the ABL revolving credit facility and our net debt to EBITDA leverage ratio was two times at the low end of our stated target range of 2 times to 2.5 times. Turning to slide 11. Today, we are providing full-year guidance which reflects a range of continued uncertainty surrounding chassis business building, key components supply, and our expectation for increased inflationary pressure that has impacted a portion of units in the backlog, adequate earnings in the first half of fiscal 2023. Today's topline guidance of $2.3 billion to $2.5 billion or 3% growth at the midpoint. Adjusted EBITDA guidance is $110 million to $130 million, an increase of 14% at the midpoint. Given the seasonably soft first quarter lingering key components shortages and the stop-ship recall of luxury van chassis, we expect the first quarter to be the trough for revenue and adjusted EBITDA margin with sequential improvement throughout the year. We expect first half consolidated revenue to be approximately 45% for the full-year guidance and first half consolidated adjusted EBITDA to be approximately 35% of full-year guidance. Cash conversion is expected to be 90% or greater with free cash flow in the range of $39 million to $55 million. Adjusted net income is expected to be $42 million to $60 million and net income $28 million to $47 million. Full-year capital expenditure is estimated to be in the range of $30 million to $35 million, which includes carryover projects that were initiated in fiscal 2022. Maintenance CapEx remains in the range of $15 million to $20 million per year and our growth projects have internal payback and IRR targets that must be met before being approved. Expected interest expense in the range of $25 million to $27 million is an increase, compared to the recent run rate that was resolved in the current and anticipated interest rate hikes as well as an increase in customer advances. Yes, good morning and thank you for taking my questions. I'll start that with your last comments there, Mark. Just wanted to get some commentary on the free cash flow outlook for the year. I see, EBITDA up the taxes, pointed to higher interest costs, a few million higher than the prior year, perhaps mentioned my own question here, can you just give us some of the other parts of free cash flow that might be changing next year, especially inventory and any other moving parts that kind of lead you to believe there will be a slightly down year for free cash flow? I think a couple of components, Mike, obviously, we're still managing through our inventory. We have the opportunities to reduce inventory, but as we -- as our backlog continues to flow in the F&E business as we've discussed before, we will see an outward fall related to our customer advances. So when you look at our overall capital, it's really a result of our customer advances decreasing, as you see, we've had an increase this year in advances, so as those normalize exiting 2023 or drop, it wonât be as -- will be larger than our actual reduction that we are able to get in inventory. So that's really the main driver of that including the items you talked about, the interest expense that is an increase, obviously, $10 million year-over-year as well. Okay, great. And I also want to talk on the same slide, just some color on your cadence about how earnings is going to play out from quarter-to-quarter in fiscal â23 as well. Looking at the first and second quarter, might be a little bit rough, it sounds like you still got some lingering issues, but do you expect the third and fourth quarters to somewhat represent a more normalized problem-free environment at this point and is that like a good annualized rate to kind of think about going beyond those two quarters? I would say, like we talked about, we're good in first half, second half, but you know what our guidance would imply that we see the improvement, especially what we've been talking about recently in the last couple of earnings calls, and the multi-sourcing that Rod even highlighted today that some of these problematic key components, we have internal plans in place to multisource, so exiting the second quarter, entering the third we'll see improved throughput, as well as anticipated chassis supply picking up. We do have good visibility on the Commercial side as we've talked about into Q2 with those chassis. So, from a progression perspective, we probably be more normalized in fourth quarter rate versus not yet fully realized in Q3. Certainly, I would project with a ramp following, a typical ramp in Q1 through Q4, with Q1 really being down by what we highlighted in the recreation, as you know that high-end RVs that we have used that luxury van, so those are margin accretive to that segment. So those pushing from Q1 and Q2 will have a little shift there, but Q3 and Q4 will normalize as we exit the year. Okay, great. And then turning to Recreation, you had noted that dealer inventories are 50% below pre-pandemic levels, could you comment on the desire of dealerships to replenish their inventories at this point with interest rates a bit higher and just, in general, consumers open to buying a six figured car, a sight unseen with an online order, it seems like how necessary are inventories at this point and their desire to come all the way back to what we saw back in 2019. We continued, like Rod mentioned, our products that we're offering to the market, we continue to see our products not staying on floor that long, we did see a drop in retail sell-throughs here, but at the same time, we continue to see good throughput on the dealer lots and as we've talked about before in the Recreation space, the dealers will carry what sells and what moves as quick as rightfully OEMs incur the flooring cost, so we continue to see our products move through the channel versus the orders dropping off in the reduced likelihood of them carrying the units on the lot. Yes, I just would add to that, we've been very cautious and conscious when we talk about well before this peak in the RV of managing our throughput. So we did overfund and replenish inventory, so we can get sell-through and get a good pull in advance. So a lot of our units are still retail sold as they come through and that percentage has dropped a bit, but we're still very consciously working with our dealers around making sure it's returning and did not stay on the loss, so we get a better dealer pull for that. Yes, I apologize, this far into the earnings season, I should know where the mute button is, sorry about that. Good morning and happy almost holidays, everyone. I'm wondering if you just talk about â23 EBITDA guidance, nice to see the growth versus â22, can we just talk about it at the segment level, how much of that growth is anticipated in RV versus the sequential improvement in Fire and Emergency and Commercial that you spoke to earlier on the call, can we just talk about by segment the growth drivers â23 versus â22? Yes, so I think from an overall segment perspective, we'd be looking at -- as we talked about the throughput in our F&E side, getting into that -- coming off from where we ended up, relatively flat $2 million to $2.5 million to more into the $30 million and $35 million range for next year. And then, Commercial being in the $20 million and $30 million range, more of a normalized between $21 million and $22 million range, and then some downward pressure in Recreation related to the mix that we talked about, right, that having more in the towables and as you know, we've extended our reach into the East, so we'll be selling more towables in the East through some of the backlog, so with the mix, we will have a downward pressure on Recreation, but would be more in that $95 million to $100 million sort of range for Recreation -- for those three segments to get to where the full year number is and with some choppiness as we talked about in Q1 and Q2 across those segments. Super. And then, can we just talk about Recreation, I mean, you folks have done an outstanding job of expanding margins in that line of business. Obviously, we're going to give a little bit backward mix as you alluded to, but how do you think about the full cycle range of margins for the business as it stands today, what would you view as trough and peak, as you run a range of scenarios of what volumes might look like given all the improvements you've made in RV? Yes, with the mixture, we're still confident that we're in that 10% range, so we've always said, Class A can dip in the low single digits since there was a real trough, but ultimately with the mix we have with the Bs and Cs exposure, as well as what we've done on the towable side and improving that business, as we do that, we're still -- based on the guide we've given today, we're still in that 10% to 10.5% range for the year. But, I guess, you could say we're probably in that 7% trough margins following the mix that we have when you mix in the As and towables against our Bs and Cs. Good morning. Just two questions. One, if deflation starts to materialize, where do you think you can continue to have the most pricing power? And then my second question, understanding you have a strong backlog with Recreational, but just given concerns of a consumer recession, this business has been driving the majority of your EBITDA growth [Technical Difficulty] mix of EPS from Fire and Emergency or just relying on Recreational? Thank you. Yes, I think on the Recreation side, like we highlighted, Jamie, previously, I think we're in a different position than some of our competitors like Rod talked about that and we didn't get ahead of ourselves in stopping some of the dealer channels here. So when you look at our actual inventory, it's still down 50% from our pre -- from pre-COVID levels and we continue to see strong demand for those Bs and Cs market, as well as we have -- as we've talked about for our REV's product and the towables unit, and the towables' business is more of a niche product and it still has a strong draw from the market. So we have not seen a dip from that perspective and we have actual -- our backlog continues to hold up a full year's worth of production. So we're not seeing -- even with the minimal cancellations I talked about, we're not seeing a hit to our full-year guidance at least what we're providing here. So -- and then from a price realization perspective, obviously on the Recreation side, that will be more maintaining the price that we have going after inflationary cost to make sure we get the savings that we deserve as some of the commodity prices come down. And when you talk about price realization, majority of it is getting to that â21 and â22 pricing that I highlighted in my call, that just given the throughput challenges we have -- had in F&E. We have a lot of older units that haven't had the pricing that's been injected over the last couple of years, so it's really a throughput story. The first half is really, both in Commercial and F&E, it's getting through the units that have aged in our backlog so that we get the units that have margin expansion opportunity in the second half of the year. That's really the story here in the first half. It's all around throughput within F&E and Commercial, and getting some of the older units out of the backlog, and then realizing pricing in the back half that's already been sold into the market. Thank you. Good morning, and I hope you all managed to get over the cold that you are [Multiple Speakers] even I'm in the same boat as you are. So sticking with the discussion on Recreation, sorry to be the dead horse here, but in the press release you talked about backlog normalization and I'm sort of curious as to how you think about that dynamic in fiscal â23, what is normalized backlog look like in Recreation, how would you expect backlog to exit the year? Yes, so it's sort of more in the six to seven-month window, that's sort of what we traditionally have seen, as you know like we're over two-year backlog, which was not normalized, so we're talking about getting back to the levels that we expect, so we'll have less booking, but weâll be aiding through the backlog, and as you know, in this business, we do have new model year. So some items like I highlighted in my discussion, if orders are replaced in â22, that'll be converted to â23 model, so there's always the ever-changing backlog dynamic there, but we are seeing reorder rates on the â23 and some of the things that Rod highlighted with the awards that we won at the open house, so we are very happy with those. So it's more of a six to seven month, sort of, window that we're talking about here on those versus the two years down to more of a one year that we're experiencing now. Understood. Because, where I'm going with this, I'm trying to get a sense for where underlying market demand really is for your product. I recognize that you have backlog, right, but if we're kind of thinking about the order run rate and how that should inform us into â24, I mean, if your backlog is coming down to the extent that you are talking about in fiscal â23, should investors be thinking that revenues are going to be down in â24 or do you think â24 can actually be a growth year for this business? Yes, well, I don't think I have given â24 guidance, but we know we've elevated backlog. So it's really getting that business back to a normalized level, which we're very comfortable in the performance. And as we've been talking about this for the last 3 years to 2.5 years is we're really managing the business for margin expansion and doing the work that we've done here. So even at a lower revenue, especially as we look at our performance issue in our Class A business, even at lower revenues, we've been able to produce margin expansion. So it's more about holding the margins here in a challenging market as we enter here, so. Okay. And then maybe my final question, surrounding your â23 guidance and I appreciate it all the color on the moving pieces here. The 35% to 65% split on EBITDA, first half versus second half, I mean, if I look at fiscal â22, it was about 40%, 60%, so arguably speaking, you're a little bit slower in â23 relative to â22 and the way you start the year. So I guess I'm wondering what gives you the comfort or the visibility that you'll be able to achieve that ramp in the back half because it sounds like the timing issue in Recreation is really between first and second quarter, not first half or second half, so any help there would be great? Yes, so it's more around the units like we talked about around throughput and our ability to get these older units out, as I highlighted for Jamie, so it's really a margin discussion and we'll have the revenue, but these are at lower margin units like I highlighted on the commercial, which we've talked about in the last couple earnings calls, as well as on the F&E side as we convert, especially in our Holden facility could be -- convert the older KME, as well as for our units there, those will have no pricing related to the â21 and â22 increases that we have put out there. So it's really a margin discussion now, again getting the throughput on those units, and we do have truck-by-truck visibility, so we know what we're producing and what the margins are in those trucks, so we feel pretty comfortable that that is the shift that will happen. Obviously, if there was a supply chain challenge that extended beyond â23 -- beyond Q3 or Q2 I should say, into Q3, that would shift a little bit, but we feel comfortable about our ability to ramp as well as through obviously qualifier making sure we get the chassis that we need to produce, but we do have ramps built into our plan as we continue to see improvements in supply chain as well as in the chassis supply. Yes, Fire and Commercial, really Fire and Commercial. Recreation, yes, to your point, first half, second half, you wouldn't see that sort of jump there. It's really just the Q1 comment, actually in Q1, with this recall not being able to ship, but we're expecting to ship those in Q2 as you noted, so it's not a first half, second half challenge, that's more of a normalized revenue recreation. It's more in the F&E and Commercial segments as you can see a disproportionate first half, second half based on the items we highlighted. We have reached the end of our question-and-answer session. I would like to turn the call back over to Rod Rushing for closing comments. All right, thank you. Okay, I appreciate everyone joining us on today's call. While fiscal 2022 presented continued external challenges, we maintain a course of action deploying the elements of the REV Drive System, targeting multi-sourcing supply, improving our engineering and production planning and materials management capabilities. We also remain disciplined in our pricing actions across all of our businesses with price taken to offset inflation and provide margin expansion opportunities. We have just begun to realize initial round of these priced actions. These pricing actions combined with increased throughput from an improved supply chain environment, we believe will position us well for improved results as we move through this fiscal year and in our fiscal year 2024. In closing, I'd like to thank our entire team for the efforts throughout the past year and wish everyone a safe and happy holiday season. Thank you for your time today. Thank you. This does conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.
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EarningCall_1601
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Good morning, everyone. Thank you for joining us. I'm Lauren Schenk, Morgan Stanley's small and mid-cap Internet analyst. And I'm thrilled to be joined this morning by Rachel Glaser, Etsy's Chief Financial Officer. Before we begin, one disclosure on my end. Please note that all important disclosures, including personal holdings disclosures and Morgan Stanley disclosures, appear on the Morgan Stanley public website at morganstanley.com/researchdisclosures. And Rachel, I know you have one as well. I'd just like to refer people to Etsy's IR website where you can find our safe harbor and read it at your own leisure. All right. So, with that out of the way, maybe for those in the audience that are less familiar with the Etsy business model, talk about Etsy's market differentiation, the opportunity and sort of the strategy going forward. Yes, thank you, and thank you for having us. It's nice to be here. Etsy is a two-sided marketplace, meaning that there are sellers from all over the world, selling over 100 million items to buyers all over the world. There's about 5 million sellers in our core Etsy marketplace and about 90 million buyers on the other side. What differentiates us is that we are selling, for the most part, things that are handmade, customized or personalized especially for the buyer's specification. And a certain percentage of our inventory is vintage items. So, we consider ourselves squarely in the space of owning special. So, you can buy things from lots of sellers on the Internet, on and off the Internet, but we feel like there's no other -- it's hard to think of another competitor that's exactly like Etsy where it's 100 million items of things that are really special. We're in the whole long tail of almost every single category you can think of, maybe with the exception of electronics and things like that. But we have a good top six categories that are each one of them in significant addressable markets, each of their own. And we've identified in previous disclosures and conversations that we think all in, it's a TAM that is in the trillions of dollars, not the billions of dollars. And so, we have a significant room for future growth. Okay. Great. Maybe following up on that. I think one of the things that people like so much about your business is you don't have a real formidable competitor, right? There's Amazon Handmade, which hasn't really scaled. And then the two that often people come to me with are sellers just having their own Shopify site or going directly to consumers through Instagram. So maybe talk about the competitive landscape, and why those business models are not threats? So, great questions. So, Etsy sellers are not exclusive to Etsy. They can sell in lots of places. And many of them do, in fact, have their own websites, which may or may not be powered via Shopify. And -- but we find that for the vast majority of our sellers, they make the vast majority of their revenue on Etsy. So, one thing that Etsy gives them that they can't find on their own, it's over 200 million unique visitors that come to their front door every month. We put a lot of our effort into helping to market on their behalf. And over 80% of our sales are actually coming to Etsy organically, typing in www.etsy.com. And so, sometimes we call it putting -- setting up a lemonade stand in the desert. If you were -- if they were to go on their own without the support of Etsy, they are certainly free to do that, but they would have none of that traffic showing up. And so, a Shopify provides lots of tools and services, but they're not bringing a marketplace to them. We invest significantly in the overall marketplace, not only in marketing, which I can talk more about, but in the entire member support and trust and safety organization where we handle a lot of the post-purchase experience both for buyers and for our sellers. Lots of things having to do with compliance. We have a very robust and secure payments platform that handles a lot of the transactions. And in fact, very early on in my tenure and in Josh Silverman's tenure, we tried something, we call it seven simple words, just by putting on the payments page as consumers were checking out, âThe seller never sees your credit card,â improves conversion rates significantly because they know that there's a large public company with a really stable and secure platform behind it that is going to keep all of their information safe. So, one of our pillars for -- core to our strategy is that we are a trusted brand. So, those investments are differentiated from a seller trying to sell on their own or sell through a Shopify account. When we do our research and then we do put a lot of seller census data annually in our 10-K, so you can go back and look at it. We see that for the most of them, Etsy is their number one site. The second site, surprisingly, the second biggest place where they make sales, surprisingly, is things like craft fairs and flea markets and things like that. It's the first -- it's well below that. It's the next biggest Internet site where they're making the greatest number of their sales. Very interesting. As we hindsight the third quarter earnings season, I think one of the key themes, not only in e-commerce, but consumer spending more broadly, is a lot of people thought October slowed relative to September. But Etsy actually said on a three-year basis, October accelerated. So, why do you think you're bucking the trend? I get -- I'm getting that question a lot. In fact, we've had great success maintaining the vast majority of our pandemic gains, even though our year-over-year GMS is a slight single-digit negative. That means we've maintained -- we grew 2.5 times since the start of the pandemic, and we're maintaining over 95% of those gains. And we saw -- let me go back a little further in January of 2022, starting early on in Q1, we started to see a steeper decel, and that decel continued through April when we started to see a leveling off of our sales, May, June, July. And in fact, what we said about Q3 was that we had pretty much stabilized. And in fact, in October, we had slightly accelerated versus Q3, because we did our earnings call, I think, on -- that was November 1 -- November 3 or something like that. And so, we had just -- we give as much data as we can. We could see what October was, and we saw a slight acceleration. The why, why have we maintained so much of our gains when other companies have kind of reverted back to their pre-pandemic levels, what's different about Etsy, it sort of goes back to your first question is that it's hard to think of anything that's quite like us. I mean, there are some things similar. There are some mono-category companies that are similar to some of our categories. But when we think about the -- sorry, did I just -- when you think about the breadth of categories that we're in and that in every one of them, we're offering something that's unique, it's probably customized or personalized for you in some way. It's handcrafted. Over 80% of our sellers are female. The vast majority of them are businesses of one working from their homes. So, you're -- when you're shopping on Etsy, you're actually shopping to help support a small, micro-creative entrepreneur. You're buying something from a sustainable -- a business that cares about sustainability and environment and diversity. So, you're not only buying something that's handcrafted and special, but you're doing something good for the world. I think there's a lot there in that package. And particularly in today's environment where inflation is very high, there's a lot of uncertainty geopolitically, macro-economically, you can buy a relatively affordable, somewhat luxurious item that still has meaning. It's holiday time. It's your mom's birthday. You're still -- even when inflation is high and your budget is constrained, you're still going to throw your child a birthday party. Why not? Buy it at a place where it's going to be really special and meaningful and unique. Okay. Maybe talk a little bit about what you're seeing from a cohort dynamic perspective such as high versus low end, and maybe you'll touch on Europe as well, as you have a sizable Europe business. Okay. I just want to make sure I got the question right. So, one of the things we've said about our pandemic-era cohorts is that they're at least as valuable as the pre-pandemic cohorts. In fact, for a while there, we were seeing them slightly more valuable than the earlier pandemic cohorts. From an overall buyer perspective, we -- for the first couple of quarters of 2022, we were seeing a net churn of about 1 million buyers, but that was -- in the last quarter, that has leveled off, and we've actually reactivated more buyers in the last quarter than we had before. One thing that's interesting about Etsy's cohorts is that they -- let's say, let me back up a minute. The vast majority of our buyers, for a very long time, were buying only once a year, and 40% were buying two or more times a year, we call those repeat buyers. Post pandemic, we've shifted, so that 50% of our buyers are now buying two or more times a year, and the average for them is five times a year. So, we've made this shift, and that seems to be maintaining. In the repeat -- in that repeat, two or more times a year segment of buyers, we have another category we call habitual buyers who come to us six or more times a year, and that has been the fastest-growing piece of our buyer growth. Habitual buyers have grown faster. That's about 9% of our buyers, but over 40% of our total. So that sort of lays out the composition of the existing active buyers. We've actually -- because we've had such a surge in buyers during the pandemic, when you go back historically, these buyers that come only one time a year, what's interesting about them is that they come one time a year almost in perpetuity. A lot of companies will see one time a year a trip to zero eventually. And our buyers come one time a year in perpetuity. And because we had such a surge in buyers as they lapse out and their year has passed, we've had a greater and greater pool of what we call our lapsed buyers, ripe for reactivation. In fact, that lapse pool is generally newer than they have been in the past because we had so many people come in during the pandemic period of time. So, we've had -- we have a really rich pool of lapse buyers to go out and reactivate. Geographically, on the new buyers, attracting new buyers to come in, we've seen more significant growth internationally. And that seems reasonable to us because we've only been able to, in the past year or two, get to what we call two-sided equilibrium in both the U.K. and Germany. That means there's as much buyer demand as there is supply. And that turns on a lot of goodness in that when you get to that two-sided equilibrium where we're able to turn on performance marketing quite effectively in those markets, we're able to do things with our search algorithm so that the local sellers are more prominent in the search results. So, if you're a buyer, you're seeing purchases, items to buy in your local area, meaning you can get them quickly. You have maybe a higher trust factor with a local seller that the item is going to arrive in time. And so, we've seen that growth in the U.K. and Germany. We've been able to turn on brand marketing campaigns in each of those markets. I don't know if anyone here has seen the ads that are running on television in the U.K. or Germany. Show of hands? Yes? No? Yes, some of you. And that brand marketing campaign is the thing that not only introduces new buyers to what Etsy is, like what are we, but also, it's the tap on the shoulder to remind people, âOh, yes, remember that Halloween costume you bought for your dog last year, come back because you can also buy all this stuff for holiday.â And it's really in those European markets that are relatively new to the Etsy story, it seems like it's a brand-new exciting thing for them to find. So, it's reasonable to us that a lot of the new buyers are coming to us internationally. We see a lot of opportunity for continued growth in those markets not yet penetrated. In fact, the U.S., we feel is a relatively immature market. And we have our sights on other key European markets. And we've started to lay down some foundational track in India to sort of invest in that as both an export market and a domestic two-sided marketplace. Okay. Great. Maybe let's double-click on a few things in there. So, you mentioned habitual buyers going from 5% to 9% of the buyer base during COVID. I think in '22, that sort of stabilized. So, what are you doing to reaccelerate habitual buyer growth? And then, on the lapsed buyer side, you've done a nice job of driving reactivated buyers. Maybe just talk about some of the strategies there. Yes. So, we have an overarching sort of what we call our Right to Win, a strategy for the company that has four pillars that involve being best in -- world-class in search, which I want to talk about a little bit. The human connection, which is really unique to Etsy. There's a seller on the other end of every transaction that you can actually have a conversation with when you're making your purchase. Your item usually arrives with a handwritten note. You can see the process by which your seller is making the product. A trusted brand. I talked about the seven simple words that -- and there's a lot in there that we've done with the whole post-purchase experience and feeling confident that you're going to get your item when you think you're going to get it, it's going to arrive safe and undamaged. And then, the platform they all -- those three sit on is this breadth of unique items, 100 million items. Best-in-class search is one of the key factors that I think has helped us grow our audience and continue to grow frequency. Like I said, our repeat buyers are only about 50% of the audience. The other 100 -- the other half of our buyers are coming only once a year. And growing -- and that 50% that come twice -- more than twice a year is average of five times. I buy things every single month, probably twice a month. So, it seems reasonable to us that growing frequency is a very possible and reasonable thing to do. I can think of a holiday, an occasion, a season that comes at least once a month. I'm sure you can all imagine -- you're already thinking in your heads of things that happen every month for which Etsy would be a great place to buy. And getting that frequency number up is, I think, one huge factor, and doing that is the search opportunity. Because when you come to a site where there's 100 million items and you type in, I need a gift, you're probably going to get a search result of 100 million items. In fact, we gave an anecdote on our last call about a buyer who's -- we did some surveys and the buyer had searched for lamps. And his answer was, "I got 400,000 lamps." "That's a hard pass," that was his exact quote, because who wants to search for 400,000 lamps. Who has time to do that? So, getting search right, and we've done a lot of work really honing in on various -- three different search models to really get closer and closer to, you want lamps, we know a lot about you. We know a lot about what you last bought, what your style and taste might be, what your price -- your best price point might be, what your geography is. And we know a lot about the lamps. We know this one is nautical and this one is Boho. We know a lot about the sellers and their return policy and their reliability and shipping. And we can amalgamate all that information together to get a much better search result. And we use an internal metric to measure our progress there by how often people click on the first page of results, click through to a purchase on the first page of results. And we've gotten better and better at that. So that's one -- the whole concept of search in using machine learning to give a better and better experience for the buyers, one huge element in improving on frequency. The other is that the journey we've been on, on the post-purchase experience. So, starting with when you -- when the consumer is expecting to place an order today and get it tomorrow and have it shipped for free and have the return be free, Etsy, three years ago, was very far from that, and we're still pretty far from delivering on that. But it isn't our aspiration actually to ever get there. Because when you're shopping on Etsy, any item that can be in a warehouse with 1,000 dozen of the item is not an Etsy item. These are people hand-knitting the sweater where they might have gone outback to shear the sheep to be able to get the wool to handknit the sweater and it's going to be made. It probably doesn't exist yet when you're making your order. Many items don't exist yet when you're making your order. And so, we want to get closer to a great buyer experience, but it's not necessarily going to be next-day delivery. And for us, the things we've worked on is making the shipping price fair or free. So, we eliminated the vast majority of what we considered egregious shipping prices. We want to be able to display when are you going to get this item, so that you know when you order it, when is the expected delivery date. We want to get it there on time. We want to get it there when we say we're going to get it there. We want buyers to be able to search on what things are ready to ship tomorrow, and what things will arrive in the next day or two. And we want people to understand what the seller's return policy is. So, we've systematically, and I think the chart -- we have a chart in our last earnings deck that shows many of the initiatives we've put in place to make that post-purchase experience a lot more compelling to a buyer. Okay. Let's move to take rate for a moment. You increased your transactional take rate earlier this year, bringing sort of the blended take rate on core Etsy to about 19.5%. Maybe talk about what levers do you think are remaining on the take rate side? And how we should think about sort of the medium-term take rate in aggregate? So, I wanted to first differentiate between take rate and transaction fee increase. So, since we've been a management team, I think pretty much every year, we've been able to increase take rate, but we've only done a change to our transaction fee two times in the company's entire history. Both of them increased -- have the effect of increasing take rate. But here's an example of something that increases take rate without changing pricing for sellers, and that's Etsy Ads. So, we have a product, it's an optional product for sellers, that allows sellers to spend some of their own budget to make themselves more prominent and search result is the old paid inclusion model. And we manage both the bid and the ask and sort of guarantee or we self-police ourselves to give our sellers a very acceptable, attractive minimum return on ad spend. And they give us a lot of budget. In fact, we have more budget than we can spend because we won't spend it if we can't give them that minimum amount of ad spend. But as our traffic has increased, that increases more page views, increases more clicks. And we've been able to put more of their dollars to work. And that Etsy Ads has grown significantly over time. It creates additional revenue, and that brings take rate up, and that's a completely optional item. Another example is Etsy Payments. We've expanded where Etsy Payments is available to use, that's Etsy's internal payments platform. We know that buyers that transact through Etsy's payment platform, there's a much higher conversion rate. We now have about 93% of our GMS running through Etsy Payments, and that has also grown take rate. And the last example I'll give that isn't a straight transaction fee increase is Offsite Ads. So, about two years ago, Etsy spends a lot of its P&L on performance marketing. And we changed that program so that it's a cooperative spend with our sellers when we place performance listing at on a site like Google. When the seller has a successful sale from a listing -- one of their listings, we charge a slightly higher transaction fee on that transaction that effectively was about a 1% take rate increase. It offsets about 40% of our performance marketing budget. And it's a win-win. It's basically a success fee-based ad product like a CPA model, and that was another way that we brought our take rate up. We also have twice done two transaction fee increases. Your question was, what's the opportunity to continue to do that? We are not dogmatic in that we say we'll do something every year. And we're not dogmatic in saying, we'll never do any kind of take rate increase again. The divining rod for us is, is there a fair exchange of value? Is there a service we can introduce that we feel the seller should pay for, but we're giving them value back? And I think there's lots of growth ahead, we think, through things like our Etsy Ads product, through further expansion of Etsy Payments from 93% coverage of our GMS to 100% coverage of our GMS. There are more services that we can offer to sellers that are going to be win-win for seller, buyer and Etsy. I'll give one example. It's a live product, so it's not a disclosure. But we talked about, I think, on our last call, we are currently testing with two partners the concept of digital download. So, if you go on to Etsy and you want to download a piece of art that maybe you're going to take to your printer and have framed, we now have partners that will actually do the printing for you. And that's also a revenue increase, which brings take rate up. Just -- I mean this may be obvious, but take rate is just revenue divided by our GMS. And the higher the revenue is as a factor of GMS, the higher the take rate is. Okay. I know you haven't given official guidance, but is there any sort of initial high-level commentary you can give us on how to think about 2023? I think we gave notes on our last call that these are more modeling notes. But when you think about 2022, we still had a pretty big Q1 of 2022. We were still seeing the effects of Omicron. People were still staying home, which causes people to spend more online. We were still seeing some stimulus benefits hitting people's wallets. The conflict in Eastern Europe hadn't yet begun. So, there's -- we talked about in the notes for modeling, but there is still one more big comp coming out there in 2023. I love another CFO I heard on her earnings call used the quote, "Time heals all the lapping," meaning once we get past some of these quotes and we -- as we've talked about, where we've maintained our rate of being at 2 to 2.5 times bigger than we were pre-pandemic, we've hung on to all of that. And we have really good initiatives in the bank that we think we're going to start to return to some growth in 2023. And then, if you map out, once we get past those big comps, you should start to see that growth be positive year-over-year, particularly as we head into the back half of the year and we get our seasonally biggest quarters in Q3 and Q4. Okay. We have a few more minutes. I wanted to maybe wrap up on capital allocation. You generate close to $600 million in free cash flow per year. You've repurchased stock in the past. You've obviously made several acquisitions. How should we think about uses of cash going forward? And if acquisitions is a piece of that, what are you looking for? So, we have $1 billion in cash today. We have a revolver that's undrawn on. We do have $600 million of share repurchase authorization authorized by our Board. I think we repurchased about $151 million. Last quarter, we consider that to be not only ROI positive because the stock price has been a little bit bumpy, but we're offsetting dilution that's created by equity we grant to our employees as a form of compensation, and that equity allows us to be very competitive with the largest tech companies in the world to get the very best talent. So that share repurchase is a form of return of capital. So that's one way that we use our cash. You have seen us use cash to do some acquisitions in the past. We're still digesting and getting those acquisitions integrated and off to -- they are immature in their markets in getting them situated into a position for growth. And then, the last bucket would be organic investments. We don't use our balance sheet to fund our organic investments, but effectively our choice to invest in marketing, to invest in people, to invest in our cloud infrastructure is a use of capital in and of itself. We talk about being in this $2 trillion TAM. We're barely scratching the surface of it. I think the number we said is that 40% -- 30% of women in the U.S. and the U.K. -- only 30% of women have bought on Etsy in the past year. 10% of men and the -- all the other geographies outside the U.S. and U.K. combined are like an enormous opportunity that are completely untapped. So, I am very excited about the future growth of new buyers, the future growth of all of the reactivated buyers that we can have, and the increase in frequency. It's almost holiday time, and you all still have time to go shop on Etsy for your holiday presents. So, choose wisely, there's lots out there.
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EarningCall_1602
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Ladies and gentlemen, thank you for standing by and welcome to the Korn Ferry Second Quarter Fiscal Year 2023 Conference Call. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. We have also made available in the Investor Relations section of our website at kornferry.com, a copy of the financial presentation that we'll be reviewing with you today. Before we turn the call over to your host, Mr. Gary Burnison, let me first hand the call over to Tiffany Lauder [ph], Vice President, Investor Relations, to read a cautionary statement to investors. Certain statements made in the call today, such as those relating to future performance, plans and goals constitute forward-looking statements within the meaning of the Private Securities Litigation Act of 1995. Although the company believes the expectations reflected in such forward-looking statements are based on reasonable assumptions, investors are cautioned not to place undue reliance on such statements. Actual results in future periods may differ materially from those currently expected or desired because of a number of risks and uncertainties which are beyond the company's control. Additional information concerning such risks and uncertainties can be found in the release relating to this presentation and in the other periodic and other reports filed by the company with the SEC, including the company's annual report for fiscal year 2022 and in the company's soon to be filed quarterly report for the quarter ended October 31, 2022. Also some of the comments today may reference non-GAAP financial measures such as constant currency amounts, EBITDA and adjusted EBITDA. Additional information concerning these measures, including reconciliations to the most directly comparable GAAP financial measures is contained in the financial presentation and earnings release relating to this call, both of which are posted in the Investor Relations section of the company's website at www.kornferry.com. Good afternoon and thank you, Tiffany and thank you, everybody, for joining us. Our fiscal second quarter results were very good. We generated about $728 million in fee revenue which was up 20% at constant currency and 14% at actual rates. I'm really proud of our performance given that the global economy has been in transition for several months now. We're seeing change on every front from over a decade of high liquidity and historically low interest rates to changes in central bank policies, significant shifts in global trading partners and persistent inflationary pressures. In response, companies and our clients will undoubtedly have to continue adjusting their organizational and workforce strategies to tomorrow which is opportunity for Korn Ferry. As we come to a close of another calendar year, I think it's good to take stock of just how far Korn Ferry has come and how much more capable we've become. First, when we look at our historical performance through the cycles, it's clear our diverse offerings and larger scale have resulted in progressively better results from peak to peak and trough to trough. In other words, the ceiling and the floor continue to be incrementally higher through each term. For example, our peak and trough revenues from the Great Recession to the COVID recession are more than 3x higher. And over the long run, our 10-year CAGR has been 13%. There's no doubt that we're a substantially different firm today than we were even just a few years ago, with far greater scale and relevance of our offerings. Our evolving capability and broad offerings are propelling Korn Ferry and our clients through this moment this transitory period. This combines organizational strategy, leadership and professional development, assessment and succession, rewards and talent acquisition, capabilities to help clients execute their business strategy. We've anchored a firm around a well-balanced, diverse slate of solutions. Number one, a major account strategy that now represents 37% of our portfolio, consulting and digital capabilities that represent almost 40% of our firm. And the integrated go-to-market strategy, One Korn Ferry that's resulted in almost 30% of our revenue coming from cross line of business referrals, a new Korn Ferry that trains and develops over 1 million professionals a year on compensation and rewards advisory and digital offering would comp out on more than 25 million executives, a new interim transition management staff capability with about $225 million of annual revenue on a run rate basis. And this offering essentially didn't exist for us a little over a year ago. An award-winning RPO business with consistent top line growth which now represents 14% of our firm. Today, RPO has nearly $1 billion of revenue under contract. This includes 2 major 3-year contract wins with a combined value of nearly $200 million that we secured in the second quarter. And we're a much, much more globally, geographically diverse firm today. No doubt there's economic uncertainty as we enter 2023. But this transitory time like others in the past is also the proving grounds for the effectiveness of our strategy, the strength of our culture, the resilience of our colleagues, the relevance of our solutions and our offerings and the potency of the Korn Ferry brand. The truth is that great companies make their best moves in times like these. And Korn Ferry is a great company. Looking forward to 2023, we're going to continue to refine our account strategy to take advantage of changing global trade lanes, putting further emphasis on our regional accounts. We're going to pursue a larger addressable market, almost $100 billion in the U.S. alone of interim and transition management, particularly around the skilled positions of finance and accounting, digital and technology, supply chain and legal, just to name a few. We're going to build on our health care expertise, particularly in the RPO area. We're going to further develop our partner ecosystem to distribute our consulting and digital capabilities globally. We're going to invest in our professional and leadership development offerings, especially our digital platforms, upskilling technologists as well as sales professionals. And we're also going to pivot towards cost optimization solutions that will be even more relevant in the current environment. We're going to carefully balance our cost structure and profitability to seize both short and midterm opportunities. And finally, we're going to continue to deploy a systematic and balanced approach to capital allocation between share repurchases, dividends and M&A. I'm confident that we've built a company that provides a suite of core and integrated solutions that line up perfectly with the talent and organizational issues our clients are wrestling with today. In addition to Tiffany, I'm joined on this call by Bob Rozek and Gregg Kvochak. And Bob, I will turn it over to you. Great. Thanks, Gary and good afternoon or morning, depending where you are. As Gary said, the global economy is in transition. Today, unprecedented economic forces are driving companies to rethink their business and their talent strategies. As this transition continues to unfold, it is also clear that the organizational and talent issues facing businesses are more complex than ever. Today, companies are seeking new ways of filling essential roles while also keeping their existing workforce retained, engaged and developed. Our company is built to help our clients navigate through this transition. Today, our suite of workforce solutions is aligned with the needs of the market even as economic growth slows. This transition provides an opportunity for us to guide clients through these uncertain times with the same unparalleled service and expertise that has built our strong brand over the last 50-plus years. Now as our clients adjust their strategy, organization and workforce for the realities that lie ahead, we stand ready to partner with our broad range of core talent solutions which were outlined by Gary. When we take bits and pieces of these core solutions and package them together into an integrated solution, we believe our ability to service our clients is unparalleled. It gets even more interesting when we leave our industry-leading data into our integrated solutions is then we can form unique and differentiated points of view that our competitors simply cannot. Now, let me turn to our second quarter results. Fee revenue grew to $728 million. It's up $88 million or 14% year-over-year at actual rates and 20% at constant currency. Growth by line of business was mixed. We saw good demand in consulting, digital, in the interim portion of professional search and interim. As we anticipated, this was partially offset by moderating demand in executive search in the permanent placement portion of professional search and interim from the elevated levels that we saw during the pandemic recovery period. At constant currency, measured year-over-year, Consulting was up 12%, digital was up 15%, RPO up 19%. Professional Search & Interim which was aided by the recent acquisitions, was up 147% and Executive Search was down 4%. The consolidated new business, excluding RPO, was seasonally strong in the second quarter, with year-over-year growth in nearly every line of business. Similar to fee revenue, we continue to see new business demand moderating in the permanent placement portion of our talent acquisition businesses which was more than offset by our recent acquisitions and new business growth across the rest of the company. Consolidated new business, excluding RPO was up 8% year-over-year at actual rates and 14% at constant currency. As Gary indicated, RPO was awarded a record $290 million of new business in the second quarter which included the 2 large assignments that also Gary referenced. Synergies between Professional Search & Interim and our other lines of business have been very strong. If you go back to November 1, 2021 and that's when we did our first acquisition, in the Pro search & Interim business. Referrals between Pro Search & Interim and our other lines of business have resulted in approximately 600 new assignment wins with a combined contract value of nearly $36 million and that really reinforces the complementary and synergistic nature of our core solutions. Earnings and profitability also remained strong in the second quarter. Adjusted EBITDA in the second quarter was $131 million at a margin of 18%. The earnings and profitability in the quarter were impacted by a mix shift in fee revenue by line of business as well as our continued investment spending into digital. Finally, our adjusted diluted -- fully diluted earnings per share were $1.43 which was down $0.10 or 7% year-over-year. Now. it's important to note that our adjusted fully diluted earnings per share were negatively impacted by $0.09 due to a higher tax rate which was 27.8% and that compares to 25.1% in the second quarter of fiscal '22. Our investable cash position remained strong. At the end of the second quarter, cash and marketable securities totaled about $831 million. Now if you exclude amounts reserved for deferred compensation and for accrued bonuses, our global investable cash balance at the end of the second quarter was about $457 million. Our capital deployment continues to be well balanced. Through the second quarter, we repurchased approximately 992,000 shares of stock using about $56 million. We paid cash dividends of about $17 million, funded about $33 million of capital expenditures that again were directed towards our digital business. And we deployed about $99 million on M&A. Thanks, Bob. Starting with KF Digital. Global fee revenue in the second quarter was $94 million which was up 6% year-over-year and up approximately 15% at constant currency. Digital subscription and license fee revenue in the second quarter was $29 million which was up 12% year-over-year and was approximately 31% of revenue for the quarter. Global new business for KF Digital was $112 million, with $40 million or 36% of the total tied to subscription and license sales. Earnings and profitability in the quarter were marginally impacted by investments in both commercial sales representatives and product development initiatives. In the second quarter, Digital generated adjusted EBITDA of $27.5 million with a 29.2% adjusted EBITDA margin. For Consulting, fee revenue in the second quarter grew to $173 million which was up 5% year-over-year and up approximately 12% at constant currency. Fee revenue growth continued to be broad-based with growth in almost every solution area and was strongest regionally in EMEA and North America which were up 17% and 11% respectively, at constant currency. Additionally, global new business for consulting in the second quarter was up 2% year-over-year at constant currency. In the second quarter, adjusted EBITDA for Consulting grew 3% year-over-year to approximately $31 million with an adjusted EBITDA margin of 18%. Growth in Professional Search & Interim remained strong in the second quarter and was aided by new and enhanced capabilities recently acquired from Lucas Group, Patina and ICS. Fee revenue tied to permanent placement search was $79 million in the second quarter which was up approximately $24 million or 44% year-over-year and was positively impacted by our recent acquisitions. Our Interim Service fee revenue in the second quarter grew to $55 million, driven in part by the recent acquisitions of ICS -- acquisition of ICS which primarily provides on-demand, high skilled IT professionals on a flexible or project basis. Our Interim Services average bill rate was approximately $107 per hour and we generated $850,000 of fee revenue per billable day in the second quarter. In the second quarter, adjusted EBITDA for Professional Search & Interim was up $10.7 million or 49% year-over-year to $32.5 million with a 24.1% adjusted EBITDA margin. The outlook for Recruitment Process Outsourcing business remains strong. As previously mentioned, RPO was awarded a record $290 million of new business in the second quarter, including 2 large 3-year contracts totaling almost $200 million. This brings the total revenue under contract at the end of the second quarter to approximately $958 million. Fee revenue in the second quarter was $107 million which was up $11 million or 12% year-over-year and approximately 19% at constant currency. Sequentially, RPO fee revenue was down 6% in the second quarter, primarily due to moderating volume tied to a few of our life sciences and technology clients. Additionally, going forward, it is also important to note that larger, long-term RPO assignments like those awarded in the second quarter are more complex to set up and therefore, there is a timing delay between initial startup and implementation costs and the recognition of revenue. Adjusted EBITDA for RPO in the second quarter grew to $16 million which was up $1.6 million or 11% year-over-year with an adjusted EBITDA margin of 14.9%. Finally, global fee revenue for Executive Search in the second quarter was $218 million which was down 7% year-over-year and down 4% at constant currency. Growth in EMEA which was up 21% year-over-year at constant currency, was offset by slower demand in North America and APAC which was primarily tied to China. North America and APAC were each down approximately 10% year-over-year at constant currency in the second quarter. Global new business in the second quarter for Executive Search was down 8% year-over-year and down approximately 4% at constant currency. At the end of the second quarter, the number of dedicated Executive Search consultants worldwide was 621 which was up 51 year-over-year and up 2 sequentially. Annualized fee revenue production per consultant in the second quarter was $1.41 million and the number of new search assignments opened worldwide in the second quarter was down 11% year-over-year to 1,637. In the second quarter, Global Executive Search adjusted EBITDA was $54.5 million with an adjusted EBITDA margin of 25%. Great. Thanks, Greg. Our third quarter is historically our seasonal low quarter for both new business and fee revenue and that's really due to the slower calendar year and holiday season. Consolidated new business in November followed our historical patterns and was in line with our expectations. If current trends remain consistent with historical seasonal patterns, we expect December new business to be down sequentially from November and for January to rebound slightly. We are evolving to an organization that is selling larger, integrated solutions. And we're doing that in a world that is moving from offshoring to nearshoring. Because of these factors, in the recent moderation in our permanent placement talent acquisition solutions, we are in the process of developing a plan to realign our workforce, making investments to match the right resources with the right skill sets in the right geographies as well as reductions where we have excess capacity. Also in this review, we'll be looking at further reductions in our real estate footprint, along with reductions in other discretionary operating costs. We expect that the plan we are developing will generate $45 million to $55 million in annual run rate savings and will cost $25 million to $35 million to implement. Now with respect to the realignment of our workforce, we expect the plan to be completed and implemented by the end of the third quarter. We expect annual run rate savings of between $40 million and $50 million, starting in the fourth quarter. Now certain of the real estate savings are included in this run rate, with the remaining amounts are going to be realized in future periods as we execute the plan. Now in summary, assuming no new major pandemic-related lockdowns, further changes in worldwide geopolitical conditions, economic conditions, financial markets and foreign exchange rates, we expect fee revenue in the third quarter of fiscal '23 to range from $660 million to $690 million. Also, given the factors leading to the development of our realignment plan, we expect our adjusted EBITDA margin in the third and fourth quarter to temporarily fall to a range of 14% to 15%. And our consolidated adjusted diluted earnings per share in the third quarter to range from $0.88 to $1. Finally, when you include the charge for the previously discussed plan, we expect our GAAP diluted earnings per share in the third quarter to range from $0.40 to $0.66. Now, while the transition in the economy will result in some short-term volatility for our business, it's also an opportunity for us to prove the value and relevance of our solutions and the power of our brand. We remain more confident than ever that our strategy is the right strategy. We've built a firm that provides the right core and integrated talent solutions that help solve the talent and organizational issues our clients are facing. Today, more than ever, we believe our clients realize that an integrated talent management strategy is essential for their long-term success. And working with the right partner is critical and we believe that Korn Ferry is that partner. Could you describe a little bit about like what you ended up seeing in terms of the sequential trends in terms of new business and confirmed orders coming through on the Executive Search side and how that ended up flowing through? And what you're hearing from your clients right now in terms of the prospects, in terms of further confirmations as we go into December, January and February? Well, I'd say, first of all, November new business compared to October, so sequentially was exactly like we would have imagined it to be and it's in line with historical trends, Mark. The new business for the firm overall in November was up 6% [ph] at constant currency. Now to your question on Executive Search, we've been now seeing this, as you know, for several months. There's been a moderation from the very heightened levels that we saw 1.5 years ago. And with respect to Executive Search, we saw in the -- take the second quarter, we saw a new business down about 4%. And we saw the same thing in November. So both in the quarter and November, this is constant currency, Mark, we saw declines in both of those. And the outlier was EMEA. EMEA was actually very strong. EMEA was up 13% in Executive Search in the quarter, again, constant currency. And constant currency in November is up 17%. So clearly, we've been saying the air we got out of the tire in the global economy for several months; and that's what we saw in as recently as November. The only thing I would add to that is in my remarks, I commented that the -- if you look at the volumes that we're seeing in Executive Search today and this is probably over the past 4 or 5 months, they've moderated but they've moderated back to sort of the, what we would call, a good month in the pre-pandemic period, right? So I'll give you North America as an example. Prior to the COVID shutdown, a good month for us is about 250 to 275 searches. Coming through the recovery, we had bumped up to elevated levels. There were 325, 350. And for the past 4 or 5 months, they've come back down to somewhere in the 260, 265 range. So right back to where we were pre-pandemic. And Bob, would you expect that to hold here as we think about like the way the new orders are going to trend over the next 3 to 6 months. I mean, obviously, you guys are sharp. You read all the headlines. You could see it. I'm not sure what your clients are saying. But most CEOs are basically expecting a recession, so you would expect some belt tightening. So how are you thinking about the new orders on a go-forward basis? Yes. I think we have some -- Q3 is our seasonal low. So obviously, December will be the worst month of the year. So we're going to follow that pattern and then we'll have a slight rebound in January. Kind of what we're -- as we're looking at things going forward, we're kind of holding serve with where we are today from a unit volume perspective. When I talk to folks in the field, what I hear the most is it's not that people are saying, "No, we're not going to do this. It's just taking longer for compensation letter to get signed." And so for the foreseeable future, that's what we expect to continue. Great. And then can you talk a little bit about what you're seeing on the Professional Search & Interim on an organic basis or a pro forma basis? Obviously, the numbers are skewed by the acquisitions. But how is that looking on a pro forma basis? The interim business is looking good, Mark. On an organic basis, looking very good as recently as November. So no pullback at all on the Interim which isn't -- that's -- I think given career nomad landscape. In Pro Search, we're seeing the same thing that we're seeing in Executive Search. The -- what I want to go back to your question because when you look back at the last 3 recessions, they were all event-driven. This one seems to be a slower leak and there's massive changes that are happening under our feet from the inflationary pressure to changing global trade lanes, to near shoring, a lot of companies are making moves around transformation. But the one thing that's substantially different this time around and I'll just take the U.S. as an example, is the labor force. And the reality is the labor force, 164 million Americans in the workforce hasn't changed in almost 3 years. And the labor participation rate at 62%, as you know, is a historical low. So you can talk about uncertain times and you can talk about recession but that's a huge, huge difference. And I think companies are going to be pretty hesitant in doing any kind of massive downsizing of the workforce. And you're seeing the quit rate falling, you're seeing job openings falling which you would expect. But I think the general makeup of the labor force is a substantially different and new variable compared to past cycles. And the firm today is a much, much different company. When I look at the Q2 results and I compare them to the quarter before the pandemic, our revenue is up 40%. And our EBITDA is up 70%. The Q3 guide to that same period of time, going back to pre-pandemic at the midpoint of the guide it's suggesting revenue up 30% and EBITDA [ph] up 22%. So you have a completely different firm today, where Executive Search clearly gives us a tremendous access in the marketplace. But you've got a firm now that has broader capabilities. I mean our consulting new business, I mean I don't want to take 1 month and make it a trend. But in November, our consulting new business was up 20% at constant currency. Now for the quarter, it was in an elevated level but it was still on the positive side. So I think you've got just a completely different paradigm and then you throw in the RPO business, where this has been unbelievable the new logos we've put on. And as a firm overall, this new -- in the quarter, I mean, our new business was almost $1 billion. I mean, this is the highest in the company's history. Congratulations on that with regards to the RPO side, particularly. Can you -- the 2 big contracts that you ended up winning during the quarter, adding $200 million in annualized revenue. Were those brand new to RPO? Or were those switches that you gained from other players? And then you mentioned that you're going to try to become a bigger player in health care on RPO. Is that going to be organic? Or are you looking at some things? Well, we're looking at both. Those were both taken -- they were taken from other firms that operate in that space. And they're -- it's really because of our account strategy. That's really where it began. And so those are takeaways. Our health care business, one of the things we have to do is with this movement around near shoring, you could call it nationalization, however you want to characterize it, we have to be much more agile with our regional accounts. And we're putting a tremendous amount of focus on how we should rearrange resources in our portfolio to match changing global trading partners. So one of the areas that we've targeted is health care. Health care today represents about 7% of Korn Ferry globally. And clearly, in the RPO area, we think we've got an enormous opportunity. So clearly, we're going to pursue that on an organic basis. We've got a fabulous team. And if we could do something inorganically, we do that as well, Mark. Great. And then 1 last one and then I'll jump in the queue. With regards to the expense reductions that you outlined, how much of that is going to be rightsizing the personnel versus the real estate footprint? Yes. We're going to continue to look at real estate. I mean this is transitory period in many, many respects and one of those is hybrid working for sure. And so we've got to continue to look at that. We would actually like to do more there but it just doesn't make economic sense. So it's something we're going to look at our total cost base which does include the real estate. I would assume we're finalizing the plans right now but I would assume probably 2/3 or so, maybe something like that is from rebalancing the workforce. And what we've been doing is we've picked up some major contracts. And over the last few months, we've been working very, very hard to see how we can shift our own resources around. But at the end of the day, we're going to have a mismatch between language, geography, skills between some of the areas where we're seeing pullback than some of these new exciting wins. And so I -- this is not a broad-based layoff, it is nowhere near that. It's very, very targeted. It's something I wrestled with for several months. Absolutely, hate to do it but we have to rebalance our workforce to take advantage of the opportunities that we see on the horizon. Sorry for the audio difficulties earlier. So a question around the cost savings program. It sounds like it's going to be a balance of personnel, real estate. Are the cost cuts going to be more concentrated, perhaps in Exec Search where you're seeing more of an inflection in new business trends? Or is it going to be relatively broad-based across the company? No, it's very targeted and I'm not going to get into exactly where it's going to be because we're still finalizing the plans. But I would tell you that we have secured some major wins for the organization, strategic wins. And as we've looked at meeting those demands, we have an imbalance. And there is excess capacity that we cannot solve because of language and location and things like that. So that it's very targeted and we'll, certainly, on our next call, we'll tell you what we did. Got it. And then related to that, as you think about the recovery in margins back to -- call it mid- to high teens, what would the time frame be for when margins can get back to historically what you said would be the long-term margin target of circa 18%. Well, look, I think there's a couple of wildcards. We do see a massive market opportunity around the Interim Services. And when I sit on account calls, it is absolutely clear with the career nomad landscape that this is a really, really good way to further differentiate our firm. And so you've got a huge market. It could be as big as $100 billion. We've taken that from essentially 0 to a run rate this last quarter of $225 million. And I think over a 3- or 4- or 5-year period of time, that could be a big driver of differentiation for Korn Ferry. So we're pursuing a larger market there. Now what comes with that is lower margins that you would have, say, compared to Consulting or Executive Search. And so there is a mix change that's happening. And so when we talked about the 18% to 19% long-term margin target, when we were coming out of COVID, we did not have the shift in business mix that we've seen today. And that shift in business mix between RPO and Interim, it could be as much as 150 basis points or so. So, when we -- so when you model out the future, that's one thing that you have to take into account is that shift in mix. And in terms of returning to this last quarter, we did 18%. That's really hard to say right now, George. I mean the word uncertainty is such an overused word. There's uncertainty and like every single day. But uncertainty creates opportunity and we have to continue to be very nimble and make sure that we are shifting our account strategy to where there's opportunity. Got it. And then lastly, on the Consulting business, you've seen actually some pretty resilient and positive trends lately. Historically, how cyclical has the Consulting business been? And how would you compare the macro sensitivity of the Consulting business relative to the Exec Search business? Well, we haven't had it for that long. I mean, we've got today -- when I started with the company, it was 0 but today, it's about $700 million. I mean the truth is that we do not have enough resources. We are completely undersized given the market opportunity. So we that's an area for us that over the 3 to 5 years has to be a large part of Korn Ferry's future. I am really proud of the team that we have and looking at what we did even in new business in the quarter or even November and the kinds of things that we're doing is inspiring to me. I would say that without substantial amount of data because we don't have a long track record with it. But I would say that compared to Executive Search, it's probably half is cyclical. I mean, all consulting services are cyclical. But I would -- my instincts would be half. And actually, when we went through the COVID recession, that's kind of what we saw was that the -- what you would intuitively think the more cyclical parts of our business, the Executive Search and Perm Recruiting, those were hit harder. And the Consulting, the Digital, even the RPO was substantially less cyclical than the Search business. And now with the Interim capabilities we have, I think that even makes that story more compelling. You just have to recognize that the margins in that business are different. And they are not as strong as, say, the Executive Search or Consulting margins. But with the Interim business, we are definitely going to stay at the high end. There's no question about that. We're not going to go into general staff and anything like that. We're going to stay very specialized. George, just to maybe pile on a little bit. The -- if you go back to the pandemic, it was a firm overall. Peak to trough quarter, we were down about 30%. Consulting was in the 20% to 25% range down. And then if you look at the whole year period that we're going through the recovery, our RPO business actually grew 7% year-over-year. That was helpful color on the cyclicality, how you're thinking about the business. Just on the guide, real quick, for the third quarter. Your guidance assumes revenues down, I don't know, $50 million at the midpoint from the second quarter to the third quarter. But EBITDA is expected to be down like $35 million from second quarter to the third quarter at the midpoint. I would have thought the decremental margin would be, I don't know, somewhat less than that. So can you just talk about the primary factors that led to that guidance range? Are there large investments happening here? Are there near-term fixed cost that just don't come down as fast as revenue? No, that's a good question. First of all, the guide reflects what we would view as seasonality of 4% to 5% on the top line. So that's number one. And then the second contributing factor is this moderation that we've seen for a long time that we've been living with around Executive Search and Perm Recruiting. Now the -- you're right that in terms of the impact on the margin and what we've been trying to really carefully look at is rebalancing the workforce and how we do that because this is not a situation where what I don't want to do is going to make draconian changes that compromise our ability to see short and midterm opportunities. So we've wrestled with this how we can reallocate resources. And that reflects some of that carry -- that we decided to carry longer as we really thoughtfully planned out how we could redeploy resources. So that's really the answer to your question. And we'll execute on this plan and we'll talk to you about it in the beginning of calendar 2023. All right, great. That's helpful color. And I would agree. I feel like your investor base are also long-term focused. I would rather see you make those long-term decisions than the short-term gains for sure. One more for me. on Executive Search. I'm curious what your expectations are for this business in the third quarter based on what you used to build up your total revenue guidance for this segment? And more specifically, what I'm really curious about is -- how are you thinking about this business in the third quarter in terms of moderating engagements versus maybe executive compensation flattening or coming down from the really high levels we saw last year? I mean I remember last year, talking to some privately held executive search companies in the space and I'm talking about how comp was up 100%. It was just huge and that was driving higher revenue for the search business. How much of that now if this Executive Search business is decelerating, how much of it is that versus actual volumes? Sorry for the long-winded question. Well, I think, look, Bob and Gregg can give the real data behind that but there's no question that over the last couple of years that there's been significant wage pressure which has lifted our Executive Search fees. And when you look at it, in the guide, I think we're planning on something like 13% or so, could be off a little bit, down in top line and that's probably a little bit higher on the volume and more steady on the fee. I really do believe that this is a substantially different labor market which is a huge wildcard in what happens to these kinds of businesses. I think this labor participation rate is shockingly low. When I look back at the -- great Recession as an example, in the United States, we lost 7.9 million jobs. It is really hard for me with the labor participation rate of 62%, 164 million Americans in the workforce. It is hard for me to come to anywhere near that kind of number, even as companies are looking at costs and they're doing all this stuff and waiting for what the Central Bank is going to do and if indeed are going to [indiscernible]. But it is really hard for me to come to a conclusion that 8 million jobs in the United States are going to be lost like they were in the Great Recession. Gary, it's Bob. And Tim, just to add a bit more color. Gary spot on. It really is all unit count and volume related. We did see increases in our average search fees coming through the recovery but that's pretty much plateaued at this point. Now we're actually just dealing with volume. So I did want to follow up and I appreciate all the color that you gave and your thoughts behind what it is that you'll be doing for the remainder ballpark -- let's call the remainder of this fiscal year, though it seems as though a lot of it will be concentrated in the third quarter. I was wondering if you could talk a little bit about maybe without giving -- without too much granularity, I guess but sort of big picture-wise, what sort of led to that process of what you're seeing as needing to take place? And also whether that was more a function of the marquee accounts that you talked about. I think you said that's now up to 37% of revenue and substantial progress made over the last few years in that part of the business. And certainly, that would be understandable. But also, you've talked about new business wins. So I'm sort of trying to get thoughts as to how much of that is being driven by the marquee accounts and kind of trying to get to where they are or get ahead of where they're going versus some of the big picture, big ticket wins that you'll be pursuing? Well, we hope it's -- look, we hope it's one and the same. We hope we're thinking about where the market is going to be going. Clearly, we have enjoyed some incredible success securing very large engagements. And at the same time, as you read about in the paper, we've read with this like for 5 months now, we've seen companies moderating what they're doing in terms of costs overall as well as their workforce. So what you've seen and what we've seen in parts of our business is some pullback in what I would call either base or legacy business and that's been coupled with major new wins. And the reality is when you compare those as hard as we've worked over the last few months, there's just a mismatch that you can't solve because of language and because of location. And so there is excess capacity in some places. And you could guess, I mean, when you read the paper, you could guess without mismatches, particularly given the megatrend around the changes in global trading partners and global trade lanes and nearshoring, there's a mismatch. And unfortunately, we have to address that and position the company for opportunity and that's what we're doing. Great. And then I wanted to sort of highlight just given the ability to generate -- the cash that you're able to generate and the -- what the market is done with your as well as other personnel and consulting-related names, I just wanted to talk a little bit about your thoughts around what to do with cash and share repurchase activity and dividends and the like. Well, the plan right now, I think fiscal year-to-date, we've repurchased $70 million of stock. We've continue to, as Bob indicated, the dividends are a good part of our capital allocation strategy as well. But we tend to look at this in a very balanced way and we look back over the past couple of years, that's what we've done. We certainly made a conscious effort to invest in the Interim businesses, where we didn't have capability. And that would be my answer. Now if valuation levels, if they change, then our capital allocation strategy would change somewhat as well. I just wanted to double check something to start off. What was the implied revenue decline on a sequential or year-over-year basis, if we kind of take the midpoint of the January guidance. Well, it can either be sequential as you just did or year-over-year? I just want to get organic changes in either a sequential or a year-over-year basis. Organic constant currency. Sure. So last year, our third, I'm going right off the top of my head, so you're going to have Bob and Gregg correct me. But I want to say last year, actual is 681. I think when you dial it back for constant currency, that 681 translates to something like 650, 645 in that kind of neighborhood. The midpoint of the guide is 675. So constant currency, that's up 4%, 5%. And clearly, that is benefited from the investments that we have made in the interim business and it reflects moderation in our Perm Recruiting businesses. I get it. So what was the -- what's the acquired revenue so that I could just get to the answer for organic? Yes, I would take you back, Tobey to -- you have to go back to the run rate when we acquired the companies. Because once we integrate them, we lose the ability to specifically identify and Lucas Group has been integrated for -- since the beginning of the year. So I don't have the ability to identify that. But if you go back to sort of the run rate that we said when we bought those companies, you're talking somewhere in the $55 million to $60 million range. Okay. Could you give us some color about the 2 major RPO wins? I know you talked about it a little bit already but maybe in terms of number of annual hires, types of occupations, geographies and differentiators that might have prompted the client to choose you over the incumbents Well, I'll let Bob -- we're not going to reveal the client or the industries. But I think one of the key differentiators that we have is, number one, the success and the high-quality of referenceable clients now that it's pretty incredible and success begets more success. So that's number one, incredible team and process, number 2. And the three is the IP and the ability to integrate that solution with other things that, that particular client wants to achieve, whether that's org strategy, whether if it's compensation advice and so this integrated platform is also a major reason why we continue to enjoy success in that part of the business I think you described the -- correct me if I'm wrong, the cost cut is sort of substantially smaller than a classic one you might have taken [indiscernible] in the prior downturns. So it seems like you're assuming some level of stability in demand headed into calendar '23. How is the organization feeling? You've undergone a lot of volatility as the world has really with the roller coaster of '20, where job cuts, furloughs, then rapid hiring and now sort of more measured realignment that you described. Could you just speak to that. I know that wasn't a specific question but I think hopefully, you get. Well, I think it reflects where the world is. In April and May 2020, I said that the COVID -- it would be a couple-year journey then 2 years of a transitory period. In a transitory period from a whole different -- a whole range of aspects from how people are entertained to how they consume, to how they produce to where they were. And when you go back, 3 years ago, it was scary. And even this morning, very early, you hear a story somebody that got COVID. If you had heard that story 2.5 years ago, you would have fallen over and wondered was that going to be you next. So I think that we're in a very, very unique time as human beings. Now I think part of that answer is where you are in the world as well. I mean, I was on an account call a couple of nights ago in China, for example. And our team in China has more fortitude and more perseverance and they've been in a very difficult situation. It's been 3 years. So I really do think it kind of -- it depends on where you are in the world. And I think it's a very spiritual and a very human question to ask. For us, what I'm really proud of is our purpose is to change people's lives, to enable people and organizations to exceed their potential. And when we see something. We don't just talk about it, we'd be about [ph] it and whether that's -- whether that's George Floyd, whether it's our charitable foundation, whether it's Leadership U for Humanity where we put over 1,000 people of color through our leadership programs, whether it's our own Mosaic programs where we, again, put 1,000 people now through that. And I think that we're a firm that walks the talk. And at the end of the day, I think that's what it's about. Are you working for an organization that you believe in its purpose that inspires you. And the truth is, like in personal lives, companies are going to go through cycles. And this is a cycle for sure that we're in right now. And Korn Ferry has an incredible track record of accelerating through the turn. And I think that probably reflects most people's views. I'll try to sneak in a last brief one. Could you provide some color on the drivers of digital growth? We haven't heard as much about KFL [ph] or the other individual products recently. So I want to you to refresh us. Well, I think the -- look, the -- this is definitely more of a medium-term play because there's 2 aspects. One aspect is the digital offerings and the products that you have. And what are you trying -- who are you trying to reach? And for that part of the business, what we're trying to do is, number one, sales professionals; and two and this is relatively new, is creating a platform where we can upskill technologies. So those are the 2 areas that we're really focusing and the latter being one that is brand new to us. On the distribution side, I believe that when you look at world-class consulting firms, you'll find that they have partners that help to enable further business growth and that's something that Korn Ferry historically hasn't really attempted. And I think when we look forward, that a big, big part of that is to what extent are we going to have successful developing an ecosystem of partners that can help distribute our IP and that is not a 2-day exercise. And we're working very, very hard. In fact, as we speak, there's a team that's working on that right now at a client to -- at one of those partners. So it's certainly more of a medium-term undertaking. And that's what I'm expecting and we're working very hard on it. And Gary, I would just a little bit more color on that, Toby. One of the things you'll notice when we went back to Q1, we talked about where Digital landed and the lack of large deals in that quarter. In this quarter, they actually rebounded nicely and they had 7 deals above $1 million, 2 of them were about $5 million and 1 was north of $900,000. So it's also a function of selling -- continuing to be able to sell the larger deals. Okay. Amy, I want to conclude and thank everybody. And despite all of this talk that you read about every single day, there is opportunity. And that's what we have a demonstrated track record of seizing and that's what we're going to continue to do. And so -- during this festive season, I wish everybody Happy Hanukkah [ph], Merry Christmas, happy holidays and we'll talk to you in 2023. Thanks, everybody. Ladies and gentlemen, this conference call will be available for replay for 1 week starting today at 3:00 p.m. Eastern, running through the day December 15, 2022, ending at midnight. You may access the AT&T Executive playback service by dialling 866-207-1041 and entering the access code of 6225763. International participants may dial 402-970-0847. Additionally, the replay will be available for playback at the company's website at www.kornferry.com in the Investor Relations section.
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EarningCall_1603
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Thanks again for joining us today. We have an update with Microbix talking about their year-end and Q4 numbers that were released just before the holidays. With me, I have Cameron Groome, CEO; Ken Hughes, COO; and Jim Currie, CFO. We will do a little bit of an overview of the year and the quarter and then open things up for questions. So as always, if you have any questions, feel free to input them in the Q&A box at the bottom. We will try and get all of those answered. And as always, this will contain forward-looking statements. If you'd like to know more about those, you can find them on the company's presentation on their website. And with that out of the way, I'd like to open it up for Cameron Groome to give us a little bit of an overview of Q4 and year-end results. Hi, Cameron. Hey. Hi, Deborah. Well, Happy New Year, everybody. Thank you very much to all the participants for joining us on an update call. We are going to run through a little bit the year just ended, give some operational updates, and a little bit of an outlook for what we see emerging in fiscal 2023. I would urge everybody to read from the Microbix website our full Q4 disclosures package, which consists of the news release, describing our year-end and Q4 results, the CEO Letter to Shareholders, the management discussion and analysis and the full financial statements of the company, which for the year ended and fourth quarter, which constitute the full corporate disclosure alongside the Annual Information Form of the company, which is also filed. With regards to Q4, I'll just briefly touch on a few high points and then hand it over to Jim for a little bit more context to detail. We had a reasonable Q4 top line, bolstered by some better antigen and QAPs sales, but those were offset by the lack of any viral DxTM brand, viral transport medium in the quarter. And those of you that are monitoring the wires, may have seen that a new CEO was appointed to Supply Ontario just on December 23rd, so there is a lot influx with regards to procurement in the province and we continue to work with the authorities on directing that for our DxTM product line. In terms of our -- so sales mix, strong on antigens and QAPs in the quarter and no DxTM sales in the quarter. So a little bit lighter than the prior year that had each of those three constituents. In terms of gross margin, that is affected by a heavy weighting of lower margin antigen sales, specifically sales of lower margin antigens in the quarter that pushed down margins a little bit along with some cost pressures not yet passed through to customers. SG&A was up. There is an increase in the quarter, and that's largely due to increase in selling expenses as we resumed participation in trade shows and events for customer acquisition purposes, and the lack of grant offsets. Net-net, a reasonable quarter, not our best, but ends up another firmly profitable year for the fiscal year ended 2022. It's not quite what we were targeting, and that's as outlined in my CEO letter, largely due to the major contract we signed in August and that top 10 diagnostics company continuing unexpectedly to iterate on the final design of its point of care testing instrument and assays related to that, that was, frankly unexpected by us. And that continues to impact the timing of revenue realization for that customer, although we are seeing quite a reasonable amount of service revenues, as we work with them on this process of perfecting assays for that important instrument. And those same factors are likely to influence our Q1 and our Q2 of this year as well. We foresee fiscal 2023 as being very firmly profitable as well. But that profit will be certainly generated in the back half as opposed to the front half year. So overall, I would say that 2022 has been a year of transition from full on pandemic in 2021 to a post-pandemic or at least endemic world in 2023. And whereby, we generated another year of record revenues and another year of convincing positive net earnings for the full year. So Jim, maybe I can ask you to provide a little more color in relation to Q4 and the full year. Jim, you're on mute, the immortal words. Sorry about that. Yes, I think my focus and comments here is on the fiscal year performance. Strong revenues. That was a record, another record year of revenues, profitable revenues. As Cameron said, it was a meaningful profit year as well. We continued with our strong margins. We saw some improvement in margins in our antigen business. And we certainly have stronger margins in our QAPs, and VTM business which led us to 58% margin. And our expectations for margins are probably in the 60% range. So we're not that far off where we had expected to be in terms of our margins for the year. That was a year where we've made a number of investments. Our cash position improved, where we were at $13.5 million at the end of the year. However, we did make some sizable investments during the year. We paid off approximately $3 million in debenture and long-term debt. That decreased our interest, lowered on an annualized basis by over a $0.25 million. We invested $1 million in equipment, both new and replacement of aging equipment. We also invested in new labs and facilities over $1 million. And we've also invested in some of the key areas that Cameron was talking about, sales and marketing, invest -- continue to invest in that area, as well as research and development. It's a key for us to be on top of what our customers need and invest in new products that come along and IT infrastructure. So we've had a sizable investment in staffing, as well as ERP solutions. We're in the process of implementing a new ERP solution and an eQMS system as well. So we're investing for the future and we've made those investments, a large chunk of them in fiscal '22. And we will continue to make them in fiscal 2023 as well. We've got a strong balance sheet. We've got current ratio for the year improved from 3.68 to 8.45. Our debt equity ratio improved from 0.55 to 0.33. So I think we're well positioned for the growth that we've been indicating, are on the cusp of -- for fiscal '23 and beyond. I think it's worth noting that on top of the considerable investments that Jim has highlighted that we've been making for -- in capabilities and capacity, along with the debt reduction and share buybacks even, we're still ending the year with a very strong cash position and weâre at approximately $13.5 million; and as Jim has indicated, very, very strong and meaningfully improved financial strength ratios, liquidity and leverage. Well with that -- we will let Ken do so. But this is converting the company from paper-based quality management records into a fully digitized system. For complex biologicals as we make there's tremendous detailed records for each individual batch of product. And those are literally telephone book sized documents that are now being moved into digital form. And Ken maybe I can ask you to start your comments with a bit of a description of what that is and why we're doing it. Yes, I mean, the cumbersome nature of a paper-based system, which is fully integrated and repeatedly audited and we get great feedback from our auditors in that regard. I guess everybody's aware that we're ISO 13485 accredited, ISO 9001 accredited, and we operate a total quality management system anyway to be a regulated provider of biological solutions. But it gets to a point where there's a critical mass of paper that would just -- would become an impediment to the growth that we're pursuing. And so to kind of get ahead of that, we've been digitizing our systems and we have a program for the electronic nature of the quality management system where paper documents are transferred into digital form, and therefore easy to handle and manage going forward. And also with that the enterprise resource planning software that fully integrates into that to manage the financial aspects of the business. This creates an efficiency which allows growth. Weâre investing in this as we said we would. It's part of building capacity and capabilities for the growth trajectory we are on. Yes, I mean, from operations, I mean, stated objective for before 2022 and including 2022 was to build flexible capabilities and capacity. And we've done that. We've commissioned a number of labs and manufacturing suites. We've built teams and capabilities. And this has been illustrated in how we've pivoted in the face of the pandemic, for instance, the clear examples would be all our QAPs, which are on the various variants of COVID-19 or indeed pivoting to make our VTM product portfolio, which weâll continue into the future. But as a consequence of the activity and creating that infrastructure, we have additional capacity on antigens, QAPs, on viral transport medium and other special projects that may come up as we move forward with a very integrated R&D quality control, quality management and manufacturing group to allow us to pursue these capabilities going forward. So as we go to that, as our business continues to grow, we now have the capacity in place to realize that it's not going to be a problem in terms of the facilities, and we continue to add capabilities as we move forward as we continue to build and diversify the business. So operationally, things are going very well, and we have basically done what we said we would do, thatâs what we do. Yes. And I think that's a great point to make, Ken, that if anyone looks back over the history of our disclosures and in the forward-looking statements made in them, we are very much executing consistently on what we say we are setting out to do. Our QAPs business over the past three years has tripled. Our antigen business has increased margins, as we said we were targeting, and we created out of nothing the opportunity of our DxTM business, our viral transport medium where we have realized over $10 million in grant and product sales income associated with identifying that acute need through the pandemic and now exiting it. So timing is -- and certain aspects of our customers' behavior is beyond our control. But the things within our control, I think, we're certainly executing on. I mean, we have an excellent scientific and technical and production and testing team, which we have been building to address all these diverse opportunities and be able to pivot so well and build that capacity going forward. And weâve specifically put that capability in place. I mean, examples would be, we are currently launching a multiplex QAP by -- which really illustrates the type of technical acumen we have. But also all the production processes we put in place are deliberately flexible and have a capacity so we can pivot in the new product opportunities as we need to, and because obviously we're on a very rapid growth trajectory that's in QAPs also in the DxTM portfolio and with the antigens as well. So we are continuing on that route. Very, very much the case. And I'll make some concluding remarks. But Jim, was there anything further you wanted to touch on before that, just in regards toâ¦? Okay. Very Good. Well, to recap, I would say, again, we expect full year 2023 to be firmly profitable. We do foresee due to customer issues, softer first half followed by strength. The realization of sales growth is to a large extent driven by what we see in the point-of-care testing area and opportunities to supply in QAPs for such major customers. And by nature, we are subject to their assay and instrument launch times associated with that. I think we are satisfied with the operational and strategic directions of the company. We have the balance sheet to execute on these plans and we are not -- we are not certainly subject to market volatility, capital markets volatility as we have no need to raise capital at this time. So we are not subject to the negative sentiment other than as it affects our share price in the shorter term. We are, as was mentioned, deploying capital as we generated both on enhancing capabilities and capacity on debt reduction and as well our normal course issuer bid otherwise known as a share buyback is certainly active. And in the first three months of that program, we have bought back over 0.75 million shares or cancellation. So that's certainly something that is being actively used not just as window dressing. We have the ability to buy -- in theory to buy back 5% of the shares outstanding, which is up to 7 million shares. There are, however, strict constraints on how those buybacks function imposed by the TSX. We can only buy back a portion, a quarter of the average daily volume in the six months preceding the start of that normal course issuer bid, weâre not able to buy in an uptick and so forth. So it does have some practical limitations on how you can use it. But we certainly put it in place with the intention to buy back shares up to that limited to the extent permitted. So those are, I think, the conclusion of our comments, but happy to move to addressing specific shareholder questions, Deborah, or any that you've perhaps received offline, prior to the call as well. Sure. Sounds good. I've got -- let's start with one for Mr. Hughes. So when will the physical renovation of the third plant be complete? And when do you expect it to be operational? It is and it is, is the short answer. So yes, we have a production suite in the third facility already operational and being used. We actually have some plans to build out some further space into the warehouse to build some additional functionality and capacity in the next little while. But the production suites that we're going into the third facility are there. Our third facility is fully qualified under our ISO 13485 and 9001 quality systems, and is fully functional for its intended uses. As Ken has indicated, that facility has a front end which it has office workstations for staff in different departments. The middle section of that building has been built out for DxTM production and there's a considerable amount of warehousing space. So we're evaluating potential for other production or QC labs or other purposes in towards the back of that building. And actually to adopt new accreditation -- for ISO 13485 accreditation, manufacturing has to be occurring in all buildings that are under the auspices of that. And in 2022, we added our Building 3 at 275 Watline under our ISO 13485 certification. In fact, we were looking at the potential to add a fourth building to our facility -- our facilities. But we felt with some of the customer timeline delays, that was a little bit premature. We don't want to get as the saying goes too far ahead of our skis. So we elected to pull back on that for the time being. Well, Deborah, youâre on... I got it. Well, let's go thematically then. I see a few questions on VTM, so let's start there. So from one investor, why no sales of VTM especially to others beyond the Government of Ontario? A lot of a lot of testing practices have changed over the past short while. As for example, Ontario has moved from testing all comers, where respiratory viruses to those in hospital, entering hospital or in long-term care facilities. So patterns of consumption are renormalizing across not just Ontario but multiple provinces and in Ontario, specifically, the whole supply chain has been reoriented in Ontario, the whole procurement practices are reorienting. In fact, if -- the new CEO of Supply Ontario was appointed on December 23rd. So we are on top of these matters. We are evaluating opportunities in Ontario and other provinces, but these things are very much in flux. And our big advantage of course is domestic production. And the closer you can get it to home, the better it is. So Ontario, we expect will remain a principal client for DxTM for the foreseeable future. But it is not without lumps, unfortunately, In terms of VTM, like if you're going to try and access different markets, do you need to change the formulation of it? Or is it like a standardized product? Formulation is driven by application. Our DxTM is currently qualified as a viral transport medium, its formulation makes it compatible as a universal transport medium but some of the work to make those claims has not been -- in that may or may not be important to end users but we have to respect the appropriate regulatory pathways. We have certainly ambitions to sell the product more broadly in Canada and have done so in small quantities. We do not presently have ambitions to extend that product to international or U.S. sales and that's something we'll certainly evaluate with our partners and stakeholders before we move forward on that. No, we're not. We have sufficient inventory for our purposes currently. And we are not in production at the present time. Okay. I'm just seeing if there's any more VTM. Is $2 million a good estimate for top line fiscal 2023 For VTM or is it too optimistic? We're still evaluating that. We have a conservative budget number for DxTM in mind, but certainly we'd like to exceed our budgets to the extent as possible. And given that certainly discussions are ongoing with different purchasers, I think it would be strategically inappropriate to put a number on the table as to what our current expectations are. We do see overall 2023 being another year of record sales for the company. But how that will be comprised between the three major operational lines of the company is something we'll see how it emerges. But we see -- we'd like to see certainly growth in all three if we can or as many out of three as possible through the year. Okay. Then moving on to QAPs. Have there been any changes in the point of care diagnostic market that would impact demand for QAPs? Are you seeing potential customers coming to you following the sunsetting of EUAs? The EUA question and this is the Emergency Use Authorizations of the United States where tests were permitted to be put on the market without the perhaps same level of scrutiny that they would need to undergo under the customary 510(k), which is the predicate device approval pathway or the PMA premarket authorization approval where there is no predicate device. So there are a number of tests that are out there, under Emergency Use Authorizations. And it's really a stage, I believe, certainly and Ken please step in if you have heard much different. But what I've been hearing is that, companies right now are being encouraged strongly by FDA to get their files in order because the FDA doesn't want there to be gap and test be unavailable. But as a certain number of people have gotten their files in order, the door will be shut on those that have not. And they are not setting a bright line or a firm date by which this has to happen. But we are seeing more companies entering into dialogue with us about whether we can help them get their houses into order. So short answer would be yes, but not as a -- but more of a process of persuasion rather than brute force on the part of the FDA. Yes. I mean, that's exactly right. That the traffic to Microbix has increased as a consequence of this reality. People are anticipating what's coming down the pike at them and if they are sensible enough to do that. And use of our products to help them to get it right is something that they are well aware of. Yes. And some of the key points that we have highlighted in the corporate presentation, which as you know Deborah we will be revamping to update in a short while. But there is some key points in there with particularly FLOQSwab-based QAPs are particularly well suited for point-of-care. The format of course emulates for many forms of testing how the sample is collected, so provides a streamlined and indicative simplicity to that use of controls. The long-term temperature -- room temperature stability that we have demonstrated with our QAPs is also very key because the controls under non-Emergency Use Authorization utilization need to be able to be kept at the same room temperature storage conditions as the cartridges. You can't have one needing to be refrigerated or frozen, where the other can be at room temperature. And they have to be very simple so that non-laboratory people that are not trained laboratory technicians can run the controls as well as the tests. So those are key. Another element is the FLOQSwab itself, whereby the very quick and consistent uptake and release of analyte is very important in the context of control as the regulators really want the control to really test the lower level of detection of the test to see that it's working, not just barely, but optimally. And there is some real issues with other forms of controls where there is tremendous variability in the control, so you can't actually consistently test that lower threshold of protection, and that's a real advantage that we are finding is necessary for our customers. organism growth purification and activation stabilization be it native, wild type viruses and other pathogens, or indeed, viruses or pathogens produced by a synthetic biology techniques that we have in-house. So they're well aware of that. And then the overarching on that is the quality management system we have to make sure the product behaves the same way every time. And the customers are well aware of that expertise, which is specific to Microbix, if not unique to Microbix. And then staying on the theme of QAPs. Looking at this year's shareholder letter, you don't mention the $100 million market opportunity in QAPs anymore. Why has this opportunity changed? I think we can't repeat the same things every time or it'd be pretty boring letter. I don't think our view on the scale of the opportunity has changed, perhaps our view and the timing of that opportunity has evidently, but we can continue to be very optimistic about our ability to realize very material revenues in that segment. So I wouldn't change that viewpoint, I think it's a question of industrial sales, acquiring customers, seeing them roll out more assays on that instrument. It's a little bit like a, I'm going to date myself, I'm not a gamer, but I guess it's an Xbox or PlayStation or the gaming consoles, you can have the best gaming console in the world. But if you don't have games to play on it, nobody's really going to buy it. And so what we're doing is helping enable them to have more games to run on those consoles, more tests to run on those instruments. For each one of the tests that they plan to roll out, they need the accompanying controls, if those point of care instruments are going to be permitted to be used outside of a clinical lab. And point of care is meant to be used in settings where you don't have access to a full lab quality management system and controls that come with that. So those are doctorsâ clinics, those are pharmacies, those are long term care facilities, schools, workplaces. These applications require in controls with the instruments in those quasi institutional settings, where there's going to be a relatively high volume of test usage on those instruments. And you don't want errors persisting or problems persisting and giving you false positives or false negatives. Very much so. Yes, yes, absolutely so. Microbix continues to be intensely active with human papilloma virus molecular testing. This is the virus that is the direct cause of cervical cancer in women. It's becoming a very common cause of head and neck cancers in men. It is a cause of other cancers in other geographies of the body. And historically, the means of diagnosing cervical cancer, in particular was to examine cells from the cervix through a Pap test. And then look to see if those have transformed into cancer cells or sometimes high grade precancerous cells. Molecular technology, PCR technology enables you rather than to look at the conformation of the cell and say this has transformed into cancer, lets you look years beforehand to say there is the presence of a form of the HPV virus that will or could cause cancer years down the road. So imagine the improvement to healthcare to say, you are at higher risk of cancer, let's watch closely to make sure that doesn't happen versus saying congratulations you have cancer. Those are two very different outcomes. And I'm very pleased that Microbix is now very much at the front of that transformation from looking for cancer to looking for the viruses. And we're helping multiple companies in multiple jurisdictions on enabling that transformation. And that will be a very material revenue generator for us in the not too distant future we believe, forward looking. And how are delays at the large OEM affecting your revenue projections on this contract, previously, $5 million in the first year? We had certainly baked in some buffer on our own statements to -- as to expectation, I think we've now used up that buffer. So we would still see around that number for fiscal 2023 from that agreement in our budget, but it will be certainly back-ended. And that is unexpected and we did not foresee months of further iterating on that particular program. And that iterating is generating some service revenues for us. But it is not generating the high volume recurring product revenues that we were targeting yet. Okay. And then I think there was one last QAPs question and bear with me it's a little bit long if you want to look, Cameron, it's the third question in the box right now. Let me open it up if it's got a whole bunch of parentheticals, it may take me a moment to read just a moment. It's all good. I'll read it out. But considering repeatedly discussed delays in QAPs orders and the share price development over the last few months, it seems the capital markets has lost confidence in management projections. What do you actively do to make those QAPs contracts happen? And what is your base case for guidance for revenue in 2023? We don't provide formal revenue guidance, let's get that off the table. It's not something we're in the business of doing. We do see revenues being a record and certainly in the 20s, certainly well north of $20 million in revenues, perhaps not $30 million. But what we are looking for another record, we are looking for another profitable full year. It's not to say we won't see a quarter or quarters of negative net earnings, but those are not sea changes, those are blips. Further to our confidence, what we see day-to-day is our team working, supporting the teams of major multinationals to enable their very important new product launches happening and supporting existing and new products, tests and instruments. And that's really where we derive the confidence in our outlook. When teams are working side-by-side on a daily basis, we have in some cases, double-digit numbers of companies, instruments in-house supporting their product development and these are not commitments that are made lightly on either side. So, well, it tests everybody's patience and sometimes faith, when there are delays in realizing revenues. These are not -- these are very concrete relationships and commitments that we are working with and working on. Alright. I don't see any other VTM or QAPs questions. I mean, a favorite is always, can you give us an update on Kinlytic? Yes. We -- the file continues to be very active and we are moving forward, I would say, in a direction of discussions that seems to be very satisfactory. And when we have something definitive to announce, we will be very pleased to do so. And I think our target certainly remains to move Kinlytic back on to start the funding to drive the work forward to generate new drug substance and new drug product and move that through regulatory filings and bring it back on to the market. There certainly is an ever-growing use of long and dwelling catheters to deliver therapeutics, and other interventions for the catheter clearance indication that is really the tip of the spear for bringing that product back into the market. And there is also indications of increasing incidence of blood clots and need for thrombolytics generally. So we are seeing there is a stated shortage of tissue plasminogen activator in the European Union. We have received news of shortages of high molecular weight. This is the urokinase derived from pooled urine, which is not something that would ever be approved in the West, but there are shortages even if that product across Asia. So we definitely see a real material need for the return of Kinlytic in the marketplace, not just to provide price relief, but to provide added supply and added security of supply. And we see it as a very material opportunity, as do respective partners. I had a follow-up question. So after all these years waiting for a deal, what's your view of the main reason holding back securing a partner for this opportunity? I think we were proceeding along a very good track in 2019 as the pandemic roleplayed in the year. And that certainly upended more [out of carts] than just our own in respect to that product, companies that were in the specialty pharmaceutical field and specifically companies focused on hospital directed product sales. So again, patients were going to hospitals for anything but COVID, by and large, and that affected healthcare quite badly, but it affected the revenues of those companies and they were not in a position to take on new development projects at that stage. So it's really only is we are coming into some sort of new normal that companies can look and say, yes, I'm ready to take on a development project, and it will be a US$20 million to US$30 million spend to bring the product back and relaunch it. So this is why we're not doing it ourselves is even with the strong balance sheet that we have, it would be an all or nothing bet for Microbix, whereas a larger company in the context of a portfolio can more responsibly make that venture. And for us, we want to participate and absolutely believed in the upside economics of the product. And that's why while it has been written down to zero on our balance sheet, it still has attention with regards to partnering that asset and finding third-party funding -- finding partner funding to drive it forward, not consuming Microbixâs own capital, that is of course being intelligent use for growing our immediate revenue businesses. Okay. And going back to COVID, I think there's some misperception in the market that Microbix remains a COVID story. What percentage of business is now COVID dependent? Certainly, the viral transport medium in the near term has had an element of that. COVID testing is broadening out as everybody knows, and I think most people have been sick with a flu or RSV this season. Respiratory testing is not just about COVID. So our DxTM was initially used for COVID testing. But it can certainly be used more broadly for testing for respiratory and other viruses and other infections even. So in the near-term, that could be tarred with that brush to some extent the DxTM revenues. Beyond that, it starts to get very difficult to tag things as COVID related, as many of our QAPs are multiplex already. Respiratory QAPs are not a single unless somebody's qualifying to detect a single variant of COVID and needs to remain qualified. So the -- what we call the proficiency and accreditation sales, well, they may be COVID directed or very secure. And more broadly, those are multiplex tests. So is a QAPs product that is a 4-plex between COVID flu A, flu B and RSV, is that a COVID sale? No, that's a respiratory disease sale. And whether COVID is up, down or sideways? Really doesn't overly affect those sales. When we talk to public health officials about what's next after COVID, and what other things should you be involved in? Two things really come up -- a lots of things come up, but two things come up. One is HPV, which you've already had a question about. And the other one is anti-microbial resistance in various pathogens. Microbix has been deeply involved in both of these areas since before the pandemic and continues to be there. The launching of molecular testing for HPV was delayed because every PCR machine in the world was doing COVID. So we have a whole portfolio of new products coming out there. And we expect the ratios to change, I think COVID I think we all know is now endemic and various variants are going to be with us for a while, but we have the capacity to deal with many other market opportunities and I would just cite HPV and antimicrobial resistance as exemplifiers of that. Yes. And at the risk of tooting our own horn a little bit, it's worth perhaps listening in on some of the webinars that we've started to do with leaders in the industry, whether that's with Becton, Dickinson and Memorial University with regards to COVID, whether that's about antimicrobial resistance as Ken was indicating with SpeeDx, whether that's talking about sample collection technologies with Copan, these are the relationships we continue to build. And working with leaders in the field continues to build our credibility and the comfort level that prospective customers become real customers. And we lock in increasing amounts of business in that regard. But it's difficult to do it, in a perfectly smooth exponential trajectory, sadly, does not happen in the real life. So that's where we have a bit of the âbumpiness.â You beat me too and I was going to say, let's get Jim on the hot seat for a bit. So I've got some financial related questions for you, Jim. So first, you mentioned $3 million in debt reduction, while long-term debt is up $0.5 million year-over-year. What was that increase used for? And true long-term debt reduction looks closer to $2 million year-over-year. Is that correct? Yes, so, I'm just trying to recollect the long-term debt. There was a treatment. It was a financial statement treatment of the debt that impacted us, just at the year-end was year-end reclassification that impacted the long-term debt. But certainly we've had the reduction in the debentures the $2.5 million reduction and conversion of a $0.5 million was made in the April timeframe as well during the year. We also paid off BDC loan in the area of about $250,000 during the year. Certainly we don't expect to see any climb in our long-term debt in the near-term.... I think it would be helpful for the person asking the question. Great question. A, the -- a large part of the debt that was repaid was in the current liabilities section of the balance sheet in 2021, would not appear in the long-term debt portion. So you will see $2.2 million going to zero in the current liabilities section that was related to debt was paid off as it came due rather than refinanced. Yes, valid point, Cameron. Yes, we had a couple of debentures that were -- that could be called. And therefore, they were treated as current. And those were two that one was paid off and the other was converted. So there has been a substantial pay down of debt as well as a BDC, another debt instrument that was repaid as well. And we will evaluate depending on the direction of interest rates, whether we should pay off further amounts of debt as well. The other area that weâre just thinking about is we do have some climb in debt, and that's the Fed debt agreement where we get 0% loan for project that we are working on with the Federal -- FedDev and that adds to our long-term debt. None of that is payable until 2025. And we are still getting loans on a quarterly basis to support our growth as well from the... Alright. And I got one more for you, Jim. And I'm not sure if you can really answer this, but are you forecasting other quarters of unprofitability? I think that we are looking at a breakeven number of approaching $5 million in revenues depending on product mix. It can be lower than that or higher than that, depending on the margin mix in that particular quarter. So I think it would be surprising where we never to see a quarter where we dip into a loss, but we don't see those as being a systemic set of losses more circumstantial and short-term. So I wouldn't rule out losses, but I wouldn't expect a protracted period of losses. Yes. No, no, no. That's fine. I think as you had indicated before, I think you'd indicated to the audience here that we were looking at record revenues for the year and profitable revenues for the year, so. But it does that. Product mix has a significant impact on our margins and our quarterly profit, and timing in terms of some of the larger orders that we get in, whether it's for VTM, QAPs or our core antigen business. Yes. Depending on which side an order falls on the quarter end line, has a dramatic impact on the top-line and the top-line of quarter has an impact on the bottom-line. So we certainly can say, Q1 is not going to be a barn burner and we will see what the balance of the year brings, but we see revenues coming in more strong -- much more strongly in the second half of 2023 than in the first half. Okay. And then another one for you, Cameron. What do you think are -- sorry, I'm going to rephrase this question. Why do you think Microbix is underappreciated or misunderstood by the market in respect to your company/stock? I'm not convinced we are, Deborah, misunderstood or under -- whatever underappreciated. I think weâve just gone through. We're in the midst of -- perhaps we are more than halfway through, perhaps we are not. But we are in the midst of the most aggressive interest rate making cycle that has been seen in 40 years and small cap utilization companies across the board have seen tremendous pressure on their share price. You were mentioning some statistics in the healthcare sector more broadly where all stocks effectively have been affected negatively by the increased cost of capital. I think the difference -- the biggest difference for us is that, we have ''real business'' and that we manufacture products that customers want to buy, and we generate significantly positive gross margin selling those products. So, this is a real business. We have a real balance sheet with tremendous financial strength $13.5 million in cash and we expect to continue generating net cash in 2023. So our business ultimately water finds its level. And this is where we will just continue building the real fundamental value and telling the unvarnished truth on calls like this and investors will do their analyses and call things as they see them. And sometimes we are surprised as we have been on the timing of revenues from new customers. But we communicate these, the information as we receive it and as we see it. Okay, thank you. Now, the remaining questions are a bit of a hodgepodge Cameron and the first one's long, but it's the first question in your question box if you want to follow along. So, I have noticed in recent shareholder calls that youâve mentioned M&A opportunities more often against all the bullishness around QAPs, VTM and Kinlytic. We've heard from you in the past year -- I'm sorry, I said that wrong. Against all the bullishness around QAPs, VTM, Kinlytic, we've heard from you in the past years we're facing delays now, why not double down efforts in the already existing opportunities instead of diluting attention? So I guess just asking, like, where are you with M&A? Are there opportunities you're looking at? There are opportunities we're looking at. I mean we're in a very strong position with -- as is pointed out in the question with strong existing businesses, and it's a great question, why are you risking getting distracted if you're looking at other potential opportunities. Well, there are two reasons why we would, why we are in fact. One is, do opportunities provide complementary capabilities or product lines that enhance the business that much more? Second, are those available at prices that are less expensive or cheaper than where we are trading? Certainly, we're not going to pay a higher multiple than where we're trading for an opportunity. So it has to be a good value relative to where Microbix is, if we're going to pay that with shares, or if we're to pay that with cash, it's got to be compelling. So there are two categories of opportunities. One is, are you just adding size? Now there's some value with respect to that. People like scale in companies. More people watch the heavyweight fight than the bantamweight fight because of that issue, and larger companies can trade at higher multiples than smaller companies. But we would really question, is that enough? We would much rather look at an opportunity where there's some really compelling strategic value to that opportunity where it adds some capabilities that we don't currently possess or adds a product line that allows us to cross-sell more products and add a new base of customers to who we can sell more products. So those are the things we would -- we will and are looking at. But to be damn sure we will measure twice and cut once before we transact on anything. But it's great to be asked, you don't have to [dance]. Okay. Another long one Cameron which is now number one in your box if you want to follow along with me. Cameron has talked about on-site due diligence efforts undertaken by potential clients, the company's facilities in the past before, how many prospects have decided to continue work with Microbix? How many are waiting to do business with you later because they can't be serviced by you now? And how many have walked away from a potential collaboration and why if this has happened? That's pretty granular. Let me think about how deep we'll go down those particular rabbit holes. But certainly we do have companies come periodically to visit us and do due diligence for audits. If we're a supplier to a company, they will sometimes have the right or obligation to come in and make sure that our quality systems are as they're represented to be just as we are audited regularly by the ISO accreditation agencies. So that happens periodically. Some of those audits during the pandemic were moved to virtual audits where it's a documents review, rather than a physical site visit, but some of those are coming back to be more in-person, which is certainly easier to do, and we're happy to do. I'm not aware of anybody has come and audited or visited our site and declined business with us as a result of such a visit. Quite to the contrary, I think it adds to -- greatly adds to the comfort and confidence in the company when those visits take place. With regards to how many companies are waiting to do business with us, I think it is more of a two-way interaction. There are multiple companies that were providing evaluation samples to determining whether they can use off-the-shelf products or need custom products from us to satisfy their needs. And I'm only aware of one instance in which we were not able to come to agreement on price for a particular project piece of work. And for a portion of that, that company has gone a different direction and we wish them well but it's an open question as to whether that other pathway they've pursued will succeed. So, of certainly many companies that are in discussions or are currently working with us, I'm aware of one instance in which we didn't get a piece of business for and the reason being what we feel was an unrealistic price expectation. We don't take on businesses at a loss. If somebody else will God bless, but it isn't our business. Yes, we have multiple site visits and virtual visits every year, be it from clients or regulators to audit formally or informally our quality management system, our technical capabilities, and so on and so forth. And to Cameron's point they always walk away with a good impression. And we have never lost business. Because of that we operate a very tight ship from a quality perspective. And our scientific and technical and production capabilities are well understood and manifested in these audits. So we always do very well. And we're used to getting good feedback from. Yes. I think while our customers -- and they may not necessarily be under the control all the time, meet their expectations or deadlines. We as an organization, certainly do meet our deadlines, whether it's on a research and development project or launching a new product or shipping a new product, we always meet our commitments. And I think that's seen as a very, very positive with our customer base. And this is not to say that we haven't faced supply chain challenges of our own, be it delivery timing, be it quality issues that we've seen as a result of all the disruptions going on. But I think we have done a very good job of managing through those. Okay. And then I had a follow-up question from when we were discussing Kinlytic. Has the company analyzed selling Kinlytic outright and using the proceeds to buy back stock? Kinlytic requires the technical knowledge that Microbix has. For a purchaser to be successful, there really has to be a process of either support or knowledge transfer. And in our evaluations, we just don't see. We would much rather get tens of millions every year in a few years following the relaunch of Kinlytic, rather than sell it for a few million today and walk away and not get the benefit of that. So again, we are about building value in the medium and long-term for the business, not about crystallizing it that way. And there's a bit of, I think, misunderstanding in how normal course issuer bid share buybacks work. You can't just walk in one day and say, oh, I like the price today. I'd like to buy back 0.5 million shares. That's not the way it works. You are allowed to buy specific volume of shares every day when the stock is -- and then you cannot uptick the stock. So you cannot drive the share price higher. So the stock buyback has to function over time and it has -- you have to look at it management and say, what is the weighted average price at which we are acquiring those shares. Now the last public offering we did was at a $0.60 share price for 1 unit of a share and a half warrant. If you look at the imputed value of the warrant, you are at somewhere $0.50 to $0.52 effective value of that share. So we look at things and say, certainly we have built a hell of a lot of value in the business since then. So we feel very good about buying shares back at or below the price of that 2021 offering. So -- and we will continue to do so actively almost every day. I had a throwback question that was previously answered. Can you just update us on the status and stage of the repurchase plan? Sorry for the repetition. Certainly. The repurchase plan became -- the normal course issuer bid became effective October 1. And we bought back shares in October, in November and December, closer to 400,000 shares in October and closer to 200,000 shares in each of November and December. So over 0.75 million shares have been repurchased and the October and November ones have been canceled and have been deleted from the base of shares outstanding, and I'm sure the December ones will be in the next week or two. And likewise, we'll be continuing to decrease the number of shares outstanding, somewhat as a result of the normal course issuer bid. Somebody was just saying, you can use a block exemption, you can. There's some discussion between TSX ongoing as to whether the block has to be an internal cross, dealer running the offering. But this is all inside baseball and technicals. But if anybody has a block they want to sell, please reach out to the company. And we'll see if we can arrange to buy it through the normal course issuer bid. Just in terms of shares, certainly, you see a substantial purchase and increasing ownership by management over time and I think that is another expression of our commitment, our belief in what we're doing. Okay. I have one last question, it's for Ken. So is the BSL-3 lab built yet? And what advantages will that bring? Right. So the BSL-3 lab has been planned out, but has not been operationalized to be a BSL-3 suite, has not been operationalized as yet. And the reason for that is simply the volume of work thatâs underway. We have so much going on right now but it's been putting -- something about holding patent, we expect lots of progress in this year. But the planning is complete. We expect to operationalize it in this year. But right now we're focusing on the opportunities in front of us at the [CL2] level, which are already there. What would it add to us? It will add additional capacity and portfolio. We're always building capacity to service the upward trajectory of the company and that will just basically blend straight into that provide us with further product development and realization opportunities. Well, one comment that we haven't chatted about. While we've got the cash to make investments, that has not stopped us in approaching the governments for funding support. So we continue to look for funding support to support projects, like we just talked about, and we hope to obtain some further funding, as we have in the past. Yes. We'll continue to use our capital judiciously. But there's also a value when companies are looking to rely upon us as a critical sole source supplier to them, you need to be able to show some balance sheet strength. So it's not like we can just throw -- that we want to just throw all our cash all at once into all sorts of things. One, we want to grow profitably. But we also need to demonstrate the financial strength to companies and we can certainly as governments -- as Jim was saying, and as governments look to help drive economic growth, we can make legitimate asks and saying, we might not prudently be able to undertake this as soon as we might be able to if we have some support by the government, this will add jobs, and this will add economic activity for the province and the country as well as accelerate the creation of value for shareholders. So, it's a balancing act, and I think we're doing a reasonable job of it. And speaking of jobs, I'd also just want to take a moment to compliment and thank all the Microbix staff. I think, our job as senior management is really to enable everyone to do their best work and everybody really is stepping up and doing just that. And it's a privilege to work with such a wonderful team of people that are not only talented but just damn nice folks as well. With two or three exceptions. I guess the last question that I have, Cameron is looking into, this year, what sort of catalysts can investors expect? Maybe give some exciting things that investors can look forward to? I would like to see, and I would expect to see some very material growth in our QAPs business, as the things do click into place. And there'll be C level executives at companies, many, many, many, many, many times larger than like Microbix that will likely have their heads on the block if some of this stuff doesn't happen. So we do have a reasoned belief in realizing some of what we're talking about with regards to QAPs. Second, I think we will see some strong resumption of acceleration of activity in our antigens business as well. Some of our product lines, we see going flat out for the balance of -- certainly the balance of 2023. And making product as fast as we can manufacture it and release it, but that is multi-month production cycle. So it takes some time for that to be realized in the revenues. The order timing certainly is an issue when revenues are recognized. Third thing, I'd very much like to see Kinlytic alliance in 2023, and have reasoned optimism that, that will happen. And then other opportunities, we'll see how those emerge. Certainly, I'd like to see the resumption of some order flow, and hopefully with some continuity associated with it, with Ontario, and others with regards to DxTM. And we'll do careful evaluation of opportunities to add strategically important business lines to the company as well from an M&A perspective. So I think on all three of our business lines and more, there are opportunities. So there are, at least five that I would identify from what I've just said. Oh, sorry. Some repair guys showed up. So I was just telling them I was on a call. My apologies. Well, I think that's a good summary. Ken, Jim, did you want to add anything to what would you look forward to in '23? No, I think those five aspects that Cameron just touched on, are dead right. There's the three elements of the core, which is QAPs, antigens and viral transport medium portfolio, and we have M&A and Kinlytic opportunities going forward. But other stuff may come up. We have flexibility in our capacities, in our manufacturing and development capacity. So we can be responsive to that, and pivot like we did when the pandemic started. There'll be other pivots to do and we'll be set up to do that in the infectious disease diagnostic space. Yes, my only add is that I think we've -- I want to talk with what Cameron outlined, and we've got the financial and human resources to make these things happen. Yes. And I don't see that there are specific issues holding us back. I think it is very much a company that is advancing and continues to advance and we have gotten from -- gotten to a position of relative strength. And we are going to keep building forward from that position of strength. No. I think let's call it a wrap. We're quarter past the hour and just thank everybody, thank the shareholders for your time, attention and continuing support and we are going to keep building value for you and we will see it recognized in due time. Yes. Thanks everyone for participating. If you have any follow-up questions, feel free to reach out and I'll get those answered for you. And thanks Cameron, Ken and Jim for your time. And Happy New Year.
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EarningCall_1604
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I'm Blayne Curtis. With us, up next from Analog Devices, Prashanth Mahendra-Rajah, heâs the CFO and I thought maybe you just reported. It might make sense in this case for you to maybe kind of recap a little bit. Obviously, you know the cycleâs been the topic. You know I think Analogâs taking a little bit longer to kind of you know correct and see it. I mean you have seen some areas. Maybe walk us through you know a few minutes on that, and then we can jump into questions. Yes, yes, great. I do want to congratulate you Blayne. We got the request from you to come out for your conference. Mike and I said, "Oh, we got to support Blayne. We got to figure out how to make this work.â So we were actually out here for some other meetings. We Ubered up just really for two hours to take care of this for you, and about three days after we agreed to come out here, you downgraded us, so well done. So, as you said, yeah we â our fiscal year ends in October, and so we reported our FY '22 just prior to the Thanksgiving weekend. So let me just kind of take you through the highlights. It was a pretty incredible year as it has been for many companies in the semiconductor space. We grew revenue about 25%, 26% year-on-year. Extraordinary gross margins, you know pushing up into 74%, operating margins getting into the high 40s. Out of that $12 billion plus of revenue, we did roughly 4% share reduction through repo, about $3.5 billion on top of another $1.5 billion of dividends. So very strong capital return from that very strong revenue growth, and extraordinary margins, which is really a reflection of what is unique to ADI, and that is we're an innovation-driven company, and we look for those high margins to be representative of the R&D that we spend. So just in terms of â and actually, you know you guys walked in and we were talking about the review you're going to give me. I mean, I do think you've been looking at the market realistically and you know I think, in terms of the way you look at your order book, you talked about kind of trying to scrub it. I was wondering if you could just walk us through that process. And obviously backlogs have gotten crazy. I mean they are beyond what you know probably will end up being shipped. But how do you sort through that and figure out⦠[Cross Talk] Yes, let me give some context on Blayne's question. So in a normal environment â if there is such a thing anymore, but in a normal environment, we would have about eight to 10 weeks of backlog going into a 13-week quarter. And then in the quarter we would look to find anywhere between three to five weeks of orders to ship and kind of close that quarter out. We are currently siting, and this is as of two weeks ago with the fourth quarter earnings call. We're sitting on â instead of an average of nine weeks, we're sitting on more than 52 weeks of backlog. So, a very big delta there that we are trying to get our arms around. Some of that is clearly a reflection of extended lead times and customers putting orders in anticipation that they are unclear what their future demand is, so get their orders in now. What we have been doing as Blayne referenced is, we've been actually putting a very concerted effort, and I think contrary to some of our peers to encourage customers to cancel their orders. So working through the process with our distributors as well as our end customers, to get as much of those orders off the books and try to get that backlog to represent true demand. So how do you do that? Its art and science. Thereâs clearly the conversations that you have with customers and the encouragements, and frankly, when we did a pricing action, we opened up a window and said, "Hey, if you don't like the pricing action, this is a good time for you to let us know and cancel your orders and kind of move through that process of encouraging them to do that." And there is a part that is more data-driven, where we look at here's the orders from a customer, we look at what you've historically taken from us. We look at what we've shipped to you in the past and sort of triangulate and say, âthat looks to be unreasonable. So we are going to proactively go ahead and cancel out on you and force you to reenter, but when you enter, you reenter at the back of the line.â You know when people say, what's the channel looks like, you know usually people are talking just the disti channel. You know I think that's obviously when things are short, but this has been a sell through everything, right? So it's not a really great read. It's really the end customer that I think are back you know. So that was good that you said, look what we brought out on our balance sheet, like and put it in their hands, because they don't even know where the demand is. But how do you gauge where the inventory levels are at that end customer? I think you just partially answered it. Yes. So not an easy answer, but let me â first, ADI runs its business internally on POS or on ship through. So, if you talk to the management team, the numbers that are in their head are what has gone to end customers either directly or through distribution. We do not â we kind of create this reporting framework of shipping to distributors, largely for investors, because we're required to by the SEC, but it is not how we run the company. So we really do use the end demand signals to drive the business. And all of our distributors are required as a consequence of doing business with us, to provide weekly data on who they are selling to, the destinations, the pricing, tons of information that allow us to look at the business really on a sell-through framework. When we think about inventory levels that are with end customers, and I know that's on a lot of people's mind, I would â Iâd break that into areas that we have good visibility on and areas that we're trying to reconcile disparate facts. So, where do we feel better? We feel better about automotive. And when you look at our sales in '22, up roughly 30%-ish year-over-year, so Iâll call it flattish. So a big delta there that some folks from the outside would say, ha-ha, there's proof of significant inventory build for ADI in the automotive channel. We then look at what did we sell into automotive. We break that apart into what we can correlate very clearly to factors like electric vehicles and the growth in EVs, because clearly our BMS product is going into EVs, and we are confident that that's not sitting in inventory. Our A2B product, which is going into infotainment systems, and we know that there are design wins that are moving through customers. So even in a flat SAAR environment, more models are deploying A2B. Maxim had a similar product called GMSL. So there's a couple of ways that we do that. And when we finish that out, we're left with, and with our pricing in there as well. We're left with, call it mid-single-digit growth that we can't explain. So for a lack of knowing where that is, we would say that's kind of our risk on inventory for automotive, is call it, mid-single digit on a year-over-year basis. Industrial, what we're trying to reconcile is, we look at our data and our trends against a variety of macro indicators and we have, we've got a number of ways that we do relatively good correlations and regression analysis that says, hey, if this is what's happening in the macro, this is what should be happening to these businesses. We talk with our customers and whether these are executive conversations or through the sales force, we get a very different view. They are still asking for product. They still feel in the industrial market. They still feel very bullish about what's in front of them and what they need from us. So that's the part where we're a little less comfortable, because the two don't reconcile. Good answer and you actually pulled forward some questions. I'm glad we talked and we might circle back. But I wanted to just, on the supply side it's interesting, you know that you had â you had talked as a company that you're moving more externally, and then I think through the pandemic, I think you're now maybe shifting back internal. So I do want to talk on that decision, to try to own more of your capabilities. But I'm obviously kind of curious of your perspective. As you look at some of your competitors, you have Microchip adding a 300 millimeter fab maybe. It just kind of blows my mind that people are adding this much capacity, TI has got three fabs. I mean, Analog was a mature industry, predictable growth, you know good stewards of capital, and there seems to be this like recent move to add a lot of capacity, both your peers [ph] are talking about adding fabs. Now how does that play out for Analog as a whole? In terms of you know supply/demand we're already now potentially moving to oversupply. Everybody seems to be adding inventory on the balance sheets, right? So, you might have that⦠[Cross Talk] So, let me do that quickly and then I'll come to the ADI specific answer. Where I guess I would say is that as we have seen a slowdown in Moore's Law or maybe just kind of advancing to finer and finer lithographies, existing geometries are getting longer life and therefore, what would have normally moved, if not moving, and you're going to, I think you're going to see more steady out at existing nodes and that's there. So, I'm not overly concerned that there's going to be excess analog capacity, because I do believe that the market is clearly coming to Analog. That that is where the Intelligent Edge is going to be and that's clearly the drivers, the secular drivers that we are enjoying and that some of our peers support more Analog content in everything. From an ADI strategy, we have always been committed to hybrid manufacturing. So just to clarify something, Blayne said, we are not changing that strategy. We are not moving to more internal. So our long-term model is still to have a good balance between what we can make internally and what we â where we use our foundry partners. Some of that reliance on foundry partners is because there are technology nodes that we would never do internally. For example, I believe the coms team is taping out certain products now for test at 5 nanometers. We would never in our lifetime try to go do 5 nanometers internally. So there are reasons based on the technology that we need to build out the functions that we serve our customers, that we will need our foundry partners. We also use them for supply surge. So the capital that we've been investing to expand our internal manufacturing is all swing capacity. And by swing capacity it means that every tool that's coming online can be used as a replacement for what is done outside ADI. It does not mean it will be used to bring capacity inside, but it gives us that flexibility. So during peak growth periods where there is significant demand for our products, we will rely on our foundry partners. During times where there may be a slowdown in demand due to macro conditions, we have the ability to notify our foundry partners usually with about a quarter's notice, that we are not going to make certain wafer starts there, bring those internal to us, keep our fab utilizations high. So the goal for us is, we want fab utilizations high during periods of real strong demand and moderately high during periods of softer growth, and that's what gives us that confidence in the gross margin model we gave you in April, of a 70% floor through the cycle, which is again an extraordinary number since many of our peers can't even get to 70% at peak. In terms of the â you know the dual supply, is that something that's in place today or are you still â I mean it is a long process. No, thank you. Yes, it's in place today. When we did our Investor Day in April, we were kind of in the mid-20s. Now we're kind of getting to the mid-30% in terms of coverage of SKUs. We'll make significant progress in 2023, and by the time we exit â24, we'll have close to 70%, a little north of 70% of our SKU coverage that we can make internally or externally. It is â with this kind of this CHIPS Act Gold Rush, is that something that's not of interest to you given this model that you're laying out or⦠? Well, the CHIPS Act often misunderstood has three pieces to it, so let's go through the three pieces. The first is a straight up tax credit for any capital that you spend in the U.S. So we, like all of our peers are going to take advantage of that cash credit and you'll see us, that is for tools that are placed in service starting January 23. So that will be a check and ADI will take advantage of that. The second is funding for a national semiconductor technology center, and the idea is to create these semiconductor research hubs around the country that can really work on very advanced ideas in research. We expect to be the lead for the analog mixed signal, NSTC. We've been involved very closely with the Department of Commerce in shaping how the NSTC structure should be evolved, and then the third piece of that is grant money where commerce is encouraging companies to add significant capacity in a more ecosystem environment. We are planning to make proposals as part of the expansions of some of our existing fabs. I don't expect those grants to be meaningful from an Investor Analysis. But as we talk about internally, there is no reason to turn away free money, so we will go through that process. Well, I was intrigued and this is more of another kind of getting your perspective on the analog market, because I think a big part of the answer is it's not a direct threat to you. But China try to go after things like modems and memory unsuccessfully. They seem to be pilling a lot of money into MCUs and low-end analog. I think you've positioned the company to be high-end industrial auto, but I am just kind of curious of your perspective on those efforts and whether you see anything in the market, maybe you sit next to or whether that's going to be successful or not in terms of their efforts there? Yes. I think it's a bit of an ROI challenge and if â with enough money you can make good progress, reverse engineering, anything that's really available to some extent? I mean, maybe not the most advanced lithographies, but you can make good progress from â in reverse engineering. You need to have enough volume to be able to underwrite that investment. So why does it get challenging for companies like 3Peak, Silergy and others to move up into the higher analog space is, you have to put significant R&D into a particular, let's say, you focus on a particular ADI capability. But you're only going to be able to capitalize that opportunity against a small set of the market. And even then it takes you, as our investors know, it takes you a long time to go from design in to a meaningful revenue ramp. So it becomes a very difficult economic challenge to solve, but if you look at something like an MCU, which has a much higher volume, because similar SKU can be used across a wide range of end market, it's easier to make that math work. I want to go back to some of these end markets. You did a good job explaining autos. Industrial, you said it's harder. Can you walk us through â I mean you break it out, I think as six groups. At one point, I mean they are all kind of hit records. I think medical kind of came off of it, but I think they are all still⦠No, I think medical, so let me go through our end markets, right? So health care is on its seventh year of double-digit growth, and we remain pretty confident that that's likely to continue for the foreseeable future based on our pipeline. Our aerospace and defense business again is not subject to some of the same macro trends that are plagued the rest of the industry, but again a very steady grower and very good profitability. Then we have our industrial automation business and the Industrial Automation business has really been benefiting from the move to onshore more manufacturing. And the way to think about the return analysis for our customers is that if you are going to move manufacturing out of Asia, out of China, wherever it might be, you have to overcome the fact that whether you put it in the U.S. or Europe, you're going to be dealing with a much higher labor cost and the way to payback now to pay for automation becomes much easier, because you have the ability to use fewer U.S. or European workers, particularly in an environment where it's very hard to get manufacturing workers and the manufacturing labor shortage, both the U.S. and Europe are facing right now, that becomes a very, a much more easier economic return. So factories are putting more money into the automation efforts and that is a secular trend that we feel is going to continue to drive this business. It will be lumpy just based on capital deployment, but very â we feel very good that this is â that's a trend that will drive the business for several years to come. Sorry? Of course, test and measurement which is sort of a hidden gem in ADI, because we have extraordinarily high market share. So our instrumentation and test business is where our technology is used for the precision and high-speed testing needed by test and measurement, by scientific instruments. It is a â the nature of that market is that you need tremendous accuracy, and because we, that's our specialty really is that precision, we end up with a predominantly high market share in that space. That's probably the market that is going to be most subject to sort of the macro activities. We still have great demand, and we see the demand that is being put on. You know for example, all the capital that's being deployed in the semiconductor industry often uses our instrumentation products. But, we also see that volumes are falling for end markets like memory and that may also have an impact. So that one we'll keep an eye on over the next couple of quarters to see how much of that will impact us. So, I have great confidence longer term, but I'm more cautious in the near term. And then we have a new group, which is our energy business. It's still a bit smaller from a size standpoint, but energy has been seeing significant demand as the amount of electricity and energy that's being used by moving parts, motors, etc. is a substantial amount of our global energy consumption. And there's a variety of ADI technologies that can help improve the efficiency of that and that is getting more traction as part of the effort for a lot of our customers to think about how to be more sustainable. When I see about communications, you know I think [inaudible]. I mean this is an area that you had a really interesting kind of 5G story. I mean, I guess how do you think about that business kind of going forward. So maybe the two pieces, what's going on in the near term in terms of supply chain inventories and⦠So our communications business, think of as two pieces. One, wireless, which is really, we are a very key enabler and extraordinarily high market share in 5G radio networks. And then on the wired side, you'll see us in data center power and in the optical connectivity. On the wireless side, our view is that for 2023, expect limited activity in the U.S. and Europe, certainly Europe given what's going on there, but we would even say the U.S. The big deployment in 2023 is going to be India, and I think it's public information that the two European infrastructure carriers have carved up that market and we have, as I mentioned, we have extraordinarily high share of both. So as long as India goes forward with its deployment of 5G system, that will prove to be a good year for us in the wireless market. I would expect Europe will, Europe still has to solve their 5G gap. They are far from it. It's not going to happen in '23. Unclear, given the Ukraine situation, whether it's going to happen in '24, but that would be, that is going to be on the come and when it does, it will - that business will come to us. And in terms of the inventory in that channel and time to work through, is there a way to kind of think about it? Can you walk me through it? Yes, I would say that we are shipping into the two Europeans who plan to deploy into India. And beyond that, we don't have a lot of visibility that would suggest there's excess wireless inventory out there. I want to go back. You did a good job with auto math, but I want to go back to it, because it's been really the toughest end market to get a handle on, right? You have production at lower than [inaudible], so that should make you feel better. You have trends like ADAS and EV that are clearly here to stay and going to keep going. There's been that other piece where I think some of the cars that have EV have a lot more content, and then you also have this kind of like mix where I think when people can't make everything, they'll just make a lot more high end and the consumer was just lapping it up. When you did that math, how do you think about those two variables in terms of the mix of cars, because I'm assuming â I don't know the exact math, but I'm assuming your BMS and A2B is probably a third or something, maybe not even, I donât know⦠Yes, I would have to check with Mike what's public on that. So I'm not going to answer that unless Mike, do you want to speak up loud enough for the mic. So the â in a flat SAAR environment, I have extraordinarily high confidence that we will do double-digit revenue growth. We have enough secular drivers in the shift to electric vehicles and the amount of content we're putting on electric vehicles plus the design wins we have on a number of our key technologies, you know A2B being one, GMSL being the other, where we know those products are continuing to deploy and as they continue to deploy that there are model, there are car models that are coming out in future years that have already selected our technologies, they are just yet to hit production. So it's a great place for us right now. On the BMS side, I think this is well known. We have a pretty high share position in BMS relative to the Number 2, and then of course we're the only company that has a wireless BMS that's actually in production and been designed in by three large OEs. General Motors is public. The other two are not, and then a small racecar company, LOTUS, which has also been public. Of those, you could argue whether General Motors is shipping because they're still very early in the Cadillac Lyriq and the Hummer, so all that revenue growth is in front of us. And I spent a lot of time talking about what could go wrong, right? I mean, in terms of '23, '24, I mean is there any areas or end markets that you're excited about and maybe you don't get enough questions on in terms of people focusing on it? I think Blayne, the - we are trying to position the company to be prudent given the macro environment. The conflict that we have inside is that the leadership team is saying that there are some challenges out there in the global world. We need to be ready and mindful and we want to be very thoughtful in our spending and our positioning. But the sales organization is coming in saying, that's not what we're hearing from our customers, we're going to have a great year and getting those to reconcile I think is where there's that conflict, because the folks who are close to the customers are saying, we came through this pandemic and the supply chain disruption extremely well. We have been really applauded by our customers for the strength of our service and our delivery. We have been applauded by customers for being able to continue to help them solve complex problems and bring innovation, which is moving their products forward. So the relationships we have with our customers are extraordinarily â I would say, our peak levels, and the market is coming to us. I mean the investments that are being done are all happening at the analog edge, and that's our sweet spot. So with the market coming to us, with our customers feeling good, management team are the ones that are leaving that kind of bearish tone inside the company saying, "Hey, we hear all that. But we need to be prudent, we need to be careful and let's be mindful of how we spend and position ourselves until we get more visibilityâ. And I did mention manufacturing guys are saying, "Well, we have a year of backlog. What are you talking about? With that we're out of time. I appreciate you making the time from your Board meeting to come see your favorite [inaudible] analyst. Hopefully, we can convince you to come to another event at some point.
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EarningCall_1605
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Good day, ladies and gentlemen, and welcome to Daktronics Fiscal Year 2023 Second Quarter Earnings Results Conference Call. As a reminder, this conference is being recorded today, Monday, December 12, and is available on the company's website at www.daktronics.com. We will have a question-and-answer session after the prepared remarks. [Operator Instructions] And I would now like to turn the conference over to Mr. Kevin McDermott, Daktronics Lead Independent Director. Please go ahead, Kevin. Thank you, and good morning. My name is Kevin McDermott. I am the Lead Independent Director on the Daktronics Board and the Audit Committee Chair. I joined the Board in June 2015. Prior to my retirement in 2013, I was with the accounting firm at KPMG for 33 years. I served in various capacities at KP, the majority of which involved auditing the financial statements of publicly held companies. This morning, before passing the microphone to Reese and Sheila, I wanted to join you to acknowledge the concerns reflected in the stock price reaction to announcements made last week and to give you some background. Daktronics announced the going concern conclusion, the post fulfillment of the second quarter earnings release and call and a delay in the filing of the company's second quarter Form 10-Q. Daktronics was unable to provide further information at that time, because there were still related accounting and disclosure matters that had to be resolved. My presence today is also meant to underline to you that in addition to focusing on liquidity enhancement, your Board is prioritizing engagement with shareholders. Our goals today are to explain the substance of that going concern conclusion, share with you the exciting order pipeline, backlog and revenue update that might otherwise be overshadowed and give some specific detail on the plan and activity already underway to improve our liquidity situation and the cash flow generation from operations that has been hampered due to the necessary inventory buildup, given supply chain issues in order to serve this historic level of customer demand. Before Reece and Sheila take you through the earnings release and related commentary, I want to explain the going concern disclosure conclusion. Generally accepted accounting principles in the U.S. require a reporting company to consider at each annual and interim reporting date, whether there are conditions and events considered in the aggregate, that raise substantial doubt about the company's ability to continue as a going concern for the 12 month period from the issuance date of the financial statements. If such condition exists, management then must evaluate whether its plans sufficiently alleviate that substantial doubt. Management's assessment is then considered by the company's independent auditors. As discussed in this morning's release, and to a greater extent in the Form 10-Q Daktronics intends to file tomorrow. The company's order and backlog coming out of the pandemic has been very strong. However, Daktronics had to manage through significant pandemic induced supply chain issues. These supply line constraints led to the decision to increase inventory levels in order to improve the predictability in the production cycle, which has absorbed much of the company's customary levels of liquidity. In addition, global economic and geopolitical conditions have introduced increased risk to our cash flow forecasts and our ability to predict the radar backlog will convert to cash over the next 12 months. While Daktronics bank previously increased the company's borrower capacity from $35 million to $45 million,the incremental $10 million is subject to renewal every 90 days. Further, as plans for additional financing have not been finalized and are subject to market conditions that are not within Daktronics control, U.S. GAAP does not allow the company to consider such plans in its going concern evaluation. As a result, we unfortunately had to conclude the substantial doubt as defined under U.S. GAAP accounting framework did exist. I will now hand the call over to Reece and Sheila, but will be available during the Q&A session and we'll be happy to respond to questions at that time. Thank you. Now I'll turn the call over to Reece. Thank you, Kevin. Good morning, everyone. Thank you for participating in our second quarter earnings conference call. I would like to review our disclosure cautioning investors and participants that in addition to statements of historical facts, we will be discussing forward-looking statements reflecting our expectations and plans about our future financial performance and future business opportunities. All forward-looking statements involve risks and uncertainties, which may be out of our control and may cause actual results to differ materially. Such risks include changes in economic conditions, changes in the competitive and market landscape, including impacts of global trade discussions and policies, the impact of governmental laws, regulations and orders, including those resulting from pandemics, disruptions to our business caused by geopolitical events, military actions, work stoppages, natural disasters or other international healthy emergencies, such as the COVID-19 pandemic, management of growth, timing and magnitude of future contracts, fluctuations of margins, availability of raw materials and components and shipping services, the introduction of new products and technology and other important factors. These identified important factors could cause actual results to differ materially from those disclosed in this call and the company's second quarter 2023 earnings release, and its most recent annual report on Form 10-K. We refer you to these documents. Our second quarter 2023 earnings release contains certain non GAAP financial measures and was furnished to the SEC on the Form 10 -- excuse me, 8-K this morning and is available on the Investors section at Daktronics' website at www.daktronics.com. Thank you, Sheila. Thank you, Kevin, for your remarks. In the first half of fiscal 2023, we achieved sales increases even when our capacity was constrained due to significant unusual part shortages, a challenging labor environment, operating disruptions from COVID-19 related absences and the first quarter COVID-19 mandated shutdown of our Shanghai production facilities. I am proud of our teamsâ ability to increase our sales output during the second quarter and through the first half of the year under these conditions. The unprecedented and persistent supply chain conditions caused lower gross profits through fulfillment, as well as higher cost for materials, labor and freightthat were not all able to be passed on to our customers. We made the strategic decision to keep delivery windows for our customers as close as possible to the originally committed date as supply chain and manufacturing constraints would allow. Even though this sometimes added additional cost to fulfill a project, to address supply chain volatility we aggressively secured inventory to fulfill orders for our customers, consuming cash while increasing predictability of our operations. We did all this because Daktronics has distinguished itself for 54 years for meeting our customer commitments on delivery dates, product quality and customer support. Our people displayed enormous strength, adaptability and resiliency over the past year and a half to maintain that reputation, securing supplies of critical components and responding to customers when demand came rushing back. So, through the first six months of fiscal 2023, cash was used for strategic growth in inventory stocking to add stability in our production, growth in accounts receivable due to continued growth in orders and sales and capital investments to increase manufacturing capacity. Today, our production and fulfillment operations continue to adapt and recover from the enduring implications of the pandemic. Supply chain disruptions have started to ease and we expect our inventory levels to peak in the current quarter Q3 of â23 and continue to decline to more normalized levels through production usage and reductions in purchases. Most important is how we are managing the cash implications of these supply -- strategic supply chain and production decisions. So I'd like to share more about that now. In our 54 year old history, we have not been faced with the perfect storm that dies last two years represent. Beginning with the immediate implications of the economy shutting down in the spring of 2022, followed by the sudden rebound in activity, while supply chains remain delayed, snarled and often just plain closed. These times have stressed our liquidity beyond levels that we have ever seen and our financial resources has not been sufficiently flexible. Our priority for today is to restore our balance sheet to appropriate levels of liquidity. Our entire organization is focused on four critical drivers of our liquidity enhancement plan. First is cash generation focus through proactively completing and fulfilling orders in our $463 million backlog. We will do this through productivity improvements from previous investments in factory, capacity and capital equipment and hiring only critical production and service personnel to increase output. We will focus on market -- operating margin improvement through pricing actions, product mix adjustments and prudent management of operating expenses. We will reengineer designs for supply chain resiliency and we will normalize inventory levels as supply chain challenges continue to ease. The second driver will be the aggressive management of working capital. Our third will be concentrating capital investments on maximizing asset returns, and the fourth will be to obtain additional sources of liquidity with the consent of our lead banking partner. To summarize where we are under the plan, we have already taken steps to move from a period of cash investment to cash generation to improve our liquidity and better position us for a profitable growth. We are pursuing avenues to strengthen our financing flexibility by adding liquidity and diversifying our funding sources. Additionally, since last year at this time, we have successfully increased prices and have focused on selling and fulfillment resources on the most profitable opportunities and have turned away price driven business. We have taken steps with a specific goal of improving profitability and cash flow over the coming quarters and beyond as our backlog in increasingly contains workbooked using current pricing methodologies. We are aware of the stress that the liquidity implications of the rapid re-expansion of our order book and backlog have placed on our employees, customers, communities and, of course, our investors. In the last few days, we have had employee town hall meetings and talked with hundreds of customers to reassure them and address any questions or concerns. Importantly,we have not seen order cancellations or retractions and are still booking new orders. I look forward to the opportunity this morning to engage with all of our investors who have taken the time to attend this call. I will now hand the call to Sheila to recap the financial results for the second quarter and first half. Thanks, Reese. With that, I'll move on to our financial comments. Orders for the second quarter of fiscal 2023 increased 11.7% as compared to the second quarter of fiscal 2022 and increased by 2.2% on a year to date basis. Order increases for the year were driven by live events bookings for replacements and upgrades. These increases were offset by order volume declines in other areas, primarily as the market demand levels are normalizing after a record number of orders in fiscal 2022, driven up from pent up demand after the COVID-19 pandemic. In particular, orders have softened in international due to the weakening economic outlook related to geopolitical events and currency headwinds. Net sales for the second quarter of fiscal 2023 increased by 14% compared to the second quarter of fiscal 2022 and by 16.2% on a year to date basis. Sales growth was driven by fulfilling orders and backlog even while we experienced multiple material supply chain disruptions and labor shortages. As Reece conveyed, supply chain disruptions created an increase in lead times by extending the timing of converting orders to sales. This coupled with strong demand contributed to a larger than typical backlog and inventory levels. As a result of this relationship between the past order bookings and realization of sales, product order backlog remains at a historically high level of $463.1 million at the end of the quarter and was approximately $441 million as of the end of November. Gross profit as a percentage of net sales was 16.9% for the second quarter of fiscal 2023 as compared to 19.6% a year earlier and 16% for the six months ended October 29, 2022, as compared to 20.8% for the same fiscal six months a year earlier. This comparative decline in gross profit percentage was caused by inflation in materials, freight and personnel related costs that were not able to be passed on fully to customers. In addition, extraordinary supply chain disruptions created intermittent work stoppages and factory inefficiencies, adding additional costs to meet our customer commitments. However, to reflect the realities of these inflationary costs, prices were increased in late calendar 2021 and throughout 2022. These price changes are just beginning to be realized through sales and gross profit margins as we work through the prior backlog. We expect sales price increases to be realized and reflected through the remaining 2023 fiscal year. We are carefully managing our operating expense well. Operating expenses grew 13% to $61.5 million for the first half of 2023 as compared to $54.4 million for fiscal 2022, a slower rate than the rate of sales enabling some operating leverage. The $14 million of tax expense for the second quarter of fiscal 2023 was primarily a result of the valuation allowance against our net deferred tax assets and the reversal of fiscal 2023 tax benefits previously recognized to comply with the accounting regulations related to our going concern assessment. Of course, our balance sheet likewise reflected the change in business levels and strategies we pursued in managing supply chain and growing our capacity to meet customer commitments. For the first half of the year, we used $21.9 million in cash primarily to grow working capital, especially in inventory. Supply chain disruptions have started to ease and we expect their inventory levels to peak now in the third quarter and then to decline to more normalized levels through increased production and reductions in purchases. We have invested $16.2 million in capital expenditures during the first six months of fiscal 2023, primarily focused on expanding manufacturing capacity, automation and productivity. To fund working capital and capital asset additions, we have borrowed $26.4 million on our credit facility. As of October 31, 2022, we amended our credit facility to temporarily increase the commitment by $10 million to $45 million until January 31, 2023. As part of the liquidity enhancement program Reece detailed, the finance team is focused on accounts receivable collections, cash generation and accessing additional sources of liquidity. Thank you, Sheila. To our investors and stakeholders, I would say that management understands the concern and uncertainty generated by last week's required announcement. As both Sheila and I described earlier as a key component of our liquidity enhancement program, we are pursuing other additional sources of liquidity and are focusing on reducing inventory levels. Our goal is to be able to remove this qualifying language as soon as is practical. The world has seen a lot of change over the past two years and Daktronics has navigated this as the ongoing industry leader in quality, technology and reliability. Customers continue to choose Daktronics as demonstrated by our historically strong order volume and backlog. We appreciate our customers believed in the Daktronics brand and we thank all of you for your commitment to what our products represent. Even with our recent going concern challenges, we believe our strategy to emerge from this time of the pandemic healthy and profitable by stabilizing our fulfillment performance through increased purchasing and critical components and increasing production bubbles through selective equipment investments and production staffing has reinforced the reasons why customers choose Daktronics. We have delivered many of the orders quoted with previous pricing structures and our backlog now mainly consists of orders booked under new pricing methodologies. We see signs of supply chain stabilizing, which will allow reduced inventory levels in the coming months as our production levels continue to increase. We do not believe that the geopolitical situation is back to normal or however this would be defined. But we do believe that the levels of uncertainty and volatility will not be as great in the coming months and will continue to stabilize in the coming calendar year. While macroeconomic factors continue to make it difficult to forecast the future, over the coming years we currently see signs of the following. Our high school park and recreation business unit will continue to grow through adoption of video displays for sporting and educational use. This trend toward deploying what used to be professional grade technology in new markets grows the total addressable market. In addition, video displays also have a higher average selling price than the messaging and scoring equipment traditionally purchased in this segment. Commercial business unit, out of home advertising customers continue to buy after the pandemic related economic contraction. This is somewhat an effect of their natural replacement cycle. Our on premise business also remains strong as customers continued their purchase and use of digital messaging systems. We are also focused on increasing sales channels with audiovisual integrators for end use in government, military, healthcare and corporate applications. Transportation order levels continue to be strong worldwide as project planning and approval activities resume to more pre pandemic levels and our customers move forward in purchasing displays used for intelligent transportation systems and for mass transit venues. Infrastructure spending should continue to benefit this segment as digital signage is often used in these projects. Importantly, selling costs are lower in this sector as procurements over multi year periods are often handled through master agreements. In the international business unit, we naturally are seeing some softening in the European market due to macroeconomic factors, as well as the impact of the current strengthening of the dollar. We will watch developments closely and adjust resources and commitments accordingly. Our flagship business, the complex live events segment outlook remains strong due to large stadium renovations, continued replacement cycles and expansion of sales efforts beyond sports areas. Recent installations include college football displays at Clumpson and Tennessee and we previously announced recent wins of the new super system for the LA Clippers new arena. Having said that, as part of the gross profit improvement pillar of our liquidity enhancement plan, we are being very mindful about the profitability of this segment through pricing and contract terms. Thank you to our Daktronics team for increasing our capacity, adjusting to the uncertain and volatile supply chain conditions and continuing to serve our customers. We appreciate our suppliers and vendors for also helping us through these challenging times and thank you to our investors for your patience and support. These are unprecedented times that we are working through and our management teams and employees are focused on long term profitable growth and cash generation that we believe will create value for our shareholders now and into the future. Thank you. [Operator Instructions] One moment for our first question please. Is from [B.J. Cook] (ph) with Singular Research. Please go ahead. Excellent. You had mentioned investing in manufacturing capacity upgrades. A lot of those projects finished, do you guys expect to execute on your order back -- order book faster going forward?If so, how much quicker do you guys trying to execute? We have invested a lot in automation in our different factories and many of those projects have been completed and are being used. Equipment manufacturers are having their own supply chain challenges. So some of the equipment that we've ordered has not arrived yet and will be implemented in the coming months and maybe even early next fiscal year. Okay. Thanks for that. Just one more quick one. Given the short term nature in the bump in the line of credit, are you guys expecting to realize cash from your elevated accounts receivable over the next month and a half or so or even since the end of the quarter? Yes, maybe I'd say two things. Our banking facility has been very open and flexible with us. But of course, it's only guaranteed to the end of the quarter. And we believe as our business is continuing to be increasing, our production levels are increasing, we will convert more of our backlog more quickly into invoice orders. Thank you everybody for joining us on this morning's call. We are taking the going concern situation very serious and we are working hard to remove that qualifying language as soon as is possible and to update the group on those activities,we are planning to have our next conference call at the end of our Q3. Thank you, everyone, and have a good day. Bye-bye. And with that, we thank you ladies and gentlemen. Today we conclude it with that and thank you for participating. You may now disconnect.
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EarningCall_1606
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Good afternoon, everybody. I'm John Hodulik, the media and telecom analyst here at UBS. And I'm very pleased to announce, our next speaker is Mike Sievert, the President and CEO of T-Mobile. Mike, thanks for being here. So, Mike, you just celebrated your 10th anniversary at T-Mobile. And, I got to say, over the last 10 years, we've seen a transformation of the company that, unlike any other company that we've seen, certainly, that's been presented here. Can you just talk to us a little bit about what you thought, maybe aside from the Sprint acquisition, the sort of important milestones and sort of decisions that you and your management have made to sort of get you so far so soon? Well, okay, starting with a wide lens question. Well, first of all, John, we call them Magentaversaries, and they're a very important part of our culture. It's a little weird for me to be answering a question about a 10-year Magentaversary, because I spend a lot of my day signing cards for people with 20- and 30- and 40-year Magentaversaries. Those are the real heroes. But it is kind of -- I guess, it is kind of, needs to stop and think for a minute about where we are. And maybe more importantly, how we got here and how it informs the future. I mean, if you think about the fall of 2012, we had just finished the year or we're finishing a year in 2012 where we lost 2.2 million postpaid customers. We were shrinking in customers, negative revenues, negative EBITDA growth. Just coming out of a failed merger. John Legere came in, I came in, just right on the heels of that, and we really just plotted what we could do. We had assets from the failed merger. We had a potential merger with Metro PCS. We had a commitment to go after LTE. We had new leadership. And I think the first time we used the word Un-carrier as a company was in the press release announcing that I would join as CMO. And John and I and the rest of the team got right to work at how could we change it. Looking back 10 years, there's a few things that I think kind of strike me as themes, and they're sort of obvious and they kind of sound like talking my book here, but one is, one leap of faith is what happens when you invest in customers, when you love customers and you watch while they invest back in you? And that was something this industry hadn't really been practicing. It's getting better. This industry has gotten a lot better, and we take some credit for that as the Un-carrier. Another is, looking around corners. I think one thing this management team, throughout the entire day the era, has been good about looking around corners. You mentioned Sprint in your question. This company understood that 5G would unfold in mid-band. And it understood that, that was the future when others didn't. And it focused on being the best mobile pure-play company with the best assets in this space and winning the 5G race, because we were the last guys to 4G. We were the most motivated to win the 5G race, and we saw where it was going to unfold. We've also seen the major consumer trends in this industry, I think, faster than most around what would happen if you love and invest in customers around things like vanishing contracts, or getting rid of hidden fees or buying out their contracts at other companies so they can have freedom, or giving them global roaming for free, including with their plan, or things like getting rid of data plans altogether and going unlimited. All those things that we did and all the rest that have informed the big Un-carrier moves, we're big investments in customers, big. Some of them like, people were side-eyed us, how is that going to pencil. And it's penciled. Look at where we are now, one of the largest and most valuable companies in the history of our space. So we're focused on customers. But one thing that has sort of permeated it all and sort of informs us going forward is this value -- we have five values in our company that we talk about all the time. One of them was called, we won't stop. And what that means and much to the consternation of my team, we come in to work every morning unsatisfied. You know, we're outgrowing everybody. We have a valuable company that is satisfying customers, is leading in growth, is translating that growth into financial leadership and we're completely unsatisfied. That's what we won't stop means constantly challenging the status quo. It's cultural for us. After all these years, it's who we hire, it's what we recognize, it's who we promote, it's a value that's very hard to replicate this relentlessness, this unsatisfaction with the status quo. And that informs us as we go forward because we look at everything going on in this company and ask, why can't it be better? Right. Makes sense. Pivoting from, sort of, looking backwards to looking forward. As you guys look out into 2023, what would you say are the big opportunities or big priorities of you? And you mentioned some of the customer pain points and changes you've made to the industry. Do we still have fertile hunting ground as we look forward to make changes that can, sort of, keep T-Mobile ahead? Absolutely. One of the things that, I think, we've been very consistent on are the basic parameters of our five-year plan. Next year is year three of our five-year plan. We're way ahead of schedule, obviously, on the things we committed to. But the basic theses are all completely intact. And it's one of the things that distinguishes us. We're executing a basic business model that we started talking about in 2018 when we pitch this merger and that we doubled down on after the merger with in great detail. And for us, we have big, underpenetrated logical, segment-driven growth strategies that are really differentiated versus our competitors, things like tackling smaller markets in rural areas where our market share is in the teens. Enterprises, where our market share is just breaking into the double-digits. 90% of the customers are with AT&T and Verizon. In the top 100 markets, where we've always been strong, where we're leading in the top 50, we got here out convincing tens of millions of people. We have the best network. Every single one of them came wondering whether they were making a trade-off, and tens of millions of others has never seriously considered at us. So we're the market leader in top markets, while not winning the game, something we can now do, and we're being broadly recognized for. Home Internet, you know, huge tailwind for us, something that we're very excited about and continue to execute on very strongly. And Sprint churn. We've had great performance on churn. Now two quarters in a row, beating Verizon on churn, even with Sprint, Inc., and we've got some more room to run on our worst-to-first strategy that we've already proven we can do on the Magenta side. So these things are clear articulate goal-driven, segment-driven growth strategies with lots of room to run in our core business, and it's something that differentiates us, not only having these strategies, but consistently executing them over and over and over again, just like we promised. So let's drill down into that, especially, on the growth strategy, which I sort of think of it as a, sort of, a bookend strategy. You talked about the rural opportunity. We'll get to that. But you've also talked about extending the sort of leadership, I don't know if I'd say dominance, but maybe you will, that you have in the top 25 markets to the top 100 markets, sort of, like -- sort of expanding the franchise you've built in these large cities. I mean how do you do that? I mean, what -- is it distribution? You've already mentioned network. You obviously have a very attractive pricing. I mean how's that sort of side of the growth strategy going? Well, to the premise of your question, we are number one in the big cities all across the country, and those top -- I'll say, on average, top 50 cities. We're number one on average across the top 50. And so the strategy isn't just to defend that turf though. As I said, we got here without winning the network story, and now we can win the network story. So, the strategy in top markets isn't to defend that share, it's to extend it by going after the tens of millions of people who never gave us a good look when we were coming from behind on network. In the last three years, we have slashed the perceived leadership of Verizon in network leadership, what the average consumer perceives, which is much more important than the reality. People know the reality. We're the 5G leader by far. But perception is what matters. And we have slashed that lead that Verizon has in half. And so we are coming for them as being the company famous for the best network. Why? Because we have the 5G lead and 5G is becoming the network. We've now had three major product cycles that are 5G on phones, and now the majority of customer volume is on 5G. It's a matter of time before 5G leadership is synonymous with network leadership. We're catching them. And so this market leadership that we had all these people came to us while kind of wondering if they were making a trade-off. And now we're going to say, no, you can have both simultaneously the best network and the best value. Through that same time period, we slash Verizon's lead on network perception. We have not only held, but extended our fame as the value for money leader. So, we've extended that thing. Now, they gave us an assist with all their price increases this summer, but we've extended that fame. And so that's really important because ultimately, our strategy is to convince people, you don't have to make a trade-off. You can have both and the answer is T-Mobile. So, that strategy sweeps across the top 100, while in smaller markets and rural areas, it's to go establish ourselves, and we're making incredible progress on that with share of switchers up several points from just a year ago. Yes, if we could go deeper into that. I mean -- so I think you've laid out the strategy before. It's a question of getting the network where it needs to be, then following with the distribution, and then the market share will follow. You guys have talked about sort of pushing that strategy in these rural markets, which represents a much bigger number than I would expected, 40% of POPs. Is there a way that you guys could characterize how far along you are with that strategy in terms of maybe what percentage of the POP has this -- have the network? What percentage of them have the stores? Where do you think you are in terms of like -- what inning are you in, in terms of going after this market? If you think about a company that has proven it can be a leader in places that really matter to our competitors, like New York and Dallas, okay? And yet in 40% of the country, we're teens -- we're in the teens. And so people have questions about whether or not this segment-driven room to run in our growth strategy. I mean the answer is, right? The question is, are we demonstrating we can do it. And what's happened in the last year alone is we've moved from 30% of the places to 50% of the places where we think all the factors of competition are there. So, let me back up. We actually take this 40% of the country, and we algorithmically break it into 775 markets and rate our relative competitiveness in all those markets on an ongoing basis. And when we achieve a level that we call license to play or better, that's when we pour in distribution and targeted marketing efforts and go after share gains. And we have moved from 30% of the market's license to play or better to 50% of the market's license to play or better and come within a hair's breadth of Verizon's share of gross ads, while only playing in half the markets. And so we've gained four points of switching share just in the last year alone in smaller markets and rural areas. And in the places where we have license to play, everything is happening. Our share gains match our plan or better, which means -- now we don't think we're that good at it yet. We're still learning how to compete in more rural places. There's lots of stuff -- back to the unsatisfied. There's lots of stuff we're tackling. But even if we got no better at this, all I need to do is finish the job of getting more placings license to play or better, and we'll achieve the aspirations that we put out in front of people last year. The network is competitive. It's all the places people needed for them to seriously consider us and switch to us and be better than satisfied. And that, plus then do we have the capability to put distribution in? Are we of teams there? Are we ready to -- and it's just really exciting to see what's happened. Our team has rallied around this. Right from the top, we've organized ourselves around this. Our entire infrastructure is divided. Everybody knows that there are smaller markets and rural areas, person or a top 100 persons and their incented on those goals and they're collaborating with their network people and they're figuring out which stretch or which road do those guys have us, and we need to fix it in order to be licensed to play. It's fantastic. And for us, it's unprecedented. And we've never operated this way. So like I said, we're getting better at it with each passing quarter. And I guess the next step is licensed to win, is that when you get the -- is that when you have the distribution of the stores teams in these markets? And then how quickly -- first of all, in the licensed play, how quickly do you get the other 50%? I mean is that to get to the fourth? Yes. We put that out there. We just said we have moved from 30 to 50, and that where we have the 50 where we really like what's happening. But you can tell how focused we are. And as we look forward in 2023, on the consumer side, we'll put a Home Internet for -- aside for a minute. The strategy is really simple, win network seekers in the top 100 market and convince them that we have the best network now, and they should give us a serious look in order to save themselves a ton of money. And go execute this strategy with absolute urgency in smaller markets in rural areas because it's working. And those are our two strategies. But we haven't put out specific targets within that other than to tell you that we see our way a within the planning period that ends end of 25 to better than 20% market share in those areas. It's Verizon and AT&T. They both have been in a lot of these places for a long time. Many towns, though, have one or the other choice. And so a lot of places, people have been watching our commercials on NFL all weekend and stuff like that for years, and there's never been a store in their area. There's never been a viable effort from us to go win them because we've known in the past as we were coming up the curve, our network wasn't fully competitive there, and so it just wasn't a great proposition. It just shows you how much upside there is for a business that's performing like this, bigger than AT&T now, outgrowing AT&T and Verizon combined, that has all of this underpenetrated opportunity, where we are demonstrating what we're doing is working. Right. People take advantage of the network test drive service you guys offer in these markets, whether it's the rural markets or even in the urban markets? And does that sort of kick into sort of higher gear with sort of the new eSIM capabilities of the new phone? All this stuff is in its early stages. And yes, we launched Easy Switch this summer. It was pretty exciting. And -- but it's growing in its scenario. So it works better for single line than families. It works better for bring your own device than if you're going to do a trade in, in a complicated device transaction, et cetera. It works better if your phone is already unlocked, that means paid for and unlock. So it's easier -- that second SIM is also covered by your carrier lock. So don't expect like an immediate wholesale. Everything has just changed from eSIM. However, yes, everything that removes switching friction in this industry and eSIMs are one of them, it's good for us because we're the next share taker. And so last quarter was the biggest switching quarter ever in our history. You asked about 10 years of the Un-carrier and historic turnaround and success story. Last quarter, the most recent one reported was the biggest switching quarter in our history with more new accounts. And that's what really matters, these billing relationships because those are the switchers. Our competitors can do a bunch of ad aligns and stuff like that, but what we're doing is winning the switching story and the biggest quarter ever was last quarter. Got you. The other part of the growth strategy that we focus on is the business market. And we heard from AT&T and Verizon about it. Is that -- how big of an opportunity is that? And maybe if you could size it versus the rural market? I would imagine it's about 40% of the POPs. I mean it's going to be smaller than the rural opportunity. But is that a... Yes, and some of it's duplicative to the POPs, because some large enterprise customers across both government and private sector carry more than one phone. We are seeing increased interest in company liable business in both government and enterprise, whether it's security-driven, whether it's hybrid work-driven. It's a popular new benefit that people are offering. So we're pleased with what we're seeing there from a TAM standpoint, but more so from a share standpoint. Last quarter was one of the two best quarters we've ever performed since bringing this company together on net adds in the business space. It was the second lowest churn quarter we've ever done. We outperformed Verizon on both growth and churn in the third quarter in the business sector. So it's really working. But on the other hand, we have a lot of work to do. And our strategy is to use 5G to win the corner office relationships. Because as we've come up the curve, it's very much been a kind of a game of procurement. So what happens is companies they basically want to price cut their incumbent, and so they bring in another player and throw a little business to reprice the incumbent. And we've historically been the little player that gets it a little bit. We have a 10 share. That makes sense. So -- and what's happening is our goal -- we'll keep -- we're happy to do that. We're happy to take -- be a part of them taking away our competitors' margins. But what's much more important for us is to use our 5G leadership and our leadership in standalone capabilities, private networks, mobile edge compute to win that corner office relationship. And when that happens, we're winning entire companies, which is what's happening in retail and airlines and federal government, in education and other sectors. So that's the strategy. And lastly, in terms of the segments, from the wholesale market, I mean is that an opportunity for you guys? You have a new deal you guys reworked with DISH. I mean is there potential for growth, or is that something that you expect to sort of a slow decline there on that side? Well, we have the highest capacity network in the sector, and it's going to be the highest capacity network for the foreseeable future. And we should remind everybody of the stats of that, maybe as it relates to home internet, HSI. So yes, you know what, if we can do the â we can do arrangements that are accretive and smart and win-wins, we are all for it. And you saw that in our willingness to rethink comprehensively our approach with DISH. And both companies are very happy with how that looks. And yes, we're in this business for real and very serious about it. We lost the track partnership a while back because of the Verizon transaction. So that frees up opportunity for us. So yes, no, wholesale is a very important part of our business. Maybe we'll talk about pivotal competition. I mean, obviously, it's a very competitive market as it is right now. I mean do you worry, given the success you've had and the growth that like you said you're outgrowing both of those companies combined, I mean do worry about a competitive sort of reaction from these large sort of deep-pocketed competitors, especially now that we've seen a management change at the largest one? All right. Well, you asked me about 10 years, so I'll just give you -- so that means I have handled for T-Mobile better than 40 quarterly earnings reports and probably better than 25 financial conferences. And I've been asked breathlessly what about the awful, awful competition every single time? Like, isn't it -- right now, the worst it's ever been and isn't it about the -- isn't this neighborhood about to go all bad? And it's just not what -- how we see it. We're very comfortable with this environment. And we also kind of helped to bring it about. We love competition. We love things that make this industry better for consumers. We have the speed and the cost structure to be able to compete in these environments. But at the same time, one of the things you've seen from our actions, as opposed to our rhetoric sometimes, so judge me by our actions here, is that we understand that the best strategy for our company is to be thoughtful, growth-oriented, accretive, focused on accretive thoughtful growth strategies, and that's what we do. And the results, I think, demonstrate that that's a strategy that works for us to make sure that we continue to succeed in an environment that's a good sector to succeed in. Now that said, I'll remind you, we generated more net additions last quarter than AT&T and Verizon combined, but we could have done more. And what we did was beat everybody's expectations on the financials instead, and that's the way we think about this business. I mean -- sticking with competition, I mean, over the last really couple of years, we saw cable sort of come out of the woodwork and take a meaningful percentage of gross adds, right? Do you worry that that competition from that segment intensifies? And then a little bit further out, DISH is expected to launch their service, their postpaid service. We don't know enough about the strategy or pricing or positioning that kind of thing, but sometime in 2023, I mean, do you expect that to add incrementally to the sort of competitive environment? Yes, of course. I mean it's always been in our planning assumptions. We do expect and have always expected that DISH would be a viable player in the space. Cable is probably a more important factor. So far, what we've seen is that cable success hasn't appeared to come disproportionately from us nor has it been a catalyst for wholesale changes and value propositions in the industry, which I think is an important thing. It's been focused a little more on the lower end, a little more on one or two-unit households, a little more on BYOB, not exclusively on all those things, but a little more. And these are artifacts, I suspect of their agreement structure with Verizon. And so -- but by the way, I think -- I mean, our -- we do telemetry all through the quarter, here and so to you, I know, like we're expecting Charter to have a fantastic quarter, maybe their best one ever. So there's stuff happening that I think we have to really watch, but we watch it -- we don't really watch it with concern, because the underlying assumptions of the industry appear to be intact. And it looks to us, like there's room for them. And now it might not look that way to an AT&T or a Verizon, I don't know. As for Verizon, who I know is under a lot of pressure in their consumer business, they're monetizing these customers. And so it's -- I wouldn't expect them to do some crazy or rational thing, even though their consumer business is a bit stressed, because they're seeing monetization from it. And I think the big question on everybody's mind isn't as cable going to come? Is cable going to come? And is there going to be a resulting sort of round of craziness in the industry that runs the neighborhood? And I don't foresee that. Got you. And you mentioned the churn that you guys have seen the results, which were very strong last quarter, despite the fact that I think it was your biggest quarter for decommissioning the Sprint network. And obviously, we've seen a number of acquisitions over the last 20 years. And there's always â once you touch the network, there's always churn issues. Now obviously, most of these customers have moved off the Sprint network and are on the T-Mobile, but it suggests to me that there's still room to go, right? The network is still improving. I mean, is there a way to sort of characterize where churn could go â where it could bottom? I mean, obviously, coming out of the pandemic was probably artificially low churn, but how much more room do you think you have? I don't know. I mean, I'll take you back to we won't stop and never satisfied. I won't be satisfied and my team won't be satisfied until our churn is the lowest in the industry, and AT&T caught us the last couple of quarters and so that we weren't the lowest. We want to be the lowest. And I think with the best network, we should be the lowest. If you have the best network and the best value, it should be the lowest churn. We're not done. But these things aren't â they're not easy, and there's â and some of them are longer burn things. It's about getting customers under commitments and it's about satisfying them. Our Net Promoter Scores are rising, while AT&Ts and Verizons have fallen since this summer. So there's lots of great signs. But â and yes, therefore, there's room to run. But I wouldn't make it so algorithmic as everybody is on the T-Mobile network now, so snap it to T-Mobile. There's a long history of how customers were acquired and whether or not they're on commitments, and are we doing a great job satisfying them? And â but look at our track record, and how we took the Magenta brand from worst to first. We know how to do this. The other thing that's usually complicated and where we've seen companies sort of slip up in the past after acquisitions is billing conversion. Is the billing conversion â you guys have said, it's de-risked and maybe you could sort of add some color to that, but is there a possibility we could see higher churn through that process, or maybe less sort of progress on the improvement in churn as we do the billing conversion? I'm not expecting a customer impact from the billing conversion. The last step, as you said, in Q3, we substantially completed the shutdown and decommissioning of all of the synergy sites. And so that's â the network portion is largely complete. On the billings side, we're right on track. By right on track, I mean, we continue to be about a year ahead of schedule in our business line. And it's really cool how we design this. It's unprecedented. So essentially, the billing conversion is designed to be essentially opaque to the customer. They shouldn't really see it happening. What we did is looked at every feature in the Sprint biller that would make sense to replicate on the T-Mobile billers, and we've been busy replicating those. And the ones that we decided not to replicate, we've been busy migrating those customers with a move as support. And so â and we're best about done. So now you basically just have an IT staff replicating all of these services. Trickier ones that take longer are some of the complications around leases. T-Mobile didn't do as many leases, so that's why it trickles into 2023, but most of the big scenarios are already done. And when they're done, we simply changed the bill in the background with a streaming conversion process, and they never really see it happening. And that â we've done millions so far. So, I mean, it's going fine. And our team is amazing the way they thought this through. So we'll be substantially complete by the middle of the year on consumer. We'll have trailing scenarios in the second half that are more focused on complicated B2B getting the Sprint T-Mobile for Business. And then â weâre back up â and then it will be completely done. I do think that we will be in a position in the â in the first half of the year sometime, maybe at that three-year mark or somewhere to just kind of give an update on where we are, and I'm hoping the update will be that this is just by any measure, the most successful integration of scaled telecommunications companies ever done in the history of the world that's our goal. That's direction for sure. Maybe another value driver aside from churn is ARPU trends, and that's been another brand. But for the industry and for you guys and a lot of it being driven by Magenta MAX. I mean I think right now, you're getting 60% of new sales are on Magenta MAX plan. I mean how high -- I mean is that where we should be thinking of in terms of the base? Do you think the base can eventually get there? And then given how high that take rate is, is there room to go even higher, super premium plan or something that can -- I mean you probably never thought you'd get 60% of gross adds taking such a high-end plan. But just your outlook for sort of ARPU trends and how you segment the business? I think it just says so much about the power of our brand. Back to what you asked me about on the 10-year question, I talked about a company that believes that when you love customers and invest in them in ways that might shock people they invest back. They invest back. And Magenta MAX is at the latest proof point of that story. A substantial minority of existing customers when they transact with us are moving up to MAX. That's great execution by our customer loving team that knows how to show people how to get the best out of T-Mobile and get them on the best expression of our product. That's just great execution. But it also is about the love of our customer base and the satisfaction they want more from our brand. And that's -- and they're asking to come into a better version of our product. That's brand. That's powerful. That's hard to replicate. So we don't exactly know where it goes. Nothing you asked is out of the question. We don't do price increases. So our customers that are on MAX get to keep that product at that price. But is there an opportunity to find even further ways to relationship down the road? Of course. But I'm not looking for a solve on this strategy, I mean, it's going great. Speaking of extending the relationship that brings us to fixed wireless. You guys have -- first of all, did you guys expect it to scale this fast? I think you added 570, 580 in the quarter? Yeah, no one else did. It's funny. I mean we rolled out last year in March at our Analyst Day a target of getting to 7 million to 8 million customers by the end of 2025. And that means you got to do about 0.5 million. Last quarter was -- if you'd say, if you have a business model that says, you need a $0.5 million a quarter, give or take, well, the last quarter was good. It was -- and so for us, we've got this thing designed to where it should produce about $0.5 million a quarter give or take, and we'll be satisfied no matter how it lands around that because I think it's really important that we jealously guard the Net Promoter Scores where we have absolute leadership. We're higher than fiber or cable, and we also jealously guard the business model that's predicated on not having too much CAC. So you can't overinvest in these customers and then charge them $50.00 a month, taxes and fees included. So you really have to rely on high Net Promoter Scores and great word of mouth and have a step-wise execution. And so you just run the math. We'll get to that goal of $7 million to $8 million by the end of 2025, with a production of about $0.5 million a quarter. And there are tailwinds and headwinds. The headwinds are obvious. As you grow a base, we're now well over 2 million customers, as you start to grow into that size, you start to deal with churn, you have to outrun that. But on the other hand, this is a capacity-driven business. We tell a lot of people know because we can't handle them in their neighborhood yet. And I will remind you on network, we are at 250 million people with ultra capacity 5G on the way to 300 million by the end of next year. But within that, and this is maybe even more important, right now, averagely, we have 120 megahertz of spectrum dedicated to mid-band 5G, that's going 200 by the end of next year, 200 megahertz across 300 million POPs. So, that's a huge tailwind on our ability to accept word of mouth-driven applications to be our home broadband customer. That will probably be offset by natural -- that's a huge tailwind, natural headwinds that come along by -- it gets harder as you grow. And we see this business plan of getting to 7 million to 8 million customers by the end of '25 being very much on track. So nobody thought we could do it last year, but everything that's unfolding is just basically exactly what we planned. Right. So that -- you're in that 500,000 to 600,000 now. So that's the rate we should think of going forward, which is delivery to that 7 million to 8 million. So the acceleration we've seen in net-net, is that... And is that just sort of gross add thing even, or is it more of a churn starting to scale as the base -- like you said, the base is scaling up and churn? To be the number one factor, we're obsessed about is satisfaction. And so, like I said, our Net Promoter Scores are higher than any other single provider in the country, except one, and they're higher than average cable or even average fiber, and that's really -- now we're scaled. I mean we have well over 2 million customers. It's not like the first few people that are zealous. And so we have to hold on to that. And if we hold on to that, this business will make sense for years to come. Got you. Are you seeing -- we saw that commercial from Comcast. I mean are you seeing a competitive response from cable? Are they trying to segment the market and savor plans and sort of new... I remember the first -- so there was a commercial that came out in about 2013 and that Verizon ran and it didn't name us. It's like attack AT&T and Sprint, and we were like, we didn't make the commercial. And then they did when we made it, we were so happy because they were paying attention and we were somebody in the industry. And so I don't know, it doesn't -- I mean we're just like wired for competition. It doesn't bother us a bit that we got like, we made it, like we're kind of -- we must be for real because they're advertising about us. But it's -- yes, we have such a competitive team. We love how it's going. Now right now, you guys are seeing all this growth. We're just using sort of fallow spectrum. I mean, is there -- we'll get to another possible use of capital. But is there any thought of maybe building out specifically to add capacity to the network to grow beyond that 7 million to 8 million or to grow faster or even use the millimeter wave spectrum you guys have. Yes, of course. We have a great portfolio of millimeter-wave spectrum. We also believe that there are great ways to use mid-band to be able to go after this, if you wanted to allocate capital. But all those things would be potential incremental growth. And so, our business plan gets to 7 million to 8 million on the fallow capacity model, and we're very much on track for that for all the reasons I already summarized. But yes, what you pay us to do as a management team is constantly look at opportunities. And whether there's an investment model here that smartly makes sense to go after neighborhoods with dedicated effort and extra capital and for that return, we can reach people, I think way more cost effectively than digging ditches with fiber. We can give a competitive service. We can get their years earlier than some fiber providers who are thinking about neighborhoods. And of course, we're open to that. But we wouldn't do it without deeply examining and understanding the returns and understanding the competitiveness of the offer and so forth. Speaking of digging, there's also been some press release -- press stories that you guys may evaluate of fiber-to-the-home in certain markets where it makes sense. And I imagine that's given the success you've seen competing with cable in the fixed wireless market. I mean, is that a potential use of excess cash to as you sort of go through that study? Well, we've just -- it's been a fascinating couple of years for us to become a serious player in broadband and learn the things we're good at and the things we still need to improve around. And one of the things we've learned is that, we have -- or at least relearned again, is we have a fantastic brand that resonates in the space. We have an incredible team. We have 110 million customer connections that love our brand, by and large. And these are great. And we have a proven ability to execute and fantastic data and the ability to get after things in an algorithmic way. So we have a lot going for us. On the other hand, this is an area that's expensive, it's crowded. And -- so what I said at the earnings still stands. We're open to it. We're interested in it. We're always interested in ways to thoughtfully and accretively grow our business in a way that makes sense with the basic thesis people already have about T-Mobile. And if we can find the right answer, we'd be open to it. Can we talk about the margin potential for the company? The -- you guys have always had at a big gap versus AT&T and sort of Verizon. And now with the Sprint transaction, we've always looked at it as an opportunity for you to close that gap given the scale you have and all the synergies you take out. I mean, how close can you get to sort of where AT&T is? And as you guys scale up with these growth initiatives and become larger than some of your competitors, I mean, is there a possibility that margins could ultimately be higher? But what's interesting is, for us, what we're focused on -- and next year, we're focused on this. Next year, is another year of important cash production for us. It's aside -- putting aside all the geography differences in this industry, because AT&T and Verizon have much more capital-intensive businesses. They own fiber that serves towers, we lease it. There's, all kinds of differences in our businesses. We're growing at different rates. We believe we should produce ultimately with our assets, the best cash production per revenue dollar. And we don't think. We're that far off from achieving that kind of leadership. And run rate, it could be late next year. So this model is very powerful. And it's predicated on having a much more capital-efficient business. Why we have the best portfolio of assets. We have a fantastic team. We have a fantastic customer base. We're also a pure-play business, by and large. And so next year, I think we guided in our Analyst Day, it was $9 billion to $10 billion, because the network is largely complete. We're never satisfied. We won't stop. So we have to constantly $9 billion or $10 billion is not, nothing. I mean you're perfecting the network around the edges and taking that leadership from AT&T and Verizon, but it's not under construction anymore next year. It's largely complete. And that's so powerful. And so that just opens up great cash production. And yeah, this is the superior business model. So with that -- I got two things. One, I guess, with that, I guess you remain on track in terms of the CapEx coming down over the next couple of years. There's obviously a lot of talk of sort of fixed and wireless conversion. I mean, you guys -- I guess you said is a pure-play company. Do you think, given what we've seen in other parts of the world, that's longer term, you need to -- you need a fixed infrastructure? Or do you need to sort of potentially partner, or even like you said over like we talked about you build out some of your own fixed infrastructure, or does this pure-play model sort of stand on its, own longer term? Well, it would depend on whether there's any catalyst that fundamentally changed the thesis. Some people look at convergence and say, 'Well, that's just discounting by another form. I mean those are just very different businesses, and it's just discounting by another form. Other thesis, say, 'No, actually, together, you might be able to build something better for the customer that's hard to replicate. There's also big questions about whether fiber is the ultimate winner or whether DOCSIS-based technologies will continue to be competitive beyond the kind of the initial five years, where they're clearly competitive. There's schools of thought on all this stuff. And so look, we're interested in the space. We're watching, but the broad thesis of being a mobile leader, the mobile leader, the best in the world at connecting customers to their world with a mobile leadership, that thesis is the place to be. We're -- the broad trends continue to be true. All content and communications and eyeball time are leaving. They've left their linear forms and have landed on the Internet, and the Internet is going mobile. And COVID put a temporary kind of reshaping of that curve, but the broad trend of eyeball time landing on the Internet and the Internet landing on mobile, that trend is intact. And so the place you want to be is mobile. Now if you want to surround mobile with things, if it's smart to do offensively, or defensively, or if you can create a better experience for customers in a way that makes sense financially. Well, yes, I mean be open to that. But I think you'd want to enter that discussion as a mobile -- from the mobile side.
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EarningCall_1607
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Okay. I guess we'll get started. Apologies for the delay. Good morning, everybody. And this morning, we're really delighted to have the team from Zscaler. We have Jay Chaudhry, the Founder and CEO of Zscaler; and Remo Canessa, CFO. Gentlemen, thank you so much for joining us. Before I begin, just a brief disclosure. For important disclosures, please see the Morgan Stanley Research disclosure website, www.morganstanley.com/researchdisclosures. With that, we'll kick it off. Jay, I think you had a brief presentation you wanted to share before we go into the Q&A. That is correct. If I could get the clicker. Thank you. Good morning. Good morning. All right. You need some coffee or tea maybe. All right. So I want to set the stage in terms of why we think security and networking needs to done differently that and it has been done for the past 30 years. Technology changes all the time, but it's all incremental. Disruptive architectural changes happen every 20 to 30 years. And the network architecture that security is built on was invented in late '80s and early '90s, when industry agreed upon what's known as IP, TCP, IPBS network. So you could simply buy Cisco routers and extend your data center to any branch office. You go to the branch office, you get on the network. You could laterally move, find applications and use them. Life was wonderful. The biggest breakthrough in networking and distributed computing technology. Then market invented VPN. So you could be sitting at home. You're logically in the office. You could do everything you're doing, sitting in Moscow that you do in the office. That's what VPN does for you. Wonderful. Now we are embracing cloud. Naturally, we're extending our network to every cloud region because applications and users, once they get on the same network, they find everything. It's like a beautiful highway system that takes us everywhere. And then we spend virtual firewalls thinking it's cloud security, not really. It is extending your network to every cloud region. What's the implication of all this networking for security? Well, the bad guys start by finding you. How do they find you? In the physical world, they find your house, they find your building. In this Internet world, they find your IP address that is also the open Internet, like any firewall, any VP and any application portal can be discovered. So good people can connect with it, but bad people can do the same thing. Attack surf is a big problem. The new approach is eliminate your attack surface. Hide it. You're building has no name anywhere. They can be found. They compromise you, phishing, all kind of stuff. Stopping compromise becomes important. Three, once they get on your laptop, it's on the network, they move laterally on this lovely highway at the network and they find high-value targets, and that's where they get you. Colonial Pipeline. Stole VPN credentials, got on the network, found high-value billing application rest of it is history. The traditional network and firewalls enable lateral movement. That must stop. That's why the architecture must change. Now single infector machine. If it's on your network, it can traverse the whole thing and bring everything down. That's what happened to Maersk. If you want to learn about how this lateral movement happens, read an article on Wired Magazine, search for Maersk Wired Magazine, NotPetya, you'll find it. It's a beautiful story. Then they want to steal your data. And stolen data gets sent to the Internet. So that should be stolen. So this is why, in spite of millions and millions of dollars spent on network and security, every company is getting compromised. So doing more and more of the same security legacy castle-and-moat model doesn't help. That's why when I started Zscaler, is designed for the world where you really have don't need to build castles and moat. You essentially build something we call a switchboard. A switchboard that connects users to applications without being on the network, without being inside. We all understand switchboard. I want to talk to a certain person, switch or connect to that person. That's it. You never own the network. You never an insider. That's really the fundamental architecture we came up with, which is the opposite of firewalls and VPN the like. Quite often, people ask me. Gee, how do you compare with the firewalls? I kind of say it's almost like comparing with an electric car, with the traditional car. I mean, yes, they look similar. You open the hood, everything is different. All right. Thank you so much. Especially impressive because I know you just got off a flight this morning. So definitely have that pitch down for sure. Okay. So Zscaler was founded on the premise that the traditional network security model is broken. And most of security is still done around this network architecture. Can you talk a little bit about the pace of change, though, towards this SASE, Secure Access Service Edge market. Because most enterprise IT networks are still very much hybrid. There's still a lot of legacy infrastructure there. So is that pace of change accelerating? Is it moving on pace? Is it slowing down given the macro? Just any, yes. It is accelerating. It's not slowing down. The world is always hybrid. But that doesn't mean this new approach doesn't work with hybrid. Sometimes people think that hybrid is needed. That's why you need firewalls. In this new world, where we talk about the switchboard approach, you could connect to your data center, you could connect to your public cloud, you could connect your SaaS application. You could connect to OT system in your factories. It doesn't really matter. So the approach we advocate supports the old world and the new world. It just does it in a newer and better way. I think having said that, it's true, there's always inertia out there. There's a fair amount of inertia. And we have been evangelizing. It used to be a fair amount of work. When I used to talk to a CISO 5 years ago, I would talk to 10 of them, 7 of them will say, "You're crazy." 2 will say very intriguing idea, but I'm not sure I'm ready for it. And 1 would say what a fantastic idea. Let's work together. And that got us excited. So when we got General Electric, Nestle, Schneider Electric, the world, 8, 9, 10 years ago, it was very exciting. And I couldn't handle all 10 customers, if all 10 said yes at that time. So the pace has accelerated. You've seen our growth, well over $1 billion in annual recurring revenue. This is pure revenue. This is not made up numbers being moved from this bucket to that bucket, right? There's no other thing that we do. And growth. On growth rate, you've seen us. We have been doing rule of 80, rule of 70 for quite a while. The macro situation generally slows things down. Cyber is on the top of every CIO, CISO list. It's hard to find a week when some organization is not getting compromised. So cyber is tough. The second reason that's helping us with demand is CIOs are under pressure to reduce cost. And we happen to be one of the very few security companies that actually reduces cost because we are not a better firewall. We eliminate a lot of that complicated network and a bunch of those security boxes. So when a CIO says, you're going to help me reduce cost and you can give me better security. The interest goes up. So that's why we see a lot of interest. Yes. I definitely wanted to hit on that. So there's a huge pressure to justify the ROI for these solutions. Can you give us maybe some concrete examples or quantification as to what cost does Zscaler help you, say, whether it be MPLS or brands like anything? Yes. I think you can put the cost in multiple buckets. And for interesting part is, generally, security is never -- everything you do in life is either supposed to reduce cost or increase your revenue. Traditionally, security doesn't do either of the 2, right? It's viewed as a cost. But what we do, for example, is helping customers in 3, 4 areas. First of all, there's a sprawl of security appliances out there. That needs to be eliminated. There's a lot of technical debt. So we eliminate the cost of not only security appliance, but also routers, switches, load balances and the like. So it's more than just security products. Number two, there's obviously network cost. There's a lot of money being spent on network, MPLS and the like. We eliminate that. Third is operational cost. Our customers have done study, they said it takes 1/5 the amount of resources to manage Zscaler than traditional firewall-based solutions. Those are savings. And fourth, which is business agility. We improve response time significantly. Before, if a CEO wanted to open a new office in Kuala Lumpur, IT will say wait for 3 months, I'm going to order MPLS circuit. Then I'm going to order these boxes that will be shipped and delivered to their office. It will take about 3 to 4 months to get up and running. With our approach, all you need is a broadband connection with any standard outdoor, traffic gets routed to our checkpost, reinforce policy and you're good to go. Imagine the amount of business agility you get by doing things like that. M&A integration, the number of M&As happening out there is at a record pace. So many companies are buying other companies. They're divesting companies. With Zscaler approach, you don't even deal with the networks and all that stuff. Every entity simply connects to the Internet, we become the switchboard connecting right party to right parties. So done M&A integration in, say, 8 weeks, if in the old world of networking, firewall would have taken 8 or 10 months. Got it. So you're not only saving costs in the security appliances, but you no longer have to pay for a dedicated line, the networking cost associated with that. And you charge also on a user. Basis, you're not charging for traffic, generally speaking. So that seems really compelling. Why isn't the entire market moving towards because one of the questions I get is there's still a lot of companies buying firewall boxes. In fact, it's been a record year for firewalls. So again, going back to that pace of change argument, why do you think that is? So first of all, if the market wasn't coming to us we won't be growing at the pace we have been growing. So it is happening. The question is, could it happen much faster, okay? It should, but human beings have this funky thing called inertia. People who have been trained for 30 years to do things certain ways, it's hard. So number 1 thing I personally do when I meet CIOs is really give them heads up. You're going to try to drive this thing. As you go downstream, who gets really disruptive? Networking. Your networking budget, imagine it goes from $100 million to $50 million after you deploy a Zscaler. Some people in those areas, they worry, they wonder, should I slow down? Do I lose my power? There's a little bit job security stuff involved. So we go generally top-down that CIO had to find some of these catalyst champions to drive some of the stuff. And there are people who want to really stay in the old world. That's probably the #1 reason. The mindset change or cultural change is what's really holding us back and to make a little bit of thing worse the companies that are getting disrupted. First, they used to say, "Oh, this cloud thing is crazy. It will never happen." Then they would say, well, there's proxy architecture of case. It won't happen. Now they say, gee, we have it, too. We have it better than Zscaler. Some of the legacy companies have bigger megaphone, right, and all that stuff. So they are kind of telling the world they can secure you. Now you already sold 1 million firewalls. Why haven't you secured us so far, right? I tell them that you're doing this service to every organization by really spreading a message that's not right. But that's how the world works. So we need to do our job to educate our customers. The good thing is over 40% of Fortune 500s depend upon us. And interestingly, our #1 source of getting to new business is the CIOs and CISOs and CTOs when they move from company A to B to C. They call us, and that's how this thing is working very well. Unlike we don't quite have as much channel traction as traditional guys have because what does channel do? Channel takes kind of mature technologies and take it to the customers. When anything innovative have happened, channel is never ready. It needs to be trained. So we're working on it, building lever the channel. But we had to do a little bit creative way to get to market than traditional security companies. Got it. So this is a transformational sale. And in times of macro weakness, those types of long sales cycle projects that take 9 to 12 months can be elongated further. How are you thinking about handicapping that? Maybe this is to bring Remo to the conversation, within your outlook. Because the SASE migrations aren't going away, just taking longer to close. I'll start, and Remo, you can add. Yes, we are transforming the way network and security is done. And we used to start with, you don't need this network at all. I tell you that the biggest mindset change, the cultural change that has happened in the past few years, have from the COVID hit. What's -- a large company spend somewhere from $20 million to $150 million on the network, okay? This network is connecting your 5 branch offices to the data centers. Because data center was the center of gravity, every application sat there and people sitting in various branches had to reach those applications. It was a wonderful model for 30 years. As applications are out there in the cloud some where users are out somewhere going back to a data center makes no sense. So you simply connect to the Internet. So with COVID, CIOs generally some simply realize, wow, my users are working from home, why simply connecting to the Internet. I don't use this expensive $50 million or $100 million MPLS network that's connecting our branches to the data center. It's not needed before I used to tell them, they'll say, "Well, I'm not sure I buy your argument." Certainly, it became great. I tell you an interesting story, a CISO a large U.S. company. He moved from this large company to another large company in April of 2020, 1 month after the shutdown happened. He called me, he said, "I need Zscaler here." I said, I happen to know this customer. I've been working with them. CISO wants to move forward, but the Head of Networking doesn't. He thinks he wants to keep his network. So have you talked to your networking leader. He said, "I don't need to. Because my people are working home, we're not even using the network. So now Zscaler gets deployed by simply downloading a lightweight agent to your laptop or mobile device traffic comes to us. We enforce a policy right party connect to the right party. Network is really not needed in these branches, all you need is and Internet connection. So that CIO talked to me. Three months later, when we rolled out Zscaler, he said, "I used to think about network transformation, now, I think on network elimination. So our deployments have gone from where it used to take 6 months. It takes 6 weeks. If it took 3 months, it takes 3 weeks because we don't even touch the network. It's -- security doesn't need a lot of complicated policy -- the job of security vendor is to make sure we don't let bad stuff come down and affect you and don't let good stuff leak out. So deployments are faster. If we need to work on something, it's a mindset and cultural change to educate people. So I mean, from my perspective, when you take a look at applications several years ago, there was a debate whether they should be in the cloud or on-prem. And several years ago, applications have all gone -- most of the applications have gone to the cloud. And what that's done basically is made companies a lot more efficient. The question when I met with Jay 6 years ago, and again, I came from NetScreen, which is a firewall VPN company. My core was basically security has got to come back into the data center. You've got to control it. And talking to Jay, basically, the -- if you do have a hub-and-spoke basically network, you allow people to get onto your network and basically go in any place. What Zscaler created was a Zero Trust Exchange, and that Zero Trust Exchange is in the cloud. And that was the key thing, which Jay said, that if applications are in the cloud and users are mobile, why do you want to backhaul everything into your data center? You don't. I mean for the reasons Jay mentioned, it's user experience, it's cost, also complexity. I mean, if you take a look at the number of security professionals, it's not increasing at the pace that it needs to in order to keep up with all the security threats. So moving -- pushing your traffic through Zscaler, through our Zero Trust Exchange is the simplest and most secure way to really protect companies. From an overall perspective, 1 of the things we commented on was that the macro effects, so I think the entire world and all companies are feeling macro effects related to what's going on. Our pipeline is increasing, our business interactions are increasing. Our deal sizes are increasing. The number of $1 million deals we have is $348 million ARR customers, not deals, ARR customers. It's an increase of 55% year-over-year. And so we're seeing basically more companies buying more of our platform, which is users and workloads. So it's how do I handicap it related to going forward. You take everything in consideration. But we are growing, as Jay mentioned, 50% year-over-year at this scale, it's pretty impressive. Got it. And then just quick multipart question from you and then I want to open up to the audience. How are you thinking about growth versus profitability? Because like Jay mentioned, you've been a profitable business, over 20% free cash flow margin. So how do you think about the relationship of that as we do slow down, everyone slows down. And then the second part is stock-based compensation. Historically, Zscaler has not had a lot of dilution -- but the stock-based comp, at least relative to revenue did uptick a lot in the last couple of years. So -- how do you think about sort of bringing that down? Yes. I'll take the stock-based comp question first. We expect to decrease as a percent of revenue. So you'll see it decreasing. This last quarter it was 31%, which is down from where it was before. So you will see stock-based compensation percent of revenue decreasing. And basically, as companies mature, when you're -- when you go public, and when you're a private company, you incentivize basically employees with stock. You still do that at a pretty large degree when you're first public as you're trying to attract talent, but as you mature, less people get stock. So stock-based compensation will decrease. From a balancing top line growth and operating profitability, you mentioned, we're free cash flow over 20% the last 2 years. From my perspective, the key thing for Zscaler is to get market share. This is a race. And if we get that market share, it gives us the -- basically, the foundation to continue to grow. Our -- absolutely, we sell both new and upsell. Our net retention rate is 125%. So from my perspective. Over 125%. Over 125%. So from my perspective, basically, continue to invest in the business, be more mindful, basically, on operating profitability, which we are. We increased our guidance on operating profitability. We had an outstanding quarter in Q1 in hiring. And going forward, we're going to moderate our hiring in the future quarters, still prioritizing revenue-generating salespeople as well as innovation. So when you think about your, let's say, some of your flagship customers, the ones that have been with you for longer that we're like the early adopters of the technology, do you see case studies where some of them are indeed no longer using firewalls or have abandoned some of the earlier types of security? Yes. The question is, do we have customers who basically have no firewalls? When Zscaler comes in, typically, -- most of the firewalls go away, there's 1 place they still stay. It's a data center. Data center still has a complicated DMZ sitting there. I'd rather not go after the data center, which is going away over time. I would rather go where the puck is headed. We have solutions where you don't need firewalls in public cloud, our solution, the Zero Trust can do it. So that's really how we're approaching it. You just alluded to the fact that you're in a race. Can you talk a little bit about the competitive environment? Who are your direct competitors? And what gives you the confidence that looking down 5, 10 years down the road, you're going to become the standard of the industry? So first of all, competitors have been changing. For the first several years, these -- there are 2 kind of competitors we had: proxy vendors, Websense, Blue Coat, Symantecs of the world, McAfee of the world, they had dominant on-prem position. They just couldn't move the cloud in a multi-tenant architecture. They're kind of there, but not there. Still, the #1 vendor we replaced out there for outgrown traffic is Blue Coat, Symantec. For the private access, VP and vendors like Pulse Secure of the world, Cisco and ECON of the world have been key vendors, but they are actually withering away. Now firewalls are trying to come and say, we can do it just because we can spin our firewalls in the cloud and become virtual thing. It's almost like when Salesforce came to the world, Siebel Systems dominate everything. And what did Siebel say? Of course, you can run me as a virtual machine in the cloud. You don't need to buy Salesforce. Unless you build a cloud-native architecture, you can't really do this kind of stuff. It's an architectural change. It's not adding a feature. It's like I like to say, you may be the best DVD player vendor. But when it comes to building Netflix, you can take 1 million DVD players, put in a data center. And here's a DVD player dedicated for customer. You need a different architecture. That's what we built. So I do believe that these firewall vendors will try to come, they'll probably get back to where they belong. They really don't really belong in this Zero Trust type of architecture. If I look at consensus estimates for your revenues, the rate of growth goes 40% in fiscal '23, then 31%, then 26%. And each year, you add exactly 500 -- roughly $500 million. For a company which is investing very hard in itself, that seems to be a slowdown. Is that macro? Is it -- that we have no idea at the moment? Or is it analysts being conservative? Yes. I mean the -- we only give guidance out for 1 year. And basically, if you take a look at how we've given our guidance, we've been prudent. We've been able to beat and raise for the most part. And so we're being prudent with our guidance. We don't want to disappoint shareholders. We don't want to disappoint ourselves. And so we try to be prudent with our guidance only 1 year guidance we give out. In terms of macro, I think we are doing relatively speaking, quite well. Here's the last comment I'll make and we are out of time. When macro conditions get tight, demand softens. We haven't seen a slowdown in our demand because we have a record pipeline the number of engagements with C level or kitting right or record engagement. So there's no lack of pipeline activity. Then the question ends up being, would you be able to close business, right? You could have pipeline, but do you close it? It is harder because there's more scrutiny today than it was 3 months ago or 6 months ago. The 2 things we do that are helping us do better than other companies. One, we have been selling at C level from early on because we had to. Remember, there's a mindset change. We couldn't go and sell to techies. So having C-level engagement, a CIO getting approval from CFO, it's a lot easier than dealing with 4 levels down and then your project that killed somewhere before even reaches the C level. It is true if before CIO went to CFO, the deal got approved in 2 days. It may take 10 days or 2 weeks because CFO is asking a lot more questions. Now for that, 1 of the things we have been doing for years is something called business value assessment. We actually quantify the customer that we can take out these products, these networks, these things, this is what the ROI will be. Those studies are needed far more today than they were needed 6 months ago. So we are doing a lot more business justification studies that helps us close our deals.
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EarningCall_1608
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Good morning. And welcome to the RPM Internationalâs Fiscal 2023 Second Quarter Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After todayâs presentation, there will be an opportunity to ask questions and please note that this event is being recorded. Thank you, Cole. And welcome to RPM Internationalâs conference call for the fiscal 2023 second quarter. Todayâs call is being recorded. Joining todayâs call are Frank Sullivan, RPMâs Chairman and CEO; Rusty Gordon, Vice President and Chief Financial Officer; and Mike Laroche, Vice President, Controller and Chief Accounting Officer. This call is also being webcast and can be accessed live or replayed on the RPM website at www.rpminc.com. Comments made on this call may include forward-looking statements based on current expectations that involve risks and uncertainties, which could cause actual results to be materially different. For more information on these risks and uncertainties, please visit RPMâs reports filed with the SEC. During this conference call, references may be made to non-GAAP financial measures. To assist you in understanding these non-GAAP terms, RPM has posted reconciliations to the most directly comparable GAAP financial measures on the RPM website. Also, please note that our comments will be on an as adjusted basis and all comparisons are to the second quarter of fiscal 2022 unless otherwise indicated. We have provided a supplemental slide presentation to support our comments on this call. It can be accessed in the Presentations and Webcasts section of the RPM website at www.rpminc.com. Thanks, Matt. I will begin todayâs call by sharing commentary on our consolidated performance for the second quarter, Mike will provide details on our financial results and then I will turn the call back over to Matt to provide some business updates, and then, finally, Rusty Gordon will conclude our prepared remarks with our outlook for Q3. After our prepared remarks, we will be pleased to answer your questions. In the second quarter, we continued to build on recent momentum to deliver both record second quarter sales and adjusted EBIT. This represents the 10th consecutive quarter of record revenue and four consecutive quarters of record adjusted EBIT, an impressive accomplishment in todayâs uncertain economic and volatile climate. An important factor in achieving these results is our MAP 2025 Operating Improvement Program. Across RPM, associates have embraced MAP 2025 principles of collaboration and efficiency to successfully implement initiatives and help drive top and bottomline growth and performance. MAP 2025, which officially began at the beginning of this fiscal year is off to a strong start and we are on track to meet or exceed our first year EBIT target improvement of $120 million from MAP initiatives. This hard work was evident in our second quarter results where we achieved strong revenue growth, as well as significant adjusted EBIT margin improvement. Importantly, we achieved these positive results despite meaningful macroeconomic headwinds, including intensifying weakness in Europe, FX headwinds and a slowdown in some of our end markets. Turning to the next slide. Revenue growth was broad based with all four of our segments achieving record second quarter sales. This was accomplished primarily through the implementation of pricing increases in response to continued inflation. We also generated volume growth in several of our businesses that benefited from continued reshoring and infrastructure spending, as well as from improved material availability. Importantly, we not only generated strong sales growth but also expanded margins to achieve record second quarter adjusted EBIT on a consolidated basis at three of our four segments. This was driven by the successful execution of margin enhancement initiatives across the organization. The one outlier segment that did not achieve record second quarter adjusted EBIT was the Construction Products Group, which was most acutely impacted by macroeconomic headwinds, because of its relatively outsized exposure to Europe and to new residential home construction in North America. Looking at sales by geography on the next slide, Europe is clearly the laggard among the regions we serve with sales down nearly 12% for RPM and unit volume down even at a greater rate. This was driven by weak macroeconomic conditions, including persistently high inflation, additionally FX weighed heavily on our results in Europe. FX translation also negatively impacted our sales in emerging markets, so we still achieved healthy growth in these regions. Thanks to the hard work of our associates to align our businesses and products with growing end markets, and to successfully increase prices in response to cost inflation. Demand in North America remained strong through the second quarter with growth in all of our segments, growth in the region was fueled by price increases in response to continued inflation and strengthen our businesses to serve customers who are reshoring manufacturing to the U.S. and it serve infrastructure-related activities. Better material availability also contributed to organic growth in a number of our businesses in the quarter. I will now turn the call over to Mike Laroche to discuss our consolidated and segment financial results in more detail. Thanks, Frank. Sales increased 13.4% excluding FX, which was at 4.1% headwind. The result was a 9.3% increase in reported sales to a second quarter record of $1.79 billion, compared to $1.64 billion in the prior year period. Organic sales growth was 12.4% or $204.1 million and acquisitions contributed 1% to sales or $15.7 million. As mentioned, FX decreased sales by 4.1% or $67.6 million. Our consolidated adjusted EBIT increased 36.4% to a second quarter record of $214.7 million, compared to $157.3 million reported in the prior year period. Second quarter adjusted EBIT margins expanded 240 basis points compared to the prior year period. We achieved this expansion despite significant foreign currency translation headwinds and continued cost inflation. Adjusted diluted earnings per share were a second quarter record at $1.10, representing an increase of 39.2%, compared to the $0.79 in the prior year period. Turning to the next slide. Our Construction Products Group generated second quarter record net sales of $634.1 million, an increase of 3.2%, compared to the prior year period. Organic sales growth was 6.9%, with acquisitions contributing 1.5% and foreign currency translation reducing sales by 5.2%. Sales growth was driven by the restoration times for commercial roofing, facades and parking structures. Admixtures and repair products for concrete continued to gain share during the quarter. Price management in response to continued cost inflation also contributed to CPGâs revenue growth. Partially offsetting this growth, demand was weak in Europe and new residential home construction, both areas where CPG has a higher exposure than the RPM average. Demand in these two areas was particularly weak at the end of the second quarter. These headwinds, along with the negative impact from FX, unfavorable mix and reduced fixed cost leverage at plants, including the Corsicana, Texas facility that was acquired in fiscal 2022 2nd quarter, resulted in adjusted EBIT declining 12% to $80.4 million. As a reminder, unadjusted EBIT declined 40% in the quarter versus the prior year period. That was primarily due to a $41.9 million gain from the sale of real estate assets in Q2 2022 that did not recur this quarter. This gain was excluded from adjusted EBIT in Q2 2022. As you can see on the next slide, the Performance Coatings Group achieved record fiscal second quarter net sales with revenue of $335.2 million, an increase of 10.8%, compared to the second quarter of fiscal 2022. Organic sales increased 15.4%, acquisitions added 0.6% and foreign currency translation was a 5.2% headwind. Flooring Systems, Protective Coatings and FRP grading, all generated double-digit revenue growth. Manufacturing customers fueled the increase, including demand for those who are reshoring their production to the U.S. such as pharmaceuticals, food and beverage, EV manufacturing and electronics companies. Good demand in energy markets and price increases in response to continued inflation also contributed to the growth. Adjusted EBIT increased 16.6% to a second quarter record of $46.2 million. The growth was driven by positive volumes and price increases. Partially offsetting these positive factors, foreign exchange translation was a headwind to adjusted EBIT. Turning to the next slide. The Specialty Products Group reported record second quarter sales of $212.1 million, an increase of 9.5% compared to the prior year period. Organic sales increased 11.5%, acquisitions added 0.9% and foreign currency translation was a headwind of 2.9%. Second quarter sales were led by strength in the food coating and the additives business as a result of strategically refocusing sales management and selling efforts. In the disaster restoration business, the response of Hurricane Ian contributed to strong sales growth and its ability to quickly meet increasing demand was aided by prior operational improvement investments. Price increases in response to continued inflation also contributed to the sales growth. SPG generated record second quarter adjusted EBIT of $30 million or an increase of 43.2%, compared to adjusted EBIT of $20.9 million in the prior year period. The increase was driven by strong sales growth and benefits from MAP 2025 initiatives. Moving to the following slide. The Consumer Group grew sales 15.3% to $610.4 million, which is a record for the second quarter. Organic sales increased 17.5%, acquisitions contributed 0.4% and foreign currency translation was a headwind of 2.6%. The Consumer Group sales growth was driven by price increases to catch up with continued cost inflation and strong sales growth in North America. Adjusted EBIT increased 180.3% in the fiscal 2023 second quarter to $94.2 million, which was a second quarter record. Successful implementation of MAP 2025 initiatives, many of which were enabled by improved material supply, as well as strong sales growth were key drivers to the increase in profitability. As a reminder, the Consumer Group experienced extraordinarily low profitability in Q2 2022 as a result of an explosion at an alkyd resin suppliers plant that caused severe supply disruptions and from high material cost inflation that was not offset by commensurate price increases. This contributed to the strong second quarter of 2023 year-over-year growth. Thanks, Mike. During the second quarter of fiscal 2023, we paid cash dividends of $54.2 million or $1.68 per share on an annualized basis. On a per share basis, this represents an increase of 5% compared to fiscal 2022 and is the 49th consecutive year we have raised our dividend. Over the course of these 49 years, our strategically balanced business model has given us the ability to continually generate steadily improving cash flows and return over $3.1 billion to shareholders via dividends during this period. With regard to investments in working capital, for several quarters we have talked about increases in working capital driven by higher raw material inventories that were designed to improve supply chain resiliency. As material availability has significantly improved, we have begun normalizing our purchases of raw materials in Q2 2023 and we expect these actions to contribute to improved working capital levels in Q3 2023. On the topic of M&A, we have completed six acquisitions so far in fiscal year 2023. These have been small deals and we have remained disciplined as multiples from any potential targets have been elevated above historical levels. With the recent rise in interest rates and changes in economic forecasts, multiples appear to be normalizing and we have a strong pipeline of potential acquisition targets. We expect to continue to be active in M&A and have the financial flexibility to do so, but we will retain our disciplined approach to valuations with a sharp focus on value creation. Looking ahead, while long-term visibility remains limited, we expect economic headwinds to persist in the fiscal third quarter of 2023. Although we are not immune to economic challenges, the balanced portfolio of businesses I just referred to has historically helped us navigate economic slowdowns. Our varied businesses tend to perform differently throughout the economic cycle, which helps reduce the volatility of our results and insulate us from downturns. Additionally, several of our businesses are positioned to continue to benefit from positive reshoring and infrastructure spending trends, which we expect to continue in the future. We have also positioned our businesses to primarily focus on maintenance and restoration markets, which tend to be less economically sensitive than new construction or OEM demand. As you can see from slide 12, approximately two-thirds of our revenue is generated by demand for maintenance and restoration products and services. The reason maintenance and restoration demand tends to outperform new construction during times of economic slowdowns is demonstrated by the example on slide 13. When compared to buying or building new, our products offer a compelling value proposition during periods when budgets are in sharper focus. This is true not only for Consumers but also commercial and industrial customers as well. As an example, within our Consumer segment, Rust-Oleum offers a suite of complementary and easy-to-use products that owners can utilize to renovate their bathrooms at a fraction of the cost of a typical bathroom remodel. Rust-Oleum also offers products to renovate other areas of the house, including kitchens, garages and furniture. Thanks, Matt. As Matt mentioned, we expect the headwinds that we have recently experienced to continue in the third quarter of fiscal 2023. These include slowing overall economic activity, rising interest rates, reducing construction activity and negatively impacting existing home sales, which have declined for 10 consecutive months. The bull up effect as some customers temporarily moderating purchases to normalize inventory levels as material availability has improved, a strong U.S. dollar compared to the third quarter of fiscal 2022, and lastly, continued year-over-year cost inflation. Through a combination of these headwinds, results in November and December have been meaningfully below the prior months in fiscal year 2023. At this point, it is too early to determine how much of the recent slowdown is due to weakening economic conditions versus the short-term impact of inventory normalization. Customer feedback on the reduced demand has been mixed as has recent economic data. Taking all these factors into account, we anticipate third quarter fiscal 2023 consolidated sales will increase in the low single-digit to mid single-digit percentage range compared to the prior year record results. By segment, we expect PCG to be the leader with sales up in the high single-digit to low double-digit range compared to the prior year record results. The strength is being driven by growth in businesses serving manufacturers who are reshoring their production to the U.S., including strength in energy-related markets. Additionally, PCG is expected to benefit from CS 168 initiatives, which are part of our MAP 2025 Commercial Excellence Program. Consumer sales are expected to increase in the mid single-digit range compared to prior year record results, led by pricing increases in response to year-over-year inflation Additionally, now that our material availability has increased, we have begun implementing new marketing and advertising initiatives, which we expect to benefit growth in the coming quarters. Partially offsetting this growth, we expect that the low levels of housing turnover will have a negative impact on Consumer volumes. SBG sales are expected to be flat to prior year record results. Here strength in food coatings and additives, and disaster restoration equipment in response to recent winter storms is expected to be offset by volume declines at businesses serving OEM customers, which are more economically sensitive. As an example, some OEM customers have extended shutdowns of their facilities above and beyond the usual holiday timeframe for the first time in several years. We anticipate that CPG sales will decline in the low single-digit to mid single-digit range compared to the prior year record period as it continues to be weighed down by a weak European economy and softening construction activity. With the softening macro environment, we are reducing production at some of our plants to be better balanced with expected demand. As a result, we expect to reduce inventories, which have been temporarily elevated to navigate supply chain challenges and positively impact our cash flows. We also expect that these actions will lead to lower fixed cost absorption and be a headwind to earnings. Taking all this into account, we anticipate that third quarter fiscal 2023 adjusted EBIT will be in the range of $75 million to $85 million, compared to the prior year record amount of $80.6 million. Included in this guidance are the expectations for year-over-year headwinds from FX and cost inflation. Yeah. Good morning, Frank. Thanks for taking my question. So I guess the first one would just be on the raw material environment. It looks like a lot of base chemicals coatings raw materials, construction raw materials as it started to slide. I guess can you speak to what you are seeing in the raws that you are buying today and how much they may be coming off? And then, I guess, tied to that, is it fair to assume that you donât have that in the 3Q guide just, because of your FIFO accounting and it probably doesnât impact you yet, you probably get the benefit more in the May quarter, I guess, how should we be thinking about that? Yeah. I think thatâs correct. So in the second quarter year-over-year inflation was up about 17%. It was down sequentially in the quarter about 3%. We are experiencing better recovery on the spot market as you are suggesting today, but because of FIFO accounting, thatâs not going to show up until the end of the fourth quarter or into the first quarter of next year. I can give you a couple of data points. Again, we are seeing sequential improvements, but thereâs still some significant areas of inflation year-over-year, metal packaging is up 59% in the quarter, alkyd resin were up 30% in the quarter versus the prior year. But we are in the marketplace starting to see sequential improvements. Got it. Got it. Fair enough. And then I guess on the destocking side, I guess, can you help us to think about, it sounds like thereâs a little bit of confusion out there and even your customers arenât necessarily sure how much of its destocking versus actual demand. I guess, can you give us a little bit more color as to which channels may be seeing kind of the heaviest level of destocking and the negative impact of that and where things maybe are kind of running more hand to mouth and more kind of in line with demand, I guess, how should we be thinking about that? Sure and itâs a great question. Historically, when we would talk about destocking or any of our peer competitors or companies that deal in Consumer markets, it tended to be understood as a reference to inventory adjustments by major retailers, big box consumers discount. In this case, itâs really inventory adjustments across the whole supply chain. So with many of our customers in industrial markets, we are in a similar fashion. Supply chains were so broken, you saw people buying what they could get. While our inventory is higher than it should be, in the quarter, we have seen a meaningful improvement from higher than usual raw materials to finished goods, which is the proper step of a cash conversion cycle. And so across our customer base, you are seeing people take actions to readjust inventory levels from kind of the extraordinary actions people had to take over the last year and a half or two years in light of supply chain disruptions. So, specifically, in the third quarter, Rusty referenced the Specialty Products Group and we have seen for the first time for the last couple of years some of our OEM customers did not take their usual shutdowns during the Christmas to New Yearâs timeframe. In this case, they have, and some are extending it into January and part of this is inventory level adjustments as opposed to necessarily recessionary moves. So thereâs some volatility there thatâs going to play out with more certainty in the next couple of months. Got it. And then maybe if I can squeeze in more [Technical Difficulty] just on just on MAP 2025, can you just give us an update where you are, I think, you were at about million run rate in the prior quarter. I guess, can you help us to understand where you are at, it sounds like you may have some upside to the $120 million target for this year? I will hit that $120 million target this year. But one of the things that people have to adjust relative to original expectations in Q3 is most of the MAP 2025 programs are focused at the gross profit level. So itâs greater efficiencies. Itâs establishing greater levels of capacity through greater efficiencies. Itâs a much more deliberate data usage on managing cost price mix. And itâs having a good effect. The reason thatâs relevant to Q3 is it doesnât flow through your P&L until you sell something and given the seasonal low of our third quarter revenues, the impact in Q3 of MAP 2025 will be less than what you saw in Q1 and Q2. And then you will see a disproportionately larger impact of MAP 2025 in Q4 because of our higher sales. Sure. Yeah. Just to qualify that further. I think thatâs an important thing to note that the MAP 2025 benefits will, because of where we are targeting them, be driven proportionally by a revenue basis as opposed to taking our communications about for instance $120 million and dividing it by 12 or dividing it by four, it wonât play out that way. Hey. Good morning, Frank, and Happy New Year to you and everybody there. The comment was made that November and December saw a significant slowdown. So I was wondering if you could kind of quantify maybe on a percentage basis or a dollar basis or what have you, the negative year-over-year impact that you have seen particularly in December. And as part of that, Iâd be curious as to what your -- whatâs being embedded in terms of recovery in January and February in the $75 million to $85 million operating income? Sure. So I will try and address it in two ways. Number one, the biggest negative impact in Q2 and at the end going into Q3 is regional and itâs Europe. Europe was down 11% in revenues. If you assume price in there, you can make some assumptions that Europe was down even greater on unit volume and while we donât disclose EBIT by region, EBIT in the European market was off by more than 50% year-over-year. And we have a disproportion, out of a $1 billion base of business, roughly half of that is in our Construction Products Group. And so that gives you a sense of the greatest challenge that we are facing, which is regional. We also saw a slowdown in residential, which today with Nudura and a few other product lines out of a $2.7 billion. Construction Products Group, we have about a $200 million exposure to residential new construction. And including some of our Consumer businesses, Iâd say our total exposure to residential new construction in North America is about $300 million. The last comment I will make again, which makes the performance at the end of Q2 and the beginning of Q3 difficult is, we had a weather event not dissimilar to a year ago that impacted the entire United States and so that slowed down results for us as we start off this third quarter and it will be interesting to see [Audio Gap] recessionary. Got you. Thatâs very helpful. And interestingly, thereâs a lot of discussion regarding destock among the customer base, et cetera, your inventory levels continue to tick higher. I am wondering how we should be thinking about that? And as we sit here today, our inventory levels are being adjusted appropriately. We had more normal cash flow in the quarter and I think you will expect -- should expect to see better cash generation out of us in the coming quarters relative to focus on inventory adjustments. Itâs happening across the whole supply base and our customer base and not just, again, I want to make sure that people donât equate destocking to Consumer big customers. This is basically the supply chain across almost every business or industry that we serve adjusting back to normal levels of inventory. So that is circumstantial and thatâs playing out as we speak, because we are not the only company whoâs got higher levels of inventory in relationship to trying to adjust to the supply chain challenges in the last two years. Yeah. Hi. Thanks for -- hey. Good morning. So just curious if you could comment on pricing, one, I apologize if I missed it, but can you comment on what pricing was in the quarter, and then specifically for construction, if you are having weaker demand, I mean, given how that business is more project based pricing. Is that having any impact on your ability to get further pricing or are you having to give some of that up given some of the destocking? Josh, we have not provided price detail by segment. But on a consolidated basis, price was in the 15% to 16% range on average across RPM in the second quarter and unit volume was up in some of our businesses down in the CPG and particularly in Europe. So on a total basis, unit volume in the quarter was down about 3%. We have held on to our pricing pretty much everywhere and as the supply chains adjust, typically in the past, there are very few areas where we would have to get back price. Some of it is in more commodity spaces. One example is in silicones in the Construction Products Group. There have been extraordinary spikes in silicone costs over the last year and a half, and that was a real problem for us in cost price/mix. There are significant declines in silicone prices. So you are likely to see some price adjustments in commodity -- more commodity areas like that. Other than that, historically, we have tended to hold on to our price across RPM and we intend to do that through this cycle as well. Okay. Thanks. And then I was just wondering if you could comment on Consumer in terms of what you are seeing. I mean, you have had strong volumes in the first quarter on some restocking and supply availability improvement. I think some of your competitors have noted some destocking in that chain. Are you now seeing more of that or I mean, my assumption is you are kind of assuming negative volumes in Consumer at least for next quarter. So just curious what the driver is among that? Sure. I think thatâs correct. There has been some destocking. I think thatâs stabilized. Consumer takeaway has still been very volatile from one week to the next. It could be down in units 10% or up 2% or 3% depending on the retailer. We have lost over the last year about $40 million in market share and I believe that that market share adjustment is over, and thatâs been in some categories of spray paint and wood states and finishes in a big box account. Our Consumer Group is pretty excited about the spring and we are going to be initiating a advertising and promotional initiatives in the spring, much larger than we have over the last couple of years. Itâs a combination of some new product introductions, some new market share opportunities. And finally, a supply chain such that we can deliver at the high fill rate levels that historically we have been able to deliver at. So we have done a lot of work, both through MAP 2025 and then specifically on the operations side at Rust-Oleum around some supply challenges and manufacturing efficiencies. Those have been addressed and we will be in a really strong position to be able to meet demand and also to drive demand in the spring selling season. So thatâs one area of strength for us as we look into the finish of fiscal 2023. Thank you. It sounds like M&A discussions are picking up. Can you provide some color on whether itâs in the weak areas like Europe or Construction Products or is it broad based across your businesses? Itâs kind of broad based across our businesses. We have done six transactions this year, all very small product lines. But there have been some nice additions to Construction Products. Through some of the big construction product mergers, we were able to pick up pieces of concrete, I am sorry, of cement additives, which was a category that Euclid Chemical was not in. We have also invested internally and through some regional acquisitions and penalization for greater energy efficiency and wall construction. So some exciting areas for us, small acquisitions that with our distribution should be able to double or triple revenues in the coming years. So, thatâs pretty much what we have been seeing. As Matt commented on, we have been holding our discipline and we are seeing valuations coming down, and I suspect that we will continue to see small to medium-sized acquisition activity in the coming quarters. And then how much more price do you need to get to fully get caught up on alkyd silicones and metal containers? I think we have the price that we need now in the marketplace. I think the final straw of margin recovery is going to come through holding on to the price that we have got as raw materials cycle back to more normal cost levels. And when you look at our Consumer Group, the year-over-year improvement in EBIT is impressive. It has as much to do with how poorly we performed a year ago as it does today. We are still not back to record EBIT levels, but we expect to get there both through some commodity cycle recovery and the benefits of the MAP 2025 Program. Thanks, and good morning, Frank, and everyone. I wanted to ask about the bidding activity that you see mainly in Construction Products and Performance segments, more maybe looking over the next two, three quarters, perhaps, outside the residential projects area where you highlighted the weakness? Sure. So the -- as you would guess and you are seeing in the numbers in our results, the residential piece has been weak and Europe has been weak. We have a very strong backlog in our roofing and waterproofing division going into the spring. And so as we sit here today, it looks like the spring and summer season for that portion of our Construction Products Group, which is the largest and most profitable will be strong, but we will see. Again, the volatility that we are seeing in different parts of our business, itâs hard to understand how much of some of the underperformance here that we are expecting in Q3 is inventory destocking across customers and adjustments and/or weather related here as we start the quarter versus recessionary. As we sit here today, we have a very strong backlog and I think thereâs some comfort in the fact that unlike residential construction or normal commercial construction, thereâs been a lot of federal money and state and local money that will be going into school construction, into healthcare, and those are two very strong end-use markets for our roofing waterproofing division. Thank you. And then I understand itâs hard to differentiate between demand weakness and destocking, I mean, customer side, but your intentional reduction of inventory, is it possible to estimate how much thatâs hurting EBIT in the third quarter? Yeah. Itâs a good question and itâs definitely a drag on EBIT. We have dropped shifts in certain places where we had previously been operating on a three-shift basis and that was not demand driven. That was inventory adjustment driven. And when you do that, your overhead absorption takes a hit and so thatâs temporary and you are seeing that in a number of places across RPM. So thereâs a deliberate effort to get inventory levels in a number of our businesses back to a normal pace and that will hurt us in the seasonally low third quarter as these actions again negatively impact overhead absorption. Iâd like to think, I donât know how quickly we will adjust it will be adjusted through the spring and the summer selling season, which are our strong seasons and so those temporary negative impacts on gross margin should pick back up. Yeah. Thank you. How much of your MAP 2025 would you say is driven by targets on the manufacturing side versus initiatives on commercial improvement? And in the former, do you expect to get more active in raw material manufacturing and in the latter view, is it more driven by cross-selling? So itâs mostly, Steve, focused on areas that would affect gross profit and so it is a continuation of what we call MS 168, which is driving lean manufacturing disciplines on a consistent basis across our manufacturing base. We had in our original MAP program, done so very effectively but really in our top 50 plants and thereâs another 75 plants out there that are more small- to medium-sized our ability to get to effectively was interrupted by COVID and so thatâs having an effect. There will be some modest plant consolidation, nothing to the extent of the original MAP program, but some modest plant consolidation and so those are two big areas. Then the other area is literally being in a position today to use data much more effectively to understand cost price mix better and to be able to drive a more deliberate margin profile that we want relative to really not having that data all the way down to a salesperson level such that we can really be deliberate and effective there. And so those are the primary areas that will affect principally gross profit margin. You have other -- yeah. The last piece of that we talked about is, we do expect somewhere between $100 million and $200 million of gross margin recovery from commodity cycle improvement as well, which is consistent with the margin recovery that we have had in past commodity cycles and in reference to a response to an earlier question. I asked about the cross-selling, because one of the takeaways for us from the events you had in Cleveland with Construction Products was an apparent awareness that cross-selling was an opportunity there and just would like to hear your view on that, Frank. Is this an area that you think that RPM has some significant opportunity to cross-sell between businesses, and perhaps, regionally, do you have aspirations for sales ex North America to meaningfully increase above the 20% level that itâs at now? Yeah. Absolutely. So as you saw in the Investor Day presentation, over the last four years, our internal cross-selling efforts have increased from $60 million annually to $180 million, and certainly, the opportunity for that to double in the coming years exists. One example is, because of the success we have had with Arnette Polymers, which is a pre-polymer raw material resin division of Stonhard and then the Corsicana plant which, while itâs part of our Construction Products Group, today is principally serving Consumer and Rust-Oleum. We are utilizing the leadership there to create a resin center of excellence in Europe to create the same type of stability and certainty in supply, competitive advantage in raw materials and cost selling and thatâs going to play out over the next 12 months or 18 months. So thatâs one of many concrete examples of trying to continue to accelerate whatâs been a pretty good story in terms of intercompany supply and/or cross-selling revenue benefits. I guess, Frank, on the inventory adjustment dynamic, as you kind of think about it, do you see this as sort of a multi-quarter phenomenon or one thatâs going to disproportionately impact one of your smaller quarters, which is 3Q and then things sort of normalize from there? And then just related to that, just given all the complexity in the current operating environment, is there any historical payrolls that you can think of that are sort of equivalent to what you are seeing at this point? Sure. Thank you. It will have a disproportionate negative impact on Q3 and thatâs certainly part of our guidance. As you trying to ramp down production in this case in a few specific areas to address inventory imbalances as opposed to absolute demand and I had commented earlier about the overhead absorption hit. It will be less in Q4 and into Q1. I think it will take another six months or nine months for us to get inventory back to where we want. Itâs just a slow and steady progression. But you are already seeing this. Our inventory levels quarter-over-quarter on a relative days basis havenât improved much. But thereâs been a significant shift from what was a higher-than-usual carrying of raw material inventory into finished goods, which is obviously the cash conversion cycle that we like to see. Now we got to sell it and turn it into cash. And I have never seen -- we have talked about destocking in the past when some of our big consumer customers would work to get to the next level of inventory stock efficiency and that certainly happened to us and people have talked about its impact circumstantially when itâs happened. In my career, I have never seen the supply chain disruptions and then related inventory imbalances. And so, for instance, there were there was demand we couldnât meet in some of our Consumer businesses over the last year because of these things. So we would have certain customers order in excess more than what they probably needed because they wanted to get what they could sell. We had customers in our Construction Products Group over the last year going to the same thing. So you just had odd circumstances across multiple businesses and channels and industries in terms of order flows caused by this supply chain disruption and with a settling down of supply chains, which I think were back to normal, now you are seeing people try and modulate back into a normal inventory level and a refocus on working capital position back to something thatâs more normal and more stable and more predictable. I know thereâs a lot going on. And for my second question, in terms of your comments related to the weakening in volumes late in the quarter, which specific businesses and end markets were the most impacted, I know you called out new construction, but just more color on that? Sure. As we think about Q3 going into the spring, we saw solid performance from our Consumer Group and we would expect to see that continue. We saw really solid performance in our Performance Coatings Group and given their infrastructure function and focus and heavy industry focus and some of the onshoring and infrastructure dollars out there, we expect that to continue. The weakness was really in the Construction Products Group at particularly as we start Q3. I canât tell you sitting here whether itâs a sustained weakness thatâs continuing thatâs more recession like or whether some of it was a result of the winter storm that impacted all North America. We saw weakness in the OEM portion of our Specialty Products Group or our Specialty Products Group is about $800 million, about half of that is OEM coatings, powder coatings, liquid metal, wood stains and finishes, and again, some of that could be circumstantial. Over the last couple of years, the normal between Christmas, New Year shutdowns that some of our cabinet maker customers, door customers, RV customers had traditionally, they did not have, well, they had those again this year and some of that is extending into January. And how much of that is in anticipation of continuing recessionary pressure as opposed to some of these inventory adjustments we wonât know for another month or 2. Hi. Good morning. Your corporate costs are annualizing at $132 million versus something like a little less than $100 million last year and even in 2021, maybe your corporate costs were $113 million. Whatâs going on there? Is this a large onetime increase for this year or is it something more permanent? Why are corporate costs up so much? Jeff, this is Rusty here. Corporate costs are up primarily from two categories, itâs pension and insurance. In terms of pension, our assets have been hit in the pension plan and that leads to higher non-service related pension costs, as well as the fact we have had pay and wage inflation higher than our actuarial assumptions. Also, in terms of insurance, as you know, there have been several property events and insurance costs are up as rolled. The other thing I would add to that as a result of our MAP to Growth program, as well as MAP 2025, our corporate staff has increased by about 30%. Now it starts on a relatively low basis of, letâs say, 90 people, and Iâd say, we are up to about 125, 130. Thatâs in areas of IT, which we are driving center led in a number of areas. Itâs in a team of continuous improvement in engineering professionals that number about 12 and itâs a team of corporate staff procurement people of about eight, none of which existed in the corporate payroll three years or four years ago. So your SG&A expense, I think, adjusted was up, a little bit more than 10% this quarter versus a 9% increase in sales and it sounds like volumes are not growing or not as strong as you expected. Is there anything you are going to do to reduce your SG&A levels and get them below your rate of sales growth? Sure. We look at SG&A levels across all our businesses on a regular basis. Some of the SG&A increases are along the lines of what Rusty talked about in terms of wage increases. Itâs been a challenging not -- for everybody a challenging employment environment and so inflation is not only raw material and raw material inflation is stabilizing and coming down, but wage inflation is here and itâs here to stay. So thatâs part of it. The other issue is a return to, I donât know that we will ever get back to pre-COVID levels of travel and entertainment, but we are certainly getting back to more ordinary levels of investment in those categories than what we experienced during the COVID period, because they were damn near zero and that includes in-person sales meetings, traveling to customers and getting our people on site in front of customers more aggressively than we did, letâs say, 12 months or 18 months ago. Yes. Good morning. Frank, just to extend the discussion on the monthly cadence and the concept of destocking, have you seen any customers following the closure of the calendar year end books that have become more liberal and their orders more willing to resume a more normal cadence of purchasing? And if so, where might you be seeing that, it didnât sound as though thatâs very prevalent from your remarks? Yeah. I think that our third quarter is probably the wrong period of time, especially this quarter to be able to answer that question. Europe is the biggest driver of the deteriorating performance. And again, if you follow my comments, the world is not ending for RPM by any way, shape or form. I talked about in Q2, regionally, Europe was down 11% and given price increases, you can assume that unit volume was down more and then EBIT was off 50% in Europe. Gives you a sense of the strength of RPM anywhere else. We are seeing the weakness that we talked about. And Kevin, itâs too soon for us to be able to say how much of it was weather related, how much of it is inventory driven shutdowns and OEM customers versus how much of it is full on recession. And so, I donât think we can answer that question today with any certainty. If you want to ask that our April call, I think, we would be in a much better position to have some clarity around that question. Okay. Fair enough. And I just had maybe a couple of quick housekeeping ones. First, did you give a MAP savings number for the quarter or if not, would you comment on that? And then second, I wanted to ask about some verbiage in your press release. I think it mentioned some unfavorable mix and fixed cost leverage at Corsicana, in particular and just wondering if you could elaborate on those dynamics. Sure. The fixed cost leverage both at Corsicana, which is serving Consumer and some of our Construction Products businesses, also Carboline in terms of alkyd resins. Itâs not just Corsicana, itâs knocking off some weekend activity in plants or knocking off a shift to try and make inventory adjustments. That basically to slow down production so that we can get our inventory back in line and so the overhead absorption hit as a result of that, itâs going to negatively impact Q3. I donât recall the other... Yeah. We -- I think we have commented the conclusion of not providing MAP savings every quarter. Our target is $120 million for fiscal 2023, which we are comfortable in hitting. I think we have disclosed, Rusty or Matt, what have we disclosed year-to-date in the prior -- in the first quarter? $30 million -- yeah. $30 million in the first quarter. So I think you can extrapolate that across the quarter, particularly as it relates to understanding since most of this is being driven at the gross profit level. It will -- that $120 million will flow around that basis in proportion to our revenue growth by quarter. If you think about the current environment and you have a lot of EBIT growth anchored with the MAP program going forward, if it started to stay this way for a while, is it challenging to grow EBIT even with the MAPs program and maybe another way to look at it is, what do you think needs to happen in the external environment to get back to the growth that you were showing prior to the third quarter? So a couple of things. I think we need to be effective in the sales and marketing and promotion activities that we expect to generate consumer and we are excited about that in the spring. So you will see some new product rollouts, and again, a higher level of advertising and promotion, because we have gotten ourselves back to the point of being able to supply on a very high level efficient basis. And I think we have a number of growth initiatives around Nudura. Thatâs just -- thatâs a business that grew from $40 million to $100 million. Itâs a big. Itâs got a disproportionate amount of that work in residential. We have a lot of work to do to get that specified into commercial markets, particularly schools and other areas and we are working on that and the economic circumstances are not going to change that focus. So we have a number of exciting areas for us that we are going to continue to invest in, notwithstanding whatâs going on with the economy. Broadly speaking, Mike, we have got to see the Fed quit raising interest rates and we have got to see some stability in housing and things like that. And so those are the macro issues that are not only affecting us, but I think they are affecting everybody and so thatâs -- I guess thatâs the best answer I would have. We -- to an earlier question, we manage our SG&A unit-by-unit. We will continue to do that where appropriate. But we are not in a position where we see any need to come out with any broad based expense reduction program. We are still focused on executing our MAP program and selectively investing aggressively in a number of growth initiatives. Good morning. Just two quick ones for me. Frank, I just wanted to clarify, you -- the $40 million of market share in spray paint and wood stains. Did you gain that or did you lose that? I just didnât follow it. We have lost that over the last 12 months and I think thatâs in relationship to, it wasnât unique to us, but the challenges that we faced in meeting demand because of supply disruptions. And so that was a between spray paint, where we have had a bare gain, a modest amount of spray paint in Home Depot and also some wood stains and finishes, about $30 million or $40 million of market share loss and I believe thatâs over. Okay. Thank you. And then, Rusty, you mentioned increasing marketing ad spend and I just wanted to clarify whether that was an actual increase versus, say, 2019 levels or whether itâs a just sort of normalization, because you took it down when you didnât have sufficient raw materials to actually make the product. So why would you advertise? So can you just clarify whatâs going on there? Yeah. This is Frank. Itâs a little bit of both. It will be up year-over-year just because we didnât spend a lot in the face of the supply chain challenges. But we are working to get back to normal levels pretty quickly and we have got some exciting new product introductions that we will talk about in the spring. And we have some exciting new products, we have some new market share opportunities and we have our operations in a position to lean in hard to support all of that. So we are going to get back to an advertising and promotion level thatâs more consistent with the past and there will be necessary to support that growth. Okay. Is there any quantification of that just in terms of, I assume that will fall into SG&A as well or is that already in there⦠That -- it falls in SG&A and we will be in a better position to provide details on that in April. Great. Good morning, Frank. Happy New Year. Thanks for taking my question. A lot of my questions have been answered, but I think maybe I will try this in a slightly different way. So, it sounded like the Construction Products sales cadence really slowed down in November, December and it sounded like, I donât know if that was surprising. So would you say that we are still in early innings of this slowdown and you noted that maybe it will take six months to nine months for inventories to be worked off. Is that kind of how you feel about the demand trends as well and maybe you can just comment on if thatâs the case for some of your other businesses as well? Thanks. Sure. So, at some point, we are going to be rounding easier comps in Europe, because Europe, we have been talking about since last spring has been deteriorating. And so I donât -- we are not in early innings there at all, we are in the teeth of a pretty good recession in demand destruction. And so, I think, boy, six months from now, nine months from now, at the very least, we will be stabilizing and moving in the right direction there. Part of that is geopolitical circumstantial in terms of the Russian war in Ukraine, in terms of energy markets in Europe and those things. The one area, and again, itâs about $300 million, about $200 million in Construction Products and $100 million in Consumer, is our exposure to residential, new construction. And I wouldnât say it surprised us, but data has slowed down significantly and profitable business there. And I think you need to see stabilization of what the Fed is doing on interest rates before you are going to see stabilization both in the new home construction space and better housing turnover, which also drives a nice chunk of our [Audio Gap] ⦠potentially sluggish demand trends and destocking thatâs going on, do you expect to give back some of the price initiatives that you have achieved in a little bit more rapid fashion? How do you kind of plan to maintain the margin trajectory and recovery that you kind of had hoped for and experienced through the last couple of years? Is there -- are there other measures other than pricing like mix or anything else that we should think about or, yeah, how do you plan to keep some of that margin recovery? Sure. In the past cycles, we have been able to maintain the vast majority of the price increases that we have initiated and we would expect to do exactly the same thing here. If you look at our performance in past commodity cycles, on the down cycle we should pick up $100 million to $200 million of margin benefit and we are working hard to do that and we intend to do it. And as I said, even Consumer with the very strong recoveries are showing there, and certainly, some of that is price driven, while the year-over-year performance is really strong. We are not yet back at record margins and we intend to get there through a combination of maintaining price where itâs appropriate and the benefits of the MAP 2025 program. And this will conclude our question-and-answer session. Iâd like to turn the conference back over to Frank Sullivan for any closing remarks. Thank you, Cole. Thanks to all of you for your participation in our investor call today. We are pleased with our second quarter results, which reflect the resiliency of our balanced business model and the extraordinary efforts of our associates around the globe. We are carefully monitoring early signs of economic slowing, but are confident in our ability to manage effectively through the entire business cycle. We look forward to providing you with details of our results in April. We will have a much better sense of where we are headed in terms of what seems to be an exciting opportunity for continuing growth in our Consumer Group and Performance Coatings Group, and hopefully, some improving performance out of Construction Products and Specialty Products as well.
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EarningCall_1609
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Thank you for standing by. This is the conference operator. Welcome to the Fiscal Fourth Quarter and Unaudited Full Year 2022 Results Conference Call for Quip Home Medical Corp. [Operator Instructions] We remind you that remarks today will include forward-looking statements that are subject to important risks and uncertainties. For more information on these risks and uncertainties, please see the reader advisory at the bottom of the company's results news release. The company's actual performance could differ materially from these statements. Thank you, operator, and thank you all for joining us today on the call. My name is Greg Crawford, and I'm the Chairman and Chief Executive Officer of Quipt Home Medical. Joining me today is Hardik Mehta, our Chief Financial Officer. I want to start by thanking the more than 900 Quipt team members for their ongoing commitment to delivering first-rate patient care in order to enhance the quality of life for each and every patient we serve. We are able to successfully run a patient-centric ecosystem across the entire company by collaborating with our key sales touch points, which include health care providers like hospitals, doctors, rehab centers and long-term care facilities. Our ability to harness the technology platforms we have established over the past few years, along with our specialized clinical respiratory programs, has made it possible for us to efficiently treat patients at home in a way that best meets their needs with the ability to monitor patients in greater numbers, reduce organizational redundancy and lower overall health care costs. The high touch service model we employ geared towards enhancing the quality of life for all of our patients is what distinguishes Quipt in the market. As we carried out our strategic growth plan and future vision, fiscal 2022 has been another active and successful year for Quipt, which included 37% year-over-year revenue growth and continued strong margin stability. For us, it goes without saying that offering a full range of end-to-end respiratory solutions is essential to maintaining our success and a significant growth factor in our key markets. Our objective to grow from a regional to a national at-home respiratory care provider is well underway. And as we enter 2023, we are very enthusiastic about all of our progress. Above all, our primary goal continues to be to provide the best possible treatment to over 200,000 patients that currently make up our patient ecosystem. As we move towards a post-pandemic environment, we have placed a renewed emphasis on growing our sales team, and we are making meaningful progress with this initiative. During the peak of the pandemic, our sales activities were restricted by access restrictions in the health care settings. We can now interact with our main sales touch points more actively, which we anticipate will fuel organic growth in the future. To that end, we are concentrated on regions with a high prevalence of COPD focusing on hospitals with high readmission rates with the aim of obtaining patients sooner in their illness stage, which is a key factor to our overall growth plans. With a focus on our record-breaking fourth quarter and full year fiscal 2022 performance on this call, I will update you on the regulatory landscape, which continues to be the best in over a decade and the current supply chain environment and our core business, which continues to be strong. We are operating in an extremely bullish regulatory environment, which was most recently evidenced by the Medicare fee schedule adjustments resulting in a significant CPI increase for DME providers for calendar 2023 of 6.4% to 9.1%. The percentage depends on whether products serviced our competitive bidding program items or in former competitive bidding areas. This CPI adjustment is extremely meaningful for us in 2023 as we have seen margins stabilize and believe peak inflation has already run through our business to date. As a result, we believe that the CPI increase will have a materially favorable effect on our net income in calendar 2023. Moreover, starting in 2023, CMS has eased restrictions for home oxygen therapy by discontinuing the long-standing requirement for patients to obtain certificates of medical necessities, relieving the administrative burden for health care providers and providing better accessibility to patients. Additionally, access has been open for patients who visit the emergency room setting and patients diagnosed with either chronic or acute respiratory conditions will now have coverage for home oxygen therapy. These changes are all excellent for our company. Finally, the underlying positive regulatory environment is anchored by the decision CMS has made to cancel the 2021 competitive bidding program for 13 product categories. The cancellation of this program has provided us with a clear margin outlook across our product mix and ensured our patient stability for the foreseeable future. We are glad to see these ongoing favorable regulatory improvements because the need for the home medical industry has never been greater. Turning to the supply chain environment. We expect to see major improvement in calendar 2023, with the expectation that exiting calendar Q1, we will be back to pre-pandemic supply levels. We saw steady and timely inventory allocations of sleep devices through fiscal Q4 and in real-time in fiscal Q1 and continue to drive patient setups. This real-time development is anticipated to be a powerful tailwind and to significantly contribute to our organic growth in the upcoming year. Looking at the financial performance for our business, our team of operators once again delivered exceptional results, in particular, the robust margin profile maintained during this period of high inflation. In fiscal Q4, we saw revenue of $40.1 million, putting us on a run rate of over $160 million and bringing our total to $139.9 million for fiscal 2022. Once again, a 37% increase over fiscal 2021. We saw healthy operating cash flow, consistent bad debt expense, and our adjusted EBITDA margin was very strong at 20.9% for fiscal 2022 and 21% for fiscal Q4. This performance exemplifies our ability to aggressively scale and increase revenue through strategic acquisitions without compromising our billing capabilities and overall margin profile. The infrastructure we currently have in place offers us the freedom to add locations to our platform as well as successfully integrate assets that have been purchased. Our strong team is focused on our continued growth and enables us to seize opportunities across all of our product categories and markets. We have once again had robust growth throughout the year, focusing on the effective use of technology, streamlining workflow procedures to increase operating effectiveness and expanding our comprehensive resupply program, all of which continue to produce reliable results. We have several opportunities to increase our geographic presence into appealing areas during 2023, thanks to our financial flexibility, operational resilience and the best regulatory environment we've experienced in well over a decade. In summary, Quipt has had an extraordinary year reaching nearly $140 million in revenue, achieving over $29 million in adjusted EBITDA, growing to 94 locations in 19 states and surpassing 200,000 active patients, all while maintaining our impressive operating margins. As we prepare for another year ahead, we continue to be excited about what we have achieved to date and what the future holds, all while continuing to be laser-focused on increasing shareholder value. With that commentary, I'd like to hand the call over to Hardik to discuss our fourth quarter and full year fiscal 2022 financial results. Thanks, Greg. Here are some key highlights. Through the company's continued use of technology and centralized intake processes, respiratory resupply setups and/or deliveries increased to 231,495 for the year ended September 30, 2022, compared to 158,072 for the year ended September 30, 2021, an increase of 46.4%. The company's customer base increased 23% year-over-year to 173,203 unique patients served in fiscal year 2022 from 140,996 unique patients in fiscal year 2021. Compared to 364,367 unique setups deliveries in fiscal year 2021, the company completed 516,328 unique setups or deliveries in fiscal year 2022, an increase of 41.7%. Revenue for fiscal year 2022 was $139.9 million compared to $102.4 million for fiscal year 2021, representing a 36.7% increase in revenue year-over-year. Recurring revenue as of fiscal year 2022 continues to be strong and exceeds 77% of total revenue. Adjusted EBITDA for fiscal year 2022 was $29.2 million at 20.9% margin compared to adjusted EBITDA for fiscal year 2021 of $21.4 million, representing a 36.5% increase year-over-year. Net income for fiscal year 2022 was $4.8 million or positive $0.13 per fully diluted share compared to net income for fiscal year 2021 of a loss of $6.2 million or negative $0.20 per fully diluted share. Revenue for Q4 2022 was $40.1 million compared to $29.1 million for Q4 2021, representing a 37.8% increase in revenue year-over-year. Adjusted EBITDA for Q4 2022 was $8.4 million, at 21% margin compared to $5.5 million for Q4 2021, representing a 54% increase. Adjusted EBITDA margin continues to be strong and in the midst of inflationary operating environment. Cash flow from continuing operations was $26.3 million for the year ended September 30, 2022, compared to $17.8 million for the year ended September 30, 2021. For fiscal year 2022, bad debt expense was at 8.7%. This exemplifies our ability to scale and add more revenue through add-on acquisitions without compromising our billing capabilities. Operating expense for the year ending September 2022 was 46.6% compared to 43.8% the corresponding period in 2021. The company reported $8.5 million of cash on hand and total credit ability of $96.5 million as of September 30, 2022, with $11.5 million available towards the line of credit and $85 million available on [indiscernible] . Current assets totaled more than $41.5 million compared to $41.7 million in net short-term liabilities. We take pride in the ongoing execution that is evident in the strength of our fourth quarter and full year fiscal 2022 performance. For our fiscal fourth quarter and fiscal full year, we have revenue of $40.1 million and $139.9 million, respectively. Full year adjusted EBITDA margins were also very strong at 20.9%, given the present inflationary environments and the acquisitions made in fiscal 2022 that created a short-term lag to margin, we are very pleased with the margin stability and expect margins to improve further as calendar 2023 progresses. Additionally, we believe that the recent CPI adjustment announced will have a meaningful positive impact on our net income in calendar 2023. Through fiscal 2022, we have significantly improved our organizational capabilities, which includes any fantastic new team members across key areas of the business. The ongoing operating results are very encouraging, and we believe we have created a strategy that regularly and successfully promotes growth. Our recurring revenue base has stayed tremendously robust at 77% of our overall revenue base, which gives us additional security and consistency as it relates to our financial reporting. The scale we are gaining combined with the powerful tailwinds, such as an increase in the number of Americans with various chronic illness and aging U.S. population and the need for health care to be provided and monitored in the home continues to enable us to produce consistently solid financial results. From an M&A perspective, during calendar 2022, we successfully completed 5 acquisitions and in the fiscal fourth quarter added Hometown Medical, which greatly enhanced our presence in the attractive state of Mississippi. The 5 acquisitions in calendar 2022 added over 45,000 active patients, $35 million in revenue and over $7 million in additional adjusted EBITDA once integration is completed, which are all currently on schedule. On September 19, we announced the closing of $110 million in senior secured credit facilities with CIT Bank, a division of First Citizens Bank and Trust Company. The senior secured credit facilities are comprised of a term loan facility in an aggregate principal amount of $5 million, a delayed draw term loan facility in an aggregate principal amount of $85 million and a revolving credit facility in an aggregate principal amount of $20 million. The senior credit sales as another validation of our business strategy. In spite of rising inflation and supply chain constraints, our operational resilience has allowed us to maintain trend in our cash flow, margins and revenue base. As we approach 2023 with ample financial resources, we are well positioned to continue to implement our growth and acquisition strategy and increase shareholder value. As we work towards our long-term objective of becoming a national provider of home health care in the United States, we continue to adhere to our strict criteria along with our integration processes, which has been the catalyst of our consistent revenue growth of over 35% displayed on an annual basis. As a health care organization with the concentration on respiratory treatment, we feel well insulated from any potential economic challenges given the nature of our business and sector. As Greg mentioned, our current acquisition pipeline and enhanced balance sheet provides us significant opportunity, and we anticipate being active as we move into 2023. Thanks, Hardik. Quipt is actively expanding across the country, completing hundreds of thousands of deliveries to more than 200,000 active patients with over 21,000 referring physicians across 19 states. In terms of revenue, we estimate Quipt is presently the fifth largest HME supplier in the United States. This gives us the scale and opportunity to find ways to grow our patient base and penetrate attractive markets while continuing to streamline our operational platform. By carrying out the crucial elements of our growth strategy, such as making attractive acquisitions, investing in future organic growth development and expanding our health care network across the nation, we anticipate continued momentum going into 2023. A major milestone achieved was the nationwide insurance contract from UnitedHealthcare, the biggest health care insurer in the country. As we continue on our aggressive growth strategy, this arrangement with UnitedHealth has greatly increased patient accessibility. With regard to securing additional national insurance contracts in early 2023, we have a high degree of confidence, and we will keep collaborating with sizable commercial payers to help them comprehend the advantages of our robust patient-centric strategy for both patients and payers. We have the opportunity to take a land-and-expand approach to future growth, thanks to our valued commercial insurance contracts and robust physician referral network and sizable patient base we have amassed. As we can see from the existing landscape, a substantial effort is being made to ensure that a patient is treated in a home care setting wherever possible. As a result, we will continue to focus on ascertaining the best ways to develop our connection with referral sources, which will continue to benefit our organization. Whether it is through the continuous usage of our automated ordering systems, revenue cycle management or through our automated subscription-based resupply program, we continue to invest in technology to increase our operating efficiencies. These efforts help the business create long-term value, enable us to keep raising productivity levels. Furthermore, investments in our scalable connected healthcare platform fuel cash generation, targeted margin expansion, accretive acquisitions and organic sales growth. And additionally, this helps promote compliance enhances results and increases patient engagement. Additionally, we may encourage early treatments, lower hospital stays and track the effectiveness of treatment plans, all of which are advantageous to payers. I would now like to review with you the 3 components of our core growth strategy as we move into 2023. First, through our initiatives for organic growth, we are completely focused on increasing market share in a way that is both profitable and economically sound. This includes growing our sales team, which is how Quipt reaches important touch points like hospitals, doctors offices and rehabilitation facilities. Extending patient accessibility by signing additional national insurance contracts with significant payers in the U.S., expanding into synergistic product categories, providing numerous cross-selling opportunities across our existing and future patient population, considering opening brand-new locations to supplement the current infrastructure in all of our markets. Second, we will look to continue to deploy technology across the business to enhance operating results. This includes our robust respiratory resupply platform, which keeps us on the forefront of the market in terms of technology implementation and offers us excellent revenue synergies on the acquisition front. Strategic acquisitions make up a third element of our growth plan. We are searching for turnkey respiratory businesses that can easily be incorporated into our scalable platform. We are concentrating on economically building scale with the strategic objective of diversifying our payer base and growing our geographic reach into both new and existing states. We have the financial flexibility to execute on our acquisition pipeline, which should provide us with ample opportunities to continue to grow revenue, EBITDA, our patient base and overall geographic reach, we expect to be active in 2023. Thanks to the reintroduction of in-person investor road shows and conferences, the company has been active in the capital markets front in 2022. This has been the first opportunity for U.S. investors to interact in person since the NASDAQ listing in May of 2021. Our amazing story has only just begun to be told, and we see many opportunities to broaden the caliber and geographic diversity of our shareholder base. We have already seen our institutional shareholder base increase as well as our overall U.S. ownership throughout 2022. As a health care organization with a concentration on respiratory treatment, we feel well insulated from any potential economic challenges given the nature of our business and sector. As we move into 2023, we will continue participating in important conferences and taking part in investor road shows. As of fiscal Q4, we set at over $160 million in run rate revenue and over $33 million in run rate adjusted EBITDA, we are very confident in our aggressive growth trajectory as we move into 2023 and look forward to updating investors on our successful progress. When I consider how our business has developed, I am incredibly proud of the entire team for their perseverance and commitment to going above and beyond. The outcomes are the direct results of those efforts. We are continuing to strategically position the company for continuous strong growth. And given the industry's bullish landscape, we must continue to be proactive in seizing the numerous possibilities that are currently available to us. We have all the tools necessary to carry out our aggressive expansion strategy, thanks to our operational excellence and our pristine balance sheet, which includes or $110 million in senior credit facilities. We are extremely optimistic about what the future holds for Quipt in our more than 200,000 patients we care for. Once again, I would like to take the moment to thank the entire Quipt team for its tireless efforts and its stakeholders for all of their continued support. Thanks for the very comprehensive uptick, Greg and Hardik. When I look out into 2023 across your various products, can you give us a sort of outlook by category, say, between oxygen, CPAP and events where you see growth like is one more than the other? Or just a bit more color on the growth of each of the products? Thanks, Doug. That stayed pretty steady for us in that -- actually, over the past several years in that with that product mix in that, and we would continue to expect that in that to stay on that kind of 80% respiratory side and the other 20% being kind of other invert DME supplies and things like that and other supplies as a total percentage of revenue, although we are starting to look at different product categories that can complement in that those -- and help those other respiratory patients that we do have. But I don't think there'll be any big swing in that as a percentage of revenue in 2023. Okay. Hometown Medical closed, I guess, early July, and you almost got a full quarter contribution, I guess, from that in the quarter. Is there any -- are all the acquisitions, say, from access to NORCAL, you could maybe -- are all of them fully integrated now? Or do you anticipate any more cost savings along the line? Yes, that's a very good question in that. I'll say we're winding down in that the complete integration of those and looking out into '23 and that especially with the CPI increases that have came out. And then we also believe that peak inflation that is likely run through the business should we kind of stay the same on that front in that, that there could likely be some pickup in the margin as we complete the full integration of those acquired businesses, especially the ones that were kind of towards that, we'll say, June, July time frame. Okay. And last one for me. Just that you talked about your growth -- the three-pronged growth strategy, increasing the sales team, to add more to the sales team. Can you quantify that? And are you looking to grow the sales team by 10% kind of thing? Or what -- maybe just give more color on that? Yes, sure. That's been something that has -- frankly, has been a little bit of a struggle for us just through the pandemic and everything and really the access points in that more than anything, we'll be able to make those call points. But we've consistently seen that open up and that to where they've been able to have face-to-face meetings and presentations in that. So we would expect this year in that to and increase that 50%, and that would kind of be the bar -- the low part of the bar on that. We're well on our way to get that done in that. We've consistently been adding additional reps. It does take some time to get them ramped up and that to where they're really contributing in that 6-month-plus or so. So we're pretty excited about '23. Congrats on the rep growth this year. So I just wanted to check in on the guidance of $180 million top line by the end of calendar year, given that we've seen how much in July, partial contribution. How is the company tracking towards that guidance? Yes, sure. So that was some guidance that was given on exiting in that our fiscal Q1 '23 number here in that, which is the calendar in that. So I'll say we do have a little, ways to go. We haven't reported those numbers yet, and that will be in February. It's hard for us in that to predict the timing in that of some of these acquisitions in order to kind of give out in that exactly when that's going to happen, but we do have a very high confidence level in being able to meet that outlook. Okay, great. And if you don't mind if I just drill a little bit further. So in order to meet that outlook, you probably need to be adding about $20 million in annualized or just less than over Q1 towards the end of the calendar year. And so even if we estimate sort of smaller acquisitions, that's around 4-ish. So could you maybe give us a sense, even though timing is a little less unpredictable, how we should be thinking about the number of acquisitions in order to get that -- hit that target and sort of the general sort of size of those acquisitions to hit that target? Yes. Well, we continue to remain focused on all three prongs in that of our acquisition strategy in that. So with the smaller sized companies, say, 5 million are under and then also kind of those key -- turnkey respiratory in that, that would be in that $5 million to $20 million and then also in that continue probing through additional larger acquisitions. So it's really hard to kind of give what's going to make it to the finish line with that timing and that on those particular acquisitions, whether it's 1 or it's 3 and that to kind of get us there. Okay, that's helpful. And then as we look forward into 2023, or calendar 2023, given sort of the rising rate environment, given sort of the compression on multiples more generally out there, how are you seeing pricing of deals in your pipeline? Are they static? Or do you find that there is -- you're able to pick up assets at slightly cheaper prices given the current environment? Yes. Sorry about the pause of silence in that, I believe, Hardik, in that was answering that question, but having -- Sorry to hold. This is Hardik. My bad, I probably had been mute somewhere. I guess my response was going into 2023, we certainly believe that some of the reasons that you just explained would contribute into some kind of adjustments mostly in the favor of a buyer. The magnitude of that is kind of skilled GBD. Generally, we are seeing markets having a slightly lower multiples than what it used to be 3, 4, 5 months ago. But again, from the ones that we are actively working on, they are kind of in the pipeline, but the newer ones, we do expect it to be in favor of a buyer, can't speak to the magnitude of it just yet. On the sleep device backlog, I think you mentioned in your prepared remarks that your -- the supply levels are approaching pre-pandemic levels. Are you able to quantify where that backlog sits today? Yes. As far as the backlog in that, we're not monitoring it quite like we were before in that because it -- the supply chain in that has drastically improved for us really in real time in that as we're in our fiscal Q1 here, and we expect that to continue into '23, if not, even -- some items even become off of allocation and that, that we're able to order in that. So we've just been laser-focused here and that as we've gotten towards calendar year-end in that towards setups rather than looking at what the backlog is. Understood. Okay. So we could still see that kind of bubble of increased volume as that backlog has been alleviated in fiscal Q1? We are seeing an increase in the amount of setups in that -- during this quarter due to availability of inventory. Yes. Just to make sure I heard this correctly, what's the question, what was the organic growth for the quarter versus Q3? Yes. So frankly, the organic growth was pretty flat from Q3 to Q4 specifically with the addition of hometown, if you factor that in, I think organic growth was pretty flat. Okay. And then lastly, on the labor side of things, I know you mentioned that you're starting to grow your sales team a little bit. But even when it comes to the other qualified members of your labor base, what have you seen in terms of wage inflation in the last few months? Yes. We've seen it stay pretty steady in that. And I think a good way to gauge that and that for us is really look at how efficient has the organization became and look at that labor as a percentage of revenue in that, which is stayed in relatively in the same range really that it has. But we're truly -- we are seeing significant increases in salaries. There's no question about that. But at the same time, in that our talent pools got much better. So we've been able to create a lot of efficiencies throughout the organization and that have really kind of helped with the overall labor expense. Just calling in for Chelsea. Just a couple of quick ones from me. In regards -- just a follow-up to Tanya's question about the sleep devices. What's the status of any like updates for the sleep device? Is there any like implementation of like new sleep devices once this current backlog eventually clears? I'm just kind of wondering about that. As Greg mentioned earlier, right, we are seeing some influx of how fresh inventory coming in. We are also getting indications from our suppliers that as we go into Q2 2023 or calendar Q1, some of the restrictions that were in place, even those restriction have reduced over the last couple of quarters, but even whatever the minimum restrictions they still have in place or allocations they have in place, which should be fully lifted by end of calendar Q1. So that said, we really don't -- based on our market intelligence and the communications we are having with our vendors, we believe that by end of Q1, calendar Q1, there shouldn't be any shortage as far as devices are concerned. All right. And my last question is, is your company going to provide like a run rate guidance for calendar year 2023? No, I think at this point, we would not, but maybe sometimes later in the year and there are a few things in the pipeline that we are not at liberty to discuss at this point. But maybe once we have those all materialized or got to the finish line one way or the other, maybe that would be a good point of time where we would discuss some guidance. I wanted to just in on organic growth for a minute. I wanted to just see if you could help us understand the trend in 4Q and then a little bit more. And then with the various components that you mentioned that will add to organic growth in the current fiscal year. If you could help frame that in some way, I'm not sure if [indiscernible] want to talk about the kind of level of growth you think is possible with these various factors, but that would be great. Sure. So maybe I'll refrain from [indiscernible] some of the things, but I'm glad you asked that question because I thought I probably didn't do it justice to my response to Tania's question. If you go back in time and look over the last 4 quarters or last 6 quarters, specifically how the recall took place and the device shortages started affecting, there is a casketing effect of those things, right, from review setups to eventually a tax setting effect of the recurring increase of that business, which is resupplies that you put in place in every 3 months. And I think what you see here in the last Q3, Q4 time frame is us kind of hitting that bottom from that casketing effect. And I think from what we are looking at in terms of fiscal Q1 '23 and going forward, now we are going into the reversal of that casketing effect where you would now see not only the device setups are increasing, but then as you go into the next few quarters, 3, 4 of 2023 and going into Q1 of 2024 as well, we will start seeing the -- again, the good casketing impact of new setups with increased recurring supply that continues to grow and you see the full impact of that about at least 5 quarters out is when you kind of max it out, right, in terms of recovery you got from the additional setups that we are going to do starting this quarter. So I think that kind of explains why Q3 and include in Q4, the expected organic growth or where not a thing compared to our historical standards. So again, glad for asking that question because I think I should have included that as a response to Tanya's question. I think going into 2023, certainly, there should be some increased tailwinds as a result of what I just explained. On top of that, there is a CPI increase as well. You guys all can do the math. Medicare has been a decent percentage, almost 40% of our revenue, 35% to 40% of our revenue. And the weighted average, if you look at the CPI increases from 6.4% to down 9%, so somewhere in between is where we would put a weighted average. So we can all factor in what that organic growth would look like just from a CPI increase plus the additional growth from this availability of devices and the recurring nature of those, we do suddenly expect us to, at a minimum, hit our historical growth rate, which was kind of somewhere between 7% to 10% in the past to hit in 2023, again we hope that we actually see that. But at minimum, we would like to at least go back to where we used to be, which is still substantially higher than the market growth rate of about 4% to 5%. Great. That's great detail. And so -- okay, I suppose you're including the plans on the sales force expansion, [indiscernible] locations, product line expansion. I mean I feel like there's a lot of pieces here that kind of make 7% to 10% very easy bar to get over? Yes, we would feel like that too, frankly speaking, but we obviously don't want to -- if you followed our story, you would obviously try to commit to what we think we can minimally do, but we certainly should further [indiscernible]. We're not obviously forecasting the starts, but I think given the very basis what we think, we can certainly achieve given the tailwinds. This concludes the question-and-answer session. I would like to turn the conference back over to Greg Crawford for any closing remarks. Thank you, operator, and thank you all for your participation today. As always, you can find us on the web at quipthomemedical.com, where we will be posting the transcript of this call on the site, you can also view some of the exciting products and developments discussed on this call. Thank you, and happy holidays to everyone.
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EarningCall_1610
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All right. Perfect. Thanks for joining us for the next session. I'm Matthew Harrison, one of the biotech analysts at Morgan Stanley. Really pleased to have Dan O'Day, the Chairman and CEO at Gilead with us. Just a reminder, personal analyst holding disclosures are available on morganstanley.com/researchdisclosures. I thought maybe a good place to start off is we're sort of, I guess, you're three years into your tenure almost? At almost four years, that's right. And obviously, part of the - when you came in, right, was the transformation of the company, right? You put a lot of capital to work on external assets. So where do you think you are in the transition of the company, sort of you reflect on where you are versus where you're going at this point? Yeah. I think 2022 has been a really important year to see the whole strategy play out in its entirety. And I think we've seen that every quarter this year in terms of both the commercial and clinical execution. But maybe just to take us back when I joined in 2019, I mean, the objective was to take a company that had extraordinary success in virology and obviously broaden beyond virology into new therapeutic areas, which, you know, as we all know, is not an easy thing to do. A lot of companies have tried that. I'm really impressed with what the team has done over the past several years from a couple of standpoints. I mean the first one is having a clear strategy, really understanding where we wanted to expand our scientific innovation, which was basically using our immunology scientific base and virology that we had in virology and expand that to oncology with a real focus on immuno-oncology and also to inflammation. And when I think about what's happened over that period of time, because of that and because of the people we brought in with really some depths of experience in new therapeutic areas, we put around $30 billion of capital to work over the past 2, 2.5 years to build this portfolio that I think is really extraordinary. So we've gone from 30 molecules in development to 60 molecules. But more important than the number is actually kind of the shape of the portfolio and the risk-adjusted nature of the portfolio. So we've got continued strength in virology, and I know we'll talk about that. I mean, HIV is - and the long-acting strategy has really strengthened over that period of time. Certainly, we played a role with COVID, and we'll continue to play a role with COVID. But the oncology franchise, I think, really has some strong unique assets alone and in combination that has tremendous potential. In fact, as of the third quarter, if you look at our run rate on oncology, it would annualize out about $2.5 billion. And that's a really high growth phase, which both cell therapy and Trodelvy now contributing significantly in a high-growth phase. So we have specific goals for our diversification. We want to be 30% or more of our revenue in oncology in 2030 on top of a growing HIV virology base, and we're well on our way to do that. And then the final thing I'll say is I just think the people and culture aspect of the organization is really coming along. It's tough to get the right talent in for new therapeutic areas. And because of the portfolio we've been able to attract just top talent in the industry at all levels: I mean sales and marketing, research, development and within development deeper into things like biostats, clinical operations, regulatory. So we have an organization that can really execute. And I think you're seeing that on a quarter-for-quarter basis now. Okay. Good. And maybe just to follow-up on that, like as we think about 2023, what's on the horizon, what's the biggest focus for you as you think about next year, either from an execution standpoint or a pipeline standpoint? Yeah. I mean both are going to be important. So as I said, we've had really good quarters every quarter this year, and that's going to continue in 2023. I think some highlights as I think through it, let's start with HIV. I mean, lenacapavir for highly treatment-experienced patients, the PDUFA date is in December. We have approval already in Europe for that patient population. I think that's important because that's - first of all, there's a big medical need. It's a small subset of patients, but it's a real medicine with regulatory approval now with big plans as we continue to look at long-acting and prevention and also in treatment. We'll have our oral - just to stick with virology, our oral COVID nucleoside has started now Phase III trials, and we'll see how that plays out, but as an option to remdesivir in the pre-hospital setting. And then in oncology, we have a lot of things coming up here in oncology, continued execution in cell therapy in terms of moving up in second line and execution on clinical trials into the first-line setting. For Trodelvy, we have the PDUFA date for the HR-positive HER2-negative in February this year, which expands significantly beyond our triple-negative breast cancer and bladder cancer into a large patient population for breast cancer for Trodelvy. And then a very comprehensive program in lung cancer. Trodelvy, we have at least five studies there. TIGIT, which you'll see more data on in December 20th and the ability to expand that into three trials ongoing in lung cancer and one in GI cancer. And then just the remainder of the portfolio playing out clinically, we have a lot of milestones next year with magrolimab with other partnered assets like Arcus assets with long-acting partners to Lenacapavir, and the bNAbs in Phase I. It's going to be a really robust data year from a clinical execution perspective. And from a commercial perspective, you should expect to see us continue to drive our growth. Okay, great. Great. I mean, one of the - I guess one of the questions I get a lot is around capital allocation. I guess, there's sort of two parts to that question, which is, do you need to deploy a lot more external capital to continue to build the pipeline? Or is that sort of done at least from a chunky standpoint? How do you think about that versus returning cash to shareholders and priorities in terms of returning cash? So that's done from a chunky standpoint. As I mentioned before, I mean, we put a lot of capital to work. We needed to put that capital to work to jump start and to really build our oncology portfolio. But when I look at our portfolio today across virology, oncology and an early portfolio and inflammation, we have everything we need to make sure we execute now to drive our growth through the end of the decade. We have no patent exposure until the early 2030s. We have more than enough to do with our individual oncology medicines, our pipelines in products like Trodelvy and TIGIT and magrolimab and cell therapy to expand that out. So the capital deployment will be consistent with what we've done in the past from the standpoint of priority. But to your point, much - we don't need these large transactions and we won't - unlikely to do these large transactions, we don't need to do them like we've done in the past. But the order of priority continues to be invest in this portfolio we have and both in R&D and a commercial execution standpoint. Secondly, more ordinary course partnerships and smaller M&A bolt-ons. Thirdly, growing the dividend. It's something we've done for many years now. We want to continue to do that in line with earnings. And then finally, repurchase of shares to offset dilution and to take advantage of share repurchase where appropriate. But it's in that priority order. I would say that we've been able already to return to our leverage position pre-immunomedics now only a couple of years later due to the cash generation of the underlying business, HIV, but also the cash generation of VEKLURY remdesivir during that period of time as well. Yes. Why donât we talk about oncology since top of mind, you've got some stuff coming up? You mentioned TIGIT on December 20th. It's a category where people have seen the initial Roche data right and skepticism had mounted on sort of the target and the meaningfulness of it. I think you, as a company, have maintained a lot of optimism around the target even with the sort of skyscraper data from Roche. So what's your conviction in the target? And what do you - what's your sort of ultimate outlook for that? Well, we look - it will be great to have this conversation when the data is public, and it's not that far away. It's December 20th. I'd point to a couple of things that we've said publicly from a qualitative perspective, and that is that, we believe, from a large Phase II standpoint that this data is clinically meaningful from the standpoint of three specific measures that will provide numbers with on December 20th: one is overall response rate, the other one is medium progression-free survival, and the other one is landmark progression-free survival. And what we said is this is a three-arm study. The comparator arm is a PD-1 our PD-1 with Arcus. And then the other two arms have both PD-1 and TIGIT and then PD-1 TIGIT and adenosine. We said both of those TIGIT arms are clinically meaningful relative to the comparator arm. Look, I think there's a couple of differences from the - first of all, this will be the largest data set that's been exposed on TIGIT to date that you'll see data on. I'll remind you that the previous Phase II trial from Roche was around a 50-patient trial. This is 150 patients. So it's significantly larger, not designed to show statistical significance, but much more robust in terms of the number of patients. And the other thing I would just say is that this is a different molecule at the end of the day. There is so-called Fc-silent TIGITs and there's Fc-enabled TIGITs. There's hypothesis preclinically around the potential advantages of that. And we'll see how that plays out with larger scale trials. But all I can say is back to our conviction on this Phase II data as a signal, we already have three Phase III trials that are either started or to be started soon in lung. You can imagine that we don't make those investments lightly. So we make those investments based upon our conviction on the data and the Phase II data. And it's the first time I think the world will really see the data on Arcus' and Gilead's TIGIT because previously, we've just kind of articulated, this is the fourth interim analysis, but the three previous ones, we've only kind of released qualitative data. So you'll see quantitative data this time and then we'll have the discussion. We remain convicted that TIGIT as a complement to PD-1 provides at least from a Phase II perspective, meaningful benefit. Okay. And then one of the questions I get a lot is, there's obviously significant entrance players in IO, namely KEYTRUDA right as a sort of significant wall of data as a monotherapy at least. So how do you break into that? Like - or I guess another way to say is how much clinical differentiation do you need to be able to move people from one therapy to the other, just given the number of studies and indications that KEYTRUDA has? Yeah. Look, I think that what we're going to need to show because every trial is unique in terms of patient populations and exactly how it's treated. So I think what the world will want to see and what we want to see and why we're terming this clinically meaningful is a difference to a PD-1 comparator arm alone. And at the end of the day, developing that data in large Phase III trials, we have trials that will be targeted towards different patient populations in lung cancer and other disease states like GI malignancies to show that difference. So I think just as KEYTRUDA establish its position based upon data that it compared to largely in chemotherapy in that case, we're going to need to show the add-on benefit. And that's really our goal and objective not only with exposing to the Phase II data, but the design of our Phase III protocols. Trodelvy TROP2, you talked about - you obviously mentioned Immunomedics and that asset. You talked about lung studies, which I think is a focus for investors now. So how do you think about your competitive position in one? Because obviously, there's another TROP2-ADC that's a bit ahead in lung as well. So how do you think about that outlook for lung? And is that an indication you guys are excited about? Yeah. Look, I think I'll start with - I mean, the reason one would have a conviction in another disease state is that you've had some success in previous ones. So I would just remind you that for Trodelvy, we have two different disease states in breast cancer that have shown overall survival. So triple-negative breast cancer in second-line plus. And in hormone receptor positive, HER2-negative in very late lines, right? So this is CDK4/6 plus a median of 3 chemotherapies, we showed significant overall survival in that patient population. So this is an active medicine that has shown overall survival, which is the gold standard, of course, in 2 disease states and good preliminary data in bladder cancer as well. So that gives us conviction. It doesn't mean that every indication will work, but it does mean that you've got a medicine here that is very active. Now in lung cancer, we have a very aggressive program, right? And I think there are two things that I would mention here. One is that we are doing some trials on our own. But in some cases, we've got partners helping us do trials. So for second, third line lung, we have Trodelvy as a monotherapy where there's very few options versus chemo. And then in earlier lines, first-line lung, we have two different trials, 1 PD-L1 positive, 1 PDL negative. And the PD-L1 positive, actually, our partner, Merck, is executing that trial in conjunction with KEYTRUDA. And again, they've seen the same data we've seen and are quite convict [indiscernible] about Trodelvyâs benefit, obviously, to partner with us and execute on that. And the PD-L1 negative, we'll do that with chemotherapy. So there's not only our own internal conviction, but others that have looked at the data. Relative to the competition, first of all, TROP2 is a highly expressed antigen on many, many different tumor types. So I think we're just beginning to scratch the surface of this pipeline in a product, I would say, with breast and lung. I think there are other disease states that we'll also look at. The first thing I'd say is I think there's plenty of room for more than one TROP2 player in these disease states. And we will have different focuses than perhaps the GAZ [ph] in terms of what lines of therapy we go, what order of entry and what combinations we do. So there's plenty of opportunity, I think, for both to succeed. And having said that, I think there's reason to believe that the two molecules are different. They're at least potentially different in their safety profile. We'll see how that plays out. But at least in the data that's been produced so far in multiple disease states, our safety profile has side effects that are largely reversible and manageable. And we'll see how the ADC from Daiichi Sankyo plays out, but they have a higher incidence of interstitial lung disease, and we'll see if that continues to play out in the late-stage trials. But particularly when you're treating lung cancer, one has to be at least thoughtful about the incidence of different side effects that can affect the same organ that you're trying to treat. So I think there's room for both. There's different combinations. There's different approaches, and we'll see if the two molecules, in fact, do significantly discriminate as we go into different disease states. Okay. Outlook, just on the current approved indications and as you add on breast cancer sort of runway where you are, how much upside do you think you can see in the sort of medium term from some of the approved indications? Yeah. Look, I think we're just beginning to really approach the new standard of care in triple-negative breast cancer. We've articulated that in second line plus triple-negative breast cancer. This figure was provided more. I think in the middle of the year, we said we have about one out of every four patients in second line plus. So there's certainly opportunity to grow there. When one looks at the trials we have ongoing in the first-line setting for triple-negative breast cancer, it's roughly the same population in the first-line setting of triple-negative breast cancer as it is in all other lines of therapy. So depending on the outcome of that trial, there's opportunity for growth still in earlier lines of therapy of triple-aged breast cancer and potentially adjuvant, neoadjuvant as well. And then you go over to hormone receptor positive HER2 negative, which is the largest form of breast cancer. 70% of all breast cancers are HR part of HER2 negative. And as I said, our PDUFA date is in February. And in that patient population, there's a variety of opportunities for Trodelvy to be used there. One population that's quite clear relative to the competition is those patients that are IHC zero or have no HER2 status. And that's about 35% of the total hormone receptor positive HER2 negative. And then certainly, TROP2 works across IHC status. So one could imagine then both being a benefit to patients regardless of HER2 status in earlier lines of therapy, whether they've been treated with CDK4 or certain lines of chemo or other therapies. So - and we'll be doing trials to move up into lines of therapy. So I think there's a tremendous amount of growth potential in breast cancer alone. And then obviously, lung cancer is many fold higher than the breast cancer opportunity, plus bladder plus GI cancers. So we are just scratching the surface, I think, of Trodelvy. Beyond your question on the growth rate, too, I mean, I'd just remind you, in our cell therapy business, we're also in the early stages of really penetrating that only about - in the third-line setting of LBCL only around four out of 10 patients get referred for cell therapy today of what two out of 10 actually get the therapy. So there's lots of growth potential also with our cell therapy business and not only a third line lighting setting, but the second-line setting. So these are all really near-term growth drivers as we think about 2023, 2024. And then we really start to blossom in 2025 with these other lung cancer and other things reading out and expanding the Trodelvy and the general oncology opportunity off of a very strong durable HIV business, which we haven't talked about. Right now, in fact. Maybe we should just talk about PrEP briefly. Obviously, sort of no branded competition, at least foreseeable brand and competition in PrEP. You have a clear strategy with lenacapavir. You have a further runway on Descovy now in PrEP. Sort of where are you in PrEP and sort of what's the - what's your goal for PrEP in terms of size of that business? Yeah. PrEP is a really interesting opportunity. I think one that could really change the epidemiology of this disease over the mid to longer term. Because today, PrEP medicine are very effective. I mean they're 99% effective at preventing HIV. And yet still, to this day, in the U.S., which is the largest market PrEP in the world, only around 25% of people that could benefit from taking PrEP or taking PrEP. And largely, when we talk to those people that are at risk, they say, you know what, I'm not sick. I'm not really interested in taking an oral daily medicine. But if there were other types of options, if I could go for a longer-term option, I'd be very interested in taking those medicines. So lenacapavir, by the way, is an extraordinarily unique molecule. It's the best of Gilead chemistry and knowledge around HIV coming together. It is a molecule that has a really unique PK profile in that it can be dosed every 6 months subcutaneously. That's actually what it's approved for in Europe for the highly treatment-experienced patients and in treatment and also to be soon, hopefully, in the United States. So what that does for the PrEP market because it provides an option that is sorely needed for patients that are at risk of HIV. And we believe that we can - and we should be launching this around 2025, presuming success with the 2 late-stage trials, which is - we feel pretty good about. We think we can move that market in the U.S. alone from around 25% and potentially doubling that over the course of 2025 to 2030. And we can tap into markets that have yet to kind of pick up on PrEP around the globe, including our commitment to the developing world. So we think this is a significant growth opportunity for our HIV business in 2025 and beyond. I'll just comment quickly on what's the status of the current PrEP market post-pandemic. Descovy is our branded medicine, Truvada is generic. But Descovy continues to do well. We've seen the market grow by around 9% coming out of the pandemic. And Descovy, despite generic Truvada continues to maintain around a 40% share. So 40% share in a genericized market is really pretty good. So - and I think important to note that the TAF litigation that we settled a couple of months ago, provides us runway on that from what was initially 2025, Descovy and other medicines that are based upon that backbone until early 2031, 2032, which provides even more certainty and conviction around our ability to grow the entirety of the business, but certainly the prevention part of the business because we no longer have to worry about transitioning all of Descovy in 2025. That can still be our base business through 2030 while we're building the lenacapavir base. It also has an impact on treatment as well. And then I guess on treatment, obviously, a bunch of combinations you're looking at with lenacapavir, - maybe just a 2-part question. One is what's your conviction that you will - out of those, you will have something that you can transition Biktarvy or other patients to and sort of keep that base business going past the early 2030s. And then second, I don't know, just describe for people why you've chosen different strategies, whether it's a weekly strategy or a longer-term strategy. And there's a lot of things that you're exploring there? Yeah. So the answer is it's very high. And it's very high for a number of reasons, not because I'm not aware of the attrition rate in the industry, but more because there's lots of ways to win. And I think you're getting at that, which is, as I said before, lenacapavir is a very unique molecule in terms of its PK profile and dosing frequency. But lenacapavir is not only a medicine that could be dosed every 6 months alone in prevention. But it's also a medicine that has a range of possibilities, including oral weekly oral monthly subcutaneous 3 months or subcutaneous 6 months. So as we consider partner molecules, of which we have 8 now in-house that are going into Phase I, 2 of which you'll get more information on next year that are in the so-called bnAb class, but there are other classes like NC classes. And the real question will be what is the best partner for lenacapavir for the particular treatment duration that we're looking for. And to your question, how do we know what the right treatment duration is while we've done a lot of research. I mean, we speak with both people that are on HIV treatment right now. And what they tell us is, first of all, a lot of people are very comfortable taking 1 pill once a day. I mean, it's an extraordinary advancement over 30 years to think that you could take 1 pill once a day, keep your disease undetectable and die from something else other than HIV because of the control of the disease. So that's a huge advance.\ And many people like the convenience and like, frankly, they feel good about taking a pill 1 pill once a day. But we also know that there's probably 50% or more, and we'll - obviously, when you have reality that would really like to take it less frequently. And what do they mean by less frequently. They don't mean - I mean for them, if it's an oral medicine, I think it has to be at least once a week less frequent. It could be once twice a month, it could be once a month. But it has to be at least once a week. So something that they take every 2 or 3 days is not going to work. It's going to be confusing for them. But once a week works. And so we targeted that or less frequent oral dosing is our kind of minimum threshold and maximum threshold. And as we look at these 8 medicines that are coming through, some are more appropriate for oral, some more appropriate for parenterals. We're finding the one that's going to work best for lenacapavir, and I'm convinced we'll find that relatively soon on the oral side. On the subcutaneous side then, it's about finding the molecule that could have the PK profile that could fit within once every 3 months or once every 6 months subcutaneous. So I mean not all of those are going to work. We're not going to have every option available, but we know that if we meet those minimum thresholds that those 50% of the patients that are looking for alternatives, some of them will gravitate towards that. And I think what we're seeing in the first-generation long actings out there is they're not quite meeting the mark of patients. I mean having a 2-month every intramuscular injection doesn't fit with when people with HIV see their physicians and nor does it fit with kind of their lifestyle. So we have to keep the bar high for making sure that it is something that really will shift people from daily oral and then we'll work on that accordingly. I think the important thing is we think about this franchise over the course of the next 10 years is that with all of these optionalities and all these advances, that in addition to Biktarvy, which is the gold standard right now, I mean, we have 75% market share in HIV treatment in the United States today. And Biktarvy alone is at 45% after a few years post launch. The nice thing about all these other options is it reduces your concentration risk on Biktarvy when that goes off a patent in 2033. So exactly what ones work and how they work and when they work, I think we'll discover actually in the near term. Over the next 12 to 18 to 2 years, these 8 molecules will be through development in virology is fast - so we'll know where we're going to go, including, by the way, our partnership with Merck on islatravir for the once weekly oral. We'll know where we're going to go in the next 18 months, 2 years. Okay. I guess just final question on HIV. It's been a mid-single-digit grower business. Is the outlook on that, that people should think that, that continues? Or are there any - how do you think about just sort of the overall growth rate of that business? I think that should be the threshold. I think what we've seen pre-pandemic, and now we're returning to it, we have now post-pandemic 5 consecutive quarters of return of growth to the HIV market, both in treatment and prevention. Prevention grows a little faster than treatment coming out of the dynamic. But generally, what we saw before the pandemic is a 2% - 2% to 3% market growth for HIV. So I think that should be considered the threshold. And then with some of the things we spoke about before, I mean new advances in long-acting could provide better value to patients and therefore, opportunity to see an even higher revenue growth rate. And then the untapped market and prevention that comes into that. So I think we see a really strong, significant HIV base that's growing over the course of this next decade on top of what you see oncology over this period of time. And then we didn't talk about inflammation. We probably won't have time to today. That's a little bit of a longer-term play for us. But longer term, I think we'll see things more towards the end of the decade coming out of a very innovative pipeline there, but that helps us then as the third leg of the stool as we go into 2030.
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EarningCall_1611
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Good morning. My name is Cole, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Roots' Third Quarter Earnings Conference Call for Fiscal 2022. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there'll be a question and answer session. [Operator Instructions]. On the call today we have Meghan Roach, President and Chief Executive Officer and Mona Kennedy, Chief Financial Officer of Roots, and Leon Wu, Vice President of Finance and Strategy, who will take over the role of CFO in January. Before the conference begins, the company would like to remind listeners that the call including the Q&A portion may include forward-looking statements of our current and future plans, expectations and intentions, results, level of activities, performance goals or achievements, or any other future events or developments. This information is based on management's reasonable assumptions and beliefs in light of information currently available to Roots and listeners are cautioned not to place undue reliance in such information. Each forward-looking statement is subject to risks and uncertainties that could cause actual results to differ materially from those projected. The company refers listeners to its third quarter of Management's Discussion and Analysis, and/or its Annual Information Form dated April 6, 2022 for a summary of the significant assumptions underlying forward looking statements, and certain risks, and factors that could affect the company's future performance and ability to deliver on these statements. Roots undertakes no obligation to update or revise any forward-looking statements made on this call. The third quarter earnings release the related financial statements and the Management's Discussion and Analysis are available on SEDAR as well on the Roots' investor relations website at www.investors.routes.com, a supplementary presentation for the Q3, 2022 conference call is available on the Roots Investor Relations site. Finally, please note that all figures discussed on this conference call are in Canadian dollars unless otherwise stated. Good morning, and welcome to our earnings call. Before we discuss our third quarter results, I would like to address the current operating environment. We entered the third quarter in a position of strength, with sales up approximately 19% in the first half of 2022 and gross margin trending meaningfully higher year-over-year. However, since we reported our Q2 results, we see a notable shift in the economy, which has impacted our sector. Consumer spending has tightened and discounting particularly in some of our core categories, has become more prevalent. As we walk through our third quarter results, we will highlight how these factors have impacted the business in the short term, and what effects we anticipate they will have during the remainder of the year and into 2023. Before we do that, I want to emphasize a few things. For nearly 50 years, Roots has managed through diverse economic conditions, numerous changes in consumer behavior, and most recently, the global pandemic. We have worked tirelessly over the last three years to establish a more robust financial foundation for the business to support long-term growth and enable us to weather uncertain times. We have and continue to be focused on sustainable profitable growth, creating a differentiated brand and product offerings and further enhancing our customer mix. We continue to see increased year-over-year traffic in our stores and feel good about the direction we are taking a product offering, as well as the long term strategy we have established the business As the pressures affecting the economy continue, we anticipate a further impact on results in the fourth quarter and into 2023. However, we believe the fundamentals of the business remain intact. Turning to our third quarter result, sales decreased 8.5% year-over-year to CAD69.8 million in the third quarter, while net income and adjusted EBITDA declined to CAD2.2 million and CAD7.3 million respectively. Well, Mona will dive into the financials in her section, I will speak to some of the sales trends. We experienced a notable shift and sales in the second half of Q3, which has continued into the fourth quarter, including year-over-year declines in sales during our Black Friday and Cyber Monday events. We attribute these results to several factors. The first, which I highlighted at the start of this call, are the many factors impacting the economy currently, including inflation and higher interest rates. As noted, while we saw strong traffic in our retail locations, consumer spending has tightened affecting sales. The second is the more aggressive promotional environment. At the end of the third quarter, we saw brands pulling forward Black Friday sales, and offering significant discounts to right size their inventory. This discounting was most notable in some of our core categories like sweatpants. As we discussed in previous quarters, we are choosing to remain emotionally disciplined when it comes to our core categories, as these are products we sell year-after-year. While we intend to offer some discounts on seasonal products, which may impact near term margins, we plan to continue our pack and hold strategy in core collection. Undoubtedly, we may see an impact on sales in the short term as a result of this strategy. However, we continue to believe it is important to the brand integrity and building healthy margins over the longer term. Finally, we saw a more prominent shift toward lifestyle products from casualwear as people return to offices and events. While, we had anticipated this change in consumer preferences and had been modifying or offering, it accelerated during the quarter and affected sales due to the relative importance of each category to our business. We saw good growth in our lifestyle products such as men's woven shirt, our waffle collection sweaters, however it does not offset the impacts of this near term wardrobe rebalancing on other casual items that are offerings such as sweatpants and fleece top. For the last 50 years, we've offered a mix of lifestyle and more casual items, and we will continue to shift the balance to address the market needs. Our products continue to remain highly centered on quality and comfort and clothing that marry style and function. While we feel confident our core products remain relevant, we do anticipate further shifts in this area that may impact sales in Q4 and into 2023. Turning to our recent operating highlight. We completed our website re-platforming a critical milestone supporting our mobile first omnichannel growth strategy. The benefits of a new platform include more real time data on consumer trends, enhanced mobile navigation, better search capabilities, and a more seamless back-end for order management and customer support. These technology improvements will offer additional insights into consumer behavior, render the online buying experience more frictionless, and over time should translate into higher online sales. From a product perspective, our primary focus has been a significant undertaking associated with moving our fabrics to preferred fibers and materials, in-line with our sustainability objectives. I'm incredibly proud of all the hard work by the team to get us to this position today, where we can say that the majority of our products are now made with sustainable materials. We are continuing to explore new fabric innovations in this area to allow us to move to even more products to sustainable materials in the medium term. We also recently launched several notable collaborations and capital [ph] collections. In October, we dropped a collection of OVO, starring Canadian NHL Legend Tie Domi that celebrate heritage in our current product icons. We followed this drop by making limited edition Toronto Maple Leaf jackets in support of the NHL and OVO. Our partnership with Toronto-based Adidem Asterisks under the inaugural Roots' Emerging Creators project represented another highlight in November. This design mentorship program nurtures and offers exposure to emerging brands led by a new era of creators. By marrying Roots' unique heritage, Adidem's multidisciplinary approach to design and storytelling, the collection creates a shared perspective on the Canadian experience. It features 12 gender free styles, including varsity and bomber jackets, hoodies, sweatpants and leather goods produced in Canada. Consumers are increasingly shopping across gender categories and we continue to believe that brands like Roots, which can adapt their collections to ever evolving market requirements will attract a wider range of buyers. Further responses to the collection have been very favorable. We also teamed up with Mr. Saturday, who was recently named Canadian Menswear Designer of the Year. He used an retrofuturistic [ph] aesthetic to design an exclusive collection that's inspired by the 1970s Jet Set culture and Roots Air, the brand's short-lived airline from the early-2000s. This capture features iconography derived from vintage travel items in the form of embroidery, patches and print. Combining Mr. Saturday's retrofuturistic construct with the effortless comfort and style that Roots is renowned for. The joint collection including jackets, hoodies, sweatpants, and t-shirts, along with airline inspired accessories like leather passport holders, packs, luggage tags and a blankets hit the market last week in time for the holiday season. During the quarter, we also continued moving forward with our sustainability commitments by joining the Fair Labor Association, which seeks to drive a positive impact through collective action. The Fair Labor Association provides a framework of best practices, collaboration with peers, as well as ongoing dialogue in support to improve workers' lives for manufacturing operations and supply chain. This latest milestone is another step in our efforts to strengthen our focus on CSR initiatives. As previously outlined, CSR is an integral part of our long-term strategy. And we remain fully committed to achieving our objectives toward 2022. Looking ahead to the revenue intensive fourth quarter and into 2023, we anticipate that sales and margins will continue to be under pressure, as long as the current environment remains volatile. To mitigate these effects, we are pulling in a number of levers to maintain our competitive position, including strategically managing our inventory, and leveraging our strong balance sheet and liquidity position. Our underlying strategy remains unchanged in the long-term. We remain focused on our four growth pillars that include offering an elevate omnichannel experience, reinforcing our brand position with high quality products that speak the needs of our customers, strengthening our commitments to CSR initiatives, and focusing on operational excellence. While we plan to prudent with discretionary spending, we do intend to invest in areas necessary to support these growth pillars. I want to thank the incredible team at Roots for their continued hard work and dedication to the brand, especially during our peak holiday period. On that note, I will turn the call over to Mona Kennedy, our CFO who will leaving us in January to pursue other interests in the CPG sector. I've greatly enjoyed partnering with Mona over the last few years, and I appreciate her contributions to the company. On behalf of groups and the board of directors, we wish her well. We anticipate a seamless transition with Leon Wu, who will be our new CFO. Leon joined the company in 2016 and has increasingly taken on major financial and operational roles during that time. Most recently he's a Vice President of Finance and Strategy. He's on the call today. But Mona will be delivering the financial overview of the quarter as usual and answering related questions. We look forward to having investors and analysts spend time with Leon in fourth quarter. Thanks, Meghan and good morning, everyone. During the third quarter, we faced macroeconomic headwinds and an increasingly promotional environment that negatively affected our sales and pressure that margins. Although this volatile market environment will likely persist in Q4 and into 2023, I firmly believe on the company's underlying strategy to focus on profitable growth by elevating our brand and strengthening the fundamentals of our business over the long-term. Our total sales decreased 8.5% to CAD69.8 million in the third quarter, from CAD76.3 million in Q3, 2021. DTC sales were CAD56.9 million in Q3 2022, down 10.4% year-over-year. This decrease was mainly driven by macroeconomic headwinds in the latter part of the third quarter, along with an intensified promotional environment and an accelerated consumer shift from fleece products towards lifestyle assortments. P&O sales 0.5% to CAD12.9 million in the third quarter. The increase was mainly due to a favorable foreign exchange impact of CAD0.5 million on U.S. dollar sales in the quarter. Gross margin declined 430 basis points, to 56.5% in Q3, 2022, from 60.8% in the same period last year. This decline can be attributed to the temporary impact of premium freight costs of 240 basis points, and a reduction in government subsidies of 55 basis points. Excluding these items gross margin was down 135 basis points year-over-year due to higher cost of products primarily from the shift to organic cotton and increased discounts on targeted inventory. Although premium freight costs negatively affected our gross margins by 240 basis points in the quarter, we still expect the blended impact of such costs in the second half of the year to fall in the lower end of our 150 to 250 basis points forecasted range. Similar to the industry, we have seen improvements to the global freight markets in recent months. We believe this will represent a meaningful tailwind and reduced transit times and reduce reliance on premium freight in the coming quarters. As it relates to global cotton and commodity prices, we have already made purchases through most of 2023 and will therefore not feel the full extent of the benefits of reduced input costs until 2024. SG&A expenses totaled CAD33.8 million in Q3, 2022, up CAD4.4 million from CAD29.4 million in Q3, 2021. The 14.9% increase was mainly caused by a CAD2.6 million reduction in pandemic-related government subsidies and occupancy related cost abatements in Q3, 2022 compared to the same period last year. Excluding these items, SG&A rose CAD1.8 million year-over-year due to higher store costs related to increased operating hours, inflationary pressure on labor and e-commerce shipping costs, as well as investments in talent and marketing. Adjusted EBITDA amounted to CAD7.3 million in Q3, 2022 compared to CAD19.2 million in the same period last year. Excluding the impact of government subsidies and occupancy related cost abatements, the adjusted EBITDA decrease was CAD8.9 million year-over-year. Net income totaled CAD2.2 million or CAD0.05 per share in Q3, 2022 versus CAD10.8 million or CAD0.25 per share in Q3, 2021 as an adjusted EBITDA government subsidies and rent abatements had a significant impact on the year-over-year variation. Moving to the balance sheet highlights. Our inventory position grew 10% year-over-year to CAD72.9 million at the end of the third quarter. We feel comfortable with this level of inventory as two thirds of the increase was a result of our shift to organic cotton, which comes at a higher cost. We expect to continue to see elevated inventory for the balance of the year due to a combination of factors including the higher cost of organic cotton products, our catch and hold strategy on core inventory and lower sales. In addition to our healthy inventory, we closed the third quarter in a solid financial position with net debt down 21% year-over-year to CAD58.7 million and unused borrowing capacity of CAD56.1 million under our revolving credit facility. Our net leverage ratio meanwhile, stood at 1.7 times at quarter end. Looking ahead, we intend to remain disciplined with our cash allocation strategy. In a separate release today, we announced our intention to renew our share repurchase program or our normal course issuer bid for the repurchase of up to 2.1 million of our common shares, which represents 10% of our public float. Given the volatile market environment over the past few months, we have been prudent and not repurchase any shares under the existing NCIB in most recent quarters. As we are now halfway through our peak period, we plan to be more opportunistic in share buybacks in the near term, The focus will be on controlling spending without compromising the long term growth of the business and keeping a close eye on how the market unfolds. In closing, this marks my last earnings call as Chief Financial Officer at Roots. I leave with the firm conviction that company is headed in the right direction with its highly differentiated product portfolio, elevated brand equity, longtime customer loyalty and omnichannel growth strategy, all supported by a strong balance sheet. Despite temporary headwinds, I'm confident these competitive advantages will eventually translate into sustainable profitable growth as the company focuses on its long-term strategy and operational excellence. Thank you. Ladies and gentlemen, we'll now conduct the question-and-answer session. [Operator Instructions] Okay, your first question comes from Matthew Lee from Canaccord Genuity. Matthew, please go ahead. Good morning and congrats on taking the next step. Thanks for taking my question. I suppose, it's going to be on inventory. Q4 is traditionally the period where you bring inventory down, but it sounds like it's going the opposite way based on the press release. Given that your inventory is mainly core items, I'd have thought that the level you're at now be more than sufficient for at '23, which could be a softer retail environment. Can you maybe just expand on the strategy of increasing inventory into Q4? Hi, Matthew, and thank you. So from an inventory position, we ended the quarter 10% above last year. About two thirds of this is as a result of the higher cost of organic cotton and the inventory being at a higher cost. As we go into Q4, we do expect that our inventory to be above prior year levels for a number of different reasons. So firstly, as I mentioned, the cost of organic cotton. Secondly, as we go into a kind of Q4, we know we brought in inventory a little bit earlier, so we have higher levels of inventory. And yeah, we're going into our peak season and we have seen reduced sales. So there's going to be a little bit of elevated inventory as a result of that. And as you know, our pack and fold strategy. So we do have two thirds of our inventory that is core, and as we see in lower sales, we do continue on our pack and hold strategy. But we'll do targeted markdowns on seasonal products. Okay, great. And then maybe on the top-line, can you just expand on what you can do at a company to offset customers shifting away from comfort and towards lifestyle? Yeah, I'll take that Matthew. I think what we've seen in the quarter, which is interesting is some really good performance in a number of core styles. So in our woven tops or sweaters, we had never seen [ph] that it had really performed well. As an example, you have this Fair Isle cardigan that was $158 and sold out almost immediately. So we are seeing places in our category where we've already made that shift into some more lifestyle type products that are performing well, an evening was in our sleep category, there are pockets of things that are doing well like Dark Cloud Sleep. What we're seeing, though, is that because the market is much, much more promotional also in our space right now. We saw in the last couple of weeks and into October, people doing like 30% off 40% off, 45% off and with the categories in which we play. We think that's part of what's also impacting the sell through of our products, as we're not being as aggressive promotion of some of our products. So we think it's a combination of some of the shifts that we're already doing from a lifestyle perspective, where we are getting traction. And then we think it's also kind of a rebound effect, as people get rid of the inventory that they had overbought, going into the coming into the pandemic, the back end of it. We think that will kind of keep them settling down in the competition space also, and that'll benefit us. And I think in the longer term, Matthew, as we said the core price that we've already wrapped year-over-year, it doesn't make sense for us to discount those heavily as we were going to bring you back as next year also right. So we want to continue to be prudent on that, but we do understand that that might impact our sales in the short term. Thank you. Good morning and also, congrats Mona on your next step. Just a couple of questions, can you just give a little bit of color around what you've seen on a Q4 to date basis in terms of sales or traffic? Yeah, I mean, we -- I think we've mentioned it, we've actually seen the traffic in our stores. And what we're seeing though is we have seen year-over-year declines in sales and during our Black Friday and Cyber week. So continuation of the trends that we saw at the end of the third quarter we have due to Q4 so far. And again, we continue to attribute those three factors we mentioned. So the macro environment, kind of the economic impact of consumer tightening on spending due to inflation and interest rates. The second theme, is the highly promotional environment in which we see people really playing right now. And then the third thing being rebalancing of people's wardrobes. Right now people are obviously really focused on the Christmas holidays and buying things that they can use to go out, sequins, dresses or other things like that. And so we're seeing a bit of that shift impacting us also. Right, okay, thank you. And then just on that traffic to sales ratio. So are you seeing is traffic, is traffic also declining on a year-over-year basis? Yeah. Okay, thank you. And then just on the mix of products between lifestyle and more casualwear, can you just remind us of what -- where that sits? So we basically view our inventory of kind of T-shirts at its core. We don't typically disclose kind of the lifestyle casual focus in our business. But what I would say is that, when you look at our business today, and we think of lifestyle things as plaid shirts, sweaters, things that kind of fall into that kind of woven bottom. And where we have those items, we are seeing good performance and year-over-year growth. And then in our core fleece category, as I mentioned before, which would be sweat pants and sweat tops. There definitely has been a shift in particularly sweat bottoms over the last couple of months, I think as people kind of rebalancing their wardrobes, offices, and obviously events. I think the thing that's important to remember though, is as a business that has been around for 50 years, and when we saw him sweat since 1979. From our perspective, we do believe that the core offering continues to remain relevant. Well, we do think it's happening. It's a bit of a rebalancing. And we continue to expect those core products to be relevant next year, but we do believe that in the short term, you're going to see that more or less the focus has shifted. People are thinking about parts of their wardrobe that they haven't built up for many years. [Operator Instructions] Okay, there are no further questions at this -- actually, there is. Your next question comes from Sabahat Khan from RBC. Please go ahead. Great. Thanks. And good morning. I'm just wanted to get a little bit more color on this shift that you were talking about in terms of just -- the type of products that people are buying. I guess, is it just more the world is a lot more open today than it was one two years ago? Is it kind of just the tougher comps from the past couple of years? Just in terms of what do you seen sort of the mix out there in the broader retail space given at this point? And what it was it -- is a macro also a part of affecting what people are buying? Just want to get a bit more color? Yeah, absolutely. So let me walk through a few facts. From a macro perspective, I think you're seeing a bigger impact in Canada than you are in other country. And I think, there's some great results that came out through sales force that was showing the difference between Cyber Week in Canada versus Cyber Week in the U.S., with Canada's being declined in Cyber Week, pretty meaningfully and kind of U.S. seen growth. I think one of it is the exposure that we have to business to Canada from business perspective. That's impacting us. And I think the interest rates and inflationary environment, from the economic perspective are impacting consumer spending even more significantly in the Canadian marketplace, based on some of these dots. So I think that's important. I think the second thing is that, we mentioned the promotional environment. And, when we look at our products, we have during Black Friday, or kind of a onetime storewide sale on some of our products, that doesn't include things like salt, and pepper. But that includes other kinds of fleece items. A lot of businesses that are out there right now, given that they've had excess inventory are looking at 30%-40%-50% off in some of the categories in which we offer. So again, we think that's impacting the purchasing kind of our specific products. And the third thing is, is the category shift. And I would say that we have again, for 50 years been a business that offers lifestyle and casual items, I think you've seen a mix shift that balance of the items between more lifestyle and more casual items, multiple times during the last 50 years. And what we're seeing now is new because of the factors that mentioned the beginning, and then because of the fact that people don't really have in their wardrobe a lot of items, they typically did have for going out or okay, those types of things. They're focusing a bit more time now and rebuilding those aspects of their wardrobe. And so we're seeing a bit of a rebalancing. But our perspective is in the longer term, the core categories like sweaters or sweatshirts, those types of things, they can change around a core part of our business. We believe strongly in silhouettes and styles that we have. As I mentioned, we had new really good traction with things like our cloud fleet, which again, is a sweatshirt and is flat bottom item. So we think there's definitely places within our categories that we're seeing good performance, but we do think that the industry right now is seeing a bit of a rebalancing. And I think Roots is well positioned to take advantage of that once we come on to the other side. But in the short term, we expect to see impacts on sales, obviously. And then from a margin perspective and our non-core categories, when the market is much more highly promotional, we do expect to see some margin impacts, as we will play more heavily into some of the seasonal discounting happening right now. And I guess just kind of -- there was a promotional activity that's going on out there in this space? I guess just is it because your inventory is a lot more transferable to future season or future years? And that's where you're sort of holding off on promotions? Or is this sort of a view on look, we want to hold X amount of gross margin, or EBITDA margin, and we're not going to promote kind of below that level? Just want to get perspective on how you're thinking about how promotional you may want to be here? Yeah, well, -- so first off, if you look at Q3, we mentioned our inventory was only up 10% in Q3, which we think is pretty healthy. And then when you think about that 10% was two thirds of it being associated with the cost increase of your inventory. As a reminder, we switched almost all of our fleece products predominantly, and a significant portion of our production to organic or sustainable materials in the third quarter. So part of it inventory elevation is coming from cost, right, because we have a higher cost item, that's one piece of it. The second piece of it as it relates to our core product, we really do fundamentally believe in that balance between understanding what's the profitability, you're generating on that product. And so if I know I'm going to sell something, six months from now in full price, doesn't make sense for me to discount that heavily just to pull forward sales to then buy into that product again next year. So I can sell it next year. It makes sense for me to think about the products spending sell year in year out passes. That ends up bringing them back out at the relevant time, and maintain that full margin perspective, where we do look at the markdowns more significantly in the seasonal categories, where we might say, maybe we have a novelty suite set that we brought and it might not be performing as well right now. Those items we do take deeper discounts on. And we believe it's important to you that clean up obviously our store base and our inventory balance, and make sure we can bring in more relevant items next year. But we really do think about it and broken into multiple different segments, as if you're running a salt and pepper item, which is bought again since 1979, because that's how long it's been in our collection. And we haven't discounted that for years, going back into a cadence of discounting that heavily doesn't make sense for us, because we know we have a consistent customer coming back again and again revising that product. Great. And then just one last one for me. I know there's a topic that we talked about a bunch through the pandemic. But I guess as the world has reopened, traffic patterns are normalizing sort of have you had a look at sort of the traffic level, the store base, that sort of seeing if there are any that maybe -- there's enough of the volume policy in store has moved on? And how are you thinking about the storefront at this point and cycle? Good morning, Saba. So from a store perspective, our strategy hasn't changed. We continue to be very analytical about it. As we said previously, 95% of our stores are profitable. We continually monitor their profitability. And from an expansion perspective, we are using pop ups as a test and learn strategy. We currently have 13 pop ups open. There's two of them that we've made permanent in the past year as the tests are approved, right. So our strategy in terms of store footprint hasn't changed, and we continue to monitor it. Traffic in stores have been up for the past quarter. So store traffic is improving and going to pre-pandemic levels. And we don't see any substantial shift in our store footprint in the near term or midterm. And we view it as -- we have seen this was interesting, and definitely a significant increase in tourist in urban locations through traffic perspective. So you are seeing that, people are going back to the office more regularly, where we have a more open economy where people can come to our tourist location, that's definitely positively impacting traffic. And we see some really good results coming out those location. Yes, sorry about that. Meghan, apologies. I think you've just answered my question. But I presume that you plan to execute for clean of any non-core inventory, correct? That's right. Yeah, we plan clean as a non-core inventory. Again, the market is incredibly promotional. So we will be looking at that in the coming weeks. But that's definitely a focus for us. And then just lastly, is there a margin profile difference between your lifestyle offering and your casualization offering? And are you able to, or would you want to make a shift to cater the environment in order to have a greater weighting towards lifestyle? Yeah, I think that it depends on the product specifically. And so we have items, when we look at our -- we have a concept called [indiscernible] scale. So obviously our [indiscernible] scale items, which are even smaller items we invest and to test those in the marketplace. And then look at the volume if they indicate traction, those technically have maybe a little bit of a lower margin, but we tend to focus on achieving the same margins across our collections. So we do believe we have the potential to continue to shift more into some lifestyle item. And just to re-emphasize again, from the third quarter perspective, we did see good growth and things like sweaters and wovens and those things where we have them. I think that it's a matter of how quickly we saw the shift in the quarter especially given that there was a lot of promotions in our sector, that's shift with kind of further emphasize. And I think that the secondary thing too is that you are getting to where rebuilding your other wardrobe again. So I think there will be some normalization is that that kind of comes into the second half probably next year. But we do believe we can and do have a robust lifestyle offering. And I think things like our journey collection on the active wear side of things, those are continuing to perform well for us. So there's a number of pieces within our collection, and we do believe we'll continue to see success. There are no further, sorry -- there are no further questions at this -- actually, we do have a follow up question from the Sabahat from RBC. Please go ahead. Great, thanks. Just one quick follow up, I guess this is more of a longer term question. And as, we do look at a potential macro slowdown here have - kind of permanent changes to pricing, or maybe a lower price line, have you guys kind of considered some of those things? Or do you think kind of from a brand perspective, maintaining the prices at the current level probably makes more sense? Just thinking more from a longer term perspective, whether it's a structurally new lower price point line, or just moving price points lower, even just outside of promotional activity? Just want to get your perspective on how you do that, compared to some of the competitors or the other offerings out there? No, I mean, we continuously, that we have a proprietary offer your products that, we think our consumers are willing to pay for. I think we have seen AUR improvements, continuously which is positive. But what I would say is, I mean, I can give a couple of answers. Our highlight the product category. So we launched this quarter are one gender free one robe $148. It's been almost entirely sold out. We also launched something called the Fair Isle cardigan, again, $158 sold out, right. So these are higher priced items in our collection. We're not seeing impacts from our consumer perspective on that specifically. And you mentioned, everything seems good traffic in the stores. And we do think it's a combination of those factors that I mentioned, but it's causing the performance that we're seeing. And it's not necessarily related to specifically price sensitivity. We haven't seen that people coming in and having any price and spending per se. It's just how they're building their baskets are changing. So, maybe before they would buy a baby outfit and buy a sweater, pants, t-shirt, hat with some socks or something like that. And now they may just buy a pair of pants and a sweater, right. So it's really just people are modifying and thinking about their spending habits, typically, with a combination of the other items I mentioned, that we're seeing unpacking it. But from a price perspective, we feel good about our current prices. We feel good about our current position in the marketplace from that perspective. I don't think you'll be seen as take price off anytime in the short term, because you feel comfortable where we currently are. But we do think that that's not an impact right now in terms of what we're seeing. Thank you for joining us for our third quarter results. We look forward to speaking to you in the New Year when we take you through Q4. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating. And ask that you please disconnect your lines.
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EarningCall_1612
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Good morning, everybody. I'm Chris Schott from JPMorgan, and it's my pleasure to be introducing Gilead today. From the company, we have a presentation from Dan O'Day, the company's Chairman and CEO. And following that presentation, we'll have a broader Q&A panel with the rest of the management team. So Dan, Happy New Year. Thanks for joining us, and over to you. Thank you, Chris. Good morning, everybody. Terrific to be with all of you today, and it's really great to be back after, gosh, three years, right, since we were last here. And I'm really pleased to be with the team up here today. We're going to be focusing on our work for 2023 and beyond. I want to start by thanking Chris and the organizers for the conference for getting us all together. And really, I want to say right up front today, after three years, we laid our strategy out about three years ago. I can say we've successfully transformed the company, and we want to talk to you a little bit about how we did that and what you can expect in the future. As always, I want to remind you that our presentation will include forward-looking statements, and I refer you to our SEC documents for a full discussion of the risks and uncertainties associated with these statements. So in a nutshell, this is what we would like you to take away from today's presentation, the take-home message, so to speak. I mean the first one is that we very much believe that the transformation is on track that we achieved what we set out to do several years ago, and we have tangible evidence of that, an impact to that. We're confident as a second point on this in the growth trend for HIV, and I'll be speaking a little bit more about that. And we have very strong momentum in oncology with a world-leading cell of other cancer modalities across more than 20 indications. So I'll talk to you about how we're going to accelerate this progress. But before we do that, let me start by recapping the journey that we have been on at Gilead Sciences together as a team. Our aim several years ago as we laid out our strategy was to create a diverse and sustainable business, paying heed to Gilead's legacy in virology, only strengthening that, and I'll talk about how I believe we've done that in HIV, COVID and beyond, but building through both M&A and internal R&D a world-class portfolio. And you can see that portfolio has increased double, but I would say what's underneath that story is the quality of the portfolio that we have today and the potential of that portfolio. I'd also say that we're now a company with great colleagues on Board that can really consistently execute. And I think you saw that every quarter in 2022 on both the commercial and the clinical side. And I would say it's been a holistic evolution. I mean, really taking the best of Gilead, and I'll speak a bit about that, and adding to that. And that includes both working on our culture and decision-making, which I couldn't be more pleased with where we're at. When we laid out the strategy and at the top of the slide, you see our 10-year ambitions. As a strategy, you don't want to change your ambitions every few years. These are for 10 years and they remain consistent. They remain our true North Star as we think about prioritization and decision-making within the organization. The strategic priorities that you see on the other hand, below here, and this is a subset of them, have adjusted because initially, we had to build up the portfolio. And now as you can see, we're firmly focused on the following 3 things that will also form the basis of my presentation here today: So that's maximizing near-term revenue growth; that's maximizing the impact of long-acting HIV therapies; and expanding and delivering on our oncology programs. So let me start with the first one, which is maximizing our near-term revenue growth. The first lever of near-term revenue growth is clearly our HIV business. Biktarvy continues to be the treatment of choice in HIV treatment, it continues to grow. You can see the numbers up there. I think what belies our confidence overall in our oncology business that's been built up over the past several years is a few things. First of all, the pandemic impact affecting HIV is behind us now. Number two, and I'll talk about this, our first long-acting medicine is now approved in the United States and Europe. And then the final thing is we have no -- really, no patent expiry throughout the course of this next decade. And that was solidified with the TAF patent legislation that was -- or litigation that was recently completed. So we see and expect an HIV revenue growth trend through 2030. The second slide on maximizing near-term revenue growth is really the oncology business at Gilead. And you'll see here, it's now at a $2 billion annual run rate and growing rapidly. Our oncology impact is very tangible. We have a clear leadership in cell therapy, and it's still early days as we both introduce this technology and change standard of care in large B-cell lymphoma and in other diseases, particularly as we move up in lines of therapy. So early days for that but very promising results, and I'll get back to cell therapy in the presentation. But Trodelvy is also off to a very strong start and good success in its first indications in breast cancer, and we'll talk more about the potential for Trodelvy as the presentation continues. Gilead has and will continue to play a critical role in public health. And certainly, Veklury is a shining example of that. Now used in more than 12 million patients around the world, the vast majority actually in the developing world through our voluntary licensing, it continues to be the standard of care in the hospital setting and was the first drug approved, as you know, for COVID-19 in the pandemic. We've reinvested and continued to work on that world-leading antiviral expertise for our novel oral COVID medicine that has now started one Phase 3 trial outside the United States in high-risk patients. And a new disclosure at this meeting here is that we will be starting our standard risk study that will start in the United States in the first quarter of this year. So more to come on that, but there is a significant medical need out there for patients in the non-hospitalized setting. And we believe that a novel oral COVID medicine that can help all patients could be a potential benefit for that, and we'll continue to pursue that. So the second area of our strategic priority focus really deals with leadership and long-acting HIV care. It's hard to overemphasize the importance of Sunlenca as a medicine that could transform the HIV epidemic. We think it may be the strongest tool yet to help us end the epidemic. Just to put this into context, because I think this is really the best of Gilead really shining through. This is a result of our own research and development, first in-kind medicine, 16 years of innovation, more than 4,000 compounds screened and a truly unique molecule that was approved both in Europe and the United States, just before the holiday in the very late-stage HIV patients. But our plans for Sunlenca go far beyond the late-stage HIV patients. And you can see here, we have trials ongoing in both earlier stage treatment and also prevention. I just want to talk a bit about prevention because I think as we think about ending the HIV epidemic, where in the most sophisticated developed world, only about one out of four people that could benefit from taking PrEP medicine or actually on a PrEP regimen. We believe that the advantage, if successful, in our late-stage clinical trials of a twice a year subcutaneous injection can transform the ability to protect people from ever getting the disease in the first place and really bend the arc of the HIV epidemic curve. This is true in both the developed world and very importantly, to Gilead's focus on health equity in the developing world as well. So I'm really proud to be part of a company that has such a unique molecule. In treatment, of course, we need a partner molecule. And you know the extensive nature of our R&D has been focused on finding that partner molecule. You can see here a representation of that. There are some new disclosures here today. Since we've done our virology deep dive to this audience, some molecules have progressed, and those are identified with the blue star and some new molecules have entered in, which are recognized with the red star. So we'll continue to pursue these programs in treatment regimens that we believe people that need prevention and also patients that have HIV are looking for these types of long-actings, either weekly orals or less frequent subcutaneous injections. So you can see this, and you can see on the right-hand side, we leave today an oral. With these programs, we intend to both lead today and oral, but also with long-actings as we continue to pursue these programs. And now the third area of focus that I want to speak about today is our cancer medicine portfolio. It's broad, it's diverse. You can see here it goes across almost every major tumor type, and we have a range of partnerships that have been thoughtfully curated to help us put a holistic approach to our oncology medicine approach. And what I want to do is just break this down a little bit, highlighting some of the key medicines. But just to point out that we have today 14 late-stage trials ongoing across our oncology portfolio and more than 5 medicines in those late-stage alone and in combination. But let me start with the first one, which is Trodelvy. It's, again, hard to overemphasize the potential here because of the expression of TROP2 across so many tumor types. We have an extensive development program, as you can see on this slide, and obviously, already supporting patients in breast cancer. When we dig into that a little bit deeper, starting with breast cancer, 90% of Trodelvy's current business is in breast cancer, starting with triple-negative breast cancer. We're the first and only approved ADC with overall survival benefit, and we've also shown now overall survival benefit in hormone receptor positive/HER2 negative, which is the largest form of breast cancer. But you can see our strategy, which is to start with later-stage patients with Trodelvy and then move up with a comprehensive development program into earlier lines of treatment to have an even greater impact on patients' lives. This is a drill down on the current filing that we have in with the FDA, which is hormone receptor positive/HER2 negative. You could see the potential treatment pathway here. It's pending approval. The PDUFA date is about a month away, and it could be the only ADC in HR+/HER2- breast cancer that works in patients regardless of HER2 status. You can also see that with the very strong results that we saw in very late-stage recalcitrant patients, we have a lot of confidence in moving ups and lines of therapy to have that effect be even larger, and we expect first patient enrollment in the ASCENT-07 trial in 2023. Trodelvy is also a key component of our lung cancer strategy. And you can see that represented here in both the first-line Stage IV lung cancer and in the second-line Stage IV lung cancers, where we have programs ongoing already. But of course, our approach in lung cancer goes beyond Trodelvy. It goes to the many medicines that you see here, both within Gilead and partnered molecules. And we know in lung cancer, which is such an intractable large cancer type that has a huge need that we need to also look at combinations. And we're doing those combination approaches within Gilead with a variety of different novel mechanisms and also with partner companies that are leaders in the field in lung already, and that you see represented here as well. I'd be remiss not to point out the very exciting Phase 2 data that was presented at ASCO virtual event in December on TIGIT, which is a compound that we are in partnership with Arcus. We're very encouraged by the separation of these curves. It's the largest body of evidence on TIGIT that has been communicated so far to date. It gives us great encouragement and validation as we continue to accrue patients into our Phase 3 trials and the consistency that we've seen on safety and efficacy are very encouraging to us and yet another important potential medicine in combination with other immunotherapy agents and potentially other medicines within our portfolio to move the standard of care in lung cancer. Let me move now to another medicine that has true cross-tumor potential, and that's magrolimab. You can see here the number of cancer types that we are exploring this novel anti-CD47 mechanism in we're in a leadership position with our hematologic malignancies as well, but I want to give you an understanding of the breadth of these programs that could be used alone and in combination for magrolimab. I wanted to provide a brief update on magrolimab ongoing Phase 3 programs, the so-called ENHANCE trials across the disease states that you see here and give you a bit of an update that we've had the IDMC be exposed to the data, obviously, as they do from time to time throughout the course of the study. And they recommended that the study continue as designed and as planned. We will pursue an overall survival endpoint for this from a regulatory perspective, and we remain blinded to these results. I remind you that this is an event-driven study in ENHANCE MDS and that the next interim analysis, we expect to be able to give you an update on in some form in the second half of this year. We continue to have confidence in magrolimab and want to make sure we let the study run its course to get the true benefit that could come out of this trial for patients, and we will be updating you more in the second half of this year, but continue on with our total clinical trial program with magrolimab. In cell therapy, I couldnât be more impressed by Kite and the team and their market leadership and patient reach. We also have two therapies here and five different indications, tremendous growth potential now as we see more and more community physicians referring patients into authorized treatment centers in both the third-line setting and our early enter into the second-line setting. We are expanding in lines of therapy and we have studies in earlier lines as you see here, and also in more geographies. We also have two transactions that are pending that we announced just before the holidays. One that is a partnership that provides a potential BCMA asset on our proven manufacturing and quality base for cell therapy, with Arcellx and another one community that has novel advances in different types of solid tumors and also potential process improvements as we continue to invest in our leadership position in cell therapy, which we will continue to do. We're in a very good position as we look at our M&A strategy for the future because of the richness of our portfolio and the level of investment that we need to continue to do to realize the potential in the portfolio, we can be selective about M&A given the M&A that we've done over the past several years, and we will be. But of course, we'll continue to look at that in our business. And our capital allocation strategy will remain the same, which is, first and foremost, to invest in the promising pipeline for the benefit of patients and the medicines that are newly launched and established for our patient communities around the world. Secondly, look at M&A and partnerships that will complement with the strategy that I mentioned before. We'll continue to look to return money to shareholders with an attractive dividend growth policy. And then our fourth but certainly not final capital allocation priority is to repurchase shares to both offset dilution and to be opportunistic. And again, we're disclosing here today that in total, in 2022, we repurchased $1.4 billion of share including almost $800 million in the fourth quarter, which is opportunistic share purchase, which belies the value we see and the growth of our business as we move forward. So to summarize, and I appreciate your intention and to turn it over to the team to have you hear from them as well. We just want to say that we're very proud to be a part of Gilead Sciences, honoring the legacy, building on a diverse and sustainable portfolio, we're in a very different position today than we were a few years ago. What you can expect to see from us in the future is even faster adoption of our portfolio and even greater impact for patients. And I just want to thank the colleagues at Gilead that I get to work with every day who are tremendous inspirations for me. And with that, I'm going to invite Chris back up to get us into some Q&A with the team here. Thank you all. Excellent. So maybe to kick off the Q&A session here. I thought I might start just on the HIV business. I think last year, you gave at this conference, I think, some initial kind of guidance about a stable to growing revenue base through 2030. And since then, we've had the TAF settlements, but at the same time, we had IRA move forward. So maybe as you sit here today, how are you feeling about that outlook for the existing business? Sure. Thanks, Chris. It's Johanna. We feel very confident actually in our growth trend 2030. We believe it's going to be a positive CAGR through 2030. The drivers of that have to do with our oral standard of care with Biktarvy in HIV treatment as well, of course, as our long actings, both in treatment and prevention that Dan mentioned a little bit earlier. Those are the two major pieces from a growth standpoint. I think the other thing that just opens it all up is the fact that there is no patent exclusivity issue in the next decade or so. And because of that TAF patent legislation brings us out to 2031, 2032. That also was a nice lift as well. But we were already before the TAF patent we were already suggesting that growth in the next decade or so. The IRA, obviously, the TAF and the IRA are going to kind of compete a little bit from a positive and negative. But we think the IRA with what we know today, although it's still early days, we do believe that this is going to be manageable. And that's part of the planning that we've put forth with a positive CAGR through 2030. Great. And then the HIV category, obviously, is coming up very strong in 2022, are we at a fully normalized market post COVID at this point? Or is there still growth as that market just kind of recovers as we exit the pandemic? Yes. So we've seen -- the last five quarters, we've seen consecutive growth in the market. So we're back at the 2% to 3% range, which is pretty much normalized to your point. So we would assume to see that going forward despite some of the different surges that we've seen with COVID. But we do think that's normalized. On the treatment -- that's on the treatment front. On the prevention side, we've seen a really nice acceleration of that. But that market has picked back up much faster in prevention than it has in treatment. And you're looking at about 19% to 20% growth there. And we believe with new long-acting agents, like Sunlenca in the future in prevention, that will also continue to increase that growth. Because, as Dan mentioned, only one in four that could benefit from a medicine in prevention, only today is using that. And so with new optionalities in this market, I think we're really going to see an expanded growth in the back half of this decade. Okay. Great. And then on -- maybe just staying on the treatment side. On Biktarvy, you saw, obviously, very strong market share gains. How do we think about maybe 2023 and beyond, how much more room is there to go as we think about the share potential of that drug? Sure. So Biktarvy is at a 45% market share in the U.S. We have been growing on a year-on-year basis, about 4%, so about 1% or a little less than 1% per quarter-over-quarter. And we do believe that there's still an opportunity for growth with Biktarvy. We believe that because of its profile and what it offers for this patient population, we do believe that there is still room for growth in '23 and beyond in the oral market. And obviously, as we expand, we also do believe that the long-acting treatments will also take on a different proportion as well. On maybe the PrEP market for a second, we've had a competitor launch I guess, been in the market for about a year now or so. Just anything you've learned from that rollout as we think about lenacapavir and what that could do over time? Yes. I think the learnings there have a lot to do with the reimbursement and physician habits, right? Most physicians that prescribe in HIV are not used to anything injectables or Part B kind of area. And so that's going to be learning. And so therefore, with Sunlenca, we're being very clear in the approach and the education that needs to happen prior to, so that people understand how to use it and how to make sure patients have access to it. So the access piece of it is probably the biggest learning. Okay. Okay. Great. Maybe as I think in the slides you highlighted kind of a range of treatment combinations you're looking at with lenacapavir. Can you just at this point talk about what you're most excited about or most focused on as we think of those kind of -- it seems like a growing list of combinations? Sure. Yes, hi. Merdad Parsey. We've done a great job. And I think Dan really alluded to the research group and the expertise that, that team has in terms of the medicinal chemistry and the discovery around developing new molecules and that's where lenacapavir came from. And that team has really redoubled their efforts to look for a different class of medication that will bring a similar profile. As you saw on the list, we have a number of options now. And our strategy has been to move as many forward as possible in parallel with the goal of identifying that the one with the best properties to allow us to get into an ideal position with a treatment regimen that could be long acting that could really match Sunlenca's duration of activity. So ideally, if we can find something that we can dose once every six months, for example, it would be the ideal combination, again, in treatment. Important to remember that for prevention, we are in the PURPOSE trials and those studies should read out and for prevention I think we're set for -- with lenacapavir. I guess on the treatment combinations, when do you think you'll be in a position kind of identify those kind of lead assets? Is that something we can think about this year or next? Or is it a longer-term thought? I think over the next couple of years. So some are in Phase 1, some are going to be in Phase 1. And really, because the mechanism of action is understood because we understand sort of all the machinations if you will. The key questions will be tolerability and pharmacokinetic profile. So -- and we can figure that out usually fairly early on in the Phase 1 study. So we don't need to wait till the end of Phase 3 to really be able to pick something to be able to move forward. So I think over the next couple of years, we'll have a lot better feel for which one really hits the mark for us. Okay. Great. Maybe pivoting over to oncology. I guess maybe first for Trodelvy in breast cancer. It was obviously a big year of news flow last year, both yourself and competitors. Can you maybe just help put us some context of how you see that product positioned as we kind of digest all the data we saw last year. Sure. So yes, so we have been approved in the marketplace with second line metastatic triple-negative breast cancer. And I think that position is -- continues to stay strong despite new competitive data. And I think that has a lot to do with the overall survival that we've shown in such a broad -- in this patient population. And to this day, we are the preferred agent in second line with Trodelvy. I think the data you're referring to is also in a broader breast cancer patient population with HR positive/HER2 low negative. And in that population as well, we've shown in later lines of therapy overall survival data as well. And I think we're expecting PDUFA within the next month or so. And we're really excited because these are women that really don't have any other options, so latent therapies. And to show overall survival in this very late stage, I think, is very exciting, to -- not only for these women, but also for the clinical trials that we have planned to move up lines of therapy as well. So I think we're well positioned to really make a difference for patients. When I think about competitive landscape within HER2, how do you think about that? How this is going to practically play out in the market? Yes. I think in HER2 trial is -- and you could speak to this better than I can, Merdad. But in HER2 trial is earlier lines of therapy. So I think you're comparing apples and oranges a little bit. But having said that, I also think it's important to understand the data in the patient populations that were studied. And when you think about the IHC status and what that looks like, in triple-negative breast cancer, actually IHC-0 is actually a much higher proportion than it is in in HR positive, it's kind of the flip. And so they're still, however, an HR positive, about 35% of the patients that are IHC-0, which Trodelvy is still today the only one that has proven efficacy and overall survival in this patient population. So we do believe, depending on the patient profile, I think physicians will have to make a choice as to what better suits that patient with their profile and the different dynamics of the tumor. Okay. Great. And maybe sticking on Trodelvy. As I think about Trodelvy in lung, can you just give us some perspective there as we is probably most relevant when we think about the competitive landscape there as well. So talk a bit about the studies you've got run. How you're thinking about that landscape playing out as well? Sure. And I think that actually speaks partly to your first -- your earlier question around other molecules in breast cancer, I think the thing to remember is Trodelvy is -- because we have a different target we're going to have a very different profile in terms of the tumor types that we're going to treat and the lines of therapy. And lung cancer is a great example of that, where we believe that we'll be able to move into lung cancer, as you've seen with our Phase 3 studies and really bring a new option to patients with lung cancer targeting TROP2. Itâs, as with anything these days, very competitive. And I think our approach really is loot at the broader portfolio, as weâve seen, to look for opportunities to not only bring Trodelvy to lung cancer but also our anti-TIGIT antibody and other approaches, so that we can look at combinations that could really move the needle from what our -- I think a lot of people would say, well, IO is doing great for lung cancer. But I think it's really important to remember that the median survival and the number of people who respond is still pretty poor. And we have a lot of opportunity to do better for patients. And I think adding in a TROP2 antibody, potentially adding a TIGIT on top of that, and other options down the road will really give us that -- answer those questions for us. And that is really a big part of our portfolio strategy is looking at those intra-portfolio combinations. You mentioned TIGIT. I know we just came off some data a few weeks ago. It seems like it's still an incredibly controversial category for the community for better or for worse. So can you maybe just your takeaways from that data and what gives you confidence that kind of the signal we saw in Phase 2 is going to be able to show that kind of differentiation versus KEYTRUDA as we think of the Phase 3? Yes. I think probably the first thing I would say is it's very important to remember what that study is designed to show. And that study is designed to show whether TIGIT adds efficacy on top of a PD-1 inhibitor. And Dan showed the curves. I don't think it's ambiguous that TIGIT is adding to a PD-1 inhibitor at that point. We know that TIGIT alone doesn't really have a lot of activity and really needs a PD-1 to bring that additional activity. So when you think about it in that context, the purpose of that trial, I think, along with all the other data that are there, it seems pretty clear that TIGIT is going to bring something. Now the question then becomes how broad does it become? How deep is it? How does it do when you look at apples-to-apples comparison? And I think those are the studies that have to be done now. And you're seeing us start to take on those trials where we'd be looking at those combinations in those frontline -- in the frontline setting where we'll be looking at randomized data sets and really be able to establish that. But I don't think there should be a lingering question as to whether TIGIT adds something to PD-1 inhibition. I think that -- now it's a matter of how much do we add what is the overall survival benefit that we're going to see over time, and those are going to require the Phase 3 studies to read out. And maybe on that same lane, can you just talk about your confidence that the PD-1 you're using is kind of able to show equivalent or efficacy to KEYTRUDA? We have a lot of experience with zimberelimab. It's not limited to this one study. We -- the zimberelimab performance of in this trial is comparable and what we would expect. If you saw the ASCO plenary you heard the discussant speak to that, and I think, very eloquently speak to what we would expect given very different patient populations and study design. So -- and we have data in multiple tumor types and multiple trials that show that zimberelimab is performing exactly how we would expect it to perform. So I think doing cross-trial comparisons is always a risky business, and I would encourage people to not do that. Okay. Fair enough. Moving over to the CAR-T business. Just elaborate a little bit on Yescarta and DLBCL and kind of the uptake and opportunities that you see there? Sure. So we're very pleased with the growth that we've seen, especially the impact, obviously, on patients in the onetime treatment for a potentially curative effect. Our growth is actually coming from multiple areas and really is just starting. If you look at the -- as Dan discussed, the number of products, the number of indications, those indications are expanding globally. So we have expansion into new geographies indications, reimbursement coming on board. And especially as you look at second line, reimbursement coming on board in Europe now month-after-month, we'll continue that growth. Also, the number of ATCs are growing. We have over 320 globally now. We just announced the Daiichi Sankyo deal with Japan is the second largest market in the world. So we're taking -- we now have the marketing authorization and full rights back starting this year, and we'll start actually producing and manufacturing for Japan early this year. So lots of expansion and growth opportunities just in DLBCL alone. Can I ask about just the competitive environment? I know some of your peers have been challenged with capacity, but to the extent those get addressed, whether in '23 or however long that takes, how do you think about that playing out when there's less multiple companies that have full capacity available? So we keep saying that when, right? It's not easy to do cell therapy. It's very manual in nature. We have cell therapy researchers. We tend to call them cell therapy research labs, not manufacturing sites because these are really humans doing all of the work. And now have 3 facilities that are full-fledged commercially operational. We have the viral vector site and Oceanside, which is currently producing RVV for commercial supply and LVV for clinical supply, we're also producing and we'll produce that commercially as we expand into multiple myeloma. So you -- as you look at the manufacturer, I can't speak for other companies, but I think that is the ticket to entry. The one thing, though, I'd like to point out is, it's not just about manufacturing. It's a supply chain, it's the end-to-end teamwork that has to happen with a manufacturing supply chain and the commercial feet on the street that has to happen in that ATC to make sure that, that patient from apheresis to manufacturing, back to delivery, which we do at industry best at 16 days is really an intricate process. And so I think manufacturing is one thing to get up to scale. But now we have the know-how for multiple years now being able to expand our development, commercialization, whole process end to end. Right. Great. Capital deployment, I know the company made a number of large acquisitions. I think the messaging seems to be that it's more tuck-ins now. Is that -- should we think about the strategy to be kind of committed to when we think about going forward, it's going to be more maybe what we saw in 2022 of these kind of smaller partnerships or smaller acquisitions? Yes. Thanks, Chris. Hi, everyone. I'm Andy Dickinson. I'm happy to take the question. The answer is yes. I mean what you saw in 2022 is likely what you're going to see in 2023. And the reason is, Dan touched on this in the presentation that we have a great portfolio today. It's strong, it's broad. We have a lot to digest and to work on. And we really like the growth profile. You've seen an incredibly strong growth profile in our base business. This year, we are very confident in the growth profile of the business going forward, both relative to where Gilead was as well as relative to the broader biopharmaceutical sector. So we don't need to do the same big deals that we did historically. That doesn't mean we're not going to do things. So the number of deals that we did recently with Kite, community and Arcellx the MiroBio deal, the Dragonfly deal, that gives you a good sense of the types of transactions that we're going to focus on. So we have a lot of flexibility. We generate a ton of cash flow, as you know. We're going to be reinvesting that cash flow in the business, as Dan suggested, but you should not expect us to do the large Kite, Immunomedics type deals that we did to build out the core of our oncology franchise over the last 5 years. And as I then think about the cash the company is generating, if it is smaller tuck-in deals, I guess where does share repo fit into the mix? Is that something we could -- as you further delever, could we be thinking about that as a bigger component of the capital return every year? Yes. And it's still our fourth priority when you look at our -- how we think about capital structure and deploying our capital. So first and foremost, we want to make sure that we have an incredibly strong internal portfolio, external portfolio and that we're committed to maintaining and growing the dividend over time. Then, we're going to look at opportunistically at other things, including share repurchases. And you saw that in the fourth quarter. As Dan said, we had some excess cash relative to where we wanted to end the year. And you should see more of that going forward, not necessarily the share repurchase, itâs just the optionality given the cash flow that we're building and our cash position over time. We have a lot of optionality, both with respect to share repurchases is also with respect to debt and whether we refinance debt or whether we just pay the debt off going forward. Also just when I think about OpEx and longer-term margins, you've got now an HIV business that's growing, you've got an oncology portfolio that's growing nicely over time. I guess how much can you leverage your existing infrastructure and have some of that top line growth kind of trend to margin expansion dropped to the bottom line? Or do we need to think about still increases in R&D or SG&A to support some of the growth initiatives? Yes. I mean, it's a great question and one that I would break into two pieces. Well, first of all, we still have incredibly strong margins, as you know. I think historically, we underinvested in R&D, in particular, now have SG&A investment in R&D that is on par with the rest of the industry. So you've seen a significant increase over the last three or four years. It was absolutely necessary to developing and building a company that is sustainable and will reach the growth targets that we have. We are kind of at the final stage of that is the way I would describe it, especially in Merdad's development organization and Johanna's organization, prior to a lung launch, so assuming that we have positive data in launching lung. We will build more on the SG&A side. I think Kite is the same thing. So we still have a couple of years of additional investment ahead of us. There's a lot of leverage in the model. We are a very small company relative to our competitors. So to your question, over the long run, absolutely, you should see a lot of that top line growth giving very significant growth in the bottom line over the next decade and beyond. So we love the structure and kind of what the setup is from here, both for top line growth as well as EPS growth. Great. And maybe just the last one minute or so here. Just everybody just kind of as we think about 2023, any kind of pushes and pulls you'd highlight that we should kind of keep in mind as we think about the setup. I know you'll be giving guidance in a few weeks, but any color you can provide on that front? Look, obviously, we'll be giving guidance shortly. I just want to compliment the team. I think at the end of the day, we've got tremendous potential, I think, ahead of us. We're just at the beginning really venturing that whole oncology space for the $2 billion run rate. And you heard from Christi and you heard from Johanna about that potential. We've got lots of readouts that are going to occur over the next couple of years, some in different phases, some earlier phase, some later phase. And I think what you can expect from Gilead is now consistent execution. We were growing into oncology, I would say, last year and the year before. And I think we all feel like we have an organization that can continue to execute. And so we'll be giving you at the year-end results presentation, obviously, guidance for the next year, but also the key milestones clinically that you can expect from us. So that will be coming in a few weeks' time.
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EarningCall_1613
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Good afternoon, and welcome to the Applied DNA Sciences Fourth Quarter and Fiscal Year 2022 Financial Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After todayâs presentation, there will be an opportunity to ask questions [Operator Instructions]. Please note this event is being recorded. Thank you, Gary. Good afternoon, everyone, and welcome to Applied DNA's conference call to discuss our fourth quarter and fiscal year 2022 financial results. You can access the press release that was issued after market closed today, as well as the slide presentation accompanying this call on the Investor Relations section of our corporate website. Speaking on the call today are Dr. James Hayward, our Chairman, President and CEO; and Beth Jantzen, our CFO. Judy Murrah, our COO; and Clay Shorrock, our Chief Legal Officer and Head of Business Development, will also be available to answer questions on the Q&A portion of the call. Before we begin, please note that some of the information you will hear today during our discussion may consist of forward-looking statements. I refer you to Slide 2 of the presentation and to our Form 10-K filed a short while ago for important risk factors that could cause the company's actual performance and results to differ materially from those expressed or implied in any forward-looking statements. We undertake no obligation to update or revise any forward-looking statements or any other information provided on this call as a result of new information, future results or developments. I also want to inform you that Jim and Clay will be in San Francisco next month at an offsite event to the annual JPMorgan Healthcare Conference, to meet with institutional investors and business development partners. If you'd like to meet with them, please contact me to schedule. You'll find my contact information at the bottom of today's earnings press release. Thank you, Sanjay. Good afternoon, everyone, and thank you for joining us on our fiscal year-end call. I will start this afternoon with an overview of our results for the quarter ended September 30, 2022. I will then turn the call over to Dr. James Hayward, our President and CEO, who will discuss progress against our strategic initiatives. We will then open the line for questions from our analysts and institutional investors. Before my review, I would like to note that effective with the filing of our 2022 Form 10-K today, we are reporting segment data that reflects the results of operations for our three reportable segments which are comprised of: therapeutic DNA production, which is identified as LineaRx, our majority-owned biotherapeutic subsidiary; MDx or molecular diagnostic testing services and products, which is our ADCL Clinical Laboratory; and DNA tagging and security products, which is our supply chain traceability segment. Given the recent substantial growth in our clinical laboratory business as well as the evolution of our LineaRx subsidiary, the tools and processes put in place over the course of the fiscal year will enable the executive management team to manage the company's performance on a segment basis, assess expected future cash flows and make more informed decisions about each of our three business segments going forward. To begin, we are pleased to report continued quarterly year-over-year revenue growth for the fiscal fourth quarter as well as record revenues for the second consecutive fiscal year. Our revenue performance across both periods was driven by ADCL and its COVID-19 testing service and due primarily to the addition of a key testing client just prior to the start of this fiscal year. Operationally, we moved to optimize our cost structure and manage our expenses. A key component of our cost management program was to reduce the cost associated with our key COVID-19 testing contract. We are continuously monitoring and rightsizing our costs relative to this contract that has been extended through July of 2023. Turning to our consolidated results for the quarter. Total revenue was $3.6 million, an increase of 17% from $3 million in the prior fiscal period, reflecting a $1.3 million increase in ADCL COVID-19 testing revenues associated with our key clients that offset a decline in product and service revenues from other businesses totaling $782,000. The decline primarily reflects a decrease in sales of DNA concentrate to protect a textile supply chain as well as a decline in sales of our MDx test kits and supplies. Gross profit was $417,000 or 12% compared to $992,000 or 33% in the prior fiscal period. The decline in gross margin was primarily the result of a higher portion of clinical laboratory service revenue coming from managed services testing contracts that carry higher costs compared to ADCL's surveillance contract. To a lesser extent, the decline was due to a change in product sales mix as product revenues in the prior fiscal year period included sales of diagnostic test kits and supplies and DNA concentrate for textiles that are at a higher gross margin. Total operating expenses were $4.8 million compared to $5.5 million in the prior fiscal year period, reflecting the absence of a $822,000 impairment charge related to goodwill and the remaining net book value of intangible assets incurred in the prior fiscal year period that was associated with our 2015 Vandalia asset purchase, and to a lesser extent, a decrease in research and development expenses of $313,000. These decreases were offset by increases in insurance expense of approximately $209,000 and in bad debt expense of approximately $237,000 to reserve a customer balance that was deemed to be uncollectible. Our operating loss was $4.4 million compared to $4.5 million in the prior fiscal year period. Excluding noncash expenses, adjusted EBITDA remained relatively flat at a negative $3.4 million compared to a negative $3.3 million in the prior fiscal year period. Turning to our balance sheet. Cash and cash equivalents totaled $15.2 million on September 30th. Cash and cash equivalents include proceeds from an August public offering of common stock and two series of warrants for total net proceeds of $10.7 million as well as a subsequent warrant conversion for an additional net proceeds of $3.7 million. Accounts receivables stood at $3.1 million, the majority of which has just been collected. For fiscal 2022, our average monthly cash burn stood at $786,000, representing a 41% reduction from fiscal 2021, average monthly burn of $1.3 million, and is reflective of increased cash receipts as well as our cost management efforts. Our warrant balance increased as a result of the recent public offering. Our outstanding warrant balance on September 30 stood at $7.3 million. Approximately 2.2 million warrants have exercised prices ranging from $2.80 to $2.84 per warrant share. That would represent total proceeds of $6.2 million to the company, if exercised. The balance were $5.1 million warrants at an exercise price of $4 per warrant share, of which $2.1 million warrants expire in September 2023. I would like to note that also effective with the filing of the 10-K, we have alleviated the substantial doubt of a going concern on the company through the cash received from the August public offering and the warrant exercise as well as collection of our accounts receivable. We estimate that we will have sufficient cash and cash equivalents to fund operations for the next 12 months from the filing of our 10-K today. Cash and cash equivalents were $14.7 million on November 30. Additionally, we identified a material weakness in our internal controls over financial reporting as part of our â the annual audit. The material weakness is nonoperational, and it did not require restatement of any previously issued financial statements. The identified material weakness is related to controls around accounting for complex financial instruments, as it relates to the accounting for our outstanding warrants and the related tax impact. We are committed to maintaining a strong internal control environment, and are implementing procedures to help ensure this material weakness is remediated as soon as possible. Capital expenditures are projected to be less than $3 million, the bulk of which will be focused on development activities to support our two near-term go-to-market application for LineaRx's linear DNA platform, that Jim will address in his remarks. In parallel, we are pursuing nondilutive funding sources, including grants that may offset or supplement our projected spend. This concludes my prepared remarks. Thank you for joining us today. I hope you all have a happy and healthy holiday and New Year. I will now turn the call over to Jim for his comments. Okay. Thank you, Beth, and good afternoon, everyone. Thank you for joining us on our fourth quarter and year-end fiscal 2022 investor call. It was a strong year for Applied DNA, both from the perspective of revenue growth and operational execution. In fiscal 2022, our strategic priorities were: first, to maintain momentum and revenue after a record fiscal 2021; second, to advance our pivot to biotherapeutics, which we recognize as having the greatest opportunity to build long-term value for our shareholders; and third, to evolve our DNA tagging and clinical lab segments toward positive cash flows to support the value-creating potential of LineaRx, our biotherapeutics segment. To that end, the fourth quarter capped off a consecutive second year of record revenues in which we also recorded four consecutive quarters of year-over-year revenue growth. While our revenue performance was once again generated from COVID-19 testing, what is most impressive is that these record revenues were achieved while concurrently putting into place the potential drivers of continued growth beyond COVID-19. And I'll initially focus on our clinical lab, ADCL. As Beth noted, consolidated revenues were driven by ADCL and the acquisition of the key COVID-19 testing customer, just prior to the start of the fiscal year. Since the contract began, we have continuously aligned our operational model and costs with the fluctuating testing demand over the academic year. We continue to proactively manage costs to demand following the receipt of a one-year extension to our contract through July of 2023. Beyond its contribution to revenue, the expertise that we gained from high throughput COVID-19 testing, enabled our clinical labs to become tailored to serving large populations and enterprise customers as a population health platform, which is a key differentiator versus other clinical labs that focus on individual patient testing and payment from third-party payers. We ported this domain expertise to MPOX, which was previously known as Monkeypox, with the rapid design and approval of our own PCR MPOX test, which, at the time of development had a strong demand but which became almost irrelevant shortly afterward due to effective vaccines and changing social behavior. Nevertheless, we did gain additional valuable diagnostic development experience. The speed with which we develop the assay and obtained regulatory approval from the New York State Department of Health serves as a model for Applied DNA Clinical Labs going forward. We moved to expand ADCL's menu of diagnostic tests for a second time with the initiation of development for pharmacogenomics testing service, which once again we'll be marketing to large populations and enterprise customers. Now looking ahead to fiscal 2023, we are focused on new sales opportunities and incremental gross margin improvements in our ADCL segment. To this end, we'll continue to optimize costs associated with our largest COVID testing contract to maximize gross margins, coupled with the launch of a higher-margin pharmacogenomic testing, which should return higher margins relative to our COVID-19 testing. Now we're also cognizant of the shifting climate for COVID testing. ADCL has been, and is today prepared for a post-COVID world. The two largest cost centers for our COVID-19 testing services are the third-party providers who staff our testing locations for our key client throughout New York City, followed by our clinical laboratory staff. Our clinical staff is already cross-training on our pharmacogenomics assay. Costs associated with our third-party staffing can be terminated with 30 days' notice, without impacting the balance of ADCL's testing customers. Now our pharmacogenomics testing service is borne out of a lesson learned from our COVID-19 strategy, that is to open up new sales opportunities that specifically serviced large population and enterprise customers. Now, pharmacogenomics is a field of precision pharmacy that combines the science of pharmacology and genomics to understand how an individual's genetics may influence their response to drugs. It looks at specific genes to help determine the types of medicines and dosages that may be best for a patient, ensuring fewer adverse reactions, better drug response, and ultimately, more efficient treatments. All these benefits culminate in better patient outcomes and lower health care costs, especially for large populations. For these reasons, we are focusing on large cohort health care opportunities for pharmacogenomics, particularly regional health systems and large self-insured entities where the economic benefits of pharmacogenomic testing can really be substantial. Numerous published studies show that pharmacogenomics do help guide drug selection and dosage, and can significantly reduce both direct and indirect health care costs for an individual. While these potential individual savings are substantial, we believe the real benefit of pharmacogenomics comes to light when it's used in a large population, thus amplifying the potential individual health care cost savings across an entire organization or community. Several studies have shown that large-scale pharmacogenomics testing can drastically reduce an organization's overall health care costs, while at the same time, providing better care for each individual. Thus, by leveraging our unique large-scale population testing expertise honed from COVID-19, we believe we can offer a differentiated population health care, pharmacogenomics testing services that return significant value to larger organizations. Whereas our COVID-19 and MPOX assays are single target tests. Our pharmacogenomics panel interrogates 120 targets across 38 genes, making it a more complex development process. Initially, it was estimated to be submitted to the New York State Department of Health in October, but we now expect to do so by the end of January 2023. This slight delay is due to complications with our clinical validation partner, which we have since remedied. Subject to New York State Department of Health approval, we are targeting a late Q2 fiscal year 2023 commercial launch date. Now to our DNA Tagging segment. That has not yet experienced a rebound in demand post COVID. The recent confluence of cotton margins being squeezed and low cotton inventories resulting from the worst drought in a decade, blunted demand for DNA tag cotton. Nonetheless, we believe demand in this segment may return in fiscal year 2023. The Uyghur Forced Labor Prevention Act went into effect over the summer. The act identifies cotton and apparel as two of four high priority sectors for federal scrutiny. DNA Tagging and isotopic testing, two constituent components of our CertainT platform, were identified by guidelines issued by Customs and Border Protection as the key means of compliance with the Act. We entered into an exclusive partnership with our long-time isotopic testing partner to give us a best-in-class multilayered approach to supply chain traceability and assurance across the entirety of natural fiber-based value chains. Since implementation of the act, we have secured new certainty customers focused on isotopic testing initially as a means of demonstrating rapid compliance with the act, and we are now working to potentially move these customers to DNA Tagging. And to remind you, 20% of global cotton production originates in the Xinjiang province of China, the primary focus of the act. The remaining 80% of global cotton now also need to prove that it is not tainted with Xinjiang cotton and we are moving to access that 80%. Historically, demand for DNA Tagging and testing has been triggered by the authentication demands of American-grown Pima and Upland cottons. We've worked in collaboration with a world-leading cotton merchant and a manufacturer to brands. While the revenue stream has been irregular, the platform is proven and has been successful with both Egyptian and Australian cottons as well. The drought in the U.S. in 2022 highlighted our dependence on American cotton. I noted earlier that all cotton products entering the U.S. must comply with the UFLP Act. Consequently, for fiscal 2023, we have adapted our go-to-market strategy by moving along the cotton textile value chain and engaging with spinners, weavers and other supply chain participants who transact in substantial amounts of cotton annually, and each with a vested economic interest in delivering products compliant with the UFPL Act. We are in active discussions with participants in the textile value chain, and will report on new developments or new orders as they occur. Given this, we believe there is a significant operating leverage to be realized from potential new demand supported by the infrastructure we already have in place today. Now to LineaRx. In fiscal 2022, we focused on research and development activities to support our two near-term go-to-market applications for the linear DNA platform. The first, to produce linear DNA templates for in vitro transcription to enable the manufacturer of the mRNA therapies; and the second, to generate veterinary biologics, particularly linear DNA vaccines. Let me briefly summarize our achievements during this past fiscal year. We generated data showing that linear DNA makes for a compelling case as a template for a messenger RNA drug manufacturing over plasmids. Specifically, linear DNA holds a greater copy number advantage. It contains homogeneous poly T tail sequences that are necessary for the required poly A sequences in the RNA, and it removes the use of expensive restriction enzymes that comprise up to 5% of the total cost of goods for mRNA therapies. The data were sufficiently compelling to attract interest in proof-of-concept projects with several mRNA developers, with whom â we hope will evolve with us as we bring our cGMP capacity online. In addition, we published seminal data that showed for the first time that a linear DNA-based vaccine can mitigate tumor growth and can protect against live infectious virus and animal models. Moreover, we also work to optimize the in vivo delivery of linear DNA to increase its ease of administration via lipid nanoparticles or LNPs, moving away from the specialized administration via electro gene transfer. And during the year, we reported our first successful administration of a linear DNA construct in vivo using LNPs by a simple intramuscular injection in animals, which is a very important first step towards increasing the commercial viability of linear DNA. With these important milestones behind us, we now need a cGMP production capacity to grow our in vitro transcription templating business, and to get linear DNA veterinary vaccines into the clinic. Shortly after the close of the fiscal year, we committed to standing up a small-scale cGMP facility for the enzymatic production of DNA by the end of calendar 2023. We also received a full year commitment for quarterly delivery of linear DNA from a diagnostic customer. Moreover, we are leveraging valuable data generated and published during fiscal 2022 to progress linear DNA as both a prophylactic and therapeutic cancer vaccine platform for the growing veterinary health market. The veterinary immuno-oncology market is a particularly attractive target market for linear DNA. Market data suggests this market is projected for a three-fold growth by 2030, and we believe, linear DNA is well suited to address common veterinary cancers such as lymphoma, which represent up to 24% of all cancer in canines. Currently, we are conducting two additional LNP related studies. In one, we are working with Cornell University to test whether linear DNA encapsulated with an off-the-shelf LNP formulation, can elicit a successful immune response when delivered via intramuscular injection to an animal model. This is an important study. And if successful, would be the first time LNP encapsulated linear DNA, would be shown to be immunogenic, opening the door for both prophylactic and therapeutic LNP linear DNA veterinary vaccines. We expect initial data from this study late in the first half of the fiscal year. The study's second goal is to optimize an LNP formulation for use with linear DNA. We are currently working with a very well-regarded CDMO to screen numerous LNP formulations. The goal of the study is to identify or develop a cost-effective LNP formulation that maximizes linear DNA immunogenicity in vivo. Since linear DNA is much more stable than mRNA, we believe that we may be able to utilize non-IP-protected LNP formulations that may lower LNP costs. This study was kicked off just last month, with completion slated for the second half of fiscal 2023. In addition, we are also serving the marketplace for potential oncology and infectious disease targets that could be adapted for the linear DNA platform. As we've previously noted, our goal for veterinary vaccines is to gain USDA conditional approval, after which we would seek out to license the vaccine to a large veterinary health company. This is a common development pathway in veterinary medicine, which potentially minimizes therapy development costs and time lines. Finally, as we execute the platform's development plans and are today more fully armed with data to support the linear DNA platform. Strategic partnerships become increasingly relevant to this segment's future. We have established dialogues with other companies to the production of genetic medicines as well as with therapy developers. Of particular interest to us are companies that can amplify linear DNA's value proposition as a template for mRNA drug manufacturing and as a veterinary vaccine platform. We believe we are well positioned in two growth markets and we'll be seeking potential partnerships as part of our attendance at the JPMorgan Healthcare Conference held in January in San Francisco. Finally, in fiscal 2022, we strengthened our balance sheet to support our strategic priorities. As Beth noted, our balance sheet is at its healthiest and includes warrants that should our share price align with our business execution could serve as a capital efficient source of additional funding. Now just before we open the call to questions, let me offer a brief recap. We are seeking to sustain momentum in our topline in fiscal 2023, while we also moved to put in place the constituent components for long-term and profitable growth across each of our business segments. At LineaRx, we are putting in place the necessary foundation to address our target commercial markets with our linear DNA platform. We also expect to have in place a small-scale cGMP facility by the end of this calendar year â calendar 2023. At ADCL, we plan to launch our pharmacogenomic testing services late in Q2 of 2023, subject to New York State Department of Health approval, and we are currently laying the necessary groundwork to ensure a rapid launch and help drive market interest. For DNA Tagging, we are broadening our addressable market to take advantage of the UFLP Act and similar legislation being proposed worldwide. Finally, we have the capital necessary to execute on our near-term goals. Be assured that we are very focused on the value creation opportunity and the growth trajectory ahead of us. We will now begin the question-and-answer session. [Operator Instructions] Our first question is from Yi Chen with H.C. Wainwright. Please go ahead. Thank you for taking my questions. My first question is, could you give us some â your expectation with regard to potential annual revenue generated from pharmacogenetic testing service? Yes. It has not been our habit, Yi, to provide guidance, but we can tell you that our survey indicates there's a real vacancy in the pharmacogenomics, particularly in New York State. And we've spoken to very large health care networks who have shown in intense interest. So suffice it to say, we're excited and have great expectations. Okay. Thanks. My second question is, could you tell us how many biopharmaceutical companies are currently evaluating or have adopted the enzymatically produced linear DNA for their manufacture of genetic medicines? I don't have a precise number in front of me, but I would guess that number is in the neighborhood of 20, actively collaborating, and that covers the range and size from start-ups to well-established decades, old biotech firms. Well, we're encouraged by the amount of testing that we're doing when, of course, many of our competitors have stepped away from COVID testing, thinking that the pandemic was over. I can tell you it's not, and we are seeing high rates of positivity in the cohorts we're testing, and we are testing at a steady state, consistent with the revenues of last year. And we're hopeful that we'll stay at that steady state for at least in the next six to eight months. Hi, Jim. Thanks for taking the question. Can you talk a little bit about â I know you can't reveal specific partners for the linear DNA program, but the types of therapies â you had mentioned oncology, but is that more towards cancer vaccine? Or are there other approaches in there, including things like DNA-based antibodies, particularly checkpoints? Not that many groups have done that, and I wondered if linear DNA can be applied to molecules that large? Right. Well, we have been able to incorporate quite large open reading frames than our linear DNA system. And so, we think that the range of applications is extraordinarily diverse. We have customers with interest in cancer and redirected cell therapies and novel approaches to rare diseases and vaccines. And so, I think, of the applications that have so excited the marketplace for RNA, many of them or most of them are addressable with linear DNA. And of course, with greater stability â and in some cases, far fewer problems like double-stranded RNA or in homogeneous poly A or challenges in capping, so we're being very conservative, Jason, by starting out focused on IVT templates. But we also think that gradually, as we prove that linear DNA does not integrate into genomes and is expressed episomally, we think the range of applications will grow quite quickly. Can you â from a linear DNA-based RNA type approach, can you talk about what the interest level is in that area? Because, as you know, the, mRNA â obviously, RNA has captured everybody's attention because of COVID, but there are very specific reasons why it was successful as an infectious disease vaccine. They've never really been able to deliver it with great success anywhere else for a variety of reasons. Maybe DNA â linear DNA makes sense and solves that delivery problem and maybe there could be strong interest there? Or can you describe the level of interest around that type of approach? We can do things with linear DNA that you can't do with plasmids in terms of serving as a template. The flexibility we have with the chemistry of primers, the capacity to do unusual things like biotinylation, the fact that there is no restriction enzymes required in the processing of the RNA, the fact that we have a copy number advantage in linear DNA, have all proven motivating factors for the companies that are developing RNA drugs, both because of potential improvements in the RNA itself and in the consequent therapy and because of the opportunity for a decrease in cost and time. [Operator Instructions] Showing no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Dr. Hayward for any closing remarks. Okay. Thank you, operator, and thank you to our investors and fans of the company for joining us on our call today. On behalf of the management team, the Board and all of our employees, we're very grateful for your continuing support. We wish you the best of happy holidays and look forward to speaking with you again on our first quarter call. Thanks very much. Goodbye.
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EarningCall_1614
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Good day, ladies and gentlemen, and welcome to the Evertz Q2 of Fiscal 2023 Investor Call. At this time all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions] This call is being recorded on Tuesday, December 06, 2022. I would now like to turn the conference over to Brian Campbell, Executive Vice President of Business Development. Please go ahead. Thank you, Michelle. Good afternoon, everyone, and welcome to the Evertz Technologies conference call for our fiscal 2023 second quarter ended October 31, 2022, with Doug Moore, Evertz' Chief Financial Officer; and myself, Brian Campbell. Please note that our financial press release and MD&A will be available on SEDAR and on the company's Investor website. Doug and I will comment on the financial results and then open the call to your questions. Turning now to Evertz' results, I will begin by providing a few highlights, and then Doug will provide additional detail. First off, sales for the second quarter totaled $113.2 million, an increase of 5.6%, compared to $107.2 million in the second quarter last year. Our base is well diversified with the top 10 customers accounting for approximately 55% of sales during the quarter with no single customer over 15%. In fact, we had 98 customer orders of over $200,000 in the quarter. Gross margin in the quarter was $67.5 million, or 59.6%, which is within our target range. Investment in research and development during the quarter totaled $29.6 million. Earnings from operations were $28.4 million for the quarter, a 20% increase from the prior year. Net earnings for the second quarter were $20 million while fully diluted earnings per share were $0.26. Evertz' working capital was $154.1 million with bank indebtedness of $4.2 million as at October 31, 2022. Operational highlights for the quarter include Evertz' stellar presence at the International Broadcast Conference where Evertz XPS compact encoding decoding platform with 5G Wireless won the TV Tech Best of Show Award along with Evertz reflector cloud video platform - cloud video processing platform. And Evertz IO Stream was recognized with a TVB Best of Show award. This revolutionary new cloud-based Software as a Service video platform combines the technological and future requirements of traditional broadcast channels, conventional OTT channels and free ad supported TV fast channels into a single platform that supports file-based player, advanced live events, and a wide range of streaming inputs and outputs, including 4K UHD with HDR. In addition, September 15 was a historic night, which saw the NFL kickoff its first ever broadcast package carried exclusively on a streaming platform with Amazon Prime's Thursday night football. The broadcast also marked the launch of Prime1 arguably the most state-of-the-art mobile broadcast units built around as SMPTE ST 2022-7 IP routing core. Prime1 is fully redundant, and that redundancy starts with a pair of Evertz 400 gig EXE IP routing cores managed by Evertz MAGNUM control monitoring and analytics software. In addition, all the edge routing is handled by Evertz award-winning NATX fabrics switches. At the end of November Evertz purchase order backlog was an excessive $149 million and shipments during the month were $39 million. We attribute this strong financial performance and robust combined shipments and purchase order backlog to HD channel proliferation, the emergence of 4K Ultra-HD, increasing live content, increasing global demand for high quality video anywhere, anytime, the ongoing technical transition to IP, IT and cloud-based architectures, and specifically to the growing adoption of Evertz IP based software defined video networking solutions, Evertz IT and cloud solutions, our immersive 4K 8K UHD solutions and our state-of-the-art DreamCatcher IP replay and live production with BRAVO Studio virtual production control suite. Today, Evertz Board of Directors declared a regular quarterly dividend increased to $0.19 per share, payable on or about December 22. Thank you, Brian. Good afternoon everyone. Looking at revenues, sales were $113.2 million in the second quarter of fiscal 2023 compared to $107.2 million in the second quarter of fiscal 2022, an increase of $6 million quarter-over-quarter. For the six months ended October 31, 2022, sales were $214.8 million compared to $204.4 million in the same period last year. That represents an increase of $10.4 million or 5.1%. As it relates to revenues in specific regions, the U.S.-Canadian region had sales for the quarter of $88.3 million compared to $78.2 million last year. This represents an increase of $10.1 million or 13% quarter-over-quarter. Sales in the same region for U.S.-Canada were $166.5 million for the six months ended October 31, 2022, compared to $142.6 million in the same period last year, an increase of $23.9 million or 17%. The International region had sales for the quarter of $25 million compared to $29 million last year, a decrease of $4 million quarter-over-quarter. International segment represented 22% of total sales this quarter. For the six months ended October 31, 2022, sales in the International region were $48.3 million compared to $61.7 million in the same period last year, a decrease of $13.4 million. Gross margin for the second quarter was approximately 59.6% compared with 57% in the prior quarter and within our target range. For the six months ended October 31, gross margin was approximately 58.7% and also within our target range. Turning to selling and admin expenses. S&A was $14.7 million in the second quarter, a decrease of $0.1 million from the same period last year. Selling and admin expenses as a percentage of revenue were approximately 13% as compared to 13.8% for the same period last year. Selling and admin expenses were $27.7 million for the six months ended October 31, 2022, a decrease of $1 million from the same period last year. Selling and admin expenses as a percentage of revenue were approximately 12.9% over the period as compared to 14.1% for the same period last year. Research and development expenses were $29.6 million for the second quarter, which represents a $5.2 million increase from $24.4 million in the second quarter last year. Investment tax credits related to R&D expenses were $3.2 million in the quarter compared to credits of $2.9 million in the second quarter last year. For the six months ending October 31, research and development expenses were $57 million, which represents an increase of $7.9 million over the same period last year. R&D expenses as a percentage of revenue were approximately 26.6% over the period as compared to 24% for the same period last year. Foreign exchange for the second quarter resulted in a gain of $3 million when compared to a gain also in $2.2 million in the same period last year. The quarterly gain was predominantly resulted the increase in the value of the U.S. dollar against the Canadian dollar between July 31 and October 31 of 2022. Foreign exchange for the six months ended October 31, 2022, were the gain of $4 million, thatâs compared to a gain of $3.6 million same period last year. Turning to a discussion liquidity of the company. Bank indebtedness as of October 31, 2022 was $4.2 million thatâs compared to cash of $33.9 million as at April 30, 2022. Working capital was $154.1 million as at October 31, 2022, compared to $158.9 million at the end of April 30 2022. Looking now specifically at cash flows, the company used cash and operations of $7.7 million, which is net of $33.1 million change in non-cash working capital and current taxes, a change including a quarterly increase of inventory of $7 million and the combined decrease in accounts payable and deferred revenue of $25 million. If the effects of the change in non-cash working capital and current taxes are excluded from the calculation, the company generated $27.5 million in cash from operations during the quarter. The company used cash of $5.6 million for investing activities in the quarter, which was principally driven by $2.4 million in acquisition of capital assets and $3.2 million in purchase of investments. The company used cash in financing activities of $16 million, which was principally driven by dividends paid to $13.7 million. Finally, Iâll review our share position as at April 31, 2022. Shares outstanding were approximately $76.2 million, and options outstanding were approximately $4.9 million. Weighted average shares outstanding were $76.2 million and weighted average fully diluted shares outstanding were $76.4 million for the quarter ended October 31. That brings to a conclusion of the review of financial results and position for the second quarter. Finally, I would like to remind you that some of the statements presented today are forward-looking, subject to a number of risks and uncertainties, and we refer you to the risk factors described in the annual information form and the official reports filed with the Canadian Securities Commission. Brian, back to you. Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from Thanos Moschopoulos of BMO Capital Markets. Please go ahead. Hi, good afternoon. Brian, could you comment on the spending environments? I mean, obviously you had a nice uptake in revenues this quarter versus the prior quarter, backlog and November shipment seemed healthy, but more broadly, I mean, given that thereâs a lot of macro uncertainty out there how are your customers responding? Have you seen any change in customer behavior in recent weeks or has it been kind of status quo in that regard? Yes. Overall, our demand environment continues to be very robust. You can see that we have a solid back over - backlog - order backlog of $149 million along with our $39 million shipments in the first month. So weâre cognizant of the macro environment as our customers. However, weâre very well positioned within an extremely robust business model and a large backlog to be able to handle macro uncertainty. With respect to the international, itâs down correlate year-over-year, but strong trailing 12 months and up sequentially. So thatâs a good solid indication for us as well too. But on that point, I mean, clearly international has been significantly lagging to growth youâve seen in North America. Would that be a function of maybe a different macro dynamic? Is that just lumpiness in the projects that they kind of come? Is it deployment issues still with lingering COVID restrictions? What would you attribute that to? Itâs actually all of the above factors that youâve noted have contributed to. Weâve got a solid international business in certain regions, specifically there is definitely lumpiness to the delivery. Weâve done very well with some large customer orders that youâve seen, play out Mediaset being one of them over multiple years and thatâs, quite a high profile delivery that weâve had ongoing. And yes, there are continue to be challenges delivering in certain regions, whether itâs due to macro uncertainty or COVID restrictions as well too. So all those things, play into it. However, we have had a good solid trailing 12-months. If you look at an average, itâs can be lumpy quarter-to-quarter, but itâs just under 30% of the revenue in total. Okay. Has supply chain been getting any better or would you describe the status being consistent as far as component availability relative to last quarter? Yes, I mean from a quarter-to-quarter basis, itâs still a represents significant challenge to be honest. But we are seeing some vendors with lead time improvements and, improvements on deliveries, but at the same sense, other ones, itâs weâre seeing no improvements at all. So thatâs really has why weâre sitting with $23 million more in raw materials this year ends and even $40 million since the last of October. So weâve continued to stockpile raw materials as it continues to be a challenge. And finally the gross margin was obviously very strong. Is that just reflective of the mix during the quarter? Is there anything, youâd call out that the - margin? Yes, I mean as thereâs always including, anything with the mix. There is some larger projects that are higher margin that were completed during the quarter, youâll see a corresponding decrease in deferred revenue to kind of align with that. But really its product mix and what was delivered and signed off in the quarter. Hi, do you remind us what the target range for gross margins is? I think 56% to 60% or you just remind? Yes, I mean, thereâs always some fluidity to itâs been on the mix of itself, but if I - there were a couple larger projects that were signed off in the quarter that were higher margin in nature. So that wouldâve been a partial reason of the uptick on the higher end of the range. Right. Is that like a cost matching thing? Or is it like just a mix of the product? Is it more software related? More⦠Okay. The - on the macro, are you seeing any delays on signing deals? It sounds like youâve got large projects that are closing. Are you seeing any delays on large projects or any reticence on the part of your larger customers that are signed larger deals to sort of get those across the line? And that has been ongoing for the last couple of years that there have been large projects delayed. However, we do have very significant projects that continue to move forward with our customers and thatâs what weâre focusing on delivering for them to keep their business plans moving ahead at the pace that they need. Okay. So itâs more consistent with what youâve seen over the last couple of years as opposed to any big change? Okay. Maybe you could talk a little bit about access to customer sites. I know thatâs been an ongoing issue. Has that improved material or is there anything you call out there? It remains consistent. So in North America, we've had good access; and internationally it still can be a challenge in certain areas. And we've been managing through it and - but there has been no significant change since last quarter. Okay. Notable the cash, you have net debt this quarter, I think you have to go back to 2008 or so to see something like that in your financials and at the same time that you're raising the dividend. So I'm curious about those two things having at the same time is right change in the way you think about your - the structure of the business? Or are you going to carry a larger amount of debt? Or is the set of that $75 million revolver, I think you have? So the $75 million revolver is able to cover the current indebtedness. And there's definitely like we - like I said, we've stockpiled quite a fair amount of inventory, like we've increased raw materials by $40 million in the past 12 months. There's some timing to the - if you look at our payables, deferred revenue, we used to pull those came down quite a bit, so there's a cash flow impact there. But the expectation is with carrying on business as is, the indebtedness would go away in the next quarter or so. Okay. So same as it happened in 2008. Okay. And then the $3.2 million in acquisitions, I didn't have a chance to go through the MD&A. I don't know if you discussed it in there. Maybe just give some color on what that is? Thank you. There are no further questions at this time. I will now turn the call back to Brian Campbell for closing remarks. Thank you. Iâd like to thank the participants for the questions and add that weâre very pleased with the companyâs performance during this second quarter of fiscal 2023, which saw strong quarterly sales of a $113.2 million, solid gross margins of 59.6% in the quarter. We are entering into the second half of fiscal 2023 with significant momentum fueled by a combined purchase order backlog plus November shipments totaling in excess of $188 million. With Evertz significant investments in software defined IP, IT and cloud technologies, the over 500 industry-leading IP, SDVN deployments and the capabilities of our staff. Evertz is poised to build on our leadership position in the broadcast and media technology sector. Thank you everyone and good night. Ladies and gentlemen, this does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.
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EarningCall_1615
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Good morning, and welcome to the Mercantile Bank Corporation Fourth Quarter 2022 Earnings 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 note that this event is being recorded. Good morning, everyone, and thank you for joining Mercantile Bank Corporation's conference call and webcast to discuss the company's financial results for the fourth quarter and full year of 2022. Joining me today are members of Mercantile's management team, including Bob Kaminski, President and Chief Executive Officer; Chuck Christmas, Executive Vice President and Chief Financial Officer; and Ray Reitsma, Chief Operating Officer and President of the Bank. We will begin the call with management's prepared remarks and presentation to review the quarter's results, then open the call to questions. Before turning the call over to management, it is my responsibility to inform you that this call may involve certain forward-looking statements such as projections of revenue, earnings, and capital structure, as well as statements on the plans and objectives of the company's business. The company's actual results could differ materially from any forward-looking statements made today due to factors described in the company's latest Securities and Exchange Commission's filings. The company assumes no obligation to update any forward-looking statements made during the call. If anyone does not already have a copy of the fourth quarter 2022 press release and presentation deck issued by Mercantile today, you can access it at the company's website at www.mercbank.com. Mercantile released its December 31st financial results this morning, which reported another strong quarter, finishing 2022 with continued success in numerous performance metrics. Highlights for the fourth quarter include: continued increases in net interest margin rising to more normal ranges for Mercantile, which drove strong profitability in the quarter; solid growth in many fee income categories; continuation of our strong asset quality; disciplined control of overhead expenses; and while loan growth was dampened by some loan payoffs, customer relationship building by the sales staff continued to generate successes and pipelines remained strong. For the fourth quarter, Mercantile produced earnings of $1.37 per share on revenues of $58.4 million. Full year 2022 earnings were $3.85 per share on revenues of $190.3 million. This morning, we also announced a cash dividend of $0.33 per share, payable on March 15, 2023. This represents a 3% increase over the fourth quarter dividend. Ray will have more information on the loan portfolio, fee income and other operational topics, and Chuck will provide more detail on overall financial performance for the quarter and full year, as well as some guidance on our performance in 2023. The Michigan economy continues to perform at a level we would describe as steady. Unemployment is only slightly higher at 4.3% in November compared to 4.1% at the end of the third quarter, but lower than what it was at January 01, 2022, when it was 5.1%. Mercantile bankers and our clients continue to prepare and position for a potential economic downturn of some sort. Customers have been able to absorb higher interest costs thus far. This seems to reflect the strong balance sheets and robust performance coming out of the pandemic. The real estate sector, most notably multifamily housing, has demonstrated some signs of reduced activity toward the end of 2022 as a result of higher borrowing costs and the level of new projects has slowed. Our overall pipeline, however, remains very healthy. Our team continues to diligently monitor our client base and engage our borrowers, so that we understand their financial condition and any challenges they may be encountering. We remain very pleased with the performance of our customers and their ability to navigate in economic slowdown. Should difficulties arise, however, the deep customer knowledge of our bankers allows them to provide meaningful feedback and counsel to assist the borrowers and ultimately help manage risk for the bank. The loan portfolio, however, continues to be very strong. While our senior management team is keenly focused on maneuvering through near-term economic conditions, we eagerly look forward to the future with much anticipation to craft strategies for long-term sustainability and success of our company. Our team ensures comprehensive plans are in place to create, develop and leverage opportunities for growth and excellence in performance in our existing markets as well as potential new markets. An important key to future success is maintaining the steady pipeline of new talent entering our organization and the ongoing development and training of all employees so they can help us achieve our strategic initiatives. Relationship-focused banking allows us to understand the clients' immediate and long-term needs and design and implement products to fulfill those needs. Attainment of these objectives allows our company to provide best-in-class service to our customers, demonstrate peer-leading performance and provide attractive returns for our shareholders. In closing my initial comments, I want to thank the Mercantile team for their excellent work in the fourth quarter and throughout 2022. Each day our staff members engage our clients and demonstrate the Mercantile way of relationship banking. Consumers and businesses have seemingly endless choices for their financial needs. For 25 years, customers and our markets have discovered the benefits of banking with Mercantile. As a result, Mercantile has grown consistently and profitably for its shareholders and proven to be a strong partner for the communities we serve. Core commercial loan growth for the year is 7% despite a contraction of 2% annualized in the fourth quarter. This contraction is attributable to payoffs of $39 million resulting from asset sales, $24 million from refinancing to the secondary market, and $39 million paid down from excess cash flow or cash reserves. Our commercial backlog has grown sequentially over the last four year-ends and over each of the last four quarters, and currently resides at a four-year high. The pipeline for commercial construction commitments that we expect to fund over the next 12 to 18 months totals $197 million compared to $170 million last quarter. Presently, line of credit utilization is 42% compared to 37% a year ago. However, bank commitments in aggregate have increased $385 million or 21% over the past year. The portfolio is well positioned for a rising rate environment, as 65% of the portfolio is comprised of floating rate loans, up from 50% at March 31, 2021, accomplished largely through our swap program. Asset quality remained strong with nominal amounts of past due loans and non-performing assets of 16 basis points of total assets compared to 3 basis points last quarter. A single addition to non-accrual loans accounted for 90% of the increase to non-performing assets during the quarter. The deterioration of the C&I credit is attributable to an isolated management failure rather than stress in the industry or the general economy. While we are proud of our outstanding asset quality metrics, we remain vigilant in our underwriting standards and monitoring efforts to identify any sign of deterioration in our loan portfolio. Our lenders are the first line of defense to recognize areas of emerging risk. Our risk rating process is robust with an emphasis on current borrower cash flow and our rating model, providing sensitivity to any challenges evolving within a borrower's finances. All that said, our customers continue to report strong results to-date and have now begun to experience impacts of a potential recessionary environment. We continue to closely monitor concentration limits within our loan portfolio. The mortgage business has slowed due to the rising rate environment, seasonality and lack of available housing inventory in the markets we serve. Higher rates have led to more demand for adjustable-rate mortgages, and the lack of inventory has led to more construction lending activity. We hold each of these types of loans on our balance sheet and, as a result, residential mortgages have increased 60% over the prior year. Compared to a gain on sale event and immediate recognition of income, a portfolio loan takes about 24 months to generate an equal amount of income. We continue to pursue share in the purchase market with originations in the fourth quarter decreasing 36% compared to the fourth quarter last year due to the increase in mortgage rates since that time. Availability under residential construction loans is $72 million this quarter compared to $59 million one year ago. Refinance activity is just 13% of last year's comparable quarter. Noninterest income for the fourth quarter is down 38% compared to the fourth quarter of 2021. The primary contributor to the overall reduction was the previously described decrease in mortgage banking income of 75%, which more than offset a 5% increase in service charges on accounts, a 23% increase in payroll services, a 7% increase in credit and debit card income and a 47% increase in swap income. The optimization of our branch network is an ongoing endeavor that has yielded seven-figure annualized savings. Utilizing tools such as appointment banking, limited-service branches, live ATM machines and branch consolidations complemented by investments in our remaining facilities resulted in a nominal deposit attrition in the impacted markets. We have added commercial and mortgage lending talent in Saginaw and Traverse City markets, and plan to establish loan production offices in those markets in the near future. As noted on Slide 10 of our presentation, this morning we announced net income of $21.8 million or $1.37 per diluted share for the fourth quarter of 2022 compared with net income of $11.6 million or $0.74 per diluted share for the respective prior year period. Net income for the full year 2022 totaled $61.1 million or $3.85 per diluted share compared to $59 million or $3.69 per diluted share during the full year 2021. Higher net interest income, stemming from an improving net interest margin and ongoing strong loan growth, combined with continued strength in asset quality metrics and increases in treasury management fee income revenue streams, more than offset a significant decline in mortgage banking revenue, as industry-wide originations come off the record levels of 2020 and 2021, which were driven by low mortgage loan rates and resulting refinance activity. Our earnings performance in the 2021 periods also benefited from lower loan loss provisions, reflecting improved economic expectations. Turning to Slide 11. Interest income on loans increased significantly during the 2022 periods compared to the prior year periods, reflecting an increase in interest rate environment and strong loan growth in core commercial and residential mortgage loans. Our fourth quarter loan yield was 93 basis points higher than the third quarter and 142 basis points higher than the fourth quarter of 2021. The yield on loans during the full year 2022 was 44 basis points higher than the full year 2021, as the increase in interest rate environment impact didn't start in earnest until the second quarter of 2022, and the 2021 period was significantly impacted by PPP net loan fee accretion. Interest income on securities also increased during the 2022 periods compared to the prior year periods, reflecting growth in the securities portfolio to deploy a portion of the excess liquid funds position and the higher interest rate environment. Interest income on other earning assets, a vast majority of which is comprised of funds on deposit with the Federal Reserve Bank of Chicago, also increased during the 2022 periods compared to the prior year periods, generally reflecting the higher interest rate environment. In total, interest income was $21.2 million and $38.3 million higher during the fourth quarter and full year 2022 when compared to the respective time periods in 2021. We recorded increased interest expense on deposits during the fourth quarter of 2022 compared to the fourth quarter of 2021 in large part reflecting the increase in interest rate environment and enhanced competition for deposits. In comparing the full year 2022 to the full year 2021, we recorded an increase in interest expense on deposits, as deposit rates increased primarily during the latter part of 2022 and average interest-bearing deposit balances grew about 4%. Interest expense on other borrowed money increased during the fourth quarter of 2022 compared to the fourth quarter of 2021 and grew during the full year 2022 compared to the full year 2021. The increases largely reflect interest costs associated with $90 million in subordinated notes issued between December of 2021 and January of 2022, and higher rates on our floating rate trust preferred securities. In total, interest expense was $3.1 million and $4.2 million higher during the fourth quarter and full year 2022 when compared to the respective time periods in 2021. Net interest income increased $18.1 million and $34.2 million during the fourth quarter and full year 2022, respectively, compared to the same time periods in 2021. We recorded a credit loss provision expense of $3.1 million and $6.6 million during the fourth quarter and full year 2022, respectively, compared to a negative provision expense of $3.4 million and $4.3 million during the respective time periods in 2021. The provision expense recorded during the 2022 periods was necessitated by the net increase in required reserve levels stemming from changes to several environmental factors that largely reflected enhanced inherent risk within the commercial loan and residential mortgage loan portfolios, as well as loan growth and increased specific reserve for certain distressed loan relationships. A higher reserve for residential mortgage loans reflecting slower principal prepayment rates and the resulting extended average life of the portfolio also impacted provision expense during 2022. The negative provision expense recorded during the 2021 periods mainly reflected reduced allocations attributable to improvement in both current and forecasted economic conditions and net loan recoveries, which more than offset required reserve allocations necessitated by loan growth. Overhead costs decreased $4.8 million during the fourth quarter of [2002] (ph) compared to the fourth quarter of 2021 and were down $2.9 million for the full year 2022 when compared to the full year 2021. Adjusting for charitable contributions to the Mercantile Bank Foundation, overhead costs decreased $1.8 million during the first quarter -- fourth quarter of 2022 compared to the fourth quarter of 2021 and were down slightly for the full year 2022 compared to the full year 2021. Salary and benefit expenses declined during the 2022 periods, mainly from lower compensation related costs, in large part reflecting lower residential mortgage lender commissions, reduced stock-based compensation costs, and higher residential mortgage loan deferred costs. Regular salary costs, primarily reflecting annual merit pay increases and market adjustments, and bonus accruals were higher in the 2022 periods. Continuing on Slide 14, our net interest margin was 4.30% during the fourth quarter of 2022, up 74 basis points from the third quarter of 2022 and up 156 basis points from the fourth quarter of 2021. The improved net interest margin is primarily a reflection of an increased yield on earning assets, in large part reflecting an increase in interest rate environment in 2022 as well as strong loan growth. As I noted earlier, we recorded increased interest income on loans during the 2022 periods compared to the 2021 periods, which was achieved despite a significant reduction in PPP net loan fee accretion. During the full year 2022, PPP net loan fee accretion totaled $1.0 million compared to $10.8 million during the full year 2021. Our average commercial loan rate increased 252 basis points during the full year 2022, a significant increase at a loan portfolio that averaged $3.1 billion during that time period. Given the asset sensitive nature of our balance sheet, which includes 65% of our commercial loan portfolio comprised of floating rate loans, any further increases in short-term interest rates will have a positive impact on our interest income. After increasing only about 3 basis points per quarter over the past three quarters, our cost of funds increased 17 basis points during the fourth quarter of 2022. Despite the increase in interest rate environment, our deposit rates and those of our competitors were not meaningfully raised during the first nine months of 2022, which we believe reflected a relatively low level of competition for deposits given the excess liquidity positions of most financial institutions. However, as interest rates continue to rise and excess liquidity positions decline and end, deposit rates are now increasing and we believe deposit rate betas will ultimately return to historical levels. We remain in a strong well-capitalized regulatory capital position. Our total risk-based capital ratio and all of our bank's regulatory capital ratios were augmented about a year ago with an aggregate $90 million in issuance of subordinated notes, of which a vast majority of the funds were downstreamed to the bank as a capital injection. As of year-end 2022, our bank's total risk-based capital ratio was 13.7% and was $166 million above the regulatory minimum threshold to be categorized as well-capitalized. In regards to our thoughts on -- for 2023, on Slide Number 18, we share our latest assumptions on the interest rate environment and key performance metrics for 2023 with the caveat that market conditions remain volatile, making forecasting difficult. This forecast is predicated on 25 basis point increases in the federal funds rate at the next two FOMC meetings and then unchanged for the remainder of 2023. This forecast also assumes no significant recessionary pressures. We are projecting total loan growth in the range of 7% to 9%, with commercial loan growth itself of around 5%. While our commercial loan pipeline remains strong, we experienced a high level of payoffs and paydowns in 2022, especially in the latter part of the year. We are forecasting our first quarter net interest margin to decline from the just-completed fourth quarter, as expected increases in our cost of funds more than offsets further increases in asset yields from the FOMC interest rate decisions. For the remainder of 2023, we project our net interest margin to further gradually decline as our asset yield remains stable, but our cost of funds continues to increase from competitive pressures and growth in interest-bearing liabilities to fund expected loan growth. In closing, we are very pleased with our 2022 operating results and believe we remain well positioned to continue to successfully navigate through the myriad of challenges faced by all of us. Thank you, Chuck. That concludes management's prepared remarks this morning, and we'll now open the call up for the question-and-answer period. We will now begin the question-and-answer session. [Operator Instructions] And our first question here will come from Brendan Nosal with Piper Sandler. Please go ahead, sir. Maybe just to start off on kind of the balance sheet side of things as you look ahead. Maybe just talk about your expectations for deposit flows as we move through 2023? And then, maybe tie that together with your ability to grow loans of that 7% to 9% clip [indiscernible] in the context of your loan to deposit ratio at 106% today? Yes, Brendan, this is Chuck. I'll take a swing at that one. So, clearly funding is back in vogue. Certainly, it was something that this company was very familiar with throughout its history up until the last couple of years, which obviously, virtually every financial institution saw itself with a strong level of excess liquidity. We worked through that primarily through funding loan growth that we've had over the last couple of years. We did enhance our securities portfolio a little bit. And then, more recently, we are starting to see depositors use their funds. Although I will say in December of each year and this follows into January, we do typically see some meaningful reductions as our commercial customers pay taxes and tax payments as well as bonus payments. But clearly, that's going to be -- one of our primary jobs as we get into 2023 here and likely beyond is getting back into the -- our ability to efficiently and effectively build our liabilities of the balance sheet instead of being able to rely on the asset side, primarily our funds at the Federal Reserve Bank of Chicago to fund any increases in our total assets. So, we have -- even though we had all that excess liquidity over the last couple of years, we have never taken our foot off the -- we need to grow deposits [title] (ph). We knew that the excess liquidity was going to dry up at some point in time, it was just a matter of when. So, we have been enhancing our deposit relationships, bringing in new deposit relationships throughout this period, and that's something that, obviously, we'll continue to strive to do. We also get meaningful deposit growth with our growth in our commercial loan portfolio, especially on the C&I credits when they bring over their operating accounts and, obviously, we try for ancillary business owner and management accounts as well. I wish I had a silver bullet. I wish I think every CFO or management seem to wish to have a magic bullet when it comes to deposit growth. But a lot of it is just kind of, as I mentioned, keeping the foot on the gas pedal. It's a job for everybody, not just our branch and treasury management staff, but we expect every sales employee here at the bank to help us grow our deposit base. We think there are some opportunities in some of the markets that we're in and some of the deposit products offerings that we have. So, we're in the process of enhancing some of our products, looking at some markets and types of depositors that maybe we didn't spend as much time on historically in an effort to fund any asset growth that we do have. All right. Awesome. Thank you, Chuck, for all the color. Maybe just one more for me. Just on the margin, perhaps more conceptually, I definitely appreciate the detailed guide here, I guess what would be better for the margin once the Fed has done raising rates? Would it be stability in short-term rates for a period of time? Or would it be better if they cut rates sooner? I think from a pure margin standpoint, it would be better if they hung on to rates for a while. Clearly, our margin has improved dramatically with the big increase in interest rates. Although I think it's important for us to remember that those rates came off incredibly low levels, which in fact had a pretty negative impact on bank net interest margins. Ours is -- I can vouch for over the last three to five years, pre-COVID days, and into the COVID period. So, I think that it would seem that unless there's a significant recession coming, if the Fed does decide to start reducing rates, we don't think that they're going to get down to where they started from before. So, there would be some reduction in interest rates. It would have some negative impact on our company. But to the degree that the Fed holds rates steady or it has a slight decline in the future, that would be better on our net interest margin and certainly if they got very, very aggressive in cutting rates. I think that being said, clearly one of the things that we keep an eye on, and Ray already kind of touched on a little bit, is what is the impact that the Fed is doing on the economy and more specifically to Mercantile, what does that doing to our commercial customers and our retail customers as well, and clearly their ability to pay existing debt and what type of impact that has on future decision making as that could impact loan growth opportunities as well. So, clearly changes in interest rates have an impact on our net interest margin, but we certainly aren't going to take our eye off the fact that, that can also have a pretty big impact on our asset quality as well. Maybe just a follow-up on the balance sheet management question. So, given where -- as Brendan mentioned, you had at 106% on loan/deposit ratio. Do you -- I think last quarter you said 100% to 105% is kind of where you wanted to be. Does that mean you expect to see the balance sheet grow kind of in line with loan growth going forward? And then, I guess, along with that, is there a breakeven point or how are you thinking about the ability to -- or your loan growth, given the ability to fund that -- I mean, if you're continuing to see net interest -- noninterest-bearing deposits come off and you've got to fund that with CDs or wholesale deposits, is there a breakeven point where you would perhaps take the foot off the gas on the loan growth side? Yes, I'll answer the first part, and let the guys chime in on the second part from an overall strategy standpoint. But you're right on. We desire to have our loan to deposit ratio somewhere between the 100% and 105%, which as you noted, we're pretty much there. So, our expectation is that if we do have additional growth on the asset side, which we certainly expect, is that a significant portion of that's going to have to be funded. On the liability side, and it's our druthers to certainly make sure that that's core deposits as much as we can, trying to stay away from wholesale funds to the degree that we can, but that's going to be based on the success of growing our deposit franchise. So, we typically -- and I kind of mentioned it before in December, but we typically see deposits decline. It's seasonal for us. Because of our strong -- our large commercial focus and because of the payments that we see for taxes and bonuses come out at the end of the year and the early part of the first quarter of each year, we generally do see a deposit decline this time of year and then that builds up over time as well. So, we expect some of that natural seasonality to help us out a little bit as we go into 2023. But clearly, that's -- as I mentioned before, that's going to be a big challenge of all banks, and I think that's what we're seeing now with deposit rates escalating. Definitely, there was some lag going on there and, a large part, deposit rates are maybe getting back to where maybe they should have been using historical betas in that type of analysis as well. But it's going to be a battle out there for deposits. And what we're going to strive to do is make sure that we can bring in those deposits when we need them, again as efficiently and as effectively as we can. Chuck gave some color as far as the annual cycle as to what our deposits do. But on a longer-term basis, Mercantile has been through these cycles previously where interest rates rising, interest rates falling, deposits being in high demand. And we've demonstrated an ability to cope with ideas and plans to be able to make sure that we don't need to take the foot off the gas pedal at all from a loan growth standpoint. That's been the nature of our company for a long, long time is commercial loan growth, overall asset growth. And so, we do the things that we need to do to make sure that, that continues to be the case, and we have some ideas that we're working on to be able to come up with different flavors of deposits and things that are specific to certain markets or certain types customers that can help overall funding of that ongoing loan growth. Okay. I appreciate that color. And then, switching gears here. Just on the fee income guidance, it seems like a decent drop. I know you talked about it a little bit in the prepared remarks, but from the fourth quarter level, the first quarter guidance is below kind of what I was expecting. Maybe you could talk a little bit more about what's driving that? And then, kind of as it goes throughout the year, what you may be looking for? Yes, I think there's two things going on there, Danny. One is just the seasonality of mortgage lending. You're in the Midwest. There's just not a lot of activity in January and February when it comes to buying and selling homes, and, of course, that's what we're relying on, certainly lot more than refinance. Although with rates -- with the long end of the curve doing what it's doing, it's going to be an interesting time when it comes to -- are there going to be some refinance opportunities from people that have gotten mortgage loans in 2022. So that's a big part of it. The other thing that we're seeing is in service charge income. One of the big calculations in that is the earnings credit rate. And with interest rates going up, we have had the need more recently to go ahead and increase that earnings credit rate, which effectively brings our service charge income down. That earnings credit rate, which is kind of set right along with our deposit rates, while rates were increasing last year, it really wasn't until the fourth quarter that we had to increase the earnings credit rate and we've had to do that again just kind of like lock, stock and barrel with the deposit rates. So, there's a little bit of -- it's still going to be strong. We're just not going to see the very strong loan -- fee income growth that we saw on service charge income. Okay. But the increase in the swaps in the fourth quarter, is that -- are you still thinking that's going to be a similar number or that comes down to what we saw more in the middle of the year as well? Yes, that one's pretty hard to -- it's kind of like investment banking. It kind of comes and goes and it's hard to project on a quarter-by-quarter basis. I pretty much just straight line it in my budget, and just to let you know we've got about $200,000 budgeted each month. But again, that's -- there's a lot of volatility in that number, but we definitely see interest in that product. And I think that if medium- and long-term rates keep declining as they have, I think there'll be even more interest in that product. It's our desire of not offering fixed rates to larger commercial real estate products, and to put them into the swap product if in fact they want a fixed rate. So that's really driven by the borrower and their decision as to what type of rate structure they want to have. First question for me. Just looking at the forecast for overhead costs in 2023, curious, one, does that include any charitable contributions? Okay. And then, just looking at 2022, you had contributions, I believe, in the second quarter and fourth quarter. Would you like spec something in those quarters? Or I guess, how do you guys determine the timing and magnitude of those contributions? Yes. Typically, Erik, what we look at is in the fourth quarter, when we see how the bank and the company has performed from an earnings perspective and, obviously, making sure that we're comfortable for asset quality and our capital levels, we typically make the decision in the fourth quarter. But we also -- if things happen during the year, if we have some maybe some non-core income come into the company, we may, at that point in time, go ahead and add additional contributions. But generally speaking, it will be a fourth quarter event, notwithstanding any one-time events during the year. Makes sense. Thanks, Chuck, for the color there. And maybe I guess another one for you. Just looking at the forecasted range for those costs -- total overhead costs in the first quarter of '23, if I look at the run rate from the most recent quarter and back out that charitable contribution, it seems like you're forecasting kind of flat to maybe even potentially $1 million better on that run rate. So, just curious where that leverage is, or where you could see some improvement quarter-over-quarter? Yes. Most of that comes in our bonus accruals with the strong year that we had and, obviously, finished up with. We asked the -- executive management team asked the compensation committee to enhance our bank-wide bonus program. So, we had some -- which we doubled actually for non-senior management. And so, we had some catch-up accruals we needed to do in the fourth quarter associated with that doubling of the bank-wide bonus program. Got it. Thank you. And then, switching gears towards credit. One, if you could remind me the industry of that larger kind of commercial NPA that you referenced that the management failure? And then, I guess, what's the remediation strategy and timing for a resolution on that credit as well? This is Ray. That was an automotive supplier. We're working with the company through a number of remediation steps. We expect that we'll have a pretty good resolution to this, I would say, within the next 90 to 120 days. Okay. Thanks. And then, just thinking about the loan loss provision for 2023, let's, I guess, kind of assume that the Moody's forecast doesn't change materially and that there's not any material deterioration in the remaining credit in the portfolio. How -- given the outlook for 7% to 9% annualized loan growth and that mix being a mix of both commercial and residential, how are you providing for each dollar of new loan growth today? Yes. Everybody -- somebody had to bring up my CECL friend, but we have to provide a lot more on the residential side as a percentage of the loan balance than we do on the commercial side, primarily given the duration. Really kind of what we're looking at assuming no significant changes in the credit, obviously, no recession, a nominal level of net loan charge offs, we kind of expect that we'd be providing for maybe 1 basis point or 2 basis point of increase in the reserve coverage ratio as we worked our way throughout the year. Hey, good morning, guys. Thanks for taking my question. Most of my questions have been asked and answered. But just to circle back on the LPO strategy, could you just kind of go back over the locations and the timing regarding those? Sure. We hired some talent in Saginaw, Michigan in the middle part of the year and have been seeking to establish a physical location. Those people are currently working out of their homes. So, we've begun to enjoy some asset growth in that market. Similarly in Traverse City, Michigan, where we've hired a commercial loan manager who we expect will grow a team out there. We do have a mortgage presence there, and are in the process of securing a physical location to go with the personnel. So, we have had a commercial loan presence in Traverse City for some time, and we're seeking to augment that. So, we're both in each market in the early stages of growing out into a more physical presence from -- early presence that basically originated from people working out of their homes. Great. Thank you. And then, with respect to the lending opportunities that you're seeing, kind of tough to pinpoint the exact percentages here, but how would you characterize the opportunities coming from market disruption where you're taking market share from other customers from -- that have been associated with banks that have been acquired versus increased credit demand from current customers? I would characterize it that the majority -- trying to further -- think of the right adjective here. I'd say, if I just had to throw a fraction on it, somewhere in the two-thirds of new growth is coming from disruption in the market. Some of the larger players that we compete against are having trouble getting out of their own way and have, over the long haul, made it difficult for some pretty good customers to continue to bank with them. And we have been the beneficiary of that. And somewhere between a third-and-a-half is existing relationships that continue to grow and prosper, and, as a result, require more lending from us. And, Damon, those new client acquisitions take place over a period of time. In most cases, that the relationship is engaged and the lender or the salesperson works on building, enhancing the relationship. And it takes one more event that the incumbent bank does where they don't respond in a timely fashion or they mess something up with respect to someone's loan or account, and that's less strong, and then they look to flip the switch and move to Mercantile, which the relationship has already been developing in many cases for some time. So, it's a process, but as Ray said, we continue to benefit by the actions of -- or in actions of some of our competitors. And with no further questions, this will conclude our question-and-answer session. I'd like to turn the conference back over to Bob Kaminski for any closing remarks. Thank you very much for your interest in our company. We look forward to speaking with you next at the end of the first quarter in April, and this call has now ended. Thanks, again.
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EarningCall_1616
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Yes. Thanks for joining. Iâm Blayne Curtis, happy to have with me Liam Griffin. Heâs the President, CEO, and Chairman of Skyworks. Welcome. Thanks for joining. I thought maybe just start off, I mean, weâll obviously get in the supply chain part of it, but I wanted to talk on just the overall handset market, right? So this was one of the markets that we â a year and a half ago for various reasons, weâre entering the fifth year of 5G, so weâre all getting older and so is 5G, so Iâm kind of just curious your perspective outside of any inventory adjustments, whatâs your feeling on the market, market growth, areas of 5G adoption beyond what weâve seen today. And you have the U.S., you have China kind of fully penetrated. Where are you looking to for further growth? Sure. Well, overall, I think the opportunity for growth is still very much in sync for us. The technology and the burden of technology is never been higher now. So we continue to see more complexity in the device. Obviously, mobile is a big driver for us, but weâre also seeing IoT nodes blossom doing a lot more in the broad markets business and a great setup going into 2023, despite some of the headwinds that weâre seeing across the globe that we all know about. Weâve never been more diversified. The I&A business that we acquired has been running incredibly well. Weâre scaling that. Our Bulk Acoustic Wave technologies are growing right now and capturing more and more technology as well with the larger customers. So we feel really good about it. But the market, of course, is a little bit bumpy. As you know, weâre a company that does a lot of our work inside. We have our own fabs, our own labs, and we craft our solutions one account at a time. So thereâs a lot there. But we feel really good about the opportunity as we go forward. And I think youâve even seen the crane customer correct as well. So clearly, youâre under shipping the market. When do you think this clears up? When can we look at some sort of rebound back to whatever that normal rate is? Yes, thatâs a great question, Blayne, it really is. So for us, weâve been in this business a long time and obviously the mobile business for us is key. Broad markets is great, but the volatility in mobile you really have to understand the market and the nuances. So what we were seeing and what we call the OBX, OPPO, Vivo, and Xiaomi market within Android. We started to notice kind of an overbuilt in that market and that segment. And we just de-risked, we de-risked that business over that period. You could even see in our filings that the revenue there was virtually zero. It doesnât mean that the opportunity is virtually zero, but we just wanted to make sure that there was no inventory builder on â build on us. So moving away from that, other Android customers still have great opportunity. Samsung portfolios are going to be extremely important as they are now. We think we can do a lot more in content. A company like Google never really played in mobile very much. We have Google design wins that are up to $15 in content with a company that has scale and firepower to do some amazing things. So I like that the de-risking of China is happened already. So we â thereâs no downside for us. Itâs only upside from here and that end. And then also continuing to push 5G into other markets. So I like to always tell investors think about 5G as a technology, not a product. Itâs a technology that can go into an automobile, it can go into an in order to position, it can go into a mobile phone. And thatâs what we want to be able to do and create that usage case, right? And embody usage cases for our customers so that they can do more flexible things. I wanted to ask you about the content piece billion the storyline in RF was always handset market is going to have some modest growth and RF should grow faster. And clearly 5G helped, but there was, I think this tail after 5G where youâre adding more bands or more capabilities, I think people are now kind of confused is that still true? So how do you think about just the â I understand the other markets will be additive and weâll get to those, right? For just handsets, is it still a handset plus market? And is there anything you can point to as to where that contents coming from? Yes. No, great question. So what weâre seeing is, if you go back three or four years ago, you had spectrum 2.5 gig up to about 3 gig, populating that spectrum in 5G. But -- and whatâs happening now though is that weâre seeing a much higher demand for quality and technology. And when you want to move up, even though it looks like the same handset, the technology is inside, the performance inside requires unique solutions. So one of the things that weâve done over the last few years is move from a standard SAW Surface Acoustic Wave device within filtering, then a temperature compensated device TC-SAW all made in-house. And then after years of work, we were able to unveil Bulk Acoustic Wave at a level that is among the best. And that technology is not only really important because it opens up new spectrum and content and value, but itâs really, really hard to do. So we were working on this for years behind the curtain at Skyworks, and then when we were ready to go, we stepped out and won some really big programs. And Bulk Acoustic Wave is going to be important in automobiles. Itâs certainly going to be important in smartphones. Itâll be important in other vectors across the technology space. And we really like what weâve been able to do, a lot of the capital assets that we needed â the capital funding that we needed to make this happen to actually build the fabs. That was really hard and it drove a lot of cash. The upside is that has been peaking now. So weâre kind of at the top of the hill here on that. So weâll do better on the cash flow side. Weâre going to have a great technology involved. Weâre already shipping this and weâre also taking Bulk Acoustic Wave and moving it into other markets as well. I would say, I mean, was the only one who was a little skeptical when you came into the ball market, whether youâd be successful. I mean, you look now, you shipped I think three different modules at your largest customer. They include some form of BAW within it, right? Hundreds of millions of units. So I think one of the struggles, at least from my side, looking at your business has been on the Android side, you donât find as many customers want to pay for the performance and have as many bands, kind of, you think about leveraging that BAWs at an Android. Are you seeing, you mentioned Google, but I mean, are you seeing anything broader in terms of that higher end capabilities, which would pull you back into some of these customers⦠Yes, yes, no, thatâs a great point. So I think a lot of it Blayne comes out of the coaching. If we can â we do this stuff actually, if we can demonstrate with a customer, literally like in the lab and show this is the difference between this level of performance and this level of performance, and this is what the cost delta will be, and we work with these customers to try to get to the right answer. And I think whatâs very helpful with Skyworks and whatâs unique with Skyworks, and youâve heard us say it before, we really want to make the right choice for each customer. So we donât have the same recipe for everyone. If you think about the OBX Android portfolio that is right for more content, I mean, it just needs to be, itâs falling way behind. Weâve already talked about the inventory. Weâve managed that. But the opportunity $2, $3, $4 of incremental opportunity could really make a big difference. And the nice thing there is a lot of units. So you could get a content plus unit gain and that part of the business, we know how to do that right now and then complement that with some of the other factors that we talk to before Samsung, Google, and then obviously continuing to do well with the largest customer. You mentioned, and I just want to put a finer point on it, in terms of the CapEx that you did spend for BAW, how much was that? And I think is the point youâre making that that CapEx spend can come down and you can -- as youâre returning profits or what was the kind of point youâre making in terms of your leveled ball investment and what youâre looking at in the future? Yes. So what we have here is pretty steep investments. And weâre talking about like factories too. I mean, this isnât just technology, technology investment of course on the R&D side, but physical plant capabilities like real scale to develop -- if you think about bulk acoustic wave, it is a vertical structure. Itâs different than temperature compensation, which is basically laminate and layers. BAW is a vertical structure really, really hard. And you have to have different equipment and different types of technologies within that fab. So that was a big, big nugget to go through. And weâre still walking it, but the good news is that funding is paying for itself now with the execution of BAW and the heavy CapEx burdens are behind us right now. Weâre going to continue to grow as a company, but on a ratio basis, the heavy CapEx burden is behind us and weâll have an opportunity from the cash flow side going downhill from here. I got to ask on your largest customer, you can answer as you may, obviously, itâs always challenging, but in terms of people look at what happened in Android and say, well, why hasnât it happened with this customer? I think you -- when you gave guidance, you kind of gave a high level kind of some conservatism overall. And just how you think about that supply chain. What can you say and obviously thereâs been a lot of -- in the news about shutdowns and issues in terms of production. I know you canât probably speak to that, but can you speak to the fact of, I mean, are your parts on like a hub? So they have lines that are down, those parts donât come through. And how does that mechanics work and kind of what can you say about how you think about that risk over that stuff⦠Yes. Well, the good news is that weâre kind of battle tested operationally at Skyworks and vertically integrated. So we have very good processes around inventory and execution and being really close to the customer. We donât -- we do everything we can to try to match the real demand, really important for us to do that. We have great relationships with the large customers and the communication is ongoing daily. Itâs a really deep collaboration and communication so that no one wants to be out of balance. We all want to grow. We all want to deliver the right level of material and win the business. But weâre also vigilant on what we even with some of the distributors, and we have to be very careful about that. We donât want any over bills or under bills. And we manage that all the time. We do a great job with our own supply chain. Iâve talked about that before. Again, 75% of our products are made in a Skyworks facility gives us a lot of control. But I think we do a good job on the ups and downs. Thereâs always going to be volatility in this market, and not just handsets. I mean, you can look at any industry. But I think on the operational side, weâve got some really good talented people that really understand how to run supply chain in this business. And itâs big. I mean, these are really big dollars that weâre talking about. Itâs a great lead. And I was going to ask you this later, but Iâll ask you now, in terms of the supply chain, clearly, you have your own factories, you do buy externally for some components. And youâve see now -- I think everybody knows that semis were short, but youâre now starting to see like inventory build on everyoneâs balance sheet, right? So there must be some catching up that companies are seeing. I mean, how do you think about that balance in terms of like, if you do see further weakness, can you keep these factories and utilizations high and build inventory. Are there any areas that are still tight for you? And I guess, when you look at the inventory going up on your balance sheet. Is that just like different components? Do you still have one should it be tight? Walk us through that. Yes, good question. So thereâs a couple things. I mean, obviously, thereâs volatility still in supply chain, where thereâs some gaps where everything is ready. And then thereâs a component over here thatâs not available. It may not be our component, but some other thing that can create some headwinds in supply chain. Thatâs one thing. Behind that, our teams are really, really -- we really have a team that is focused on cash execution to a high degree. So weâre very careful with that. Weâre looking at ways to be leaner, but also effective and get the highest returns. And the way we look at our technology nodes and the investments that we have, we -- our engineers and our operations team and our finance team, and we talk about what the modelâs going to look like if weâre going to go spend more money in a certain zone or expand capacity in a fab, we do our diligence internally to figure out, okay, whatâs the right best answer? And also communicate with our customers who actually want to ride on that wave. And so it isnât a knee jerk approach, but itâs something that has worked well for Skyworks. And the other part of this is that you kind of build -- and these kinds of technologies every year you try to improve the process and move up a level and move up a level. And again, having the know-how, having the in-house capabilities, having the funding to get it done is one of the reasons why we win business with customers right now. Right. I want to ask you just the competitive landscape. So youâve had a couple moving pieces. Clearly, Qualcomm did enter the market over the last five years, when particularly 5G attached. I think as the China market moved up to more module approach, maybe some of the domestic suppliers went the other way. Iâm kind of curious like where you see you kind of looking forward here, I think just overall the competitive landscape, the domestic China players come back. Itâs always been the fear. Itâs been the fear since I -- aslong as Iâve known you. Never really amounted that much. And then Qualcomm was the risk, right? Theyâre run the market. I guess, theyâre not going to report it as much, these days going forward. Kind of just level set us as to where you think the biggest risks are and do you think its good that shareâs going to move around all that much? Yes, I think the share is going to get tighter. I think that thereâll be three or four companies that are really going to drive this business for good reason. And I think itâs just if you look at the capital intensity in some of these markets, the scale, the intellectual property, thereâs a lot there. And I think itâs, and Iâm speaking about Skyworks, but to be honest with you, I think about mobile, and mobile, is gets discounted. It just does. And it shouldnât, but it does. We continue to do, what we need to do. And mobile has been a tremendous market for us. And I think it will continue to, I think, create amazing things in technology. I mean, weâre talking about things like automotive, of course, data center opportunities, a lot more stuff out there that is just kind of emerging outside of what we have today in our business today. And our business today is really solid. So thereâs a lot more going on there that doesnât always get, I donât think it gets fully complimented within the valuation of the business. I want just change gears because I, there is a bunch in broad markets I want to talk about. I wanted to talk about the acquisition of I&A, weâre talking a little about it before, we should recap that conversation, it was quite good. You now have this asset; it was supply constraint when you bought it. Where do you -- walk us through the asset a little bit and, kind of talk about where you see opportunities where maybe under the prior ownership they werenât applying those technologies to the same customer base and markets? Yes, yes, sure. Good question. So as you and I know, and you -- we just talked about it, we are a company that weâre not an M&A machine thatâs just not really hasnât been our DNA, right? Doesnât mean we canât jump in there every once in a while. But to be honest with you, weâve looked at a lot of opportunities and we often, we look in the mirror and say, look we can do better ourselves. We could deploy the cash in a different way. Fortunately in this transaction, we were able to carve out a really unique situation with this, the I&A business of Silicon Labs, we paid about $2.75 billion for that. And it has been, believe me, weâre conservative, but it has been, I wonât say a home run, but itâs a triple at least Okay. Really, really good results. Weâre really happy about it. Great people, great people, smart people, a ready now team. There were no synergies by the way. This was not a deal where we came in, broke the windows that take the goods. This was a transaction, very unusual, a transaction where we kept just about everybody. We added people, we co-mingled, human capital from Skyworks in Newbury Park and Irvine and in Texas to create a really good new business. And it has been going really well. Now, the cool thing about it where you have like kind of the opposites where the core Skyworks were big game hunters. Thatâs just the way it is. And we, and thatâs been the way itâs been forever. I mean, you go back to the Nokia days, right? Before we were dealing with our friends in the north here, but weâve always been going after the big game. That was our thing. When we got into the deal with Silicon Labs, it was kind of just a different, it was like a right brain, left brain kind of thing. Different mindsets, but on the slab side, great technology. But the scale was low. And the thing about these businesses, once you get the part -- once you have a part that really works, you can take it anywhere. But our view was we werenât seeing in the transaction the ability to take those really good parts and bring them to the bigger accounts. Thatâs what the Skyworks team was able to unlock. So the Silicon Labs team created really high performance, unique technologies, but those technologies hadnât really blossomed in the scale and the dollars that we would want thatâs now changing. And so weâre collaborating where we can take great stuff that they have already, and we can take those technologies and bring them to the customers that we have, not just the mobile guys. The relationships that we have in broad markets, in our $2 billion broad market business. We take that $2 billion plus the I&A business, bring them together, and itâs been really working well. And again, from that team, they were used to doing great work, but it was at a low level of revenue. But that was fine and that business. But when you go into a $5.5 billion Skyworks, you got to put some dollars out there. And so thatâs what happened. We were able to cultivate the sweet spot within I&A, bring it to customers that we already know and trust, or they trust us to drive more and more revenue in different markets. So thatâs kind of the overview of that. Youâll see you just had record revenue right, in I&A business. So youâre looking, wow, weâre talking about corrections, and that was record revenue. So do you think this stuff youâre talking about, is that in as part of this record revenue? Or was it, is the reason that youâre at record revenue on wins that they had even before the deal, and you just were able to get supply or whatever and everything youâre talking about is additional to it. Like, walk us through this timeline and how weâre sitting here at record revenue. Yes, no, exactly. So a couple things. We, I think look, we had, we got the business at a certain level. We put a lot of people, a lot of bodies, a lot of smart people from the core Skyworks business to get in there and work. There were a lot of supply chain issues that were just globally. And they were hitting the I&A portion pretty significantly as well. Just not as many people and resources on that. So we were able to kind of get in there and drive that really hard to kind of unlock some of the capacity. That was one thing. That helped revenue. Adjacent to that, the I&A team on their own had some really, really, really good technologies, but they, again difficulty with supply chain that helped, that hurt. And also kind of a bit of a lack of the big accounts. So what we were able to do was help mitigate some of the supply chain constraints with our relationships with some of the companies that we donât, things that we donât make inside. I mean, some things, we had to negotiate with TSMC or another, another outside fab occasionally most of the stuff done in house. So we were able to drive that and open that up a little bit to give them a little bit more room, get some more product through. And then our supply chain teams at Skyworks are awesome. I mean, weâve got great people and operations. So, we were able to not only leverage the relationship, but actually, we had people that would go down in Austin and just drive the solutions together now. So with more scale. And then the next part of it is, has the design when execution, I mean, we talk about the numbers right now, the business, we havenât had this business that long. So to have the numbers move this quickly is a real testament of the customer demand more than anything else. And so weâre really excited about it. And M&A is always hard and youâre always kind of, youâre second guessing, and maybe this is just me, but youâre thinking about, you have a good business, and like well, do we want to dilute this? This has been a transaction that, we had our own bar internally, and it has been absolutely, an execution right now. Weâve jumped over that bar. And itâs also, it gives our team, a sense that we really can do more on the M&A side as well, given what weâve gone through. And itâs carve-outs are harder than straight up acquisitions, right? Itâs really hard to do that. So teamâs done a great job, exceeding the numbers that we expected. Again, we got to continue to do it. Itâs still, itâs a good size business, but we want it to be bigger. But itâs a great for us, it was a great litmus test and execution around diversification and M&A. And I was ask you this later, but Iâll see you now because itâs a good lead in, I mean, in terms of, I mean, Iâm sure youâre not happy with the multiple of your stock trades at, and I had welcome CFO sitting right where you are. And, there multiples quite surprised as well. So clearly mobile, has this burden. I think even beyond some of the supply chain issues, people really, just subscribe a lower multiple on that, right? So when you look at M&A, obviously thereâs the financial benefits and youâve passed on a ton of deals. But then thereâs, Qualcommâs talking about diversification and what percentage could be outside of mobile. How do you think about that? Do you, does that matter to you? Do you want to see the business, 50-50, in a decade or more, or is it not really? Because when I first had you here, I had to check the dates, so Iâm losing my mind in the old age, but it was 2016 and you said, I got enough on my plate with mobile. It was kind of, you actually walked away at the time for some deals that could have been done. Is it different now, or you look at it still the same lens that you have enough in mobile and something comes along like this great deal, fine, but itâs not a priority? No, thatâs a great question. And I would say to you at that time we had a full plate of opportunities that were ready now that needed to be addressed. And if you look at the revenue, I mean, you go back, we havenât talked about revenue here, but if you go back and just think about where we were a few years ago, even go back to like 2020, we were at one point we grew our business a $1 billion in one year. I mean, we put up some unbelievable growth and we were, that was kind of the priority we had. We had opportunity in front of us, so we just, we went after it. And that propelled the company from, going from a $3.1 billion going through COVID to get to $5 billion, and now weâre at $5.5 billion with an $11.24 EPS for the year, which is unbelievable. And if you look back at what the market expected from us two, three years ago, look back at analyst reports, they would, they had nowhere near an $11 EPS for us, when our stock was at $1.50 [ph], $1.60, $1.70 the EPS was much, much lower, and yet the valuation is where it was so frustrating. But itâs the reality, right? The flip side of it is, itâs a great opportunity right now given where we are. And so weâre going to continue to work on that. And when it comes to deals, the nice thing with the, I&A business that was cash, was at all cash deal, weâre a generator of cash. Skyworks has always been that way. But to do something more, substantial, itâs absolutely within the card. So, I would say to you, thereâs no hard and fast rule that weâre going to go this way or weâre going to go that way. But we definitely do know from the investors that, diversification is an important vector for us and important element in the strategy. So we hear that and weâre, we â you should expect more of that tone going forward. Again, I&A was one example but thatâs just one. And weâre only have like time for more questions, so Iâll wrap two into one, but it just, when you look at the rest of the broad markets, we spent all time talking about I&A, wireless LAN as learned timing has seen some corrections along the way. Thatâs a big part of that, within broad markets, wireless LAN is a big part of the revenue stream. You talked about that supply chain, but I really want to know kind of where else do you point to, youâve mentioned particularly in the intro, things like autos and IoT and edge and all that. Kind of just, whatâs a quick answer too? Like what are you most excited about within broad markets? Automotive, and this is another really tip of the hat to the guys at slab. Weâre going to be, 200, 250 in automotive revenue within the next 12 months. I mean, that wasnât, you wouldnât have that at Skyworks two, three years ago. So itâs not all slab, but they actually have good relationships there. The technologies that youâre going to, you start to see now with EV, ADAS these kind of technologies require the things that we do well, you can, we can call it whatever we want to call it. We wonât call it mobile, but the technology vector to connect these vehicles is right in the sweet spot of what we do. So we think that market, we know that market is going to add significantly to us, and weâre going to invest more in that area. IoT broadly, lot more opportunity. I mean, WiFi, WiFi has going through its own cycle, but as we go into WiFi 6E, the performance levels there, the data rates, the speed is going to be a real driver for the consumer. And if you look at whatâs happening right now, even simple things like, just look at streaming as just one little thing, right? That everyoneâs going to be having a streaming TV set, thatâs going to be done. Itâs like, itâs not going to be five years from now, itâs happening now, itâs going to turn over markets and those kind of things. When the performance levels are good enough, you can unwire, you can just completely unwire all this stuff, right? It creates a great opportunity for the customer and the consumer, and it can create a unique cycle the way we had in 5G, but doing in a different market and WiFi.
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EarningCall_1617
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Good day, everyone, and welcome to today's Live Ventures Incorporated Earnings Call. At this time, all participants are in a listen-only mode. [Operator Instructions] Please note, todayâs call maybe recorded and I will be standing by, should you need any assistance. It is now my pleasure to turn the conference over to the Director of Investor Relations, Greg Powell. Please go ahead. Thank you, Chloe. Good afternoon, everyone, and welcome to the Live Ventures fiscal fourth quarter and full year 2022 conference call. Joining us this afternoon for the call are Jon Isaac, our Chief Executive Officer and President; David Verret, our Chief Financial Officer; and Eric Althofer, our Chief Operating Officer. Some of the statements we are making today are forward-looking and are based on our best view of our businesses as we see them today. The actual results could differ material due to the number of factors, including those outlined in our latest Forms, 10-K and 10-Q filed with the Securities and Exchange Commission. We have no obligation to publicly update any forward-looking statements after this call. Whether as a result of new information, future events, changes in assumptions or otherwise, you can find our press release referenced on this call in the Investor Relations section of the Live Ventures Web site. I direct you to our Web site www.liveventures.com or www.sec.gov for our historical SEC filings. Thank you, Greg, and good afternoon, everyone. Overall, the company delivered a solid fourth quarter and full year 2022 performance in spite of increasing economic headwinds. During our fiscal year 2022, we continue to execute on our multi-lever, buy-build-hold strategic plan to maximize stockholder value. On the buy side, we added Kinetic and Better Backers to our steel manufacturing and flooring manufacturing segments, respectively. On the build side, we made significant capital investments in new equipment in our flooring manufacturing business, Marquis Industries. In addition, we repurchased 86,451 shares of our common stock during the year. Before we jump into the numbers, let me discuss the acquisitions that we completed during the year. At the end of June, our steel manufacturing segment acquired The Kinetic Company Incorporated, a 74-year old Wisconsin-based company. Kinetic is a highly recognized and regarded brand name in the production of industrial knives and hardened wear products for the tissue, metals and wood industries, and is known as a one stop shop for in-house grinding, machining and heat treating. We believe that Kinetic is a great fit within our growing steel manufacturing segments. In July, we acquired certain assets of Better Backers Incorporated for approximately $3.2 million. Better Backers provides carpet-backing for its carpet manufacturing customers. For more than 40 years, Better Backers has taken great pride in its reputation for standing behind the quality of its products and providing its customers with the highest level of service. Better Backers is a nice addition to our flooring manufacturing segment. Now I'll briefly discuss the financial results for the fourth quarter and full fiscal year 2022. The revenue for the fourth quarter - our total revenue for the fourth quarter increased to $73.8 million, up 4.6% as compared to $70.5 million in the prior year period. The increase in revenue is primarily attributable to the acquisitions of Kinetic and Better Backers, partially offset by decreased revenue in our corporate and other segment. Gross profit for the fourth quarter was $22.9 million, down from $25.6 million in the prior year period. The gross margin percentage for the company decreased to 31.1% from 36.3% in the prior year period. The decrease in gross margin percentage is primarily due to increased raw material costs. Operating income decreased to $1.2 million in the fourth quarter of 2022 as compared to $9.1 million in the prior year period. The decrease in operating income is attributable to the SW Financial goodwill and other intangible assets impairment charge of $4.9 million and inflationary cost increases. For the 3 months ended September 30, 2022, net loss was $0.6 million as compared to net income of $7.1 million in the prior year period. The decrease in net income is attributable to the goodwill and other intangible assets impairment charge and lower operating income. Diluted net loss per share for the current quarter was $0.20 per share as compared to a diluted earnings per share of $2.23 in the prior year period. Adjusted EBITDA for the fourth quarter was $7.2 million, a decrease of approximately $4.3 million as compared to the prior year period. The decrease in EBITDA is primarily due to the increase in cost of revenues resulting from inflationary cost increases. I will now discuss the financial results of our fiscal year ended September 30, 2022. Fiscal year 2022 total revenues of $286.9 million increased approximately $13.9 million or 5.1% as compared to the prior year period. The increase in revenues is primarily due to the acquisitions of Kinetic and Better Backers, the inclusion of a full year's financial results for SW Financial and inflation-based sales price increases. Flooring Manufacturing segment revenues increased 0.5% to $130.9 million as compared to $130.2 million in the prior year. The increase is primarily due to increased sales prices as well as the acquisition of Better Backers. These increases were partially offset by lower sales volume stemming from decreased customer demand. The Retail segment revenues decreased 3% to $86.2 million as compared to $88.8 million in the prior year. The decrease was primarily due to inflationary pressures, supply chain issues and overall product sales mix. In addition, prior year's sales were positively impacted by government stimulus payments that consumers received during fiscal year 2021. Decrease in revenue was partially offset by the addition of seven new vintage stock store openings in 2022. Steel Manufacturing segment revenues increased by approximately $11.3 million or 23% as compared to the prior year due to increased sales pricing as well as the acquisition of Kinetic in June 2022. Finally, approximately $4.7 million of the increase in corporate and other segment revenue was due to SW Financial becoming a consolidating variable interest entity in June of 2021. Gross profit for the full year 2022 was $97.8 million, down from $99.5 million in the prior year. The gross margin percentage for the company decreased to 34.1% from 36.4% in the prior year. The decrease is primarily due to the tightened margins in our Flooring Manufacturing segment. The Flooring Manufacturing segment gross profit margin decreased to 24.4% as compared to 29.1% in the prior year. The decrease is primarily due to increases in raw material costs. Retail segment's gross profit margin decreased 52.9% as compared to 54.1% in the prior year. The decrease is primarily due to sales mix of new and pre-owned products. The Steel Manufacturing segment's gross profit margin increased to 27.8% as compared to 24.2% in the prior year period. The increase in gross profit margin is primarily due to sales price increases throughout 2022. Full year 2022 general and administrative expenses increased by approximately $2.3 million or 4.4% as compared to the prior year. The increase is primarily due to the acquisition of Kinetic in June of 2022, increases in employee compensation and related costs as a result of our Retail segment opening new locations and the consolidation of SW Financial in June 2021, partially offset by reductions in legal and other professional fees. General and administrative expenses as a percentage of revenues remained steady at approximately 19% as compared to the prior year. Selling and marketing expenses increased approximately $1 million for the full year 2022 as compared to the prior year, primarily due to increased convention and tradeshow activity, which was largely cancelled in fiscal year 2021 due to COVID. Sales and marketing expenses as a percentage of revenue were 4.3% as compared to 4.2% in the prior year. Full year 2022 operating income of $25.9 million decreased 27.6% as compared with the prior year. The decrease in operating income is attributable to the fourth quarter goodwill and other intangible assets impairment charge and lower profit margins. Net income for fiscal year 2022 was $24.7 million, a decrease of $6.5 million or 20.7% as compared with the prior year. The decrease is primarily attributable to lower operating income and one-time gains net of charges, partially offset by decreases in interest expense and income tax expense. Diluted EPS for the current year was $7.84, a decrease of 20% as compared to the prior year. Fiscal year 2022 net income of $24.7 million includes an $11.4 million gain related to the ApplianceSmart bankruptcy settlement, partially offset by the $4.9 million impairment charge and one-time acquisition related charges of approximately $1.5 million. Fiscal year 2021 net income of $31.2 million includes $7.9 million and gains related to the extinguishment of PPP loans, and the settlement of certain ApplianceSmart liabilities in connection with the bankruptcy. Adjusted EBITDA for fiscal 2022 decreased 13.8% to $38.4 million as compared to $44.5 million in the prior year. The decrease in EBITDA is primarily due to the decrease in profit margins. A reconciliation of adjusted EBITDA has been provided in our earnings release that we filed earlier today. Turning to liquidity. We ended the fourth quarter with cash of $4.6 million and cash availability under our various lines of credit of $26.4 million for a combined liquidity of $31 million. I would like to highlight our low level of leverage. As of fiscal year end, our net debt to adjusted EBITDA ratio was 2.1x. We maintained a low level leverage, while purchasing two new businesses this year, repurchasing shares and making significant capital investments at Marquis. Net cash provided by operations was approximately $14.6 million for the year ended September 30, 2022 as compared to net cash provided by operations of approximately $29.2 million for the year ended September 30, 2021. We had net working capital of approximately $78.4 million as of September 30, 2022, as compared to approximately $33.8 million as of September 30, 2021. The increase is primarily due to the net assets received from the acquisitions of Kinetic and Better Backers, increases in accounts receivable and inventories, partially offset by a decrease in debtor in possession liabilities. Total assets increased $66.9 million or 31.6% to $278.6 million as compared to $211.7 million as of September 30, 2021. Total stockholders' equity increased $22.1 million to $97.2 million. Cash flows provided by financing activities increased to approximately $25.4 million during the year ended September 30, 2022 primarily due to proceeds from borrowings under the revolver loans and issuance of notes payable, which is primarily associated with the acquisition of Kinetic. As part of our capital allocation strategy, we may make share repurchases from time to time. We believe our stock repurchases represent long-term value for our stockholders. As previously disclosed, the company announced a 10 million common stock repurchase plan in 2018. During fiscal year 2022, we repurchased 86,451 shares of common stock at an average price of approximately $31.18 per share. The company has repurchased 504,921 shares of its common stock for approximately 6 million under the plan to date. As of September 30, the company had approximately $4 million available for repurchases under this program. In conclusion, while the current business environment remains challenging, we remain optimistic about our ability to navigate the environment and drive long-term returns for our stockholders. We will now take questions from those of you on the conference call. Operator, please open the line for questions. Thank you very much. Couple of questions by segment here. In the Retail segment, you -- in your prepared remarks here you talked about sales mix being an issue. And you mentioned new versus pre-owned products, which has the better margins? Okay. In the Flooring segment, you talk here about inflationary issues. And it's saying -- it's almost the end halfway through December now, are you seeing any plateauing or of those inflationary pressures? Or is that continuing into the current quarter? Yes, we are seeing some softening and some of the inflationary pressures that we've been having. So we're just continuing to maneuver through the economic environment as things progress, but we are seeing some softening. We're optimistic about it. Yes. So our annual goodwill impairment test is as of July 1 of every year, and over the course of going through that analysis, we're looking at SW Financial and they are a broker dealer. So they're in the business, they get commissions from trading stock. And given the market conditions, the trading has really dropped significantly, which has impacted their revenues compared to where they were about a year-ago when we entered into that transaction with them. So largely driven by the current economic environment. Okay. And my last question, and you may have covered this in the previous conference call, but raw material inventory is up significantly from a year ago. And it looks like it's the same, it's been the same level last quarter, too. And you may have expected, but can you give us some -- give me some information on that? Yes. So earlier in the year, I mean, as you know, there were supply chain issues that we were dealing with. And in order to combat some of that, and to make sure that we had product ready to sell, we did get a little bit more aggressive on getting more raw material inventory in given the lag times. And then also you got the inflation aspect on the inventory as well, the higher prices. So I think the combination of those two is really what contributed to the increase in inventory. It's something that we are focused on, especially as we kind of maneuver through this year. Does that answer your question? And -- hi. And thanks to the prior caller for asking a number of my questions, so that I'll be a little bit [multiple speakers]. It looks like and looking at the different segments that they all had earnings with the exception of corporate and other if I'm reading this correctly for the quarter anyway. And that it seems that that's largely SW Financial that took the hit there. Am I right that the other segments were all in the black for the quarter? Yes, for operating income, but on the black for depreciation, they're all -- I mean, sorry, for income -- yes, everything is in the black except for corporate and other. You got to remember, the corporate does have in addition to SW Financial, which has all the corporate costs. I mean, my broker dealer, for example, has both -- does both. It's got one side as the RIA side and one side is the broker dealer side. So I didn't know how SW Financial works if you're familiar with the terminology. Okay. Are they -- I would hope that they would be expanding the RIA, that tends to be, I believe, the more profitable these days, and hopefully they'll move more into that area. That would be exciting. Do you know if they have any thoughts on that? It's certainly something which has been discussed. But again, we don't make our forward-looking statements. So it's certainly something that's been considered among other potential growth opportunities. All right, great. As far as Vintage Stock, do you -- you've opened, I think you said seven new stores. Do you see a lot more foot traffic now obviously than during COVID. But does it seem like it's going to continue to be the case as opposed to there was time where people thought everything was going to be done online. And there's going to be no brick and mortar at all. How does that look over the next 5 years, let's say or without making a specific projection just in general about foot traffic, what are you seeing in that regard? Yes, and maybe just kind of step back, even just with Vintage, in particular, I mean, its business model, really, I mean, location, location, location, and they were in the areas maybe where you don't have the fiber optics, there's less streaming and things like that. So they're still getting -- they get traffic. And actually, I think when COVID came about and what we were at home and things like that, they saw a big bump. I think they had a record year, last year. So this is continuing. This is Jon. At Vintage, we have a very, very unique experience when you walk through one of the stores. Where are you located, Joseph, by the way? I don't think I've ever asked you this. Detroit, okay. I encourage you to visit one of our stores, if you're ever visiting the Midwest, we have them in 10 or 12 different states. But we offer a very, very unique product selection and especially with other large retailers that used to offer the same product going the way, it's even more -- we're seeing more very good feedback from customers to walk in. As far as predicting what foot traffic will be 5 years from now, it's hard to predict. But we're very optimistic. We love the asset. Vintage has always outperformed. David commented on the margin, on the used product we're seeing. We have a very nice inventory build there. So we're very optimistic on Vintage, and I encourage you to visit one of our stores. I think you may find things that you didn't think you would be looking at or buying when you walk through the stores, that nostalgia feel and you can buy vinyl records and games and movies that you haven't seen in many years, and people just love the experience. Yes, I know, vinyl has been becoming more and more prevalent. So that's -- that alone is I think something that's going to be around for quite a while to come. And so that's exciting. I would love to go to one of the stores if I find my way out that way. Two other questions, though. You said sales and marketing going to shows and things like that. Is that for a particular division, or â¦? Got you. And then with regard to inflation, I appreciate the response that you gave with inflation. But the second side of that coin is, what about the pricing on the goods that you sell in addition to inflation, maybe moderating or something. Are you able to catch up with the inflation in terms of the sales costs, the product costs that you're selling, products -- the products that you're selling rather than the cost of the goods that you're buying? Yes, I think we've done a really good job in keeping up with that. If you look at Precision, you'll see an increase there. If you look at Vintage, it's very nominal, mostly just due to kind of the mix on the product, but over 50%. And so really, we're seeing that the pinching on the margins is coming from Marquis in the Carpet Manufacturing segment. We're working with them to try to get ahead, but they've been a step or two behind and trying to get those price increases, one through to keep up with it, the inflationary rate increases on their inventory. Got you. And then last question I have is, with regard to the company as a whole, do you have an idea or a thought about the areas that you like to look to when you're looking for new companies? Or can it be pretty much anything? Yes. And this is Eric Althofer again, since I oversee the M&A effort, I'll take that question. We are very opportunistic. And I think the two advantages we have are both patience and that we don't have a mandate to look at any specific industry or segment. So the direct answer to your question is we can look at any specific business, we are not constrained. We do tend to look for closely held family held businesses with a strong culture and management team, and history of profitability. Historically, we've looked more in the manufacturing and heavy asset intensive businesses. But we can certainly look at any different segments. And we don't have a mandate to deploy capital at a given rate like a private equity firm. So we can be patient and employ all of the different levers to return stockholder value, whether it's investing in our subsidiaries, buying new companies, if the valuations make sense, or repurchasing shares and managing our balance sheet. As long as it makes money, as long as we like the management team, as long as there's predictable cash flows. And I think we've done a good job at finding those companies and negotiating them and making. There are many times where we bid on companies and we've been outbid by others, but the seller ends up selecting us as a buyer. And that's because of our philosophy and that is because we are not private equity and that's because we don't come in and destroy companies or chop them up and flip them. I'm very proud to say that we haven't sold a company that we've acquired. So, the legacy remains when with the company, the founders is happy to see his employees that have been there for 20, 30 years remain there. And as I stated in the press release, we buy-build-hold and that's really what we adhere to. So that resonates very, very well with many sellers. And we're happy to look at any opportunities that come across our way. I'm impressed. And I appreciate that philosophy. And my clients and I tend also to be very patient, and long-term I don't take a client who wants to look at less than 5 years. And usually we're thinking between 5 and 20 years is really what we're looking for, to see some good results. So I appreciate very much that philosophy. Thank you so much. Thanks for your time. Thanks for answering questions.
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EarningCall_1618
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Hello and welcome to the Couchbase Third Quarter Fiscal Year 2023 Earnings Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to your host, Edward Parker, Head of Investor Relations. Please go ahead. Good morning and welcome to Couchbase's third quarter 2023 earnings call. We will be discussing the results announced in our press release issued before the market open today. With me are Couchbase's Chairman and CEO, Matt Cain; and CFO, Greg Henry. Today's call will contain forward-looking statements, which include statements concerning financial and business trends and strategies, market size, our expected future business and financial performance and financial condition, and our guidance for future periods. These statements reflect our views as of today only and should not be relied upon as representing our views at any subsequent date and we do not undertake any duty to update these statements. Forward-looking statements, by their nature, address matters that are subject to risks and uncertainties that could cause actual results to differ materially from expectations. For a discussion of the material risks and other important factors that could affect our actual results, please refer to the risks discussed in today's press release and our most recent annual report on Form 10-K or quarterly report on Form 10-Q filed with the SEC. During the call, we will also discuss certain non-GAAP financial measures which are not prepared in accordance with Generally Accepted Accounting Principles. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures, as well as how we define these metrics and other metrics, is included in our earnings press release, which is available on our Investor Relations Web site. Thank you, Edward, good morning, everyone. On today's call, Greg and I will provide details on our third quarter results, as well as our fourth quarter and full-year fiscal 2023 guidance. I will start off with a few highlights of our Q3 financial results. Couchbase delivered another strong quarter. In addition to beating our guidance across all metrics, our results were highlighted by growing momentum with Capella, healthy new customer logos, including our largest new logo deal in company history, strong retention metrics and ongoing large deal activity. Iâm also pleased with the progress we made operationally across the company headlined by our product and go-to-market teams driving continuous improvements that will serve us well into the future. Revenue in Q3 was $38.6 million, up 25% year-over-year. Total annual recurring revenue or ARR was $151.7 million, up 24% year-over-year, and up 28% in constant currency. Our non-GAAP gross margin remains best-in-class at 88%. Non-GAAP operating loss was $9.6 million, 15 percentage points above the midpoint of our guidance range, driving a 14 point improvement in operating margin from Q3 of last year. As we scale, we will continue to complement our strong top line momentum with a focus on driving more efficient growth and operating leverage in our model. We exited the quarter with 658 customers, an increase of 26 from Q2 and saw meaningful new logo contribution from Capella. Despite a more challenging macroeconomic environment, we are well on our way to achieving what we laid out to do this year, accelerate growth, grow our cloud mix, improve our go-to-market efficiency, and drive operational leverage. It's gratifying to see the investments we've made in our cloud database platform starting to bear fruit. And I want to thank all our dedicated team for their tireless efforts. Greg will provide more detail on our results in a moment. But first, let's discuss some highlights in the quarter. To begin, we continue to make rapid progress with Capella. We have reimagined the database experience with a fast, flexible and affordable cloud database platform for modern applications, allowing organizations of any size to quickly build applications that deliver premium experiences to their customers, all with industry leading performance. In today's more constrained budgetary environment, our best-in-class total cost of ownership is especially compelling for companies that are unwilling to trade off performance and price. While it's still early, I'm thrilled that Capella is becoming an increasingly important contributor to our business. In Q3, we saw robust bookings growth, meaningful new Capella logo additions, as well as migrations and a rapidly growing pipeline of exciting Capella opportunities across both new and existing customers. You will hear examples of our progress in some of the Capella customer wins and expansions I will discuss in a moment. On the product front, we remain focused on enhancing the developer experience, and we again made exciting progress during the quarter. We recently commissioned a global survey of 650 Senior IT decision makers, which revealed that 88% of developers are under pressure in their digital transformation initiatives, and in the race to the cloud. They also face an endless array of highly complex, multi factor developer tool chains. To address this challenge in October, we announced a newly designed Capella user interface that increases developer productivity and agility. The updated user interface is inspired by popular technologies that millions of developers already use to build applications, giving them a familiar design and navigation experience. A sense of familiarity makes it easier for developers, who are new to Capella to build next generation applications on our platform. Another innovation during the quarter is a high data density storage engine with compute and storage advantages that increases performance processing speed by up to 4 times, while utilizing 10 times less memory. This enhancement reduces the total cost of ownership of our cloud database platform and further widens the TCO gap compared to other databases of service offerings. Additionally, Capella now offers enhanced security and single sign on capabilities, including successfully completing a SOC 2, Type II audit and delivering support for HIPAA-compliant applications, which means broad enterprise requirements for cloud applications. We're also pressing our gains with our cloud provider partners. We launched our managed service offering on AWS just over a year ago. We then added support for Google Cloud over the summer. And in the short time since then, we have seen meaningful adoption from customers who prefer to leverage Google's infrastructure. This is core to the Capella value proposition, start with leading performance at scale, then offload the resource consuming database administration experience, and let customers tell us which cloud service provider they prefer to deploy with, resulting in a unified deployment and usage model from cloud to on-premise, from the data center to the edge and everything in between. We remain on track to round out our hyperscalar availability with the addition of Azure by the end of our fiscal year. I am also proud that industry leading analyst firms have recognized our innovation and execution on our vision. In its Q4 2022 Translytical Data Platforms report, Forrester rated Couchbase as a strong performer and gave us a perfect five out of five score on our execution roadmap. On the go-to-market front, we're continuing to enhance all aspects of our sales motion. We are executing well on our high touch enterprise sales motion and as the world returns to in-person meetings, we're back to doing what we do best, being in front of customers and helping them drive their most strategic digital transformation initiatives. Importantly, as you'll recall, we've been building increased operational rigor across our sales teams with a laser focus on increasing sales efficiency. There's much more to do on this front, but I'm proud of the progress we're making. And I'll note that the investments we have made have been especially impactful with Capella where we are engaging in new audience of developers, who prefer to buy from rather than be sold to. We recently announced the new Couchbase ambassador program, which allows developers to share their knowledge and expertise with broader developer audiences. And our recently launched Couchbase Community Hub brings together users and contributors to foster increased sharing, learning and discovery. We continue to see robust interest in our free trial model, strong engagement from existing customers, and great responses to our developer and community workshops. This will only further add to the growing efficiency of our go-to-market strategy. Our partner and alliance ecosystem remain strong and continues to contribute to our go-to-market acceleration. In Q3, we saw strong bookings growth sourced by partners. In fact, we had our largest quarter of new customer logos sourced by partners with ISVs, CSPs and Sis all contributing. In particular, I am excited that our cloud partnerships are driving bigger wins for us. In fact, we had sizable transactions with all three cloud providers during the quarter with AWS, our co-sell engagement continues to deepen. We've been working with AWS to target ISV software companies that are building applications powered by Capella on AWS. And recently at AWS re:Invent, where we were a gold sponsor, we announced that Arthrex, a global leader in minimally invasive surgical technology is partnering with Couchbase and AWS to improve patient outcomes. This close alignment with AWS has culminated in a broadened collaboration, which we also announced at re:Invent. Under this multiyear strategic collaboration agreement, Couchbase and AWS have committed to offering customers integrated go-to-market activities, commercial incentives and technology integrations. I am excited for this broadened collaboration to accelerate and streamline customer migrations to Capella on AWS. Next, I'd like to highlight some key customer wins from the quarter. Overall, I am pleased with the breadth of our customer activity across all parts of our portfolio, including mobile, server, and especially Capella. I'll start with Capella. A new Capella customer and logo in the quarter is a market leader in secure API connectivity for financial institutions. This customer was interested in migrating its on-premises applications to the cloud. They needed a high performance database as a service and after experiencing operational and financial value of Capella, this customer will be consolidating three other NoSQL cloud databases to Capella. This database consolidation trend speaks to both the breadth of Capella's multimodal capabilities and the best-in-class price performance that we offer our customers. In addition to new logos, we're seeing an acceleration of existing customers migrating to Capella. YapStone, a global provider of digital payment solutions and processing migrated from our enterprise edition to Capella. YapStone initially began with our core platform, because it needed a fast and flexible database to power its profile management applications and deliver a premium experience to its customers. For this customer, the big driver to embrace and double down on Capella was the lower total cost of ownership and overall efficiency. Of note, this win was driven through their executive management team, signifying that the value and cost efficiency of Capella are resonating at the executive level. We had a significant new customer win with one of India's most trusted and reputed business conglomerates in the quarter. This new customer creates consumer focused high engagement digital products that address the needs of Indian consumers and businesses, including an app that offers an integrated rewards experience across various consumer categories. They needed a database platform that could not only deliver the highest performance and scale for its millions of customers. But that could also offer the critical mobile device sync capability, so it could serve as customers anywhere, regardless of their smartphones, internet speed or connectivity. They chose Couchbase for our premium capabilities, and compelling value. In Q3, we also saw many great expansions from existing customers, including one of the largest airlines in the world. This customer relies on Couchbase mobile to ensure its tablet base preflight check in process works reliably regardless of internet connectivity to streamline operations, and minimize flight delays. Over the last year, as demand for travel has increased, this customer has grown its use of Couchbase to further enhance one of the airline industry's best on time and safety records, all with the top tier customer experience. As we look towards the balance of the year and into next year, I remain confident in both the near-term drivers and the long-term trends powering our growth. In the year and a half since becoming a public company, we put an enormous amount of work into all aspects of our business. And as a result, we're benefiting from strategic initiatives and operational improvements that we were not enjoying a year ago, which sets us up for more effective and efficient growth in the quarters and years to come. These include a greatly expanded product portfolio with Capella just starting to hit its stride. This is opening up a large portion of the database market that until recently was unavailable to us. We've meaningfully expanded our partner ecosystem, giving us crucial channels for reaching new customers, while bolstering our relevance as a strategic partner of choice for digital transformation initiatives. We've enhanced our sales leadership and transformed how we go to market across buy from and sell to motions, both in terms of efficacy and efficiency. And these initiatives are just starting to bear fruit. As our results demonstrate, we haven't seen a material impact to our business as a result of the increasing macroeconomic headwinds being felt across the technology space. However, like many of our software peers, we are seeing signs of some customers taking longer to make their buying decisions or requiring extra layers of approval as well as a bigger focus on the economic value of our platform. We come to work every day with a degree of healthy paranoia, and we remain focused on the demand environment and the uncertainty being felt across the economy. This focus continues to inform how we are looking at the near-term outlook, and we've added more operational rigor to enable us to be in a position to adapt to the changing environment. Naturally, this increased rigor is squarely focused on what we can control, while remaining committed to growth and improving profitability. Before handing the call over to Greg, I want to reiterate that it's my privilege as CEO of Couchbase to have the honor of leading a great team of people. One of our core values is to attack hard problems driven by customer outcomes, and I am proud of our focus on delivering for customers no matter what. Nothing prepares us for the future more than being battle-tested and my confidence in our ability to adapt and innovate in the face of macro headwinds remain strong. Thanks, Matt, and thanks, everyone, for joining us. We had another strong quarter as we beat guidance across all key metrics against a more challenging macro environment and despite increased FX headwinds and we saw overall healthy demand for our solutions throughout the quarter and are pleased with our execution. I'll now walk you through our third quarter financial results in more detail before providing our guidance for the fourth quarter and full-year. Total ARR at the end of the third quarter was $151.7 million, representing 24% growth year-over-year or 28% growth year-over-year on a constant currency basis. Like many of our peers, we saw a meaningful incremental currency headwind in Q3. Without the additional in-quarter negative FX impact, ARR would have been approximately $1 million higher or $2.4 million above the midpoint of our guidance range. Revenue for the third quarter was $38.6 million, an increase of 25% year-over-year and well above the high-end of our guidance range. We estimate foreign currency had an immaterial impact on year-over-year revenue growth. In addition to strong subscription revenue growth this quarter, revenue benefited from continued strength in professional services which we remind you is nonrecurring and does not appear in our ARR number nor customer counts. Subscription revenue for the third quarter was $35.7 million, an increase of 23% year-over-year. Subscription revenue was down 4% sequentially. The sequential decline was anticipated following a strong outperformance in our on-demand business last quarter. Professional services revenue for the third quarter was $2.8 million, an increase of 56% year-over-year. We exited the quarter with 658 customers, an increase of 26 net new customers from the second quarter and the highest in over three years. In addition to strong Capella traction, the number of non-Capella additions was one of the highest we've had since Q4 of fiscal year 2020 and the number of customers spending more than $1 million in ARR with us increased to 32% from 28% last quarter demonstrating the continued success of our land and expand strategy. Our ARR per customer performance in the third quarter was $231,000, up from $203,000 in the second quarter as Capella continues to grow in revenue contribution, we expect ARR per customer growth could continue to moderate or decline in the future quarters. Our dollar-based net retention rate continues to exceed 115%. In discussing the remainder of the income statement, please note that unless otherwise stated, all references to our expenses, results of operations and share count are on a non-GAAP basis. In Q3, our gross margin remained best-in-class at 88%. This compares to a gross margin of 88.3% a year ago and 88.7% last quarter. As a reminder, as Capella mix increases, we expect gross margin could moderate over time. Turning to expenses. We continue to invest to capture the generational opportunity we see in front of us, but are focused on improving the efficiency of our growth. Our sales and marketing expenses for Q3 were $24.9 million or 65% of revenue, compared to $21.5 million or 70% of revenue a year ago. Research and development expenses for Q3 were $12 million or 31% of revenue compared to $12 million or 39% of revenue a year ago. General and administrative expenses for Q3 were $6.6 million or 17% of total revenue compared to $5.8 million or 19% of revenue a year ago. Non-GAAP operating loss for Q3 was $9.6 million or negative 25% operating margin compared to an operating loss of $12.1 million or a negative 39% operating margin a year ago. The operating loss was well above the high-end of our guidance, resulting from our strong revenue results and incremental focus on both expense discipline and increasing efficiencies. Non-GAAP net loss attributable to common stockholders for Q3 was $9.7 million or negative $0.22 per share. Turning to the balance sheet and cash flow statement. We ended Q3 with $177 million in cash, cash equivalents and short-term investments. We remain well capitalized to execute against our long-term growth strategy. Our remaining performance obligations or RPO totaled $159.6 million at the end of Q3, an increase of 28% year-over-year. We expect to recognize approximately 65% or $104.5 million of total RPO as revenue over the next 12 months, which represents 36% year-over-year growth. We are pleased with our RPO performance despite the fact that we've seen some customers elect shorter-term contracts due to macro uncertainty and because our sales plans no longer incentivize multiyear contracts as aggressively. As such, we saw a slight contraction in billing terms. Operating cash flow for Q3 was negative $14.7 million, while free cash flow was negative $16.3 million. Q3 is seasonally a low free cash flow quarter due to a combination of timing of collections and expenses. Now to conclude the call, I will provide guidance for Q4 and the full-year of fiscal 2023. As Matt discussed, despite the ongoing macroeconomic volatility, our pipeline remains strong. We continue to see solid momentum across our industry in support of broad based digital transformation initiatives. That said, we are mindful of the macro headwinds impacting IT spending and are monitoring the environment closely. We also continue to see headwinds from foreign exchange exposure. Lastly, I'd like to remind everyone that as opposed to the annual credit portion of our Capella business, the on-demand portion is not currently cutted in ARR. And as such, we are factoring this emerging dynamic in our outlook. Accordingly, we are prudently considering these factors into our guidance. For the fourth quarter of fiscal 2023, we expect total revenue in the range of $38.2 million to $38.4 million for a year-over-year growth of 9% at the midpoint. We anticipate fourth quarter and full year ARR in the range of $160.5 million to $162.5 million, which represents 22% growth year-over-year at the midpoint, and it's unchanged from the midpoint of our previous full year guidance. We note that we anticipate approximately a 2% negative impact to our ARR growth rate due to foreign currency fluctuations. We expect a non-GAAP operating loss in the range of negative $15 million to negative $14.8 million. Now turning to our revised full year guidance. We are raising our full year revenue guidance provided on our Q2 call and now expect revenue to be in the range of $151.4 million to $151.6 million or a year-over-year growth of 23% at the midpoint. As a reminder, we've historically seen variability with respect to the implementation timing of certain enterprise deals, which impacts our revenue visibility. We, therefore, believe that ARR is a better indicator than revenue of the strength of our business. As noted above, we continue to expect ARR growth to be 22% at the midpoint. Due to our revenue outperformance and continued expense discipline, we are raising our non-GAAP operating loss guidance and now expect a range of negative $46.4 million to negative $46.2 million. Finally, while we are not yet providing guidance on fiscal 2024, I want to share a few initial thoughts on how we're viewing our business heading into next year. Our priorities will be focused on four key elements: first, delivering top line growth; second, increasing the mix of Capella across all metrics. Third, driving further sales and marketing efficiency; and fourth, continue to improve the overall leverage in our model. We look forward to providing further details on our fiscal 2024 outlook during our fiscal Q4 2023 earnings call. Yes. Thank you. Hey, guys. On the fourth quarter on the ARR, did you -- have you actually baked in some macro softness in that number and kind of relative to historical periods? Yes, hey, Jason. It's Greg. Good morning. Yes, we are obviously factoring in what we're seeing currently from a macroeconomic perspective into the guidance across all of our metrics. So we are absolutely trying to take into consideration everything we're seeing out there today. Okay. And then, Matt, can you just maybe summarize, I know you guys -- you talked a lot about it on the script, but maybe just summarize for everyone the go-to-market changes that you guys have executed over the last year or so that have contributed to the performance here. Sure, Jason. First, I would remind you that we take a balanced approach to go-to-market and we've had a very highly sophisticated enterprise go-to-market motion with a big opportunity to complement that with what we call our buy from activity. If I start on the enterprise sell-to side we have new sales leadership that's driving an amount of operational rigor that we haven't had in the business historically, and that's every aspect of how we manage things. Build pipeline, inspect deals, drive sales methodology, rhythm and rigor throughout the entirety of the global sales organization. I would also point out that we are driving incremental leverage with our partnerships in that area. And we are very excited with the activity that we're seeing across the partner types in particular with the big cloud providers as evidenced by the increased relationship with AWS at a very strategic level and that allows us to drive additional coverage and reach into existing accounts, but most importantly, as we attack new logos across all geographies and segments of our business. With Capella, we are then able to open up or buy from motion in a much more material way. So how do we engage developers as they're in the initial phases of evaluating databases, help them learn about what Couchbase and Capella can do for them, get them into trials and really start to facilitate a relationship well before they move into production. One of the additional things that we are seeing, Jason, as you put those two things together is leveraging our community addition installed base as we migrate those customers to Capella. So a lot of factors that we bring together with an overall focus on execution. And while we are very mindful of macroeconomic conditions, we do believe that these things will help us mitigate any pressure that we would feel. Great. And then one quick follow-up on the partnerships with cloud. Are you guys transacting through the cloud marketplaces. It just seems like a phenomenon we are seeing across a lot of independent software companies right now, third-party software going through those cloud marketplaces. And what's the opportunity to drive greater leverage in the model over time through that channel? Yes. Jason, we are, and we believe that that's going to be a significant area of improvement for us. I think the more strategic we become with our offerings, we have a much bigger ability to collaborate with those cloud providers and do joint go-to-market execution across our account teams and up throughout the leadership teams. I will tell you the largest new logo in company history that we reviewed in the script actually came through the marketplace and we were able to use our internal analytics to then engage our sales teams at the right time and work with the customer at a significant level to move them into a different consumption model because of how quickly that's grown. So we believe that the clouds are not only going to help us as we move down in the "pyramid" and drive new logos and increased sales cycles, but the fact that we are doing it all the way up to one of the largest companies in India and leveraging that buy from -- to sell-to motion I think, is an indicator of how powerful this can be for us. Team, thanks for taking my question and congrats from me as well to -- for the execution in this market. The main question I had for you, Matt, was like now that Capella and see what's happening there, what do you see in terms of the customer size and that is coming there and the customer type of project. And here you would think that the cloud is easier to adapt the partners are bringing you more of a business. So does that mean that you should see kind of a top of the funnel to get broader, you should kind of see different customers than what you've seen before. Is there any kind of experience that you can share already? Thank you. Hey, Raimo. So, look, the first thing I would say is Capella is dominating customer conversations across our business. That's our largest enterprise customers today down through more commercial mid-market companies that we're hoping to land as new logos. I think the value proposition of our enterprise database in a consumption model that allows customers to more easily consolidate database, offload database management, have a better TCO, but enable developer productivity and efficiency that value proposition lands with customers throughout the spectrum. I would tell you, no doubt, we are able to attract a set of customers that we otherwise wouldn't who are looking exclusively for a database as a service offering, but at the same time, with our existing customers, we're seeing migrations and we're seeing customers lean into new applications. I mean, we talked about a few new logos on the call. But if I look at customers that are taking advantage of the value proposition, we have a leading luxury home furnishing company who's running mission-critical applications on order management and fulfillment. They saw a massive TCO and productivity advantage they move in. That's very different from a major global energy and services company that shows us for 360 data management, again, because they get the features of our modern database but in a consumption model. But then we have small startups like a data privacy company that's leaning on us for data catalog and user profiles that was historically a CE customer that moved into Capella because they just benefit so much more from the value proposition. So we are seeing the demand across our funnel. Undoubtedly, we think it's going to open the aperture and allow us to engage with more companies. We've been talking a lot about wanting more of that and we are starting to see that, and it's becoming a meaningful part of our business. Great. Thanks, guys. Appreciate it. Matt, I will start with one for you. Just on the new logos, obviously, nice sequential improvement for you guys. It sounds like Capella is a driver there. As you think about the land and expand motion and kind of the free trial model there, what do you expect in terms of your expectations we could see in terms of new logo acceleration, not asking you to guide, but how should we think about a steady state? It's obviously a lot improving nicely, but still off of a pretty low base. And then I wanted to ask about the database consolidation example, which you gave us the API connectivity company really struck me because that was -- it seems also a new land, and it would strike me that you guys would have a really nice opportunity potentially for DB consolidation with existing customers. It sounds like that's a thematic that played with new customers -- so maybe you can talk to that as well. Thanks. Yes. So Bob, let me start with the second piece first. Look, I think a big part of our value proposition is database consolidation. If you go back to the core architecture that we have, we're a multimodal database that runs from cloud to edge and everything in between. It allows us to manage not just run time, real-time applications at the highest performance and scale, but allows us to do things like transactions and operational analytics and true applications at the edge. If you think about the capabilities that applications require from a database perspective, those could all be different vendors where, in fact, we've been able to put that into our very broad platform. And with Capella, we just make it that much easier to consume and allow the developers to focus on application development and flexibility while giving them the full power of the couch based platform. So we believe that consolidation is really important, but then customers are always thinking through what's my sort of payback and TCO of rewriting an application or building a new one. And the fact that we've lowered the barrier to entry with Capella and allow customers to get a feel of the solution with trials, we can make that go that much faster. I will tell you in these economic times, a value proposition of consolidation resonates extremely well. And we believe that we are set up with scale and performance and the things that we're doing on the UI and driving better TCO to further enable that as we go forward. Look, as it pertains to new logos, quite frankly, that scenario that we know we can do better. We're pleased that we are seeing improvement, which is a function of a lot of hard work across go-to-market and product. But quite frankly, we think there's a lot of room for improvement there, and we certainly expect more. We think Capella is the thing that's going to be the game changer for us. And what I'd tell you, Rob, is in addition to being proud of results that we delivered, as I study the leading indicators across Capella in particular, we are seeing what we would expect, which is headed in the direction of new logo improvement. So we think that's a big lever for us, but we also believe that we have the investments in place to execute on that as we go forward. Great. Thanks, Matt. Appreciate all the detail. And Greg, just one for you. Just on the Q4 guidance, it does imply an operating loss margin a bit bigger. I was just wondering if you could walk through and just remind are there seasonal elements to the expenses in Q4 or anything else in that line that you'd like to call out? Thank you. Yes. Sure, Rob. Yes, there is some seasonality in the sense that Q4 in particular, we do start looking at what we are going to need for fiscal '24 in terms of ramping up sales capacity to meet we are going to deliver there yet still being very disciplined and how we are hiring. We've never gotten over our skis in terms of hiring, and so we feel comfortable there. But there is some timing. And again, we are working here as we always have to provide guidance that we can at a minimum need and certainly try to beat over time. Great. Thanks very much. Greg, I think it was you who mentioned the sequential decline in subscription and some of that had to do with some on-demand revenue you picked up in 2Q. Can you maybe dig a little bit deeper into that? Thanks. Yes. Look, Brad, good question. Look, we're pleased with the overall revenue momentum, the large deal activity. We had good balance across regions. Matt talked about the logo and the expansion. That said, we did -- we do have -- the sequential decline is on-demand, a little less in the marketplace. We had a lower renewal base in Q3 than Q2 and which drives some of that because we tend to upsell at the renewal point. And then the other thing is, as Capella becomes more meaningful, which we're beginning to see the nature of the accounting is such that we don't get the upfront license from ASC 606, so we would get on a subscription business as we would get on Capella. So those are some of the drivers you're going to see on that sequential change. Great. And then, Matt, I know you guys have talked about and demonstrated operational efficiency here over the last several quarters regardless of the 4Q guide. As you think about next year, what are the puts and takes around the magnitude of the operational efficiency that you'll deliver? Hey, Brad, look, it's a dynamic that we spent a tremendous amount of time on. As we think about our objectives, which we've talked about for a couple of quarters now, we're very focused on increasing growth, increasing our Capella mix, which we believe is a significant driver for the company while at the same time, improving go-to-market efficiency and providing long-term leverage in our model. And so as I think as evidenced by our execution up to this point, we are delivering on those things, and we believe we will continue to do so. What we are constantly balancing is how do we take advantage of the generational opportunity in front of us and at the same time, as Greg said, not get beyond ourselves with the investments that we're making. We believe we have a good balance truck right now, particularly with understanding the macroeconomic environment and being prudent about our investments in both product and go-to-market. With the team we have in place, the amount of innovation that we're driving on the product side is better and more efficient than it's ever been, and we believe there are more efficiencies to find. As we drive our increased operational efficiency on all things go-to-market and get more benefit from partners, we believe that we're going to see higher returns from that as well. A big driver of this efficiency, Brad is going to be the payoff of Capella which we've been investing in for some time, and we are starting to see that return. So I think we're set up to strike that balance as we go forward. But equally excited about our ability to take advantage of the massive opportunity over the mid and long-term. Yes, Brad, if I could just jump in here. As we stated, we're not doing fiscal '24 guidance yet, but just as you all start thinking about next year, there were a couple of things that we saw besides the true operating efficiency that we drove here. We had the benefit of foreign exchanges here, and we started doing some software capitalization this year that, obviously, we haven't -- as you start thinking about next year, the software cap should be kind of flattish and not seeing a change there in FX as well -- what FX is. But just as people are thinking about the operating margins for next year that some of those benefits we saw this year aren't going to repeat. Thank you very much, Matt and Greg. Congratulations on the quarter. Matt, I'm curious to get your perspective on Capella, how do you see the go-to-market strategy of the company, pivoting more towards Capella, are you going to have a dedicated sales that will sell only Capella. We really have a continued mixed mode with the delivery and also from a product development perspective, research development perspective. At what point are we going to be dedicating most of the research development, I would assume, at some point, the company becomes 100% Capella and recent development goes into Capella because as you have been very consistently pointing out, we've reached and crossed maybe the tipping point of the functionality of the database product. So curious to get your thoughts on that. Thank you so much once again. Hey, Kash, I'd say on both questions, we are beyond the inflection point. And in my opening comments, I talked about being excited about the results, but even more excited about the operational improvements. And underneath that is directly aligned to both of your questions. We have pivoted on a Capella first mindset at the company. I'd like to say if you woke up any one of our employees have asked them what the most important thing is, they wouldn't hesitate to tell you that it's Capella and that's on both the go-to-market side and the product side. We have every single one of our go-to-market resources focused on Capella. We're, of course, offsetting that with specialists who can come in and help with nuances and details that may go beyond what we would expect everyone to be able to cover. But everything from enablement to compensation plans to how we measure the business to forecast calls, there was a maniacal focus on all things, Capella across both our existing accounts and in driving improvement on new logos. As a reminder, we brought in Gopi several quarters ago to drive the cloud transformation on all things products. And we are -- that is the number one priority. So if you think about our product teams, everything is focused on Capella. And what I tell the teams is Capella first, if we have something that can serve both businesses, meaning Capella and our existing installed base will allow those customers more time before they eventually migrate to Capella those are valid investments, and we will not invest in anything beyond that. And so I think we've made the switch. But the great thing is we have an underlying architecture with our core platform that serves it very well to how we want to run Capella and some of the architectural decisions that we made very early on, like how we manage underlying resources, how we can balance between memory and storage optimization. The fact that we can running clouds with some of the best data movement technology in the industry, the fact that we go from cloud to edge. I mean it's a platform that is now being run as a service and the transition from product to service company is one that we've made. So I'd say we're beyond it, and we are starting to see the benefits of investments on both sides of the house. Great. And one for you, Greg, if I could. How does Capella change the longer term operating model for the company, with respect to operating expenses and the kind of leverage that they can get in a 100% Capella world versus 100% on-premises world. Thank you so much. Yes. As Matt kind of alluded to, look, it's going to -- we believe it's going to drive the growth of the company for the future of top line growth, and we are excited about that, and we are starting to see the beginning of that. At the same time, it will become margin dilutive. Now we are obviously starting from a position of strength with an 88% gross margin, but it will be dilutive over the time by the nature of the offering, including pass-through of infrastructure and service. So we think it's going to bring more dollars, but at a moderated margin rate. That said, as we talked about earlier in terms of getting efficiency, we still plan to drive bottom line efficiency despite having some rate dilution that comes through the model. Hey, guys. Nice quarter. I guess, Greg, I wanted to dig into your fiscal '24 priorities, the 4s that you mentioned. Should we also take them in order of importance. And what I'm trying to get into is the balance between margin improvement and top line, you put top line as your first priority. Does that mean we should look for a moderated improvement on margin and not necessarily a significant one? Yes, Ittai, good question. Look, look, we're going to have a balance across all of them. And just to reiterate again, top line growth, Capella mix, sales and marketing efficiency and driving leverage. And the thing that we talk about is quite honestly, if we get number two, right, which is Capella, which is what we're driving towards and Matt just cover that in detail, that will help the growth. It will help sales and marketing efficiency and ultimately leveraging the model. So that's where the focus is, but it's really across all three -- are all four. We are not focused on any one more than the other per se other than we believe Capella will be the driver of all of them in the future. Okay. And in this effort to drive Capella forward, what kind of changes do you anticipate that you'll have to make to your comp plan at year-end in order to drive that type of behavior? Yes. I mean we will have to further evolve our comp plan around the consumption model, moving away from a subscription comp plan, which is a change, and we're still going through that and discussing it. But obviously, we're going to be focused on Capella first. And so we want the field team to be focused in making money driving Capella. And so we will incentivize them through the comp plan to drive Capella and not only landing Capella logos, converting the existing installed base, but obviously, working with our customers to get the consumption going as fast as possible. Yes, I would just add, we made pretty significant progress this year with the Capella focused compensation plan. So I think it's incremental changes as we take that to next level based on the learnings that we have this year. But rest assured, our field teams and the company, for that matter, are properly incented to sell and drive Capella. Got it. Maybe just last one on Capella itself. Greg, you mentioned that part of the business is on the main tell us roughly and I know you don't have too much experience here, but roughly what percent of the capital activity is done on demand? Yes. Again, Ittai, this is one thing where we're not disclosing the Capella specifics today. It's not material to the business today. But when we get to the point where we're ready to disclose the metrics, we certainly do that. Again, if anything, what we like about the on-demand model and the buy from is exactly what Matt said about the customer we land a large customer. Now that wasn't a Capella customer per se. But the fact that we can have trials and activity that gives us insight into how customers are even thinking about using Capella and we can go and sell into them. We see customers that are not customers of ours today that are using Capella on an on-demand basis that we would have never seen before, so it is giving us the ability to access and get insights from potential customers that we have had before. Great, guys. Thanks for the question. Matt, obviously, a lot of talk about Capella here, and it's great to hear the momentum there. Could you talk a little bit more about win rates there. I have a sense that they probably improved, but can you talk about the magnitude of your win rates there versus maybe some historical averages? Yes, Matt. So I think we are still early. So we hesitate to draw absolute distinctions. But I would tell you it's aligned to our hypothesis that opening the top of funnel, more opportunities, having a consumption model that quite frankly, the market has wanted that we are -- weâve been relatively behind on to be candid. I think is giving us what we wanted to, and we're seeing faster deal cycles, and we really like our competitive chances when we get into bake offs. Capella is a solution that value proposition is resonating, and we can beat other solutions with scale and performance and agility and developer productivity. So I think the metrics are proceeding as we would expected, but keep in mind, we had pretty high expectations for them. I think the big thing is, again, the customers that we are able to get after that we otherwise wouldn't have been able to -- and we think that's really meaningful for us as we go forward. As is the ability to get after new use cases in existing large enterprise customers. So a big opportunity for us to go after new opportunities. And with the industry-leading scale and performance and total cost of ownership we have a lot to be excited about when we engage in an active opportunity. Got it. Makes sense. And then, Greg, you noted you're starting to see some signs of delayed decisions or extra approval. I believe you said I'm curious, did that actually have an impact on the quarter? And I guess, do you assume in your fourth quarter guide that macros get worse before things kind of start to get better, get better, just kind of your philosophy there? Yes. It didn't have a material impact in the quarter, Matt, but we did want to call it out because we are starting to see where there's layers of approval, elongated sales cycles and what we even called out last time was customers opting for shorter term deals rather than the long multiyears. And we continue to see that. And so we just want to call that out because we are seeing that. And we absolutely have considered that and factor that into our guidance for fourth quarter and for full year based on what we're seeing today. Obviously, I'm not going to try to predict the future per se, but we factored in everything that we are aware of heading into this earnings period and the guide we've given you today. So again, we set out the guidance with the ability based on what we know to at a minimum meet, and we're certainly going to try to exceed it. Matt, what I would pile on is we have a pretty diversified business. If you think about the verticals we serve and our geographic coverage and now our ability to move from enterprise down market, and so as Greg said, we're calling this out, but we are being specific that it's some customers, not every customer. In some cases, with the addition of Capella, we're seeing faster deal process and easier sign off because we have a form factor that people want. So I think it's a balance. And where we are seeing customers that have that focus, it's our job to ensure that we're articulating the economic value of the solution. We are helping them with sizing the deployment appropriately for the application they have and with better go-to-market effectiveness and rigor, we can manage those sales cycles accordingly. So I think it's a portfolio dynamic. We are very mindful of what's going on. And quite frankly, we're obsessing over it on a daily basis across every aspect of our business to make sure that we have the best read on the demand environment that we possibly can. Excellent. Thank you. This is [indiscernible] for Sanjit. So first, I mean, very encouraging to see the strong customer adds in the quarter. So I just want to dig a little bit into your free-to-paid conversion and particularly with on what you're seeing in this environment? And then two, what are you contemplating in your outlook from here? And then separately, maybe because we haven't touched on it yet, sort of on the expansion side. I mean you mentioned a strong airlines expansion deal, so anything you can share sort of how those expansions are shaping up with your expectations? That would be super helpful. Thank you. Great. So let me take that in two parts. We're an open source company, and we've had a community addition product that software developers and enterprises could download for free and for all intents and purposes. That was our free offering before we had a trial set up on with our on-demand portfolio. As you can imagine, having had that in our arsenal for some time, we have a very rich set of deployments of CE on a global basis. And what we found is that's often been a feeder where companies can come to understand the power of the platform and then they decide to move into enterprise edition for better support or compliance reasons. But we're seeing an acceleration of that dynamic with the Capella service because as companies are making the evaluation of going into an enterprise version, the Capella form factor has even better TCO dynamics where they can have better operational spend, better optimize the underlying infrastructure for the database and free up people that would need to manage the database so they can focus on application development. And so we think that transition where we've seen success will continue as we go forward. Look, as we think about the overall expansion of our business I think historically, we've had a very healthy land and expand business model. And we're seeing that dynamic continue to play out and even accelerate it because of the applications we're able to get after with Capella. So we talked about one of the world's largest airlines. That was a significant expansion and totally aligned to their digital transformation. When you think about transforming how to get planes off the ground and digitizing the passenger experience, they're leaning into Couchbase because we have capabilities that other companies just don't. We had another logistics tech provider that does mobile application for package delivery and returns for retailers, et cetera, they continue to expand their deployment of Couchbase because we have the best performance that they can find. And now they're starting to think about international expansion on the Couchbase platform because it can seamlessly port what they're doing with applications in one country into another. So we have a lot of examples of customers seeing the -- what they can do in support of their application development and a big part of how we go-to-market and what we think will be our growth leverage as we go forward. Great. Thank you for taking my questions. I'm curious on the largest deal, largest new logo deal in company history, anything you can share there just in terms of ACV or TCV or how much larger it was in the prior record. Any color there would be great? And then secondly, completely understand you're still not disclosing much in metrics is it's not a material part of the business yet. But last quarter, you said it was the majority of new customer wins. So that the case again this quarter? Or could you share what percentage of new bookings or net new ARR is accounted for? Yes. Hey, Rudy, it's Greg. Yes, on the large new logo we did, it was over $1 million deal on an ACV basis, and it was probably about 2x the size of our previous largest new logo. So very pleased with that. And Matt gave some color about how we went about acquiring them through the marketplace. So great win for the company and opportunity to continue to grow. On Capella, look, we had a very good quarter with Capella logos. We're not breaking that out yet, but we're, again, very happy with the new logo activity that Capella drove we're also very happy. I don't think we talked about this, but we're also obviously migrating a number of our installed base customers over at the same time. So I think it's both of those things are what's driving the improvement. But Capella will certainly be a driver to the new logos in the future as well as it was this quarter. Got it. And then on the macro, certainly you did not material impact yet, some long-dated sales cycles. I guess I'm curious if you go back to COVID, certainly, retail hospitality and travel, those verticals are impacted, I think revenge travel is still kind of alive and well, although some consumer spending has come down in other areas. But have you seen your usage growth start to come down or moderate at all in some of those verticals that are more tied to the macro environment? Again, we mentioned about what we are seeing from a macro perspective. We are moving away from this COVID impact. But again, we still look at it the travel and entertainment is strong. And while we're seeing sort of pockets of some of the macro impacts, it hasn't become a broad based impact on our financials to this date, but we continue to watch it closely. And again, we are starting to see some of those things that our peers are calling out with elongated sales cycles, more levels of approval and we're just working through those dynamics. Again, we think, as Matt said, we have a diverse business that has the opportunity to see some pockets of growth within there, but there could be some pockets of macro impact. And Rudy, what I would add is the applications are mission critical. So the stuff that we do that we do really, really matters. And if you think about whether it's a booking engine or a Customer 360 application or a product catalog these typically are the applications that people would back off of even if they're feeling some economic pressure. I think they are focused on the economic value, so ensuring that the application overall is providing the business return that they would expect. I think if anything, we've seen customers knowing how important these applications are committing to growth and in some cases, substantial growth over the next, call it, 12 to 18 months, but maybe instead of going with a three-year deal, they're opting for one a little bit shorter, just in light of what's going on. So I think that's a more specific intangible example that's specifically hitting us. But as far as moderating spend on these applications, I think it's one of the benefits of where we sit and the fact that we are mission critical, and I think we can be smart about how we navigate that as we go forward. Thank you. We've reached end of our question-and-answer session. I'd like to turn the floor back over to President and CEO, Matt Cain. Please go ahead. Thanks, operator. To recap, we had a strong quarter, and I remain excited about our opportunity with Capella due to some very big trends in favor like digital transformation, acceleration of cloud and innovation at the edge. We are cognizant of the macro environment and are sharply focused on execution during these times. Thank you for joining us. Thank you. That does conclude today's teleconference and webcast. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today.
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EarningCall_1619
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Good afternoon. My name is Brent, and I will be your conference operator today. At this time, I would like to welcome everyone to the conference call. All lines have been placed on mute to prevent any background noise. After the speakersâ remarks there will be a question-and-answer session. [Operator Instructions] Thank you. Thanks, Brent. And thank you for joining us today for CleanSparkâs fourth quarter and fiscal full year financial results call. Our press release was issued about 30 minutes ago and is available on our website at www.cleanspark.com/investors. Todayâs call is also being webcast, and a replay and transcript will be available on our website. Keep in mind that some of the statements we make today are forward-looking and based on our best view of the world and our business as we see it today. As described in our SEC filings and on our website, those elements may change as the world changes. We will also discuss certain non-GAAP financial measures about our performance during todayâs call. You can find the reconciliation of GAAP financial measures in our press release, which is available on our website. I want to pause for a minute and say, âWhat a yearâ. It's true what they say about Bitcoin. It moves lightning fast, and so do we. Much like dog years, it feels like a year in Bitcoin is about seven years of experience in traditional markets. And for CleanSpark, that time distortion has been even greater. We've established ourselves as one of the leading publicly traded Bitcoin miners in the world, all in just one year. When we checked in with you last December for our fiscal year 2021 earnings call, we reported revenue for that fiscal year of $49.4 million. We had just over 10,000 machines operational for about 1 exahash. And at the time, we were just using 33 megawatts of power. We had two sites, one fully running at College Park and one under development at Norcross. And for the fiscal year, we mined 892 Bitcoin last year. And we were also operating two business segments. Now this fiscal year we've doubled, tripled, and even quadrupled some of these key performance indicators. Our revenue for fiscal year 2022 was $131.5 million, almost a 250% increase over the prior year. Our adjusted EBITDA was $65.7 million, a 500% increase. At the end of the fiscal year, we had over 42,000 miners operational, a 330% increase -- a 313% increase. Our hash rate was 4.16, a 312% increase. And our operational megawatts were 140 megawatts, a 324% increase. As of this call, we have four owned and operated sites that we own 100% with no partners and little debt. And for fiscal year 2022, we mined 3,750 bitcoins, a 320% increase in our production. I get asked all the time when I'm at events, what our secret is. I tell them two things. First, I believe that a lot of the entrants into this space thought the bull market would never end. And so, they forgot to plan accordingly. This is not to cast aspersions on our colleagues. We all hoped it would net, but it did. And we believe strongly it will come back. We started preparing early on by calibrating the three levers of capital available to us, Bitcoin, equity, and debt. And principal among those is Bitcoin. Since October last year, we've used our Bitcoin to fund our operations and growth, and that has made a big difference for us. For example, our average sale price per Bitcoin in fiscal 2022 was over $35,000 of Bitcoin. The second thing I tell people is that the key to successful Bitcoin mining is operational. Some groups believe that it as simple as acquiring capital and plugging in machines. Well, that may have been true in the bull market. The key differentiator now is operational prowess. You have to roll up your sleeves and do the work. This is what makes us a Bitcoin miner. Despite harsh economic realities, we have assembled the teams, tools and ideas to make the very most of this bear market. We believe great companies use bear markets to grow, and weâve certainly grown a lot during this bear market. We are particularly proud of the growth and development of our owned and operated facilities. In the last four months, weâve expanded our campuses with the acquisition of the Washington and Sandersville sites. We also fully completed Phase 2 of our Norcross campus. While the smallest of our sites, Norcross is truly a special place, deploying the state-of-the-art immersion cooling technology. We've recently opened the facility to the local community, including dignitaries, business leaders, and other officials, all walked away impressed. It reminds me that as we do the work of educating people about Bitcoin and Bitcoin mining, seeing really is believing. We did something similar in Washington. After acquiring the facility, we invited the Mayor, City Council, Chamber of Commerce and community members to tour the air cooled facility. Again, this is the way to the hearts and minds of the communities we operate in, full transparency as we work to cultivate trust in an industry that is new for most people. The last thing I want to mention about our growth in Georgia is that it has made us a power purchaser of consequence. We are now one of the largest power purchasers in the state of Georgia, and we are the municipal energy association of Georgia's largest customer. We intend to continue to build our relationships with our partner cities and to procure the best possible power rates for us and the communities we operate in. One last key highlight for the year, and this was a very big one for us. We transitioned to a pure play Bitcoin miner. As many on this call know, Matt and I founded CleanSpark in 2014, to help people achieve energy independence for homes and small businesses. We built localized power grids or micro-grids for military bases, factories, small businesses and people's homes. In 2020, we began applying that expertise to Bitcoin mining. When we acquired our very first Bitcoin mining campus in Georgia, since then, weâve grown our expertise in Bitcoin mining to the point that we are passing the baton on our micro-grid business. Subsequent to the quarter's end, we sold many of our energy assets, including our mPulse and GridFabric products and the contracts associated with them. Along with the sale of those assets, we transitioned our entire software team to new owners. These moves bring two clear advantages. First, it allows us to continue to deepen our expertise in Bitcoin mining by streamlining our operational focus. Second, it secures us significant cost savings in the reduction of payroll and working capital requirements that are incredibly impactful in a bear market environment. As our longtime investors know, this was a low-margin high-capital business, the exit of which will save us tens of millions in capital, in the very near-term. We are in the process of selling the remaining assets and we hope to fully divest of our legacy business and the very near future. I'd now like to transition my discussion to talk a little bit more about what next year looks like for us and what you might reasonably expect from us as we continue to grow. A few minutes ago, we filed the new Form S-3 with the SEC. In conjunction with his filing, we also filed a new at the market offering that allows us to sell into the market up to $500 million of common stock in one or more public offerings over the next three years. These are two things that -- there are two things to note about this filing and I want to address both head on. First, we previously filed an offering under the same terms. This filing functions as a refresh of our existing shelf offering, which was also $500 million, of which we only threw down about $280 million. The filing of our updated shelf registration statement is designed to give us greater financial flexibility, allowing us to continue to secure additional capital on an opportunistic basis to take advantage of current market opportunities. Second, I want to take a moment to discuss concerns about dilution. CleanSpark has established a clear track record of choosing to issue equity for accretive purposes. We make acquisitions within a specific ROI range, because we expect them to be accretive to the shareholders in the long run. This move allows us to maneuver through a bear market while strengthening our operations and establishing a platform for growth. Over the last two years, we have added more assets than we've sold in equity. Over those two years, we raised approximately 395 million in equity. And during the same time, we purchased miners, facilities, infrastructure and acquisitions, totaling approximately $440 million, also adding only around $20 million in debt to our balance sheet. All the while, employing as of today, about 130 hardworking people. To add to that, our Bitcoin mining revenue and adjusted EBITDA for last two years combined was $170 million and $77 million, respectively. These moves translated into specific growth opportunities that have made us one of the top publicly traded Bitcoin mining companies. This month, we've now hit a high of 5.8 exahash per second, and we are on track to hit 6 exahash per second before the end of the year. Because machines we were temporarily hosting our standards off site are now being moved out earlier than expected. Adding to that, our daily Bitcoin production high has reached 21.7. We also exceeded our year-end hash rate guidance, and in November mined a record 535 Bitcoin that month. I want to reiterate that our strategy of using equities is paired with how we use the Bitcoin we mine, even before the current bear market, when the Bitcoin price was still hovering around the $50,000 price level. We used Bitcoins to support our operations and growth when our peers were choosing to dilute shareholders in favor of holding the Bitcoin they produced. At the time, this was a bold move. We continue to believe in this approach to maximize value for our shareholders, and reserving equity as a financial tool to support growth. This strategy has rewarded us well, allowing us to grow even during these tough times for the mining industry. But, we will not prioritize growth at any cost, bold growth yes, but not the sort of arms race that has so quickly deteriorated the financial health of our industry. With that in mind, I'd like to spend some time talking about our growth philosophy. We set bold realizable projections for our hash rate growth in our last earnings call. At that time we guided towards 22.4 exahash by the end of 2023. Earlier this year, we announced a partnership with Lancium. As part of the agreement, Lancium agreed to build clean campuses in West Texas to host 200 megawatts of our machines or about 6.6 exahash of our 2023 calendar year-end guidance. Originally, they committed to provide the first 50 megawatts in December of this year and the next 150 megawatts in spring of '23. In August, Lancium let us know they were experiencing delays and we communicated to you that we were shifting our expectations for the initial 50 megawatts to early '23. Just recently, they informed us of capital constraints affecting their ability to meet their commitments for all 200 megawatts, pushing the readiness of these facilities into late 2023, and based upon current market conditions, it's likely to be even later. While we intend to continue to work with Lancium long-term, we all know that being in a colocation business is incredibly difficult right now. And for this reason, we're revising our 2023 calendar year-end guidance to 16 exahash. Look, if we could beat 16, which we want to do, we will. We have a track record of doing just that. We guided a 5 exahash for the end of this calendar year, and we're now looking at 6. We chose to go into the spot market for machines instead of locking up money in long-term machine contracts. And we were right about that, often setting the floor price. We chose to sell the Bitcoin we mined to fund our growth in operations and that too has proven to be correct. And all along the way, we've gotten better and better about execution. This team continues to exceed my expectations, and I'm proud of them. And I want you as shareholders to have the same pride that I do. If we could beat 16 exahash, and we certainly have a track record of over-delivering on our guidance, we'll do our damnedest to continue to do so. As I said, we will grow but not at all cost. To this point in our development, we've been laser focused on increasing Bitcoin production. With Bitcoinâs current prices, we're also focused on maximizing margins. If producing less Bitcoin at a higher profit margin is the right thing to do, we're going to do that. Let me repeat, the goal is to maximize margins. And the surest way to do that is to responsibly mine. Weâre being responsive to both Bitcoin and power prices. And to be clear, just because we are maximizing margins does not mean we are seeing large production decreases. Currently, our uptime averages are greater than 90%. Well, our internal analysis indicates that we are in or nearing the bottom of the bear market. That does not mean we're out of the woods. I want to thank our shareholders for trusting us and taking this journey with us. Bitcoin is not some passing fad it is a technological and financial advancement in human history. Our world is only beginning to understand it. Adoption is increasing throughout the world. Layer two and three technologies continue to emerge and develop. This is transformational technology. And that part about adoption is key. When the internet was at Bitcoinâs current stage of growth, adoption was growing at 85% a year versus the 165% a year that Bitcoin is growing. We're just at the beginning. So, to our shareholders, thank you for sticking with us on this journey. You invest in CleanSpark because you believe in our team, that we are efficient, skilled operators who mine at the best margins possible for our shareholders. Before passing the mic to Gary, I'd like to make one more comment, and that is to thank the teams that have made this all possible. The CleanSpark team is incredible. From corporate headquarters to the mining campuses, our people are committed to do what we are jointly accomplishing. I'd especially like to thank our teams in the field. You've racked and repaired in heat and cold, rain and shine, 24 hours a day, seven days a week. The result is a truly impressive network of mining campuses that are making a difference in the beautiful communities they are located in. Thank you. I would like to echo a few points Zach made, as they cannot be emphasized enough. 2022 was a transformative year for CleanSpark, and while the Company achieved historical revenues and adjusted EBITDA, it would not have been possible without what we consider to be a best-in-class operational team. It is that team and the individuals who comprise that team, which have made us one of the most efficient Bitcoin mining operations on the planet. Their efforts are the reason why we can talk about these record numbers today. Reviewing the numbers for the 2022 fiscal year, you'll note that our revenues were $131.5 million, which was an increase of 235% over the prior year. This was obviously due to a full year of Bitcoin mining operations, where we increased our hash rate by over 3 times by the end of the year. Granted, Bitcoin has been a volatile asset, we started the fiscal year with Bitcoin prices at near all time highs, only to end at multi-year lows. While our GAAP revenues reflected a significant decline at Bitcoin prices, we continue to mine more Bitcoin every single month and ended the year with 3,750 bitcoins mined for the year. We did see a significantly greater net loss this year, more than doubling. The primary drivers of this net loss were non-cash in nature with over $100 million of non-cash items hitting our P&L. Some of these items relate to the exiting of the energy business, as we discussed on our Q3 call. We also have significant non-cash charges related to modification of equity instruments, primarily driven by the volatility in our stock in recent years, for which volatility is a key put in evaluation of valuing equity instruments. We also saw almost $50 million in depreciation, directly related to a rapid growth and acquisition of miners and related equipment, some of which was recorded at much higher costs than current spot market pricing. While we know Bitcoin market prices and margins compressed as year went on, when you take a step back, I believe these numbers paint an important picture, and that is the power and scale of our business. When Bitcoin price is high, our margins expand, and we experience significant cash flow. However, when Bitcoin prices depressed, as we are in the current market, our business model and operations have the resiliency to still operate on a positive adjusted EBITDA basis. Our ability to mine Bitcoin efficiently and profitably during a bear market is a direct reflection of our disciplined operations and low debt leverage. Looking at the fourth quarter specifically, you can see the effects lower Bitcoin price had on the most recent quarter. We mined more than twice as much Bitcoin in the fourth quarter compared to the same quarter last year, and only recognized an increase of 15% in revenue. Comparing the fourth quarter to preceding third quarter, it's a similar story. We mined 27% more Bitcoin than the third quarter, yet saw 16% decline in revenue. Since mined more Bitcoin, we used more energy, which directly affected our gross profit. Compared to the same quarter 2021, our gross margins were only 36%, producing $9.5 million of gross profit compared to almost $20 million in the same period last year. Looking at the fourth quarter compared to the immediate prior third quarter, our margins were cut in half due to the decline in Bitcoin pricing. Moving to the next slide. You will see we had a loss of over $42 million in the fourth quarter compared to $5.4 million in the fourth quarter of the prior year. We experienced significant net losses on a GAAP basis for several reasons. Foremost, due to the decline in Bitcoin prices, we had impairments to our goodwill balance of over $12 million. These goodwill balances were originally recognized as a result of our entry into the Bitcoin mining industry back in December of 2020. The analysis required by the accounting rules did not support the carrying value of the goodwill. Like many of our industry peers, our goodwill was written down. Our stock-based compensation was almost $14 million, which is significant higher than the prior periods due to modification of certain equity instruments. It's important to note that these two items represented almost $26 million of the gap base loss alone. And both of these charges were noncash items. Additionally, we did see the loss of discontinued operations decreased from $7.5 million in the third quarter to $1.1 million in the fourth quarter. This is a direct effect of our exit from the energy business. And we expect this number to drastically decrease in 2023 and eventually be zero as we complete the sale of any remaining energy business assets. On the right side of this slide, you will see our fourth quarter adjusted EBITDA, a non-GAAP metric management uses to evaluate the cash flow from operations. This also shows the effect of a low Bitcoin price has our cash flow. As you saw adjusted EBITDA margins decreased 11%, about a quarter of what the adjusted EBITDA margins were at both Q4 '21 and the preceding third quarter of this year. However, I want to point out that while our margins and cash flows have been compressed, our excellent operations team continues to mine Bitcoin on a profitable basis. This is achieved by an hourly assessment of breakeven pricing models, incorporating current Bitcoin prices, current power prices, and our hash rate as a percentage of the global hash rate. This constant monitoring of our operations allows us to not only recognize Bitcoin on a profitable GAAP basis, but also on an adjusted EBITDA basis. Taking a look at our balance sheet, you'll note that we had over $31 million total liquidity as of September 30th, with over $20 million in cash. This liquidity was primarily used for the Sandersville Georgia acquisition, and our $28 million purchase of 10,000 S19J Pro machines from Bitmain subsequent to year-end. We also had a fair market value of $9 million for assets held for sale related to our energy business. As you read in our Form 10-K, we sold a portion of these assets in November. The remaining energy business assets are expected to be sold in the near future. As I pointed out previously, we have very little leverage on our balance sheet with approximately $21.2 million of notes payable outstanding. This amount is primarily the Trinity loan that we closed early in the year. In August, we had a $7 million of assumed mortgages and a short term seller carry back loan related to the acquisition of the Washington Georgia site. We believe we have one of the best, if not the best, balance sheets in the mining industry. And we expect to utilize our balance sheet for continued growth in the coming year. On the next slide, you'll see a snapshot of our current CapEx. We have 58,500 miners deployed with over 4,000 ready to be deployed and another 6,400 to be delivered in January. Our current hash rate is 5.8 exahash, and as Zach mentioned, we expect it to be at 6 exahash by December 31st, numbers that have surpassed expectations and are a testament to the operational team we have on the ground in Georgia. I also want to point out that we have no current outstanding commitments for miner CapEx. This is an important data point as it provides us the ability to be nimble and quickly acquire assets on the spot market if we so choose. We also have budgeted $70 million for construction to build the 200 megawatt expansions at Sandersville and Washington, which represents an approximate cost of $350,000 a megawatt. We currently need an additional 95,000 miners to reach our current guidance of 16 exahash by December 31st of next year. This number is not reflected here as the number of miners and the cost of that CapEx will fluctuate. This cost will fluctuate depending on the model miners we purchase and the cost per terahash. The 95,000 number was based on assumption that all of those miner purchases would be S19J Pros. And the number could potentially be lower if the company decides to purchase more XPs or other models with higher processing power. As you also see them on the slide, we have over 10,500 miners that we energize in the near future, which represents an additional 1 exahash of processing power, which would get us close to 7 exahash early next quarter. I want to end my comments talking about our capital strategy, something that has really set us apart amongst our peers. Our first quarter call, we discussed the three levers we could pull for capital in our business. We've applied a minimal amount of debt on our balance sheet, and having low debt service has allowed us the flexibility to grow during these tough times While debt markets are currently closed for most mining companies, we continue to have positive conversation with lenders, primarily because of our balance sheet and financial position. However, we remain cautious given the contracted margins and we'll obtain debt at a time when we feel comfortable, something I previously referred to as smart leverage. And what I mean by that is that we aren't going to take on toxic debt that will jeopardize the great work and growth we've experienced thus far. Bitcoin is another lever of ours, which we have been very transparent about using. In 2021 and throughout 2022, we were vocal about selling Bitcoin to pay for operational expenditures and growth CapEx. Our strategy again proved effective as we sold Bitcoin at an average price of over $35,000 for the fiscal year 2022. Now, it's easy to Monday morning quarterbacks this considering where Bitcoin prices are now, but we believe then, as we do now, that Bitcoin is our functional currency and we'll continue to use our Bitcoin production as a means of liquidity. And last I want to address our use of equity. As Zach discussed earlier, we have filed for a refresh in our ATM facility of $500 million. I see the facility as just another tool in our toolbox, one of several tools in equity we can use but do not have to use. We have used both the Bitcoin and equity levers to get us to this point and itâs paid off as our hash rate has exponentially increased in the last year, especially over the last few months. We will continue to use equity as appropriate. But I want to be very clear. When we use equity, we intend to use it for growth capital expenditures where the return on investment is meaningful and helps produce accretive result for our shareholders. From where I sit, using equity will allow us to acquire assets, which will produce free cash flow and have no encumbrances or debt service. This is important to our company as we want to be prepared for the next increase in Bitcoin price. And having unencumbered assets will allow our free cash flow margins to greatly increase. Furthermore, we have said before that a rising tide lifts all ships. That means with a rising Bitcoin price, we would expect there would be corresponding increases in the price per terahash of machines and infrastructure, and hopefully an increase in our stock price too. However, we also expect that a higher Bitcoin price would increase economics and essential miners, also reducing the number of opportunities for low priced acquisitions. In fact, if Bitcoin price were to rebound significantly, the limited acquisition opportunities might actually call for a premium opposite of what we're seeing currently in the marketplace. Therefore, we see much opportunity in the short and midterm to make accretive acquisitions at historically low prices. Good afternoon, guys, and congratulations on how much youâve been able to accomplish over the past few months, despite this bear market, really -- really impressive to see. My first question, if you could provide a little bit more color on the expansion roadmap and deployment timeline for the additional buildout at Washington and Sandersville. I know you mentioned you had about 200 megawatts of additional capacity at those two sites, so just curious how we should expect that to layer in over the course of 2023. Yes. This is Zach. I'll address that. So something exciting about our Sandersville site is we are still actually shelfing more minors. So, we actually have some capacity yet to come online, almost 35 megawatts that will come online, likely by the end of January, fully billed, fully paid for. As we mentioned earlier in the call, we are just waiting for machines that were temporarily being hosted there as part of the exit of the prior owner to come off shelf. So, you're going to see a bit of a bump in the very near term in Sandersville. Now, after that, we intend to expand Sandersville another 150 megawatts. We expect that buildout to be complete and functional, likely near the end of 2023. It's going to be a fairly significant process, so it's going to take a while. But Washington, we are adding 50 megawatts, and that construction has actually begun. We expect that to be ready and energized by April of this year, which will give us room for I think about 16,000 machines. That's great. Appreciate the color there. And any visibility you can provide on blended power costs for the quarter, how prices have trended since, and when we might expect you to negotiate any additional power contracts similar to what youâve secured at College Park, as we look out? Yes, absolutely. So, over the last quarter, our fourth quarter, our power prices landed on a weighted average basis, just over $0.05. And it's interesting. I was in Amsterdam. I spent some time speaking on panels as we looked also at sites worldwide. And here in the U.S., what we are seeing as a result of the different pressures in the market is pressures related to pricing. What we are not seeing pressures on is access, like they are in Europe. And anybody can see -- and a great place I would point people to is following the Henry Hub. We use that as part of our predictions for power pricing. So, we are starting to see power prices come in on an elevated basis as a result of the macroeconomic events, but we are also predicting those to drop off fairly quickly come spring. And so, yes, we have absolutely seen these pressures. But one of the key things, and we've spent a lot of time and effort on this, and I mentioned in the call, we're the largest power purchaser for MEAG, which is our largest provider. They partner with the cities that we operate in. And as a result, we have a lot of purchasing power. So we are actively working on securing agreements to lock in lower rates from a long-term point of view across all of our sites. And that's what we want to bring to the table in this process is our combined purchasing power with three out of the four cities we operate in, being through, through MEAG. And we expect the right time to lock in the best rates is going to be the same time that we start to see the declines. So we're kind of aiming for a springtime period to make some of those moves. But with that said, I want to emphasize we picked Georgia for a reason because we're comfortable in our ability to manage rates wherever they may be and still manage to run profitably and effectively from a direct mining cost point of view. So, we're really happy with where we're at, but we do expect to make moves early â23, mid â23 to bring significant improvements to our blended power cost long-term. I was curious, if you can make some commentary on what you're currently seeing in the secondary market as far as pricing for rigs is going. What gives you confidence in your ability to acquire the 95,000 or so of rigs to hit your 16 exahash target based off the prices right now? Thank you. Hey, Josh. Thanks for listening in. What we're seeing right now from a rig pricing point of view is we are seeing buying opportunities continue to persist in the teens. And we do expect to -- and what I mean teens, it's in the dollars per terahash anywhere from $11 to $19 and most of that on the low end, depending on if the units are state side or not. What we are anticipating is we're anticipating there to be plenty of inventory available, especially over the first six months of next year. I do think that prices will stay largely suppressed for at least a few more months. With that said, though, one of the things we're keeping a very close eye on is that when Bitcoin prices move up, the price of rigs seems to move up a little quicker than Bitcoin does because everybody's moving in anticipation and worry that they're seeing in the rear view mirror, which is why we have strategically chosen and the way that we're going down its path is from a dollar cost average point of view. We've acquired machines in the low teens. We've acquired machines in the 20s. We think that the fundamental long-term value is probably in the 30s. So, anything below the 30s we see is a really good thing. But we are absolutely confident that we can acquire those rigs at the low prices. So, a lot of inventory out there, we've obviously been privy to everything from new rigs coming directly from brick Bitmain. We've seen bankrupt asset cost. We've seen a lot of different things. So, there's definitely 95,000 rigs out there for us to acquire. We also could, of course, evaluate doing future contracts back to the traditional way with Bitmain. And again, Bitmain is not the only manufacturer out there. There's MicroBT and, and Canaan. We, of course, have chosen to work mostly with Bitmain. That's what we watch closest, but we're seeing some really great technology moves out of MicroBT and the whatsminers in particular. So, suffice it to say, great prices, plenty of rigs. Great. That's extremely helpful color. Thank you. And I was wondering if, you can provide investors with the update on how to think about your auto [ph] balance, especially, the significant decline we saw in October. Is this kind of the new level that you feel comfortable with or is it more around tactically selling Bitcoin to help fund both, your site expansions as well as your miner rig purchases? Thanks. Yes. How we want our investors to think about it is simply that using Bitcoin real time is the right move. Auto [ph] balance is the same as having cash in a bank account. But if we can use Bitcoin to get more Bitcoin by putting the cash flow from those into expansion, into rigs, whatever it may be, that's the reason that we're selling Bitcoin. It's the one to support our operations -- essentially we're paying for our own lunch and not our shareholders. And that's really how we want to see it. So, our shareholders should know that whenever we're selling Bitcoin, that means we're not pulling the equity lever or the debt lever to grow our business. Hi. Thanks so much for taking my question. You've given us some really good color on your hash outlook, but could you maybe clue us in a little bit about how you're thinking about global hash and how that might evolve over the next 12 months if Bitcoin pricing was to remain near current levels? Yes. I think if Bitcoin mining was to remain near current levels, we'd see a fairly muted growth in global hash rate. The fact that we saw global hash rate climb last month and then start to taper back off with the decrease in difficulty, but also how quickly we saw, it -- looking to move back up a little bit, and right now just with Bitcoin moving, another $1,000 dollars what it was averaging a few weeks ago, as it moves into the 18th. So, I think it's going to be fairly muted at these levels because I think we've found a point where either less efficient or the higher cost miners are really having a lot of pain and having to unplug. And even a few thousand more dollars in, in Bitcoin price goes a long way for them to bring them back online. So overall, if it was to stay where it is, I think we kind of see it trend slightly up, but mostly flat. Now, we are of course, believers that Bitcoin is going to go up, so I do think that we'll see a healthy amount of hash rate come online. But, we feel confident also to keep up in both scenarios. Yes, thanks. And you've also given us some great color on your appetite for acquisitions and the hurdle rates that you consider. As you step back and view the entire industry, I suppose, do you think that your competitors are as disciplined as you are, and what type of consolidation would you expect? Yes. I'll speak to the consolidation on that. I think we have set a good example of how consolidation can be done responsibly. I still think that there is more consolidation to come. Some of that's going to come from pain of other players, but also there is other private miners out there that are creating some interesting opportunities. There is also infrastructure players that build infrastructure that needs to be finished off that will create great opportunities for new sites. So, I do think that companies like ours -- we are going to continue to have great opportunities to consolidate in public, private and also just infrastructure that's underutilized, in the very near-term. And, yes, we are really happy with the direction that we see it going. Thank you and good afternoon, everybody, Zach, Gary. Gary, I was wondering if you could talk a little bit about the rig finance market. Clearly there has been a lot of stress in that market. And really just kind of curious as you think about acquiring more rigs over the next few quarters, is there any kind of market currently for rig financings? Yes. Great question. So, primarily the rig financing market has been the secondary market. And that's typically -- it has -- before the recent interest rate hikes, they were like low to mid-teens. And with the recent hikes, it's really gone to the high teens and it's just dried up, right? The economics just don't work for financing rigs at 18%, 20%, 24%. As good as anyone else, I mean, there is money out there to be loaned at 20%, 25%, 30% because there is that risk reward. So, if we wanted that cost of capital, we could go get it, but that's not -- doesn't fit into our ROI calculation. And so, we are just being much more-choosy when it comes to debt. Looking forward, I think that, we are really going to wait for the more traditional debt markets to open up and for that margin expansion, just because we want to be more comfortable to be able to service that debt, which means that we -- we are not going to be going after 18%, 20% cost of capital. And so, so going forward, I just -- I think we are just going to keep our eye on it. And as things improve, I think that there is going to be more money that's available for financing. Okay, great. And then, I mean, like you guys kind of highlighted your ability to execute and grow hash, a lot of your competitors haven't been able to achieve what youâve done. Clearly, there is a lot of rigs now that have gone from, I guess, you'd say, more traditional conventional Bitcoin miners, maybe to some financiers that were providing financing for rigs. Have discussions started to come into the market about these new owners of rigs looking to deploy those rigs? And really, I guess what I'm wondering is, is that something -- just given what you've done on the infrastructure side, is that something that CleanSpark would think about entertaining in 2023, i.e., I guess I'm kind of asking is there any -- do you -- Zach, do you see a path forward where CleanSpark is actually hosting other miners? I think that's an easy answer for us, and that'd be absolutely not. The colocation business is a business where you have to take margins that are not only highly volatile, but when in a time of strain to get highly compressed, and you have to try and chop those amongst multiple players. You have to cover your own dollar plus a margin, and then there's the owner of the rig that has to try and not only make money to pay your bill, but then they want to, of course, make something else. We specifically chose to avoid hosting anybody all the way from the beginning. And we definitely wouldn't go back into that. I think if you look at where the most pain has been experienced in this industry over the last nine months, you're going to find it in the colocation space. So, we wouldn't take that risk, and we also would much rather just buy those rigs from other players. And when it comes to the opportunities too, we -- when we evaluate a site, it's got to meet the CleanSpark standard. And that standard means that we have to run it in the CleanSpark way. And that means, we are going to manage our power actively. And that's also one of the biggest strain points that colocation client -- colocation businesses don't have. If you have an uptime guarantee with a client, you may not be able to make the right choice to manage power the right way without a lot of complications in an agreement. So, we're going to stick to doing what we do best and run our own sites and self mine. Thank you. I'd like to thank you for your questions and everyone who's joined us today. We wish everyone a good afternoon, a good evening, and happy holidays.
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EarningCall_1620
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Welcome to the Novartis presentation at the 41st JPMorgan Healthcare Conference. I'm Richard Vosser, European pharma analyst at JPMorgan. It's my great pleasure to introduce Vas Narasimhan, the CEO of Novartis. Before I hand over to him for his presentation, I'd just remind you that the â we will transition after 20 minutes to Q&A in this room, no moving, which is a big round of applause clearly. And there will be microphones. So there'll be people â so just put up your hand, I'll indicate, and we'll do questions that way. Awesome. Vas, good to see you. Thank you, Richard. Hi, everyone. Great to be here back in person at JPMorgan. Novartis has a 250-year history. And throughout that history, we've had to constantly reinvent the company. And most recently, when you think about the creation of Novartis 25 years ago in its current format, we were a healthcare conglomerate with eight different units, spanning everything from nutritionals and animal health to, of course, innovative medicines, pharmaceuticals and oncology. Today, I have the opportunity to â I'm sorry, have to go back here, to really introduce the company in its next form as a pure-play innovative medicines company. Because with the planned spin of Sandoz, for the first time in our history, we will really be a focused company with a focused strategy, and we believe that's a strategy that can create sustained value for shareholders, and importantly â more importantly, sustained value for patients, healthcare and of course, all of the stakeholders that we serve. Now our vision is to become the most valued and trusted medicines company in the world. That's a long-term vision. Of course, visions like this take decades to form. But that's what animates our organization, gives our organization energy, the relentless pursuit of this goal. And what we've rolled out inside of the company is a focused strategy, one where we really thought hard about where do we want to play and how do we want to win. And our focus now is on five core therapeutic areas, which I'll speak a little bit more about in a moment, five technology platforms; two that you know well, small molecules and biologics; and three, advanced technology platforms that we've been working on now for many years; four, priority geographies that we think will ultimately enable us to grow for the long-term. And in terms of how we do this work, actually, the five elements here are the same five elements that I started with as CEO. But importantly, we've tried to prioritize thinking about growth, returns and thinking about foundations; culture, our unbossed philosophy, scaling data science and technology in the company and continuing to focus on ESG matters, building trust with society. Now when you reflect on how we got there, and this has been a journey that's taken a good part of the last decade. But most recently, over the last five years, we've done over $100 billion of transactions â or planned transactions to come to a 100% innovative medicines company. And with each one of these, we really strive to do things in a shareholder-friendly way, notably with the spin of Alcon, which was one of the largest spins in European public markets history and a very successful device company. We exited the Roche stake at a relative price high and then executed our ongoing share buyback program and most recently, our planned spin of Sandoz, which we also aspire to do in a tax neutral manner to our shareholders. And what that allows us to be now going forward is uniquely positioned, we believe, as a scaled pure-play medicines company. In this chart, you see company revenue on the Y axis, you see pharma contribution to the overall sales. And with the changes that we have now implemented, we will be uniquely positioned as a scaled pure-play innovative medicines company with the scale of over $40 billion in sales, importantly with a global footprint operating in over 100 countries, and the scale in terms of R&D capabilities to win in the long run. We believe that applying that scale on the focus of innovative medicines will allow us to deliver returns for our shareholders. And when you think about how this could translate specifically over time in terms of how the company is rated, what we know is diversified companies in our sector do trade at a discount. And over time, if we can demonstrate consistent growth with the work that we are doing within our R&D enterprise, we hope we can also rerate with some of the peer set that is more pure-play, more focused on high-end innovation. Now turning to our five focused core therapeutic areas. In each one of these therapeutic areas, we have strong in-line brands supported by a deep pipeline in cardiovascular, of course, with Entresto and Leqvio and the number of assets now advancing into the â into the late-stage development and/or into registration; in immunology, Cosentyx and Ilaris and important assets such as remibrutinib or ianalumab advancing in the pipeline; in neuroscience, with Kesimpta and then our ongoing work with remibrutinib, our BTK inhibitor as well as earlier stage assets and other neurodegenerative diseases; solid tumors, hematology, each one of these areas consistent approach of building strong in-line brands and backing it up with outstanding pipeline. And alongside that, we continue our long-term effort to shift towards advanced technology platforms. Today, they constitute around 27% of our sales. We have an aspiration with biologics and these technology platforms to be well over 50% of our sales by the end of the decade. In each one of these areas, we have anchor brands, we have key focus areas, and we have projects, and you can see with scale in each one of them. And taking each one in turn in gene therapy with Zolgensma, one of the most successful gene therapies ever to be launched. We continue to work on the intrathecal approach with Zolgensma. And now we have advancing into the late-stage development in multiple assets, including one that we are really interested and excited about from a recent acquisition of Gyroscope in geographic atrophy. In cell therapy, building on the base of Kymriah, we recently launched data at ASH that showed with our rapid CAR-T, we have the opportunity to hopefully bring a next-generation technology that's more scalable and also the opportunity to move into new areas like immunology, which clearly now is a focus area for these cell therapies. Radioligand therapy, I'll come back to you in a moment. And of course, within RNA therapeutics, building on the back of Leqvio; pelacarsen, our ASO, we have the opportunity to build out a broader RNA portfolio. Now specifically on radioligand therapy, this is an area we believe we've put ourselves in a pull position to win for the long run and with the opportunity to treat a broad range of solid tumors. We have a robust manufacturing network now, four manufacturing facilities, two in the U.S., one that is under construction in Indianapolis and should be up and running soon. This allows us to meet the challenge of just-in-time delivery, where you have no inventory. And so this is a real logistical challenge. A large pipeline of assets, multiple proof of platforms, and we'll come back to Pluvicto later in the presentation, and strong commercial execution. Now with over 500 centers executing on radioligand therapy, it's attractive to the centers, highly efficacious for the patients and then, of course, allows us to drive differential growth. Now turning to geographic focus. One key priority of ours is to improve our position in the U.S. We are the number one player in Europe. We will be one of the top three players in Japan and China. But clearly, the U.S. now is the place where we want to get to the next level. And the way we're doing that is a very clear approach. We've moved the U.S. to report directly to me on the executive committee. We are embedding a U.S.-first mindset within our development teams and our commercial organization, prioritizing that within our target product profiles. And what we believe we can do, as you can see on the chart, is while maintaining our strength in Europe and Germany, continuing the growth in Germany and Japan, we have the aspiration to get to number five organically in the United States. Now turning to our R&D engine, which is, I think, another critical thing if we're going to be a successful pure-play innovative medicines company. When you look at the last 22 years, Novartis has been the most successful company in this industry in delivering drug approvals both in the U.S. and Europe. And you can see it's quite a margin that we've been able to consistently do that. Where we haven't been good enough and where there's a huge priority for us now is delivering high-value medicines. Medicines have really moved the needle for patients, for healthcare systems and for the company. And with that mindset with our new R&D leadership, we're really embedding that in every element. We're willing to not win the race of getting the most approvals, but hopefully winning the race of getting the most high-impact approvals. And we'll hopefully see that in improved success rate, cycle time, and most importantly, value per asset delivered. Turning to our research engine. One of the things I think that is a strength of our company over the long run is our ability to really scale technology platforms within research. There's a full list of many of the areas that we're working on, showing where we are relatively speaking, where we have in-market assets. And again, the mindset we are now putting into our NIBR organization is as much around the high science as about high value and can we make the trade-offs early on. So we would prioritize the select assets we think that can really drive long-term performance. And maybe lastly on the strategy and kind of where we are. We've refreshed our leadership team, multiple new additions to our global leadership team, a new Head of our Drug Development, Sriram; our new Head of Research, Fiona, Ronny Gal has joined us as our Chief Strategy and Growth Officer; Victor Bulto, leading the United States. I really believe this is the right team for a pure-play innovative medicines company to really enable us to deliver on our long-term goals. Now turning from that strategy and how do we translate that into financial performance and financial performance consistently over time. When you look at our profile, we have 6 major in-market brands, each with multibillion-dollar potential in sales, most of which have long LOE time lines; three, additional multibillion-dollar assets, which I'll talk a bit more about it, have data readouts in the launch phase, and then a rich pipeline that's maturing. It will take time, of course, to mature over the middle part of this decade. But that gives us that internal engine to grow the topline. And then alongside that, we've taken on a relatively large restriction, one of the largest restructurings in Novartis' history, to save about $1.5 billion in sales â in cost run rate and also simplify the organization so that we can be much more fast and agile. And what we expect that to deliver is consistent 4% sales growth and over 40% core margin. It's important that 40% margin is for the total company, inclusive of the corporate cost of being a conglomerate. So that's a pretty big step up from where we are today. And you can see that in each one of the elements, sales, free cash flow, core operating income and return on invested capital, with the spin of Sandoz, the restructuring program and the sales growth we expect to deliver, a very nice profile of consistent upgrades in terms of how we perform. I'm very interested, particularly in return on invested capital, where I think we have the opportunity now to rerate ourselves into the top quartile of the peer group. I would want to emphasize that with Sandoz, the spin, we do plan to maintain our dividend as where it is today and continue to grow that dividend as we've grown it over the past decades. Now in terms of our capital allocation and how we think about capital allocation, we continue to balance investing in our core business and returning capital to shareholders. The investments we made in our core business are consistent, $9 billion in R&D, $1.4 billion of capital investments in 2021. We've done about $30 billion of value-creating bolt-ons since over the last five years, continue to evaluate those opportunities. But at the same time, we are consistent in returning now $53 billion over the last five years to our shareholders with our ongoing share buyback program, $15 billion share buyback program with approximately $5 billion still to be completed. And then when you look at that balance sheet that the company currently has, we have a lot of flexibility. You can see on the left-hand side of this chart, we are well positioned versus the peer set in terms of our overall rating. And then similarly, when you look at our leverage, very nicely â a nice balance sheet that gives us a lot of flexibility either to pursue attractive M&A or to continue to return capital to our shareholders. Now turning to the pipeline. And I wanted to say a few words about some of the upcoming catalysts and some of the recent data that we've announced over the last six months. Six major assets where we have exciting data that we think will hopefully enable us to make these medicines significant with Pluvicto readouts in earlier lines of prostate cancer; Iptacopan in PNH, but setting us up to be a broad-based therapy in a range of rare diseases; Kisqali in the earlier adjuvant setting; Remibrutinib in both CSU as well as in MS; Scemblix with the opportunity to move into first-line CML; and then OAV101, which is our name for our Zolgensma life cycle management program to move into the intrathecal setting in two- to 18-year-olds. And that, I think, nicely sets us up for a period of time in 2024 and 2025, where we have a very catalyst-rich period across this portfolio of assets. And we'll continue to build with our efforts in NIBR to add to this and also add to the 2026 time period and on. But I think it shows we have a solid set of catalysts in the near-term and an expanding set of catalysts over the mid part of the decade, which will enable us to drive that growth 2025 to 2030. Now turning to each one of the assets in turn. Kisqali has a proven OS benefit. We had new data at San Antonio, which only highlighted that further, what we believe a best-in-class profile amongst CDK4/6 inhibitors in the metastatic setting. You can see the data we've presented in the past in terms of our OS, new data, which demonstrated that Kisqali doubled PFS response rates in the RIGHT CHOICE study in patients with an aggressive form of metastatic breast cancer; and then in the MAINTAIN study, NICE data also demonstrating that in the second line in patients that had already failed a CDK4/6 inhibitor, Kisqali can provide a nice response even in those patients as they try a second CDK4/6 inhibitor. Now our NATALEE study is continuing as planned to the final readout in the second half of 2023. We passed the interim in the second half of 2022 last year, and the study is continuing unchanged. We are fully enrolled. As a reminder, this is a unique study, an opportunity to address both intermediate and high-risk patients. So you can see the data here, but 60% Stage III and 40% Stage II within the study with an effort to get a very broad label in this setting. We have a longer treatment duration than our competitor with three years versus two years, which we hope will enable us to capture the time period when often these cancers recur, and then a lower dose that we hope also will enable us to manage the side effect profile for this medicine. So this is an exciting study for us. We're working hard to make sure that we hit the time lines and have a readout in the course of 2023. Now turning to Pluvicto. Pluvicto has really impressed us in terms of its in-line performance already in the late-line setting of metastatic castrate-resistant prostate cancer. And in the recent study that we read out for a radiographic PFS, the PSMAfore study, 1:1 randomization in patients who failed a prior RP, you can see we hit the primary end point. We're looking forward to sharing that data over the course of this year. It really gives us opportunity now to move into the earlier lines, where there are significantly more patients. And when you look at our goal with Pluvicto, it's very much to cover the entire first-line setting and then perhaps move into even earlier lines of therapy. With the PSMAfore study now read out, we will wait to see how to get also OS data out of that study, the PSMA addition program as well. And you can see the opportunity for us to move into expanding the opportunity for Pluvicto by 3x to 4x over the coming years. So a very exciting program, validates the radioligand therapy platform gives us an opportunity to expand it further over the coming years. Now turning to Iptacopan, which is our factor B inhibitor. This is data that we presented at ASH, very consistent data. We believe this medicine will become the standard of care in PNH. We believe this medicine will become the standard of care for any patient who is suffering from an alternative complement pathway-driven disease. Consistent data here, whether it's baseline hemoglobin, hemoglobin over a threshold of 12, transfusion avoidance, breakthrough hemolysis. Striking data, you can see 42 out of 60 versus zero out of 35, 51 out of 60 versus zero out of 35. P values are impressive, really demonstrates the attractiveness of this oral molecule. And then similarly, when you look at the secondary end points, very consistent data here as well whether looking at fatigue reticulocyte hemoglobin. And importantly, we were able to maintain LDH, which I think was a question on many investors' mind, very consistent. So controlling both intravascular and extravascular hemolysis. And I think that just speaks to the attractiveness of this molecule. I think it's really unique. It's got the opportunity to address a broad, broad range of diseases that are hit by the complement pathway. I think in the interest of time, I won't drag you through the alternative complement pathway. But just to say that you can see that we have the opportunity in IgAN, C3dA, who's â and then we'll have a number of other ongoing Phase IIb studies. Our goal is to expand this medicine as broad as we can and really make it into a multibillion-dollar asset. And then lastly, within the assets, I wanted to say a word about Scemblix, which is our STAMP inhibitor hitting a different pocket on the BCR-ABL molecule than the historical TKIs. Very nice 96-week data. But then importantly, we also shared data that demonstrated in the first-line setting in an IIT, very, very nice response rates as well as combination setting data in the second-line combination of this drug, Scemblix, with established TKIs, also very strong response rates. This study is enrolling extremely fast in the first line. We'll have the opportunity to read it out in 2024 and then hopefully continue our long legacy in being the global leader of CML, bringing another important innovation on the back of Gleevec to Cigna and taking the next generation going forward. So in closing, just a few comments on some of the work we are doing to be a leader as well in the sector and across sectors on ESG. When we think about ESG, we think about it, if we just do our work well, we are delivering on our ESG mandate. We serve â because of the scale of Novartis globally, we serve 280 million patients with our innovative medicines, which we believe is the largest footprint of any company in the sector, 500 million patients served with Sandoz, a broad and rich pipeline, as we've already discussed, an effort to really be at the leading edge of new technologies. And if we do that well consistently, that's the best way for us to create value for society in the long run. And we see that work reflected in our ratings across the various ESG rating agencies. We are now within CDP. We were number one in the sector out of 456 companies with Sustainalytics. So across the board, we continue to take this seriously and continue to embed this in our daily work. So in closing, we have a clear road map to success. We've transformed ourselves into a pure-play IM company. We have five core TAs and a clear set of technology platforms and a U.S. geographic focus, nine big in-market brands, a focus on upskilling our R&D productivity and prioritizing high-value NMEs, commitment to deliver attractive financials consistently over the decade, shareholder-focused capital allocation and commitment to building world-class foundations. And with that, we hope to continue to demonstrate to all of you that Novartis is on the track to become the most valued and trusted medicines company in the world. Right, transitioning to Q&A. So if there are any questions, please put up your hands. I believe there are mic runners in the room. So if there are questions, there's a question over there. So let's try that one with microphone number one. Hi. [Angus Liu], Fierce Pharma. So Vas, we know cell and gene therapy as part of Novartis technology focus. So do you think that technology platform buildup is complete right now for this platform? I mean with cell therapies, we know after Kymriah, you have this T-Charge platform. But what's going to happen after Zolgensma beyond Zolgensma IT? Are you interested in gene editing, for example? So what's your plan â Novartis plan in gene therapy? Yes. Thanks, Angus. So first on cell therapy, with the T-Charge platform, we have the opportunity, I think, not only to continue to life cycle management â with life cycle management within the B-cell cancer space but also, as I mentioned, move now into immunology, where we're rapidly trying to progress into SLE â late-stage SLE patients as well as other late-stage patients within severe immunological disease because what we see is you can really create an immune system reset by using CAR-T therapy. So I think that's a tremendous opportunity. I think the industry overall will likely focus on this. And that's a place where we want to win with the T-Charge platform. In terms of gene therapy, I mean we've learned a lot, and I think the whole sector has learned a lot that this is a complex task to match the right capsid with the right tissue with the right disease biology with the right construct. So we have well over 15 projects in-house that are continuing to advance. In the clinic, our recent acquisition of Gyroscope is probably the most advanced gene therapy that we have post SMA-related gene therapies. And I think going forward, I mean most of the work that we need to now do is around some of the foundational technologies, capsids and capsid design, can you move beyond AAVs to engineered capsids. I think that's where a lot of the energy of the sector and Novartis will go in the coming years. Further questions? Maybe I'll build on that and just think about the radioligand technology. So we've seen the PSA4 â or we haven't seen it yet, but we'll see it, which is broadening that. But beyond sort of PSMA, where do you see that technology taking you? Yes. I mean, I'm quite excited, I said one of my goals today, Richard, is to get you to take up your forecast, see if I can get you to do it. But I think it's a powerful technology. When you think about targets that you have, where you can either do an ADC or a radioligand therapy, I mean there's a number of targets which are very attractive that show up on PET scans. You light up tumors. And then you have the opportunity where ADC may not make sense to use a radio particle to nanatactic cancer. So we see opportunity already, of course, prostate well, neuroendocrine tumor, programs in glioblastoma in small cell lung cancer, in GI tumors. So we have two other assets in the clinic right now besides â beyond prostate in that. And then we've done a few deals recently as well to add additional ligands into the portfolio. So I think over time, this could really build out into a broad-based solid tumor technology. Other questions? Maybe building on that ADC, I saw Phase I with ADCs. Maybe you could talk about that, your efforts there for more sort of traditional maps with linked to keep toxins or chemotherapy? Yes. I mean I wouldn't say we've been one of the leaders in ADCs historically. I mean, clearly, some of our competitors were able to thread the needle on the pharmacokinetics of really ensuring you could avoid a lot of the toxicities associated with ADCs and still get the high therapeutic benefit. But nonetheless, we've learned from their efforts and in-house, we have a lot of the technologies that are required. So we're advancing our own what we believe are novel targets. So mostly, we pursue novel targets. We're not trying to do fast fall all our ADCs. And also the question is, can you use multi-format? So could you use bispecifics or trispecifics to hopefully broaden the overall therapeutic index for some of these ADCs. I have a question here around like, one of your growth drivers. And person is asking about the recent article on â in the British Medical Journal around FOURIER and a reanalysis of that on Amgen's PCSK9 showing maybe a questioning the CV benefit. So I suppose the question is thinking about Leqvio. Leqvio doesn't have a CV benefit at the moment. Do you think this â how do you think this impacts Leqvio's uptake in the U.S. and globally? Yes. First, I think just on the science. I mean, I think the correlation between LDL lowering and cardiovascular benefit is one of the most well-studied correlations in our sector. So whether there was a nuance on that study, I'm not close enough. But I think broadly speaking, the fact that U.S. payers and, frankly, NICE has taken on faith that if you lower cholesterol 60%, you will generate a cardiovascular benefit. So that gives me, I think, a fair amount of confidence that we will demonstrate. Now one of the things about the study that we've run with Leqvio in our cardiovascular outcomes is we have much longer follow-up than the PCSK9 monoclonal antibodies. Now we did that deliberately to try to demonstrate a larger CVRR. So we target a 25% to 30% CVRR with that study. And I think â at least everything I know about this biology would suggest we should be able to do it. And the ramp-up in the launch, how is that going globally? Are you starting to see pockets of acceptance to buy and build here in the U.S. that within cardiologists that are notoriously, hopefully none in here, slow at adopting medicine. So how do you see that? Yes. So as you know, we have a lot of experience with this. It took us a couple of years to get Diovan going. It took us a couple of years to get Entresto going. It will likely take us some time to get Leqvio going. But we do see, I think, the beginnings now of the momentum. And what we have is a pretty broad base now of physicians' offices, close to 5,000, that are actively prescribing the medicine. And really, our focus is to get more depth within those clinics. So can we get from two to three patients to the entire clinic changing over to the use of Leqvio? When we index it versus Entresto and you look at where Entresto, if you start, Entresto was improved at a June time point. We're roughly in line with the Entresto launch trajectory. Most of the metrics in terms of the number of visits to get an office to convert, the time lines to actually get the payers to get, all of those things are trending very much on it. Now our goal is to beat Entresto but we seem to be on an Entresto-like trajectory, at least for now. And maybe broadening out, you mentioned midterm targets, 4% growth. Important drivers to that, what do you see as the â you've clearly got very key brands in line, Kisqali, Kesimpta, et cetera. But balance between pipeline and key brands to deliver that? Yes. So the 4% is predicated on Kesimpta. I mean, I think versus where maybe the consensus is, we have a view that Kesimpta, Kisqali can do better based on the trends that we're seeing. That's a big driver. Clearly, we need to demonstrate that Leqvio can get to where we believe it can be because I think the consensus would not even see it getting to where Entresto was at that time point. But I think the other two big ones are going to be now Pluvicto and Iptacopan. I mean Pluvicto, we believe has â and we're excited to share more data over this year, but we believe this medicine can be a very significant medicine for the company. And I think Iptacopan, if successful in C3G and hopefully IgAN, but even in PNH, could be a blockbuster medicine just in PNH alone. And I think as everyone sees more data with Iptacopan and how consistent this data is in different settings, I think that hopefully will become more conviction in the markets as well. Sarah from Pepticom. I wanted to ask about â since we are here in San Francisco, very close to. We're in the epicenter of technology. How do you see AI playing into whatever you guys are doing, especially on the discovery side? And you've mentioned this current novel targets, right? So I'll be happy to hear your opinion about that? Thank you. Yes. We've had ongoing efforts in AI now for, I mean, close to six, seven years. I think where we've seen the use cases in the research space, most successful are primarily after we have a target when we want to optimize the candidate molecule, an iterative chemistry and really enabling us to design attractive molecule relatively quickly, it's very powerful. And clearly, alongside our researchers, it's really sped up drug development or that part of drug development. I think the opportunity now clearly with AlphaFold and some of the other discoveries that are happening, is could you move further upstream and could you use AI to speed up your ability to identify novel targets altogether. Fiona Marshall, our Head of NIBR, is very keen on this. We have a large collaboration with Microsoft. We actually house an AI innovation lab with Microsoft. And that's a big focus of the effort is to try to see can we accelerate the discovery of novel targets, which would then hopefully lead to more medicines in the portfolio. I've got a question here on your PD-1 collaboration with â and TIGIT collaboration with BeiGene. A person basically asking for an update. It wasn't on the slide. So how are you thinking about the immuno-oncology efforts at Novartis, I suppose? We remain committed to the collaboration with BeiGene. I mean one of the challenges we face is the inability of FDA to inspect sites in China has delayed the launch within the first set of indications for the PD-1 inhibitor. We're hopeful that at some point this year, it doesn't look like we will be in the early part of this year, but at some point this year, those inspections can happen and we can start the commercialization of PD-1. It's continuing to progress in Europe. I think on the TIGIT, we'll see. We'll see how the data matures. Of course, one of the competitors put out some data a few weeks ago, yet another set of data. But I think we can all agree, it's still unclear as to what exactly TIGIT's role is going to be within the treatment paradigm in non-small cell lung cancer. Hey, Vas. Quick question, [Jami Ison, new Biotix]. Could you again kind of give an overview of Novartis' role within the ADC space? And also, if you have considered any glycopeptide conjugates, basically tagging peptides to conjugates as a way to enable T- cell engagement? Yes. So on ADCs, we've had a long-running effort actually based out of our San Diego site for some time. So we have the, we believe, the relevant linker technology and understanding of the chemistry to target payloads. What we haven't done as well perhaps at AZ and Daiichi and Seattle Genetics is get that all together in a way to, as I said earlier, thread the PK so that you can get that high efficacy without the toxicities that we've often seen with ADCs. So we don't feel at the moment that we need to bring in any novel technologies but rather apply the learnings of the sector and to what we have already in the portfolio. We do have, just to your question, though, a collaboration with PeptiDream in radioligand therapy, where PeptiDream is generating novel peptides that we're evaluating for whether they could be used in radioligand therapy. So that's been certainly a large focus for us is on the RLT side with peptides. You mentioned the inability to inspect manufacturing sites in China. And obviously, China is now starting to open up like the rest of the world. Maybe a couple of questions. Just near term, how is that impacting your business? But also longer term, you've got, as you said, you want to double the size of the business. What are the drivers for doing that? How are you seeing the impact of Chinese government on pricing, et cetera, and your ability to deliver? Yes. So first, I'd say, in spite of all of the challenges that we've had in China in the last year, the business still grows pretty well. And so I think it demonstrates that it's a tremendous opportunity. We continue to see the opportunity to be one of the top three players is one of the big growth opportunities for Novartis as one of the most global players in the sector. But without question, I think through the Q3, Q4 and now getting into Q1, there's a significant impact to the wave that we're seeing. We see that. We have manufacturing sites. We have a very large presence. We have close to 10,000 people in China. And so we certainly see that impact. I am optimistic that as this wave and perhaps one more wave to come that as we exit Q1, we'll see a normalization. And what we might see is a pretty strong rebound in terms of growth. I think you're going to see a lot of pent-up demand start to come back, and it will come back quite aggressively. I think there's a lot â in the middle class, a lot of desire, of course, to have high-end medicines. So we remain, I would say, in â over the course of the back half of 2023 and then beyond, this will be a critical growth driver. But through Q4 of 2022 and the first part of 2023, this is a challenge for sure. We've transitioned our portfolio out. So the Glivecs and Diovans are not a priority for us. We put those on carryover. We're very much focused on the innovative medicines. I think the challenge in China is to strike the balance that when you are NRDL-listed, you have significant volumes. I mean you look at our Cosentyx performance, our Entresto performance, these are very significant medicines and still very attractive gross margins. But then over time, as your volumes get higher and higher, your price has come down quite dramatically within the NRDL. And so you've got to be thoughtful about how do you approach that and at what point do you say you have to pull out, right, because the prices get too low. Thus far, we haven't gotten there. And I think Leqvio is a massive opportunity in China. We are on our way to an approval there. And when you think about hypercholesterolemia in China, this could be huge if we can get it right. Yes, me again. So Vas, you've laid out five focused therapeutic areas. How should we think about the assets beyond those five therapeutic areas? Should we expect â there were some market rumors about the [respiratory and ophthalmology asset]. So should we expect further slimming down in Novartis? Yes. So we have another TA that we keep internally called TAX where we incubate, let's say, TAs that we think might ultimately mature. And so our ophthalmology assets, for instance, in ophthalmology gene therapy as well as we have a portfolio of assets in optogenetics as another example. They remain there. The research and development teams continue to operate. Right now, we have no intention of despite what that Bloomberg article said. I mean we're very committed to Xolair. Xolair is a very attractive medicine. We're committed to our in-line ophthalmology brands. But of course, we're â from a relative prioritization, I mean these are just less resourced. I mean our focus is in those big five therapeutic areas. Now if something were to come up and if something were to be a significant breakthrough, if for instance our gene therapy for geographic atrophy were to ultimately demonstrate it could meaningfully stop or improve the deterioration of patients with GA, we, of course, would build back up because this could be a very, very significant medicine. But right now, not the priority. We resource as kind of a lower-priority TA, and then we see what happens in the early-stage research. And taking that wider maybe on capital allocation. You mentioned $5 billion left on the buyback program. Over time, you've done varying sizes of deals. Where are you on all the capital allocation at the moment? I mean no big change. I mean I think the one shift, and if you notice on the slide, is we don't now have a kind of rank order on these priorities. So we're quite comfortable that when our current share buyback ultimately completes, if we don't have attractive M&A that's imminent, we're happy to continue returning capital to shareholders. We continue to evaluate, I think, all of the various M&A opportunities. But we try to be very disciplined to take the lens of is there real value creation, is there a real strategic fit and try to stay disciplined. I would say we see most of the opportunity in the sub-$4 billion, $5 billion space, not in the larger space at the moment. Prices are quite high, as you've seen. So I think â yes, I think that's where we are. Maybe time for one more question. Maybe I'll take it then. And just â oh, there's one over here. Sorry, I will be quiet. Yes. I think â we've made a real breakthrough on cell therapy manufacturing. If you saw our recent data at ASH with our YTB, what we call our T-Charge process, we believe once we fully optimize it, we can bring it down to a seven-day manufacturing process. And on seven days, we think that is attractive enough in terms of the scale that we have that we wouldn't need move into any sort of allo-based technologies. So we restate the course on autologous-based therapies. We think that we can scale that now at the volumes that you would need. So we feel pretty good. I mean we've had multiple rounds of FDA inspections, and we think we've now gotten over the hump in terms of really having a sustainable manufacturing model for cell therapies.
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EarningCall_1621
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Good afternoon. Welcome to Aspen Groupâs Fiscal Year 2023 Second Quarter Earnings Call. Please note that the companyâs remarks made during this call including answers to questions include forward-looking statements, which are subject to various risks and uncertainties. These statements include our restructuring initiatives, including efforts to reduce our expenditures and the anticipated results and benefits of these efforts; our plans to subsequently increase marketing spend rate and the impact that is expected to have on in timing of achieving our year-over-year enrollment growth; our plan to maintain an approximately breakeven adjusted EBITDA; the continued strong demand for the MSN-FNP program; our search for candidates for potential AR facility; and the intended use of proceeds from any loan transaction that may result; anticipated future revenue from the teach-out of our pre-licensure campuses; our future growth and growth strategy; our fiscal 2023 guidance and our liquidity. Actual results may differ materially from the results predicted and reported results should not be considered as an indication of future performance. A discussion of risks and uncertainties related to Aspen Groupâs business is contained in its filings with the Securities and Exchange Commission including the Form 10-K for the fiscal year ended April 30, 2022 and in the press release issued this afternoon. Aspen Group disclaims any obligation to update any forward-looking statement as a result of future developments. Also, Iâd like to remind you that during this conference call, the company will discuss EBITDA and adjusted EBITDA, which are non-GAAP financial measures and talking about the companyâs performance. Reconciliations to the most directly comparable GAAP financial measures are provided in the tables in the earnings release issued by the company today. Please note that the earnings release is available on Aspen Groupâs website aspu.com on the IR calendar page, under News and Events. A transcript of this conference call will be available for 1 year on the companyâs website. Please note that the earnings slides are available on Aspen Groupâs website aspu.com on the Presentations page under Company Info. Good afternoon and thank you for joining our call today. We are encouraged by our second quarter results, which reflect the impact of the actions we have taken to reduce marketing and general and administrative spend as part of the restructuring initiative that we launched in the prior quarter. Gross margin improved by 900 basis points on lower revenue, and we narrowed our net loss and delivered positive adjusted EBITDA. USUâs revenue grew 9% on continued strong demand for the MSN-FNP program as that program continues to account for 83% of USUâs total student body. This growth helped to offset the expected decline in AU revenue, coming primarily from the combined effects of the teach-out of our BSN pre-licensure program and significantly lower marketing spend. We set out to right-size the company with the restructuring initiated in the first quarter of fiscal year 2023 and our efforts are delivering results. The savings from the restructuring plan drove a year-over-year increase of approximately a $0.5 million in gross profit, which flowed through the P&L and reduced cash used in operations in the quarter by $2 million compared to a year ago quarter, allowing us to improve adjusted EBITDA to a $0.5 million versus negative $0.7 million last yearâs second quarter. For the quarter, cash flow from operations was positive $1 million. And we ended the quarter with unrestricted cash of $2.3 million on par with the cash balance at the end of last quarter. Stabilizing our cash balance is a priority and we are rigorously managing the company to achieve that. One last item related to our cash balance. As I discussed last quarter, we engaged Lampert Capital Advisors to assist with securing an accounts receivable financing agreement. Lampert conducted due diligence on our accounts receivable, which they recently completed. Subsequently, they began an outreach program to prospective lenders and we are in the process of identifying potential candidates. Switching now to our operational metrics for Q2, there have been several events in the past calendar year that impacted our enrollment patterns, some due to external factors like increased workloads for nurses, but the two primary events were the enrollment stoppage following the announcement of the teach-out of our pre-licensure program and the significant reduction in our marketing spend levels following the posting last April of an $18.3 million surety bond with the Arizona State Board for Private Postsecondary Education. On October 31, however, we signed an updated stipulated agreement with the Arizona State Board for Private Postsecondary Education, which reduced the surety bond from $18.3 million to $5.5 million. This has resulted in the insurance company recently agreeing to return $1.5 million of the $5 million of cash that was previously being held as collateral for the larger bond, providing the company with additional cash for operations. As result of the two events just discussed in Q2 of fiscal year 2023, our marketing spend was down by $3.1 million over the prior year quarter and $3.7 million sequentially. Consequently, new student enrollments decreased 46% year-over-year. The downward trend in enrollments has reduced AGIâs active student body by 23% year-over-year, mostly due to AUâs total active student body decrease of 29%. USUâs total active student body decreased by 5% on a year-over-year basis, nursing students continue to comprise 86% of AGIâs total active students at the end of Q2 fiscal 2023. Of the students seeking advanced nursing degrees, 8,269 are RNs, including 5,517 at Aspen University, and 2,752 in USU. In contrast, the remaining 1,123 nursing students at quarter-end were enrolled in Aspen Universityâs BSN pre-licensure program in the Phoenix, Austin, Tampa, Nashville and Atlanta metros. In terms of our future growth plans, with the pending release of the $1.5 million from the insurance company and our expectation that we closed an AR facility during Q4 of fiscal 2023, we intend to return to a marketing spend rate in our fiscal fourth quarter that is anticipated to resume year-over-year enrollment growth by the second half of our upcoming fiscal year 2024. As we have communicated over the last few quarters, we have revised our business plan to refocus on our traditional post-licensure nursing education business, designed to methodically replace the anticipated loss pre-licensure revenue that winds down at the end of fiscal 2024. Our near-term objectives are twofold. First, we intend to secure an AR facility that will allow us to spend on an annualized basis between $7 million to $9 million on new marketing campaigns that will drive enrollment growth in our USU FNP and Aspen online nursing programs primarily. Second, we plan to manage the company with steadfast commitment to maintain an adjusted EBITDA level in the breakeven to slightly negative range. Given our long history of driving post-licensure nursing enrollments and highly efficient online marketing initiatives, our entire management team is confident we can meet our near-term and medium-term goals. I will now hand the call over to Matt to cover the details of our second quarter financial results. Please go ahead, Matt. Thank you, Mike, and good afternoon, everyone. In my comments on the quarterly results, I will refer to the second quarter that ended on October 31, 2022. Unless otherwise stated, all comparisons are to the prior yearâs second quarter ended October 31, 2021. I will begin with a review of our financial results for the 2023 fiscal second quarter, including some detailed commentary on P&L items and additional commentary on the restructuring program initiated late in Q1. I will then conclude with comments on our balance sheet and cash flow. Before I jump into the details, I want to call out three unique elements in this quarter to provide context to the details I will cover. First, as expected, we saw a sequential decrease in our active student body, which is consistent with the marketing spend reduction begun in fiscal Q4 2022 and the stoppage of enrollments in all of our pre-licensure campus locations. This resulted in a quarterly sequential decline in revenue in both our Aspen University online and pre-licensure programs. Our active student body decreased from 12,048 in Q1 2023 to 10,957 in Q2 2023. Second, as part of the restructuring announced on last quarterâs earnings call, we significantly reduced the marketing spend in Q2, which positively impacted our gross margin and adjusted EBITDA. Marketing spend was reduced to $825,000 in the second quarter of fiscal 2023 compared to $4 million in the year ago quarter and $4.5 million in the sequential prior quarter. Third, continued cost controls and the restructuring further reduced ongoing G&A costs versus the prior year second quarter and the sequential prior quarter. Now on to the details. Total revenue was $17.1 million versus $18.9 million in the year ago quarter or a decrease of 10%. This decrease is attributed to the decrease in marketing spend that was initiated two quarters ago in Q4 fiscal 2022 and the halt to enrollments at our pre-licensure locations. Gross profit and gross margin increased to $10.2 million and 60% respectively versus $9.7 million and 51% respectively for the year ago quarter. The year-over-year gross margin improvement is primarily a function of lower marketing spend, as I discussed in my opening remarks. Instructional costs for the quarter were $5.5 million or 32% of revenue, up from $4.8 million or 26% of revenue in the year ago quarter. Our core student population is increasing due to the progression of pre-licensure double cohorts in our Phoenix locations and the entry of pre-licensure students into the core curriculum in our newer locations. This in turn increases instructional costs as a percentage of revenue due to the requirement of a higher ratio of instructors to students during the curriculum portion of the pre-licensure program. Additionally, higher USU clinical immersion-related instructional costs were incurred in the quarter due to the growth in the MSN-FNP program. Total marketing and promotional costs for the second quarter were $825,000 or 5% of revenue, down from $4 million or 21% of revenue. The decrease in marketing as a percentage of revenue, results from the planned decrease in marketing spend across all programs. The quarterâs general and administrative costs were $10.9 million or 64% of revenue compared to $11.6 million or 61% of total revenue. The year-over-year decrease in G&A spend is due to both the impact of the restructuring and cost controls designed to reduce G&A spend across all functions, primarily corporate AGI. Total net loss was $2.3 million or $0.09 per basic and diluted share compared to a net loss of $2.9 million or $0.11 per basic and diluted share. From a unit perspective, Aspen Universityâs net income for the quarter was $1.1 million compared to $1.3 million. USUâs net income was $1.8 million versus $877,000. Finally, AGI incurred a net loss of $5.2 million compared to a net loss of $5.1 million. Included in the AGI net loss is interest expense of $700,000 compared to $100,000. The Q2 interest expense includes a 1% commitment fee of $200,000 on the undrawn 2022 revolving credit facility, which will not repeat in subsequent quarters. Consolidated EBITDA for the quarter was a loss of $603,000 compared to an EBITDA loss of $1.9 million in the prior year period. Again, reduced marketing spend and cost control measures in G&A drove the improvement in EBITDA. Second quarter EBITDA compared to the prior year quarter for each of the three units was as follows. Aspen University generated $1.9 million compared to $2 million. USU generated $1.9 million compared to $976,000. AGI had an EBITDA loss of $4.4 million compared to a loss of $4.9 million. The increase in USU EBITDA is mostly attributed to the increased revenue in the unitâs FNP post-licensure degree program, which has the highest concentration of students and the highest LTV. Consolidated adjusted EBITDA was $537,000 compared to a loss of $715,000. From a unit perspective, Aspen University generated adjusted EBITDA of $2.1 million compared to $2.3 million and adjusted EBITDA margin was 20% as compared to 18%. USU generated adjusted EBITDA of $2.1 million compared to $1.1 million and adjusted EBITDA margin improved significantly to 32% compared to 18%. Finally, AGI Corporate incurred an adjusted EBITDA loss of $3.7 million compared to a loss of $4.1 million. As Mike mentioned, we implemented a restructuring plan late in the first quarter of fiscal 2023, which has already resulted in significant cash benefits for the company. These benefits are apparent in the second quarter results, and we expect additional benefits for the remainder of the fiscal year. There are two key components of the plan. First, we scaled back marketing ad spend to maintenance spend levels of $150,000 per quarter, which resulted in savings of $3.7 million in Q2 versus Q1 and should deliver savings of $3.8 million in Q3. The Q3 savings estimate is based on a normalized marketing ad spend run rate of about $4 million per quarter. Second, the restructuring included the elimination of approximately 70 positions, mostly within our G&A functions at Aspen University and AGI. As a result, additional restructuring savings of $600,000 were realized in Q2 and $1 million of additional savings are expected in Q3. The Q2 G&A savings were $150,000 less than we initially expected, primarily due to the timing of eliminating positions, which does not impact our forecasted future savings. Total spend reductions were $4.5 million in Q2 and are expected to be $4.9 million in Q3. In summary, these significant spending reductions positioned the company to generate positive cash flow from operations beginning in the second quarter. Moving to the balance sheet. As of October 31, 2022, our unrestricted cash and cash equivalents were $2.3 million and restricted cash was $6.4 million. As of April 30, 2022, our unrestricted cash and cash equivalents were $6.5 million and restricted cash was $6.4 million. Cash used in operations for the first 6 months of fiscal 2023 was $2.6 million. Importantly, though, cash generated from operations for the second quarter was a positive $1 million. The shift from operating cash flows using cash of $3.6 million in the fiscal first quarter to being a source of cash in the second fiscal quarter was the result of lower discretionary spending on marketing and the benefits of our restructuring plan, which narrowed our net loss. Our second quarter cash generated from operations also includes $418,000 of tenant improvement reimbursements. A cash flow positive change in working capital also played a role. The positive working capital impact was expected as decreased marketing spend reduced enrollments, which then decreased capital needed to finance growth in student receivables. We also had CapEx spend during the first 6 months of $842,000. Without the continued investment in pre-licensure campus locations, our CapEx spend going forward should approximately â should approximate $300,000 to $400,000 on a quarterly basis. As Mike previously mentioned, subsequent to the end of Q2, $1.5 million of restricted cash associated with the surety bond will become unrestricted, providing additional cash for operations. Additionally, the insurance company agreed to terminate the draw restriction on the 2022 revolving credit facility agreements. When the AR facility closes it will become senior secured. And at that point, we will terminate the 2022 revolving credit facility agreements. With respect to our share count, the weighted average number of common basic shares outstanding at the end of the quarter was 25,282,947 versus 24,957,046. We are not providing guidance at this time. We plan to update our business plan when we close and execute an AR financing agreement. The objective of the AR facility and the related business plan will be to resume marketing spend at a level which allows us to offset the decline in the pre-licensure student body with a growing post-licensure online student body while at the same time achieving operating results of approximately breakeven to slightly negative adjusted EBITDA. That concludes our prepared remarks. I will now turn the call back to the operator for questions. Operator, please open the call for Q&A. Yes. I wanted to dive into the marketing spend just to get a feel for that. It sounds like itâs all kind of contingent on the AR financing. But just to get the quarters correct here, you said Q1 was $4.5 million of marketing spend; Q2, it dropped down to $825,000; and then your plan for Q3, could you tell me that again? Hey, good afternoon. Eric, itâs Mike. Our plan in Q3, because weâre looking to close the AR facility round about at the end of the third quarter, which is the end of January. So this full quarter is kind of a maintenance spend. So it will be sub $0.5 million spend rate this quarter. Okay. And then the â I know weâre pulling back across the board here. But the â we had growth in revs at the USU segment level, but our student body actually declined. Can you help me understand that? Well, when we â I think in the last couple of quarters, we did mention that we had a little bit of a price increase at USU and a few other of our degree programs. So I think the pricing is whatâs helped increase the revenue for USU even though there is a very, very small modest decline of student body year-over-year. Okay. And then whatâs the expectation? Is that, that does USU student body continue to decline as we â the â as the marketing spend is reduced here this quarter? Yes, I think one of the pieces of great news that I would love our analysts and our great shareholders to take away today is that even though we dropped our spend rate quite significantly in the second quarter and as well in the third quarter, and Iâve mentioned historically that we have such strong brands, and weâve been spending so much in marketing over the last 5 years, 6 years, that about third of our enrollments are organic in nature. In other words, we donât pay for the ad. So our enrollments, as you guys can see, if you take pre-licensure out of the equation, our enrollments have not declined as much as one might forecast or expect. So weâre hanging in there quite well even though our spend rate went down to a maintenance level. So hopefully, folks are impressed by the results of the enrollments, even though, again, there is not a significant spend rate. I know youâre not giving specific guidance for the third quarter, but seasonally, itâs a softer quarter with the holidays. Should we anticipate any change in that trend? In other words, the January quarter down sequentially from the October quarter? Yes. This is Matt. Iâll take that. So from a revenue standpoint, you can expect to see our results decline modestly from Q2 into Q3 because of the fact that there is a seasonal weakness. And the other factors, weâre continuing to teach out the pre-licensure program. So the effects of both of those will put some pressure downward on revenue. As a result, from a bottom line standpoint, we will still hover around that breakeven adjusted EBITDA, but we will probably dip slightly negative for the next quarter. We will still realize all of the savings that we put in place from the restructuring. So we will have another solid quarter when it comes to G&A savings and the marketing savings, but the revenue declines that will mostly impact the bottom line. Well, I donât think itâs â I would disagree that itâs taken forever. We tried to get a facility back in the spring this year. And there is a fairly significant amount of regulatory noise, I think that all the shareholders are aware of. And so we got a couple of term sheets that we didnât like. So we declined. And we made the decision to hire a banker that specifically focuses only on helping companies find debt solutions, which is Lampert Capital. So weâre making great progress. And again, we have every expectation that we will close it in the next couple of months. Yes. Thank you for taking my questions. Good results. I wanted to follow-up on the AR financing. It seems like the marketing â youâve said marketing is in maintenance mode. But I think you also â youâve also just said that youâre waiting for â youâre waiting for the AR financing to kind of ramp the marketing spend backup and so that you can get year-on-year improvements in the starts. Can you kind of give us an indication of what that level would be? And are you going to take it right back up to $4.5 million or half of that or â and what does growth mean, 5% starts growth you are aiming for kind of just a little bit? Because it seems to be dependent upon â your marketing budget seems to be dependent â significantly dependent on AR financing. More color on that would be great? Yes. Good afternoon, Raj. Itâs Mike. Our plan right now is for the upcoming fiscal year, starting May 1. What weâd like to do, and Matt kind of mentioned this in his comments, weâd like to implement a business plan that we maintain a kind of a breakeven adjusted EBITDA type of a level as we regrow the company. And in order to do that, weâve methodically analyzed that the right spend rate is kind of in the vicinity of about $7 million to $8 million per annum. So call it back of the envelope, a couple of million dollars a quarter. So thatâs our current plan for the upcoming fiscal year as to â once Q1 rolls around in the spring, weâre looking to go back to approximately a couple of million dollars a quarter. Hope that helps. And what kind of an enrollment growth you think we could kind of plan for or model the $2 million a year spend â quarter spend? Well, what you have to realize is last year, we were generating on a quarterly basis for pre-licensure anywhere between 300 and 500 enrollments a quarter. So, when you start to do the year-over-year comparables, you have to kind of take that out of the analysis or out of the equation. So, as we enter next year, there is no reason why in the second half of the fiscal year that we canât be increasing our enrollments on a year-over-year comparative, right. So, in Q3 last year, we did about 1,800 enrollments, and then in Q4, which is a softer quarter, we did about 1,500 enrollments. As we get â if we look at that comparative a year from now, we should be able to hit that or exceed those numbers. And of course, there is obviously a lag between the enrollments and what happens in the student body, which is driving your revenue. And so by the second half of 2024, the student body as a whole will start to flip and start to grow again, and that includes whatâs happening in the pre-licensure business, right. So, once you get into the second half of â24, the pre-licensure wind down has largely taken place. There is still some left that becomes less of a factor in whatâs going on. And at the same time, the enrollments start to generate that new student body. And so thatâs when you start to see the inflection point of enrollments actually increasing sequentially quarter-over-quarter. Got it. And then â definitely helpful. And then the surety bond reduction caused the release from the collateral, and you said as pending, liquidity â that helps the liquidity, but when do you think you should have that money back? It is imminent. Okay, great. And then just lastly on Phoenix and the four new campuses and sort of the teach-out, any indications on where we should look for revenues this year and the next year, has any of that changed? No. Our estimates for pre-licensure, because we know precisely how many students in each of our markets will be taught out over the next 15 months to 18 months, we have a very good idea on exactly what the revenues are going to be. We are going to be in that like $11 million range for the full year, the full fiscal year that we are currently in fiscal 2023. And then it drops down into that $3 million or $4 million range in the final year, fiscal â24. Hi Mike. Hi Matt. A question on the timing and how we extricate ourselves from the leases on the pre-licensure campuses, I mean you have got long-term leases, but you canât sublet it until the teach-outs are over. Whatâs the timing factors there? Yes, great question, Brett. So, just so you guys are aware, we typically, historically, for the campuses, we have had leases that are ranging in kind of the 7-year level, in the 7-year duration. And all the leases, once our teach-out is done, will be at least a couple of years in. So, we really only have about 5 years to go with those leases. We are actively â our commercial realtors, Colliers International, huge firm with local with â commercial realtors in each of our local areas. We have already had a good amount of activity in terms of showing these campuses to other nursing schools. And so what we are looking to do, Brett, is to actively sublet space in all of our pre-licensure locations by approximately January of next year, January of 2024, so about a year from now. Our teach-out, it ends in Phoenix in April of â24 â sorry, yes, April â24 and in the summer of 2024 in these other locations. Now, one thing to be aware of is that, at this point, we are planning to keep our Phoenix campus location. And we are going to convert that building, that suite into a USU nurse practitioner immersion space, because we have decided to no longer conduct immersions in other locations and no longer conduct them in San Diego, all of our immersions in the future with thousands of students that are going to be in our Phoenix campus. So, we can very easily convert that location and utilize that space as the USU business continues to grow. So, we really only have to worry about our other four locations. And I am pretty confident we will have the sublets done by the time our teach-outs are over in each of those four locations. Mike, in the four locations other than Phoenix, are you paying at or below market rents right now, do you know? Yes. I mean our â the leases in each of our locations were all in kind of the low-20s per square foot. So, it was a fair commercial deal at the time for each of those, and thatâs kind of the market rate. Okay. You have touched on this, but I just want to make sure I think I heard it. The release of the $1.5 million of the $5 million restricted cash, the balance of that release is imminent. Did I hear you say that in response to one of the analyst questions? No. The question was, the $1.5 million that has been agreed to be released by the surety bond provider, when is that going to happen, and I said that was imminent. So, that question was regarding the $1.5 million. That is a very good question. We â once earnings is over with today, we are looking to have some subsequent conversations with the bond provider, now that they have seen our results for the quarter. And we are hopeful that we can convince them to release some more. But I would prefer not to, at this point, indicate either way of how much or when that might happen. Okay. And last one for me. The two qualified investors that invested $5 million apiece in these convertible type notes, what is the status of that investment? And are these people working with you? Are you in compliance with your obligation to them? Could you talk to us a little bit about that? Sure. I donât â this is a convertible note that doesnât have any covenants as it relates to that. So, there is no compliance issue whatsoever. And we are making the requisite interest payments each month as required. And the convertible instrument is currently priced at $1 a share. So, they are unlikely, obviously, at this point to convert. So, thatâs really it. Hey guys. Thanks. And Michael, you said that you got a couple of term sheets on an AR facility earlier, but you didnât like the terms. Any sense of kind of the range of terms you might be looking at now? No. I mean Mike, just to be clear, the terms that we received from a commercial perspective, there is a pricing and a cost perspective. They were probably okay. They are probably acceptable to the company. But because of the pre-licensure at the time, the pre-licensure probation cause them to add some regulatory covenants that the company was uncomfortable with. We are not â we donât have to worry about that now because of course, we just announced the teach-out and itâs a smooth 1-year to 1.5-year teach-out process. And so that regulatory concern now has been mitigated. So, it was more about covenants as opposed to pricing. Got it. Okay. And assuming you get this new AR line and assuming you resume this marketing spend and that grows enrollment and revenue growth, what is the rough level of revenue you need to achieve to be EBITDA positive and to kind of begin to throw off cash, if you will? Well, so thatâs an interesting question because we are EBITDA positive now because of the restructuring and all of that, that we put in place. So, once we put the marketing plan in place, this â it would be possible with the AR facility. We will be ramping spend at a rate that keeps us at that adjusted EBITDA breakeven-ish type of level. So, there isnât a magical revenue number in the future that would cause that inflection point. The idea is we maintain the place that we are. We donât get ahead of ourselves with spend as we ramp up the marketing spend. That makes sense. Hopefully, that makes sense to you. Yes, it does. I mean I guess I am just trying to figure out steady state, what does the company look like in a couple of years? Is it â you are spending these marketing dollars to drive breakeven adjusted EBITDA. When does that flip, if you will, and when do we get more? Yes. So, the way you just described it is the way that we think about it for the next couple of years, okay, so fiscal â24 and â25. And the reason that those years were kind of staying at that flatter adjusted EBITDA levels because we still have the pre-licensure teach-out as we are ramping up the marketing spend and starting to grow the online business again from where it is today. Once we get into after fiscal â25, the pre-licensure drag goes away entirely, and you see the full effects of the growth from the new enrollments in the online post-licensure programs. So, I would start thinking about kind of that larger adjusted EBITDA number laid in â25 and into â26 and â27. And we have reached the end of the question-and-answer session. I will now turn the call back over to Michael Mathews for closing remarks. Thanks everyone for participating in todayâs call. We look forward to speaking with you again in our third quarter earnings call in March of 2023. Thank you. Have a good afternoon.
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EarningCall_1622
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Okay. Hey, welcome to our next session. Mike, I'm glad you made it. It's a traffic jam in the one-on-one meetings is like I hear it's like terrible. Yes. No, I know. I was more trying to get investors out of the room when I finished my last meeting. Yes, yes, yes. Hey, one more question. Yes, yes, yes, one more question. Yes. Hey, you just reported like really good solid results last week. Maybe just to get the room kind of all on the same page, like what were the highlights from your era [Ph]? Really strong free cash flow, happy with the revenue growth. I've been saying, since day one, we try to guide the business to try to have a 3% to 5% beat, I think is a good beat. And given the challenges as what's happening in the economy right now, I'm pretty pleased with how the company has performed. Yes. Can I mention like, I think the one thing where you were surprising me a little bit is like the -- you know when you went back to the olden days and you had like a economic turmoil, then customers often became like very inward-focused and just kind of said like, "Oh, let's keep the lights on, and let's just not change anything." Like what do you see in terms of new customer business? Really no change. What you need to understand is new customers are coming to us that they have made the decision they want to be in the cloud, they don't want to continue to manage their data on-prem. There's many of these customers that feel they're behind and want to catch up with their competition. They are also looking at the cost and are understanding the price performance of doing things in the cloud versus on-prem. And you have to understand, too, we don't just find a customer in the quarter and close them. The average customer is seven months, the average across the board. But large customers are one to two years to land these customers to just get them to get that first PO to start. And these guys aren't making decisions for the next three months, six months. These are 10 to 15-year decisions they're making in what they're doing. And most, when you talk to customers, they are very much focused on the long-term. And the beautiful thing about Snowflake is, from an expense standpoint, you only -- the expense only hits you as you consume. And that's why with our model, many of our large accounts, our average Global 2000 lands at $100,000. Yes, we've had customers that have landed at $3 million as a Cap One, we call them, but most land at $100,000. And, by the way, when they're doing that, they also typically sign big service contracts with GSIs to do their migrations or us. I was actually just looking yesterday, our top 15 GSIs year-to-date, through October 31, is the data that I had. It -- they actually sold $1.425 billion in services around Snowflake. And that's what gives me the confidence. People who would be spending of that type of money, if they didn't plan -- have in their roadmap, in their plans to move to Snowflake. Yes. So, like what do you see -- like they must be kind of training and hiring like on the GSI side as well if you keep up-to-date. The GSIs themselves are really -- and we spend a lot of time with them on certifying their people to be Snowflake certified, there's different certification levels. I will say, if you went back three years ago, we used to hear from customers, one of their biggest concerns was they didn't have people who really understood Snowflake. Today, that's not as big of an issue. We see people within new -- it's funny, you can see when we're trying to sell into a Global 2000, and then you can see through their job postings, they have people that are looking for Snowflake talent. But it's getting better right now. We spend a lot of time training both customers and, more importantly, the GSIs. And they're building up significant practices. Yes. And then, like, in a way like that lending spot, like $100,000 that -- I mean it used to give you a lot of comfort to kind of because you have that kind of expansion there. Is there a pattern for you that you see in terms of like there's a typical guy? Or like can you talk about the journeys there? And some companies like to start with the easy stuff first. Others, we have one that I know is going to do the hard stuff first. It really depends upon the customer and what their journey is. Yes. I have one large financial institution that wants to do their main big teradata warehouse, but they have hundreds of other data warehouses. Yes. Okay. I remember, like on the diligence calls for the IPO, there was -- a lot of the guys were first surrounding, and then kind of the core was kind of the last step. Like, okay, so that's interesting. But then the -- like is that in a way like the explanation for that crazy â well, a crazy good dollar net retention as well, like -- and from what you can see, you don't sound like it's slowing down anytime soon. Yes. No -- well, the high net revenue retention is driven by some of these big customers ramping very quickly. And if you look at, and we've said on the call, six -- and I will give you this disclosure every quarter, six of our top 10 customers grew faster quarter-over-quarter than the company's growth rate. That tells you and I did have three customers who this was actually the first time that sequentially declined quarter-over-quarter. And those are three in the technology crypto space. Those three customers, actually from when we guided at the beginning of the year, they took out $41.8 million of revenue from us for the full year. These were three customers who have gone through some challenging times, but also did some heavy optimization. And by the way, all these three customers, we've been telling them for a while, we can help you save money, but they didn't -- they were growing so fast, they didn't pay attention. And now, customers are paying attention. But I would say those were three of our worst in terms of how big they were, and we knew there were big savings. Yes. And then the -- going back to that original question of like people kind of coming to you and haven't made the decision, it's from -- on our end, it's a little bit tough because we get like the noise from everyone. Like, you had like, "Oh, no, we have a cloud solution, and this one is really good." Like what's the number one -- well, what are the kind of top points that customers say like, "I want to go to Snowflake. And yes, my legacy guy said I have cloud, but actually, I really want to change." Because it's a big decision; it's a lot of work. It is a lot of work. When we are competing for an on-premise migration, it is always we're competing with Google, Microsoft, AWS tends to partner with us more at the gate. Google is definitely the most competitive there. Many of the times we only win in an Azure account when Synapse fails. And I'm not saying there isn't any, but I have been asking my sales people for a successful implementation of Synapse in a large account, and they can't find one. I have a lot of customer -- companies we've heard trying. But generally, we get in there once they fail. I'm sure they must have some, but we can't find any. We are never competing with Teradata. When a customer has made the decision to go off-prem, it is never against Teradata. They've made the decision to leave. And by the way, I've never seen and I ask our sales people, too, "Have you seen anything with Oracle and HeatWave," or whatever. Yes, okay. No, okay, it makes sense. I mean, that's what in Europe, in the market as well, quite a bit. So, it's like it's kind of the same. Maybe let's change gear a little bit with like consumption models. So, you were kind of one of the first to kind of drive that consumption model change. Like where are you on that realization journey of like, okay, this is different? You had ServiceNow, it's nicely placed, nicely predictable, or relatively. Now, we're on consumption, like you were few quarters in, like I think this year was the first time where your AI models were not totally perfect anymore. Like, where are you in that journey, and then how happy you are? Are you in like -- Actually, I'm pretty pleased with our models and what we've done. And where we've had skewing has been driven by a couple of customers that have been unique to those customers. I'm comfortable with this model. It took a little bit of time to get used to it, but I actually like it and the level of detail that we have in Snowflake, using Snowflake to do our forecasting at a customer -- every individual customer, we have a forecast for their rolls up. And we, using our predictive models, we predict where it's going to be. And we've been pretty accurate from the finance side on where we're going to land in terms of consumption. But I want to stress too, when we start a quarter, we start with zero revenue. Unlike a SaaS business, like I know I was at ServiceNow, I knew pretty much 96.7% of our revenue was in the bag at day one of the quarter, unlike a model like a Snowflake in consumption model. And then the -- if you pick this year, like you remember at the beginning of the year, there was like people were taking holidays, so it's like a new input factor in the model. Like, is that kind of in a way like you're constantly fine-tuning and -- We constantly fine-tune our model based upon the history. And we have seen, as we've become more of a global company, and especially what we have seen, for instance, we sold to a lot of U.S. companies, but they have employees around the world. They have a lot of users in India. And you actually see during the Indian holidays, and there's a lot of holidays in India, I've really noticed this year, that the downtick in daily consumption tied into those holidays. And so, our models are all -- the more history we have the better we are at forecasting that stuff. And, unfortunately, during COVID, it was very different when people were working remotely; people weren't taking holidays when people were sitting at home, they were continuing to work -- do work. Yes, yes, yes. And do you think there will be -- I'm asking because like one of the companies later is Mongo, and they kind of start talking about that they're starting to see like season -- more seasonality coming in for their quarters in terms of like there is a -- the Q4 has like a -- the holiday effect, in the summer the Europeans will go on holidays, et cetera. Is that something that kind of will eventually kind of come through for you as well? Well, I do see seasonality in consumption. Clearly, this quarter has a lot of holidays. And around July 4th, and in the summertime holidays, you see that, because remember about - roughly about 70% of our consumption is done through scheduled jobs. No human interaction, about 30% is human interaction with the system. And you can see that on the holidays. I see it on Saturdays and Sundays how it drops off, but it stays at the base roughly 70%. Yes, the machines are doing it. Yes, okay. No, that's interesting. I mean, like, on that note, like, in terms of like if you -- with the consumption model, you see all these new clients coming up. Like how do you think about like the current uncertain macro environment? Because like in theory you would think like -- remember like, you probably attired all these investor calls we had over the summers like consumption model, less economic activity, things come down, but you have so many ramping customers that kind of lead out, they're like, how do you feel about those, the environment and your goal there? If I had such a massive market share, I would be more concerned. We are still very much in the growth phase and the early innings of migrations with customers. And what I would say is what you need to be able to do when you have challenging economic times is be able to sell on value. And it's not just a cost replacement. It's what the value you are driving. And data is becoming one of the core assets of most companies today. Whether you are a media advertising company or financial institution, getting real-time data and insights into your business is pretty important piece to companies. And we are getting data. There is one large oil and gas company. I know, we sold them $3 million worth of Snowflakes they have consumed. And they themselves have said they see $30 million in value. Yes.And the one thing that surprises me all the time when we have the cold times after the quarter is like how much confidence or how much knowledge you have in terms of customers ramping? Like how do you get that? Is like customers telling -- like how do you know like, "Oh, this customer is ramping and next quarter he is going to be so much bigger. Like â so how does that work?" My FP&A team, I have a team of data -- small team of data scientists that built the model where we forecast by customer. We kind of go down to the top 200 -- I forgot, 280 customers. We actually go and talk to the reps. Does this make sense? What's going on? I sit through a lot of the big accounts. I sit through EBCs. I read. I get this all kinds of deal information I read and what customers are doing. That's what gives me the confidence. But I get a lot of confidence when I started looking a lot more into what people are spending with GSIs. People don't spend that type of money unless they plan on doing something on Snowflake. And I am digging into who are those big customers and where they are in their journey. Yes, okay. So, that's interesting. Yes, I mean that should give you a lot of comfort if you kind of see that sort of stuff is coming, yes, okay. Yes. Maybe let's shift gear little bit like the one thing that kind of got me excited and surprised is like how much you are changing the world. Like, I remember in the early days of Snowflake, I was like "Oh, this is like a data warehouse on the cloud." Now if I look at it, you are changing the world the way how a business is conducted. Like, if you think about data sharing, what I am hearing from customers and how they are using Snowflake is just like, "Oh, shoot, this is a whole new world." Like what are you seeing in terms of that understanding on the customer base in terms of like this is not just the one/two, this is like a much, much bigger thing. This is fundamentally changing the way that - well, first and foremost, it's eliminating data silos. It's getting all of your data in one place, but it's really dealing with a governance issue that you know exactly where your data is, who is accessing the data, and then allows that sharing of data without actually transferring data. And that cuts cost when you are not having to transfer data. And we think this is our belief that there will be a world where instead of bringing the data to the applications, bring the applications to the data. And that's why we fundamentally think that Snowflake can become an application development platform where you have all the data without having to move it. Think of a world where you -- because today, what happens you have transactional databases and then you move all that data into your analytics. There is a huge cost associated with moving that data. You can eliminate that cost. There is also a lot of security governance issues with moving that data that you eliminate that. And so, we do think fundamentally we are going to change the way that people operate. And the whole concept of data sharing is really resonating especially in the financial services industry, which are very data-intensive. And there is all kinds of data sharing that goes on between whether it's between a trading platform in the banks or think of the fidelity with all the reporting they do out to various other financial services they deal with. BlackRock Aladdin is in there. We're doing something interesting with DDTC they spoke about it or financial services meeting in New York. So if you think about that, like so that you become that, do you think that will be part of within Snowflake, or is that just in kind of wherever it is like AWS et cetera and then you just kind of using? Okay, that will be interesting. Okay. Is that kind of in a way, like you mentioned earlier, and I'm surprised you said it that AWS use you more as a partner and less of a Redshift competitor, because like they probably had with Redshift, like a decent solution. We are becoming very meaningful to AWS, we are just at reinvent, and they're leaning heavier on us, and we're looking at renegotiating our contract with them right now. It's not just about pricing. It's about more commitments from them to work with. So, as I said, AWS, pretty much partners with us day one. They don't try to compete. Yes, they still compete in the small accounts of Redshift. And that's pretty good business for them. But within the large accounts to get all the data in one place, Redshift just can't do that. Yes, yes, yes. Okay, that's interesting. And then the -- at your Analyst Day, almost like a few months ago, we talked about the new development projects, and one of them was striking for me was like the idea of operational database that would come out in a way that fundamentally then would change the world because like, if you think about operational databases in the cloud, the only thing we have is like a MySQL, which is kind of dated, and now, AWS equals Aurora, but to MySQL, which is like 30 years old, Postgres is 30 years old. Nothing was built for cloud native, like, is that kind of? I mean, it sounds like if it works, it's going to be like, really exciting. We have been working on this for quite some time. And it's really more with a transactional database within analytics database, all in one system. We see it being for more net new app development. Don't think of this as going out and replacing Oracle transactional databases and stuff. It could one day but that's not what we're doing. We're listening to our customers. That's going to be more applications that are very data rich and have a lot of data. Yes, yes, yes. Okay, that will be exciting. Okay. Shifting gears a little bit like the one big surprise last quarter. We also would like to the cash flow comments you made, the commitment to the cash flow margins for next year as well. Can you talk a little bit about the levers that you have as a CFO in terms of like, where are we on that gross margin improvement journey, which kind of happened over the last few years in terms of where we are on our tax? So gross margin, I've said this since day one. And I'll continue to say this is never going to have the same gross margin profile as a ServiceNow or a Salesforce, I really don't see it may get to 80%. But it's not going to go above 80%. I think we can get into the high 70s. Free cash flow will continue to expand. We really but there is seasonality in free cash flow on a quarterly basis, you really need to look at it on an annual basis. We've now guided to 21% free cash flow for the year. And I feel very good about that. And I think you'll continue to see free cash flow margin expansion, we are very much focused on growth but it's not growth at all cost, it has to be efficient growth actually just had a four hour meeting yesterday with all of our executives who are all hounding that they need more money, need more money and it's not unless you can justify how it's going to drive revenue and actually see the payback you're not getting it. Yes, and if you think about like the lot of the margin and cash for improvement like in the earlier part with gross margins, like even we negotiated the contract with the Hyperscalers, I'm sure it's more like as you said like with AWS now what's the -- what's from you to next like, it's like basically keep growing, but kind of realizing so productivity et cetera or like, what are the factors? Yes, there's still more room in gross margin, in the gross margins. We still we think 32, 33 deployments around the world. We have a lot of them that are at scale. When you set up a deployment say in AWS Singapore, we're paying for a certain amount of free pool, we call it that's that reserved capacity, we're paying day one, before we have a customer, we have to get to a certain level before that starts to become profitable for us. We have a lot of deployments that are not at scale, that that will help drive margin up. And as the bigger customers become a bigger percentage of a row of business that are on business critical, those guys with better margin profile on those customers, so that will continue to drive gross margin along with renegotiating with the cloud vendors over time. I think it works. Storage is 10%. Compute is 89%. And egress charges, that data transfers 1%, that's a pure pass through, we don't make any margin on that, the storage margins are very low. That's the compute, that's the value of the software, we make all of our margin. And then clearly, as we get into these bigger customer relationships, you're going to get a lot of leverage out of sales and marketing, if you can have $50 million plus customer relationships, those are very, very efficient from a sales and marketing standpoint. And on that note, like talk a little bit about when you joined, please like the one thing that was interesting at this conference is now that the times have been tougher, like so many vendors that are just talking, it's like yes, we were growing and we're just getting every customer and now they're like, should some of these customers are actually not really profitable or why they are spent my time on that like when you joined Snowflake, like you looked at how they were growing. And it looked like were like, how did you change it? And how did that help you kind of on the profitability side? Well, we're very much focused on large customers, I will say, when we joined, when Frank came on to the business, I'm not going to say, they didn't have large customers, they did, but they had a disproportionate amount of what I'll say, commercial customers. We're very much focused on the largest companies in the world. And that's why I always tell people, I don't even look at how many customers we have. I look at how many global 2000, how many Fortune 500, who are the marquee accounts in certain regions, countries verticals, that's what I'm more concerned about the quality customers, the ones that I know can be $10 million plus a year in revenue. And so, we're very much focused on those large customers, not saying we're ignoring the low end of the market, when I say low end, the S&P, we have a group that focuses on those 500 and less employees in the company, I called out that we saw some weakness in those. And what I want to stress so, those guys are still growing and consuming. They just are not growing at the rate we're forecasting is a growing consumption. APJ, definitely we see some weakness there. They're not declining. They're just not growing at the rate we thought, they were going to grow in a lot of APJ. It's mainly Japan, Korea, and Australia, a lot of that is the dollar. The strength of the dollar, we price in dollars there, it's become more expensive for people. Yes, yes. I mean, on that note like, obviously like, you have your competitors and they're like, but eventually is going to get expensive. Like, what are you seeing? Like, if I look at your net expansion et cetera, it seems like it's vendor BS, but like, what are you seeing in terms of like price discussions, because you are getting quite big ticket items for some of the customers but the value must be this. There is price performance. You got to look at price performance. When we actually sit down with customers, and look at real data and not benchmark data, put actual workloads and do POCs, nine times out of 10, we are winning in price performance, and by a considerable margin. So is it in a way, like a situation where yes, you're doing a lot for the customer, which basically means that the bill is high. But like⦠Yes, yes. So, you're getting bigger as basically a function of you're adding value and not like you're getting or coming Oracle, yes. Last couple of minutes, like, how do you think about cash because like, you are now generating cash, you have a very strong cash position, how do we have to think about that, like, I'm not quite sure how much M&A makes sense for you guys at the moment, like, how do you think about that usage of cash? Yes, we're going to do M&A, but it's going to be that is -- when we look at M&A, it's really two things we're looking at, we're looking at, can we find a team of engineers that have domain expertise that can help accelerate the development of a core functionality within the company. We've done some of this, the Acqui-Hire M&A and we'll continue to do those. There's also people who who solved a interesting technical problem that was something that was on our roadmap that we just don't have the DNA, so, we were getting both the -- they approved the technology but also good people. Think of that like the Applica acquisition we have done. Or, the Streamlit acquisition we have done. We are going to continue to do those. There are not going to be -- don't think of us doing multi-billion dollar acquisition. [Multiple Speakers] Because anything we do, we completely rewrite it in Snowflakes. So, it's all just one product. At the end of the day, Snowflake is a simple business. We sell compute. And there is storage that comes with it. No, as I said, I am looking at a number of things. Right now, it's earning pretty good interest, but I am not naïve. I have been looking at different things with share buybacks and other things like that, but haven't formalized anything. I mean you are always slightly different in terms of like stock-based comp. Like dilution to get out from there. Can you remind of us of your philosophy⦠We have been running at pretty low dilution. Given our growth, we have been running around 2%. I think this year it's going to probably be close to 3%. But longer term, my goal is to keep at 2%. And clearly, you have the trade off is you pay people more cash and less equity or vice versa. I am spending a lot of time looking at all of that, but clearly, our cash balances we have with $4.9 billion in the bank at the end of last quarter. And that will continue to grow. While we have been doing M&A, we have done quasi-buyback in terms of we are now doing that settlement on our issues with people where we can. Do you see the employees getting kind of -- are there investors that they kind of say, "Look, at this share price, I want more stock," or is actually the other way, "Oh, can I have more cash?" You know what I would say now it depends upon the country and where you are. In certain countries, they don't value the -- in general, they don't value equity as much as they value cash. And I am hearing from people in the U.S. and some of the bigger markets too that they are more concerned about their mortgage payments and stuff and need cash versus equity, and so, looking at all of that.
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EarningCall_1623
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Good morning. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Rite Aid Corporation Third Quarter Fiscal Year 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakerâs remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Heyward Donigan, President and Chief Executive Officer; and Matt Schroeder, Executive Vice President and Chief Financial Officer, will begin the call with prepared remarks; Andre Persaud, Executive Vice President and Chief Retail Officer; and Chris DuPaul, Chief Operating Officer of Elixir will also join the call during the question-and-answer session. As we mentioned in our release, we are providing slides related to the material we'll be discussing today. These slides are provided on our website, investor.rideaid.com. While management will not be speaking directly to the slides, these slides are meant to facilitate your review of the Company's results and use as a reference document following the call. Before we start, I'd like to remind you that today's conference call includes certain forward-looking statements. These forward-looking statements are presented in the context of certain risks and uncertainties that can cause actual results to differ. These risks and uncertainties are described in our press release in Item 1A of our most recent annual report on Form 10-K and in other documents that we file or furnish to the SEC. Also, we will be using certain non-GAAP measures in our lease and accompanying slides. The definition of our non-GAAP measures along with the reconciliation to the related GAAP measure are described in our press release and the slides. Thanks, Byron. Good morning, everyone, and I just want to thank you for joining us today, and welcome to our third quarter earnings call. The third quarter came in better than consensus on both revenue and adjusted EBITDA despite the continued challenging macro conditions. There were some clear positives, but I'll give you, there's also some challenges. And then for me, I want to share some key takeaways with you. I'll go into more detail on these combined with some discussion on some exciting new initiatives that I believe will set us up for success going forward. But first, a quick review of our third quarter results. Revenue for the quarter was $6.1 billion compared to $6.2 billion in the same quarter last year. The third quarter adjusted EBITDA was $121.9 million compared to last year's adjusted EBITDA of $154.8 million. In our Retail Pharmacy business, total revenue decreased 0.5% from the prior year, driven by the expected reductions in COVID vaccines and COVID testing revenue in addition to the store closures that we've discussed. Results on a same-store basis are encouraging, with improved growth rates in all key categories in the third quarter year-over-year. Overall, same-store sales increased 7.5% and with pharmacy sales increasing 9.5% and front-end sales when excluding tobacco, grew 2.7%. Total same-store prescriptions increased 4.4% and when excluding COVID immunizations, prescriptions increased 3.6%. Same-store maintenance prescriptions increased 2.1% and same-store acute prescriptions increased 8%. We also improved our overall prescription market share by 20 basis points for same stores bringing us to over 11% share in the markets in which we operate. This is a testament to the high performance of our front-end and pharmacy teams, their customer relationships and even in this challenging labor market. Demand for flu immunizations and COVID vaccines in the quarter were both weaker than we expected consistent with trends in the overall industry. The demand for bivalent COVID vaccines has been less than we anticipated, and we expect that weakness will continue into the fourth quarter. However, due to one of the strongest flu seasons we've seen in decades, we expect a longer tail to the flu immunization demand and into the fourth quarter. We expect to finish the fiscal year administering approximately 5.2 million COVID vaccines and 2.7 million flu vaccines. Turning to the front-end, we're pleased to post market share gains of 20 basis points in the third quarter. Front-end same-store sales were aided by good results in health, consumable and the beauty categories, offset by underperformance in alcohol and general merchandise. Shrink for the quarter was $9 million worse than the prior year's third quarter. We expect shrink to be a continued headwind in the fourth quarter. Additionally, we're seeing signs the consumer is remaining cautious particularly in demand for discretionary seasonal products, which has driven increased markdowns. However, high demand for cough, cold and flu products has resulted in higher out-of-stocks. You've probably heard this in the news. Turning to our Pharmacy Services business in the third quarter, Elixir reported revenues of $1.7 billion compared to $1.9 billion for last year's third quarter. This was primarily due to a planned decrease in Elixir insurance membership and a previously announced PBM client loss on 1/1 22,] partly offset by a combination of higher drug spend and utilization. Elixir's third quarter adjusted EBITDA was $40.2 million versus last year's third quarter adjusted EBITDA of $28.9 million due to strong procurement economics as well as a reduction in SG&A expense. Procurement economics refers to contributions from an expanded set of solutions, including plan design and administration formulary and rebate management services, network performance management and specialty and mail order pharmacy purchasing. These services add economic value economic value to our clients and also to Elixir. As we look ahead to the fourth quarter, we expect some of the negative trends that we experienced in our retail business in the third quarter to continue. This includes lower pharmacy margins due to drug mix weaker consumer demand for discretionary items, which will likely result in higher seasonal markdowns as well as continued higher shrink expense. As a result, we're reducing our adjusted EBITDA guidance to $410 million $440 million for the year, down from $450 million to $490 million previously reported. This guidance reduction is concentrated on the retail side of the business. The key takeaway is that while we're seeing good script and front-end sales growth in our retail business and strong operational results at Elixir, we remain challenged by retail margin pressures because pride in the way we mobilize to continue to serve our communities during COVID. Now that the pressures of the pandemic are easing, we're working to bring that same call to action that same agility and strong execution back to driving growth and performance in the core business. The core drivers of growth include script growth with a focus on adherence, smaller-format store launches digital engagement, growing our loyalty membership and driving increased own brand penetration. We are also laser-focused on the long-term growth of our PBM membership with development of a strong pipeline for the 2024 selling season that is already underway. At the same time, we will continue to reduce costs and free up cash. We are focused on adherence with our Courtesy Refill Program 1.2 million new customers have enrolled in our program since June. As a result, we're seeing a 1% increase in adherence scores for our Medicare book of business. The value we're seeing from these adherence initiatives reinforces the growth potential with our current customers. Also, we have a central fill facility that currently serves over 800 stores. This facility helps us dispense a higher volume of maintenance medications outside the stores, thus freeing up our in-store team for increased script growth and the delivery of enhanced clinical services. We're planning to expand our central fill capabilities to service the remainders of our stores in the coming year. We're introducing technology and innovation to streamline core non-dispensing tasks such as inventory management, automating customer prescription transfer requests and taking non-pharmacist calls out of the stores. We're bolstering our centralized pharmacy teams to include additional clinical support for customers through our Medication Therapy Management Program, or MTM, as we call it. So our in-store pharmacists will always be available to counsel and support our customers. That's crucial. But growing a centralized pharmacy team allows for additional touch points with our customers. And by growing our MTM program, we'll increase the number of medication interventions that focus on preventing or reducing drug-related risks, increasing customer knowledge about over-the-counter and prescribed medications and supporting good habits to become or stay adherent to drive regimens. That's crucial to good health and preventing hospitalizations. And finally, this is all the first step of putting a pharmacist in your pocket. A virtual alternative to allowing customers to be able to access our pharmacy teams anywhere and anyhow. We're also upgrading our proprietary pharmacy workflow technology to streamline the user experience for pharmacists and increase operational efficiency. These enhancements include the expansion of remote quality assurance, remote data entry and problem resolution and centralized support for other prescription filling functions. Additionally, we just launched our first two small format stores in Virginia. We believe these are a great way to expand and complement our footprint and better serve our communities. We have strong momentum in our digital business with sales up 65% year-to-date over last year and healthy margin contributions as well, up over 50% in EBITDA from prior year. Our loyalty program also delivered strong results with 500,000 new members enrolled in the quarter. Rite Aid Rewards members spend 34% more on their front-end basket compared to non-members. We also had 300,000 members create digital accounts in the quarter. Our new own brand portfolio also continued to grow. We've talked about this before. We now are at 64% of our planned new own brand SKUs rolled out into the store year-to-date. The owned brand sales comp growth was 8.1% in Q3 year-over-year and up 67 basis points in penetration. Not only are our own brands more affordable and higher margins. We believe this growth shows the promise of our new packaging and our new brands that are appealing to our target growth customer. Q3 once again demonstrated the ability of our Elixir business to generate increased EBITDA on a year-over-year basis, despite a significant decrease in lives going into the plan year. The performance was the result of consistent execution of our management plan put in place during Q1 of FY '23 and to increase our EBITDA margins through improved profitability and strict control over SG&A. We are on track to achieve our Elixir guidance of $145 million to $155 million for the year. Moving into Q4, we will cycle through significant membership losses on 1123, resulting in a net decrease of 700,000 members. This change in lives is attributed to one large client loss that was previously disclosed and an expected reduction in Elixir Part D membership as a result of bidding above the benchmark in 23 of our 34 regions. We are aggressively working to adapt our cost structure to the lower life count, and we'll provide more details when we issue guidance for FY '24. We are taking action to improve and accelerate our performance and business execution across Rite Aid. While we're gaining real traction on many of our strategic initiatives, we recognize that we have to do more and faster. We have -- that's why we've launched a new performance acceleration program. We've already mobilized and trained over 400 associates on this new approach to fast-tracking initiatives that will improve business discipline and drive outcomes that increased growth and profitability. We will approach these initiatives with a focus on prioritizing our limited capacity and capital, and we will closely measure and track execution to build needed internal capabilities and processes. While it's still early days, we have already identified hundreds of opportunities and initiatives that will improve sales and script volume, expand our operating margins and free up cash. We see a real potential for this to drive performance through FY '24 and beyond, and we will share further details and expectations during our next earnings call. To close, we're encouraged by our strong script growth, our increasing front-end sales comps and solid Elixir results. We're focused on the acceleration of initiatives that will propel the growth of our business going forward. We're leveraging a new model to identify and manage initiatives positively impacting our operating results. We're committed to creating long-term value for our shareholders, as we execute on our performance acceleration initiatives and grow our modern pharmacy business. Thanks, Heyward, and good morning, everyone. As we have said previously, paying down debt, maintaining strong liquidity and effectively managing our capital structure are top priorities for the Company. During and just following the quarter, we completed two transactions to help us achieve these objectives. In October, we completed a securitization of approximately $170 million of our 2022 CMS receivable, which represents the amount of the receivable that accumulated between January 1 and June 30, 2022. This transaction preserves available borrowings under our revolving credit facility and was done at a rate similar to the rate that we incur on our revolver borrowings. We expect to securitize the remainder of the 2022 CMS receivable before the end of our fiscal year. In November, we launched an additional tender offer focused on our 2025 bonds. Through this transaction, we paid down over $165 million of our 2025 bonds at a discount and lowered our overall debt outstanding by approximately $40 million. This also brings an additional benefit of interest savings as we are replacing these bond borrowings with revolver borrowings, which have a lower interest rate. In order to partially mitigate the impact of the tender offer on liquidity, we expanded our ABL revolver from $2.8 billion to $2.85 billion and increased the FILO term loan from $350 million to $400 million. These expansions added $100 million of availability in total under our senior secured credit facility. We have lowered the amount of outstanding debt on our 2025 bonds, which is our nearest debt maturity from $600 million at the beginning of the year to $320 million after the completion of our latest tender offer. We had over $1.3 billion in liquidity at the end of the third quarter and expect that number to improve at fiscal year-end as we reduce our seasonal build of inventory and complete the remainder of the calendar 2022 CMS receivable securitization. Now I'll review our third quarter results in more detail. Revenues for the quarter were down $145.5 million or 2.3% from prior year's third quarter, driven by a decline in COVID testing and vaccine revenue, the impact of store closures and lower membership at Elixir. Third quarter net loss was $67.1 million or $1.23 per share compared to last year's third quarter net loss of $36.1 million or $0.67 per share. The increase in net loss in the current quarter is due primarily to a decrease in adjusted EBITDA, an increase in interest expense and an increase in restructuring charges. These items were partially offset by a reduction in facility exit and impairment charges. Now, we'll discuss the key drivers of operating results in our business segments. Retail Pharmacy segment revenue for the quarter was $4.4 billion, which was $20.3 million lower than last year's third quarter, driven by the decrease in COVID-related revenue and store closures partially offset by an increase in both maintenance and acute prescriptions. Retail Pharmacy segment same-store sales increased 7.5% and with increases in front-end same-store sales, excluding tobacco of 2.7% and in same-store pharmacy sales of 9.5%. We administered 1.9 million COVID vaccines in the third quarter of fiscal 2023 compared to $4 million in last year's third quarter. We also cycled a reduction in PCR testing demand from $1.2 million last year to $68,000 this year, offset somewhat by the impact of increased antigen testing sales. Outside of COVID vaccine impact, maintenance scripts were up 2.1% and acutes were up 8%. The third quarter Retail Pharmacy segment adjusted EBITDA was $81.7 million or 1.9% of revenues compared to last year's third quarter adjusted EBITDA of $125.9 million or 2.8% of revenue. The decrease in adjusted EBITDA and EBITDA margin is attributed to lower COVID vaccinations and testing and higher shrink results, partially offset by increased non-COVID prescription volumes and reduced SG&A. Retail Pharmacy segment adjusted EBITDA SG&A expense was $81.2 million or 173 basis points better as a percent of revenue than the prior year third quarter due to lower payroll, occupancy and other operating expenses, driven by store closures and our cost reduction initiatives. We are on target to achieve the $190 million in SG&A savings in FY '23. Shifting to our Pharmacy Services segment, Elixir, in the third quarter, Elixir saw revenues decreased $132 million or 7.1% to $1.73 billion due primarily to a planned decrease in Elixir insurance membership and a previously announced client loss, partially offset by increased utilization of higher-cost drugs. Elixir's third quarter adjusted EBITDA was $40.2 million or 2.3% of revenues versus last year's third quarter adjusted EBITDA of $28.9 million or 1.6% of revenues. The current quarter benefited from increased gross profit resulting from procurement economics and network performance management as well as a reduction in SG&A expense, partially offset by the decline in revenues associated with lost clients. Turning to our cash flows and balance sheet, our cash flow statement for the quarter shows a source of cash from operating activities of $132.6 million, driven by the sale of the first part of the 2022 CMS receivable. Cash used by investing activities was $40 million for the quarter. Included in investing activities were script file sales attributed to our store closings and sale-leaseback proceeds. Our net debt balance was approximately $3.1 billion at the end of the quarter as we continue to build the CMS receivable and seasonal inventory in our regional business. We expect our leverage ratio to be around 6x by the end of the fiscal year and to generate positive free cash flow for the year. Now let's turn to guidance. While we saw good top line results in our retail business, we are seeing greater-than-expected pressures on retail margins. Pharmacy margins are expected to be lower than previously forecast due to our actual mix of generic dispense having lower sales values than planned. In addition, our front-end margins will continue to be pressured by cautious consumer demand and the related impact on seasonal markdowns and higher than forecast shrink. Based on these factors, we are lowering our adjusted EBITDA guidance for the year. Adjusted EBITDA in the Retail Pharmacy segment is expected to be between $265 million and $285 million. Adjusted EBITDA of Elixir is expected to be between $145 million and $155 million. We expect the procurement economic improvements in SG&A trends that we saw in Q3 to continue through the remainder of the fiscal year, partially offsetting the reduction in lives that will occur on January 1. Total revenues are expected to be between $23.7 billion and $24 billion, adjusted net loss per share is expected to be between $2.18 and $1.78 per share. Capital expenditures are expected to be approximately $225 million. We continue to make investments to grow our business, including pursuing prescription file purchases and investments in digital. We also continue to seek to enhance our efficiency by automating our supply chain and transforming our processes and technologies at Elixir. Interest expense is projected to be $220 million and reflects the impact of the latest round of rate increases announced last week. We expect to generate positive free cash flow to continue to pay down debt. Maybe just I apologize if I missed this while you were talking. In terms of the $190 million in savings for the quarter, can you just sort of talk us through where you are on that, sort of where the future pockets of opportunity are, and how we should think about that exiting the FY '23? Yes. Elizabeth, it's Heyward. And I'll let Matt answer. This is largely complete. Matt, you want to just update on that savings target? Yes. Thanks, Elizabeth. Yes, we are on our way certainly to hitting our target of $190 million in SG&A savings for the year. And I think you saw a pretty sizable savings number year-over-year in the third quarter of this year in both the retail business but also in the Elixir business as we made some real efficiency improvements and manage through the reduction in lives. As we think about next year, still a lot of work to do on building out our plans for 2024. But we'll continue to look at opportunities to close stores. We'll continue to look at opportunities to rationalize our labor and we've got a lot of opportunities around getting more efficient on procurement and indirect procurement that are coming out of some of the work. The initiative work we're doing that Hayward described. So more to come, but certainly looking at further cost reductions in 2024. Yes. I think with the emphasis Elizabeth being on Elixir because of the lives lost, that will have to be addressed. So, that's the main -- that procurement are really the main opportunities for next year. Got it. No, that makes sense. And it looks like at least on sort of my math here that your core profitability like was much closer to sort of like 1Q levels in terms of dollar versus last quarter. But I just wanted to check that I had two things, right? On the OTC test, when you said the antigen tests were increasing, did you mean sequentially you're on a year-over-year basis? They're increasing on a year-over-year basis, but they're also a little bit up sequentially as well, particularly in the last couple of weeks of the quarter, and I am really in the first couple of weeks of the fourth quarter as well. Okay. Got it. And then flu testing, you would -- or sorry, flu vaccine, you would say, 3Q over 3Q were about flat? Flat, yes. Yes. I think as we think about the fourth quarter, Elizabeth, what we're kind of seeing from a flu vaccine standpoint is anticipating a slightly better than prior year fourth quarter, but not dramatically so. I guess, Matt, on the change in the guidance in the Pharmacy Services segment, you talked about the mix of generic the spend as being part of the issue and kind of pharmacy margin pressure. I'm just wondering if you can disaggregate that a little bit. And I guess I'm wondering, if you can kind of bucket into what are we seeing it from reimbursement from payers how much of it is lower margin in the mix? And I'll kind of pause there and then come back. Yes. Thanks, George. So with regards to the pharmacy margin headwinds that we're looking at and really the piece that drove a component of the guidance change. What we've seen is an increase in generic dispensing, which is positive for us. That's a good thing. But the mix of drugs that we've dispensed in that kind of generic mix has resulted in a lower recovery rate than what we previously modeled. So it's really -- it's more -- it's mix. It's not actual rate changes from our PBM partners. We don't expect this mix issue to persist in the next year. Okay. That's super helpful. And then my follow-up question on that is you guys talked about procurement. I guess we go a little bit more into that? Are we talking about the procurement of drug products in particular? Or are we talking about front-end products or kind of like I'm wondering if you can kind of bucket what is the opportunity for savings in procurement? Yes. I think we've used the procurement in a couple of different ways. So on the call on -- in reference to Elixir is really a combination of both drug purchasing, especially but also network management, rebate management and just kind of managing the best -- better managing the spread between what we kind of get in, in various contracts and what goes to clients while at the same time, of course, being very competitive in the market and with our clients. On the retail side, a lot of opportunity that we see into next year around procurement for indirect, so think of that as like not for resale non-payroll SG&A spend. And with an addressable spend volume that we have about $1.3 billion in the retail side, there's a lot of opportunity for improvement there. Okay. That's helpful. If you sure with two more quick ones, are the shortages of amoxicillin and Tamiflu meaningful and then are the sale leaseback proceeds that you guys called out? Is that just an earnings contribution, a cash contribution or both? We really aren't having any significant experience issues with the amoxicillin or the Tamiflu, although you could probably hear this morning a number of people talking about that there certainly are some pocketed challenges. I think for us, the bigger issue is the over-the-counter drug supply chain issues. Yes. So George, the sale-leaseback proceeds that we're referring to are a cash benefit. They had nothing to do with -- there's a small gain on assets that's non-EBITDA. That's part of that. But the main benefit is the cash benefit. And the proceeds we had for sale leaseback, this quarter, it was about $10 million. Matt, if I can start with just a couple of numbers questions. So one, when I think about fiscal '23 and the current guidance, can you talk about how much you have in there for COVID in general. I mean every quarter, we've talked about numbers and we talk about the swing factors of those numbers. But as we sit here today, can you give us a total number? I'm just trying to think of what the core business looks like as we think about '24 would be my first question. So Lisa, we have -- I think as we said in the script, we have about $5.2 million in COVID vaccines kind of modeled out for the year. That's the big is by far the biggest COVID factor. PCR tests have really fallen off to almost a negligible number. And then on the antigen test, we've seen a level of management test disbursement as we talked about, that's a little bit higher than last quarter. Those are really kind of the main factors. And so if I think about that, right, so think about the $5.2 million at roughly $15-ish EBITDA, is that still the right number to think about -- when we think about the COVID vaccinations. And again, it may carry-forward into 2024, but I'm just trying to think about the core business. Yes, we've been using $20 million as a proxy for EBITDA for the COVID vaccines. I think that's the right number to use. And then as I think about the fourth quarter and I think about the $30 million swing factor, you talked about a number of things, whether you talked about the mix of generics, I think that you talked about the shortage on the over-the-counter side. Is there anything that you can help us -- I mean it's already in December, right? So you only have a couple of months left. Is there anything you can point out when we think about the swing factor on either end? Or is it kind of a midpoint that you're more comfortable with? Any color would be helpful as we think about modeling the fourth quarter. Yes. Yes, Lisa. I mean we try to pick a guidance range every quarter. There really is an estimate of a low and high end of the most likely possible outcomes. And that's what we've tried to do in the $410 million to $440 million. As far as like what could swing the number around, I think what could swing the number to the high end of the range and to the good way is if we continue to see strong straw flu prescriptions. If COVID and flu vaccines are a little bit heavier than what we thought and a lot will depend on how we do on the front-end and the Christmas season with OTC. But if we continue to see like pretty strong demand on OTC and flu, then you're probably looking at something that's a little bit on the higher end something that gets you probably to the lower end or COVID and flu vaccine demand dropping off a flu shot. And then certainly, markdowns and shrink continue to be things that we're looking very hard at from the standpoint of the front-end business. And those are probably the swing factors. If things go bad in those areas would get you more towards the lower end. And then I guess my last question just would be kind of longer term, Heyward, this would be more for you, I guess, as we think about your comments on the PBM membership and the potential positive for 2024, really two questions there. One, can you maybe size the RFP opportunity that you see for 1124 ? And then secondly, do you see any midyear start opportunities in calendar '23? Well, first, I'd say that we -- it's so early. And right now, we're selling into 1124. There are always some midyear opportunities. I wouldn't consider them at this stage, big enough to swing things one way or the other. The big business, the bigger business and the bulk of the business is going to be 11. But we are launching our Laker Software as a Service business. We just hired a new sales leader there. We are also deep into the mid-market business, the public sector business, and we're showing a significant amount of interest from the national practice leaders who have -- we had almost every pharmacy national pharmacy business, national practice leader come visit us at our collaboration center a few months ago. And to a person, I would say very, very interested in supporting Elixir as a credible alternative in our target markets. So but we have a big road to climb here. We have a big hill decline because of this loss of this one client and the Elixir Insurance business, which we had planned for that, but so SG&A is goal one is to get the SG&A right-sized at the same time so that we can impact next year, and then at the same time, really both maximizing our margin opportunities and our procurement economics alongside of really trying to get that sales season to beat this year's sales season on a sequential basis. And if I could just squeeze one in just as you're talking about that. So, the 700,000 lives that will move off your platform for January 1 to '23, we lose any of your leverage or purchasing power for the PBM? And then secondly, should we think about that as being kind of normal margins on those lives? Or is there anything else that we should take into account as we're thinking about that? And I know I'm asking a lot of questions trying to figure out '24 with wanting to give '24, but we just want to start to think about how to model some of those? Yes. Look, as we go into '24, those lives are split between the large client loss and the Elixir insurance book of business, and we run those two parts of the business through different sets of paper. We're continuing to push through on the changes that we've made and how we handle our rebates and our rebate economics. And we've been very pleased with what that has done for the business this year in terms of our ability to be competitive. We consistently are finding ourselves, when we get into finalist meetings with a very competitive and compelling offer on the table. And we expect that position to continue into next year. So, I don't expect those lives to impact our ability to be competitive and to win business and continue to show improvement in our sales performance. But as Heyward mentioned, we do have an overall set of economics that we have to manage in the business to make sure that we're rightsizing our operations to match the life count that we have. I recognize you probably don't want to say much here, but Hayward, in your prepared remarks, there were some pretty optimistic commentary about hundreds of opportunities to improve sales and scripts and our operating margins in fiscal year '24. Is it possible that EBITDA could actually be up next year despite a couple of these pretty large headwinds? Well, obviously, we can't comment on next year because it is too early, and obviously, we're not releasing guidance. All I can say is that we are facing headwinds, as you know, every year. And every year, we have to fill those gaps. And we did a very good job this year on a number of initiatives to fill both EBITDA cash gaps and reimbursement rate gaps, whether it's a combination of growth, which we're now seeing nicely and SG&A reductions and cash and debt actions. So Matt, I'll let you jump in. That's -- our goal now is to double the number of initiatives. And what that leads to from a next year point of view is TBD. Matt, anything else you want to add? No, nothing else to add, Bill. It's too early for us to be kind of putting a line in the sand on what EBITDA is going to be directionally. To Heyward's point, our job is to use this initiative process to work to do what we can on the headwinds, more to come when we give guidance. Yes. I was expecting you to answer something like that. Okay. And then, Matt, you did bring up the opportunity to potentially close more stores. Is there any sense you can give us of what the negative EBITDA is of those stores which are not profitable at this point? Yes. It's not a number we've put out there to disclose, Bill. I think what I would tell you is there is an opportunity to close more stores. It's not nearly the size of the opportunity that we had this year. So, it's on a much smaller scale because we have done a pretty good job in the latest last store closure program of really pruning a lot of the unprofitable stores or at least unprofitable even with leases and drain in out of the fleet. So smaller than this year -- more to come as we go through. Yes. This is no longer our key focus. We've done what we needed to do. Everything else is either a large lease long-term lease that you don't want to vacate for dead rent or it's -- or these are stores that are on the bubble where if you can continue to see some of this growth that we are showing now, you could turn these stores into something profitable. That would be our primary goal. Okay. And then just lastly for me. it's been pretty well publicized the challenges of shrink. I was wondering whether you've been able to make any recent changes that could lead to shrink actually declining on a year-over-year basis over the next year? Yes. Thanks, Heyward. What I would share first and foremost, as we think about shrink the safety of our associates and our customers is prioritized in how we manage this. And similar to others, we have seen a rise. It's organized crime driven. And to answer your question, what we're doing, we continue to be very, very involved working with our organized retail client team with local law enforcement and government to address. We continue to have a range of product protection opportunities in our stores, and that's how we're managing it at this point in time. On the CMS receivable sale, that was nice to see in the quarter, do you still expect to do about $450 million to $500 million for the full year? Hey, Carla, thanks for the question. Yes, probably more like $450 million for the full year. So the build in the second half of the year is greater than what it is in the first half of the year. So, we've got a pretty sizable receivable is going to build through December that we'll be looking to securitize here before the end of the fiscal. Only change in term is that it's no change in terms. It's tied to SOFR. So, the interest is a little higher than it was last year, consistent with overall market conditions, but no change in terms other than that. Okay. Great. And then on your overall script count, can we just get an estimate kind of where it stands today? I think at year-end, it was $170 million on an equivalent basis. Okay. And then I'm just curious, with the changes in the cost cuts you're talking about at Elixir how integrated are Rite Aid and Elixir at this point? I mean where does business overlap in terms of is there a shared overhead, warehousing? Or how do they interact on a customer basis? Yes. So, we did a significant amount of integration between Elixir and Rite Aid over the last three years. That's -- that was the first initial big body of work that we undertook. So, all of the corporate functions like HR and finance and legal and compliance all roll up into one leader within the Rite Aid enterprise. Regarding mail order and specialty procurement, we leverage the Company-wide procurement arm to purchase those prescriptions, which is part of how we get such good economics. And then, of course, Elixir in and of itself is undergoing a significant integration between the two PBM businesses that they have, and we call that Project Fusion. And that project, which will be complete over the next couple of years and is well underway is going to release additional synergies, economics, process improvements and savings. So consider those kind of the two big bodies of work, and I'm not sure if that answers your question fully. No, that's great. And then how you cut costs there, are there assets closures and asset sales that we could look to for potential proceeds as you're cutting costs as well? Or it's pretty much just an overhead analysis. Yes, I guess one piece of color I would put on it is, when you look at the performance of Elixir across the course of this year, it would be -- it would be misleading to say that it is entirely overhead and cost cutting. We certainly have done significant work throughout the year to streamline operations to take out SG&A and the right side according to the losses that we had coming into this calendar year. And we'll do those same types of actions as we go into next year to adjust the business. But the performance that you're seeing in Elixir from Q1 through Q4, is more heavily driven by the changes we've made in the overall operations and performance of the business, the procurement economics that we referenced earlier. And that's why you see the EBITDA margins climbing throughout the year, and that's why you see the EBITDA performance stacking up so well over prior year. It's not because we just ripped all the cost out of the business. It has much more to do with we're doing a better job operating the PBM and that delivers better value to our clients, and it delivers better value to our shareholders. Sorry, the only thing I would add, Carla, because I think part of what you're asking is about monetizing assets, really you think about like what we have Elixir between the mail order facility between the specialty pharma business and the Laker adjudication platform, those are all assets that really help us compete in the business and are very valuable to us. So, when I would think about assets to monetize for cash in the overall enterprise view, it's really more on sale leasebacks and any file sales we would do when we close a store. And we have time for one more question. Your final question comes from the line of Karru Martinson from Jefferies. Your line is open. So when we look at that 700,000 life loss here at the start of the new year, what is Elixir going to be standing at? And kind of what's the opportunity as you get part of those lives back in terms of live served? Yes. So as we move into 11 of this year, right now, we are coming in roughly around $2.3 million. So, we're forecasting that 700,000 life loss, and so you can do the math there. As we look forward, where I think we have the opportunity to gain that back. If you have to look at both sides of the business, you've got to look at the PBM side, in terms of our PBM services. And as Heyward mentioned, we're actively building our pipeline. We're looking forward to the upcoming selling season. The last year was very much a rebuilding year for us. We went into the season with a relatively new commercial team, and we had several gaps in critical areas, including sales and underwriting. And so as we move into the 2024 selling season, we filled many of the gaps, and we've also matured as a team. And so we're entering this year, I think, the stronger and more sophisticated organization. And so when we look at how we're going to go to market, we're spending a lot of time with the top consultants, but we're also creating sort of a clear road map for our sales function with a set of key milestones across the next year to significantly increase the live at the top of the funnel. Because if we look back on the prior year, we think that's one area where we really have the opportunity to grow lives to bring more opportunities from our target markets into the top of the funnel. When you move on to the Elixir insurance side of this, which is a significant portion, we've been very consistent over the last several earnings calls that the individual Part D market, which we participate in, is a very challenging market to be in as a stand-alone plan. And so, we've been very consciously managing the economics of that, making choices around how we manage that. And that's why you've seen the decline -- the steady decline in lives. On the flip side of that, we also participate on the EGWP side. And in contrast, we see the EGWP side of Part D is a much more attractive segment for us, both in terms of the margin and economics that are available, but also in terms of our position and our right to win their relative to large integrated health plans because our interest is clean and clear in managing the EGWP benefit. And so, I think what you'll see over time is we'll work to rebuild the PBM services side, focusing in our target markets. And then I think on the Elixir insurance side, we'll gradually over time, continue to make that shift from the individual market to the EGWP and supporting Medicare Advantage clients. Okay. Last quarter of shrink was, I believe, like a $5 million headwind. What was it this quarter? And what are your expectations for fourth quarter? It was a $9 million increase quarter-over-quarter for third quarter. We haven't given a specific number for fourth quarter, but certainly, one of the components of us guiding down versus where we were last quarter as we do expect continued shrink headwind. Okay. And then just lastly, there's been a lot of news of settlements with CVS, Walmart, Walgreens on the [opioid] front. Where are we today on that? And what are our expectations? Yes. So, we have settled about three states, critical states, West Virginia, Ohio and New York for nominal settlement numbers. So, we're pleased with that. We were not a part of the global settlement agreement that CVS, Walgreens and Walmart participated in. We were not invited to be a participant in that. I think they were going where the money is. And yes, it's framework now for global settlements for other companies like us, smaller companies. And we do anticipate that we will be a part of next ground of global settlements. When that is, we have no idea and how much we couldn't even comment. Thank you so much. Okay. Thanks for the questions. And I just want to close by thanking all of our teams for the work that they've done in this quarter, particularly the pharmacists and technicians across our organizations. The service associates and store managers in the store who have kept our customers happy and you can tell they're happy because we're taking share and growing the business. But more importantly, helping our customers achieve whole health for life, especially in these times of any kind of sickness seems to be ranging in this environment right now, not just COVID and flu. So, we want to protect our people, our teams, our customers, their children, their parents and their pets, each and every day. I would also like to congratulate the Elixir team for executing against an aggressive plan. And lastly, I want to thank our corporate associates who have shown incredible agility and ingenuity in identify and managing these new initiatives and the past initiatives, but more importantly, these hundreds of new initiatives for our future growth for our shareholders, for our customers and for our teams.
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EarningCall_1624
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Excellent. Well, hey, good afternoon, everyone, and welcome to Day 1 of the Barclays TMT Conference. It's an honor to have with us the team from Palo Alto. Of course, we've got Nikesh Arora, Chief Executive Officer. We also have Walter Pritchard, Head of IR, around here somewhere. So, we've got about 30 minutes together. Maybe I'll take the first 20 or 25 minutes and do some fireside chat here with the Nikesh, which I know is going to be fun. And then, maybe in the last five or ten minutes, let's make this interactive. So, if anyone has a question, I think we've got some mic runners around here. Just pop up your hand, and we'll make sure we get your question in. No, absolutely. Maybe just to start off, make sure weâre all on the same page, a lot to recap from last quarter. But maybe to level set for all of us, what were some of the things that you were particularly proud of in Q1 to help maybe frame the discussion? Well, Saket, as you can see, we've had a flurry of reporting in the security industry. I think the key highlights of Q1 was there have been reports from many of the security companies dipping on the margin, slightly off from what you might have expected. But across the board, as an industry sector, it still is more resilient than most subsectors of technology. That was kind of obvious in Q1. Business is not going away, at least that's not what anyone is telling you, that's not what we're seeing. You're seeing as per people ramp deals or business deals elongating, which is something you contend with. All that means is things are getting more scrutiny, because Jay Powell is being hammered. Everybody is worried that he's going to be successful, in which case, there will be some slowdown of economic growth and everybody is kind of preparing for it, be it us or our customers. And you're seeing the impact of that in everybody's narrative. I don't think we're seeing as much of it just yet, but everybody is apprehensive, and hence, expecting that's going to happen. Now, from our perspective, I was excited that our teams are still able to nail the number. Theyâre still able to go out and get it. We saw it a bit earlier in the quarter and we decided to accelerate our go-to-market efforts and get people out in the field and on the payment much faster. We went ahead and accelerated hiring on key sales roles, because we expect that we need more feet on the street, we need people fully trained out there, because we think if this trend continues over the next six to nine months, which means you can contend -- contended with sort of more activity upfront. So, generally, across the board, there are some increasing signs of customer attention to budgets. We can hopefully execute our way through it. As I have said before, there was a silver lining, the consolidation conversations, we-can-save-you-money conversations by having lesser vendors and lower total cost of ownership, those things are now beginning to work in our favor. Yes, absolutely. And certainly, what I would add to that last quarter, and Iâm sure weâre going to talk about later on is while nailing the number, we were still able to raise the margin guide for the year despite everything else. Saket, there's a time and place for everything. You've been asking me and people have been asking me what about your margins, and I always maintain that you've got to balance growth and profitability. Growth was our key focus because we were trying to build new product categories. We're trying to make sure we establish our capability across various categories. We feel comfortable that we have repeatable go-to-market motions in our cloud security business, in our network security business, and our cortex business. As we told you at the end of Q4, we are converging our network security teams, trying to extract more efficiency out of those teams. And we just put all that into play. We're beginning to see the benefits. I think in long term, if you want to grow north of 20% in our business, you should be able to sustain north of 20% operating margins. I think, that's fair. I think one of the benefits that Palo Alto Networks has is the broadest portfolio in security. Maybe notwithstanding some of the macro backdrop that we mentioned, the question is, how is that broad portfolio helping in closing business? And maybe where I'm going there is, you've talked about building this muscle internally for selling the broad platform. Where do you think the company is in that evolution of platform selling? So, the first two, three years at Palo Alto, I had to spend 70% of my time with the product teams, making sure we have this extensible platform. And it's kind of clear that there are approximately three buying centers. There's a whole network security team, which is focused on Zero Trust, which is dealing with the impact of the cloud, how do I take my data center infrastructure, figure out a hybrid infrastructure between the data center and the cloud, and now people working from home. So, they're all busy being network transformation projects and we have the ability to come in and say, "I can do Zero Trust for you." And I use this explanation the other day when somebody asked me a question if firewall is going to be dead. And I was particularly delighted with the way we talked about this. So, if all of you who are worried about firewalls and network security, what firewalls are, they are a mechanism to inspect traffic, okay? That's what they do. They look at traffic to see if there's malware, bad URLs, bad DNS, they're just inspecting traffic, making sure traffic flows without security flaws. Traffic is exploding in a big way, whether it's traffic from the campus to the data center, from the data center to the cloud. So, generally, traffic is going up. That traffic must be inspected. You can inspect it with the hardware firewall or software firewall or a SASE product. Now, we're one of the very few people in the industry who actually have form factors in all three categories that work together. So, our network security people are working hard towards this platform notion of providing that capability. Cloud? Same thing. We have seven different modules we can go from code to deploy to run, so we, again, have a platform in cloud security, and that's the conversation that's beginning to happen and continues to happen. And then, with our most recent launch of XSIAM, we're finally putting our stamp in the idea that SOCs need to be reinvented, they need to be automated, and we have very good early signs that this is going to be an emerging big category. Absolutely. A lot of fun stuff there that I want to dig into. But maybe we can just dig into the three main parts of the portfolio, maybe starting with Prisma Cloud. I think Palo has been investing more in software supply chain security, most recently with the proposed acquisition of Cider, and of course, it started with Bridgecrew. I guess, with this now under the Prisma umbrella, can you just talk about how you view the software supply chain opportunity? And how Palo could maybe disrupt us with the portfolio that youâre assembling? I think it's important for everybody here to understand what the challenge or the opportunity is, and I'm presuming most of you have not done coding in today's environment where -- and if you have ever coded in the past, in the past, when you coded, you wrote an application, there are application testing software, whether it's Checkmarx or Veracode, which are 15 years old, they checked your code, if they said everything is cool, you ship it to production and you're off to the races. And you wrote this stuff in a -- I remember programming in COBOL and FORTRAN. Iâm sure thereâs a bunch of stuff that happened after that. But todayâs cloud world is very different. On average, every enterprise has about a 100 tools that they use, which are third-party tools, which are grabbed from open source, they grab widgets and images, and itâs actually an assembly exercise. Software is assembled more today than itâs coded. Thatâs why itâs got a supply chain problem, because youâre assembling software together using a bunch of tools which could have a bunch of security flaws. So, in cloud, the point of insertion of malware, the point of insertion of security flaws is in the coding process. If you donât fix the security in the coding process, you will forever be playing whack-a-mole in deployment or production. So, you got to get ahead of the problem. The way you get ahead of the problem is you scan every piece of code. You scan every image. You look at every tool thatâs being used from a third-party perspective, thatâs where supply chain security comes in. We brought Bridgecrew that was doing all the scanning. We brought Cider, which is going to do all the CI/CD work and the supply chain stuff. So, weâve got the left. Now, what we can do is we can investigate the left and then track you through the entire development process to see where the problem came from, so you can go fix it. Thereâs nobody else in the industry. We think that generally, the industry is about two to two-and-a-half years behind where we are in terms of our thinking, our product capability and what weâre working on. Absolutely. I think you've talked about Prisma Cloud having more of a multi-product opportunity, I think with nine modules. And clearly, we've talked about software supply chain is one module. And of course, I think the cloud workload protection is also a popular module. Maybe the question for you, Nikesh, is what modules here do you think have the most room for adoption as you think about Prisma Cloud becoming a $1 billion business someday? Well, Prisma Cloud is going to be $1 billion business in the next 12 to 18 months, so not someday, thatâs pretty much in the near future. So -- and it depends what $1 billion business means. Weâll do $1 billion in bookings in the next 12 to 18 months in Prisma Cloud. I think about it differently, Saket. The way I think about it is, in our lifetimes, if you look at evolution in the next five to eight years, there'll be $1 trillion of public cloud being consumed every year, if you believe that. Now, I'll give you a data point. Palo Alto Network spends approximately $250 million a year in public cloud. And if I had to pay for my own cloud securities to my own products, I'd be paying somewhere between $10 million to $15 million, right? That's 5% to 7.5% of my cloud spend. That's how I benchmark the TAM for cloud security. So, if there's $1 trillion out there, there's got to be a $50 billion to $75 billion spend on cloud security in the future. If you believe thatâs the size of price, the question is, what can I honestly aspire to. Iâm saying half of that will be taken by the public cloud providers. They will just take it away as part of the ELA business. Thereâs still half up for grabs. So, thereâs $25 billion to $37.5 billion opportunity in cloud security in the next ten years. The current market is $2 billion. So, thereâs a 17x on the high end and a 10x on the low-end opportunity in ten years, right? So, I think people have to consume cloud security in its entirety. Itâs not one particular module that needs to be consumed. You have to secure the entire development process, deployment process and production process. So, itâs an arms race. You got to rush fast to make sure you have the capability and to make sure your customers are deploying you in their infrastructure. Can I aspire to 25% market share? I got 29% market share in firewalls, and we were the last player in firewall to show up and the first player to show up in cloud security. Thatâs how I think about it. Interesting. I mean, maybe said another way, in that cloud security market, still a lot of greenfield opportunity, just a lot of... Thereâs lots of opportunity. You just have to go a grind it out. There are not enough perfect go-to-market motions being built. Thereâs not enough solutions architects out there. Thereâs not enough cloud consumption capability out there. So, thereâs a lot of work to be done, but the TAM is huge. Right. I'd love to maybe shift to Cortex a little bit. And there's a lot to talk about there, I mean, with Xpanse, with XDR, with XSIAM, to your point. And maybe Xpanse is a good place to start, particularly with the large U.S. federal deal that we announced last quarter. Congrats on that, by the way. I mean, maybe the question is, whatâs the breadth of that opportunity with Xpanse? And are there other potential deals out there like that federal deal that -- you remind me of the size, right, but those are⦠Itâs $125 million deal, of which you recognized $67 million last quarter. Look, again, I'm sorry to keep twisting your question slightly differently. This past weekend, I spent more hours than I needed to on GPT-3. I don't know how many of you have been enthralled by this conversation on GPT-3, it seems to be the talk of town. I was in a Board meeting in a private company before this, and the whole conversation was how is GPT-3 going to upend your business model. And now GPT-4 is about to show up. And the reason I bring that up is 4.5 years ago, when I started at Palo Alto Networks, I showed up with two words, because I didn't know security. I had to show up some value-added. My value added was cloud and AI. So, cloud, we know the impact. We built cloud security business. We reoriented our network security business to build a SASE product, which we're one of two players in the market. And we haven't seen our AI capability yet. Our entire AI capability is centered around everything we're doing in Cortex. And we took a point of view that saying that security is structured. To do post-breach analysis, security needs to become real time. You can't do anything real time unless you have good data. So, we spent the last 4.5 years figuring out how to get good data, which is why we launched the products 12 weeks ago called Cortex XSIAM. The whole notion there is you collect all the data you can, you run AI models against it, and try and remediate security. Xpanse is one aspect of it. It is the aspect which looks at data which you can see from the outside in. And Cortex XSIAM looks at it from inside out. Question is, can you marry outside in, inside out? Outside in would say, a hacker looks at it and say, âMy God, I see seven windows open. I can go in.â And look from inside out saying, âI've locked all doors and windows. So, wait a bit, what about the seven that you can see from the outside?â So, it's a way to marry the data from the outside in, inside out. So, I think, yes, AI is going to have a huge impact on how real-time security is deployed. I think everybodyâs got awareness as of last weekend that, yes, itâs going to be real. Itâs going to happen. And I think [indiscernible] we think the next big market thatâs going to be created. So, remember, in the last 4.5 years, weâve created three businesses net new which are going to be hitting the $1 billion mark in the next 12 to 18 months; thereâs Cortex, thereâs Prisma Cloud, thereâs SASE. We think this whole notion of XSIAM will be our fourth business that gets there in a similar timeframe that we were able to get the first two businesses there. So, great segue into XSIAM. And frankly, the way that you positioned it just an inside looking out, too, makes a ton of sense. Maybe said another way, it almost feels like a little bit of a cloud-based SIEM replacement to me. Maybe the question for you⦠So, I mean, maybe we can dig into that a little bit. Like how can Palo disrupt that? What I would argue is a relatively competitive SIEM market and also... Itâs not competitive. Itâs like youâre selling chariots and Iâm selling cars. We do the same thing, right? Horses shit, and cars donât. Sorry. I donât know why I said that. One of the interesting things, though, that you mentioned about XSIAM last -- on the last quarterly call was that you kind of -- it felt like you wanted to balance demand with capacity there, right? Like -- or just want to be careful with how that scales. Can you just talk to us about the idea behind that? Traditionally, the way security resolution happens is you deploy a lot of security vendors and infrastructure, you set a bunch of policies. Any time a policy is violated, you get an alert and there's people who stir at all these alerts and go and figure out what the alert was. If the other was caused by a bad actor, then you go out and remediate, you block it, if you haven't blocked it by automated needs. Remember, if firewall didn't block a bad DNS or bad URL, you have something else happen, it flips an alert. The alert looks at it and says, âOh my God, thereâs an anomalous activity.â Now, we used to get 67,000 alerts a week. It's humanly impossible to interpret them, analyze them and remediate them. So, you prioritize. That's what a SIEM does. SIEM says, "I got 67,000 alerts. Let's focus on these 500. These are very important. They look like bad alerts." Well, there's 66,500 more where the first 500 came from. That 67,000 is becoming 150,000 now, because you are deploying more tech and more vendors. So, this is not a human problem. This is an automation and the AI problem. So, what I meant by -- that the SIEM industry is sitting duck is most people are trying to solve this by giving you prioritization tools and UEBA tools to say, âHereâs a SIEM, collect all the data into a large data lake, thereâs a query language that lets you query that database and you can figure out what happened.â Well, if you take through 27 days to figure out what happened, the bad actors in and out and stolen your data and put it in the dark web. So, youâve got to get it to as real-time as possible. Itâs taken us 4.5 years to get our own internal SOC from 27 days to under one minute. Now, the question is, can I deploy that for all of my customers? So, instead of going on in a big rush and saying, âHereâs the product. Go deploy it,â Iâm saying, âIâm going to work the customers myself.â Weâve done the first nine. We signed design partnerships. All of them have converted into customers for us in the last three months. Weâre going to take them down the journey of reducing their meantime remediate from 27 days to a lot shorter. And I think we can prove that model again and again, and weâre going to go partner with a bunch of SIs out there who will then take our product capability and data execution capability and go take the market on. Thatâs our plan. Makes sense. Maybe we can go to Prisma SASE. I mean, clearly, a big change, I think, this year is moving this out of specialist sales and into your bigger general sales teams, maybe I'll call it. It's still early, but maybe what are some of the early signals that you're seeing? And any risks that you want to make sure you manage just around having too much to sell, maybe focusing on one tool versus the other? How are you thinking about that? Look, as I said, I spent the first two years doing product. Now, the next two, three years, Iâm going to spend on making a go-to-market more efficient and deploying to every customer. At the end of the day, we used to sell firewalls, right? Itâs our primary business 4.5 years ago. Our core sales team out there is the primary -- we used to be a firewall sales team. We supplemented that with cloud security and Cortex and SASE. But as weâve converged our SASE capability into a larger network security capability, which is Zero Trust focused, the functionality is 80% the same; what a firewall does and what a SASE product does. And weâve combined the management pain in such a way that you can deploy SASE from us or you can deploy entire Zero Trust framework from Palo Alto, which is pretty consistent. So, our sales reps are actually not conversion. Theyâre becoming network security, Zero Trust salespeople, and they say, what is the problem youâre trying to solve? Are you trying to protect your data inspected? Great. The way to do it is through a hardware firewall or software or SASE. What hybrid architecture would you like? But donât forget we have 62,000 firewall customers out there who all want to go to SASE. So, there is a part which is a transition path from their existing Palo Alto firewalls to assess the outcome, which is a combination of what they already have and what we can give them on top. So, our salespeople need to know how all of that fits together and work. So, weâre not merging two different sales teams, weâre making sure they have a higher order pitch that allows them to present a Zero Trust solution and we feel comfortable enough that weâve made enough product integration and marketing capability integration and training that these people can do it in a comprehensive way to all of our customer base. Now, that gives you more efficiencies even better. Yes, absolutely. I'm going to shift to the Strata firewall part of the business, but maybe before I go there, any questions here from the audience? I guess, Nikesh, if we think about the Strata piece or maybe Iâll just call it the product business, Palo, just like a lot of the other industry participants are seeing easing supply, but also more scrutiny, sweating appliances longer [indiscernible]. Now just to be clear, appliances are a much smaller part of Paloâs business. But maybe the question is, how do you think about demand for appliances in this coming year, and maybe beyond that, to the extent, youâve got a view? Look, as I said, the firewall-need functionality is not going to go away. You'll continue to have to inspect traffic. The question is, what is your use case and what is the best form factor for that inspection. If your use case is a data center, you better off putting a box, right? If you use case is a distributed set of 2,000 stores in the country, you're better using SASE, because you don't want to go send a truck every year to try and upgrade your boxes in 2,000 different stores. So, generally, software has a lower total cost of ownership, higher security, because you can update it simultaneously from a remote location. So, you want to preference software form factor. There are specific use cases for hardware form factors, which are low-latency, high-bandwidth use cases. I think generally, the firewall requirement doesn't go away. I've heard the comments perhaps somebody else made recently today, I think the industry grows at 5% to 8%. I've always maintained that. I think you get to see 5% to 8% growth. In tough economic times, you go towards the lower end. In better times, you get to 8% or 10%. I think the last two years have been confounding. So, nobody actually has a good sense of what happened. Most of the industry players did price increases. One or two of them, I think, they've gotten a bit confused that two price increases of 10% each can get you to 20% growth on a for -- on a unit per unit basis. Now some of them, we're not lucky enough, we cannot pass prices to our customers. In the enterprise space, our customers negotiate our prices. I increase price by 8%, my yield is 1%. So, I have no intent to keep increasing price and get a little yield. If you're servicing the small to mid-size businesses, you get to pass price to small to mid-size businesses, so you get a better uplift on your business. Couple that with people ordering ahead, because of the supply chain issues, couple that with some of our industry competitors not being able to supply for 12 months, you get a distorted market with differentiated growth rates, which you're not clear what the annual growth rate is. I think you get the 5% to 8% growth rate. Hardware is the easiest thing to postpone, because you already have it deployed, you can say, âSo I did for one more year, buy it another year.â You can't postpone SASE. You can't postpone cloud consumption. You already paid for it. You can't postpone cloud security. You can't postpone SOC automation. So, hardware is this susceptible part of the market, 5% to 8% growth, we feel very comfortable. We can deliver that -- I think, that kind of sustainable rates for the next two to three years. Make sense. Iâd love to wrap up with just some more specific financial questions. And maybe we can start with billings and cash. I mean, clearly, you beat your guide last quarter on billings, but we beat NGS ARR by a lot more. And so maybe the question is, are there any timing or duration points that we should keep in mind when⦠Thatâs not -- thereâs no lag in financial metrics. I canât add anything to ARR unlike private companies which is not already in our billings. Yes. But remember, I bill for the year. And ARR has this funny word call A, which is annual. I build it this year, itâs annual. What Iâve not built for next year is not -- itâs next year anyway, itâs not this yearâs annual. I think the question was, why is our NGS ARR growing so well, right? And generally, the answer is if your billings stay constant, your NGS ARR does a lot better, that means your non-NGS is now shifting to NGS. Now you could say our non-NGS is not performing or you could say our transformation is working, but you wanted to say just truth. We said weâre going to make our entire business cloud enabled, and weâre aggressively converting our business to cloud. So, a lot of our subs are cloud, a lot of our new products are cloud, a lot of our old business we are replacing with cloud-delivered capability, which is part of NGS. Got it? Maybe just in the last couple of minutes that we've got left, again, one of the things we said at the beginning that I was really happy to see it was just the profitability, right? I mean, to me, it was clear that Palo pivoted quickly given the macro backdrop. And I think we took operating margins up by 50 bps, free cash flow margins up by 100 bps. You mentioned some front-loading of hiring. Maybe the question is, are there any other actions that you've taken or plan to take that give you confidence in driving the higher profitability despite the more uncertain macro backdrop? Well, remember, there's revenue and thereâs cost. Now, with revenue, you have -- the more you become a [reliable] (ph) business, the more visibility you have on revenue. So, we have ample visibility in revenue. Our percent of revenue that we know for next quarter continues to go up as you get more and more business converted to NGS ARR. So, I know what my revenues going to be, because they've booked in the past, right? So, I have a good sense of my top-line, barring my product sales, which I do in the quarter. Most of my billings or most of my software sales in the quarter don't have a huge impact on revenue in the quarter, it actually benefits next quarter. So, hardware benefits this quarter, most of everything else benefits next quarter, because most of the businesses are done in the last three, four weeks, right? So, I have a reasonably high visibility on my revenue on a quarterly basis, barring product sales. On cost, those are in our control, right? And I always maintain that the bigger our revenue base becomes, the more leverage you have on profitability, because then you have a lot more revenue to amortize costs against. So, we're at a point where we have a reasonably good sense of our cost bases. The macroeconomic environment gives us the cover to be able to make sure we can do cost-managed things. When everybody is talking about is hiring people up to -- and there's a -- two quarters ago, the question you were asking me was, what's going to happen to wage inflation? There are so many jobs out there. There's not enough people. There's a talent war. What about attrition? Now, you're asking me how are you going to maintain cost? Guess what? My attrition has gone down. My cost of hiring has gone down, right, which is good for me, because I have less productive people leaving. Don't underestimate if my attrition is running at 18%. There's a huge cost of onboarding, a fifth of your workforce gets renewed every year. Thatâs a lot. Plus, the added people. Iâd be at 14,000 people. I joined Palo Alto with 5,000 people. You do the math. 12,000 people are new to Palo Alto out of 14,000, just based on attrition. Attrition has gone away. Wonderful. My cost of onboarding, my costs are training, my cost of productivities, I mean -- so there is leverage in the system. So, that's the leverage we're trying to bank on to try to make sure that we can focus on better operating margins. Absolutely. Maybe the last question here, just in the short amount of time that weâve got left. Capital allocation. I mean just with the increase in free cash flow margins and just the cash that the business is generating, how do you think about sort of rank ordering the priorities that you and the Board have in terms of uses of cash? You should be asking that question to the FAANG companies. We don't have a cash -- we don't have excess cash problem. They have excess cash problem. Look, we have convertibles to pay, $3.6 billion of converts we have to pay out. We will generate north of $1.5 billion of cash this year. If we pay all the converts, weâll probably end up with $3 billion, $4 billion in cash. The one silver lining of that big hammer is I can get interest on my cash now, which I never got in my first 3.5 years at Palo Alto. I asked this question, and I will leave that question with you guys and feel free to e-mail Saket with the answer, because not me. I went to business school as well, like many of you, and weâre taught capital allocation, and what is that Miller- Modigliani, or whatever? That guy, right? Those two guys, right? And the challenge we have is that right now, if I use cash to buy back stock, the EPS impact I have is lower than if I put the money in the bank and get interest. So, then the question for MBA students is, what would you do? Would you get more EPS because the market is short-sighted? Or do you rather buy stock, because long term, your stock is worth a lot more? And Iâve asked this question to legendary fund managers, I wonât name them, and theyâve sided on the, put it in the bank and get more interest income. What do you think, Saket? He writes every day about everything I do. What do you think? I'm asking -- answer my question, dude. This is not fair asking one question, he hedges. What's the answer? Do you want me to do interest income? Or do you want me to buy back? Well, with that, guys, I think thatâs about all the time that we got with Palo Alto Networks. Nikesh, thank you so much.
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Hello, and welcome to the Skillsoft Third Quarter 2023 Financial Results Conference Call and Webcast. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. Itâs now my pleasure to turn the call over to Eric Boyer, Senior Vice President and Head of Investor Relations. Please go ahead, sir. Good afternoon, and welcome to Skillsoft's third quarter fiscal 2023 earnings call. After the market closed, we issued our Q3 earnings press release and posted supplemental materials to the Skillsoft Investor Relations website. Today's call will contain forward-looking statements about the Company's business outlook and expectations, including statements concerning financial and business trends, our expected future business and financial performance, financial condition and outlook. These forward-looking statements and all statements that are not historical facts reflect management's beliefs and predictions as of today and therefore are subject to risks and uncertainties that could cause actual results to differ materially from expectations. For a discussion of the material risks and other important factors that could affect our actual results, please refer to the risks described in the Safe Harbor discussion found in the Company's SEC filings. During the call, we will also discuss certain non-GAAP financial measures, which are not prepared in accordance with Generally Accepted Accounting Principles. GAAP requires accounting periods before and after the merger and leaseback on June 11, 2021 to be separated the predecessor and successor periods to reflect the change in ownership and lack of comparability between periods due to different ownership and investment basis. In addition, Global Knowledge activity is only reflected in the GAAP financial statements after June 11. References on this call to pro forma results referred to our results that have been prepared and presented to reflect historical periods as of Skillsoft, Global Knowledge and Codecademy had merged on February 1, 2021. A reconciliation of the non-GAAP financial measures, including today's commentary and in the supplemental materials to the most directly comparable GAAP financial measures as well as how we define these metrics and other metrics is included in our earnings press release, which has been furnished to the SEC and is also available on our website at www.skillsoft.com. Thanks, Eric. Good afternoon, and thank you all for joining us. Today, I'll provide some financial and operational commentary on the quarter and then turn the call over to Rich Walker to cover our financial results in detail. I'm very grateful that Rich has agreed to take on the CFO role. Rich has been involved in Skillsoft since before the company's return to public markets, served as our Chief Strategy and Corporate Development Officer, and was previously the CFO of two public companies, including IHS, where we worked together. Before turning to the business, I also want to thank Gary Ferrera for his contributions to our company and his commitment to a smooth transition. Q3 results were in line with our expectations and we are pleased to reaffirm our full-year guidance. Importantly, we successfully stabilized our Global Knowledge instructor-led training or ILT business, delivering 3% sequential bookings growth. While the segment was down year-over-year in the quarter due to reduced subsidies by one large partner, we've seen healthy growth in other products within the segment. With a new general manager with deep experience in instructor-led training reporting directly to me, we are cautiously optimistic in the potential to deliver continued progress. We also remain focused on integrating instructor-led training into relevant subscription offerings and continue to believe it can be a meaningful differentiator. Turning to our core Skillsoft Content segment. We believe the best way to look at bookings growth is on a trailing 12-month basis. This metric was up 5% in constant currency, driven by customer wins and cross-sell and upsell success with large enterprises. That said, our Skillsoft Content business was down in the quarter due primarily to a downgrade by one account. Despite the general macro headwinds, we continue to expect solid growth in Q4, which generally represents approximately half of our subscription bookings. Finally, turning to Codecademy. As a reminder, we acquired the business earlier in the year to establish a leadership position in tech and dev, where Skills gaps are most acute. Codecademy is one of the strongest brands in tech and dev learning, and we are still early in realizing the potential of the acquisition. Codecademy bookings were up 6% and revenue was up 16% in constant currency. We believe our revenue growth and traffic are outpacing other B2C competitors. We also continue to see early traction cross-selling Codecademy to our enterprise customers. It is important to note that we had a slow start to the quarter due to a promotion that depressed short-term results in return for longer term benefit and returned the business to double-digit bookings growth on a constant currency basis in October. We've learned a lot during our first two quarters since acquiring Codecademy that will help us achieve what we believe to be a substantial cross-sell opportunity. We are in discussions with more than 100 enterprise customers regarding Codecademy and have already cross sold the offering into some of the world's largest and most recognizable brands in tech, retail, pharma and professional services. Given the impact of currency exchange rates, wage inflation and slower economic growth, we've been relentlessly focused on managing our cost structure and I'm grateful to our team members for making numerous difficult decisions, doing more with less and shrinking our employee base through attrition, reductions in staffing, and a disciplined approach to hiring. We are fortunate to have an important base of operations in India that's helped us manage our labor costs. Managing our costs will be an ongoing focus while continuing to make selective investments in growth. Overall, I'm optimistic about the future. We serve a large and growing market and an important purpose, propelling organizations and people to grow together through transformational learning experiences. Through organic investment and acquisition, we've built a community of more than 80 million learners who we serve with a highly differentiated suite of capabilities. Our content covers leadership, business skills, technology skills and compliance. We leverage a wide array of modalities, including micro videos, hands-on-learning, assessments, coaching and mentoring, instructor-led training, and blockchain-enabled badges. We deliver our content through a flexible AI-driven learning experience platform, and we add additional value to our clients with a team of nearly 200 instructional design professionals and systems integrators. Together, we believe no one is better able to deliver on the complex workforce transformation needs of the world's most demanding and sophisticated customers, including approximately 70% of the Fortune 1000. In Q3, we continued to extend our tech and dev offerings with the release of our Cloud Career Journey, which helps learners achieve proficiency in cloud platforms such as AWS and Azure with hands-on practice and instructor-led classes. The strength of our instructor-led training was recognized by AWS as their 2022 training partner of the year in North America. Similar recognition was awarded to Skillsoft by Nutanix, Palo Alto, Red Hat, VMware, and EC Council. We released new code of conduct training to the market, featuring 12 engaging scenarios that help our learners navigate the complexities of highly nuanced situations. And we released the first editions of our newly-refreshed business skills courses, featuring real-world perspectives from our leadership coaches in topics such as problem solving, critical thinking and wellness. These courses have been well received by learners with NPS in excess of 60 and are designed for the way people learn online. We continue to expand our local language coverage and have recently released an AI-powered automation caption capability that makes our content available in a dozen languages. We also continue to expand our assessments offering and add new and compelling courses to our content collection focused on helping our customers deliver under most important reskilling, upskilling and workforce transformation initiatives. As a result of these investments in content and platform, we are seeing strength in our most important learning metrics. At the end of Q3, on a year-over-year basis, monthly active users are up 23%, completed courses are up 19%, and badges issued are also up 19%. We are encouraged by these strong positive trends and believe there are evidence that learners are embracing our unique science-based approach to reskilling and upskilling. Importantly, we are in the early innings of integrating our capabilities to create a new, more absorbing and connected way to learn online and are excited by the potential of what we are creating. We've also largely completed our go-to-market transformation. We've hired key talent, made investments and tools and technology, and realigned our salesforce to a coverage model that better enables cross-sell, upsell and acquiring new logos. We also redesigned compensation to drive higher levels of performance. This transformation was predictably disruptive, but now better positions us for future growth and value creation. In Q3, some notable wins include two large U.S. government agencies, a large French energy company, a global hospitality leader, and a major media corporation. Finally, we are pleased to have released our first annual impact report entitled, Living Our Values, a Responsible Business for a Sustainable Future. This report serves as an important milestone in our ESG journey. During our first five quarters as a public company, we've made much progress transforming Skillsoft into a business that can deliver growth and margin expansion over the long-term. We acquired three businesses and divested another, have been executing a complex salesforce transformation and made important investments in content and platform. We've returned our Skillsoft Content segment to growth on an LTM basis and stabilized our Instructor-Led Training segment on a sequential basis. Despite a challenging macro environment, we are entering our important Q4 and next year with confidence and look forward to updating you on our progress. Thanks, Jeff. Welcome, everyone. I just want to start by saying how excited I am to be able to take on the role of Chief Financial Officer. Gary has built a strong finance team, which I've been working with closely already, and this has made for a seamless transition. I will now begin with the summary of Q3 results before turning to our thoughts on the remainder of the year. The prior year comparisons will be presented on a pro forma basis as if Skillsoft, Global Knowledge and Codecademy had been merged and their fiscal quarters had been aligned to end on January 31, 2022. Additionally, due to the SumTotal divestiture, the pro forma comparisons exclude SumTotal for all periods. Before I get into the financials, I want to provide just a few high level thoughts on the Skillsoft financial model as it has gone through changes over the past year due to acquisitions and divestitures. Skillsoft now has approximately 70% of its revenue from the content business, which is primarily subscription-based with a large portion that are multi-year contracts. This part of the business is the SaaS-like business with strong operating leverage and low capital intensity. The seasonality of the business remains largely the same, with approximately half of our content bookings in the fourth quarter. Therefore, looking at the business on a quarterly basis can be difficult. As such, we try to focus on the last 12-month trends as a more useful measure. The remaining 30% of the business is our Global Knowledge or Instructor-Led Training segment, which is transactional and lower margin. Over time, we expect the Content segment to grow more quickly, which should drive margin expansion. Now moving on to the Q3 results. Bookings for the total company for the third quarter were $133 million, down 13% and down 9% on a constant currency basis, which is due largely to declines in our lower-margin transactional business and the downgrade of a large customer that Jeff referenced in his comments. We continue to believe our subscription content bookings are on pace to have a solid end to this year. Notably, as a result of our realignment efforts and incremental focus, our ILT bookings grew sequentially, both on a reported and a constant currency basis. Content bookings in the third quarter were $85 million, down 6% and down 4% in constant currency due to the aforementioned downgrade of one larger account. Due to the smaller contribution in our first three quarters, it does not take much to move our quarterly year-over-year growth rate in either direction. On an LTM basis, content bookings growth was 5% in constant currency. In the third quarter, Codecademy bookings grew 6% on a constant currency basis and is included in the Content segment. We continue to make progress closing more enterprise deals in Q3 and are encouraged by the success in building our pipeline for this product. We would expect to report material progress in cross-sell bookings in the fourth quarter, which is our heaviest renewal period, and when we signed the bulk of cross-sell activity. Bookings for ILT in the third quarter were $48 million, down 23% and down 16% in constant currency. On a constant currency basis, the year-to-date decline was due primarily to changes in the training program with two large technology partners, one of which has recovered in the quarter. We have also largely stabilized the sales efforts within our ILT business and expect the productivity of recent sales hires to continue to improve. Turning to revenue. GAAP revenue was $139 million in the quarter, down 8% and down 3% on a constant currency basis. We are no longer reporting adjusted gross revenue to conform with GAAP accounting, which is net of reseller fees. Reseller fees in the quarter were $7 million. GAAP revenue for the Skillsoft Content segment in Q3 was $98 million, which was flat and up 3% in constant currency. GAAP revenue growth for Codecademy, which is included in the Content segment, was up 12% and up 16% on a constant currency basis. Our quarterly DRR was 96%, and on an LTM basis it held steady at 98%. Q3 GAAP revenue for our ILT business was $41 million, down 22% and down 15% in constant currency. The decline was due to lower prior quarter and in-quarter bookings as these bookings typically convert to revenue within two quarters. Moving on to profitability. As we've mentioned on previous calls when comparing adjusted EBITDA year-over-year, you need to also consider the increase in public company costs as we move through the first year as a public company. Accordingly, Q3 adjusted EBITDA was $28 million, down $6 million, a decrease of 15% compared to last year and down 8% in constant currency. Adjusted EBITDA margin for the quarter was 20.1%, down approximately 160 basis points from the prior year. Our GAAP net loss from continuing operations was $520 million for the quarter, which included an approximate $571 million impairment of goodwill and intangible costs. Our adjusted net loss was $31 million for the quarter. Moving on to capital allocation. At the end of Q3, we ended the quarter with $175 million of cash on the balance sheet and pro forma net leverage of 4.6x, which includes the negative contribution of Codecademy for periods, which we did not own them. On a reported basis, net leverage was 4.1x. As previously mentioned, we closed the SumTotal transaction in mid-August. Net cash proceeds after all fees and other adjustments were approximately $175 million. We paid down $31 million of debt in the quarter. We also repurchased 645,000 shares. Our trading window was cut short due to information that has now been shared publicly. Moving forward, we expect to continuously weigh the benefits of reducing debt versus share repurchase based on market conditions. We are reaffirming our prior outlook, however, as I mentioned earlier, we are moving to a GAAP revenue presentation to conform to GAAP accounting, not due to a change in the fundamentals of the business. As such, our GAAP revenue outlook is now $520 million to $550 million, and we are trending above the midpoint of the range. Our booking range remains $580 million to $615 million, our adjusted EBITDA range remains $105 million to $125 million, and we are trending towards the lower end of the range due primarily to revenue mix. Thank you all for joining our call. While there is uncertainty in today's operating environment, we believe our approach provides unique benefits to organizations and their employees. By optimizing our solutions for how people learn online and aligning with the strategies of our enterprise customers, we believe we are uniquely positioned to deliver on the upskilling, reskilling and workforce transformation needs of the most complex and demanding organizations. Certainly, we will now be conducting a question-and-answer session. Our first question today is coming from Raimo Lenschow from Barclays. Your line is now live. Hi. This is Shel McMeans on for Raimo. Thanks for taking our questions. I wanted to first ask about the core content business. This quarter was the first time in a while that we saw negative bookings growth here. You discussed a reduction in the quarter. And my question is, what gives you confidence that this is an isolated incident as you approach the large Q4 renewal period? And I have a follow-up. Sure. Thanks. As you pointed out, the quarter we feel was an anomaly. It was due to one large customer that was experiencing severe financial pressures and downgraded quite significantly their business with us. We really don't have many accounts of this size, and we really don't have any significant revenue concentration at all. So the loss of an account that is neighborhood 1% of revenue was a really unusual event. As we look at the quarter going forward, we're one month into the quarter. We can see how large our pipeline is, how much business we've closed. We've closed approximately 60% of our quarter, and that's ahead of where it was last year this time. So we feel really good about that. We feel really good about the pipeline. And so despite the fact that the economy is a little shaky, we feel good about how we're keyed up for our most important quarter. Got it. Thank you. And then second for Richard. First, congratulations on the new role. I wanted to ask just a broad question on how you feel your guidance philosophy is relative to previous. Is there any changes to call out there? Thanks. Thanks for the question and the remarks. I don't have a different viewpoint in how we think about guidance. We only give annual guidance. I think it's so critically tied to how we finish our forward planning for the coming year. And that's informed by how we finished the quarter, in this case, our fourth quarter. We are trying to make sure that when we guide, we're giving consistent guiding metrics. I personally want to look at bookings and think if there's not more relevant metrics, perhaps looking at total bookings, the lifetime value and then showing a backlog against that. But short of looking at bookings guidance, no change in philosophy at all. Yes. Good evening. Tom here from Citi. So thank you very much for taking the question. Yes, I suppose I wanted to go back to that. You're very clear about the driver of that one account, but [technical difficulty] sensitivity to the cycle. I was just wondering whether you can talk to that, whether there's any difference in outlook for smaller companies versus larger ones, international versus U.S. Any color on, as I say, sort of your perspectives around sort of broad cyclicality? You can start with that, and I have a quick follow-up if that's okay. Thanks, Tom. It was a little broken up. So if I didn't get the question exactly right, just let me know. But I think what you're asking is are we seeing segments of customers that are performing better or worse than others or than we've seen historically, and you asked specifically about SMB. So historically, SMB has performed â has had lower retention rates than our large enterprise. So when we give you a dollar retention rate, you should anticipate our large enterprise customers are meaningfully outperforming that blended rate, and our SMB customers are underperforming that blended rate. We haven't seen significant change in that other than the fact that our mix has shifted, and we have less exposure to SMB than we had a year ago. So at this point, we consider roughly about 20% of our enterprise â of our customer base, rather, to be SMB. And I hope that answers the question. And we would expect in this cycle that to continue to see more pressure on SMB, less pressure on large enterprise. When we look at the business through the lens of geography, the biggest impact we see is the impact of currency, which has been a quite substantial headwind given that we're a global business and do have exposure outside the U.S. But other than that, nothing really new or remarkable to report. Very clear. And then on the cash usage, you sort of talked about the â well, you sort of intimated that the buyback has been somewhat curtailed. I just â I mean can you just sort of once again sort of outline the sort of priorities for cash usage from here on in, especially in the context, I suppose, of rising interest rates and therefore sort of higher interest cost? Great. It's Rich. I think it's pretty simple. Given the magnitude of fourth quarter, we've consistently signaled that as our confidence grows with that quarter, we'll be informed as to what we want to do from a capital allocation. Second, if juxtaposing between debt and share repurchase. On the debt side, I think the simple answer is we are definitely going to do something. It's a question of when and how much, particularly as exacerbated by the current rate environment. Even since our second quarter call, there's been two rate increases, 150 basis points. So when you put a very specific disciplined financial analysis, attending to the capital structure and the debt profile is probably an increasingly higher priority for us. We did announce and approved up to a $30 million share repurchase. We only executed about less than $2 million against that. And that plan is still in place, and we'll continue to evaluate share buyback. Hi. Thank you for taking my questions. I wanted to address a few things just in terms of the Global Knowledge uptick sequentially that you see. Do you expect to see that continuing stabilization/increase in the next several quarters? And then I have a similar question on Codecademy, just in terms of the growth and the metrics and the product uptake if you could give some color on that. Sure. Raj, thanks. So we are really pleased that we've been able to stabilize the Global Knowledge business, and we also have a much better understanding of that business with each passing quarter. So I feel good about continued stabilization for the foreseeable future. Now keep in mind, it's a transactional business. So we don't have â our visibility on that business is more limited than our subscription business. But with that said, from what I can see today, it is stable, and that's good news. To understand why it's stable, a couple of key points. First of all, the entirety of the year-over-year decline in that business can be attributed to two partners on a year-to-date basis and one partner in the quarter. Those partners reduced their subsidies. In other words, they subsidized the customer in purchasing training. And when they changed their subsidy model, that reduced consumption. That is largely behind us, and we understand it very deeply today. The rest of the business has actually been growing. So that's good news, and that's where we get our confidence that this business is stable at this point in time. Great. And then on Codecademy, the growth metrics and product uptake, any color on that? And whether you're expecting to reach a breakeven in the following 12 months as you had expected earlier? Yes, certainly. So let's talk about Codecademy through the lens of code B2C and code B2B. Code B2C is growing. It got a slow start in the quarter, but then reaccelerated as the quarter progressed and into the current quarter. So we feel good about the B2C business as sort of, at this point, a high single-digit, low double-digit grower on a constant currency basis. If we look â and by the way, I'll point out, while that is below what we thought when we acquired the business, it's above where we believe most of our competitors are performing. So we believe that we're taking share in code B2C. If we look at the B2B side of the business, we're getting good traction with some very sophisticated customers. I'm talking Fortune 50 customers of real scale and sophistication taking Codecademy. That's the good news. Sales cycles have been a little longer than we expected, and I believe that's largely due to just caution that is with all customers in this economy. But we are seeing uptick. We are talking to more than 100 customers, most of them very large companies about code, and feel very good about our ability over time to achieve the original expectations we set on the B2B side of things. Got it. And then I just wanted to clarify on the Skillsoft, the Content business. Am I understanding this correctly that you expect a good bookings quarter? And that's largely obviously the new customers. But in terms of this one downgrade you had from a large enterprise, you don't expect â that is a one-off event in your minds, and we shouldn't expect to see that occurring consistently, especially since you say the large enterprises are going to perform better than the SMBs despite a potentially shaky economy. Is that... We have very few customers of that size, and so we have no reason to believe there's anything like that hanging out in the foreseeable future. I'd also say our organization has learned from that experience, and that's another reason why I feel that we're well positioned going forward to not have that kind of event, again, anywhere in the foreseeable future. If you look through that one event, the metrics in the business in the quarter were pretty consistent with our LTM metrics. So that's another way to look at the business and really get some confidence around Q4. Hi. This is Nancy Liu on for Ken. Thanks for taking our questions. I have two. The first one, as you focus a bit more on cost savings here, do you see more areas or levers you can pull to further reduce the OpEx going forward and have the full effect of prior cost savings with the P&L yet? So why don't I start and then Rich may add something. We're taking a very disciplined approach to our cost structure going into Q4 and next year. I'm really pleased with how the team is approaching that. And our headcount, we've been managing that very tightly. Actually, headcount was down sequentially. We've been focused on offshoring talent where that makes sense, and I expect that discipline to continue. Rich, anything to add? I'd maybe add only the context. We did in the first 15 months bring four companies together and divest of another. So we're constantly on a journey, on a continuum of degrees of integration. And as we continue to do that, we'll drive further efficiencies out of the business. And great companies do this all the time. And part of our culture is continually and unrelentingly to look at how we're organized, spans and layers. And I think the quick response around our ILT business is evidence of organizing smartly and driving efficiencies in the process. Got it. That makes sense. Very helpful. Thank you. And then my second question, I believe you mentioned previously you were increasing your inside sales capacity for Global Knowledge specifically. Can we get an update on that? Are those reps fully productive now? Or is there some more to go? The organization is largely staffed. Now that's a continuous effort because there's always turnover in functions like that. And in terms of fully productive, the answer is no. I mean people that are hired take generally 12 to 24 months to be fully productive. It's one of the reasons we feel good about the future of this business. We made a lot of changes to our salesforce, not just within our Instructor-Led Training business, at Global Knowledge, but the Subscription business, too. And we hired a lot of great talent, and we expect that for that talent to be fully productive will take 12 to 24 months. So we won't achieve full productivity on those hires until next year. Hey, thanks for taking our questions. I guess, first, what changes are you looking as CFO, Rich? Is it basically going to be essentially the same kind of approach to things? You already touched on guidance, but I'm thinking kind of operationally. And then how much of your time right now is spent on more CFO-type activities versus your old role of strategy and development and how do you expect that to evolve over the next few quarters? Yes, I think â thanks for the question, Robert. I'm spending a lot of time on capital allocation, not only the debt and share repurchase that we spoke to. But as we look at the portfolio, we make sure we're driving the investment to our highest growth, more profitable areas of the business. And that address your second question. I'm spending almost all of my time on that. Have a good team, a continuity of team in our business and corporate development and our transformational office. We're not in an environment now where we're acquisitive. We'll continue to evaluate partnerships as they make sense, but that's not consuming my time. Mine is entirely focused on driving more efficiencies, productivity and good, smart, disciplined capital allocation. Got it. And then on the Global Knowledge transition to Subscription, can you give us an update on how that's going? You have briefly alluded to it, but any more detailed color would be great. So I don't want to overstate that. It is a transactional business, and it's not going to suddenly and remarkably become a subscription business. So we see the subscription opportunity on the margin, and we see the ILT capability as a differentiator for our subscription business. So for example, we've included ILT in our growing suite of career journeys. Those career journeys blend all of our capabilities to deliver a really immersive experience, really transformative experience to our learners and an experience that's aligned with the strategies of our customers regardless of what the topic area is, whether it's business skills, leadership, technology, all of the above and leveraging all of our modalities, including ILT, and we see that as a source of future growth. But beyond that, the core ILT business is transactional in nature and will likely continue to be. Got it. That makes sense. And then so you touched on this or you talked about this for Codecademy. But what are you seeing in terms of changes in your sales cycles for the rest of the business? How much longer are they getting? Are you seeing deal compression or breakup? Any kind of color there would be helpful? We are seeing sales cycles prolong from maybe six to nine months to more nine to 12 months. These are larger transactions with big sophisticated companies. And everybody is watching their budgets these days, so we're adapting to that. And you see that in our performance, you see it in our guidance. And that's â we should assume that continues for the foreseeable future. With that said, reskilling, upskilling workforce transformation remain critical imperatives. We also have a labor shortage in certain key roles, and employees are looking increasingly to development, their own development as a reason they stay with companies. So I believe we're well positioned. This is an increasingly critical service inside the enterprise. It just takes a little longer to close new business or upsell. Hi. Thanks for taking my question. Yes, I just wanted to follow-up on some of the comments you just made on the sort of overall demand environment. You indicated on one hand, you have some of the deal cycles that are taking longer. And from my own checks that I've done on enterprise spend, it looks like 2023 budgets will likely come in pressured. Like overall, tech, education. I mean just kind of overall, it looks like kind of spending will be a little bit more curtailed in 2023 versus 2022 based on initial checks. And while I fully appreciate that budgets have not yet been finalized, that's kind of where â how things are looking. But on the other hand, it also looks like there's pretty good demand for â kind of pretty good demand that you're seeing. Can you just kind of help reconcile those, right, because you have budgets coming in, but it feels like the demand environment for Skillsoft still seems quite healthy. Yes. Thanks for the question. We see a critical need for what we do. The key to growing in an environment like this and growing profitably, we believe is to be really smart about segmentation, really understanding where we can win, where we have a high likelihood to win where we can grow and aligning our products and our packaging and our pricing to those segments. So we're hard at work, doing that hard work to make sure that we can deliver the best possible outcome next year. The environment is a reality and the critical need for what we do is a reality too. And we believe we have a really unique offering. We are a player with deep enterprise heritage and the largest enterprise customer base. We have a tremendous breadth of content. We are the one player that's deep in technology, business skills, leadership skills and compliance. We have a tremendous breadth of modalities that allows us to deliver a truly transformational experience to our learners. And we're â we've designed our product as a content creator for the way people learn online today. For example, large percentages of the workforce are mobile. They don't have laptops or even tablets. They're working on mobile phones, and we are optimized with our micro learning approach for that kind of delivery. We believe this â the value that we deliver positions us in a really unique way, and we're going to seize that opportunity as the quarters progress. That's helpful. And just on pricing, right, like as some of your clients maybe looking to keep kind of volumes and to keep kind of business healthy and growing with you all, are you seeing any pressure on unit pricing? Well, I think in this environment, we always â we often end up in those kinds of conversations. We try to move them to be conversations about value and ROI. And we have really compelling ROI data, including a study we just did with Forrester on our ROI, which is really quite powerful. So we're equipped to have those conversations. The other important tool is to have clear segmentation and thinking about pricing and packaging. There is a segment of the market that sees learning as a check box, and we generally don't serve that part of the market. Well, maybe we need to play there. We tend to play and win where there's a workforce transformation imperative and there's a need to get employees from point A to point B. So for example, from hire to billable or reskilling a cohort for a project or develop from development people to their first promotion to people leader. Like that's where we win, and we intend to get better and better at that and extend our lead. Terrific. And if I can just get one more in. It's been about a year since you've announced Codecademy. If you can provide any sort of update on sort of how business on that side has gone? I mean I would assume the businesses are fully merged and may not be keeping full discrete drag of one growth rates. But how is Codecademy â have been a good acquisition, whether it's kind of help you land some new deals? Or is growth accelerating there? Any sort of updates on Codecademy would be super helpful. Well, we're a little more than two quarters into our period of ownership. So while we announced last year, the starting gain really went off this year, and I feel good about the progress we made. I should say, first of all, we operate the business much as it's been operated before. The B2C team has a tremendous amount of autonomy to grow their business. They're really good at it, and I believe they're outperforming the competition in that particular segment. That's the B2C side. On the B2B side, we're just getting started. Sales cycles are nine, six, nine, 12 months. We've closed our first deals with very large customers. We've got about two dozen very large enterprise customers that have signed. We've got a pipeline of more than 100 customers of scale that we're talking to, and I feel good about where we are and the progress that we're making. In terms of being able to tease out the various costs, we are integrating a lot of the back office cost structure. So we don't report bottom line for Codecademy. It's not a separate reportable segment. But there was a question I neglected to ask earlier, and I think you're asking that, too. Are we roughly on track to be roughly breakeven in that business next year? And as best as we can tell, yes, the fact is that there has been substantial integration of back office, and so it's hard to break that out. But I feel roughly on the trajectory that we set at the time of the transaction. Thank you. Weâve reached the end of our question-and-answer session. I'd like to turn the floor back over for any further or closing comments. Super. Thank you very much. First of all, I'd like to thank the entire Skillsoft team around the globe. This is a challenging operating environment, and I'm pleased with the way the team is stepping up to that challenge and the opportunity ahead. I also want to thank all of the analysts who are on this call and follow our business. We don't take you for granted. We greatly appreciate all the hard work that you do to follow our company. And to all of our shareowners, thank you very much. We are deeply committed to delivering a return. And in many ways, we're just getting started on the operational execution of a vision that we feel is very big and very important and will make a difference. So thank you very much. We look forward to keeping you posted. Thank you. That does conclude today's teleconference and webcast. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.
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EarningCall_1626
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Good day, ladies and gentlemen. And welcome to the Avid Bioservices Second Quarter Fiscal 2023 Financial Results 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 maybe recorded. Thank you. Good afternoon and thank you for joining us. On todayâs call, we have Nick Green, President and CEO; Dan Hart, Chief Financial Officer; and Matt Kwietniak, Avidâs Chief Commercial Officer. Today, we will be providing an overview of Avid Bioservices contract development and manufacturing business, including updates on corporate activities and financial results for the quarter ended October 31, 2022. After our prepared remarks, we will open to questions. Before we begin, Iâd like to caution that comments made during this conference call today, December 6, 2022, will contain certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, concerning the current belief of the Company, which involves a number of assumptions, risks and uncertainties. Actual results could differ from these statements and the Company undertakes no obligation to revise or update any statement made today. I encourage you to review all of the Companyâs filings with the Securities and Exchange Commission, concerning these and other matters. Our earnings press release and this call will include discussion of certain non-GAAP information. You can find our earnings press release, including relevant non-GAAP reconciliations on our corporate website at avidbio.com. Based on the Companyâs performance during the first six months, we anticipate that fiscal 2023 will be another strong year for Avid. During the second quarter, the Company recorded record revenues for any Q2 period, reflecting increases in both, process development and manufacturing work. On the new business front, we signed multiple new customer agreements with both existing and new customers, contributing to our strong backlog. With respect to the Companyâs facilities, we continue to make progress with our expansions, and at the same time successfully concluding both our Franklin and Myford annual shutdowns. We remain on track to have the Myford expansion complete by the end of quarter one calendar 2023. We also expect the new cell and gene therapy facility to come online mid-calendar 2023. And finally, to manage our growing business and capabilities, during the period, we added significant talent across a broad range of functions, along with some notable additions to the senior management team in operations, process development, and human resources. Matt and I will provide additional details on business developments and operations for the period following an overview of our second quarter and first six months of fiscal 2023 financial results. And for that, Iâll turn the call over to Dan. Thank you, Nick. Before I begin, in addition to the brief financial overview Iâll provide on the call today, additional details on our financial results are included in our press release issued prior to this call and in our Form 10-Q, which was filed today with the SEC. Iâll now provide an overview of our financial results from operations for the quarter and first six months ended October 31, 2022. Revenues for the second quarter of fiscal â23 were $34.8 million, representing a 33% increase compared to $26.1 million recorded in the prior year period. For the first six months of fiscal â23, revenues were $71.4 million, a 26% increase compared to $56.9 million in the prior year period. For both the quarter and the year-to-date periods, the increase in revenues can primarily be attributed to increases in process development and manufacturing revenues as compared to the prior year periods. Notably, our second quarter process development revenues were at an all-time high, representing a year-over-year increase of 74%. Gross margin for the second quarter of fiscal â23 was 12% compared to a gross margin of 35% for the second quarter of fiscal â22. Gross margin for the first six months of fiscal â23 was 19%, compared to a gross margin of 36% for the same period during fiscal â22. For both the quarter and six-month periods, the decreases in gross margins were primarily due to increases in costs associated with our growth of our business and our facility expansions. The primary drivers of these costs were increases in labor, overhead and depreciation, which accounted for incremental decreases in margins of approximately 11% and 9% for the quarter and six-month periods, respectively, split roughly 50-50 between our mammalian, and cell and gene therapy operations. It is also important to note that the prior yearâs gross margins included benefits from unutilized capacity fees. Excluding all of these factors, our second quarter and year-to-date gross margins were in line with the same period the prior year. We expect the expansion related costs incurred to date will continue to affect near term margins. In the coming quarters, we foresee incrementally incurring additional expansion related costs in line with anticipated growth. Total SG&A expenses for the second quarter of fiscal â23 were $6.8 million, an increase of 36% compared to $5 million recorded in the second quarter of fiscal â22. SG&A expenses for the first six months of fiscal â23 were $13.2 million, an increase of 39% compared to $9.5 million recorded in the prior year period. The increases in SG&A for both the quarter and year-to-date periods were primarily due to increases in compensation and benefits related costs, legal, accounting, and other professional fees. For the second quarter of fiscal â23, the Company recorded a net loss of $1.2 million or $0.02 per basic and diluted share as compared to a net income of $3.5 million or $0.06 per basic and diluted share for the second quarter of fiscal â22. For the first six months of fiscal â23, the Company recorded net income of $400,000 or $0.01 per basic and diluted share, as compared to net income of $9.8 million or $0.16 and $0.15 per basic and diluted share respectively, during the prior year period. For the second quarter and the first six months of fiscal â23, the Company achieved an adjusted EBITDA of $1.9 million and $8.1 million, respectively. This concludes my financial overview. Iâll now turn the call over to Matt for an update on commercial activities during the quarter. Thanks, Dan. The second quarter was both, busy and productive. We continued to see strong demand in the marketplace for Avidâs current offerings as well as interest in the cell and gene therapy capabilities online and coming online in the near term. Our expanded team continues to build visibility within the industry, regularly interfacing with potential as well as existing customers. Weâve seen an increase in client interaction through face-to-face meetings, as well as through our increased presence at trade show conferences. As a result, we continue to add to our client base, our new business pipeline continues to be strong, and our proposal values and other leading indicators continue to develop in a very positive manner. During the second quarter, our team signed $26 million in net new project orders, bringing the total new business for the first six months of this fiscal year to $67 million. Our backlog at the end of the quarter was $147 million, representing a 23% increase compared to the backlog of $120 million at the end of the second quarter of fiscal â22. We expect to recognize the majority of our current backlog over the next 12 months. We are already starting to see the impact of the investments made earlier this year in our commercial team as it relates to the leading indicators we measure internally. We anticipate these opportunities converting into backlog as we bring on our new capacity and capabilities. Looking ahead, we believe that the momentum generated during the first half of the year will continue, and the team is ready to embrace the challenge and looking forward to a successful second half of the year. This concludes my overview of commercial activities. I will now turn the call back over to Nick for an update on operations and other achievements during the period. Thanks, Matt. I am pleased to report that our team continues to execute according to plan. Our business development team continues to fill our project pipeline on top of a significant year-over-year revenue growth. Our manufacturing team continues to produce and deliver on time while employing the highest quality standards. Our facilities and capabilities expansions remain on track, and we continue to invest in the talent required to ensure success across the business. This consistent execution has strengthened and expanded our customer base and significantly improved the Companyâs financial position as compared to prior years. This is perhaps most evident through our revenue growth. In the first six months of fiscal 2023, our revenues of $71.4 million represented 26% increase compared to the same prior year period. It is very important to note that this growth is not simply a result of expanding the Companyâs core manufacturing business. During the second quarter, we had particularly strong revenues from process development services. Specifically, revenues from PD during the second quarter of 2023 exceeded PD revenues from the first quarter by 37%, and exceeded our prior high PD revenue mark by 23%. This is particularly encouraging as PD is where the majority of new customers and new projects are on-boarded. And it bodes well for the future growth of the business as a whole and validates our decision to invest in further expansions of both, capacity and capabilities in this key element of our business. As we look forward to the new calendar year and the new capacity we have coming online, we are excited to report that our recruitment staff required to operate these facilities is progressing well. Our assets require high-quality, well-trained individuals and in many cases, these must be brought in and trained ahead of time. As we forecast, these investments have impacted and will continue to impact our margins in the short-term. This investment in personnel is essential to meet anticipated process demand. What is particularly gratifying is as we have been making these investments, we have seen continued growth and the growing interest in Avidâs offerings, further validating the decision taken almost two years ago to move ahead with Phase 2 of our expansions. With the expansions progressing to plan and coming online at the end of Q1 2023, we will be in a great position to start to consume this capacity. And at this stage, we look forward to seeing positive margin development towards our longer term targets. During the second quarter, we continued to make progress with our cell and gene therapy expansion. As we announced during quarter one, we have already launched the analytical and process development capabilities for this business, which has allowed us to escalate our dialogue with respect to new customers. We are pleased to report that our first customer is already onboarding in this facility. With respect to the GMP suites for our cell and gene therapy business, construction continues on schedule and we expect them to be completed by mid-calendar 2023. Based on discussions with prospective customers, we believe this timing will align well with our customersâ needs to advance early projects into GMP suites. Likewise, our mammalian cell business capacity expansion is progressing according to plan. During the first quarter, much of the downstream equipment was positioned in the facility and validation of this equipment was initiated. During quarter two, we installed the upstream equipment. And as we stand today, the facility is mechanically and largely complete and validation is well underway as we remain on schedule for release to operations during quarter one calendar 2023. And finally, expansion of our process development capacity is also well underway. As we announced during quarter one, this PD capacity will provide additional space to onboard future customers, ultimately seeking to utilize the new manufacturing capacity. I am pleased to report that we remain on-track to have all the current mammalian expansions complete by the end of quarter one calendar 2023. During the quarter, we successfully completed both annual shutdowns in Myford and Franklin alike. It is also worthwhile noting that our shutdown this year was extended slightly to accommodate tie-ins of certain services and the new central utilities plant. It is an incredibly busy time at Avid. The Company is transforming, expanding and growing. And in order to manage this transformation, we recognize the need to bring on expertise and experience to manage and lead our growing workforce. As you have seen during the quarter, we have continued to strengthen our management team. In September, Avid promoted Michael Alston Jr. to the position of Vice President of Operations. Mr. Alston was promoted from Avidâs Director of Project Engineering, a role in which he led all of the Companyâs ongoing facility expansions. Mr. Alston has more than 15 years of experience, starting operational and capital management responsibilities, supporting GMP manufacturing, facilities engineering, and environmental health and safety functions. Oksana Lukash also joined Avid as Vice President People. Mr. Lukash has more than 20 years of human resource experience with both established and entrepreneurial organizations across a range of industries. Prior to joining Avid, Ms. Lukash served as Vice President People & Culture at Oncocyte Corporation, a precision diagnostics company. In closing, I wish to again highlight our accomplishments in the first half of fiscal 2023. Our top line revenues remain strong. Our backlog is substantial and has grown 23% year-over-year. And given the demand we continue to see in the market, we expect it to continue to grow. As we approach full utilization of our current capacity and with additional capacity and services soon to come online, we expect this momentum to continue. For all of these reasons, I am pleased to report that Avid is increasing its revenue guidance for the full fiscal year 2023 from between $140 million to $145 million to between $145 million and $150 million. Yes. Thanks. Good afternoon. Maybe just starting with the macro backdrop, there continues to be a lot of concern around biotech funding, the extent to which thatâs affecting demand, just kind of broadly. Nick, it sounds like client interest continues to be strong, but the $26 million, you signed a new business in the quarter, is lower than it had been running at. So I guess, is there anything notable you can share there around -- are you seeing a change in behavior, body language around spending, anything around delays and placing new work, reprioritizations, et cetera? Is this just new business wins can be lumpy quarter-to-quarter and this shouldnât necessarily represent a trend or a theme? Yes. Hi Sean. And I think, the latter point is really the overall overarching comment that I would make is that it is about the lumpiness quarter-to-quarter. Weâve talked about this before in terms of sometimes people will sign just before the quarter end, which is always great and some people are signed just afterwards, which is not so great when it comes to reporting quarterly numbers. But, if you look at the -- if we look at the sort of backdrop behind that, weâre very happy with the amount of interest and the demand, perhaps at least for Avid services that we see in the marketplace. General trends in the marketplace, do we see some of the smaller players who are more cash strap than others maybe doing a little bit more navel-gazing and taking a little longer. I think thatâs probably the case. Sometimes itâs always difficult to determine whether thatâs a macro impact as we only see a relatively small subset of everybody. But overall in general, we wouldnât be raising guidance and -- if we werenât seeing continued strong demand. And I would highlight that we saw the same thing in the last quarter -- the same quarter last year as we did in this one. It was a little lower, but not -- it again was no -- there was no general influence of the strength of the market as we see. So, we remain optimistic as far as the interest in Avid. Okay, great. And then, Dan, just on margins and trajectory over the next several quarters, I guess the question is, are we pretty much at the bottom here? You talked about Myford Phase 2 set to open very soon and the weight that the growth related investments are adding to margins. As those facilities open and become revenue producing, I guess, should the trajectory of margins, the direction of margins from here be upward? Hey, Sean. Thanks for the questions. Good questions. As far as looking forward, Iâm still confident that we will see incremental margins as we start to fill new capacity and start to absorb some of the costs that we brought on. Weâve invested aggressively through the second quarter in getting the folks in place and some other operational cost for the expansions and the standing up of the cell and gene therapy business. Going forward on the cost side, we plan to make some further investment, weâre going to -- but weâre going to make that investment in line with the anticipated growth. So essentially, as we start to roll out the new capacity and start to fill that new capacity, we should be able to continue to move towards incremental margins and ultimately get to that margin goal that weâve discussed in the past. Good afternoon. Thank you for taking the questions and congratulations on the progress on building up the new capacity. Maybe the first one for me, as you talk to customers -- well, I guess letâs back up. You made a comment in response to one of the prior questions about some orders coming in late in the quarter, some coming in right after the quarterâs closed. Can you talk about, has anything closed already this quarter? Matt, I canât really talk about the next quarter, as we just concluded this -- the prior quarter. But, again, just going back, weâve raised guidance. Weâve obviously brought in the labor ahead of the capacity coming online for a reason. We remain very optimistic regarding the interest in the business that we see. And again, we see lumpy quarters that weâve had them in the past. We have some lumpy good ones, and we have some lumpy not so good ones. Itâs not a trajectory of the overall business, which I think is pretty clear. Got it. Thank you for that. And then maybe one of your peers had talked a little bit about not just kind of delays or dragging of the feet and signing new contracts, but even on the payment side. Now looking at your DSOs for the quarter, I think Iâm coming up with 54 for the DSO here in Q2. But are you seeing any of that from customers or are payments coming in as you would anticipate? From our side, Matt, payments continue to come in as we would anticipate. I do see some more conversation than weâve had in the past. But, as you can see with the DSO dropping, I think itâs approximately 20 days or so from the prior quarter. People are still paying. Fantastic. And then maybe one last one and then Iâll hop back in the queue. But, as far as your conversations with customers, both existing and new customers, as they look at this new capacity and the timelines for those to come on, are you hearing from those prospects some excitement that, hey, this is going to work out perfectly with our internal timelines? Is anybody pushing you to maybe try and get something done a little bit faster? I guess, just what are you hearing from your customers? Thank you. Yes. I mean, I think Matt alluded to that and Iâll let him add to any comments I make, if you have got anything further, Matt. But I mean, I think we have had some really good response to the facilities. Itâs been really quite nice over the last few months, probably the last five to six months, if not more available to people around without having to go and up and go and see every little bit of it and walk them around the flows and the like. And I think weâve had nothing but good comments, positive comments and people very happy with this sort of high-quality capacity alongside Avidâs offering is going to be available shortly. So, we are delighted to be standing that up in the very near future. I think timing is pretty close to ideal. I mean, obviously, I think on the first phase expansion that we did last year with DSP2, our backlog actually hit our capacity in the same quarter we brought it online. So, weâd love to do that again this next quarter coming up. And if we did that, then I donât think we could have timed it any better. So, again, my summary would be lots of really good interest and just excited to have it online and then starting to fill it and then absorb some of those costs that weâve invested in ahead of time and see that progression in margin. Matt, anything further on your side? No. I think, well said. I think itâs accurate. A lot of client interest in the build-out and the additional space and a lot of excitement and positive, really great feedback. Weâve had a number of clients come out and actually tour the site as was early on in construction and eager to get back and see how the progress is going and get engaged. So, it shows very, very well. And there has been a lot of interest. So, we remain optimistic for sure. Hey. Thanks. Good afternoon. As we think about kind of forward-looking KPIs, I think backlog was a bit shy of what many of us had expected. But, you also had a record quarter in process development. Can you just talk about how -- what that record quarter in process development could mean, as we think about looking forward? And then, just a related question. Can you remind us kind of how much process development capacity you have today and maybe where you are in the PD capacity expansion on the biologics side? Yes. So, the PD is, in my view, a really encouraging sign. I mean, when somebody takes transfers the projects into the business, typically, weâll go in, weâll do some small scale runs in PD. Depending on the client, obviously, we may do some work on that process or if the process are well developed, weâre just basically sort of demonstrating what they have already told us, ready for moving it across into the manufacturing facility. So, itâs really the front end of the business where things are coming in. So, to see those sort of revenues in there for me is a good indication that people are getting in. And then obviously we hope to see those people move from small to leader scales up to the larger 2,000 ultimately. So, that to me is a really good indicator for where the business is heading. And then, in terms of the capacity, the 7 million this quarter is actually over capacity. I think, weâve often talked about capacity is a little bit of a fungible number, because itâs not a perfect science. It can vary between certain different activities and whether youâre doing campaigns and all that sort of thing. So, we actually beat our capacity. We wouldâve had our capacity down somewhere around 5 million for the quarter and we hit 7 million. So, that was really sort of the super quarter. In terms of where the capacity is going. So 5 million would give us 20 million a year, annual. We are doing the expansion that comes on in quarter one as well. And that would give us then effectively 40 million or 10 million a quarter, obviously give or take based on the super performance in the last quarter. Got it. Thanks for that, Nick. And then just as a follow up to maybe put a finer point on the gross margin discussion, I think cost of goods sold up sequentially. You called out a variety of things, but it sounds like a lot of hiring. And I donât know if thereâs a way to quantify kind of the number of people you have and the revenue that would support, but could you just talk about maybe as we think about the journey of staffing up the various capacity expansions, how much you accomplished during this quarter and maybe how much is left to go going forward? So, Jacob, so on the gross margin front, as far as heads, we ended the quarter at approximately 360 folks, which is up significantly over where we were last year. Looking forward as far as how many heads do we need to bring in, thatâs kind of a function of what the anticipated growth looks like. And as we start to fill and backfill or add the specific needs that we see in the different groups -- I think, thatâs essentially kind of where weâre at, why we see that weâll as we start to fill these expansions and start to load some of that additional revenue within that capacity, weâll be able to absorb some of those costs as we move forward. Yes. And I think the other part Iâd add as well, Jacob, is that you see -- youâve seen the sort of costs come into the organization in different areas. So, for example, we started beefing up the commercial organization with additional BD representation. We also increased marketing and increased proposal rises and all those sort of things that are all on the front end with zero revenue associated with those. The initial BD calls, the marketing stuff, all of that doesnât get any revenue. So that certainly hits the margins in the short term. Again, I donât think we need very large numbers of increases in those areas to fill out those facilities. So, we donât need to repeat those as we go forward. And that sort of goes then all also through the organization as you start to bring in project management and things like that that have got to onboard these in PD. And then ultimately as we see going forward, and I think this is where youâll see more of the growth as we go forward, is in the more hands on operational people where theyâre actually making the batches. So, what youâve seen is the early investment and effectively the hit on margin is by standing up all the things that you need to get the business in. And then, as we go forward now, then weâll start to just supply the people, which is kind of the variable cost associated with a manufacturer. Nick, I didnât quite catch the number of process development revenues and how much that number was up in the quarter. Okay. And, the -- I guess, a question for Matt, and that is what are customers responding to well? Whatâs giving Avid the edge on some of the larger competitors today? Yes. I think the available capacity -- I think that the track record of success, the quality background I think resonates very, very well. I think our approach to dealing with clients is unique in that weâre accommodating and flexible and a good partner to work with. So, clients respond well to that. So, lot of active engagement for sure. And Matt, whatâs your customer? Is it large biopharma, medium, small? Is there a profile that they like, or you -- they fit in your view? Itâs --- at this point, itâs all the above, everything that you mentioned. We had brought on someone to manage key accounts for us six, nine months ago. And weâre already seeing an impact there, and always had already previously been engaged with the small and emerging biotechs and that continues. So, weâre encouraged by the add each quarter of new client base, as well as additional work from existing client base. Okay. And Nick, a question for you, and that is, could you talk to, in your opinion, is there still tight supply in monoclonal manufacturing? And secondly how is the supply chain for you and getting things brought online and produced? Yes. So, I think, when you -- youâve always got to look at the mammalian capacity in some of the segments that you operate in. And when it comes to sort of commercial grade, high quality mammalian capacity, we still see plenty of shortage of capacity, I would say. We see lots of demand for what weâre doing. And I think thatâs the only explanation you can have really for this seeing the demand that we are doing. So, in terms of the supply chain itself, again, itâs one of those things that just seems to continue to slowly get better. I wouldnât say itâs perfect by any stretch of the imagination. So, we still do scramble for things here and there. We are able to anticipate some customer demands. So we do find that customers will come here where there maybe is a shortage in the market. And fortunately, we have actually -- have the various components available so we can move quickly on that one. So, it continues to get better, not where it needs to be, and still a little bit variable, because itâs not always in the same place where you see the shortage, which makes it difficult to manage, but again, quarter-on-quarter better than previous. Thank you. And Iâm not showing any further questions. I would now like to turn the call back over to Nick Green for any closing remarks. Thank you, operator. Thank you to everyone participating on todayâs call. In closing, I would like to emphasize our excitement as we draw closer to launching our new capacity and capabilities. This could not be possible without the hard work of our many talented employees who drive and take pride in Avidâs continued success. Thank you again for participating on todayâs call and for your continued support of Avid Bioservices.
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EarningCall_1627
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Good evening, and welcome to the Aehr Test Systems' Fiscal 2023 Second Quarter Financial Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. Thank you, operator. Good afternoon, and welcome to Aehr Test Systems' second quarter fiscal 2023 financial results conference call. With me on today's call are Aehr Test Systems' President and Chief Executive Officer, Gayn Erickson; and Chief Financial Officer, Ken Spink. Before I turn the call over to Gayn and Ken, I'd like to cover a few quick items. This afternoon right after market closed, Aehr Test issued a press release announcing its second quarter fiscal 2023 results. That release is available on the company's website at aehr.com. This call is being broadcast live over the Internet for all interested parties and the webcast will be archived on the Investor Relations page of the company's website. I'd like to remind everyone that on today's call, Management will be making forward-looking statements today that are based on current information and estimates and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. These factors that may cause results to differ materially from those in the forward-looking statements are discussed in the company's most recent periodic and current reports filed with the SEC. These forward-looking statements, including guidance provided during today's call, are only valid as of this date and Aehr Test Systems undertakes no obligation to update the forward-looking statements. And now with that, I'd like to turn the conference call over to Gayn Erickson, President and Chief Executive Officer. Gayn? Thanks, Jim. Good afternoon, everyone, and welcome to our second quarter of fiscal 2023 earnings conference call. Thanks for joining us today. Let's start with a quick summary of the highlights of the quarter and the momentum we're seeing in the semiconductor wafer level test and burn-in market and then, Ken will go over the financials in detail. After that, we'll open up the lines to take your questions. We had a very solid second quarter reflecting strong sequential and year-over-year growth in our revenue and net income, both ahead of consensus estimates. Revenue for the quarter was $14.8 million, an increase of 39% sequentially and 54% year-over-year, and we generated non-GAAP net income of $4.5 million, slightly over 30% net profit. Our momentum in silicon carbide wafer level test and burn-in continues to grow and we see this momentum continuing for the next several years as companies are adding significant capacity in silicon carbide semiconductors to address the incredible forecasted demand, particularly for the electric vehicle and electric vehicle charger markets. Forecasts from William Blair estimate that the silicon carbide market for devices and electric vehicles alone such as traction inverters and onboard chargers is expected to grow from a 119,000 6-inch equivalent silicon carbide wafers for electric vehicles in 2021 to more than 4.1 million 6-inch equivalent wafers in 2030. This represents a compound annual growth rate of 48.4%. This equates to almost 35 times larger in 2030 than in 2021. In addition, 6-inch equivalent silicon carbide wafers for other markets such as solar, industrial and other electrification infrastructure are expected to grow to another 3 million wafers by 2030. This expands our silicon carbide test and burn-in market even more. We are excited to have added two new customers for silicon carbide test and burn-in during the quarter. The first is a major silicon carbide semiconductor supplier that purchased our FOX-NP dual wafer test and burn-in system used for engineering and device qualification during the quarter, and after the quarter closed, has since placed their first orders for two of our FOX-XP multi-wafer systems for volume production test and burn-in of their silicon carbide wafers, including the order we just announced today. This company is one of the world's largest suppliers of silicon carbide devices and serve several significant markets, including the electric vehicle industry, as well as other industrial applications. We now have two of the top four silicon carbide market participants as customers. They have indicated to us that they plan to order a significant number of FOX-XP systems for volume production of their silicon carbide devices at facilities around the world to meet the rapidly expanding forecasted market demand for silicon carbide devices for electric vehicles and other industrial markets. This new customer selected our FOX-XP multi-wafer test and burn-in system configured with our new fully Integrated and Automated WaferPak Aligner for high volume hands-free operation. They have told us how important automation is to them across their wafer fabrication and assembly and test and that in addition to the cost effectiveness and scalability of our system, our fully integrated FOX-XP with automated WaferPak alignment handling is key to meeting their automation needs that are critical to their scalability, as well as the quality and reliability goals of the customers and markets they serve. The FOX-XP multi-wafer level test and burn-in system can be configured with up to nine or 18 wafers depending on the customersâ specific test requirements. It provides the test electronics and the device contactor technology that enables contact to 100% devices on a single wafer and the handling and alignment equipment to provide a total turnkey single vendor solution to meet the needed critical test and stress requirements. Our Automated WaferPak Aligner adds a number of very valuable features to the wafer-level test and burn-in process. This new FOX WaferPak Aligner is available in both standalone and integrated versions. In the standalone version, customers can align their WaferPaks offline from the FOX-XP systems using our new FOX WaferPak cards that can be docked to the Aligner. The Aligner will automatically load the WaferPaks with wafers or exchange tested wafers with untested wafers and can be used to support up to five or more fully-loaded XP systems for an extremely low-cost application with long test and burn-in times. The integrated version of our new Aligner docks directly to a FOX-XP chamber that can test and burn-in up to 18 wafers at a time. This can be preferable to customers for lower test and burn-in times or in the case where the customer wants near hands-free operation. The new Aligner can work with all types of wafer sizes, including the high volume runners of 150 millimeter and 200 millimeter used for silicon carbide and can also test 100 millimeter silicon carbide or other wafers. It can also test 200 millimeter and 300 millimeter wafers typical of silicon photonics devices, memories and logic devices. We see automation more typically desired in 300 millimeter fabs such as silicon photonics and memory devices where automation is much more typical. The Automated Aligner also allows for unattended change or reverse from one product type to the next and the ability to run multiple different product type wafers in parallel. Adding automation through our new Aligner gives our wafer-level test and burn-in offering even greater value, as well as opens up several large incremental markets to Aehr such as high volume processors and chipsets with integrated photonics transceivers, flash and ultimately DRAM memories and also higher mix devices requiring extremely high reliability and 100% burn-in such as automotive microcontrollers and sensors. The new second customer added this quarter is a multi-billion dollar annual revenue global manufacturer of semiconductors that serves multiple markets, including supplying devices to the automotive industry. This new customer has already has experience in power semiconductors and quickly understood the value proposition of being able to test and burn-in 100% of their devices at wafer level. In a fairly short period of time, they selected our FOX-NP dual wafer test and burn-in system for qualification of their silicon carbide devices for multiple markets, including electric vehicles. We anticipate that this customer will move to high volume production using our FOX-XP systems after their customer qualifications. Adding two new customers now provides more optimism about our ability to gain significant market share of the test and burn-in market for silicon carbide devices. These customers expand our penetration beyond our initial lead silicon carbide wafer level burn-in customer. Regarding that lead customer, they continue to ramp their capacity and use of our FOX-XP multi-wafer test and burn-in systems and WaferPaks which is being driven by increased demand for silicon carbide, particularly for, but not limited to electric vehicles. We expect significant orders from them for the necessary WaferPak for wafer contactors to match their previously purchased FOX-XP systems and they continue to forecast orders for significant numbers of new FOX-XP systems and WaferPak contactors over the next several years to meet growing demand. In addition to the customers that have now placed initial orders with Aehr for silicon carbide wafer level test and burn-in systems, our ongoing benchmarks and evaluations with multiple prospects made great progress during the quarter. These include significant market leaders in silicon carbide, as well as several smaller existing and up and coming suppliers. We expect several of these companies to place their initial orders with us before the end of this fiscal year ending May 31, 2023. We also continue to see very positive responses from our discussions with a number of new potential customers in silicon carbide this quarter, and have also begun detailed discussions with gallium nitride semiconductor suppliers from around the world. Silicon carbide devices and modules have key advantages for traction inverters in onboard and offboard charges for electric vehicles, as well as other high power industrial applications, while gallium nitride is generally believed to be superior for lower power applications, particularly under a 1000 watts. Both device types are forecasted to grow significantly over the next several years and into the future. Both silicon carbide and gallium nitride semiconductors address the high voltage power semiconductor markets that are significant opportunities for our FOX wafer-level test and burn-in systems and WaferPak for wafer contactors. As we look to further penetrate these markets, we continue to add new capabilities to our wafer-level test and burn-in systems. These include the new bipolar voltage channel module and very high voltage channel module options that enable silicon carbide and gallium nitride semiconductor manufacturers more flexibility to address a wider variety of stress and burn-in conditions for their engineering qualification and production needs. These advanced capabilities enable manufacturers to ship product with higher reliability and parametric stability necessitated -- easy to say -- necessitated by applications such as electric vehicle traction inverters, onboard chargers and several other industrial and power conversion markets. With these new features, test and burn-in at wafer-level ensures even better control of yield loss and improved product reliability. Many questions have come up on what does the addition of these two new silicon carbide customers mean. Both have a history in the automotive space and one is currently a leading supplier of silicon carbide devices to this market. We announced our lead customer about three years ago, right before the pandemic started. Silicon carbide's massive ramp did not really start until the latter half of the pandemic as electric vehicles, chargers and worldwide electrification of infrastructure really began to take off. Our lead customer did not place an order for their second system until the middle of 2021. If you aggregate the orders we've announced from them and the WaferPak contactors to support their orders, their choice of Aehr has meant roughly $75 million of business for Aehr already. And they've publicly said they have plans to expand. So, we are enjoying their success. The new customers can be equally significant. For the major supplier silicon carbide customer, we first tested their wafers on our machines at Aehr and then they purchased a FOX-NP for engineering qualifications three months ago and have since tested their wafers at their facility. Since then, they have already purchased two of our multi-wafer FOX-XPs for production test and burn-in of their devices, including the order announced today, and they have told us they'll need a significant number of additional systems. This happened in a fraction of the time that it took to get to this point with our initial customer. As Aehr has now validated our wafer-level solution with multiple customers and their end customers, that our solution is very effective at screening out defects to automotive qualities. We believe this new customer can be as large as our lead customer. So, while we only announce purchase orders as they come in, the fact that this customer is depending on Aehr for its production volumes going forward should give investors confidence that Aehr is right in the middle of this electric vehicles tsunami. The second new customer this last quarter is a very large player in discrete and power semiconductors today and is already qualified for automotive. Interestingly, this company has yet to announce their silicon carbide MOSFETs that they're already characterizing on our FOX wafer level burn-in systems. We believe that most customers of our FOX wafer level test and burn-in systems have the potential to be a significant revenue source for Aehr and this customer is no different. We've said in the past that we haven't seen any real competition in terms of cost effectiveness, footprint and manufacturing capacity compared to our proprietary FOX wafer level test and burn-in systems and WaferPak for wafer contactors. We continue to engage with both current suppliers of silicon carbide devices, as well as other new entrants into this market. The industry data suggests CAGRs of close to 50% over the rest of this decade, as the electric vehicle and charging infrastructure markets develop. Solar and wind will also be part of this growing market. So, naturally you'd expect lots of new entrants, some will succeed wildly, some may make niche inroads. We want all of them to come to Aehr for their test requirements. Our use case is compelling. Since their customers such as the automotive companies require zero failures, not one in 10,000 or one in 100,000, but no failures. So test and screening out early defects becomes very, very important to our customers and prospects. And from the level of interest we're seeing, we believe our message is getting through. We set out to be seen as the industry standard for wafer level test and burn-in, a critical piece of the production process for several semiconductors and their target applications, including silicon carbide and silicon photonics. With the momentum we're seeing, we feel we have a very good chance to be recognized as that industry standard and to gain significant market share worldwide. Now let me move on to silicon photonics. We're also seeing a strong recovery of our silicon photonics wafer level test and burn-in business after the weakness we saw during the pandemic. Halfway through this fiscal year, we've already shipped over $5 million in systems upgrades in WaferPaks to silicon photonics customers and that's over 300% of last year's fiscal year's first half revenue for silicon photonics. This jump in revenue is also spread across multiple customers and much of it is for new product designs and qualifications that we feel will lead to production volumes. We have systems installed at over half a dozen customers testing silicon photonics devices used in 5G infrastructure, data and telecommunications transceivers and a few yet to be introduced applications that we're very excited about. With multiple market leaders announcing plans to integrate photonics transceivers into their microprocessors, graphics processors and chipsets, we believe silicon photonics will become a significant market for wafer level test and burn-in over the next several years. Looking ahead, we continue to be very encouraged by discussions with current and prospect customers and the continued momentum opportunities we are seeing. Europe has a large number of potential customers for power semiconductors, including both silicon carbide and gallium nitride, and the U.S. East Coast has a number of companies that are already in or getting into silicon carbide, as well as companies that are making investments in silicon photonics. And we're also seeing -- starting to see companies in Asia getting into the power semiconductor game. The lifting of COVID-related travel restrictions in Taiwan and Japan is really helping with our new customer engagements in those regions. With the significant increase in market demand we're seeing for our products and in our sales activities, we have been investing in building up our sales and support teams across the globe. During the quarter, we expanded our senior sales leadership with the addition of several proven executives that will manage our sales activities in Asia, Europe and the East Coast of the United States. These are experienced semiconductor capital equipment sales veterans with significant expertise in test and direct relationships with our target customers. We're very happy with these additions and have already seen a positive impact from their efforts. In conclusion, we continue to believe that we will receive production orders from additional silicon carbide companies beyond our current customers and begin shipping systems to meet their production capacity by the end of our current fiscal year that ends May 31, 2023. We expect a strong second half of this fiscal year and are maintaining our guidance for revenues of at least $60 million to $70 million for our current fiscal year that ends May 31, representing growth of at least 18% to 38% year-over-year and also represents revenue growth of between 35% and 75% in the second half of the fiscal year, compared to the first half of this year. Additionally, we continue to expect bookings to grow faster than revenues in fiscal 2023 as the ramp in demand for silicon carbide and electric vehicles increases and we build momentum going into fiscal 2024. Thank you, Gayn, and good afternoon, everyone. As Gayn noted, we had another solid quarter in Q2 with strong sequential and year-over-year growth in our revenue and net income. We also saw improvement in gross margin and beat analyst estimates in both the top and bottom lines. Looking at our financial results in more detail, net sales in the second quarter were $14.8 million, up 39% sequentially from $10.7 million in the first quarter and up 54% from $9.6 million in the second quarter last year. The sequential increase in net sales from Q1 includes an increase in WaferPak/DiePak revenues of $6.1 million. For the second quarter, these consumable revenues accounted for 45% or $6.6 million of our total revenue, compared to only 5% of revenue in the preceding first quarter. The increase in revenues is primarily due to shipments of WaferPaks for our lead silicon carbide customer in Q2 related to prior quarters' system shipments. As noted previously, customers often buy systems and then WaferPaks later after they have completed their WaferPak designs. Gross profit in the second quarter was $7.9 million or 53% of sales, up from gross profit of $4.5 million or 42% of sales in the preceding first quarter and up from gross profit of $4.5 million or 47% of sales in the second quarter of the previous year. Several factors contributed to the improvement in gross margin. The change in product mix had a favorable impact on gross margin. Consumables revenues which deliver higher gross margins accounted for 45% of total revenues compared to only 5% of revenues in the prior quarter, resulting in a 4.7 percentage point improvement in gross margin from Q1. We also saw an improvement in unabsorbed overhead cost to cost of goods sold due to higher revenue levels in the second quarter, accounting for a 3.2 percentage point improvement in gross margin over the prior quarter. With our use of contract manufacturers, we have the ability to keep our costs relatively fixed while revenues grow, which contributes to gross margin. Gross margin also benefited from lower freight, duties and tariffs and lower warranty costs providing a 3.5 percentage point improvement in gross margin. We are definitely seeing an improvement from the challenging supply chain environment we saw over the last year -- fiscal year. Freight costs have come down substantially. As noted in prior calls, due to the shortage in ocean freight capacity with shipments into the U.S., we were required to ship by air. This is no longer the case and we are saving over $50,000 per chamber consolidating chambers on ocean shipments. We continue to minimize our use of suppliers in China and use these suppliers only when their total cost including tariffs is lower than other suppliers. Warranty costs also improved which is actually reversing some warranty reserves as both our quality continues to improve, as well as our costs associated with repair has lowered significantly using our repair center in the Philippines. Non-GAAP net income for the second quarter was $4.5 million or $0.16 per diluted share. This compares to non-GAAP net income of $1.3 million or $0.05 per diluted share in the preceding first quarter, and non-GAAP net income of $1.4 million or $0.05 per diluted share in the second quarter of fiscal 2022. Non-GAAP net income excludes the impact of stock-based compensation. Operating expenses in the second quarter were $4.4 million, an increase of $403,000 or 10% from $4 million in the preceding first quarter and up $624,000 or 16% from $3.8 million in the second quarter of the previous year. The increase from the preceding first quarter is primarily due to an increase in SG&A of $350,000 related to cost of growing the business, including increases in headcount and corresponding recruiting fees, increases in company-wide salaries and increases in outside commissions, travel, entertainment and trade shows related to our significant increase in selling activities. We've invested in human capital with key additions to our sales and marketing staff to expand our customer engagement and marketing reach, customer support and manufacturing staff to support revenue growth and engineering staff for our development programs. The increase from the second quarter last year include increases in SG&A of $386,000 related to the cost of growing the business, and R&D of $238,000 related to increased spending on development programs. During the quarter, we announced two new enhancements for our FOX-P family of wafer level test and burn-in systems. These include the bipolar voltage channel module and very high voltage channel module options, which enable new advanced test and burn-in capabilities for silicon carbide and gallium nitride power semiconductors on Aehr's FOX-P wafer level test and burn-in systems. Our R&D program initiatives also include a new automated WaferPak Aligner which can be configured in either a standalone configuration or integrated with our FOX-XP systems. We have taken orders for both configurations, including the recent announcement of an order from our new silicon carbide customer for a FOX-XP system, which includes the integrated configuration which provides hands-free operation of wafer handling and auto loading. We continue to invest in R&D to enhance our existing market leading products and to introduce new products to maintain our competitive advantages and expand our applications and addressable markets. These R&D programs include enhancements in all our key markets, including silicon carbide and gallium nitride power semiconductors, silicon photonics and other photonics semiconductors, mobile 2D and 3D sensing devices, and memory and data storage semiconductors. Turning to the balance sheet for the second quarter. We finished the quarter with a strong balance sheet. Our cash, cash equivalents and short-term investments were $36.6 million at November 30, up $437,000 from $36.1 million at the end of the preceding first quarter, and up $1.6 million from $35 million at the end of the second quarter of fiscal 2022. Also, we are now investing excess cash in short-term investments to take advantage of the recent increases in interest rates. Working capital at November 30 was $54.8 million. This represents an increase of $5.4 million from Q1 and $15.3 million from Q2 of the prior year. Inventories at the end of the second quarter were $18 million, an increase of $739,000 from the preceding quarter and up $4.9 million from the second quarter last year. We are increasing inventory to support our expected growth in the second half of fiscal 2023, and we continue to purchase inventory to ensure adequate supply to meet current customer and future customer market demand. Our highly differentiated FOX family of systems allows us to purchase material that is leveraged across many customers and markets, which provides us confidence in our ability to meet the significant market opportunity. Bookings in the second quarter were $10.8 million. Backlog as of November 30 was $15.5 million, compared to $19.5 million at the end of the preceding first quarter, and $36.1 million at the end of the second quarter last year. Effective backlog, which includes backlog as of November 30 and all orders since the end of the second quarter, including the order we announced today, is $23.5 million. Now turning to our outlook for 2023 fiscal year which ends on May 31, 2023, we are confident in the company's growth trajectory and our unique capabilities and product offerings to meet customer demands. As such, we are reiterating our previously provided guidance for full year total revenue of at least $60 million to $70 million, representing growth of at least 18% to 38% year-over-year with strong profit margins similar to last year. We continue to expect bookings to grow faster than revenues in fiscal 2023 as the ramp in demand for silicon carbide and electric vehicles increases, and we've built momentum going into fiscal 2024. Lastly, looking at the Investor Relations calendar, next week we'll be meeting with investors virtually at the 25th Annual Needham Growth Conference on Thursday, January 12. We hope to see some of you virtually at the conference. Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Christian Schwab with Craig-Hallum Capital Group. Please go ahead. Hey, congrats guys on continued strong business and new customer momentum. Gayn, it sounds like you're updating the number of customers that you expect to be shipping to by the end of the fiscal year. Can you just clarify how many customers in total you would anticipate selling to by the end of the fiscal year? Yes, I mean, we don't intend to try to be too vague, but getting yourself too accurate can also get you in trouble, but there's a couple of few customers that have not bought production systems from us yet, that we believe could be taking -- giving us orders and requesting deliveries even as soon as before the end of the year and we have capacity to be able to do that. So, we have enough inventory and prebuild against market forecast as well as specific customer forecast to allow us to actually ship systems before the end of May. That's great. I know you've highlighted this before, but could you just quickly remind us what your capacity is on a yearly or quarterly type of level whichever way you would like to break it down? Okay, that's good point. It's actually, as youâve seen, itâs a combination of capacity and sort of our current reality. And I mean that as terms of just right now, what are we doing and what are we. Right now, we're probably shipping somewhere in the 50 blades or wafers of capacity a month. So, if you think of a FOX-XP with 18 blades in it, two in a little of those or something, that's about what we're currently doing. We have more capacity than that, but that's actually our build plan. That's equal to or a little bit higher than what our current customer requests and demands are. We have the material and pipeline to be able to ship upwards of maybe five systems or 100 wafers of capacity a month by this summer and could actually ship another perhaps even 2x that or 10 systems a month in a year. That is not what we're currently believing our forecast is, candidly, but it's feasible to be that. And so, it's an interesting scenario. We're actually using our capacity in our short lead times and our supply chain as one of our believed to be competitive advantages. We have companies in our space that have 52-week lead times, that's not Aehr Test. So, we've deliberately taken the position that we are putting capacity and infrastructure and material in place to be able to go say yes to as many customers as we possibly can and that's why we have this capacity available to us. Now, one more thing we have said in the past, we did extend our lease here and finalized that just over the last month or so. We've got plans that were in the works right now to do some facility upgrades and all, that's actually going to help us with some infrastructure in terms of electrical and water to be able to do more in parallel. That would be needed we think to be able to hit those high-end numbers by the end of next year. So, those are some investments we'll be making over the next year-and-a-half or so. We'll gradually do it without being disruptive. But I think we've told the Street that might be a $3 million to $5 million investment or so and then depreciate that over the rest of the lease. Okay. It's fabulous. And then on the new wafer handling technology, which really seems to be a game changer for some of your new customers. Does that come with an ASP that's any materially different than the prior generation product? No, it's pretty similar. We had said before that our automated handlers are in about 800,000 range type of thing, whereas the manual liners are significantly cheaper than that. So, if you use that kind of number, that's probably fair. And again, you could buy one that could feed five XP chambers. If you had 10 chambers on the floor, you might need two of them and use WaferPaks and WaferPak cards moving around and there are some companies that prefer that model, that's similar to how Packaged Part Burn-in has operated for years, or you could take an Aligner and bolt it onto the front of each of those 10 XP systems. You'd think, wow, that's a lot more expensive. Turns out it's still pretty negligible if you look at it over, say, 18 wafers, and for some companies that's a big deal. If people that know me, I am super passionate about this new Aligner. We've stayed steady on the course. We've been heads down working on this thing completely through the entire COVID pandemic and just really happy at where it's at right now. And our plans are to be shipping that here over the next, by the end of the fiscal year to multiple customers. Great. And then my last question and congrats on the product success during the COVID period and the recent uptick in silicon photonics, I know it's relatively modest revenue, but materially better than it has been in the most recent time frame. But as you look at that in a multiyear time frame, could those customers be the same size as we've kind of mentioned as your lead silicon carbide customer at 75 million or is it materially greater or modestly less? Could you give us any color there? Yes. So we've been kind of holding our cards to our chest for several years on this thing and just recently have started to talk about it. So with the announcements by some major suppliers, the two largest microprocessor suppliers in the world, the main graphics processors companies in the world, even some of the large fabs like TSMC and GlobalFoundries have created these consortiums to talk about heterogeneous integration, which is a fancy word for multiple chips in one package that include a fiber optic transceiver port on it. And what they're saying is servers first are going to start having chipsets that are in communication with processors and disk drives and data storage through fiber optic ports directly. That is a huge deal, okay? Because the fiber optic transceiver itself will still require the stabilization in the burn-in that we have now been doing for years. It's really what all the hub up has been about and why there are so many companies and so much investment that's been in there. Now having said that, I think there's going to be probably fewer big players than there can be even in silicon carbide, but there'll be lots of smaller players certainly over the next, say, three years or something along those lines. But any one of those big players could be larger than our biggest silicon carbide customer. So the total available market for the silicon photonics when you start talking about it being embedded in servers and chipsets and processors and GPUs, I think is bigger than the silicon carbide business. And so as we start to look at the second half of the decade, when that will really kick in, in particular, that's a huge opportunity, and we are all in on that. So a number of investments that we're already making some we haven't told you about are directed directly at that space. I guess my first question on the -- your first new silicon carbide customer, the one that's purchased two XPs with the automated handler. Is the automated handler going to be shipping at the same time as the shipment of these two tools? So will you have both available to ship with that automated handler at the March time frame? That's a pretty good specific question. Let me leave it a bit -- so yeah, -- well, I'm going to just go out and say, the customers actually requested that we shipped the XP system with the first one, shift the second one integrated with the aligner and then upgrade the first one with the aligner. That's what we are doing. And so there's a little bit of timing, but they're all about the same time frame. So there's like a -- but it's sort of a risk reduction thing for everybody on doing that. Got it. And from a rev rec perspective, is -- or do you expect that these will fall into this fiscal year's revenue recognition or is it⦠Another good question. Yes, no, that's the advanced question, Jed. Folks, we did not see, Jed, with these questions, okay? So -- no, Jed, that's dead on. So as you understand, we seldom if ever get into rev rec things. But our policy, which is extremely conservative for a hardware company, is that if we have a new product going to a new customer until that customer says, I've accepted it, we do not score revenue, even if they pay us for it entirely. So the interesting thing here and embedded in our kind of weird range of forecast for the $60 million to $70 million includes the timing of when one or both of those systems would get rev rec. So -- but it could very well happen that we don't get revenue recognition for those systems until Q1 when they're finally accepted even though we ship them in Q4. Got it. That's helpful. Thank you. And I guess, I was wondering if you could just outline if the material quality of silicon carbide milliohm (ph) resistance, it's coming down in the material, it enables for a multiple shrinks. Every time you would have a shrink or your customer would have a shrink in terms of chip design, that will trigger new consumables from a WaferPak [Multiple Speakers]. That's right. Yeah, WaferPak -- full wafer contactors are unique to the wafer design, which is unique to the device design. So the very nature of the word that shrink means that it's going to -- the X by Y square area would get smaller. And as such, the pads would change and it would require to add new WaferPak. This is very similar to what the test business is referred to as a probe card. And so the probe cards become the consumables. And even if they don't need more capacity, if they simply change all their wafer patterns, they would buy only probe cards or WaferPaks in our case. Got it. So when you look at and you talk about capacity needs simply for silicon carbide from a wafer start perspective, there's a third that presumably if this industry gets on a similar to a -- I hesitate to say it more as well, but a shrink scale, you would have a 30% recurring revenue stream associated with that, not to mention sort of the movement over of additional machines for different diameters. Yeah. So let me put better numbers around that. So in a typical purchase upfront for our tool, we've talked about these ASPs in the like $2 million, $2.5 million or so for a tool and then a set of WaferPaks might be $1.5 million or somewhere in there. So there's sort of this two-third, one-third rule. So if you use the one-third rule and call that 30%, I'm with you, okay? So upfront, they would buy 67% tester and 33% what consumable or WaferPaks. But in some point in time, they would then -- those WaferPaks would be no longer valuable or useful because they no longer sell those wafers. They would then buy all new WaferPaks from us. So the one thing that's still going on with us is trying to get our arms around what is that cycle going to be. On one hand, automotive devices tend to last longer. So they might be the ones that might last multiple years, whereas something like a consumer device or memory might only have a 1.5- or two year life, meaning every other year, all of the probe cards are replaced on a fab, okay? In our case, though, with silicon carbide, there's multiple things that are going on. Everyone is talking about Gen 2, Gen 3, Gen 4 shrinks. They're talking about a planar versus trench. They're talking about going from 150 millimeter to 200 millimeter, each of those create dynamic transitions that would actually accelerate the obsolescence of the previous generation device. So we've been using maybe every four years right now, and they're still yet to see it. But there's no doubt that when you look out four, five years, a significant amount of our revenue is going to be coming from WaferPaks of the installed base. And we're already seeing that with our silicon photonics customers, for example. So -- and as our installed base grows, that number would grow as an absolute value as well. Got it. That's helpful. Last question for me, I'll jump back in the queue. The -- did I hear you correctly when you talked about your second new customer, did they have not announced products in silicon carbide? I was wondering if you could just help clarify that. Yeah. I'm choosing my words very specifically. They have not introduced silicon carbide MOSFETs, and I looked at their website again last night just to double check. They still have not -- they still have said it. So they have figured out a program to come stealthily at this, they have multiple devices I know because we have their wafers. And so I -- we're being pretty elusive. I realize someone -- I think someone asked to why you guys can't never mention about customers? I'm telling you that customers do not want to be mentioned. It's the biggest secret around. And weâre always trying to be very careful. I don't even mention the name of the customer outside of the context anymore because they will get bad at me if I mention them, right. So it's a difficult thing, I realize. We've said we have two of the big guys. I will be bold and I mean, I think because of them being a 10-K -- 10% customer in our 10Ks, I think people understood that on Semiconductor was one of our biggest customers. Everybody is trying to guess who the next big guy was -- is. And we're -- I'm not sure exactly how that's all going to play out. Right now, burden is very clear. I'm just going to win them all, and then we can say we have all of them. So -- but in the meantime, I apologize that you guys don't have better insight as to who they are. Hey, Gayn. I wanted to ask the WaferPaks, the various burn-in equipment on both a silicon carbide side and photonics side, is that going to be in the wafer fab or can it be in the test fab? Because I was just trying to think about it from my perspective, and I think it could be in either. Yeah. You know what, it absolutely can be an either. People -- the closest analogy is what's referred to as known good die, where people sell die sales, okay? In that case, the final test of the die often happens in what we would refer to in the test community is the back-end operation where packages are, okay, versus the front end where the wafers are. In this case, the wafer level burn-in process step feels like a known good die step. So it would be reasonable for somebody to put it in their back end. Having said that, I -- most of our equipment today, if not all of it, is in the front end. It naturally fits in the wafer fab right next to the fab. Our systems are rated for clean room specifications. They're intended to go into the clean rooms. And so we'll see both for sure. But I've heard both. I think we'll have systems both places. No, there's test after burn-in on your wafer always. So our recommended process is take a raw wafer, no need to test it. We will test it and tell you which are the good and bad die, we will burn it in and we'll let you know which ones die during the process and exactly what time it did. And then you would correlate that with a functional final test of that singulated die because you can get tighter accuracies and some other things that you might want to do. But you would do a single insertion test with a test system like the likes of a Teradyne, there's a handful of little companies that are out there that test one, two, three, four devices at a time. And then on a wafer with a 1,000 devices, they might test 250 to 500 insertions of about one sec in a piece. And then they would singulated the good die -- singulate, separate the good die and oftentimes then that die, so they will pick and choose die with matching parametrics. One of the things that people -- I've spent more time on in the past is part of the process of silicon photonics today and silicon carbide. And I did this in a white paper in Munich in a presentation of it. There's also a bunch of technical white papers out there. Silicon carbide devices age and actually their parametric voltage threshold, the threshold at which the device turns on, changes in time over multiple hours and then stabilizes. If you put that into a module like you would do in, say, a module that goes into even from Tesla, but Lucid or Ford's or any of the automotive modules that are going on. You -- and you put, say, eight devices in there. The devices would all be turning on at different times, if you do not cherry pick them. So let's say, you cherry pick them and put them in, during the first 24 hours of use, the threshold voltage varies. So then the one that turns on the fastest will wear out the fastest and can become a reliability problem. So when people use our tools, they're not just being good from bad or weeding out what we call infant mortality or early life failures, we're actually stabilizing the threshold voltage, which takes a period of time such that they can cherry pick them and then sell them to the likes of the VWs of the world or Dan Foss or BorgWarner, who are going to be purchasing known good die from all of the suppliers with specified threshold voltages and RDS on voltages or RDS on impedances or resistances to catch all that. Thank you for the color. I'll have to reread it here. But one quick last question was about the China's reopening. I'm curious if you've been scheduling any travel there because there's a ton of companies like TankeBlue, [indiscernible] so on and so forth that are all there that are investing a ton and -- yeah. So we've had multiple conversations with several of the China suppliers. We have people in country, okay? So other than the restrictions on the local travel or intercountry travel, our team has been able to move around with customers throughout this entire period, and that includes both sales and support people. Most of the Chinese suppliers are behind relative to other folks. And in many cases, what we're doing today is, we're working with companies outside of China who are building silicon carbide devices to ship to those China automotive suppliers. So right now, that's where we see the primary opportunity from us. Over time, the Chinese industry may also pose a real opportunity for us. I'd say that the bulk of our energy has been in the U.S., Europe and Asia outside of China to-date. Hi, Gayn. The way I understand is the FOX-XP system allows for 18 wafers to be burned out -- burn-in at the same time. In this system with all the WaferPaks costs of $4.5 million, what's the next closest competition look like? I've heard the commodity system is one way at a time 90,000? Yeah. So $700 million to $1 million for the equivalent per wafer cost. So it would be -- there's an equivalent -- please go ahead. We are significantly lower than the other folks. There are people that have $1 million per wafer cost, and we might be $200,000 in kind of one of the -- in some of the silicon carbide cases, for example. And people usually go, well, why are you giving them away? Well, we don't feel we're giving them away. We're pretty open with our margins with our customers. They know what we're doing. I think we have a good relationship with them that allows us to continue to invest. And at the same time, our goal was not to just be cheaper than the other guy. In fact, to some extent, we were ignoring them. What we're trying to do is be as cheap as back-end production burn-in, which we have also been a supplier for 30 plus years, almost 40 years. And if you look at our cost to test, the cost of test of us at wafer level is the same as at package level, which people in our industry are shocked to see. And if you go up to 2,000 die per wafer like you would with an onboard charger, it's half the cost. And so they not only get the yield advantage, which is more than the cost of test, they also get it cheaper than they would any other way. And we've chosen to position this product that was its initial intent. We think we've successfully done it, and we're focusing now on being able to ship enough to everybody in the world if we need to. And tagging on to Jed Dorsheimer's last question, there's -- and there's also a second customer with no silicon carbide announced plans that is kicking the tires with Aehr. Yes. Okay. So specifically, if you want to call it, the third customer that bought an NP system, they also -- they have not actually announced -- they haven't publicly announced that they're selling silicon carbide MOSFETs yet. We know they're talking to customers. So we don't really understand the strategy on that, but that's okay. They're a big player, they're serious, and they are very well qualified to be a big customer of ours. We also have benchmarks. We've talked about it before in our previous calls. We've had an ongoing benchmark with one of the other large suppliers for well over a year now. That's a very extensive automotive benchmark that has gone very well during the quarter, and we would hope to give you guys some updates on that over the next -- at our next call. Okay. And then I have a moonshot question, which is -- in medical testing, there's LabCorp and Quest Diagnostics where they would actually run the test for the customers. What does Aehr Test Systems think about running the burn-in for the customer and/or like having an Aehr Test Systems certification where it's a best practices? This is a known good -- not only a known good die, but this has been best practices burn-in in Aehr certified wave? There's multiple things to that. I like everything you're saying, okay? So first of all, we actually do -- we do customer wafers inside in one of our secure labs here. We have multiple labs that are secured with cameras and lockouts, et cetera, to ensure that there's no cross-politization of IP. And we've done that with multiple customers so that we can give them a risk-free demonstration of show there, their failures on their wafers with the equipment. That has proven 100% successful so far. So we do that. Second, we actually have -- we haven't announced our name yet, which is kind of an odd thing to. But we have a partnership with one of the largest subcons in the world who has our tools both in their front-end engineering as well as in production. Stay tuned for some announcements on that during the year. But we -- during this next half, but we already are working with them to qualify them to be able to do silicon photonics-based or silicon carbide-based burn-in in addition to the silicon photonics that they're doing today. And that would allow us to direct someone towards them if they wanted to do services, et cetera., different than us trying to actually be in the services business. We're still kind of focused on capital equipment engineering support services and the consumables themselves. Related to an endorsement by Aehr, there's something to that. We get to see a cross-section of all of the wafer -- many of the wafers around the world and see kind of the good and the bad and the whole thing, I have some very strong opinions about what burn-in time should be, what test conditions should be. And we -- what I will tell you is, we've started working with the -- what's referred to as OEMs, which is the end customers related to, can there be an industry standard for what those burn-in times should be in order to achieve a specific level of quality? And I would hope to try and drive that in the industry if nothing else for the good of the overall industry because there is a difference. And if people want to cut some corners or something along those lines, candidly, I'd prefer they don't do it on my machine. So that's it, thank you for the thoughts there, Brad. And those subcontractors are where the die maker, the wafer makers shipping out the whole wafer to Asia or whatever to get burned in and then it goes on from [Multiple Speakers]. Yeah. I didn't mean to confuse that. We are working with companies that will use their own subcons and they will buy the tool and put it there and it's dedicated for them, okay? What I was referring to is, we've actually identified a generic subcon who would make themselves available for just services to anybody and their brother kind of thing. And so we've kind of kept that to ourselves candidly, deliberately. So I know that we mostly have investors on the call. Any customers or potential clients that are interested in potentially using the subcon, they can contact us and we'll be happy to make an arrangement in a proprietary way to enable that -- the ability to test your wafers at a secure subcon. Yeah. Good afternoon, Gayn and Ken. I guess a couple of follow-ups here. So Gayn, when you talk about -- and I can appreciate that you have capacity to do even a couple more clients by the end of the year. But when you look at the 15, 20, maybe more silicon carbide players that are ramping right now, do you have capacity to serve a majority of them? I think so, yes because I don't think not all of them will be -- most of them will not be anywhere near as big as the first one. So it's -- we do actually look at the total capacity need. And to some extent, we only need to have enough for everybody and then the inefficiencies, right? Because guess what, people will over buy at some point because they're all thinking they'll have more market share. But you sure don't need to be 10 times the total market. So we are focusing on all of it, if you will, and who wins that were kind of -- doesn't really matter to us. Yeah. Okay. Great. And I know, obviously, this is a very early stages of this market growth. But just curious if there's been any kind of a slowdown from any of the customers just based on China's EV market and some of the broader concerns in the marketplace? We haven't seen it at all. And I obviously pay attention to it all the time. I think -- remember thatâs -- okay, there's -- I'm going to simplify the categories of silicon carbide players. They're the multinational or multi-segment large players, big automotive guys, et cetera. I mean obviously, the folks like the STs and Infineon's and ON Semiconductors of the world and TIs or whoever, I'm trying to just make it generic, please don't quote me, they have a big product portfolio. And what they've seen, I mean, across the board, they're just slowing down. There's cancellations out there. There's just stuff where the -- this is the 17 cycle in semiconductors if people aren't paying attention, okay and there will be in 18, okay? As they contract, what they'll do is they'll figure out where the hot markets are and they redirect their energy, okay? I've always referred to as waves. It came back to my HP days, okay? We're in a hot way right now. Customers are pouring their energy towards silicon carbide right now, even though, obviously, there's other business units that aren't doing very well. And so for those companies that have multiple products and all they focus that are in silicon carbide, the pure players are pure and they're all in, right? I think some of the discussion that's been going on at Tesla stock or what's happening, Tesla is going to lose market share. Of course, they are. Guys, they have a dominant market share. There's no way they're going to ship that many to the rest of the world. That doesn't matter. There's way more opportunity in lower-cost EVs than they're in the high-end ones, but they all have traction inverters, they all have engines, they all need silicon carbide, if they want to go for efficiency mileage and charging times. And so we think there's going to be tons of players out there. And the more the merrier, the more -- the faster they're going to get market penetration of all the BBs. So we have not seen it. It has picked up right now. Vernon is so excited about having, we have these three new senior guys. I've had a chance to meet and be in front of customers with them, they're fantastic. And that's going to be a big deal to help us to get to more people. All right. That sounds good. And final question, I was quite frankly shocked when you said earlier today that the silicon photonics customer could be bigger than your current silicon carbide customer. I was always under the assumption that after the initial set of orders, they're doing 100% burn-in and then it goes down to like a 5% sampling over time such that, that market itself would be a lot smaller. All right, two things. First of all, silicon photonics as we -- it's different than when we talk about maybe photonics 2D, 3D sensing. And it is -- they're very different. Our 2D, 3D sensing in mobile those applications that people understand what 2D and 3D sensors are the things that recognize fingerprint or facial recognition or proximity sensors, et cetera, okay? Those actually have a reasonably high infant mortality rate, but they also sometimes have redundancy. It has proven so far that because of the life of those devices, they may only be on for 10 seconds lifetime because they're only on for a millisecond at a time -- times 100,000 or whatever the math is. They have -- the customers that are using it, we have multiple installed base applications, they're all doing sampling, okay? So they only sample 1% or 2% or some number. And as such, they don't do 100% for that application, okay? That's one thing. We actually didn't spend any time until now talk about 2D, 3D sensing, which is still an ongoing business that we get annuities from, et cetera. Silicon photonics is actually the definition of where they are actually putting a photonics transceiver, fiber optic transceivers a way of thinking about it on to a piece of silicon bypassing the normal discrete modulators, demodulators and infrastructure that's required to create transition electricity to optical and back again. This has been the holy grail that people like IBM and Intel have been working on for over 20 years for several reasons. One is to continue to meet the shrinks of silicon and the process or improvements over time, electrical signals can only travel so fast, and we're very close where within people say a generation of it cannot go faster. About 240 gigabit is the upper high end range of an electrical signal on a conductive path. [indiscernible] is 112 today. So we're like one generation or double from that's it. So the folks that have been writing the white papers have been saying, what we're going to need to do is we're going to have to switch to photonics transmission, which if you remember from your business class, photons are neither waves or particles. In the case that they're not a particle, they have no mass, therefore, there's no limitation to go to the speed of light and you can modulate it at much faster rates than you can in the electrical signals. So where electrical signals completely cannot go faster than 200 gig, photonics is just getting started. And so Intel, AMD, NVIDIA, IBM, TSMC, GlobalFoundries, these guys have all been making announcements recently to talk about their investments in what is referred to as silicon photonics to put that photonics transceiver on to chipsets, microprocessors, graphics processors, okay? When you do that, instead of the traditional market that I said two years ago, you would have heard me say on these calls, I do not believe silicon photonics is going to be bigger than silicon carbide. When I said that, I meant it related to transceivers. Now that there's been public announcements for leading suppliers of intent to put those transceivers into chipsets, the market is 100 times larger than silicon photonics and the test times are longer, okay. I'm sorry, yeah, longer â 100 times larger than the silicon photonics transceivers. And I believe -- and I've now stated, I believe it is ultimately larger than the silicon carbide market. It is way more devices. It is 100% burn-in and it is much longer test times. And so because of the stabilization of silicon photonics is very real, and it's been around for 20 years, this is not a 4 hour burn-in time or 6 or 12, nobody is going to be that low. And so with these long burn-in times, that's a big opportunity. And we're -- like you said, we're all over that. And then if you make an investment in us, you are making investment in that as well as some of the other markets we've talked about like memory. And one of the leading edges of that is the -- is our new automated aligner. Well, thatâs an exciting stuff. Look forward to the second and third phase of growth here. Thanks for your time today. Hey, guys. Great quarter. Ken, your beat on the gross margin, which drove the bottom line. Is that sustainable? I know the mix was a factor, but since the revenues are going to be going up, you feel confident you can beat 53%, maybe 55%? Your thoughts on that? So Larry, I would think that the Q2 was an unusual quarter. We had some benefits that were onetime benefits like we talked about, we had some reversal costs that were previously accrued. We had the mix issue. We also had labor and overhead going to inventory with some of the growth in inventory that we had as well as the mix like we talked about in the [indiscernible]. But I think mix would be pretty consistent in the second half though kind of more close. Yeah. There is lots of items driving the margin. So in terms of 53% saying, are we going to get up to 55% that was what your question? I would not plan on that. In fact, I'd reiterate what I talked about in previously and said I think we forecasted for an overall gross margin for the fiscal year being about 50%, and I think that's what the plan should be. All right. So the automated aligner, the automated XP, I know, ideally, you want a long burn-in to drive more equipment sales. But I think there could be a heck of a market out there for -- as you mentioned parametric testing of all sorts, whether it's threshold mortgages and silicon carbide and figure out how many cells are operable on a 3D NAND wafer? What is -- do you have a sense of what the maximum throughput is on a fully automated XP if that thing was constantly moving wafers and WaferPaks? What's... Yeah. That's a good question. Maybe I'll come back. I'm not sure I want to get into all that with all of the introductions, Larry, and I'm not trying to skirt it or something. But there is an indexing time as we would refer to it, how long it takes to index a WaferPak. And if you had 18 wafers -- but if you -- yes, I mean if you're looking at 6 hours or 2 hours or 2.5 hour burn-in times, it's negligible in the background, okay? At some time, you would start to notice it. I mean if you had 1 win at test times or something like that, then that would -- you would start to eat into the overall throughput because of the indexing time. But your first comment is dead on though. This changes things. You would never do -- trying to do a 2 hour test time on a burn-in system is would never work because it takes 15 minutes or 30 minutes to ramp up the chamber and 30 minutes to ramp it down before you can pull the devices out, and it takes hours to exchange all the devices on what's called the burn-in boards. The whole processing of the historical package part burn-in has so much overhead associated with it that I'd tell you people resisted at all costs. Not to mention the cleanliness and the quality implications of package for burn-in of having to scratch the leads and have these in these processes where they could actually introduce a failure into, trying to get to zero PPM defects where the package for burn-in system is extremely difficult. Whereas in a clean wafer environment, where we can make a contact with that wafer 100,000 times with the same WaferPak and never have a different measurement result, you can't do that in a packaged part burn-in system. So there's opportunities that will expand by us taking this tool, making it look now as a high-volume production tool where you can walk up to it with [indiscernible] or use overhead material handling and drop it down without even touching or we have systems that use robots that move boots (ph) onto our auto liners today. So you can actually be hands free. And using a interface front end into a wafer fabrication, you don't even need to touch the tool. There's process engineers sitting around with problems, trying to figure out how to characterize their devices for either sorting purposes or whatever. And I think if they had a sense that there's a system out there that could stress them and then get a measurement and if the throughput was, say, 30 wafers per hour. If that cycle time of moving a WaferPak, unloading it, putting a new wafer in aligning it, putting it back into the system. If that's on the order of 2 minutes, that's 30-minute wafer per hour system. That probably would raise some eyebrows and probably drive demand from places you and I and anybody else hasn't thought of yet. So anyway, it's just⦠Yes. I'm obviously a big believer. It's one of my absolute pet projects, and I'm very passionate about it. I mean, Larry, one of the subtle things too is, remember that we're putting these systems into large multinational, multiproduct line companies, okay? There is no such thing as a broad wafer-level burn-in system out there. There are companies in the memory side that are doing kind of a wafer level burn-in step using standard probers, okay? But they again -- they're all memory guys. They either do flash or DRAM or both. I mean there's not much. You put one of these systems into a silicon carbide floor in one of the big multinationals and deploy it in a large scale, they're going to know about it. I mean, their CEOs are signing off on the money for it. So they're going to know that it exists and they can say, well minute, could we use it over here. So I'm completely on board with you. And really excited that we're turning the corner, not just for Aehr Test, but really wafer level burn-in for the first time in history. Yes. Well, I'll go beat up, Vernon and his team about a little bit. We've got the systems here and there -- if you're a tester guy, they're beautiful. It's like -- they've got pictures out next to my children. But yeah, I think it's about time for us to put something out there, but stay tuned. And one last quick question. As you know, being in the industry as long as you have, a slowdown in, say, the memory space is the opportune time to get your foot in the door for new technology, certainly an automated wafer level burn-in system, particularly as they're getting money from the Feds to at least break ground on new fabs that probably won't come online for years. But -- now is the time to get your foot in the door for tool of record designation. And I just -- I wonder if one of your sales guys is oriented towards that goal. That's a fair statement. I also concur with you. We used to refer to as straights and turns. During the straightaways, it's really tough to sell test equipment or any new process tool of record. They are just ramping and that's what we saw over the last few years. And [indiscernible] scenario with these new products and customers were selling the heck out of the old stuff. And we were not seeing that strength. Then in the terms â the turns that happened now the straightaway for silicon carbide, we're super excited about it. But you're right, the memory guys who are right now relooking at their business models and their cost structure and everything else, I think, would be -- have a vested interest to review what we have as a product offering. All right. So hopefully, we get an announcement here soon that -- would the process be an [indiscernible] tool, would you announce that somebody got tool to run it through its paces? I'm always cautious about getting too far out ahead of our skis and giving people a heads up of what we're up to. But there'll be -- when the timing is right, as people know from my background, I came from a memory business. I've always been extremely passionate about memory, and we -- Aehr is always getting into the memory business. We have some examples and some wins of proof of concept of us to be able to do flash or memory on these tools. We've even done prototype proof of concepts for DRAM in the past as well. And I believe that, that is an opportunity. There is also a sense right now, candidly, of us making sure that the bulk of our resources are focused on the obvious immediate opportunities in front of us of trying to win every single company we possibly get in silicon carbide gallium nitride and the silicon photonics where our strengths are, but we do have energy into the memory as well. So I'll better leave it at that, okay, Larry? There are no further questions in the queue. This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks. All right. Well, thank you, everybody for attending. I wish everyone a happy new year. As always, we'd love to take your calls. We're located here in the Bay Area, just around the quarter from Tesla. And if you happen to be in town, feel free to reach out to us or the IR folks will be happy to take a short meeting. We're really proud of what we're doing here, the manufacturing production floor, which is sort of blowing at the seams right now is pretty exciting to look at too. So I would encourage you, if you'd like to reach out to us. And if not, we'll either see you at the Needham Conference or talk to you at the next quarterly call. Have a nice day. Good afternoon to you.
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EarningCall_1628
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Good afternoon, everyone. I'm Rayna Kumar, and I lead US payment processors and IT services research at UBS. And today, I am joined by President and CEO of PayPal, Dan Schulman. Dan, thanks for joining us today. Great. Well, if you could start, companies are currently operating in and working through a difficult and rapidly changing macro environment. We've heard how PayPal is adapting to this environment with the work you are doing on reprioritizing your strategic initiatives and the progress you're making on cost savings initiatives. How do you feel your efforts are going so far? Great question. So first of all, good to see everybody on -- happy holidays, everyone. So actually, kind of, really no surprises as kind of I've seen results come in. I think we all know it's a very difficult macro environment. I look at the history of e-commerce over time. And if you look at between 2015 and 2018, that four-year period, e-commerce was growing in the mid-teens, pretty consistently. If you then go to 2019, it dropped 13% and then the pandemic hit and bounced up to 33% during the holiday period, November and December. Last year, that dropped down to 9%. And this year, our prediction as it was going to come in somewhere flat to maybe up a basis point or two. And I think that's what happened to the holiday period so far. Adobe came out, predicted about 2.5% e-commerce growth, Salesforce just came out with their numbers, global e-commerce for the month of November, negative 2% and the US was positive 2%. But that's pretty much right in line where we thought it would be. And honestly, I think as you go into 2023, there's no reason to think it's going to get better. There's plenty of reasons to think it could get slightly worse than that, we will probably talk more about that. In the midst of all of that, we continue to invest in the things that we think we have high conviction and growth, check out our unbranded platform, Braintree, PayPal commerce platform and our digital wallet. And we are very focused on the things we can control, which is our cost structure. And that -- we said we were going to take out $900 million this year, $1.3 billion next year, and we are ahead on that right now. So I feel like in general, things are going as we anticipated, probably slightly better on the cost front than we imagined, and we could talk about revenues and other things later, I'm sure. Great. So on your third quarter earnings call, you sounded a bit cautious around overall e-commerce growth and expectations for the holiday season. We're now -- it's now been one month since then, and we have Black Friday behind us. Are you feeling any more optimistic about the overall environment or have you seen trends improve? Yeah. Well, I think there's been a lot of different reports that have come out. I think as I look at global e-commerce. And when I look at global e-commerce, and what the reports are on there, it's negative to maybe flat overall. That's in line with our expectations and our branded TPV is greater than that and pretty meaningfully so. So I feel like when I look Q3 to date, I look at our TPV and I look at all the reports that have come in. Through Q3, we, as best we can tell, held or slightly grew share and I think as I look at November, I would posit the same thing on that. We didn't put out any flashy headline during the Black Friday. We could have put out some flashy headlines. But I think flashy headlines are misleading. And what I will say is that we said we were going to grow our revenues approximately 9%, we're right on track for that. I think our cost controls are probably slightly better than I thought. So I think we'll be slightly ahead on the EPS guidance that we gave. And so I feel like, the business is performing as we expected. And Q4 is an important inflection point for us. Our operating margins will grow for sure. Our OpEx growth will be negative growth for the quarter. So we had said, we'd be kind of flattish, will be negative. As I look into next year, our OpEx will be negative year-over-year. We said, it was going to be probably flat, maybe slightly up. It will be negative next year for sure. We see a lot of opportunity to continue to hone our cost structure. And next year, we said, we grow our operating margins by at least 100 basis points. Clearly on track to go do that and that our EPS will go up by 15%, that's still true off of what I think will be a more elevated end of year EPS. And I think we have a lot of room to continue to be more efficient, more productive. And our expectation as we go into next year is that it's a more muted e-commerce environment than what we're experiencing right now. That may not be true. Maybe it will be better, and then we'll be in great shape if that's the case. But I think it's prudent to plan for a more difficult economic environment. I think Europe is not in great shape right now. I think the war in Ukraine is going to continue for quite some time. The intelligence we've heard from different government officials is that Russia is regrouping to do another offensive in February. That war could last for quite some time. And still â it ends, I think Europe is going to be under quite a bit of pressure. UK, for instance, e-commerce growth in November was approximately negative 10% in the UK. By the way a lot of what we're seeing on the retail side was pretty negative in the UK outside of e-commerce. Even here in the US, retail sales over the Cyber 5 or Black Friday through Cyber Monday were down negative 5% revenues overall. So, I think it's going to be a tough environment. US is probably best positioned, but I think there's probably more than a 50% chance that we go into at least a shallow recession in the first part of the year. So we're planning for muted growth flat to likely down in terms of e-commerce overall and having a cost structure that enables us to both invest and be sure that we can deliver at least 15% EPS growth. PayPal continues to simplify the checkout process and enabling pass keys on all iOS devices to log into PayPal and deploying mobile SDK appears to be steps in the right direction. What do you believe are the next steps to continue to improve the checkout process in regards to either the merchant or consumer experience? Well, we've talked about it a number of times. But the way that, I think about it is we have a lot of assets around checkout already. 80% of the top 1,500 use PayPal, we clearly have the largest network of both merchants and consumer active accounts, so almost 35 million active merchant accounts almost 400 million active consumer accounts. As I mentioned, I think we are holding or gaining slight share overall. When I look at our results, there's a clear consumer preference to use PayPal at online and merchants get higher off rates and lower loss rates when they do. However, clearly, there's a lot of room for improvement as well, and that's why we're investing. And I would say that's in three areas. One is basic hygiene. Like, how do we decrease the amount of time it takes when you push the button to when you can check out, that's latency overall. We improved that by about 40% this year alone. The second thing is just availability of the platform. And we've become mission-critical for merchants, and we are closing in on 5-9s of availability 99.999% availability. And when you've got the scale that we do â do improve availability even by small amounts, it makes a big difference in our results and the results for merchants. So that's kind of different hedging. Second is how do you improve and take out friction from the process. Two ways to do that. One is through password-less sign-in, 44% of consumers abandon a transaction because they can't remember their password and answer it, only 44%, it's a crazy number, and we are working very hard for us to do away with password. Honestly, username and password are not good protection mechanisms anyway, consumer loses their identity every two seconds right now. I will bet you that 80% of you in the audience as great as you are, your credentials are compromised. And I can find them on the dark web, if I search hard enough for them. So we barely use password as a check. We do about 130 checks on every transaction to be sure you are who you say you are, not who you've signed in as. And we're making good progress on password less, over 50% of our base can now check out without using a password, pass keys will be another really -- a step forward where we can integrate directly into the operating system of the OSs out there, whether it be Android or iOS and use biometrics to go use -- when you check out. The second thing to reduce friction is what we call in-app as opposed to bouncing out. So in many ways, when you use PayPal, you balance out of the merchant experience into the PayPal experience and then you bounce back into the merchant experience. We put out now a pretty nice SDK that allows a full in-app, a pretty easy integration. All of our latest integrations through Braintree are all in-app. And when people use in-app the person is bounced out, conversion rates can go by as much as 9%. And so we're pretty focused on moving as much of our base as fast as we can over to in-app. But let's be clear, have 35 million merchants out there, this will be a multiyear process to move everybody over to in-app. And then finally, we are also working on what we think is the next generation of checkout and that's really a leapfrog where we think we can work with merchants to utilize the multiple billions of stored financial credentials that we have to reimagine the whole checkout process, so that it is a single click checkout process across not just PayPal but cards, any other APM on there moving further upstream so merchant knows who the customer is. And the truth is, if we can implement this, nobody has the scale that we do, and it will be quite differentiated. So we're working on the tactical things to just make checkout better. And also what is the next generation of checkout look like. But we'll invest quite a bit on it. It's our bread and butter. It's extremely important, and we see a lot of room to get better. From time and time again, PayPal has displayed its ability to partner with other industry leaders. This new partnership with Apple is particularly unique. Can you please discuss how the Apple partnership is progressing? And how it may evolve next year when the PayPal card and Venmo cards can be added to Apple Pay? Can PayPal provide some incentive for the consumer to alter their card selection on Apple Pay? Yes. I think Apple is another just -- a long line of people that we've partnered with. When I came in, we established the concept of choice for the consumer, not steering the consumer to the low-cost instrument that was best for our financials, but -- kind of put us at odds with financial institutions, networks, tech companies. And since that time that we move towards choice, we've done over 130 major partnerships. This partnership with Apple is the latest substantiation of that. It's meaningful. It isn't the be-all and end-all of a potential partnership that we could have with Apple. But it is very meaningful, and we've been working on it for quite some time. To your point, it enables basically three things to happen. In no particular order of importance, one, it allows our small and micro merchants to use their iPhone as a mobile point of sale to do off-line acceptance and all you need to do on that is give us your social security or eID, your phone number, and you're basically ready to go on that. It's very simple, clearly easy thing to go do, and it enables us to help our merchants accept payments in a fully omni manner. Second thing is we are now able to enter our cards into the Apple wallet, whether that be our debit or credit cards, which will enable you to use a PayPal instrument inside the Apple wallet at a physical point of sale or even online. We've done that now for some time with Google Pay and Android. And for instance, in Germany, where somebody uses their PayPal instrument inside Google Pay, and we're one of the major ways that people pay off-line through Google Pay happens through PayPal. Their branded checkout goes up by about 20%. They're just much more engaged with our service. So we're really excited about that potential as well. And the final thing is we're adding Apple Pay into our unbranded flows so that when we go out to a merchant, they can also use Apple as one APM, alternative payment method, amongst cards and everything else. Without Apple Pay, our unbranded offers are less competitive than they should be, and it's also a win for Apple as well. And so -- and we've had Apple on Braintree from the very beginning of that. So we have a long history of working with Apple on that. So I think it's quite meaningful. I think we're both very excited about it. We're both going to put a lot of resource behind the partnership. It begins really next year. And so it will slowly rollout, but there's a lot to be excited about on that. Over the past year or two, we've heard you talk about how driving engagement can be even more impactful than just adding new accounts to the platform. How do you feel so far about that initiative to date? Will next -- as we think about next year, do you still expect to be more focused on engagement than adding net new accounts? Yeah. I'm interested in all things that can grow our franchise, just to be clear. But I think the single most important thing we can do is increase engagement on our platform for sure. We have 400 million active consumer accounts. Our transaction proactive went up a record 13% last quarter to 50.1 times per year that is well below kind of what our aspirations are. If you can drive great experiences, and I'll talk about that in a second, and you can drive more engagement. Naturally, net new actives will follow. We have a very small top of the funnel demand for PayPal. We always have, and it will remain that way. But as we've gotten bigger and bigger with a constant churn rate, as you get bigger, the bottom of the funnel gets bigger as well. And so it's really a matter of top of the funnel, minus bottom of the funnel equals and NNAs. And so if you can increase engagement, your ARPA goes up, average revenue per active account goes up, your churn rate goes down and your NNAs go up as well. And those are healthy, good, active NNAs. My view is NNAs are an interesting metric, but not the metric go forward. I mean I'm not even sure whether it's -- we'll always report out on NNAs, but even whether it's worth guiding on NNAs. I think it isn't a big part of what is going to drive the growth of PayPal going forward. They will be important, and they will come naturally. But our focus is on monthly active users and daily active users, ARPA and beautiful products like our digital wallet. When somebody goes into our digital wallet, there ARPA is 2 times that of people who don't use our digital wallet. The churn is 25% less, their checkout is 25% lower. And so we know the ways of increasing the engagement, and we just need to get more and more people into our app, make it a more rewarding experience to pay through the app. And if we can increase engagement and lower churn, then you'll see both NNAs come up, but that's really what will drive our business going forward. Recently, UBS Evidence Lab ran a consumer survey on Buy Now, Pay Later for me. So according to the survey, in 2022, 36% of Buy Now, Pay Later users chose PayPal's Pay in four as the most often used NPL product and up from 30% in 2021 and that's bypassing Afterpay, Affirm and Klarna. Given your unique value proposition, particularly to the merchant we're paying for, are you seeing improvements in your merchant contract negotiations either with pricing or with--? Yes. I think that's one of the flashy headlines we could have put out. Our Buy Now, Pay Later was up over 110% over the Cyber 5 period, we're probably now the number one most preference Buy Now, Pay Later player in the world. That's after two and a half years of launching it, over 1 million consumers use the Buy Now, Pay Later on just Black Friday alone. So, we have tremendous momentum on Buy Now, Pay Later. And it's because we have the best value proposition, we have no late fees, no incremental fees for merchants. Over 90% of the consumers that want to use our Buy Now, Pay Later services we already know. And so our acceptance rate for them are 90% plus, whereas other competitors; one, have a much higher cost of capital right now. They don't know the consumers coming in. And when you don't know a consumer, your approval rate is in the 60% range. And so we have, I think, amongst, if not the lowest loss rates in the industry. I think the best value proposition. I mean, if you look at the results of our competitors in that space and they continue to lose money. And Klarna reported losing $200 million last quarter. And last quarter, we generated $1.8 billion in free cash flow, it is just a radical difference in business models. And what we're seeing out in the market is a lot of movement towards our Buy Now, Pay Later and we have -- closing in on 300,000 merchants who have used Buy Now, Pay Later up further on product pages as opposed to check out. When Buy Now, Pay Later is up on the product page, we see a pretty nice lift in share of checkout vice versa by the way, on the other way. And we are winning now global accounts that are coming up for rebid on there, and we will not lose a profitable Buy Now, Pay Later deal. We won't lose it. And our competitors have to pull back. because they can't continue to lose money every single quarter. So, we have a big advantage. There's a flight to quality in the market. We're picking up on that. Like I say to my team all the time, market leaders, if they do the right things, if they have the right cost structure in place, they're investing in the right places to drive growth in their market. They come out stronger after a more difficult time. And I feel like we're in that position right now where we can double down and emerge stronger when the economy starts to turn. I do think things like e-commerce is going to continue to grow. There's no question about it. It's normalized over the last couple of years. Penetration went up by almost five or six points over the pandemic, it went from like 18% penetration up to like 24% penetration of overall retail. The big debate was, was it going to go to -- from 24% and start its normalized climb or was going to adjust back down and it adjusted back down. It's probably somewhere around 22% or 23% of overall retail right now. My bet is next year, stays about 23% or 24% overall retail. And then it begins to climb up as the economies recover and discretionary spend recovers. But e-commerce will be a constant growth. Digital payments will be a constant growth. We're the market leader, and we should emerge stronger from that. Buy Now, Pay Later, is just one of many examples of where I think we've done a really good job in putting out a great value proposition and really executing well against it. Well, yes, that's up to almost 300,000 merchants now putting our Buy Now, Pay Later above the checkout page. And when that happens, as I mentioned, our share of checkout goes up pretty dramatically. And that's -- you're continuing to see that just accelerate as we go forward. So, we're bullish on it. But by the way, like we're not going to chase unprofitable growth on that, where we -- it's a new customer that we haven't seen before. We're tightening on credit on that, because we don't need to chase the unprofitable growth. We have no conflict of like, oh like let's have -- if we have slightly higher loss rates, we're going to have higher revenue growth. We make all of our money on Buy Now, Pay Later on the halo effect of checkout. And so, we're in a really good place to react to changing conditions. We've seen no change in loss rates. They remain low and continue to be low. But we'll tighten where we don't see -- where we have you don't recognize the customer already and don't have history with them. So, 90 million Venmo active accounts. And in the third quarter, you began to on board charities. What are the biggest opportunities where PayPal can expand its Venmo network and improve monetization of its users? Yes. We have 90 million people on Venmo. We have 57 million monthly active users. So, now, it's a beloved brand, and those who use it, love it, are passionate about it. I think there are probably five or six things that we're focused on in Venmo. The first is Pay with Venmo. And the best example is PayPal. That started off as a P2P service, then become an eBay embedded service and then become a merchant service and I kind of think about the -- what PayPal was to eBay like Venmo will be to Amazon and that kind of thing. So, we're looking quite carefully at what we might be able to expect out of the Amazon relationship. We're both excited about it. It's started November 8, and when have a quarter or two of results, we'll be more accurate than what we can say about it. So I don't want too either ahead of ourselves or not ahead of ourselves by saying anything on it right now. But that, I think, is a big opportunity and other merchants that have seen us now do pay with them with Amazon are also putting them on their checkout pages. That's kind of number one. Number two is, we can do much better on attachment of PayPal debit and credit onto the Venmo platform. There, we've been outperformed by some of our competitors. And there's no reason why that should be the case. And so we're putting a lot of attention on both debit and credit associated with Venmo. The next thing that we're spending a lot of time on business profiles on Venmo, especially with the Apple Pay, both Apple and I feel like that's a prime target for us to accept omnichannel payments through business profiles on Venmo. Number four is kind of just like a revamping of our P2P services. We can improve search functionality, discoverability. So the team is working very hard. You just kind of make sure that all of the underlying elements of that work, as well as we can. We're also really looking very hard at interoperability between Venmo P2P and PayPal. Right now, you've got P2P separate on PayPal, P2P separate on Venmo. They can only P2P to their separate networks, but we'd like to do interoperability because obviously, it's more of a network effect. And if you look at SMS on the carrier platforms, it took off when there was interoperability between them because of the network effects of that. So we've got quite a number of things, charities is another one, teen accounts is another that we're excited about. So I think there's a lot we can do. Look, I feel good about the progress that Venmo has made, but I feel we can make better progress going forward. Braintree TPV growth continues to remain a standout in your results and your new agreement with Live Nation is promising. As we enter 2023, how is your Braintree pipeline looking? Yes. I think Live Nation could be one of our largest accounts that we have, it's that substantial of a relationship that we can envision both companies and we're both quite excited about it, and there's been a lot of CEO-to-CEO conversations around that. So we're both quite linked at what we can do there. Braintree, it's had a great run, and it should have a run it's got a great value proposition. We're investing heavily in our unbranded platforms, both Braintree at the upper end of the market. And you'll hear a lot more about this in the year ahead. PayPal Commerce Platform, which will be our unbranded platform for the middle and small markets as well. And so we know when somebody integrates through Braintree or PayPal Commerce Platform, they have the best native integration into our tech stack. So itâs all in app, it's all password less. It is seamless, the largest mobile app players in the world use us, whether it be Spotify, Airbnb, Uber, DoorDash, Insta, they all use us, because they have the highest off rates, lowest loss rates, best integration across PayPal, Buy Now, Pay Later, Venmo, any APM or currency across the world. We have a terrific orchestration layer where we can do multi-PSP routing on that. And so it's for that market, it's a fantastic value proposition. We have pay in, pay out capabilities for a lot of marketplaces that's extremely important. The payout happening through our Hyperwallet acquisition that's integrated now into the platform. So, I feel really great about what's been happening. Venmo, it's been growing quite substantially year-over-year-over-year, probably begins to slow down at some point. We have chunky installations that will increase growth rates one quarter or two quarters and then come down and then depending on the next installation. But it's really catching on in the market, and the team has done a super job. We also have a big sales force that does face-to-face selling of our unbranded and branded services, and they're doing a good job and have learned how to sell it very well. We'll take a question or two from the audience now. Here's the first one. How is user engagement time spent in app trended in Q4? And what's expected in the first quarter? And then second, how is the Venmo launch on Amazon during Black Friday? Was it below or above expectations based on user improvements you've highlighted? The question is on the user engagement, how it trended in the fourth quarter and your expectations for Q1? The fourth quarter is not over yet. And by the way, the holiday period this year is back to what kind of -- well, I think it will be back to what 2019 looked like. So a less -- really sharp kind of contraction of a lot of spend during the Cyber 5 and less around that. What we saw is actually quite a bit of shopping going into the Cyber 5 because retailers were doing a lot more discounting than less discounting during the Cyber 5 sees actually a reduction in some spend in the Cyber 5, and we're seeing them coming out of the first week of December and uplift again versus kind of what our expectations were. So the holiday period is going to play out different than it did last year. So the next three weeks will be important. Yeah. I think, we'll just continue to see increases in engagement. I hope that, that continues at the same pace or even improves. But when you're dealing at the scale we are, there's nothing revolutionary that will happen one quarter to another. It will be evolutionary. But everything we do is making a difference and an impact right now. It's more, I think, revolutionary maybe on the cost side because we firmly see that coming in, and we understand exactly where we can be more efficient and continue to look for additional ways. But on engagement, it will be slow and steady and we're seeing that in the fourth quarter. And on Pay with Venmo on Amazon, again, it's just too early to give anything. Anything I would give might seem flashly, because they're a big company and we're a big company and two big companies coming together early on things went flashy. But let's see where they wind up and give them more accurate and measured view in the quarters to come. PayPal and Venmo are two great brands. Have you ever considered consolidating the two brands into one to offer a more seamless experience for consumers and merchants? Yeah. No, no would be the answer. They are both great brands without â as one of the most powerful brands in the world. I think Interbrand just named it as one of the top 40 most powerful brands in the world. And Venmo here in the US is extraordinary in the millennial segment. Like, if we were at any college on the East or the West Coast, and I have spoken at many of them, I was doing my own market research by saying how many of you use Venmo and it's not 90%, it is 100% of the class that will raise their hand on that, it's extraordinary. So, we will keep two separate brands because they both resonate with different segments of the market. However, underneath that, you'll have a common platform and on the side of services that increasingly will be API-driven where you basically take a service that's inside PayPal and export it and expose it to the Venmo customer base. So we've done that on risk. I mean, the reason our loss rates have come down to single digits and clearly the best in the industry on that is, because we've now combined the Venmo and PayPal risk platforms together, really utilizing all of the history and expertise we have at PayPal on that, and that's taking Venmo loss rates down dramatically. That's happening just across the platforms right now. So common back -- back-office architecture, common service-oriented architecture, but two separate brands and probably a different feel of this as well. As you think of all the PayPal leading assets where do you think it still makes sense to have an acquisition, what areas? I think, one of our strengths clearly is both our balance sheet and our free cash flow generation and we'll do over $5 billion easy of free cash flow this year. We will do approximately $4.2 billion of share buyback this year. And as Gab has mentioned on our last earnings call, we think we'll probably do another $4 billion of share buyback next year. So we think it is a -- I think our stock is significant and the valued where it is right now, and we are going to be aggressive in using our cash to buy back shares. Clearly there is the potential for some acquisitions out there. But they really have to be like center of the fairway for us. We have a lot of things that we want to do and do extraordinarily. One of the things that I like right now is we are very focused on three things; checkout, unbranded platform, digital wallets, that's it. We have the right cost structure in place and we're going to continue to execute on that cost structure, because I think we should be able to at least 100 basis points of margin expansion next year. In a very conservative revenue and e-commerce outlook, my view is plan for dire times on that and have the right cost structure to deliver with confidence, a 15% increase in EPS and if the economy is better or the e-commerce environment is better. That will benefit us tremendously going forward. We have plenty of resource to invest in those areas, while still generate significant returns to our shareholders. So I think that's kind of where we're going to be focused. I think there's plenty of opportunity yet both on the cost side with some opportunity in the market right now. And the team has done a really good job right now. So I'm pleased with that. Coming close to the end of our session. So just as a final question. What are you most excited about as we enter 2023? I think, we find ourselves in a unique place right now where many of our competitors are retrenching. That gives us a huge opportunity to be aggressive in the marketplace. You can't buy placement anymore, buy payment placement by using venture dollars that's done and over. And we did not chase after unprofitable deals, but there really aren't unprofitable deals going on out there right now, and that's why we're winning so many of them. I wouldn't want to compete with us right now because we're going to be aggressive and making sure that we win the deals that are profitable. And we're in a good place to go and do that, given our model. Cost structure is really coming along right now. I mean, we are ahead of target. The teams are fully aligned on what they want to do. There's a lot more opportunity for us, which is why we feel so confident on the 15%, even with a pretty conservative if not very conservative revenue outlook on that. And I think Q4 results will come out and our jump-off will be in the right place for that based on what we can see right now. And so I think there's a lot of opportunity for us. I think the macro environment is something that -- is something we'll keep a close eye on. I think we're very focused on what can we control, that's good, a darn good job on doing that. And there are things that may be out of our control where the industry is right now. But that will bounce back over time. And let's just be sure we're in the right place to execute, hold or gain share and have the right cost structure in place.
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EarningCall_1629
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All right. Weâll go ahead and get started here. First Iâd like to welcome Fred Crawford COO of Aflac and Max Broden, CFO of Aflac. Thanks very much for being with us today. So to kick it off, I wanted to ask a little bit more of a high level question for you. I thought we can start with a general update of the strategy that you outlined at your Investor Day. Could you run us through your strategic focus that you outlined there in Japan and the U.S. for spurring more sales growth? Sure. And I -- can you hear me? Great. So, look I think one of the underlying themes of our investor conference a few weeks ago here in New York was that there are a lot of things that are very well positioned, capital, cash flow generation, core margins in the company are all very strong earnings and earnings performance has been very strong and itâs been quite resilient through COVID. And we expect to remain resilient in current conditions related to inflation and recessionary dynamics. However, what we have been very focused on in recent years is growth. That is where we have seen weakness. Certainly some of it brought on by COVID and the face-to-face dynamics of our sales model in the U.S. and Japan, but not just COVID. There are investments that we have needed to make and changes in our business model to set the stage for better growth or another leg of growth going forward. So we spent a lot of time on Japan and U.S., what types of investments are those. In Japan, I would very simply say this, we are expanding our third sector, which is basically supplemental health portfolio in Japan to attract new customers and approach new demographics mainly younger demographic and carry that customer relationship through their lifecycle. So, for example, introducing a disability product naturally attracts a younger working generation in Japan. The renewal of our approach to small denominated life insurance and savings related products tends to be popular with the younger generation. One of the products being Child Endowment for example where within a whole life policy you effectively put deposits in there to save and then pay for your child to reach his college age in Japan. So bringing that younger generation in through disability products and renewed savings products is part of the strategy. Then we carry them through the lifecycle by then as you age, you naturally become more a candidate for medical insurance and medical coverage, as you become a working individual, married family, et cetera. Then, later in life our cancer business becomes very popular, because cancer is still a disease of age although you will find the younger generations inflicted with cancer in Japan. It is still a disease of age. And then we introduced elderly care products which are supplemental elderly care products not to be confused with long-term care that we are used to in the U.S. This is a different type of product that has a very different, in fact, lower risk profile than you would expect. But itâs carried that customer through the lifecycle and refreshing that product on a more continuous basis. So, obviously, our two big products in Japan are cancer and medical and we have refreshed our cancer product this year. We expect to introduce that product into Japan post this coming year, which is one of our largest distributors of cancer insurance in Japan and we are refreshing our medical product later in the year. So a fast refreshment cycle as well as expanding through the lifecycle. You go to the U.S. and that growth strategy is really an outright build strategy and buy to build strategy where we have acquired and entered into the group life and disability business, as well as the network dental and vision business. Why? While we are moving into those businesses, because if we can offer whatâs called first page benefits meaning benefits that you are interested in on the first page of your enrollment experience when you enroll each year for your benefits that will naturally attract a higher penetration rate inside the company more employees within the company like the first sector -- the first page benefits impart, because your employer is often subsidizing those benefits. So why wouldnât you sign up for them. But if it can be offered alongside our voluntary product weâll see halo effect, we call it, where we sell more of our voluntary product as a halo impact of offering dental and vision through life and disability. So itâs not just the growth of those acquired platforms, but itâs that halo effect or benefit of increased sale of our core voluntary alongside those new lines of business. And then we launch direct-to-consumer business for many, many years people have said you have such an amazing brand. I am surprised you donât go direct-to-consumer and the answer has always been actuarial and that is adverse selection. Imagine for a moment that the individual who wakes up in the morning and goes shopping online for a supplemental health insurance, critically illness insurance, accident, cancer, et cetera, right, so actuarially you got to be very careful and understand thatâs likely to be the case. So you need to structure your product and target your market in such a way to get a broad and diverse set of individuals that you can actuarially meet the loss ratio expectations that are priced into the product. We now have that sorted through and figured out and itâs really important to have a direct-to-consumer model now, why? Because the gig economy is the fastest growing part of the labor force in the U.S. and they donât have a traditional payroll deduction W2 relationship with their employer. So we must get to them through the phone and direct and thatâs why we built that program. So those are our core, in a quick statement, those are our core growth aspects. But itâs addition by subtraction meaning we are focused on growth because quite candidly every other aspect of our financial model in growth and value model is actually performing very, very well and through the pandemic, itâs all about growth. Maybe just drilling into the Japan post that you made as part of that response, thatâs been bit of a recovery story over the last year or so? How do you expect the new product launches that you mentioned, as well as more face-to-face interaction as the pandemic hopefully subsides here in Japan? How do those factors drive that sales growth back towards the historical levels that you got there? Sure. Now, first what I would say is COVID in Japan has played out much different than it has here in the U.S. and they are now on their 7th wave of various strains of COVID running through the system. The strains of COVID that you are accustomed to and have read about, but the nature of society in Japan is that when there are these waves of COVID, you will see pieces of the economy shut down and close up. Once upon a time it was through emergency orders and actually government regulation and governmentâs pressure to shut down. More recently, the government is doing the opposite in trying to encourage businesses and consumers to open up despite the COVID environment, because the severity level and hospitalization has been quite low, everything weâve experienced in the U.S. Yes, Japanese society is not opening up during periods of COVID for the same reasons they were masked during cold and flu season, they wear a mask and they avoid contacts and density, if you will or experiences that jeopardize the density during COVID. That is impacting not just the sales but also Japan Post and think about it, traffic through a post office and face-to-face meetings of the Japan Post Insurance agents who we sell through are all down. What people often miss is that, when you have a large wave through Japan, itâs not just a matter of an inability to schedule a face-to-face meeting. And by the way, you should know, in Japan that is the way sales are done. There really isnât a robust digital sales environment in Japan. It is face-to-face. Itâs often two meetings, not only -- not just one meeting before a sale is made. But itâs not just a face-to-face meetings, you quite literally have thousands of agents who have come down with COVID and are unable to actually go out in the marketplace and work and make sales. So, Japan Post, like everybody else, given the size of their army, I mean, right now we sell through 20,000 post offices in Japan and 10,000 agents at Japan Post Insurance. If those numbers are down due to COVID and the traffic is down, that has an impact. So they need to recover from COVID. Beyond that, Japan Post obviously went through some well-recognized compliance issues. They were quite literally shut down for a period of time by the FSA. You shut down a sales model getting that rev back up again from zero is very difficult. Itâs not just that Japan Post was down, they went down to near zero sales because of regulatory restrictions. So it has been slow to build back but each month we are seeing increased proposal activity. Each month we are seeing increased sales and when we launched the new cancer product in their system in the second quarter, history has suggested that there is a lot of excitement and a lot of activity around that. In fact, the last time at the peak sales we ever did through Japan Post Insurance was deep in the relationship when we refreshed the cancer product. So we would expect a similar reaction this time around albeit not at the levels, pre-COVID because of what I mentioned earlier. So, sales can be quite volatile and you have seen it over the last over the last couple of years. But net earned premium continues to be very, very stable because of the very high persistency we have in that Japanese business. Yeah, when we move into and going forward, we would expect that to be negative 1.5% to negative 2.5% on an underlying runrate basis going forward. In 2023, there is some important changes that are taking place. One is accounting related. So we have the installation of LBPI starting on January 1st. With that, we are going to make one, we are going to elect to do one accounting change and that is how we account for deferred profit liability, which historically, we have run through the benefits line, but we are now going to reflect that in the earned premium line or set. This is really in a much better way reflects the growth rate of the underlying business. The essence of this is that it will rebase our earned premium in Japan in that segment and it will rebase downwards by 200 basis points. We are also on January 1st going to execute a reinsurance transaction where we will seed business, to block the business from -- by Bermuda. What that means is that, from an accounting standpoint, that will lower the net earned premiums recognized in the Japan segment, but they will then occur in the corporate and other segment. This will lower net earned premium in Japan by about 300 basis points. So that holds a sort of a rebasing of the net earned premium. From this new base, we would expect to, going forward, have a growth rate of negative 1.5% to 2.5% in Japan. Thatâs all really helpful. Maybe shifting to the U.S. business for a moment. Could you talk about the -- your performance you are seeing headed into the end of the year to the open enrollment process. This in terms of take up rates and we consider maybe inflationary pressure on some of the consumers and whether you are seeing that. More face-to-face in your distribution for us -- able to get back out there in a bigger way this year? Unlike Japan, I would say conditions in the U.S. have in fact improved considerably. In fact, the notion of a COVID-related impact to your sales model is really not in existence than more I would say. The only implications of the COVID environment to our sales model in the U.S. right now is actually a continuation of remote working that accelerated during COVID and what I mean by that is, remember, we have agents in the small business category that are going into a business and meeting face-to-face with the employees. And if more and more of those employees are working remote, the only way to get out to them is through more electronic enrollment with medium-sized companies and larger companies thatâs always been the case that everybody is electronic enrollment, very little in the way of face-to-face and so there is no real impact to that business, the group business, the broker-driven larger and mid-sized company business continues to march along and that is the fastest growing part of our business and we continue to see that momentum. You have little more of a backlog dynamic that you can track in those businesses where you know a little bit earlier how things are coming together same with glad and we know already that we are heading towards a continued level of growth rate and good growth rate in the group business. The small business individual sector is one where is it a little bit more difficult to predict. You donât have that backlog type dynamic and thatâs the one thatâs most impacted by things like face-to-face COVID remote working conditions. What we are focused on there is recruiting. Recruiting has been weak in that small business agent category and we are now working hard to create incentives and embed incentives to drive as much recruiting as we do outright sales and we would expect that model to come back. It typically have weak recruiting atmosphere during periods of strong employment. This is one of the things that makes our business model very defensive in nature heading into a recession. Itâs usually in times of recession, you donât have much impact on morbidity margins for obvious reasons and thatâs the biggest part of our profitability. So what happens is in lower employment levels even though there are less employees to see, identify and sell, you end up with a lot more agents, because you can recruit much better to a commission only job in a period of weak employment. And there is so much blue ocean opportunity in what we do, meaning very low penetration rates in the U.S. That the more feet you have on the street to interface with more small businesses, the more sales will grow. And so we tend to have a resilient model, even a growth model during periods of recession. So, the key to our growth model in the U.S. is delivering on our buy to build acquisitions, delivering on the halo effect, continuing the momentum in the brokerage business, which we expect to be strong. And then bringing back to life through recruiting and development our core agent platform which includes 30,000 licensed agents across the U.S. Itâs a big engine and when itâs weaker, bringing that back is ultimately going to be an underpinning to recovery and sales in the U.S. And we are projecting a good recovery. We expect to get back to about $1.8 billion in sales which would be a peak level of sales in our companyâs history by 2025 and we expect to add incrementally a considerable amount of earned premium or revenue over that timeframe incrementally upwards of $1 billion of earned premium incrementally through those buy to build platforms and related halo effect. So, we definitely are on the growth path in the U.S. and at the end of the day, we have a mature model in Japan. Thatâs the math of it. But the end of the mature model thatâs been priced properly and run properly. Itâs throws up a considerable amount of cash flow each and every year. Parts of that cash flow are being redeployed into where we see more blue ocean, more low penetration, higher opportunity and thatâs in the U.S. market and thatâs what weâve been doing over the last few years. So one of the key disclosures you all made at the recent Investor Day was around the Bermuda reinsurance structure. Max you touched on briefly. But I thought maybe we can just come back to that for a minute. Can you discuss some of the advantages that it will provide you both on the existing book of business, as well as the product development? Yes. So, There is really two reasons why we are doing this. And the first one is really for us to be able to manage risk better around the Group and then obviously release and the redeploying capital in a more efficient manner. So, what we are doing is, when we see blocks of business from predominantly Japan through Bermuda, what you will find is, these blocks of business are very capital-intensive. And that is the cause of very stringent reserve requirements that exists in Japan today. Over time, what that will do when we can hold that at a more economic basis, which we can in Bermuda that always frees up capital. The other element to it is more of an offensive strategy, because in Japan we have seen all the time that more and more competitors have moved into our space. They also become more price competitive, as well. So what it gives us to this platform is an opportunity to be a little more aggressive in terms of the pricing, because if we can utilize reinsurance, then we can still generate very strong IRRs and very good returns on a business that we write. But at the same time we can share some of those economics with consumers going forward. This is especially important as you look at our medical business where we have been losing market share for quite some time. And then also as we then look to become little bit more competitive in the first sector space as well. Maybe sticking on capital for a minute, I mean one of the things thatâs evident as we kind of look to your business is that the capital levels are very strong. You operate with higher RBC ratios than most companies in the U.S. and I think you probably have higher ESR in Japan and most of the companies, as well. When I think through those capital levels, thatâs sort of even separate from considering the Bermuda reinsurance that you just discussed, I mean, how much flexibility that provides you? How will you potentially look to redeploy that and could you get a little more aggressive over time than maybe over the past handful of years? Yes. So, we hold a lot of capital. We generate a lot of capital and the reinsurance platform gives us even more capital which, in other words, the same that the CFO is not doing his or her -- which is we can debate. The fact of the matter is, weâve been traveling with high levels of capital for a good reason, where supplemental health insurance company and weâve been going through a global pandemic, thatâs one of the largest tail risks that we have from an operating basis as a company. But that made a lot of sense to actually travel with a lot of capital. Now we are facing a potential recession and I feel very good about going into a recession with high levels of capital. That being said, this is not the kind of level where we would like to operate long-term. Weâve been explicit in the U.S. saying that over time we would expect to run at a 400% RBC ratio. And in Japan, we continue to hold very strong levels of capital as we mentioned both on an SMR and ESR basis. And during this, we also generate strong levels of capital of $2.6 billion to $3 billion of underlying capital generation each year. Now all of this obviously is only good if we can deploy it and deploy that to good returns on capital. Otherwise, it doesnât do much for us. So, we obviously been continued to increase the dividend. We have also bought back quite a lot of stock in recent years and I would expect these to continue. And on the M&A front, we have broadened our strategic positioning especially in the U.S. with a few smaller acquisitions. That is something that we potentially could continue to do. It gives us flexibility, but execute the strategic agenda, but over time I think that, we have essentially laid out the growth platform right now. And I would expect that going forward capital deployed will be through writing new business and sort of accelerate the growth rate. So the new business streams would help us get those capital levels down maybe if you want to call it that way. But then also, the vast majority of it will come back to shareholders through dividends, buybacks. And I think our recent past is a pretty good predictor of what we will do going forward. We try to be balanced and the company has always held a philosophy balancing the way we deploy the capital. So, in recent years, weâve invested about $575 million in buy to build platforms. Weâve invested another $500 million in what we would call opportunistic investments in alliance partners and our venture capital investments. Meanwhile, we are buying back stock at a clip of at or north of $500 million a quarter. Keep in mind, we increased the dividend 20%, two consecutive years in a row into a pandemic. And thatâs a lot to say for a company thatâs now 40-years of an increased dividend track record. So, we try to look at this balancing act of first maintain robust and healthy ratios with strong ratings and good relationships with the regulators, who often act as gatekeepers to that free cash flow. Thatâs developed and released, invest into your company, but invest for good returns and you see the good returns being in the U.S. and opportunity. And then, keep that dividend track record and when the capital is in excess above that, buyback your favorite security and for us we buy our stock back as we believe in the economic value growth and strategies that weâve put together. So, thatâs really a part through, donât put our eggs in one basket. We try to be diverse and balanced in what we do. And thatâs particularly is nice heading into a recession where you know having those good capital ratios even after all that buyback and dividend is a good place to be. Thatâs helpful. Next we had gears on cancer screenings and itâs a little bit of a crisis as we sit here and think through reopening. I think the U.S. has normalized a bit more, but in Japan I think medical utilization bookings somewhat depressed. What was your perspective on that? You feel lot more the numbers than I do. So Iâd just be interested in your perspective on that and what you anticipate over the next years as things normalize? So, a couple of comments I would make and Max can jump in anywhere heâd like. But, so first, let me just talk a bit about what we are seeing in actually what was a spiking COVID-related claims in Japan in the third quarter and as we talked about, this was related to a policy that the Japanese government had, so-called being hospitalization where if you were diagnosed with COVID and even if you did not have severe symptoms and were being treated at home, you are eligible to receive claims on those COVID policies. The government then changed their stands because it was clear that hospitalization rates, mortality, severity was all very low as much more common cold like symptoms what we are experiencing in the U.S. And so they moved to more of a posture of no, you are eligible for claims if you are more vulnerable, i.e., elderly as in over the age of 65 or pregnant or have other pre-existing health conditions that could give rise to more acute hospitalization and severity. Those individuals are allowed to draw a claim on their policy hospitalized or not, but everybody else canât do that. And so, as a result, weâve seen the incurred claims trend down and itâs trended down in the month of October versus September, November versus October and even in the final week of November it dipped down much more severely. So, all of our comments at the Investor Conference on the fourth quarter call about returning to a more normalized benefit ratios in Japan seem to be on pace as of our latest data. Your question is a lag question of over a period of less in a way of screening diagnosis, doctor visits around cancer arenât you anticipating larger cancer claims experience. So far, the simple answer is, in Japan, we have not seen that. There is speculation as to why that maybe and maybe that of all of the possible concerns you have over your health in Japan, cancer is not one to fool around. We then therefore paying attention to cancer screening and cancer diagnosis was more of an acute or higher order activity in Japan. But thatâs speculation. So far we simply havenât seen it incidence rates more severity. In the U.S., weâve seen incidence rates climb to around 105% to 110%, in other words, up around 5% or 10% over 2019 pre-COVID levels. So we appear to be seeing a little bit of that delayed or lagged incident levels up. Whatâs interesting though, is both in Japan and in the U.S., itâs not pressuring our benefit ratios and the reason for that is hospitalization is down considerably. In other words, what transpired during COVID or accelerated was much more out of the hospital at home treatment or outpatient treatment surrounding various types of cancer and thatâs both in the U.S. and Japan. And remember, our policies pay you not just on incidents, but also hospitalization, particularly when you are talking about advanced stages of cancer. And so, what we are seeing in the U.S. and Japan is even though incidence rates in the U.S. has risen a bit, the hospitalization rates have come down. So the overall claims experience is remaining low. So, we continue to monitor and track it. It is too early to declare some sort of victory or conclusion on this, but thatâs what we are seeing so far. And I would add that the main component of total claims for cancer is hospitalization and surgery. It is not first occurrence that Fred mentioned. The other thing as well is that, cancer is a disease of age just because of somebody is getting cold does not mean that they are not going to get cancer. So, we actually do believe and there is no medical evidence that cancer took a break from COVID so to speak. So the fact that the matter is that we do expect that diagnosis will continue to run relatively high in the near term so the first occurrence and those benefits, because itâs essentially within the takes. A lot of cancers during COVID and when we now detect them itâs not as paid zero or one, it might be, unfortunately it takes three or four. So, we would expect that to continue. That being said, the impact on our overall results for claims for cancer is still going to be looks somewhat muted like a little bit above long-term trend is what we expect going into 2023. All of that is incorporated in our benefit ratio guidance. Itâs interesting. Weâve always been viewed as a safe place to hide within the financial service industry if you are heading into -- Yeah, if you are heading into volatile conditions, the idea of a low beta, morbidity based company that has low asset leverage and thatâs usually the assets that are most challenging when you head into weak economic conditions. And thatâs always been the profile and the makeup of the company. Whether you talk to a rating agency or a stock analyst, that doesnât matter regulator, itâs always that general view and itâs really true about our business model. Whatâs interesting is the worst thing you ever could have handled a company like ours is a global pandemic. And thatâs the one stress test if you will that we always ran that could be obviously of great concern and so here we had at least one form of test run and we all know that the next pandemic is not going to look like the last pandemic. And so you are not -- you need to kind of always keep that in mind. And what we found with our model is the number one impact of the pandemic is our sales model, okay as we talked about earlier. But remember what happens to the business model of an insurance company when sales are down, when sales are down, and because of the pandemic claims are up, capital generation remains steady. Why, because of the number one use of capital, a good use of capital is if you are growing the acquisition cost associated with putting policies on the books, paying the associated commissions, that is expense at the time of spend for statutory or cash flow. And what happens is, what you may experience in the way of elevated claims you are getting back in the way of lower sales and lower capital off the door because of this lower sales to your capital and capital generation and cash flow remains strong. So itâs still proving out to be a quite resilient business model. The supplemental nature of what we do. And we have a couple minutes left here. I know you guys laid out guidance at your Investor Day. There is nuances around LDTI the new accounting changes. I think you touched on some of it already, but was there anything else that you wanted to flush out there or just the way is it revenue and the margins are flown in? It was really on what I talked about the impacts to Japan. But -- and then also, everybody should know that everything that's going forward, all the guidance that we've given is on a fully on an LDTI basis. I am always joking internally in saying that as late for me, legacy GAAP is retired on December 31 and January 1, it does not exist anymore. It is LDTI going forward and that's just a lay of the land, and that's how we're running it going forward. The good news is that if you have good morbidity margins and good underwriting and good underwriting experience, LDTI that new accounting flushes that out into your results in a very transparent way, and we are blessed to have that. We have suffered from low-interest rates, and that also gets flushed out as a source of earnings, but the morbidity experience of the company has far and away outweighed any negative headwinds related to the low interest rate environment and for that, we're very fortunate. All right. We're just out of time. So I'll stop it there. Thank you for joining. It's very helpful. Thank you all for being here.
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EarningCall_1630
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Hello, everybody. Thank you for joining us here for this session with Cisco. Tim Long here, IT, hardware, comm equipment analyst at Barclays. Very happy to have Bill Gartner with us, SVP, General Manager, Optical Systems and Optics Business Unit. Looking forward to the discussion, pretty hot topic area for Cisco and for the industry. So, I think Bill's going to read a safe harbor, and then, maybe after that if you wouldn't mind just kind of give us a little overview of your roles and responsibilities at the areas that you're covering and then weâll get [right away] (ph). Great. Thanks, Tim. First of all, thank you for having me. And before I start, I will be making some forward-looking statements that are subject to risk and uncertainties as outlined in our disclosures. Have I got all that right, Marilyn? Great. Okay. My name is Bill Gartner, and I have responsibility for two businesses in Cisco that are related by the fact that they both rely on optical communications; one is the Optics business and the other is the Optical Systems business. And you can think of the Optics business as the transceivers that we sell with routers and switches that find their home inside a data center or inside a central office or within a campus environment. Those transceivers are used typically to send optical signals on a fiber over relatively short distance, like ten kilometers. That's the Optics business. And we serve all markets with that, that includes the campus environments, enterprise, commercial, public sector, service provider and web. And then, the other businesses, once you have to leave the data center and now send an optical signal across a city or across a country or even between continents, now it's a much more difficult problem to send that optical signal, and it requires much more sophisticated solution that is classically chassis based. It's a chassis that we have to sell for an optical system to carry these signals reliably over very long distances. And the other thing that's unique about that world is that, in a data center, when you add a new router or switch, you pull new fiber to every port on that router or switch because you're inside. You can do that. When you leave the data center, now you're talking about crossing the Mississippi or crossing the Rockies, and you basically have to use the fiber that's in the ground. And so, we have to put lots and lots of signals on one fiber. So, Optical Systems are what we use outside the data center or central office and Optics what we use inside. That's the two worlds that I have. They're very different businesses, very different business models, but they're related by common technologies. Great. Thank you for that. Good start. So, maybe across the two businesses, talk to us a little bit about kind of your priorities, looking out the next few years, obviously you've done the Acacia deal has been integrated, you got routed out optical networks. There's just a lot going on, right? So, maybe talk about two or three of your priorities, then we'll dig more into it? So, on the Optical System side, we've just introduced a new optical layer platform called the NCS 1010 that offers some very innovative capabilities for customers to simplify operations. It runs IOS XR, which is our routing operating system. So, it's common for customers that have deployed our routers, and it supports CNL band. So, massive capacity. That's our -- you can think about as a layer zero solution. We've just launched that. And the other key thing for the Optical Systems business that we have under development is leveraging something that Acacia announced, which is a new DSP supporting 1.2 terabits on a single wavelength, 1.2 terabits on a single wavelength. And we'll be trialing that in second half of next year and we'll have that available in fourth quarter of next year. Those are two key development areas for the Optical Systems business. And then on the Optics side, we're I think still early stage on 400-gig deployments. So, a lot of effort in terms of getting 400-gig out there to our customers. We are also very focused on selling Cisco Optics, not only for Cisco routers and switches, but for third-party solutions as well. So, when customers want to consider Optics as a buying center and, say, they want to consolidate their optic spend, we want to be considered as an optic supplier. And then I think the one thing that's crossing the systems world and the optics world is Acacia has a very significant innovation in something called a 400-gig ZR or ZR Plus, which is effectively taking what was classically delivered in a chassis as part of an optical system and putting that into a pluggable, a pluggable form factor. And that is a 400-gig ZR or ZR Plus. And that's part of our router optical networking architecture. So, that's an important thrust for really the Optical Systems business and the Optics business. And if you give me a minute here, Tim, I actually brought some show and tell, I'm going to try to make that a little crisp for you, because I know you guys don't live in this world. This is a line card that goes into an optical system. We sell this to all the web players, service providers. This is -- this supports 1.2 terabits of capacity and it goes plugs into a chassis with a bunch of other line cards that plug into a chassis. So, for 1.2 terabits, the customer basically can put -- get two trunks, if you will, or wavelengths, and they can combine up to 1200-gig interfaces. So, this 1200 gig ports here, and out comes two 600 gig ports. That's where the 1.2 terabits comes from. This is part of an optical system. And what we're doing with ZR pluggable is effectively now using -- taking what's in there, largely speaking and putting it in here. Now, it's not quite apples-to-apples. This is a 400-gig pluggable, that's 1.2 terabits. So, you'd need three of these to get to one of those. But from a cost, power, space perspective, this is way, way, way more efficient for customers than that. And so, if you think about it, I own this business, which is part of Acacia. I own this business, which is part of our Optical Systems. I'm going to cannibalize a part of this business in order to make this business successful. And we're okay with that because we own both businesses, but we think there's more potential for this business over time. Does that help? By the way, my supply chain lead always is terrified when he sees me walking around carrying his stuff in a shopping bag. But we're not going to plug it into any customer's network. So, maybe we'll start with this routed optical networks, ZR, ZR Plus. So, ZR, ZR Plus admittedly has been slow, right? Maybe talk to us a little bit about why it hasn't developed as quickly as most in the industry had expected? Why is that going to be different? And touch on the length power -- some of the key issue -- technical issues that need to be tackled or were tackled. So, let me disagree with you on one point there, Tim. I think for the web players, ZR and ZR Plus -- not all the web players, but many of the web players are deploying it in massive volume. And that's characteristic, I think, of the web players. They are quick to adopt new technologies. They don't have a lot of overhead in terms of processes and operations to get in the way. They don't have a lot of legacy. So, when there's a new technology that offers significant benefits in terms of power, space, cost, they can jump on it very quickly. And so, we were at capacity for much of the last year trying to serve that segment of the market with ZR and ZR Plus. For the service provider market, which is traditionally deploying like chassis-based solutions, there's -- we're on a journey that is not going to happen overnight in part because they've deployed these systems which have a lot of life left in them. And so, they're not going to jump to a new architecture overnight. There's also operations -- some operations differences that they have to accommodate in moving from a world of chassis-based solutions to a world where you plug this into a router. But we're seeing very good traction there. We've deployed to over 20 customers now. I'm very confident that over time -- this is going to be a five-year journey. This isn't going to happen overnight. But over time, this pluggable is going to replace that transponder in many, many applications and service provider markets. So, I don't think the journey has gone any slower than we expected. I think we anticipate that for service providers, it is always a much slower transition to a new architecture. And this is a new architecture. It's not just sort of a new technology. And -- but I think we're on pace with where we expect it to be. So -- yeah, let me just outline kind of at a high level what routed optical networking architecture is about. Because there's a lot of FUD out there that my competitors love to throw out. There's some misinformation on that, too. Part of it is replacing this with this. That's part of routed -- and it's a big part of routed optical networking. Some think that's all it is. It's not simply that -- although this is where a lot of the CapEx and OpEx and power savings arises, is from this. But routed optical networking really came about when we looked at the scale of routers, what's happening in ASICs that's allowing routers to scale so dramatically. It wasn't too long ago. When I came to Cisco -- I've been with Cisco 14 years. And when I came to Cisco, we had a 40-gig line card on a router, and it had 14 ASICs. And now we've got one ASIC, one ASIC that does 19 terabits of capacity. And thatâs going to go to 25 to 50 over time, one ASIC instead of 14. And nominally, you can kind of think of it as the cost of an ASIC of the cost of an ASICs. So, every time like I take 14 down to seven, down to three, down to two, down to one, I'm getting cost savings, but I'm also packing much more capacity now into that one, so that's driven down the cost per bit on a router very, very dramatically over the last 10 years. It's also driven down the power per bit, because now we have one ASIC rather than a whole bunch of ASICs. So, the cost per bit on a router has come down dramatically over the last 10 years. When we started building networks with an IP layer and a DWDM layer and sometimes an OTN layer, the motivation for that was that the router was the most expensive resource in the network. It was by far the most expensive thing in the network 20 years ago. And what we did is we -- as an industry is we basically built layers of the network to bypass routers whenever you needed to. So, if you had to go from A to B to C to D to E and you had some demands from A to E, it was very expensive to go through B, C and D to get to E. So, we went around B, C and D with an optical layer using things like ROADMs. And that made sense economically. That really made sense from a technical and an economic perspective. But now the cost of the router has come down so dramatically that it's actually more expensive to go around those routers than it is to go through them. So that was -- that's one key insight that drove routed optical networking is it's no longer more cost effective to go around the router than it is to go through it. And in fact, what we did as an industry is we built a lot of these bypass wavelengths that have very little capacity on them. So, we can now take advantage of the IP layer, aggregate a whole bunch of demands and basically go through routers rather than around them. And so that simplifies the network in a very significant way because you can simplify the DWDM layer. It doesn't go away. To be clear, the DWDM layer is still there, but it's simpler. It can be much simpler. You can take advantage of these pluggable optics. And if you can take private line services like a T1 service or an OTN service and now put it on the IP layer with something called Private Line Emulation, you can take those private line services that were traditionally served with custom products, put that now on the IP layer, now you can get down to one layer in the network. Instead of having IP, OTN, DWDM, you can have just the IP layer. And that simplifies operations, it simplifies planning, it simplifies life cycle management. So that all together, it's Private Line Emulation, it's the idea of rethinking how traffic moves through the network, it's pluggable optics, and now it's automating all of that with an automation infrastructure. It's really those things that make up the routed optical networking architecture. Okay. Great. Maybe sticking on the system side for a little bit. I'd say if you look at Cisco's industry share or anything like that, it's not where it is in routing. Talk a little bit about owning a lot more of the IP and the optical layer, does that help new products like the NCS 1010. It's real catchy name you got there, that one. Just talk a little bit about kind of that vertical integration and what that can do for you even outside of routed optical networks for the traditional systems business? So, let me say something you probably don't hear a lot out of somebody from Cisco is, I don't aspire to be number one in optical. That's not my goal, to be number one or number two in that market. The optical portfolio for Cisco is more of a portfolio play for Cisco. When customers want to buy optical and routing from one vendor and want basically an integrated solution, we're there for them. That's not to say we don't sell optical standalone because we do, but it's opportunistically that we go after those standalone plays. I don't have an objective to be number one in optical. In fact, as I mentioned earlier, when we do -- when we replace this with this, this is the profit pool in optical. This is the most profitable part of the optical system. There's other elements like the ROADMs and things like that, that are really common infrastructure that don't go in with high margins. This is where the margins are, and we're going to replace it with this. And when we sell this, we're going to count it as part of our routing sale. So, effectively, I'm going to take down the Optical business in support of routing. And we have strength in routing that we're going to leverage. So, this is very much a portfolio play where we're looking -- I'm wearing a Cisco hat and saying it's good for Cisco to leverage our relative market strength in routing. And I may have to cannibalize the Optical business in order to do that, and we're willing to do that. And we think that's the right thing for our customers. We think it's the right thing for Cisco. Okay. Maybe just last on this topic. The Optical System vendors that are trying to add routing as a software layer or something, why does that not work as a solution? I will never say never, and I don't discount our competitors. We've got 25 years of investment in routing with a couple of thousand people writing software. Hard-won lessons and building very large-scale networks around the world, and it's a hard problem. So, I wish them luck if they're undertaking that. Yeah. Okay. Good. The -- maybe back to kind of the Optics side. You talked about still being relatively early in 400-gig deployments. Kind of talk to us about that evolution and how you see the next timing and scale for the next few versions. Yeah. Well, first -- one thing I would want to be clear about is depending on which market segment we're talking about and even within market segments, different customers, the lifecycle for a given technology can be very, very long. But we're still selling a ton of 10-gig optics, a ton of 10-gig optics. And 10-gig was around 20 years ago. And so, I think the tail for things like 100-gig and 400-gig is a very, very long tail. And without generalizing too much, what you see is web will adopt a technology like 100-gig very quickly and jump to 400-gig very quickly, and then jump to 800-gig, and they'll jump to 1.6T. The service providers are going to be -- to have a much longer timeframe for deploying that technology, easily ten years for something like 100-gig, easily. And they are going to generally be slower in jumping on a 400-gig bandwagon or an 800-gig bandwagon. They'll be slower jumping on it and then have a much longer time of deployment. And then, when you look at something like enterprise, it's much, much later and much, much longer. So, like most of my 10-gig or 1-gig, we still sell a ton of 1-gig, is going in enterprise applications. So, these technologies have a very, very long tail. And if you ask like what's Google going to do or what's Facebook or Amazon are going to do, you get a very different answer than if you ask what Bank of America might be doing or what AT&T might be doing. Okay. And then talking about the big hyperscalers, what kind of trends are you seeing there? And I'm assuming as capacities go higher, there's got to be optical -- much more optics around. We know each generation of switch has more optics. So, maybe talk about the trends there, and what you think that means for the business. So, let me talk both inside the data center and outside the data center. The -- inside the data center, 400-gig is pretty well being deployed right now by the web players. That's, I would say, entering maturity. It's still relatively early stage, but entering maturity. 800-gig is probably coming in the next couple of years. And 800-gig will be a little different than what we've seen in previous technology jumps in that 800-gig will be -- on the router port, it will support 800-gig, but the optic itself will likely be two 400-gig side-by-side, packaged into one optic. And we do that for technology reasons and cost reasons. So, it will be a longer time before we see 800-gig on the optics side. It's also an issue of compatibility. If they've got a lot of 400-gig out in their data center and they put an 800-gig optic that has two 400-gig ports effectively on it, they can connect it to an existing 400-gig. So, there's a life cycle management issue there as well. Pretty mature inside the data center for 400-gig, but I'd still say, there's a lot of growth there still ahead of us. Once you leave the data center, the web guys have metro networks and long-haul and subsea networks. So, those are three very different markets. I think the metro markets for the -- or data center interconnect type market for the web players are largely going to go to this. For a couple, they're already there. Like this is exclusively what they're deploying. For others, I think they'll get there. Once you leave the metro area and get into long-haul or subsea, then I think this, which has higher performance than the pluggable supporting -- this can support many-thousand-kilometer applications, this was maybe up to 1,000 kilometers today, they'll still deploy something like this, a chassis-based solution. The other thing I would say is we're -- for the last 20 years, the industry has been sort of a game of leapfrog of let's go from 2.5-gig to 10-gig to 25-gig to 40-gig to 100-gig. And every time you do that leapfrog, you get more capacity on the fiber. We are now approaching the point where we're just -- we're hitting what's known as Shannon's limit. We're just going to be out of gas on the fiber. So, we can't play that game anymore. Like our next-generation DSP coming out of Acacia will deliver 1.2-terabit on a wavelength, but the total fiber capacity that can be supported isn't moving that much. So, we can get a little bit better economics with a 1.2-terabit wavelength and maybe a 600-gig or 800-gig wavelength, but we're not really moving the needle in a significant way in terms of the total capacity. And then, if you ask what's beyond that, it's very little incremental gain that we can get in terms of the total capacity you can put on a fiber. So, then we have to turn our attention to things like power or cost, and say, look, the game is going to be who can drive to a lower power consumption on these things. It's not necessarily a game of capacity gain. Interesting. One of the priorities you talked about was third-party for Optics. How do you go about that? How difficult is that to really start moving the needle on that business? So, I think we've made good -- I think we're early stage in there. We've made very good progress with some very key logos. When a customer -- and now, I'm talking primarily about service provider customers, because web is a little bit in a different category. But when a customer decides, for instance, that they want to consolidate their optics spend because the optic looks the same to them for whether they're plugging it into Cisco or Juniper or Nokia, we want to have a seat at the table for that conversation, because we put optics through a certification and qualification process that is absolutely unparalleled in the industry. No supplier of optic, no other vendor, whether it's Juniper or Arista or Nokia, does the level of certification on an optic that we do. So, we can give our customers very high confidence that when they buy the optic, it will work in any host and it will work under all operating conditions. That means temperature variation, humidity variation, voltage variation, all these different permutations, we test for. And we have a diverse supply chain. We make sure that even when we're sourcing the optic ourselves, even when we design and build the optic ourselves, we still have second sources for either all the technologies that go into that or the optic itself. So, we can take that supply chain management issue away from our customer, and say, âLook, we will guarantee you that there's diversity in the supply chain. We'll guarantee that when there's typhoon in Thailand or an earthquake in Japan that takes down a good part of the optics supply chain, that we've already thought about that.â And that gives our customers comfort. So, it's more than just does the optic work, because the optics are fundamentally commodity. We make sure that we can guarantee it's going to work under all operating conditions and that we can diversify the supply chain on behalf of the customer. So, with that value, I think we have a good selling proposition to customers. So, maybe talk a little bit -- it's challenging, it's whack-a-mole and golden screws and all that stuff. So, where are you guys now looking -- in your business, how are you feeling about supply chain and volumes? So, I would separate -- Optics, I think, is in pretty good shape. We're heading down to back to like four-week sort of lead times. There are hot spots. So, we're not there yet, but we're heading there. And for many optics, we are -- we're within four-week lead time right now. Optics has not suffered, in general, from some of the other areas like the high-capacity ASICs. The semiconductor industry has not hit as much in the optics area. And things like power supplies have not been a real constraint for the Optics themselves. The Optical Systems are still on pretty long lead times, like 35, 37-week lead times, but we are seeing those come down as well. I would characterize it as, I think, there's daylight. We see daylight. We see improvement ahead. We're not out of the woods. This is not a mission accomplished statement yet. There is a whack-a-mole issue going on where there are some trouble spots we're still dealing with, and then there are some just pop up randomly that we still have to deal with. So, we're not out of the woods yet, but we're in a far better situation now than we were a year ago. Okay. Just curious, obviously, you have Acacia and some real base level technology and IP. Could you talk a little bit about the broader Cisco Silicon One and having silicon capabilities in addition to the optics? How does that better position you relative to maybe some optical or optics pure-play companies? So, one thing, I think from an Acacia perspective, we worked really hard to vertically integrate as much as possible on the design and development side and really own all the key technologies there. And I think we're at a point where we can say that for all the key technologies that go into that optic, we've got ownership of that technology. That gives us control over the design, the performance, ultimately, the cost and it gives us comfort that we can manage those trade-offs between the various pieces in the optic. I think it was December of 2019 that we made a pretty big announcement that we were going to shift our business model to support a component business model. So, in addition to doing our traditional systems business of selling fully integrated routers and switches with software and hardware and services, we were going to meet our customers where they want to be met. If they want to buy just the optic from us, not buy any of our systems, we'd sell them the optic. They want to buy just the silicon from us, like Silicon One, none of our systems, none of our software, we'd sell Silicon One. If they want to buy just our software or just our hardware platform and put their own software in it, we would do that. Very different business model for Cisco, has supply chain implications, has inventory implications, cash cycle implications, and it's fundamentally a different way we think about managing a business. I think that, that opened up business for us with the web players, in particular, who were the main target for that whole announcement to say, look, if you want to go build your own, we want to be part of that solution with you. We don't want to be on the outside looking in. So, if you want to use our silicon, we'll be happy to work with you. And we now have customers buying only our silicon, only our optics, only our hardware platform with no software, putting their own software on or putting something like SONiC on it. Every combination you can possibly imagine, we are now to some customer offering. And I think it's opened up a lot of possibilities for us that we don't see many of our competitors being able to match with both silicon and optics.
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EarningCall_1631
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Hello everyone and welcome to the Fire & Flower third quarter fiscal 2022 financial and operational results call. My name is Charlie and Iâll be coordinating the call today. You will have the option to ask a question at the end of the presentation. If youâd like to register your question, please press star followed by one on your telephone keypad. Thank you Charlie and welcome to Fire & Flowerâs third quarter fiscal 2022 conference call. I am Stéphane Trudel, President and CEO, and joining me today is John Chou, our interim Chief Financial Officer, and Chris Bolivar, Executive Vice President, Commercial and Growth. Earlier today, the company published its operational and financial results for the third quarter ended October 29, 2022. The results are available on the companyâs website and through our filings on SEDAR. Prior to beginning our call, I will direct listeners to the cautionary statement regarding forward-looking information published on the news release for the third quarter of fiscal year 2022, as well as the companyâs filings on SEDAR. Today, weâll be providing commentary on the third quarter of fiscal 2022 along with an update on our operational improvements and new initiatives that will position the company for growth with the goal of generating free cash flow and realizing our mission of delivering cannabis to the world. We will also provide an update on our expansion plans across North America leveraging our unique technology that enables acquiring customers, converting to sales, and building long term loyalty. Weâll then conclude with a moderated Q&A period from equity research analysts that cover Fire & Flower. The third quarter of fiscal 2022 was the first full quarter to benefit from our new Spark Perks member pricing program launched in mid-May. Using our proprietary Hifyre analytics, we further enhanced our merchandising strategy to tailor to specific customer needs towards the end of the quarter, which has resulted in meaningful margin increases with retail gross profit at 24.3%. This program was quickly adopted by our customers and our frontline team members. In my visits in store, our team shared their excitement about this program as it enables them to engage and educate customers about the best products at the best prices in stock while not sacrificing innovation. We continue to see year-over-year increases in traffic in store, increased unit sales, and growth in market share. These positive trends in our retail metrics continued in the current quarter and support the positive year-over-year same store sales trends that we have experienced since the launch of the program. Average annualized sales per store improved by 15% compared to last quarter following last quarterâs 18% increase. Our year-over-year same store sales at minus-4% improved again this quarter, continuing the positive trend from prior quarters. Total consolidated revenue across the segment of digital, retail and wholesale and logistics were $43.8 million, an 8% sequential improvement and a modest increase of 3% compared to the same quarter last year. Our retail revenues increased 9% sequentially compared to the last quarter despite a decrease of two stores in the quarter, and decreased modestly by 2% when compared with Q3 last year with four less stores than last year at the end of the quarter. At the end of Q3, Fire & Flower represented one of the largest cannabis retail store networks in Canada with 90 stores opened and operating. The net reduction of two stores in the quarter is due to a normal retail practice of network optimization. Our disciplined approach to optimizing our store network demonstrates our focus on profitable stores within the network, which is key in driving our goal of free cash flow. Our digital revenue segment significantly rebounded from Q2 with revenues increasing sequentially to $3 million from last quarterâs $1.9 million as we enhanced client relationships and resumed and increased data subscriptions in our industry-leading Hifyre IQ data platform. In addition, many major clients have already subscribed to our two new Hifyre products, the consumer insights module and the product distribution module which will add to our monthly recurring revenue in this business segment. Our wholesale and logistics segment revenues for Q3 were $7.9 million, a decrease of 7% quarter-over-quarter while remaining flat when compared to Q3 of last year. We acquired Pineapple Express in Q1 this year, which brought medical and recreational cannabis delivery capabilities to serve B2B and B2C markets. It should be noted that the decrease came from the Pineapple Express segment while our Open Fields distribution business remained strong. We have now launched our Open Fields cross-docking service in the province of Manitoba and anticipate seeing additional growth coming from the new service being offered in this market. During this quarter, our team has turned the corner on the challenges that the business has seen in past quarters. The past two quarters saw meaningful increases in fundamental retail metrics that continue to drive growth month over month. We will continue to closely monitor these metrics to ensure that Fire & Flower remains competitive and adds to gains in market share and gross profit. Continuously improving on key operational metrics across all business segments and remaining laser focused on our goal of positive free cash flow will be key contributors to our success. The organization continues to drive change through the Get to Green program, focusing on company-wide top line revenue growth and cost reductions. John will get into more details, but our disciplined approach has resulted in a reduction of $1.2 million or 7% in adjusted SG&A over last quarter, driving our adjusted SG&A as a percentage of revenue lower by 534 basis points. Most of these reductions are structural and our team remains focused on finding ways of doing things differently to continue driving down costs. John will provide more details of our network evolution as we are continuing and will continue to work on high grading our network with the closure of underperforming stores and the opening of new stores that are already showing their capacity to perform up to our expectations. Last quarter, I mentioned that we anticipate 10 stores co-located adjacent to Circle K locations in the next 12 months. I am happy that with the latest licensed sites in Ontario, we now have seven of these stores open, expanding on that innovative asset-light model in these high traffic sites, capturing high margin licensing income. Our industry-leading Hifyre digital platform continues to be a differentiator for us at retail with now more than 510,000 members across Canada buying in store and through our ecommerce sites, engaging with us through product reviews, shop feedback, and personalized email recommendations. It also is a differentiator for our overall success because it has become a trusted source of data intelligence for many third parties, creating value outside of our ecosystem with insights on customer behaviors and inventory coverage across the industry. As a hardened store operating platform stress-tested by our 90-plus stores in Canada, itâs now extracting meaningful licensing income from the U.S. from two states, California and Colorado through our partner, Fire & Flower U.S. Its portability across borders and the fact that itâs built to manage highly competitive networks of stores more than individual operators will be an asset for us as more and more states legalize retail cannabis and plans to legalize federally in the U.S. become a reality. We remain active with our partners in the U.S., looking for ways to continue to extract more value from this massive market. Our wholesale and logistics segment has transformed itself in the last 12 months with the addition of Pineapple Express delivery and now our Manitoba cross-docking facility just entering the market. While there is a lot of noise in that segment because of these changes, we remain bullish in our capacity to offer value-added services to our external partners through these services and extracting a stable income at Fire & Flower. While our B2B business is more mature and stable, we continue to experiment to find the right service level and offering for our B2C deliveries and use our Kingston, Ontario market as our test market. Weâre happy with the response weâre seeing and excited to see that pulling on the right levers, we can make this value-added profitable service to be added to our already popular Fast Lane click-and-collect service. On October 18, Fire & Flower announced a loan agreement for $11 million with our strategic partner, Alimentation Couche-Tard, and a private placement financing for an additional $5 million subject to the approval of our shareholders. As part of the financing package, there are certain amendments to the strategic agreement with Couche-Tard, including the re-pricing and extension of warrants. More details on this are available on our website in the Special Meetings material, with the meeting occurring on December 16, 2022. Weâre excited that our strategic partner is supporting us with a broad, comprehensive financing package in addition to the capital and real estate they are committing by building franchise co-located stores. We view the financing with Couche-Tard as an important component of the potential remaining financing requirements to get the company to free cash flow as well as unlocking additional strategic opportunities for consolidation. As previously mentioned, on November 7 we also announced additional co-located cannabis store sites adjacent to high traffic Circle K stores. This brings the total to seven co-located stores within this program on our initial commitment of 10 stores and further demonstrates commitment to the Couche-Tard partnership. What weâve seen with the initial performance of these stores is that weâre leveraging the existing traffic of customers already visiting these easily accessible locations many times a week to build our sales in these highly competitive markets. We are seeing convenience, fuel and car wash shoppers appreciate the use of one-stop shopping, especially coupled with the ability to buy online and use our Spark Perks Fast Lane click-and-collect service. Our customer insight module will allow us to ensure we tailor our offer to these new customers and to existing retail cannabis customers that migrate from competitorsâ stores to these highly convenient shops. I would now like to turn the call over to John to discuss our financials and provide a more detailed overview for the third quarter financial results. John? Thank you Stéphane and good morning everyone. Iâm happy to provide a summary of the financial results of the third quarter fiscal 2022 as released to the markets earlier this morning. To begin, I would like to remind everyone that as in prior periods, Fire & Flower follows a retail calendar with every quarter consisting of 13 weeks. Today, I will be reviewing the results for the third quarter ending October 29, 2022. During the third quarter 2022, consolidated revenue totaled $43.8 million, representing an 8% increase from the previous quarter and a decrease of 3% from the same quarter last year. Consolidated revenue for the third quarter consists of retail revenue of $33 million, wholesale and logistics revenue of $7.9 million, and digital revenue of $3 million. Consolidated gross profit this quarter was $11.8 million, an improvement of 22% from $9.7 million in the second quarter this year. Gross margin percentage for the third quarter was 27%, an improvement from 24% in Q2. Consolidated gross profit was lower this quarter compared to $15.7 million for the same quarter last year, which represented a gross margin of 35%. Consolidated adjusted EBITDA this quarter was negative $2.8 million compared to negative $6.1 million in the second quarter and positive $2.1 million in the third quarter of last year. This is a very significant improvement of nearly $4 million sequentially, demonstrating our progress on the initiatives that Stéphane had discussed earlier. As Stéphane mentioned, we saw encouraging sequential improvements to all of our key financial metrics this quarter, but the company continues to focus on executing on its strategy to deliver positive adjusted EBITDA and free cash flow. Moving on now to an overview of the segmented results, starting with retail. Our Q3 results reflect the first full quarter since we implemented several new retail initiatives, including the Spark Perks member pricing program, the push to high grade our retail network, and the previously announced Circle K co-located stores. In Q3, we close four retail stores and opened two new stores, ending the quarter with a retail network across Canada of 90 stores compared to 92 at the end of the last quarter. In addition, at the end of the quarter we had a total of three licensed stores in our network, including one Circle K co-located store in Ontario and two licensed stores in the U.S. Subsequent to the quarter, the company added four licensed high traffic co-location stores in the Greater Toronto market and entered into an agreement to purchase two additional stores in Kingston, Ontario through a share transaction. We have also recently expanded our footprint in British Columbia through the opening of a new store in Kelowna, as well as a new store in Winnipeg, Manitoba. Retail revenue for the third quarter was $33 million, reflecting an increase of 9% from the previous quarter, contributed to by increases across all the provinces we operate in. This improvement was achieved despite the fact that we had a net reduction of two stores in the quarter and continued weakness in retail cannabis prices in Canada. We were able to increase sales this quarter by achieving improvements in our key retail metrics. Same store sales continue to improve upon the progress we have made in the prior quarters. Q3 same store sales on a yearly basis saw a decrease of 4%, a significant improvement from the declines seen in the previous two quarters. We also saw average annualized sales per store increase by 15% for the third quarter to $1.5 million from $1.3 million in the previous quarter. On a year-over-year basis, retail revenue in Q3 2022 decreased modestly by 2% from $33.7 million in the same quarter last year as we continued to face some headwinds in the industry as a whole, an example of which is the decreasing average price of recreational cannabis products in Canada by 3% for the 12 months ending October 2022. Gross profit for retail in Q3 2022 was $8 million, representing a meaningful 13% increase from Q2 and a 22% decrease from the same quarter last year. Gross margin was 24% compared to 23% in the second quarter of this year and 30% in the prior year. The sequential improvement of our gross profit and margin reflects our focus on store and merchandising as part of our Get to Green initiative, while the decline year-over-year was expected as we engaged in pricing activities to drive customer acquisition. Adjusted EBITDA from retail in the third quarter was negative $2.8 million, a significant improvement from negative $4.5 million in Q2 and lower when compared to positive $0.9 million in the same quarter last year. The sequential improvements in all the key financial metrics this quarter for retail give us the confidence that our merchandising strategy, consumer engagement programs, and the plans to high grade and evolve our store network are working. In addition, we continue to see positive trends in our Spark Perks program with membership totaling more than 510,000 members today. We have now seen sustained strength in our sales and membership subsequent to the quarter and expect to see continued improvement in Q4. Now turning over to the wholesale and logistics segment, wholesale and logistics revenue was $7.9 million for the third quarter of fiscal 2022, 7% lower compared to Q2 and flat compared to Q3 2021. The quarter-over-quarter decrease was mostly due to a decrease in Pineapple Express delivery revenue offset by continued and sustained growth in the Open Fields wholesale business. Gross profit for wholesale and logistics in Q3 fiscal 2022 was $1.1 million with gross margin at 14%, representing an improvement of 22% versus the last quarter but a decline of 35% compared to Q3 last year. Adjusted EBITDA for wholesale and logistics for Q3 2022 was negative $0.1 million, an improvement of $0.3 million compared to Q2 this year and a decrease of $1.3 million compared with the same quarter last year. The improvement in adjusted EBITDA for wholesale and logistics quarter over quarter is primarily driven by integration of the Pineapple Express business, while the decrease from the same quarter last year is related higher costs associated with the acquired business, their Firebird Delivery, which was launched in Q2 this year. In addition, we have now started the cross-docking logistics service in Manitoba, as previously announced, which with further contribute to revenue and gross profit dollars going forward. Turning to the digital segment, digital platform revenue was $3 million in the third quarter, a sequential increase of 55% from $1.9 million in Q2 and a decrease of $0.8 million when compared with $3.8 million in Q3 last year. The significant improvement in digital revenue quarter over quarter reflects the resumption of a number of key account subscribers and a meaningful increase in project-based work during the quarter. We recognized software subscription revenue from Fire & Flower U.S. during the quarter as well, which further built our U.S. revenue base and drove additional recurring revenue. In addition, we have brought in new accounts from the recently developed consumer insights and product distribution modules within the Hifyre IQ platform. Adjusted EBITDA for digital for the third quarter fiscal 2022 was $1.4 million, an increase of $0.9 million from Q2 this year and a decrease of $1.9 million compared with Q3 last year. Again, the sequential improvement this quarter was the result of higher revenue and s lightly lower SG&A expenses. We expect going forward to see a sustained run rate of recurring sales and adjusted EBITDA while growing the new Hifyre IQ product offerings and U.S. software licensing fees. Overall, consolidated SG&A expenses for Q3 2022 were $15.6 million, an improvement of $1.3 million from $16.9 million in Q2 and an increase of $0.4 million compared to the same quarter last year. SG&A expenses excluding share-based compensation and acquisition-related professional fees for Q3 were $14.6 million compared to $15.8 million for Q2 this year and $13.6 million in the third quarter last year. The quarter-over-quarter improvement was the result of the companyâs previously announced Get to Green initiative, including reductions in payroll, professional fees, marketing expenses, and other G&A costs. The modest year-over-year increase in SG&A expenses was mostly due to the addition of Pineapple Express delivery and PotGuide, and expenditures incurred related to expanding the Hifyre platform and launch of Firebird Delivery and Spark Perks member pricing. Consolidated adjusted EBITDA for the company for the third quarter was negative $2.8 million, representing a 54% improvement from last quarter and a decline from positive $10.1 million for the same quarter last year. The quarter-over-quarter improvement in adjusted EBITDA reflects the increases in revenue and gross profit and the reduction in SG&A expenses in the quarter. The year-over-year decline reflects the ongoing headwinds faced by the cannabis industry affecting our gross profit and a slight increase in SG&A expenses. Free cash flow in Q3 fiscal 2022 was negative $6 million, resulting from cash used in operations of $2.4 million, lease payments of $2.6 million, and capital expenditures of $1 million. Free cash flow for Q3 was an improvement from negative $9.9 million in Q2 and $8.6 million in Q1 this year, reflecting the companyâs focus on increasing top line and gross margin while reducing operating expenses. At the end of Q3, the company had $13.2 million in total debt versus $21.8 million at the end of the last fiscal year end. Total debt at the end of this quarter included the $11 million senior secured loan with Alimentation Couche-Tard that was closed and received in October 2022, reflecting the confidence and continued commitment to Fire & Flower by our largest shareholder. Last, I want to remind everyone again that we have changed our fiscal year end from a 52 or a 53-week period ending the Saturday closest to January 31, to a calendar 12-month period ending December 31, therefore the third quarter will be the last quarter where the period end does not coincide with the calendar end. As a result, our fourth quarter results will reflect the operations from October 30 to December 31, 2022. Iâm excited to see the path weâre on. The retail cannabis market continues to grow in Canada despite the negative news that mostly focuses on the licensed producers. Our people on the frontline are passionate and continue to educate existing and new customers to the ever-expanding product offering and innovations that continue to flow in the market. I canât help but feel energized and positive about our long-term journey when I visit our store managers and bud tenders, as I did last week in Ontario, and look at the positive interactions they have with our customers. Our stores and our employees have become an important part of communities across Canada and service adults of all ages from all walks of life. Again this year, to support these communities and live up to our core values, weâre supporting the Second Harvest food rescue charity in December by collecting donations and providing a corporate matching donation. The positive impact to communities now extends globally. New jurisdictions legalizing in the U.S. and now the EU show a path to a stable, profitable global market, as we are now starting to demonstrate with our licensing revenues coming from the U.S. The learnings from our home market, the first G7 country to legalize, are used as a lab to thrive in highly competitive situations will pay off for this long game that weâre playing. We are on a clear path to free cash flow generation. Some level of market consolidation will support the continued improvements and metrics for companies that can scale efficiently. As some players exit for a variety of reasons like low sales, local competition, unfavorable leases, and inability to raise capital to continue operating, we are poised to capture the growing demand of cannabis at retail and benefit from improved unit economics. We target a 10% market share in all markets we operate in and look to do it by opening or acquiring stores and maximizing the organic performance of our current store portfolio. In closing, I would like to thank our team at Fire & Flower for their focus on execution and delivering tangible results. I would also like to thank our loyal shareholders for being supportive of our mission to deliver cannabis to the world. Know that our team wakes up every morning wanting to do the right thing and playing to win. Firstly, I just want to ask on the digital revenues. Can you maybe speak to some of the key drivers behind that performance, and I guess more importantly, whether you believe that could be sustained into the fourth quarter and into the new year. How sticky were some of those revenue bases or was some of that revenue generated in the third quarter, because we have seen some lumpiness in that segment in prior quarters. Yes, so weâre definitely seeing this as a sustained run rate for recurring revenue in digital. Iâll let Chris Bolivar give you a bit more color on that side, but weâre really excited weâve turned a corner on the digital side and really comfortable that what weâve guided to in the past, we can see the sustained run rate being there. Definitely the digital segment, we saw some significant sequential growth. What that was driven by was really the resumption of a number of subscriptions by some of our key account partners, as well as an increase in some data subscriptions from the new services, which included the consumer insights module and the product distribution module that we now have in the Hifyre IQ platform, as well as really a meaningful increase in project-based work that we do within the data business. We do see the run rate for the digital revenue segment being in and around $3 million. We do see some opportunity for growth in that in the future. Of course, Q4 for this year with the stub period, weâll really maintain that monthly run rate that we have there, but we do see this trend continuing throughout 2023 with a run rate of quarterly recurring revenue in and around $3 million. Great, appreciate that color. Turning to retail, just wondering with the first full quarter of the Sparks Perks membership program and market and improving retail sales that we saw this quarter, are there any provinces in particular that stood out in terms of consumers responding well to the new membership program, and any provinces you think you may need to do a bit more work to get the message out there or continue to re-calibrate the store network? Yes, great question, because this was new. We entered a program that we needed to sell to consumers, and Iâm really excited because itâs been really a positive reaction in every market we operate in. Weâve made gains in market share in every province we operate in, as shows in overall gains in market share, so every market has responded quite similarly so we definitely try to--we follow our metrics on a weekly basis, so we think we made the tweaks that are necessary to remain with a positive trajectory but weâve seen every market respond to that offer. Best products at the best prices is definitely a value play that people were happy to see us take, and the fact that weâve been able to grow our gross margin percentage throughout all of this is really a testament to the hard work that the team has done to find the right sweet spot that customers respond to but that doesnât give away the farm. I can provide some further commentary on that, if you like as well. I think that what we see as well is in terms of the gross margin profile that comes across each one of the provinces, historically weâve seen a little bit of a healthier gross margin profile in the province of Alberta with greater upside in the province of Ontario, so we did see some very significant sales growth with some gross profit growth in the province of Ontario which certainly drove a lot of the improvement in that, and Alberta continues to be strong. What is really interesting, though, is the category performance specifically. When we look at where weâve driven gross profit increases, the largest increases in gross profits have come from the categories of pre-roll and vape, where we saw gross profit percentages increasing north of the 20% increase in variance sequentially to quarter, so I think that thereâs two ways to look at this. You want to look at what the growth is in a particular province, but as well when we look at our merchandising strategy and our assortment strategy, how weâre really using a tailored and targeted approach to drive price credibility with the member price program, but then also layer on the ability to drive additional gross profit dollars through basket adders and categories that are higher margin categories. Maybe another quick one, if I may, and--a quick one here. Just on the SG&A, we saw in the third quarter--you know, obviously being closer managed. Did that represent a full quarter of the actions you took or is there still more of that to flow into Q4? The Get to Green program really was initiated really at the beginning of--when I came in, and weâve got initiatives that we could action really short term and youâre seeing the benefit of that, but there is more of these initiatives that we can action along the way. Obviously leases, reviewing our leases is one example where sometimes it takes time to action some of these initiatives, so there is more to come there, and really itâs going to be a key contributor to our--to positive free cash flow, but there is more capacity for us to extract and reduce our SG&A as a percentage of sales. Thank you. As a reminder, if you wish to submit a question, please press star followed by one on your telephone keypad now. Just on the gross margins, Iâm wondering if we could parse out the gross margins for retail versus digital and the improvement in the quarter. Was that largely driven by the digital strength, and are you seeing any stabilization of the gross margins for the Canadian retail market? Iâll ask John to just give us the split between the retail gross margin and digital here, and--but weâre definitely seeing a stabilization on our side of retail margin and even growth, as Chris mentioned. We saw improvements in gross margin from all three segments, so with retail, gross margin improved to 24% from 23% last quarter. On the digital side, it also went up from 89% to 91% this quarter. Like Stéphane said and Chris explained, the improvement is really contributed by leveraging our digital insights as well as our Sparks member programming, so despite--you know, we were able to improve margin because it gave us differentiation in terms of some of the product mixes. On the wholesale and logistics side, despite the decline in overall revenue, the margin actually also improved from 11% to 14% - again, thatâs mostly driven by improvements--increases in the Open Fields business. I was just--well, no. Maybe just again a bit more color on the gross margin on the retail side. Thatâs where a lot of the work that weâve put into--and I think your question was really also to get more color on the ability for us to continue growing that margin in the markets. Maybe Chris can give us a little bit more color again there. Yes, so I think as it relates to the competitive market, what weâre really watching is as weâre driving this merchandising strategy, as weâre driving change in the organization, what are the effects on the market share that weâre seeing. Weâre seeing continued improvements on the market share. I think to the question of the margin profile across the industry as it compares to Fire & Flower, I think thereâs two ways to look at that. You want to look at what the margin profile is from retailer to retailer, but as well what the sales mix is, because the sales mix is really going to determine where you can drive incremental margin opportunities in those categories. I think that what weâre seeing is across the industry, weâve seen--you know, we have seen increases in gross margin percentage at product. I think the distinguishing factor here, though, is rather than taking a blanket discounting strategy, how we look at a particular category, like the category and sub-category of multi-pack pre-rolls, the dry flower format, these are a lot of those categories that are driving traffic and driving price credibility in the market, but then again, how do we layer on a category like vapes. For instance, we significantly over-index in the vape category, so the category average across the industry is 15% in the category, weâre producing 22% of that, so itâs certainly a higher margin category. Edibles, we over-index slightly, and then weâre basically flat on flower to the rest of the market, so. That would be how I would look at the distinguishing factors between how weâre performing and whatâs out there in the market, but definitely seeing positive trends in terms of the gross margin percentage offered to the customer. Then in the opening remarks, I believe I heard there was some project-based work. Iâm just wondering what that project-based work contributed in the quarter and what is the expectation going forward, or maybe to ask another way, whatâs the pure recurring revenue or a good run rate to use for the digital services revenue? Thanks. I think our run rate of around $3 million per quarter is what you should be using. As Chris mentioned before, there is opportunities for growth. Weâve launched a new module there, so I think for your modeling, you should be using a $3 million recurring in digital with opportunities to increase as we expand our co-located store franchise network and get more activity south of the border as well, which will flow in our digital revenue. Yes, we donât report the detail of the revenue within that quarter and within that segment. I would say that the amount thatâs coming from recurring revenue is the most meaningful amount in that segment. The other piece I would really draw your attention to, though, is for this quarter, weâve produced--really, 10% of the revenue mix has come from the U.S. market, so as we look to further commercialize the Hifyre software business in the U.S, we expect there to be some opportunity on that, but a majority of the revenue and the Canadian revenue is coming from recurring-based revenue in that, and then the U.S. [indiscernible] certainly watch for. Thank you. As another reminder, if you wish to submit a question, please press star followed by one on your telephone keypad now. I guess my first question is just coming back to gross margin at the retail level. I think Chris mentioned--you know, he talked about Ontario, the improvement there, and I know that you guys have the Spark Perks member pricing program and you are leveraging that to grow margins, but are you seeing any impact of in terms of [indiscernible] pressures easing across the markets youâre in, any specific province where you see store closures from competitors and potentially benefiting you in terms of sales per store and margins? Good morning Fred. I would say again, itâs really across all markets, weâre seeing the competitive landscape changing. I think there is--and weâve heard it from others as well, thereâs been less pressure on margins as well as store closures really across the country, and even when the stores donât close, I think anecdotally weâre also seeing competitors running out of stock, so the fact is the stores may not be closed but they may have reduced their hours, they may have reduced their inventory to conserve cash, so this allows us to get into these markets and just increase our market share and take advantage of the situation by having the right product at the right price, being in stock, having our staff knowledgeable about the products and having the staff engaged and working with the tools we have with Hifyre to make recommendations to these customers, driving them to buy one more unit with us, come back one more time. All of that makes for us inching our way up on market share in every market that weâre in, so I would say--like, a market like Saskatchewan is one where weâve grown substantially, weâve established ourselves as a leader in that market, and weâre happy with the growth that weâre seeing there. Weâre also extremely happy with the market of Toronto. The Greater Toronto market has really been one that has performed extremely well for us, so even though--you know, you could say that Ontario and Toronto is a tough market, and it is, but weâre seeing our stores really pick up substantially in it, which bodes well for us because we obviously want to have a leadership position in Ontario, and seeing how stores react in that usually important market in the GTA is really encouraging for us, seeing that the strategies work. Okay, thanks for that color, Stéphane. Then related to that as well, you are increasing sales per store on an annualized basis, you had a good increase this quarter. I assume you want to keep that growing and I assume that you are growing that, but do you expect that same pace of growth going forward, and how do you balance that with trying to keep your gross margin increase as well? How do you balance growth with profitability from that standpoint, and is there any gross margin level that you think youâre targeting and that you think would be sustainable over the long term? Thank you. Thatâs a great question, Frederico. Weâre obviously balancing that, it is a balancing act - thatâs really the right word to use here, so we really track transactions, when we increase transactions in our stores. We have more people coming in our stores - thatâs a sustainable trend. Weâve seen this trend now for the last three quarters, since really the launch of the member pricing program. Weâve seen increases in transactions per store, increases in units sold per store, so weâre getting more people in our stores and weâre getting them to buy more units. Now, the price compression hasnât helped to support actual sales dollars, but we havenât sacrificed gross margin dollars because weâre--as weâve seen, as weâve tweaked the make-up of our mix, as Chris said, weâre playing with our mix, weâre playing with the products that we buy, and weâre constantly looking at market share. Our goal is to sustain the market share and grow it, and as Iâve mentioned before, there are factors external to us in the competitive market that I believe will allow us to continue growing our sales, average sales per store simply by executing on what weâre doing right now and making sure we continue to adapt and change the sales mix quickly, react to changes and really track the market share and make sure we capture our fair share of what will be released in the market when competitors close. Okay, thank you. Then maybe just a last question here on your Circle K co-located stores. It seems like it has progressed well in terms of pace of expansion there, and I know itâs early days, but you could comment on any differences you see in terms of sales per store for those co-located stores versus your corporate stores, and also not only your sales but also, do you see any difference in the gross margin profile from customers that buy in those Circle K co-located stores versus for corporate stores? That obviously is something that weâre going to track very closely, because we believe that they will--they will be reacting a bit differently than the rest of the network. Itâs very early, so weâre tracking them on a weekly basis. Weâre seeing week-over-week growth thatâs extremely encouraging because weâre obviously coming in markets where other players are established, so really inserting the new stores there but building on the existing traffic thatâs already coming to these locations, sometimes on a daily basis. What we see is we have a lot of customers that come back more than once a week. Anecdotally, when talking to the managers of these stores, that were previously managers of single store, even competitor stores, weâre seeing customers there being a little less price--a bit more elastic on pricing and, letâs say, more interested in convenience than large packs. I think what weâll see there is a little bit of capacity to extract more gross margin from these transactions and a different mix, probably more with--it could be less units per transaction but more transactions. Itâs early in the life of these stores, but weâre excited to see the week-over-week growth for these stores that, as I said, were just inserted in markets that were already quite busy with competitors, so weâll come back with more learnings as we go in the next quarters, and weâll be happy to share that as we believe itâs a great lever for our own growth here. Thank you. As a final reminder, if you wish to submit a question, please press star followed by one on your telephone keypad now. At this stage, we currently have no further questions, so Iâll hand back over to you, Stéphane Trudel for any closing remarks. Thanks for joining our call this morning and for your interest in Fire & Flower. We look forward to continuing our mission of delivering cannabis to the world and to share our progress with you the next quarter, so have a great day and thank you.
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EarningCall_1632
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Good afternoon. And welcome to the Fourth Quarter and Fiscal Year 2022 Calavo Growers Earnings Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] Good afternoon. And thank you for joining us today to discuss Calavo Growerâs Financial Results for the fourth quarter and fiscal year 2022. This afternoon, we issued our earnings release and it is available in the Investor Relations section of our website at ir.calavo.com.. With me on todayâs call are Brian Kocher, President and Chief Executive Officer; and Shawn Munsell, Chief Financial Officer. We will begin with prepared remarks and then open up the call for your questions. Before we begin, I would like to remind you that todayâs comments will include forward-looking statements under federal securities laws. Forward-looking statements are identified by words such as will, be, intend, believe, expect, anticipate or other comparable words and phrases. Statements that are not historical facts, such as statements about expected improvement in revenue and operating profit are also forward-looking statements. Our actual results may vary materially from those contemplated by such forward-looking statements. A discussion of the factors that could cause a material difference in our results compared to these forward-looking statements is contained in our SEC filings, including our reports on Form 10-K and 10-Q. Thank you, Julie, and good afternoon, everyone. We appreciate you joining us for the call. Today we reported fourth quarter earnings that demonstrated continued momentum, as gross profit and EBITDA, both improved sequentially and versus the fourth quarter of last year. Continued recovery in the Prepared segment, with better performance in both the Fresh Cut and guacamole divisions led our improvement by generating a segment margin of over 9%. Earnings were moderated by a slower than expected recovery in the Grown segment, as the excess Peruvian fruit that pressured market pricing at the end of Q3 remained in the market well until October. Gross profit was down sequentially for Grown, but higher than the prior year quarter. Just as a reminder, Grown is the new name of the segment formerly known as Fresh and Prepared is the new segment which represents the combinations of the old RFG and Food segments. When providing a little more detailed on the Prepared segment, you may also hear us refer to Fresh Cut as the former RFG and guacamole as the former Food segment. Looking at the full year, almost every relevant financial metric improved versus fiscal 2021. Shawn will discuss in more detail, but as some highlights, earnings improved compared to 2021 with gross profit of $16 million to $74 million, adjusted EBITDA up $8 million to $35 million and adjusted EPS of $0.15 a share to $0.50 a share. Gross profit increased in both segments, but particularly in Prepared where most of the Project Uno benefits have been concentrated. Prepared gross profit more than doubled to $23.7 million for the year as significant turnaround progress in the Fresh Cut division overcame lower profit from the guacamole division caused by input cost pressure. Grown gross profit increased by $2.4 million to about $50 million for the year, as higher gross profit per carton, resulting from our margin management efforts more than offset volume declines caused by lower supply from Mexico. In addition to the financial improvements that we achieved in fiscal 2022, it was also an important foundation setting year where we had some notable accomplishments. Among those, we reduce the size of our Board of Directors, while increasing its diversity and independence. The board also imposed minimum stock holding requirements for directors and officers that significantly increased our key leaders personal financial commitment to Calavo. We completed our executive leadership team and have aligned our compensation programs to company performance, so that at least 50% of our named executive officers total compensation is performance and/or stock based. We implemented controls, processes and procedures to run the company more efficiently and effectively. We also refreshed the Calavo brand, logo and website to support our One Calavo vision and future growth plans. In Mexico, our Jalisco avocado packing facility was officially certified for exportation to the U.S. and immediately began providing us with more optionality when buying fruit from Mexico. And most importantly, we are building a culture and a team that prioritizes continuous improvement. Although announced after the fiscal year end, Iâd also like to take a moment to talk about the long-term ESG goals we published last week. The goals are focused on four pillars, climate action, social responsibility, sustainable agriculture and sound governance. The overall ESG efforts embedded in these four pillars cover more than half of the United Nations Global Goals for Sustainable Development. Some of the key highlights include reducing our carbon footprint, reducing food waste, investing in our communities, supporting sustainable agricultural practices and transitioning to sustainable packaging. To embed these practices into our business, our governance structure and our enterprise risk management systems, we are committed to transparent ESG reporting. And we have committed to future independent third-party audits or verifications of our ESG disclosures. We are fortunate that we operate in an industry and service product lines that are inherently sustainable and responsible. So it is very easy for me to emphasize that our commitments to ESG are identical to and will complement our commitment to shareholder return and capital allocations discipline. Calavo can and should play a role in transforming the sustainability of the food industry and we believe these ESG goals will help us do more than our fair share. In other exciting news, Iâd like to share that Calavo has entered a licensing partnership with General Mills as the exclusive U.S. manufacturer of Old El Paso brand fresh guacamole and salsas. The product launched this fall and we are proud to be involved with the iconic number one Mexican brand in the U.S. About a third of all U.S. households purchase Old El Paso products on a regular basis and these new fresh products are a great brand extension for Old El Paso, as well as a consumer differentiator that Calavo can leverage for growth. While 2022 had its share of challenges, I am proud of all the work from the entire Calavo team that enabled us to deliver meaningful, improved financial results and set a solid foundation for growth in 2023. We are committed to achieve our strategic and financial goals, and we are excited about the future and about expanding our leadership position in both prepared foods and avocados. Thank you, Brian. Consistent with prior quarters we provided year-over-year comparisons in our press release. So I will focus my discussion on a sequential basis from the third quarter. On a consolidated basis fourth quarter revenue was $244 million, a decrease of $98 million from the third quarter of 2022. Grown segment revenue was $119 million, down $88 million from the third quarter, as the average selling price of avocados decreased by 45% from historically high summer prices, while avocado volumes were about 2% lower as a result of our margin management efforts. Prepared segment revenue was $125 million, down $10 million from the third quarter, primarily due to seasonally weak volume in the Fresh Cut division. Consolidated gross profit was $20.4 million, up $1.8 million from the third quarter, primarily driven by a $5 million increase in gross profits in the Prepared segment, partially offset by a $3 million sequential decrease in Grown. The Prepared segment benefited from significantly improved results in the guacamole division, where margins rebounded from Q3 levels as fruit cost declined and we started to see the impact of yield improvements from operational changes. Although, we achieved an average gross margin in the mid-teens for guacamole for the quarter, by October margins had reached the mid-20% range. Our Fresh Cut division posted an average gross margin of over 8% in the fourth quarter. Grown gross profit fell sequentially, as avocado volume declined about 2% and we manage the business for margin during the quarter, amid still challenging supply/demand conditions for most of the quarter. With the Peruvian season in full swing and new crop Mexican harvest hitting the market, avocado prices fell sharply from Q3 levels down about 45% for the quarter. Profit per carton declined from Q3 and average below our targeted range for the quarter, but began to recover in October as the Peruvian supply tapered off. For the fiscal year gross profit totaled $73.8 million, up about 29% from $57.4 million in the prior year. The $16.4 million increase is attributed to a $14 million increase in the Prepared segment and a $2.4 million increase in the Grown segment. The $14 million gross profit increase in Prepared for the year consisted of an increase of over $23 million in the Fresh Cut division offset by declining gross profit in the guacamole division. The rebound in the Fresh Cut division reflects the benefits of the various initiatives executed through Project Uno, which totaled approximately $46 million for the year. The decline in earnings in the guacamole division for the full year was largely a function of higher fruit input cost, which average more than 40% higher than the prior year. The $2.4 million gross profit increased in Grown for the year primarily was driven by an increase in per carton profitability for avocados that more than offset a 12% avocado volume decline and unfavorable foreign exchange impacts. For the full year avocado volume was down about 12% as we source more volume from California, Peru and other origins to compensate for a decline in Mexico supply. For the year total supply from Mexico was down an estimated 15%, while our Mexico volume was down about 17%. SG&A was $17.1 million for the quarter, up from $16.7 million in the third quarter of 2022. Higher SG&A included the impact of short-term incentive expense that was disproportionately higher in Q4 of 2022. Adjusted EBITDA was $9.6 million for the quarter, up from $8.1 million in the third quarter of 2022, mainly driven by the gross profit increase in Prepared. Relative to prior year, fourth quarter adjusted EBITDA was up $8.2 million, primarily driven by a $10.1 million gross profit increase in Prepared. For the year adjusted EBITDA totaled $35.1 million, up from $26.8 million in the prior year, as higher gross profit in both Prepared and Grown was partly offset by higher SG&A costs. Now turning to our financial position. During the quarter we sold our Limoneira shares for gross proceeds of approximately $18.5 million. We use the proceeds to pay down debt and ended the quarter with about $7 million of total debt, which included about $1 million of borrowings under our line of credit, plus other long-term obligations and finance leases. Unrestricted cash and equivalents totaled about $2 million as of year-end, which left us with a negligible net debt level at year end. In total, we reduced our net debt position by about $38 million for the full year, available liquidity was approximately $30 million at year-end. We invested $2 million in CapEx in the fourth quarter, which brought our full year CapEx investment to approximately $10 million. Now we will briefly share some thoughts on fiscal 2023. We expect Grown volume to rebound in 2023, as various industry sources estimate the Mexican avocado crop to be 10% to 20%, larger in 2023. Additionally, Jalisco fruit will be available for export to the United States for the entire season. With the current supply estimates, we also expect pricing on a per unit basis to be less than 2023 than in 2022. Despite expectations for increased avocado supply and lower prices, with our model as a marketer of fruit, expect deli buying a fruit and deli pricing of fruit and inventory management that will allow us to again achieve avocado gross profit within our targeted range for the year as we did in 2022. Lower avocado prices will also reduce input costs for the guacamole division in fiscal 2023, which, when combined with production efficiencies already in place and from some capital projects underway, we expect to generate guacamole division gross margins that approximate 25%. We will work to continue improving our Fresh Cut operations and expect to exit 2023 delivering a gross margin run rate of 10% to 12%, but keep in mind that the first quarter will be seasonally weaker. We also plan to increase the proportion of deli business in our Fresh Cut division starting in mid 2023, which will support earnings and help to dampen seasonality. There may be some transitional impacts as we onboard the new business. Seasonality plays a significant role in the cadence of our earnings. Although, we expect to continue improving the business in 2023, Q1 is seasonally our weakest and we expect around 15% to 20% of our full year earnings to be generated in Q1. We expect our Q1 Prepared earnings to declined by about a third from the Q4 level. We also expect to invest approximately $18 million in CapEx in 2023, as we pursue more profit improvement and growth projects primarily in our Prepared business. Thanks, Shawn. To build on Seanâs comments regarding our outlook for fiscal 2023. In addition to increased avocado volume coming from Mexico, we expect our Prepared segment volume to benefit from our growth initiatives, as we onboard new products and new customers. Some of them we have already successfully closed the sales process. We expect continued improvement in our Fresh Cut business as we work to further refine processes and gain efficiencies through Project Uno. Please keep in mind, we do experience seasonality as Shawn mentioned, that will soften earnings in Q1. To-date, we have achieved $46 million in annualized savings of the $70 million we set out to generate when Project Uno was announced last year. And we are on track to deliver the balance of the savings by the time we close the books on fiscal 2023. Even before then, I suspect the title Project Uno wonât be needed, because it is simply our way of operating. Itâs not a project with an expiration date. Itâs a systematic ongoing process to manage our business for success. Pricing optimization will always be our focus, labor efficiencies will always be our focus, controlling input costs will always be our focus. Those things are not going away, when we reach the $70 million mark. They arenât ever going away. I am really proud of our team for how they have embraced change to achieve the best results for the company. In fact, I am counting on our organizationâs agility to further accelerate change. We currently are in the process of developing our long-term strategic plan that will take Calavo into the future. Up to this point, I have kept things very simple by focusing on being better today than we were yesterday and by being better tomorrow than we were today. Continuous improvement will always be an expectation at Calavo. But we need to have a fixed point on the horizon that guide us and we will have that with a good strategic plan. I will present the plan in more detail in the coming months, but after stabilizing operations and creating a structure thatâs now scalable, we are planning to shift Calavo from a company thatâs improving to a company thatâs growing. Thank you. [Operator Instructions] Our first question comes from the line of Ben Bienvenu with Stephens. Please proceed with your question. Doing fine. So I want to ask with respect to your 2023 outlook, the cadence comment -- commentary is helpful when thinking about the Prepared business in 1Q versus 4Q. I am intrigued by your commentary, which you have provided before, but I want to dig into a little bit, about a run rate margin in the Fresh Cut fruit business of 10% to 12% exiting 2023. And I want to ask, is that an annual run rate you expect or should we interpret that as what you will margin -- your margin will be in the fourth quarter as you exit 2023. And I asked, because, as you highlighted in your comments 1Q and 4Q are generally seasonally lower margins that we should we be thinking about like a 2024 margin thatâs between 10% and 12% or is actually potentially higher than that? Hey, Ben. Thanks. Itâs a great question. And Iâd like to, if you donât mind that, we will answer that question. But one of the things that I want to try to do is put all of this in perspective and we will put some perspective of 2023 as well. I have been here almost a year now, and in fact, since I was announced the CEO, it has been a year. And if I think about the change thatâs happened over the course of the last year, thereâs been a lot of things that that this business has been able to manage and go through and still drive improvement. I mean, think about the Grown segment, we had an avocado business that saw 15% less Mexican volume in the market, market prices that went from $35 a case to $70 a case back to $30 a case. So extreme volatility. And somehow in all of that, in that Grown business, we managed to deliver gross profit per case, that was what -- for the year anyway, over a course of time, right in the middle of our guidance of $3 a case to $4 a case. We managed to increase the gross profit dollars and we managed to do that when volume was down almost 12% for the year. So I mean a lot of good resiliency there. I think, most importantly, and this gets to some of your question regarding 2023 and the run rate. The Prepared Fresh Cut business really has been a bright spot for us. If you think about it, when I took the seat, I think there was a large part of our investment community that didnât even know if this was a legitimate business. Could we even make money at that? And we have gone from zero gross profit to a business, at least for the last half of this year, average right around 8% gross margin percent for the last half of the year. So as we think about heading into 2023 and then exiting 2023. Think about that number of 10% to 12% as an annualized number. They will still be a little bit of seasonality and it will be less than that, and I am sure in the first quarter, probably, less than that in the fourth quarter, but annually, very similar to how we guide annually to the gross margin per case in avocado business, annually we ought to think about that Fresh Cut business as 10% to 12% exit rate headed into 2024. Okay. Very helpful. Yeah. The 9.4% margin in the fourth quarter, I mean, thatâs the highest Prepared. If you look back historically, one of the highest margins you guys have had in the combined businesses in a long time looks to me like since 2018. And what -- I am imagining the seasonally a lower margin quarter, and then you mentioned, the higher avocado costs, which would come down, but the exit rate is stronger out of 4Q. So definitely see the progress occurring and you have⦠Yeah. Ben, think about that when we talk about inflation that we probably havenât seen in 30 years, I donât know. Think about it in -- as we have swapped out an entire management team, changed compensation plans to incentive performance-based compensation plans, restructured our balance sheet and really reduced net debt to almost zero. I mean, thereâs a lot of good things that happened this year. And certainly that that run rate and the results so far in our Prepared segment have been -- that Prepared Fresh Cut division has been really good. We still have a ways to go and we are not happy and that last bit will be harder than the first chunk of margin enhancement. But we are proud of what we have done in Fresh Cut. Yeah. And Ben, this is Shawn. Just o add on. If you look at the performance for Prepared in the quarter, I mean, it wasnât just the Fresh Cut business, it was also the guacamole business, but it wasnât just the price relief in the guacamole business from the input cost. We saw a meaningful improvement in our operations from some of the operational initiatives that were undertaken in the summer, we saw that really start to take hold, call it, in September and October. So, we should see the full benefit of that in the current quarter and beyond, but it wasnât just Fresh Cut. Okay. Okay. Great. Yeah. Definitely stands out as a positive in the quarter and for the year. I want to shift gears a little bit to, in the quarter, which stands out as a little bit of a negative volume on the Grown side, which is a little bit antithetical to kind of what we saw in the industry where volumes grew substantially. So could you talk about nuance that might be involved in in your volume declines in the quarter versus the market that looks like it grew and help us understand what happens there, because next year you are highlighting that business growing in line with the market? Yeah. Ben, I think, the one little wrinkle that I would say that we really tried to manage in the fourth quarter was, if you remember, at the end of the third quarter, we mentioned that there was quite a bit of fruit in the market that prices had decreased dramatically. In fact, I think, in July, we even said prices decreased $20 a case in four weeks. We saw some of that still lingering probably longer than we expected in our fourth quarter. That was proving fruit that was available in the marketplace well until October, some of the Mexican fruit started arriving. So at least short-term, we really switch to a philosophy of margin management as opposed to necessarily volume management. Every now -- in a commodity trading environment, thereâs some volume that I would call transitory. You can give up and when you want, you can get it back with the right pricing methodologies. And so thereâs a little bit of our volume decreased that that went down in the quarter when the industry went up, because we wanted it to, we were managing for a better gross profit per case, as opposed to just pushing volume through. And again, through the course of the year that will adjust and that will change. There will be times when the dynamics are right on the supply side and the pricing side that will push as much volume as we can. This one was a quarter that it just made more financial sense for us to be disciplined in managing margin versus market share. Yeah. Okay. Make sense and totally get it. If I could ask, well, I know you are going to provide us the detail on a few months. Could you talk a little bit about kind of what you think is in the architecture of your long-term plan that serves as kind of guiderails for you guys, as you think about the long-term goals of the business? Even if you canât give us the components of it? Yeah. I -- you are right. We wonât give you the guts today. But if you think of this business, think of the foundation -- foundational change we did in Calavo. We now have a Prepared segment that is delivering best-in-class customer service and fill rate numbers. We have a infrastructure in our Grown business that that is running effectively, efficiently and servicing the customer as well and both of which have capacity. We operate in categories that are growing on a unit volume and a consumption basis may not be as growing as fast as it was 10 years ago, but growing, both avocado, as well as the convenient, ready-to-eat, Fresh Cut and guacamole segments, so growing. So, in general, I think, you are going to see a strategy that comes out thatâs based on growth across all of our segments, Grown, Prepared, and then even in Prepared in both Fresh Cut, as well as guacamole, and then you will see a segment that or at least a guardrail based upon return on invested capital, because we think, thereâs really smart investments that we can make and then thereâs some investments that might get us growth, but none of us would be happy about and I am not interested in those. We are -- Shawn and I are really disciplined. We want to make sure that when we make an investment, itâs got a really good chance to be accretive to our overall return on invested capital. But think of Calavo is switching from stabilization and level setting to growth now and growth across all segments. And I will tell you a couple areas. We have already made investments in the international sales group. We are under indexed in international sales. And I think thatâs an opportunity that, that we probably havenât devoted much time and attention to at Calavo over the last three years or four years. But the market is right. The supply environment is right. Our operational structure is now right. And so you are going to see a lot of emphasis on international growth. And then you are going to see a lot of emphasis on growth within our existing categories too in capturing more than our fair share of the category growth. So hopefully that helps a little bit. Yeah. Thanks, guys. So just a quick follow up on one of Benâs questions. So we had a pretty sticky excess Peruvian supply coming in and I also know that thatâs typically lower quality fruit. But it -- but obviously it will affect the pricing in the market. Is this something that that would -- is this now going to be an annual issue something we will have to deal with, are they adding capacity in Peru and how is -- is this going to be somewhat of a structural change in the market? Eric, that -- first of all, thanks for calling in and good to hear from you. It is a great question and itâs one that we started preparing for six months ago. And the reason I say that is, we have been expanding our sourcing regions for the last several months. I think we have had a little bit of Peruvian volume, but I wouldnât say, we are as efficient or as in-depth in Peru as maybe some of the other marketers. So we have grown our Peruvian volume this year. We will grow our Peruvian volume next year, not only increase when I say grow, I mean increase. Not only will we have our current supplier, but we have got three others that are lined up for Peru. We -- in fact, we were 33% higher out of Peru this year than we were the year before and I suspect that will at least be half as high again next year. Colombia, we went from a couple of test loads last year to a significant volume and we want to expand Colombia again as well. Jalisco opening up, gives us at least another option in Mexico and a chance to take optionality in our favor when the conditions are right. So Eric, I think, the -- yes, Peruvian overall volume is growing. Remember, itâs about the size or now a little bigger than California. So we are preparing as if thatâs a regular part of our business and our market. We are preparing our supply chain to address and adapt to that. I will tell you one thing thatâs interesting, though, when you think about growing supply. We believe the Mexican crop will be higher. When you are growing in supply, I really like a model of buying and selling every day. I really like the fact that we can control our inventory every day. If we donât like the price, if we believe we are good on inventory, if we are a little long, we donât have to buy. We donât have to keep bringing fruit to them to what could be a rough market and thatâs why we continue to believe that we can deliver $3 a case to $4 a case in gross profit, is that we have got this model as a marketer and it allows us to bob and weave and ebb and flow like a commodity trader shoot and diversifying our supply is just one more path to allow us to do that. Okay. Thanks for that. So I have just two more questions. The second one here is and we havenât heard any discussion on this in some time, but I would think that you are pulling -- putting together some longer term plans. The previous management for a whole number of years, they basically look at the U.S. market as being a 4 billion pound -- they said the U.S. market could absorb and eat all of about a 4 billion pound avocado market. I think right now, I donât know where this year ended, help me with this number, it might be in that 2.3 million pound to 2.4 billion pound range, but maybe itâs a little higher, maybe itâs a little lower, if you have got an answer that would be helpful. But do you still believe this market has the potential of growing to, letâs say, that in the proximity of 4 billion pounds? Hold on, Eric. We are doing some quick math. But hereâs what I will tell you about overall growth. I think that the U.S. market has the opportunity for continued growth, both in terms of consumption, but also in terms of consumption per capita in geographic regions. If you think about it, consumption per capita in the East Coast is about one-third of what it is on the West Coast. And so there are consumption opportunities. There are overall growth opportunities. We see growth in food service with either avocado or avocado comprised products. So I do think the market can grow. If I -- when we do our quick math, we see the -- we say the market is somewhere around $3 billion in pounds. Can it grow more from there? Absolutely, it can grow. That being said, the world is a big place and there are pockets and places in the world that are growing faster than the U.S. market, both in terms of penetration, as well as consumption for capital. And we are investing in infrastructure, both on the supply side and the sales side to take advantage of some of those opportunities for growth. Okay. Fantastic. So the other question that I have and I have been kind of asking for right quite a few years, why you folks havenât tried to get a better presence in guacamole. And now with your announcement with General Mills, that sounds -- it sounds like you are on a path to maybe being a better competitor -- bigger competitor in that Prepared market at retail. So what is the -- does -- is General Mills going to be doing the marketing? What are some of the things you can share with us regarding how you approach the business with General Mills? Well, a good, great, another good question. Thanks, Eric. One, we probably have been under indexed as Calavo and retail and guacamole and missed a lot of growth the last several years. Thereâs no use trying to sugar cut that. A couple of things, we recognize that thereâs an opportunity still that guac is a growing business and that we recognize the value of our guacamole business. It is not just a byproduct of the avocados that we buy and sell on the bulk market. So thatâs I think one thing. This relationship with General Mills is new. We just started marketing the product. But I love the fact that this is a brand thatâs already frequent in a third of the U.S. households and itâs anonymous with Mexican or Latin food. And so here, we get to take advantage on the guacamole and salsa side of a trusted Latino brand in the U.S. and where someone else has done the investment dollars to create that brand recognition. Itâs a great line extension for General Mills, itâs a great consumer differentiator for us and we are excited to keep it going. Itâs early, Eric. I donât want to sound too bullish here. Itâs early. We are in the sales process. We have launched a few products already and we will continue driving that process forward. Hi. Thanks for taking my questions. I have got a couple here. First, piggybacking off of Eric, piggyback up a better initially on the kind of volume side, the intentional volume that was left on the table here kind of throughout the year, not necessarily just in Q4, but really throughout the year. Can you kind of characterize the degree to which that volume is perpetually off the table or do you think of pricing dynamics change that, that volume will come back into play in 2023 and beyond? Well, letâs -- let me break this down for you, Ben, to make sure that we answer it fulsomely. Through the first nine months of the year, our sales volume was down about the amount that overall imports were down for the year. So in general, that first nine months, I would say, our market share stayed relatively flat to what itâs been historically. Unfortunately, itâs been relatively flat for the last three years. It was really this last period and we are -- look, we try to be smart about this and we try to be strategic about this. We are not going to lose and not going to manage the margin so tightly that we lose one of our core customers or lose one of the opportunities with our core customers. But I think if you look at our portfolio, we have a range of customers that buy in all sizes and all quality levels. There are some of those that are more transactional than strategic and the ones that are transactional, they will be there again, because they are transactional. And so our -- I think this quarter, we did the right thing to maximize the margin and forego some volume. We are also confident that if the conditions are different and we have an opportunity to go get that margin or get that volume at a reasonable investment that itâs there for the getting again, because itâs transactional in nature. Got it. Okay. Very good. Thank you. Next question. You talked about the CapEx expectations next year. Can you characterize the intention there by growth versus maintenance and maybe high level initiatives you can talk about at this point? Yeah. So, yeah, CapEx expectations next year about $18 million versus about $10 million this year and so think of that, probably, call it, $1 million to $2 million that is just a matter of timing, so spend that we expected to make in 2022 that slipped into 2023. But the remaining increment, call it, between $12 million and $18 million, that represents incremental profit improvement projects in 2023 versus 2022, most of that is going to be concentrated in the Prepared business. On an ongoing basis, you can think of our sustaining and maintenance investment in the neighborhood of $5 million. Okay. Very good. Thank you. And the -- whatâs about -- the last question I had for you, the Old El Paso relationship. I just want to -- I want to make sure I got this right. So the non -- the exclusive relationship that was just announced, Brian, I believe you said that is an entirely new relationship, correct? So, this is not something that was non-exclusive historically that is now exclusive, is that correct? Hey, Ben. I am sorry. You cut up a little bit at the first part of that question. Could you repeat that? I just want to make sure, was that -- you said this is an entirely new relationship as of this announcement. That -- is that correct or was this non-exclusive before and now is exclusive? Okay. Very good. I thought I heard that right, but I just wanted to make sure. Okay. Very good. That does it for me. Thanks for taking my questions. I will get back in line. Hey, Doug. Thank you very much. Again, thanks for all of the support and the time that you spent listening today. We really appreciate that. We gave you some guidance and thoughts on 2023. And we try to do that to help you shape your understanding of our EBITDA profile, as well as some of the things that we will be focused on over the course of the year. If we are having this call a year from now, I would like to think we will have accomplished a couple of things. We will have formally communicated a strategic plan that provides our organization, our customers and our investors a North Star, so to speak, for this company and where we are headed. We will have managed our avocado business and avocado business that we believe will grow commensurate with and maybe more than the market itself and manage that business in a way that we believe we can deliver gross margin per carton in the $3 a case to $4 a case range. We will have a Prepared Fresh Cut business that grows distribution with its existing customers and new customers, and exits the year on a 10% to 12% gross profit margin run rate. And remember, we said earlier in the call, think of that 10% to 12% as an annualized gross profit run rate. It might be a little lower, a little higher in certain quarters, but annualized in there. And we will have a Prepared guacamole business thatâs growing market share, both in the U.S. and internationally, and delivers gross profit margins approximately 25% or so in that range. And we will do all of that while having a return on invested capital thatâs appropriate for our business and appropriate for our customers and based on very disciplined capital allocation and capital management processes. If we can discuss all of that on next yearâs call, I think, all of us will be really pleased. I am happy with the amount of change we have been able to drive, the foundation we have been able to build in 2022 and still drive meaningful improvement in our profit metrics. But I am not satisfied in 2022. If we can do what I just outlined for 2023, I think we are going to be really happy at the end of 2023 and I can guarantee you one thing. I still will not be satisfied with where we are headed. Thank you for listening. Thanks for your time. We wish all of you a happy holiday, a healthy holiday season and look forward to speaking to you at the next opportunity. Thanks all. Ladies and gentlemen, this does conclude todayâs teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.
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EarningCall_1633
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Greetings and welcome to The Simply Good Foods Fiscal First Quarter 2023 Conference Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Mark Pogharian, Vice President of Investor Relations for Simply Good Foods Company. Thank you. You may begin. Thank you, operator. Good morning. I'm pleased to welcome you to The Simply Good Foods Company earnings call for the fiscal first quarter ended November 26, 2022. Joe Scalzo, President and Chief Executive Officer; and Shaun Mara, Chief Financial Officer, will provide you with an overview of results, which will then be followed by a Q&A session. The company issued its earnings release this morning at approximately 7:00 a.m Eastern. A copy of the release and the accompanying presentation are available under the Investors section of the company's website at www.thesimplygoodfoodscompany.com. This call is being webcast and an archive of today's remarks will also be available. During the course of today's call, management will make forward-looking statements that are subject to various risks and uncertainties that may cause actual results to differ materially. The company undertakes no obligation to update these statements based on subsequent events. A detailed listing of such risks and uncertainties can be found in today's press release and the company's SEC filings. Note that on today's call, we will refer to certain non-GAAP financial measures that we believe will provide useful information to investors. Due to the company's asset-light strong cash flow business model, we evaluate our performance on an adjusted basis as it relates to EBITDA and diluted EPS. We have included a detailed reconciliation from GAAP to adjusted items in today's press release. We believe these adjusted measures are a key indicator of the underlying performance of the business. 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. Please refer to today's press release for a reconciliation of the non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP. Thank you, Mark. Good morning and thank you for joining us. Today I'll recap Simply Good Foods first quarter and provide you with some perspective on the performance of our brands. Then Shaun will discuss our financial results in a bit more detail before we wrap it up with a discussion of our outlook as well as your questions. We're pleased with our first quarter financial and marketplace results in a challenging cost and operating environment. Net sales increased 7% relatively in line with estimates. In the first quarter combined, measured and unmeasured channel, U.S retail takeaway growth was about 14% and as expected, outpaced net sales growth. Shaun will provide more details on the difference between net sales and point of sales growth in a bit. Our strong POS growth was driven by solid Quest performance across key forms, customers and channels. Atkins continued e-commerce growth resulted in about 4% retail takeaway for the brand in the combined measured and unmeasured channels. First quarter gross margin was 36.9%. The 450 basis point decline versus the year-ago period was slightly greater than forecast. Ingredient and packaging inflation as well as trade investment were in line with expectations. However, logistics and contract manufacturing costs were greater than estimates. Importantly, our supply chain team performed well and customer service was near target levels. Adjusted EBITDA for the first quarter was $60.8 million versus $65.6 million in the year ago period. Sales growth which included our July 2022 price increase and SG&A cost control were primarily offset by supply chain inflation. As we move into the second quarter, we're focused on executing against our plans and we are well-positioned to deliver another solid year of net sales and adjusted EBITDA growth. Simply Good Retail Takeaway in measured channels increased 11.1%. Similar to the last few quarters, total unmeasured channel growth was additive to total company POS, resulting in combined measured and unmeasured channel growth of about 14%. In Q1, Atkins and Quest combined measured and unmeasured channel growth were about 4% and 24%, respectively, with top tier performance within the measured channel segments of weight management and active nutrition. Turning to Atkins first quarter performance. Atkins Q1 retail takeaway in combined measured and unmeasured channel was up about 4% as outstanding e-commerce growth continued from the previous quarter with the IRI MULO universe essentially unchanged from the year ago period. Atkins Q1 point of sale at Amazon increased 75% with solid growth across all major forms. We estimate total unmeasured channel retail takeaway increased over 40% and is now about 13% of total Atkins retail sales. The brand continues to benefit from shopper channel shifting to e-commerce as well as improved digital marketing initiatives. Consistent with prior quarters, Q1 brand relevance and loyalty remained strong supported by a growing base of new and total buyers. In Q1 buy rate continued to improve from prior quarters, but was slightly down versus prior year. Within buy rate strength in meal replacement bars and shakes, likely driven by post Labor Day returned to work trends was offset by declines in snack bars and confections as we lapped strong pandemic consumption from those snacking occasions in the year ago period. Moving on to measured channels and the IRI MULO C-store universe, Atkins Q1 POS was about the same as a year ago period, and as expected sequentially improved from Q4. Consistent with recessionary shopper channel shifting, performance was driven by solid trends in the mass retail channel offset by softness in the food class of trade. By form, Q1 sales retail takeaway increased 7.6% driven by solid growth across all major channels. Total Atkins bars were off 6.9%. Meal bars about two-thirds of the bar business were about the same as last year and offset by the snack bar distribution loss we discussed last quarter and price sensitivity. Elasticity on some snack bar items has been greater than our estimates in brick-and-mortar channels. And as expected, confections POS improved from Q4 and Q1 confections retail takeaway was off 5.3% as we started to lap the impact of the strong year ago dessert bar launch. Importantly, the commitment to our brands in the nutritional snacking category by major retailers remain strong. Atkins distribution gains are tracking as expected and strong New Year, New You in-store merchandising and programming is in place. Let me now turn to Quest. Q1 retail takeaway were combined measured and unmeasured channel growth was up 24% and about the same as the IRI MULO C-store universe. In Q1, we estimate total unmeasured channel retail takeaway increased about 20% as e-commerce strength is partially offset by softness in the specialty channel. Quest Q1 POS at Amazon increased about 36% driven by growth across all forms. For perspective, total unmeasured channels in Q1 were about 24% of total Quest retail sales. In measured channels, Quest Retail Takeaway increased 25.4% in the IRI MULO C-store universe. Growth was driven by solid performance across all major forms and retail channels as well as increases in household penetration, base velocity, distribution, and continued success of new products. In the quarter, Quest core bar business retail takeaway increased 16.8%. Growth was solid across the original bars as well as the new minis. Consumer response in the new recipe that provides a much softer original bar has been encouraging. The snackier portion of Quest products that's cookies, confections and salty snacks continued to do well with Q1 measured retail channel takeaway up 41%. Growth was strong across all forms and was driven by increasing household penetration, distribution gains and marketing investments to drive awareness and trial. Consumer response to the price increase initiated in late in Q4 is tracking mostly as expected, although elasticity on chips so far has been greater than our estimates. The Snack segment represents nearly 45% of total Quest measured channel retail sales, and is already roughly equal to Quest bars in household penetration. So it's a sizeable and growing segment for the brand. Further, we expect the segment to continue to contribute disproportionately to total brand growth over the next few years, driven by improvements to household penetration as well as a solid pipeline of innovation. That said, given the significant and increasing size of the segment, we expect the rate of growth over the next few quarters to moderate from its current levels. In summary, we're pleased with our start to the year and our first quarter results. Our retail takeaway was relatively in line with expectations in a very challenging cost and operating environment. Recessionary economy continues to be a concern as higher prices appear to be slowing unit demand in the category and shifting shopper traffic away from grocery to more value oriented channels. That said, we remain cautiously optimistic about our business with strong POS momentum over the first 4 months of our fiscal year. We are well-positioned in the mass and e-commerce retail channels that typically do well as shoppers seek out value. As I mentioned earlier, collaboration with key customers are strong, and they are committed to our brands in the category. As such, in q2, we have good breadth and depth of merchandising and programming in place for the upcoming New Year season. While Q1 gross margin was slightly lower than our forecast, due to logistics and co-manufacturing costs, there is no change to our full year fiscal 2023 gross margin outlook. We would note that we are seeing early signs of an improving marketplace for ingredient and packaging cost for the second half of our fiscal year. We are executing against our priorities and we remain committed to doing the right thing over the near and long-term for our brands, customers and consumers. Now I'll turn the call over to my friend, trusted business partner and prior CFO, Shaun Mara, who will provide you with some greater financial details. Shaun? Thank you, Joe. Good morning, everyone. Before I get into our first quarter results, let me start by saying it's great to be back in the CFO chair. In my CPG career I've worked with Joe for nearly 20 years. We first crossed paths at Gillette in 2000 or we became proficient in the Jim Kilts approach to managing the business. Joe and I ran Atkins together when it was PE owned. And as some of you may remember, I was CFO for the Simply Good Foods first conference call as a publicly traded company in 2017. I then stepped away to recharge and did some consulting. Midyear 2019 Joe convinced me to come back to the company in a different role, running strategy, M&A, and projects, biggest of which was the integration of Quest and the ERP implementation. It was a great opportunity for me to get reengaged with the business, helping to build out the organizational structure, systems and processes and drive the company priorities across the newly designed organization. With Todd leaving, it comes full circle. I'm excited to be back in the CFO role and believe our category and our brands have a long runway for growth. I look forward to helping the company execute against this strategy and increasing shareholder value. Let me now provide you with an overview of our financial performance beginning with sales. Total Simply Good Foods first quarter net sales increased 7% to $300.9 million. Net price realization was about 9.8 percentage points and volume was off about 1.7 percentage points. The March 2022 agreement to license the Quest frozen pizza business was a headwind of 1.1 percentage points. As Joe stated, here, retail takeaway outpaced net sales growth. On the bottom of this slide, we attempt to reconcile Q1 POS of 14% to Q1 North American net sales growth of about 8%. I'm going to walk you through the reconciliation starting with the first line, double pricing of about 1 percentage point. Recall, in the year ago period, some retailers did not increase retail price points until early November, despite being invoiced at a higher price point from mid September. Therefore the POS in the current period reflects the benefit of two price increases from a few retailers up over that period. The timing of trade promotion investment was a 2 percentage point headwind and as previously stated the licensing of pizza was about a 1 percentage point drag. Finally, recall in the year ago period, some customers are likely to build atypically higher inventory levels starting in Q1 of fiscal '22 and continuing through Q2 due to supply chain concerns last year. We expect the retail inventory built in the first half of fiscal year '23 to return to more normal levels. As a result, in Q1 we estimate the change in retail inventory compared to last year to be about 2 percentage point decline. Moving on to other P&L items for Q1. Gross profit was $111 million, a decline of $5.6 million from the year ago period, resulting in gross margin of 36.9%. The 450 basis points decline versus the year ago period was slightly higher than forecast. Ingredient and packaging cost inflation as well as trade investment was in line with expectations, while logistics and contract manufacturing costs were greater than estimates. Net income was $35.9 million versus $21.2 million last year. The year ago period was impacted by the fair value change of private warrant liabilities of $17.3 million. Adjusted EBITDA was $60.8 million, a decline of $4.8 million from the year ago period. Selling and marketing expenses were $28.5 million versus $30.5 million, a decline of 6.5% due to the timing of spend within the year. That said, [indiscernible] spend in Q1 was greater than the year ago period. GAAP G&A expense was $25.6 million, including stock-based compensation of 3.3 million and increased 8.2% versus last year. Excluding stock-based compensation in the current year ago periods, G&A increased 5.8% to $22.3 million. The $1.2 million increase versus last year was primarily due to employer related costs and corporate expenses. We continue to expect the full year selling and marketing and G&A expense will be about the same as the year ago period. Moving to other items in the P&L, interest expense increased $700,000 to $7.1 million due to higher variable interest rates related to the term loan. And our tax rate in Q1 was about 21.3% versus 25% last year. The tax rate in the year ago period excludes the impact of the charge related to the noncash, non-tax deductible warrant liability. The lower tax rate in the first quarter of fiscal '23 is primarily due to the timing of equity compensation. We continue to anticipate the full year fiscal 2023 tax rate to be about 25%. Turning to EPS. First quarter reported EPS was $0.36 per share diluted compared to $0.22 per share diluted for the comparable period of 2022. In fiscal Q1 '23, depreciation and amortization expense was $4.9 million and similar to the year ago period and stock-based compensation of $3.3 million increased $700,000 versus last year. Adjusted diluted EPS which excludes these items was $0.42 compared to $0.43 for the year ago period. Note that we calculated adjusted diluted EPS as adjusted EBITDA less interest income, interest expense and income taxes. Please refer to today's press release for an explanation and reconciliation of non-GAAP financial measures. Moving to the balance sheet and cash flow as of November 26, 2022, the company had cash at $54.1 million. Cash flow from operations of $8.7 million was affected by the timing of working capital. The company continues to anticipate full year fiscal 2023 cash flow from operations will be greater than last year. In the first quarter, the company repurchased shares worth $16.4 million at an average cost of $30.11. As of November 26, 2022, approximately $71.5 million remains available under the company's current authorization. In Q1, the company paid down $6.5 million of its term loan, and at the end of the first quarter, the outstanding principal balance was $400 million with capital expenditures at $1.2 million. We anticipate net interest expense to be around $28 million to $30 million, including noncash amortization expense related to the deferred financing fees. This is higher than our previous estimate of $25 million to $26 million due to the continuing rising rate environment. Thanks, Shaun. With the challenging economic environment we believe we are well-positioned to deliver on our fiscal '23 financial objectives. Year-to-date, retail takeaway is tracking as expected and we have momentum as we enter Q2. We're tracking to our initial full year gross margin target with pricing and cost initiatives offsetting the dollar impact of ingredient and packaging cost inflation. Additionally, we have made significant marketing and organizational investments in the business over the last few years. And we believe it will result in continued growth of our consumer base and distribution. As such, we continue to expect the total SG&A expense dollars will be about the same as last year. Therefore we reaffirm our full fiscal year '23 net sales, gross margin and adjusted EBITDA outlook. Specifically, we anticipate net sales to increase slightly greater than our 4% to 6% long-term algorithm including a headwind of almost 1 percentage point related to the previously discussed pizza licensing agreement. Gross margin is expected to decline, although at a lower rate than fiscal '22. Full fiscal year adjusted EBITDA is expected to increase in line with the net sales growth rate and adjusted diluted EPS is expected to increase although less than the adjusted EBITDA growth rate. As we proceed through the balance of the year, we remain cautiously optimistic about our POS performance. Net sales growth by quarter is expected to be choppy as we anniversary last year's second quarter significant retail inventory build and the second half inventory destock. As we look to the second quarter of fiscal '23, retail takeaway is off to a good start with December POS up about 16% and strong merchandising and customer programming in place for the upcoming New Year season. However, we anticipate that Q2 net sales will be slightly lower versus the year ago period as we expect customers will not repeat last year's abnormally high retail inventory build. Adjusted EBITDA in Q2 is expected to decline upper single digits on a percentage basis compared to last year. Profitability is pressured as a result of lower sales and gross margin contraction due to higher ingredient and packaging costs compared to the year ago period. Given the early signs of an improving outlook related to ingredient and packaging costs, we anticipate gross margin in the second half of the year will be slightly higher versus the comparable year-ago period. This is an improvement from our October forecast where we anticipated gross margins to be slightly down in the second half of the year. We're excited about our near and long-term growth prospects and we're executing against our strategies as a path to increasing the value for our shareholders. We appreciate everyone's interest in our company. And we're now available to take your questions. Operator? Hi. I just had a quick question to follow-up on some of the differential in sales between consumption versus takeaway essentially. And I did see that bridge in the slides, which is very helpful. I guess, I just want to ask, first of all, on the kind of the double pricing. Did that occur again with the most recent price increases, understand that's on could be an ongoing factor. And then maybe related or secondary to that the timing of trade promotion investment was that was promotion up in the first quarter of '23 or was it more of a comparison to the prior year that causes differential in the first quarter? So on the doubled pricing piece, Chris, the reality of that as it didn't happen in the second price increase. Retail prices went up pretty quickly after we saw the price increase out there that you're not going to see that going forward. That was just an impact in Q1. As it relates to trade specifically take a step back a bit on trade. So for the year, for trade, we're going to hold trade as a percentage of sales consistent with what we had last year. So that's not going to change overall, what you're seeing is really a shift in trade a little bit earlier in the year more in the first half, principally around display, promotional packs, some of that stuff was shipped into Q1. So effectively what that is is just a timing thing. And it impacted from gross and the net overall. Does that help? That does help. Yes. Thank you. Just one other follow-up question. You talked about seeing some early signs of relief run input costs, I just want to get a sense of how hedged you are currently. And then are there any signs of competition in the category, they might force you to have to give some of that back or get a little more aggressive on promotional spending? I know you've seen a bit of an increase here from a timing standpoint, but any signs of having to get a little more aggressive on the promotional side. Let me start with the commodity piece. I think what you're really trying to get to is kind of what we think the commodities are going out and where are we overall. I think it take a step back. I'm just going to reiterate what we said at the beginning, I guess about 3 months ago, give or take, so we thought we'd have a double-digit increases in cost of goods sold. And with that, we thought margins will be down versus the prior year, but not as much. Most of that would be in the first half of the year. And with modest declines in Q3, and Q4, as we sit here today, we've seen the softening in the dairy protein market, that gives us confidence that gross margins will be up slightly in Q3 and Q4 from our previous estimates. As it relates to the coverage, we're about 60% covered in ingredient and packaging requirements. So roughly through March, and quite candidly, we want to kind of see what plays out in the marketplace right now[to commit to] (ph) more of that as we think there's more downward pressure than upward pressure. So we can kind of see where we are, as we get towards the later in the year. But things are volatile, we'll see where we are, if we go forward more of a much better picture on that by the time we get to the second quarter earnings call. And to answer your second part, Chris, no our business is predominantly a turn business, about 80% -- 85% of the volume turns off the shelf. So we're not seeing and then we don't have unlike I think a lot of other food categories we're not particularly, because there's so many different forms, so many different price points. There's no one competitive price comparison or brand price comparison that's relevant. So we're not seeing any pressure to deal back from a pricing standpoint. If we would be spending back, it would probably be in reaction to kind of unexpected elasticity response from the most recent price increase, right. So -- and so far, we've done a little bit of that in the first quarter and we're just kind of reading the marketplace and will react as time moves on. Thank you. [Operator Instructions] Our next question comes from the line of Cody Ross with UBS. Please proceed with your question. Good morning. Thank you for taking our questions. You called out logistics and contract manufacturer costs as drivers of the lower-than-expected gross margin. How much did gross margin come in below your expectations? And can you just describe what's driving those costs? Yes, sure for Cody. So let's take a step back. So the Q1 miss versus our expectation was about a $1 million in a rate basis, right. So it's about $2 million overall. Good news and bad news here. I say the good news is the miss had nothing to do with ingredient and packaging costs increase. Those were aligned with our estimates for the quarter obviously mentioned in the remarks and just talked about the we expect that to improve in the second half. The bad news is the miss in Q1, principally related to a few items we did not properly budget for in Q1 that we knew about in Q4. The recurring charges in [nature] (ph) and should have been included in the estimate. Specifically, they relate to some charges from our co-mans for PPV, or materials, they purchased directly, some normal monthly charges from our logistics provider that we didn't properly reflect and some inventory cleanup. We put some additional processes in place to improve the collaboration here between the groups. And we'll make sure that those costs are reflected in the results as well as the forecast. We don't anticipate this being an issue going forward. Great. Thank you for that. And then just one follow-up. You noted how you expect sales to be down in the second quarter due to the timing of shipments last year and lapping that. Back of the envelop math suggests that you expect sales to be up about 10% in the back half. Is our math correct? And then what would drive sales to be up so strong in the second half? Thank you. Cody, as that second part of the question again, I followed you on the first part, I didn't follow that you follow you on the second part? Just if our math is correct, I would suggest that sales would be up 10% in the second half. And then what's just driving the hockey stick bounce in sales growth in the second half this upcoming year. Yes, so well, I'm not sure whether you're asking me an inventory question or a question about the overall health of the business in the second. To Be clear. So I make sure I answer your question. So look, we're really, if you just step back as we stand here, four months into the year, we're really pleased about where we are. So year-to-date, consumption has been strong. And as we've moved into kind of into December and early stages of kind of the New Years, we're actually picking up some speed. So we feel really good about we feel really good about the progress of the business. I don't particularly like the economic environment right now, right. And as we said is, as we've said, in our prepare marks, we're cautiously optimistic about the prospects of growth, kind of as we move through the Q2 into the balance of the year, but the current economic environment facing consumers, I think warrants a fair amount of Caution as we move through the second half of the year, and we're going to come up against a little bit more challenging comparables, and particularly on Quest. But if you look at the dynamic of the environment -- economic environment, you're seeing in food in general category volume has slowed as prices have rise, shopping, be consumers are responding in how they shop so their behaviors have shifted towards value retailers, pretty much across the store, you're seeing the growth of private label, volume is on the rise. And then we're at a point at least in our business, and in this category where prices are - the consumers are facing â are at their historic high. So, why we like our business. We like our business momentum, the environments, not the greatest environments, unclear to me what the second half is going to look like, is it - are we going to see worsening conditions, are the current conditions going to continue? So, we believe caution, like where we are from a business standpoint, like our business momentum, we think caution is warranted in the second half of the year. We'll be keeping a close eye on our consumer response as we move through the second quarter. And then we can give you an update on how we feel about and in the next quarter. Good morning, everyone. Morning. Alexia, can I ask about the international business? I imagine it's a pretty small portion of the total. But you did talk about it being down 16%. And I think you said velocities have come off there. How big is that business? How long are the sales likely to be pressured like this? Just wondering what the outlook is that is there. Thank you. Let's say you're lucky because one of one of one of Sean's response prior responsibilities was running International. So you have somebody that's really familiar with the business, right? Yes, sure. It's about an $8 million business overall international. And that is principally basically called Down Under, which is Australia and New Zealand overall. So if you break that decline now, I'd say about a third of that is exchange. So about a million dollars is kind of also our core business overall. And of that, I think majority of that business decline is the Atkins business. And they've had some issues overall, with the pricing increases and trying to get the product on shelf down there. As we kind of work through the challenges through that, I think it's a transitional thing. Talking to the folks down there, they feel like they're making good progress with the two big retailers. And with that, they should see that pop a little bit more towards the second half of the year. Can I ask about the international business. I imagine it's a pretty small portion of the total, but you did talk about it being down 16%. And I think you said Velocities have come off that. How big is that business? How long are the sales likely to be pressured like this. Just wondering what the outlook is that. Thank you. Alexia, youâre lucky because one of Shaun's response prior responsibilities was running international. So you have somebody thatâs really familiar with the business. It's about an $8 million business overall international and that is principally [indiscernible] which is Australia and New Zealand overall. So you break that decline now. I would say about a third of that is exchange. So about a $1 million is kind of core business overall. And of that, I think majority of that business decline is the Atkins business and they have some issues overall with the pricing increases and trying to get the product on shelf down there or as we kind of work through the challenges through that. I think it's a transitional thing talking to the folks down there, they feel like theyâre making good progress with a two big retailers. And with that [indiscernible] more towards the second half of the year. But Alexia just higher level, we are the number one and I think number two brands in the marketplace in Australia and New Zealand. So at two, they have been on a tear for the last few years. So double-digit growth in their marketplaces as a -- as we bought Quest and move that from a distributor market to a direct sale market. They've done a terrific job of building the business. So this has been the most recent performance has been a pause on what has been a pretty terrific, multi year run for that team. Great. Thank you. And as a quick follow-up, I know the first question was about this gap between consumer takeaway and your reported organic sales growth. As we look forward, do we expect that gap to close? And if so how quickly? And I'll pass it on? Thank you. Yes, so. good question. And let me see if I can simply explain kind of what the situation is, right. So in a typical year, in this business, we build inventory -- retailers build inventory in the first half of the year. And they depleted in the second half of the year. On average, an average year. That's about a week, maybe in some years might be 2 weeks of inventory. Typically it goes in the first and second quarter. Typically it comes out in the third and fourth quarter, by the time you get to the summer, you're back to kind of a steady state level kind of normal level of inventory. Fiscal Year '22 was not a normal year. In fact, it was highly abnormal, given and you have to understand context, right? So supply chains were disrupted. Customers were sending in orders, orders were getting cut. So there was a high degree of sensitivity from retailers not having the inventory they need. So they took a pretty aggressive inventory position. We're not unique in this but they took a pretty aggressive inventory position on our business and the way that played out is in the first half of the year, three to four times the normal of inventory levels built in the first half of the year. And then most of that came out in the second half, and most of that within the fourth quarter. So as we come up against those comparisons in particular in the second quarter, we're not going to be repeating that inventory build from last year. So that shows up as net sales far below net sales rate far below consumption rate. What's really happening is we're not building the inventory then that we then have to take out in the second half of the year. So what's going to happen in q2, our guidance is to be slightly down versus prior year, what's going to happen is what doesn't happen in q2, will then get reversed out in Q4, where we actually pulled a fair amount of inventory out of retail in the fourth quarter. That helps? That helps a lot. Thank you so much for the explanation. I'll pass it on. And Alexia,just one more comment on that whole thing. As you think about that reconciliation from POS down to a sales try to do obviously, there's a little bit of, I think the Point I make is, as you look to Q2, the only things that will be impacted, there is pizza, which is about a point and a half, and then the inventory build or the non-build. So the inventory change overall are the only two things. So as you go forward, that will be the reconciling items. Hey, good morning, folks. So scrubbing my prior year notes, I've got about a $25 million headwind for 2Q, based on lapping that inventory accumulation retails that roughly right? Okay. So thatâs about .a little north of 8 points of drag. You put on 1.5., you got about 1o point. So sales down Okay, so that's about a little north of eight points of dry, you put on one and a half, you got about a 10 point drag. So if sales down modestly, it seems to suggest that you're forecasting POS, high singles, sort of maybe let's call it 70% range which should be a [indiscernible] from the 14 points that you're showing this past quarter. What would drive that [indiscernible]? The aforementioned cautious optimism. Okay, and some of that caution to my ears was coming on the snack side quest, which isn't part just sort of basis act. Can you size that a bit more for us? How large is that as a percentage of Quest sales and specifically zoom in a bit on chips, because in your prepared remarks, you sound a little bit more guarded on ships where I think it's the one and only spot where you mentioned that elasticity was exceeding expectations. I would say our optimism is not brand and form related. Its jus overall economy related. So we're about -- we're in the process of throwing a pretty big New Year, New Year party. We want to make sure consumers show up, right, nothing worse than having displays out, have a lot of customer programming and the consumption not occur, right. [indiscernible] And we make a little of that as you make as you as you remember, last year, Jason, that was clearly the case, we just didn't see the consumer uptake. So if you just step back and look at what's going on right now, consumers are not shopping and grocery. They're moving towards online and mass, they're making value choices in our business. There's not private label alternative. So what happens is, buy rate gets hit, right. So you don't see the buy rate, they pass on a consumption occasion, they may be by one less time. That's what we're concerned about. There's no one product form, brand thing, one customer thing I'm worried about and more worried about the overall economic environment now. We feel pretty good as we moved from November into December, POS started to pick up as we start reading, merchandising that it's in place right now. Feels pretty good. But we still got, we still got two plus months to go. And you know, we're going to be working until it happens. We're going to be cautious about it. Okay, That makes sense. I'll pass it on and I'll keep my eyes open for that invite to the party. Thank you. Hey, John. I wanted to ask about buyer growth at Atkins. Joe, as it is the growth has been pretty strong. And I'm not sure if you can drill into how much of that is driven by your core demographic relative to noncore. But as you build Atkins as a lifestyle brand, how do you think about either extending your existing consumers for longer, or also raising the appeal to non-core buyers. And the other opportunities for more age specific innovation, or age specific marketing may be appealing to older folks who become lapsed buyers over time? Can you creep down a bit to younger consumers? Just how you think about building the next phase of growth at Wow, great question. I wish we had an hour. What I would tell you is this, look, the core demographic is, if you think about the positioning change on the brand, we moved from a core demographic of what we would call programmatic dieters, people looking to want to lose 15 pounds in with an event in mind over a certain period of time, or shift in that, you know, that demographic right, move from those folks to folks who, on average, are worried about their health and their weight every day, right, not looking to lose large amounts of weight, but looking to eat healthier and potentially look better, right, that demographic, the math on that demographic was for estimate the Democrats. So we had about 8 million 9 million programmatic dieter target to something around that 35,34 35 36 million kind of we call them self directed low [indiscernible] people, they want to control [indiscernible], right. Our progress against that has been pretty outstanding. So the program that when we started this, and this is relatively new data, when we started this, buyers of the brand at any one time that were actively using the program to lose weight was at what was about 15% of our buyers, that is now down to single digits. So we in the in large part has shifted the mix of our brand to these lifestyle consumers, which then begs the question, how do you feel about buy rates and dieters probably complying more lifestyle consumers new piece of data, lifestyle, consumers from a buy rate standpoint, buy at the same rate as the average for Atkins. So we're not seeing a tail off in consumer consumption based upon a move towards a more lifestyle consumer. So good news all around. The thing that I think you're asking is, talk to us about, talk to us about are you looking at different demographic groups, I'm assuming you mean, age, ethnicity and frankly, we do a lot of that in our digital platform, right. So a lot of social digital marketing to those groups within and we can handle that question for you offline and a little bit more detail. And frankly, we get you in front of some of the marketing people to talk about some of those things. Good. Morning. I just had a follow-up question on gross margin. So given that gross margin fell short of your expectations in the quarter, but you still expect gross margin for the full year to be in line with your prior outlook? Can you talk about the cadence of the gross margins over the rest of the year? And what's improved in your expectations for gross margins for the back half of the year? What's changed there? Yes, I would say the commodity costs are probably the biggest piece of it, obviously. And we talked about what we think we're seeing in the dairy protein and how much we locked in already. So I think from a standpoint of commodities that's in better shape than we have, we the way we look at this for the year, we see GM improving slightly in the second half of the year, as we said, however, I think if you take a step back on margin, we did have a 450 basis point decline and Q1, that I would say the inflationary pressures that we had led to our second price increase did not start impacting cogs until mid Q2. So remember, in Q1 of last year, our GM was actually up 75 basis points. So as we look at the rest of the year, we expect gross margins to decline in Q2, and for the total year. And just to dimensionalize it a little bit. We expect the total year margin to decline over 100 basis points and the margin decline and Q2 to exceed that. So I don't like give you more context and perspective. Yes, that's helpful. Thank you. And then I also just had a follow-up question to John's question on Atkins performance. I guess in general, what do you believe is driving the divergence in performance between Atkins and Quest? Why do you think that the brands are seeing such different trends and doesn't come back to the occasions and the demographics that they cater to? And what's working well for questions? Could you apply any of those initiatives to Atkins? Yes, well, I'll say they're in different parts of their, their lifecycle, quite frankly. So if you think about the investment thesis that we had in buying quest, our fundamental belief is strong brand, large consumer target, early stages of marketing, brand awareness, penetration growth, moving from a specialty online brand to a more Food Drug mass brand, from a bar only brand to a bar and other snacking brand. And so, as part of the combined organization, we've been able to accelerate all those initiatives, right. And so that's why you're seeing distribution growth on bars, because she's plugged in, play that into the what is essentially the Atkins Food, Drug mass, Salesforce, right. So distribution is growing, great new product pipeline, and snacking and salty snacks and chips. In confections, right? So strong, they've got accelerated the brand has got acceleration, just from our ability to execute strategies that were in place when they were freestanding company. Atkins is further along in its development. So if you just take, like the largest retailer,, take the largest retailer in the world. Atkins has on average, I think 65 items in Walmart. I think at last count Quest was in the 40s. So there is -- there they just different part in their lifecycle from a brand standpoint. So and I think the brand promise, right, this idea of fueling your ambitions, and your day, is a bigger brand promise than the weight management brand promise. So bigger target audience more people that you can go after bigger opportunity for household penetration. And we're still in the very early stages on Quest of mainstream communication via television, ramping up the spend, Atkins is just in a different parliament in its lifecycle. So I think that's accounting for kind of what's been driving Quest. On the Atkins side, it's a brand that is highly dependent upon buy rate. So if you look at the brand, on average, if you're a multiyear, buyer of the brand, your daily slash multiple times a week eater. So 100, if you're an average buyer, you're buying 100. If you're a heavier buyer, you're buying close to 200 servings in a year. So disruptions in snacking occasions, disrupt the buy rate dynamic on Atkins. And that's what we saw through Covid. Right. So, you know, I expect us to be able to reemerge from that get our buyer a backup on the brand. Today, it's growing at kind of the low Ange of low end of our algorithm, we expect better from the brand. And there's some things that we need to address to get the buy rate back now that we're kind of seemingly out of the not at work. Pandemic type point of time, there are some things that we need to clean up in the brand from an execution standpoint to get the buy rate going and do better than where we are today. Yes, thanks. Good morning. You've made reference to Q2 in store merchandising and programming in a really good spot here. I know that you address last quarter some tactical issues with respect to Atkins, losing some distribution on the bars, making waves for chips and cookies talking about needing to fix that. Can you just update us on where you sort of stand in resetting the Atkins brand on shelf into spring? Early stages, Brian, it'll play out over the next 6 plus months. So spring resets, going into the summer, reset to the current towards the end of the summer, we would expect most of the solutions that we developed in the last 4 or months will be fully implemented, kind of by the end of summer. I would expect -- look again, we're at the low end of our ag and so we don't have a business in freefall. We got a business that's growing 4%, right. So we, and we're not happy at 4% We want the business to be better, right? And there's some executional things that we could have done better, right. So if lost distribution on snack bars last spring, we got to fix that. That's an innovation pipeline thing. So we have the innovation coming, it'll start getting executed as we move through the second half of the year, on, on confections, we had a launch of dessert bars on confections that haven't repeated like we expected it to do. So again, innovation effects you need, you need a pipeline of products to replace those things, those things take a little bit of time. But if I just step back, the buy rate declines that are coming from those things are starting to be nicely offset by growth in shakes and meal bars, which is those are starting to come back because the innovations there. But also, as people have gone back to work there, they tend to be more meal replacement, and therefore more ideal for people going back to work. So we're starting to see the business. Tempo pick up on those forms, offsetting most of the declines that we're seeing, and by rate from the other two snacking product lines. Appreciate the color there. And then I wanted to ask about, within the Atkins brand, the bifurcation between channels clearly on whole, it looks like new buyer growth did increase in q1. So I guess that would I presume that's overweighted towards the E commerce channel. So I'm just I guess maybe two points on this one. So clearly, this isn't about consumers who were buying in one channel or now buying in another, it seems like you were picking up new consumers in the E commerce channel. So what are you learning about the composition of that consumer in that channel towards the actions branch? And how strategically do you think about the placement of the Atkins brand going forward as a result of this ongoing momentum in e-commerce Yes, so interestingly enough, most new buyers come in to Atkins in brick and mortar. And even though the business has been flattish, in the quarter, we still saw strong new buyer growth, which then points to the executional issues around buy rate on snack bars and confections. So we're going to try to get that fix the growth on Amazon drives by rate, believe it or not, so people, and in general, most shoppers tend to be multichannel. So they're brick-and-mortar shoppers who go over into e-commerce and Amazon and buy more. So we're very, very targeted about how we think about that. So and within, within those shoppers that are a multi channel over an Amazon, there are a handful of people that drive a lot of that volume. So we're very targeted in our marketing approach over there, encouraging purchases of that consumer group that's very valuable to us. So when -- and when we do it, right, we don't cannibalize brick-and-mortar at all. So we're, I would take we have a really good team there. marketing science standpoint, they're relatively sophisticated. We know what we're doing in that channel. And they're and we're seeing nice impact of our business. And, Frank, I just want to point out that's a benefit of having bought Quest. Quest is the number one bar on Amazon. We have a strong relationship with Amazon because of that relationship. We've learned a lot about how to market on that channel. We're applying those. We're applying those learnings to the Atkins business. You see Atkins is sitting online at around 13% of sales and Quest is around 24%. So we have a lot of opportunity, as we get smarter about how to market Atkins online. Great. Thanks so much. Just kind of broader question longer term margin potential. We obviously understand the drivers have kind of why the gross margins pulled in EBITDA margins, obviously held in a little bit just kind of given the flattish year-over-year SG&A. Yes, as you speak to kind of back half of the year gross margin, potentially up slightly year-over-year given benefits to ingredient cost, realize you're not speaking to '24 [indiscernible] Q1 '23. But again, just to kind of reiterate sort of thing I've heard you say before kind of that path to get back to, let's say, the 40% gross margin, I just want to clarify that that is really contingent, I guess, on demand, but now you have the pricing as ingredient costs come down. Are there specific needs you foresee in potential increased promotional spend or trade or what have you, that would prevent you from getting back to that kind of 40% range or no? It's essentially hey, if ingredient costs come down, we have some pricing and the demand is okay, then yes, I mean, the expectation is we get back to 40. That's just the ladder. So we have -- Rob, we -- look, we going into this year, we had to make a choice based upon what we believed about what would happen in the future, right. So the first thing is, I have been and we have been very concerned about the economic environment that consumers are facing. Why? I don't think we've declared recession. There are a lot of recessionary factors that are out there that consumers are clearly starting to react to, and have been reacting to. So when we were seeing the cost inflation coming towards us as we moved into '23, we made a choice to try to balance our margin desires with not cooling demand, unit demand off too much. So as opposed to pricing to get back to total gross margins, we price to cover the dollar cost of ingredients, and packaging inflation. So and with a fundamental belief that we could do better from a consumer recruitment standpoint, not cool off our volumes, keep our velocities on the shelf better. So we made that trade off under a fundamental belief that ingredients and packaging wouldn't stay at these historic highs for a sustained period of time. So that's our belief. And the good news is we're starting to see you can see it in the spot markets, we're starting to see in some of the negotiations that we're having in the second half of the year, we're starting to see those ingredients come off those high. We would expect that to continue to play out over time, right? Do I anticipate that we will have to spend it back? What I would tell you is we're always -- as margins, get back to 40, 40%, our ideal, our ideal shape of our P&Ls 40% gross margin, 10% spending and marketing support, 20% EBITDA margin. Ultimately, that's where we want to be. So we're going to be making investments back with that profile. As we get back to 40% gross margin, we want to get back to that profile marketing spending where it needs to be EBITDA margin where it needs to be. Yes. Okay. Make sense. And then just quickly, look and when you came out of the destacking, repackage innovated on the Atkins brand, the results of this fairly material impact, which I would argue, as Rob Lowe probably has been around now, for some time. I just curious kind of your state-of-the-art sophisticated marketing platform, like as we think about twice rain, right, like I'm hearing, shelf positioning or some fixes, have to kind of match you some channels shifts. But, you know, is there anything else in there kind of, maybe give acting just a little bit more of a splash? By like, I don't know if it's another commercial or another kind of brand ambassador? or what have you just kind of anything in sort of how you're thinking about how to push the brand a little bit more versus trying to pull the consumer maybe with some other fixes? Well, it looks -- I think it's good question. Robin it's the question we asked ourselves all the time, we're always looking at those things, right? If I look at the fundamentals of the business and the kind of the facts of the business, I don't have a recruitment problem. Rob Test [ph] is strong now as we did when we first signed him. Our ability to attract consumers to the brand has been strong. If that changes, then you got to start rethinking kind of do you have the right consumer poll to attract consumers? Our issue has been buy rate. It's been buy rates all through COVID? Is buy rate now due to executional issues? We're kind of focused on that. Because we if we know we get the product portfolio, right, that we can get buy rate back to historic levels, and the business will go from where it is today at 4% to better than 4% over time. So that's what we're focused on. But to answer your question, we're always asking ourselves that we just resigned Rob, we just shot new commercials that are going on air as we speak. He still has really good appeal both demographically as well as the people that we're talking about the benefits that we're talking about so hard to replace him is kind of the figurehead celebrity. Now, we do a lot of things digitally with ambassadors to kind of target kind of micro segments within the brand. But I don't know right now, all the data would suggest you keep firing on all cylinders within fix some of the executional issues and your business goes from 4% growth to something much better. Thank you. Ladies and gentlemen, weâve come to the end of our time allowed for questions. I will turn the floor back to Mr. Scalzo for final comments. Thanks again for all your participation today on todayâs call. We hope you continue to remain safe and look forward to updating you on our second quarter results in April. Everyone have a good day. Thank you.
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EarningCall_1634
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Okay. Good morning, everybody. My name is Alex Straton. I am the co-lead for branded apparel, footwear and softlines retail here at Morgan Stanley. I lead this sector alongside Kimberly Greenberger. We are super happy you guys joined us for the second day of the conference, and we are equally delighted to have Adrian Mitchell here with us from Macyâs, the CFO. So, before I formally introduce Adrian, I will just start with a brief overview of Macyâs itself. So, as many of you likely know, Macyâs is the largest U.S. department store, generating about $24 billion in net sales last year across over 700 store locations. The company operates the Macyâs and Bloomingdaleâs banners, as well as the luxury beauty retailer Bluemercury. So, as I mentioned, we are joined by Adrian Mitchell, Macyâs Chief Financial Officer, and he joined Macyâs in November of 2020, bringing vast and varied consulting and retail experience, strategic perspective and an operational track record to Macyâs leadership team. He previously served as Managing Director and partner at Boston Consulting Group, Chief Executive Officer at Arhaus, and CFO and Interim CEO of Crate & Barrel. So, thank you so much for joining us today, Adrian. Yes. For those of you who donât know, I am taking over lead coverage of the space from Kimberly. Sheâs sadly retiring this year. So, many of you may know that, but thatâs the background for the congrats. So, for today, we are going to start with some opening remarks from Adrian. Then, we are going to move into a Q&A style format like you have seen in a number of the other sessions. We have also reserved some time for your questions. So, feel free to build up that list as we go through. So, before I let Adrian kick it off, I do need to remind everyone that for important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. Great. Well, look, again, itâs great to be here with you and me here with everyone here today. I will start off by sharing a bit of a recap of our November 17th earnings. Weâve not released any new information since then and we wonât be sharing any new information today. But at that time, we were really excited to share that we had solid top-line performance. We had a strong beat to the bottom-line. We had inventory that was about 4% above last year, but also 12% below 2019. And again, as I mentioned, we wonât be able to comment on kind of how we are progressing through the holiday season. We clearly have a lot of runway left before Christmas and before we actually complete this kind of holiday peak. But we are excited about holiday. We are ready for holiday. We are a gifting destination and thereâs no better time to gift than the holiday season. So, we are excited about whatâs ahead for us as we think about the strategies with Polaris and just really excited to get into it. We are in a very good position. Given our inventory position, our financial health, our liquidity gives us a lot of flexibility, and I am sure we will get into a little bit of that today. But great to be with you and look forward to the conversation. Yeah, thank you. We will definitely dive into some of those topics later on in the conversation. But, perhaps, I will start with everyoneâs favorite topic, consumer spending. So, we heard from Macyâs, as well as a number of other the specialty retail and department store guys that there was definitely a slowdown in spending in mid-October that kind of bled into the early part of November. So, maybe with that in mind, how is Macyâs positioning itself for kind of this volatile consumer spending environment? Yeah. For us, there are several factors that we look at, but the two that we really pay the most attention to is the pressure on the consumer, given the inflationary environment, but also their capacity to spend on discretionary items, which is the category that we are operating in. We recognize that as you look at the late October period into early November that weather was likely a contributing factor. It was a bit unseasonably warm at that point in time. But one other factor that I think is really important is the urgency around shopping, which is quite different this year than it was last year. So, you think about where we were last year with supply chain constraints, tremendous demand, tremendous potential and capacity to purchase, people are buying early, and there was a prolonged holiday season last year. But this year, we think itâs more pre-pandemic in terms of the shopping patterns. You would expect to have a peak around Black Friday, a peak around Cyber Monday, and a peak kind of the two weeks leading up into the Christmas period. But from our perspective, we are positioning ourselves for holiday very well. First and foremost, we are the gifting destination. So, when you think about the holiday season, you think about jewelry, you think about fragrances, you think about gifts under, whether itâs under $50 or under $100, you think about toys with our collaboration with Toys "R" Us. We are really ready for the holiday season. The second piece is that our inventory position, we believe, is a real strength for us. When you think about what weâve done in terms of managing inventory, giving ourselves the flexibility to respond to consumer demand and trends in season, we believe thatâs a differentiator and positions us well not only for this holiday season, but for the future as we maintain that advantage. And when we think about holiday, we have 55% newness, which is 30 points higher than where we were back in 2019. So, if you think about the right volume, the right mix of product, the right level of freshness, as well as the right value, we just feel that -- feel really good about where we are right now. The last thing that we would add is that, the holiday season is always competitive. But given the context we recognize that it may be higher level of competitiveness than what weâve seen in previous years. But our commitment is to enter into the next year with a clean inventory position, healthy inventory controls, and continue the discipline that we have built over the course of the last couple of years. Thatâs great. Hopefully, that quenches the need for some of the holiday outlook, Iâll make sure everyone has. So, maybe just pivoting slightly, I want to talk about Bloomingdaleâs and Bluemercury. Theyâve definitely been bright spots for you guys from a comp and customer expansion perspective. So, maybe talk to us about whatâs driving that success there? Whatâs different now versus maybe previously? Well, what I would say just to start is, as we look at Macyâs being from off-price with backspace to luxury, as you said, with Bloomingdaleâs and Bluemercury, we see the entire spectrum of the consumer across income spectrums. And what we will say is that, weâve seen across different tiers that customers have responded differently with regards to the inflationary environment that we been -- with that we have been in. To your point, Bloomingdaleâs and Bluemercury has been a real standout for us this year, and we are very excited about the performance that we have seen. As you know, the healthy performance that they saw coming out of the third quarter versus last year and we think thereâs a lot of growth opportunities ahead. The luxury customer has been resilient. The luxury customers had more capacity to spend and they are looking for quality brands at a great value. And I think thatâs a really key dimension of Bloomingdaleâs and Bluemercury is high quality brands at great value. Now, if you havenât been into a Bloomingdaleâs or Bluemercury recently, we would encourage you to go in. This year, Bloomingdaleâs is celebrating their 150th anniversary and they have over 300 exclusive brands. Thereâs a lot of energy. Thereâs a lot of excitement within the brand, both in the stores and the energy -- certainly exudes itself online. And Bluemercury, very well positioned in beauty and a lot of growth prospects for us. So, we would encourage folks to definitely get out there and check out that products. Yeah. I think the Bloomingdaleâs is right up the street. So, you probably donât have to get -- beg people to go there. So, one other thing where weâve seen some strength for Macyâs this year has been the AUR gains. I think itâs something like the eighth consecutive quarter of⦠⦠strength there. So maybe talk to us about how you see AURs evolving in the future? Whatâs given you the opportunity to drive this result? Yeah. So, the AUR growth is really at the core of how we think about margin expansion for Macyâs. And so, itâs been a bit of a journey for us the last couple of years. So, let me kind of walk you through a little bit of that journey and kind of articulate where we are right now. The first step in the journey was to get -- was to actually drive lower markdown and clearance sales for a level of sales for the brand. Thatâs about healthy inventory turn. Thatâs about less inventory by right-sizing our inventory control. So, how do we reduce the volume of sales that are on a discount, on promotion, so that we can drive full price sell-through. Once we kind of right-size the inventory, the second step was really around full price sell-throughs and this is about the quality of the product, right? So having good value, but also the quality of the product, the breadth of assortment and having the relevant assortment at the right time. Once we are able to do that, we then transition into scaling our pricing signs. And our pricing signs really de-average the business, right, for the consumer, where previously we would actually have major markdowns across regions at the same time, at the same level across every store. But now what we are able to do is by store, by location, by style, we can actually drive pricing decisions based on the availability of inventory, the level of sell-throughs, when we actually end of season, so just much more sophistication. So thatâs been a real key. Now, as we look at 2022, what we have seen is that we have had to make pricing -- smart pricing changes around product price, given the inflation, but also what we have been able to do this year, excuse me, is we have been able to benefit from occasion-based categories, which tend to have a higher margin profile. So, thereâs just been a mix of things that we have been able to pursue. But what I would say is that, that all adds up to inventory discipline, and me -- being able to make sure that our inventory is right-sized for the sales that we want to drive, the product assortment that we are carrying and just being very disciplined about pricing changes, as we are actually responding to the dynamics of the consumer. The good news is thereâs more to come. Thereâs more things that we are doing around the topic of inventory, and so, we are excited to continue to drive that topic and see the benefits across the business. Now a quick follow-up on that, on the AUR piece. How do you measure consumer kind of sensitivity to higher prices? Are you seeing any of that now as you look ahead? Well, we do see pretty consistently in this environment, particularly, but pretty consistently in our consumer research that customers care about buying what they want, but buying what they want with great value. So, you think about a consumer that is buying a $5 item versus a $500 item, they are still looking for great value. And so, we do pricing [signs rates] (ph) across our brands, digitally we look at what competitors are pricing. We look at what different specialty brands are pricing. So that we understand what the consumer sees when he or she goes shopping, when the consumer is out there online, when they are in stores. So just understanding how we are positioned relative to the competition for perfect match items, for like items and also where we can differentiate in terms of our private brands, those are the kinds of judgment calls we make with a combination of our pricing signs, and our planning and merchandising team. Thatâs great. Okay. Maybe pivoting slightly. Digital has been a top of mind kind of channel for people this year as we kind of see some giveback following the outsized spend last year. So, while Macyâs is down, I think, in the last quarter, maybe 9%-ish or so percent, itâs not dissimilar to what we have seen across others and itâs still above 2019 levels. So, if you could just give us an overview of the strategy there? How you think about the trend and the size of that business, it would be helpful? Yeah. At the core for us, we are agnostic as to where the sale shows up, right? So, we are very much an omnichannel retailer, which means we are investing in both digital, as well as in stores. Now when we think about winning the customer every day, itâs about having the right number of on-mall stores with the right experience, expanding our off-mall footprint, and making sure that ubiquitous across markets we have our digital platform thatâs about investing in mobile, investing in the app, investing in the web experience, but also investing in omnichannel capabilities that benefit both the customer online and in-store. We do recognize that discovery typically starts on digital, that the customer is grabbing their phone, they are jumping on their desktop to get inspiration and discover the products and brands that they want to go purchase, and the categories that they are excited about. So, there is definitely a connection. But the key thing here is that we are agnostic as to where the sale comes from. Now, as you think about digital specifically, to your point, there is a market correction. What we saw at the peak of the pandemic was about 40%, 41% digital penetration, and thatâs coming out of Q3 down to about 30%, 31%. So there definitely is a correction there. But we do believe that digital will continue to grow. As we get to a more normalized period, we do believe that digital is a growth vector for any retailer, and certainly, for us as well. So, we are continuing to invest. We are continuing to invest in all these different digital platform capabilities that benefits the broader ecosystem. Itâs the right thing to do, and we just believe that thatâs how the customer is actually shopping. Now thereâs an additional capability we are very excited about, which is digital marketplace. So, a couple of months ago, we launched digital marketplace for Macyâs brand. We expect to launch that for Bloomingdaleâs next year, and the response has been very favorable. So, we are pretty excited about what we are hearing from the customer and what we are seeing. I am sure we will talk a bit more about that in this conversation. Yeah. So, we will definitely touch on marketplace in a little bit. I think one thing that you have consistently harped on is the change in the approach to inventory, and I think a big piece of the success has been the supply chain changes youâve made. So, walk us through kind of how you modernize the supply chain? What inning are you in? Just a quick overview of that would be super helpful. Yeah. With regards to modernizing the supply chain, itâs really about rethinking about how the supply chain serves the customer very differently in todayâs environment versus, say, 10 years or 20 years ago. And a core part of that is really operating the supply chain from an end-to-end view, which requires a combination of how the team works differently and how we apply data science to kind of the end-to-end flow of product through the system. The way we have organized our team is really from understanding sourcing, all the way to inventory management and allocation, all the way to how we deliver the product to the customer, the channel, the market, and how we actually deliver it to their home or whether they pick it up in store. And what that has actually required is for us to really think and work very differently and something that we started very much in the pandemic. The early days of the shift was really around getting the basics right, around how we manage the flow. So, for example, diversifying the countries that we source product from was a critical dimension, making sure that during the constrained period with the supply chain that we had smaller containers going to smaller ports to give ourselves flexibility, recognizing the signals around the pace of inventory through the system, we ordered things early and confirmed orders early last year. But also working closely as a cross-functional team, our merchandising team, our planning team, our supply chain team and our finance team are tied at the hip every month, working through the signals, the anticipation, the trends in order to make sure we have good control around the inventory relative to demand. Now, as we think about where we were this year, we had to make some adjustments. When we think about where we were this year, the supply chain started to loosen. So, we had higher fill rates. We are progressively watching the fill rates. So, we have to really anticipate kind of what that would mean as we progress through 2022. But strategically, as we think about where we are going in terms of the modernized supply chain, there are really three key dimensions that are critical: number one is around the analytics; number two is around fulfillment; and number three is around automation. And so, when we think about the analytics, itâs really about demand forecasting and allocation. One thing thatâs really detrimental in retail is losing control of inventory. And so, when you think about the implications on cash flow, on margins, inventory control is pretty critical. So, meshing human judgment with machine learning data science is really important. The other piece that we have done is really around fulfillment, again, thinking end-to-end about the consumer. And kind of the key thing here that we spent a lot of time thinking about is how do we increase capacity, increase speed and reduce the cost of fulfilling orders for a customer. So, as you know, we have actually retrofitted 35 of our stores, partially to have over 1 million square feet of fulfillment space that we built over the last year. Thatâs effectively a new mega-center, thatâs closer to the customer, that allows us to deliver product with speed and itâs more cost effective than where we were in previous years because of process improvements, changes that we have made to the operation. And then the last piece is really just automation. When you think about automation in our existing fulfillment distribution centers, what we are able to do is increase capacity and expedite processing speed through automation. And so, we are putting automation into a lot of our existing facilities that are relatively dated, but modernizing them, so that we can actually address the needs of the customer, which is around speed and cost effectiveness as well. So, we are making really good progress. Thereâs still more to do. We are probably in the middle innings to your question, but we are excited about the path that we are on and our results are really showing some of the progress that we are making. So, one thing you mentioned is that the supply chain has certainly loosened up throughout the year. Is there any update you can give us, maybe even, perhaps, just what you said on your latest call, just so we understand where you guys sit in that? Well, with regards to where we are, we feel that we are in a very good position. We expect to end this yearâs inventory to be in a very good position entering next year. We donât bring liability in for the next year. As a fashion retailer, we donât pack and hold anything like that, because freshness is really critical. Kind of the way we think about inventory is very much around making sure we have the right volume, the right composition, which is really a key this year in terms of we made -- in terms of us making the shift from pandemic categories to occasion-based categories. The right freshness, we talked a bit about that for the holiday season, but also making sure that as we think about the economics of our products in our inventory system, having the right value for our customers as well. So, maybe if you could summarize how youâve made inventory work so well for Macyâs this year? Itâs been such a challenging environment in apparel more broadly. Macyâs has been a clear standout in terms of the management. If you could just boil it down for us to what were like the key things that you guys did differently? You have hit on some of them, but to really hit it home, what those were? Yeah. So, culturally inventory is such a critical part of the ecosystem. So, thereâs two things I would share with you. The first is that we are buying more conservatively and we are building reserves into our buys. So that reserve gives us flexibility to be able to adjust in season. If demand picks up, we can chase. If demand slows down, we donât buy into the reserves. So that gives us a lot of flexibility. So, itâs about the optimal level of inventory. Itâs about having the right metrics like turn and GMROI, which are very clear targets that we set and we track that every month. We had new reporting to create transparency, not just in terms of where we are currently, but actually where we are going. We are forecasting out through the next season so that we have an understanding as to what the trends look like and making sure thatâs really matched up with how we are thinking about demand. And this is something that we review in depth every single month. The second thing thatâs different is we are fundamentally changing the way we buy. We have an integrated team. We are thinking about things end-to-end. We are literally in one room having the merchants, the planners, the supply chain team and the finance, all having discussion about where do we need to be, what trade-offs do we need to make in order to make sure that we are maximizing full price sell-through, minimizing our inventory liability and driving healthier margins. And I think one of the -- kind of magic sauce for us that continues to be really key is the application of data science with human judgment. This really empowers the planners to make the appropriate inventory decisions. So, that all really just adds up to the right amount of inventory, the right composition. We are able to distribute it to the customer more efficiently, and in a more cost effective way. Now, as we enter next year, these disciplines will continue. Our strategy will not change. We will continue to be disciplined in the way that I described. And again, there are just some constraints around that discipline like we are not doing pack and hold. We are making sure we are exiting aged inventory, old inventory in the season before getting into the next season, and that discipline helps us quite a bit in terms of demand and having that freshness for the customer. Thatâs a super helpful overview. I think, maybe as you think about inventory longer term, youâve made a ton of progress, but where is there still room to run there? Well, one of the things that we talk a lot about now is around inventory productivity. So, one of the things that we are excited about is marketplace, which gives us a very different way to think about inventory as an enterprise by nameplate, by category, by subcategory, by department. So, you think about the fact that we have owned inventory, we have vendor direct products, we have marketplace, marketplace where we donât have the inventory liability, but we have the opportunity to have the sales demand, that gives us a lot of flexibility to really lean into the notion of SKU productivity. So, what do we need to carry through our supply chain versus what do we carry on a marketplace, which is actually fulfilled by our sellers. Thatâs a whole new generation of how we can think about inventory productivity and something we are going to begin to lean into. Now you have mentioned the marketplace initiative a number of times. Can you just give us an overview of what that is? I think, it just started in the third quarter⦠I think, it was launched. So, give us an update, perhaps, on kind of the rationale behind it, the strategy going forward, any initial kind of learnings you have from it? Yeah. The rationale starts with the customer. So, in a very simple example, you just look at the searches that customers have on macys.com or bloomingdales.com or bluemercury.com, if you think about Macyâs specifically, there are products that we didnât carry that customers were searching for on our website. And so, what we have been able to do in the third quarter with the launch of marketplace is we have been able to lean into categories thatâs not really core to Macyâs, electronics, expansion into toys and electronics, pets, home, kids and maternity. It gives us the opportunity to really see where thereâs interest and demand, gives us the optionality to bring that into our stores if we see very, very high sell-throughs, but we are learning and testing new products, new categories without the inventory risk. Again, inventory is really key in terms of the health or not so healthy retailers. So, having that discipline on marketplace, but having one experience for the customer to see the breadth of products in a unified experience on macys.com, but not having all of that liability, itâs a huge unlock for us. Now, when you think about what we have learned in the last few months, itâs been pretty exciting. We are attracting a younger customer. We are actually having larger baskets and higher units per order for those customers that are tapping into marketplace products. 96% of marketplace customers are also tapping into broader Macyâs. So, thatâs a pretty significant stat. And we are excited to do the same for Bloomingdaleâs next year. So, we are hitting on a lot of our key objectives. And as we get to a level of maturity, ending into this year going into next year, we will be able to share more kind of what the growth profile will look like. But right now, we are continuing to test and learn. We are adding categories, we are adding SKUs and the customer is responding well across the spectrum of categories that we have been pursuing. Now have you shared anything around kind of the financial implications of adding that wrinkle to the Macyâs model, whether it be -- it sounds like you are still working through with the growth [Technical Difficulty] impact in general, more of a curve ball so. Yeah. No, we have not given anything specific. But if you think about how marketplace works, itâs a margin driver for us, right? So, you think about the economics of an own supply chain, right, you have to have the staffing to price the product to move it through the system both in the distribution center as well as in the store, thereâs just a lot of operating expense with moving things through your own supply chain. So, with our own supply chain, we have to have very productive products. High velocity products are very profitable on that side of the business. In marketplace, you can have slow movers, and itâs okay. The seller is your partner and they are the ones that are carrying the inventory. And so, the fulfillment, the shipping expense, all those dimensions are carried by the seller. So, from our perspective, what we are able to then do is really have that holistic experience for the customer, but we can optimize the operating model in terms of sales growth and margin, and so thatâs kind of the way it works. So, we have agreements with our sellers around kind of what our profit profile would look like for a sale on our platform, but itâs really a great opportunity for us to really monetize our traffic at macys.com. We are one of the largest digital platforms in all of retail. So, how do we continue to build on that strength and build on that capability, marketplace is a great addition for us to do that. Yeah. It sounds like its super early stage. So, itâs definitely an exciting opportunity. Maybe turning to capital allocation, Macyâs has done an excellent job kind of rightsizing the balance sheet, paying down debt. Talk to us about your capital allocation priorities going forward? Where we can -- how we can think about your leverage into the future? Yeah, absolutely. So, our focus is, as you said, a healthy balance sheet and investment-grade credit metrics. Thatâs been something we talked about two years ago. And as you have stated, since the second quarter of last year, we have really executed on that. We have well-laddered maturities over the next several years, and have minimal debt due in the next four years, five years, and we actually have a leverage ratio below 2 times, which is a critical metric for us to just maintain the health of this business. But as we think about our strategy, first and foremost, is maintaining a healthy balance sheet. Liquidity matters. Liquidity gives us a lot of flexibility. Controlling inventory gives us a lot of flexibility. So thatâs a really important dimension for us, because it gives us the capacity to lean into inventory when we are chasing business, but also to invest and fund the operation and invest in these kinds of initiatives like marketplace, like Market by Macyâs and some of the other things that we are pursuing. The other thing that -- the other dimension of our strategy is investing in the business in ways that build capabilities. So, we are a modern department store. Building a modern department store requires modern capabilities thatâs relevant for the customer today. Marketplace is new. The data science and our pricing science is new. Personalization is new. We are on the cusp of re-matching our loyalty program, which is one of the most scaled loyalty programs in retail. We are basically investing capital and building capabilities to continue to be relevant for the next generation of shopper. And then the third piece is really making sure that we are using excess cash to return value to shareholders in the form of a dividend or buybacks. As you know, we have done buybacks last year when it was more appropriate. And so for us, returning capital back to the shareholder and driving healthy returns for our shareholders really big priority. But fundamentally, the business has to win to drive returns. Thatâs a great overview. I think one question we are asking everyone at this conference, all of our companies that are participating is just around how they assess the health of the consumer, if you are seeing any signs of strain or stretching. You reviewed that Macyâs has exposure across household income level. So, I think itâs particularly interesting to hear what you are seeing on that. Well, the good news is that we see the customer across multiple income tiers. We have our off-price unit, which is Backstage. We have Macyâs brand. We have our luxury dimension with Bloomingdaleâs and Bluemercury. So, we are able to really see how the customer is behaving. From our perspective, the consumer continues to be under pressure, right? We do recognize that inflation is abating, but the reality is that stuff is just more expensive. And so, we do recognize that there is pressure. And so, we are watching very closely the capacity to spend on discretionary items. Thatâs the business we are in. We are not in grocery. We are in discretionary items. Now, whatâs good for the consumer? Whatâs positive for the consumer right now? Wages have stayed pretty resilient. Itâs been pretty healthy. The mindset of the consumers that they are going to shop this holiday season. They are going to get out there. They were cooped up in the pandemic. They are kind of getting back -- getting their lives back. They are going on trips, theyâre seeing family. They have access to credit. That still remains pretty strong. We do see in the data in terms of spend on services, whether it be hotels or travel that still is pretty resilient as we approach the holiday season, and people are going to see their families. So thatâs definitely the positive, right? We do believe that even with all the pressures, those are positive signs. The opportunities we see is, again, inflation is driving up essential goods. So, depending on what income band you are in, your capacity to spend on discretionary maybe limited. So, you may have to be more on a budget. So, we are watching that pretty closely. Interest rates are continuing to rise. That has real impact on mortgage rates, on the cost of homes. So, when you think about housing, thatâs a real constraint and thatâs typically a pretty big ticket in folkâs budget every month. Savings levels are down. Folks had a lot of money a year ago, put in their savings account. Thatâs certainly been dwindling. All the data that we are seeing is thatâs definitely coming down. And what we will say -- what we would say is, we have seen a real challenge in terms of consumer sentiment. The consumer is concerned about kind of where things are, their ability to not just fund their essential purchases, but how much do they have left over to do other things. So, from our perspective, we have to be very disciplined around how we think that demand will materialize. Because at the end of the day, itâs all about understanding consumer demand and how much we can get in terms of our fair share. So, again, the right level of inventory, given the demand we see on the horizon being differentiated in terms of the freshness having products people actually want to buy and value matters, and value matters a lot in this environment more so than in an environment like what we experienced last year. So, really important that we just understand the demand of the consumer, because thatâs what all those indicators add up to. I think thatâs a helpful overview heading into holiday. One thing we talked about post-earnings, I thought you were really insightful on with how you think about January and a potential kind of consumer type of hangover. The way you talked about it, it was so like -- I have been repeating it, because I thought it was such an interesting take. Could you share that with the audience? Yeah. So, when we think about where we were at January of last year, there was Omicron. So, there was a little bit of a depression that happened. As we think about where we are this year and we are going into next year, the question is, with all the constraints and opportunities that I described are folks going to hold back or are they going to lean and continue their purchase habits? We do recognize that credit is available, but also credit balances are high. And so, as we think also about the indicators that we are seeing on the credit side, we are monitoring the indicators of bad debt. And so, you are beginning to see us get to a more normalized environment. So, look, folks are committed, have already committed to being with family for the holiday. But post-holiday when they look at the credit card bill and they think about, âAm I going to save? Am I going to get back to savings. Am I going to go spend more? Am I going to use my credit card more?â Thereâs going to be some real important choices. So, as we think about the next season into spring, we have to be thoughtful about where is the consumer, and is the consumer going to continue the spending levels that we have seen in the past two years, or are they going to pull back and be a bit more conservative, just given the psychology of the environment that we are in. So, very important for us to think about that, especially with all thatâs happening in the broader economy with employment levels and things like that. Thatâs great. So, we have a couple of minutes left. I wanted to open it up to the audience, if thereâs any questions out there before we wrap it up. So, if you have a question, feel free to raise your hand. And if none, thatâs fine, I can keep it going, okay. So, maybe I will just -- I will leave it with an open ended one. Is there anything today that we didnât talk about or a key takeaway that you would like to leave the audience with? Yeah. The one thing I would say is, we are excited about our modern department store positioning. Itâs about multiple categories. Itâs about serving a diverse group of customers. But itâs also about building capabilities thatâs relevant for the next generation of shopper. So, all that adds up to the fact that our recent success is not an accident. So, our recent success is not an accident. When you think about our talent and our team alignment, we are executing very well on our Polaris strategy. When you think about our financial health, as you described earlier, weâve really been deliberate since the second quarter of last year around paying down debt, about reinstating the dividend, returning value to shareholders, but more importantly, having a healthy business that we think has the resiliency to really weather the storm in good times and also in challenged times. Inventory control is key. We harped on that quite a bit today. Because fundamentally, you win or lose in retail based on how well you are able to control inventory and match that inventory to the demand of the customer. Really excited about the capabilities we are building. Pricing signs have served us really well over the last couple of years. It continues to serve us well this holiday season given the heightened demand profile and the heightened competitive intensity that we see in the holiday season. But also, we have personalization thatâs coming out. We have loyalty changes. We have marketplaces thatâs continuing to grow in scale. So, we are just really excited about the path that we are on, and we are executing well, and we have a team thatâs engaged thatâs excited and I think our results demonstrate that.
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EarningCall_1635
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Good afternoon, ladies and gentlemen, and welcome to the Patriot Transportation Holdings, Inc. Earnings Call for Fourth Quarter 2022. 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. It is now my pleasure to turn the floor over to your host, Rob Sandlin, Chief Executive Officer of Patriot Transportation Holding. Sir, the floor is yours. Thank you. Good afternoon and thank you all for being on the call today and for your interest in Patriot Transportation. I am Rob Sandlin, CEO of Patriot Transportation and with me today are Matt McNulty, our Chief Financial Officer and Chief Operating Officer; and John Klopfenstein, our Chief Accounting Officer. Before we get into our results, let me caution you that any statements made during this call that relate to the future or by their nature subject to risks and uncertainties that could cause actual results and events to differ materially from those indicated by such forward-looking statements. Additional information regarding these and other risk factors and uncertainties may be found in the company's filings with the Securities and Exchange Commission. Now for our fourth quarter results. Today, the company reported a net income of $470,000 or $0.13 per share for the quarter ended September 30, 2022, compared to net income of $40,000 or $0.01 per share in the same quarter last year. Operating revenues for the quarter were $22,882,000, up $2,425,000 from the same quarter last year, due to rate increases, higher fuel surcharges and an improved business mix. This quarter's revenue per -- revenue miles were negatively impacted by the approximately 10 driver reduction versus last year's fourth quarter, due to the driver shortage and the closing of our Nashville terminal. Operating revenue per mile was up $0.70 or 18.9%. Compensation and benefits increased $826,000, mainly due to the increased driver compensation package, mostly offset by the lower driver count and a reduction in support staff. Unfortunately, insurance and losses increased $444,000, due to a single rollout vehicle rollover fatality accident, which was $270,000, along with higher health and other claims. Depreciation expense was down $285,000 in the quarter and gains on sale of assets was $97,000, compared to the loss of $26,000 in last year's quarter. Equipment gains on sales were negatively impacted by $199,000, due to a separate vehicle rollover caused by an underinsured third-party resulting in $178,000 loss and the fatality rollover mentioned above. The operating profit this quarter was $484,000, compared to $58,000 in last year's fourth quarter. Now for the year-to-date results. The company's net income was $7,190,000 or $1.98 per share, compared to $625,000 or $0.18 per share last year. The net income included $6,281,000 or $1.73 per share from gains on real estate net of income taxes. The prior year's results included net income of $1,170,000 or $0.34 per share from gains on real estate net of income taxes. The operating revenues were up $6,614,000 at $87,882,000, due to improved rates, higher fuel surcharges and an improved business mix, despite being down 2.5 miles, because of the lower driver count and the closing of our Nashville operation. Operating revenue per mile improved $0.72 or 21.1%. Compensation and benefits increased mainly due to driver pay increases offset by lower driver count and non-driver personnel reductions. Our fuel expenses increased by $3,658,000 over last year, while insurance and losses increased by $906,000, due mainly to the maximum limit COVID claim of $372,500 and a negative workers compensation adjustment on a prior year claim of $380,000 and the fourth quarter accidents detailed earlier, resulting in a loss of $270,000. We decreased depreciation expense by $1,117,000 with the downsizing of equipment that was mostly completed in the second half of fiscal 2021. SG&A expense was higher by $542,000 mostly due to a one-time transaction bonus following the sale of the Tampa terminal property of $394,000. The gain on the Tampa land sale was $8,330,000, compared to a $1,614,000 gain on land sales last year. The gain on sale of assets was $739,000 versus a loss of $179,000 last year. The operating profit for the year was $9,299,000, compared to $880,000 last year. Excluding the Tampa land sale and the one-time transaction bonus for management, adjusted operating profit for the year was $1,363,000, compared to an adjusted operating loss of $734,000 last year. The COVID health claim the prior year workers comp claim and the two Q4 rollover claims resulted in a negative charge of $1,268,000 for the year, which is highly unusual and something not previously seen at these levels. Now for the summary and outlook. During the year, our total driver count remained steady due to the large driver pay increase in April 2021 and subsequent driver pay increases during fiscal 2022. During the first quarter of fiscal 2022, we announced additional driver pay increases in all markets most of which took effect in early February 2022. We announced additional pay increases in about half of our markets effective in early August 2022. We are in the process of announcing driver pay increases in the remaining markets, which means that these increases will have added 25% to 35% to driver pay depending on the market. We continue to be involved in task force movement, which is designed to bring transitioning service members, veterans, military families and industry stakeholders together to improve economic and national security outcomes. We are hopeful that our DoD Skill Bridge involvement will allow us to increase our driver force with transitioning military venture soon and we have seen some applicants from military members transitioning from the military. We have the same challenge as everyone battling inflation pressures and supply chain delays in many areas, including repair parts, tires and labor. Insurance rates continue to climb at single-digit increases at the lower levels and up to 15% to 20% on the excess layers. The insurance markets are still very tight, particularly in the excess layers of coverage. To cover this cost along with driver pay increases, we have been successful raising freight rates and we are partnering with customers and understand the challenges we face along with our need to cover the added cost and to make an acceptable return on our investment. I won't belabor the point, but this was a particularly difficult year for insurance claims and equipment write-offs with four incidents costing us over $1.2 million. We have high deductibles on our health, auto and work comp insurance claims and we waive these each year during renewal periods, compared to our claims history and premium cost. Our balance sheet remained stable with $8.3 million of cash as of September 30, 2022 with no outstanding debt. We replaced 26 tractors and five trailers during this year. We also added five drybulk trailers as we continue to expand this business offering. For fiscal year 2023, we are planning to purchase 73 replacement tractors, including 29 that will replace full service lease units. We also plan to purchase approximately nine trailers with a total capital expenditure of $12 million during fiscal 2023. We were recently named Carrier of the Year for Spring Water by our water customer and we look forward to growing this business in the future. I also want to express my gratitude to all of our team members for their dedication to safety as we met all three of our safety frequency targets for the year. We have done heavy lifting over the last couple of years to right size our business, streamline cost, retool management and price our business for improved results. I'm encouraged by the improved operating profit for 2022 and we will continue to work with our team to drive improved results moving forward. Certainly, ladies and gentlemen, the floor is now open for questions. [Operator Instructions] Your first question is coming from Christian Olson from Olson Value Fund. Your line is live. Thank you. So it's my understanding that many of your customer contracts come up for renewal about once a year. And so if you look out over the next four quarters, is it approximately the same amount every quarter? Or are there certain quarters where there are more contracts that are up for renegotiation? Really thinking the way our business works and how this goes, I mean we have contracts that basically can just are on rolling one-year basis. There's not a whole lot of negotiation when it comes to renewing the contract. It's really more about the pricing and getting rate increases. And a lot of those, they really do kind of happen throughout the year depending on the customer, to be honest with you. So there is no real -- there's no pack of contracts that ever are coming due for renewal, if that's what you're asking. Christian, that was Matt. And this is Rob. The only thing I would add about that is we do have a handful of contracts that are multi-year and one-year deals that are tied to CPI, less food and energy and so especially on those two-year deals. And so we obviously, you know, what that means in terms of price increases in recent times, because of the inflation. Yes. And I guess what I was getting at was -- well, so is it -- can you go to pretty much any of your customers at any time and ask for a price increase? Or does it not typically happen say once a year? It's a mixed bag. It's historically been once a year, but as we've gone through these driver pay increases, we've gone to our customers and asked for additional rate increase to cover that plus inflationary cost intermittently. And so I would say over the last 18-months, it's been more frequent than once a year. We do have some contracts that are annual rate negotiations or escalators based on CPI. But in a lot of those cases, our customers have been forthcoming during the driver pay increase times and gave us the additional pricing to cover that cost. Okay. And how do you see rate increases going forward over the next year or so you've clearly been able to push through some, but your compensation expense especially is going up quite a lot. Have you so far gotten rate increases from pretty much all your customers? And do you anticipate being especially aggressive over the next few months? I think, Christian what we've said since really April of 2021 when we put in the first big rate increase is that the vast majority of our customers have gone along with those price adjustments, because they understood what was going on in supply chain. They understood the driver shortage and they understood the need for us to pass along those costs. So I would say there's been very little resistance. The other thing that we have told you all in these calls is that where there was resistance and we needed to go partner with somebody else than we've been willing to do that and we have made some of those changes. Got you. And then if I can also just ask about drybulk pay, you mentioned some upcoming raises. And were they plans and if there's still real upward pressure on drybulk paying in the industry? There are definitely planned and budgeted for and the price increases to go along with those, our rate increases are planned as well. And I don't think there is as much upward pressure as there was obviously we're up 25% to 35% once those raises are in from where we were in April -- before April of 2021. And so I think the double-digit type of increases are probably behind us at least for now. Hi, guys. Glad to hear everyone sounds well. A question on the $12 million of CapEx expected for next year, that's quite a large amount relative to what we've been spending. And it sounds like we're buying a bunch of new equipment. Just give me an idea of what we're setting out to do in terms of both market demand, replacement? Basically, if we take our initial -- let me phrase this better. If we take our initial capital stock of trailers and rigs, from a baseline, how much are we adding to it based on this projected $12 million? And what's the underlying rationale for the need for that add if it's significant? Steve, probably the easiest way for me to answer that question is we've got a pretty normal trade cycle on 40 units that we will purchase throughout the fiscal year, that's 10 trucks a quarter. And then the oddity that we have this particular year is that we have 29 tractors that we are leasing on a full service lease. And when you run the financial model, it makes more sense for us to purchase those trucks outright. So we're kind of looking at those 29 trucks a little differently than what we would our normal. And that's in excess of $4 million of the spend right there. I don't have the exact number in front of me, but it's over $4 million of that spend. So if you back that out, it's a lot closer to normal. I see. And the 29 trucks that are coming off lease when we compare and I know that Matt does this stuff very well, but just -- so when we compare the depreciation expense of the purchase of those trucks relative to the lease expense of leasing them which is -- do we save on expense through -- is the depreciation lower or going to be higher than what we were expensing on the lease on those? And I understand we've got really significantly increased interest rates, which probably justify the purchase, but I'm curious how it shakes out on lease expense versus depreciation for those particular trucks? I mean, the truck costs have gone up, so the inherent depreciation component will be higher for the newer trucks. However, as these were full service leases, we were paying for maintenance that you might not have as the first year on new truck. Yes. So the depreciation line and the rents line, they charge for owned truck and a leased truck is relatively flat. So we'll just be shifting that expense from rents and equipment leases up to depreciation. But from a bottom line perspective, you won't see much change going forward. Okay. All right. All right, so just our hopes in the upcoming year and we're getting normal replacement cycle. Basically, it's our normal replacement cycle, taking off the trucks that are taking them off lease, purchasing them, increased rates relative to our cost structure and demand any new increases in demand or business that's dropping off, you know, we're looking at the drybulk business and getting some better or some additional customers there? But what do we see there on it? Our pricing turns on obviously on demand management grade and I'm curious what we're still seeing? I think demand is still good, I mean, our business is not as -- doesn't have the peaks and valleys that some of the dry van businesses have or the flatbed businesses where their rates move up and down and their demand moves up and down quite a bit. We see seasonal demand as an example. We're going to see South Florida and Central Florida start to pick up late this month and run pretty heavy through March. We don't expect that to be any different. In fact, it may be a better year because we're further away I hope and I guess from COVID. And so we've started -- I think our growth and our ability to add miles and revenue are still tied to the same thing I've mentioned before and that's our ability to add drivers in those markets. And in a few of the markets where we've been able to add capacity recently, we've been able to go out and get new business at what I would consider good freight rates. If that answers that part of it? I think it does. All right. Well, I guess, we'll sit tight to have a year shapes out and enjoy the holidays coming up. 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.
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EarningCall_1636
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Hello and welcome to Citiâs Fourth Quarter 2022 Earnings Review with the Chief Executive Officer, Jane Fraser; and Chief Financial Officer, Mark Mason. Todayâs call will be hosted by Jen Landis, Head of Citi Investor Relations. [Operator Instructions] Also as a reminder, this conference is being recorded today. If you have any objections, please disconnect at this time. Ms. Landis, you may begin. Thank you, operator. Good morning and thank you all for joining us. Iâd like to remind you that todayâs presentation, which is available for download on our website, citigroup.com, may contain forward-looking statements, which are based on managementâs current expectations and are subject to uncertainty and changes in circumstances. Actual results may differ materially from these statements due to a variety of factors, including those described in our SEC filings. Thank you, Jen and Happy New Year to, everyone, joining us today. We are very much off and running as we start 2023. Today, I will share our perspective on the macro environment before recapping our performance in the fourth quarter. And then I will take a few minutes to reflect on our progress in 2022 and our strategic priorities for the coming year. The global macro environment played out largely as we anticipated during the second half of last year. As we enter 2023, environments have had better than we all expected for the time being at least, despite the aggressive tightening by Central Bank. In Europe, a warmer December reduced the stress on energy supplies and inflation is beginning to ease off its peak. That said, we still expect softening of economic conditions across the Eurozone this year given some of the structural challenges it is grappling with. In Asia, while the public health impact in China are unfortunately likely to be severe, the abrupt end of COVID Zero should begin to drive growth and improve sentiment generally. And here at home, the labor market remains strong and holiday spending was better than expected, in part because consumers have been dipping into their savings. The Fed remains resolute in tackling core inflation however and therefore, we continue to see the U.S. entering into a mild recession in the second half of the year. Now turning to how we performed. For the fourth quarter, we reported net income of $2.5 billion and EPS of $1.16. Our full year revenue growth of 3% ex-divestitures was in line with the guidance we gave you at Investor Day as was the case with our expenses. We delivered an ROTCE of nearly 9% and a CET1 ratio of 13%. This quarter, our businesses performed similarly to how they did throughout the year and we are quite pleased with some and less happy with the performance of others. Services continues to deliver cracking revenue growth. Our markets businesses are navigating the environment very well and we are seeing good momentum in U.S. Personal Banking. On the flipside, investment banking felt the pain of a drastically smaller wallet in â22, and the environment for wealth remained a challenging one. Unpacking that a bit, services delivered another excellent quarter and we have gained significant share in both Treasury and Trade Solutions and security services. TTS, the business most emblematic of the power of our global network had revenues up 36% year-over-year as we execute on the strategy we laid out at Investor Day. Thanks to strong business drivers, coupled with higher rates, TTS is performing ahead of our expectations. Likewise, Securities Services was up a strong 22%. We ended the year having onboarded $1.2 trillion of new assets under administration and custody. Markets had the best fourth quarter in recent memory, with revenues up 18% from 2021. We have the number one FICC franchise on the street during the first three quarters of the year and fixed income was up 31% in the final quarter. Equities was down as the mix of client activity, again, did not play to our strength in derivatives. With the wallet down significantly, our investment banking revenues were off by about 60% this quarter. While the pipeline looks more promising and client sentiment is improving, it would be hard to precisely predict when the tide will turn in â23. Wealth Managementâs performance was disappointing. Revenues were down 6% in the quarter, with the macro environment creating headwinds in investment fees and AUM globally, but most acutely in Asia. However, we have been steadily improving the business as demonstrated by continued momentum in client acquisitions across the spectrum and net new investment flows. Similarly, we continue to build our client advisor base albeit at a slower pace given this environment. We would expect to see these investments pay off as the markets recover. In U.S. Personal Banking, both cards businesses had double-digit revenue growth for the second straight quarter as purchase sales and revolving balances continued to grow strongly. Whilst in retail banking, we clearly have some more work to do. As you know, we have been actively managing our balance sheet and risk. Our cost of credit increased in line with our guidance. We built reserves in Personal Banking this quarter on the back of volume growth as well as in anticipation of a mild recession. And in the U.S., net credit losses in cards continue to normalize as we had expected, still well below pre-COVID levels. Corporate credit remains healthy and our low overall cost of credit was similar to last quarter, reflecting the quality of our corporate loan portfolio. In terms of capital, we increased the CET1 ratio by about 70 basis points to 13% during the fourth quarter. And finally, our tangible book value per share increased to $81.65 and we returned $1 billion to our shareholders through our common dividend. Now, let me step back and discuss what we accomplished in 2022. One of our major goals last year was to put in place a strategic plan designed to create long-term value for our shareholders and to get that plan swiftly off the ground. I am pleased with the significant progress we have already made. We simplified the bank, closing sales of our consumer businesses in 5 markets, including 3 in the fourth quarter. And we have made rapid progress winding down our consumer business in Korea as well as our franchise in Russia. We continue to invest in our transformation to address our consent orders and to modernize our bank. We are streamlining our processes and making them more automated whilst improving the quality and accessibility of our data. This will make us a better bank. We brought in very strong talent, met our representation goals and strengthened our culture by increasing accountability and shareholder alignment. To that end, I am pleased we delivered against our financial guidance for the year. We also released our first plan to reach net zero emissions by 2050, expanded our impact investing and announced the findings from an external law firm, which reviewed our racial equity efforts in the U.S. Finally, Iâm very proud of how our people handled the macro and geopolitical shocks, which define 2022 and supported our clients and our communities with excellent and compassion throughout. Before I hand over to Mark, letâs turn to the next few years and in particular, the path to achieving our medium-term return targets that we laid out on Page 5. At Investor Day, we talked about the path coming in three phases, with Phase 1 characterized by both disciplined execution and investment. 2023 is a continuation of Phase 1, laying the foundation for driving long-term shareholder value. We are focused on changing our business mix to drive revenues and returns with the expectation that our businesses will close out â23 competitively stronger. Services entered â23 with strategic momentum and a pipeline of major new innovation and market-leading product capabilities. Markets should continue to benefit from our active corporate client base with the franchise further advancing on the back of investments and the businesses focused on capital productivity. Banking and Wealth are well positioned for when the cycle turns. Thanks o the investments we have made in top talent and technology as well as the synergies realized across the franchise. As you saw, we felt this was the right time to make a change in well and we started a search to identify the next leader of this business. I asked Jim OâDonnell to take on a new role focused on senior clients across the firm. This will leverage his deep expertise and relationships and when combined with the new GoGâs additional role as North America Head, itâs designed to help us capture more of what is a significant business opportunity in our home market. U.S. Personal Banking will continue to benefit from the recovery and borrowing, taking full advantage of our market leading digital platforms and new products, particularly in the card space. We will make further progress on our international consumer exits, enabling us to simplify the firm and reduce our cost base. And we will, of course, focus on our clients, deepening relationship and bringing on new clients in line with our strategy. We will continue making disciplined investments in our franchise, including the investments in our transformation and controls. However, we will pace some of our business investments to reflect the operating environment. Looking further out, we will begin to bend the curve of our expenses to deliver against our medium-term targets. We will do so through a combination of our divestitures, realizing the financial benefits of our transformation and further simplification and Mark will cover this in more detail shortly. We fully recognize this suppresses our returns in the near-term, but we are deliberately taking the tough strategic actions and the investments necessary to reach our medium-term return targets and to create long-term shareholder value. We are carrying not just our momentum, but our determination into 2023. Despite the macro headwinds, we are very much on track to reach the medium-term return targets we shared with you on Investor Day. We intentionally designed a strategy that can deliver for our shareholders in different environments. We are running the bank differently with a relentless focus on execution and we will continue to transparently share our proof points with you along the way. With that, Iâd like to turn it over to Mark and then we will be delighted as always to take your questions. Thanks, Jane and good morning, everyone. We have a lot to cover on todayâs call. I am going to start with the fourth quarter and full year financial results, focusing on year-over-year comparisons, unless I indicate otherwise. I will also discuss our progress against our medium-term KPI targets and end with our guidance for 2023. On Slide 6, we show financial results for the full firm. In the fourth quarter, we reported net income of approximately $2.5 billion and an EPS of $1.16 and an ROTCE of 5.8% on $18 billion of revenue. Embedded in these results are pre-tax divestiture-related impacts of approximately $192 million, largely driven by gains on divestitures. Excluding these items, EPS was $1.10 with an ROTCE of approximately 5.5%. In the quarter, total revenues increased by 6% or 5% excluding divestiture-related impacts, as strength across services, market and U.S. Personal Banking was partially offset by declines in investment banking, wealth and the revenue reduction from the closed exit. Our results include expenses of $13 billion, a decrease of 4% versus the prior year. Excluding divestiture-related costs from both the fourth quarter of this year and last year, expenses increased by 5%, largely driven by investments in our transformation, business-led investments and higher volume-related expenses partially offset by productivity savings and the expense reduction from the exit. Cost of credit was approximately $1.8 billion, primarily driven by the continued normalization in card net credit losses, particularly in retail services and an ACL build of $645 million, largely related to growth in cards and some deterioration in macroeconomic assumptions. And on a full year basis, we delivered $14.8 billion of net income and an ROTCE [Technical Difficulty]. Now turning to the full year revenue walk on Slide 7. In 2022, we reported revenue of approximately $75 billion, up 3%, excluding the impact of divestitures and in line with our guidance of low single-digit growth. Treasury and Trade Solution revenues were up 32%, driven by continued benefit from rates as well as business actions such as managing deposit repricing, deepening with existing clients and winning new clients across all segments. Higher wins have accelerated due to the investments that we have been making in market leading product capabilities. These products include the first 24/7 U.S. dollar clearing capability in the industry, the 7-day cash suite product that we launched earlier this year, and instant payment, which is live in 33 markets, reaching over 60 countries. So while the rate environment drove about half of the growth this year, business action and investments drove the remaining half. In Security Services, revenues grew 15% as net interest income grew 59%, driven by higher interest rates across currency, partially offset by a 1% decrease in non-interest revenue due to the impact of market valuation. For the full year, we onboarded approximately $1.2 trillion of assets under custody and administration from significant client wins and we continue to feel very good about the pipeline of new deals. In markets, we grew revenue 7%, mainly driven by strength in rates and FX as we continue to serve our corporate and investor clients while optimizing capital. This was partially offset by the pressures in equity markets, primarily reflecting reduced client activity in equity derivatives. On the flipside, banking revenues, excluding gains and losses on loan hedges, were down 39%, driven by investment banking as heightened macro uncertainty and volatility continued to impact client activity. In cards, we grew revenues 8% as we continue to see benefits from the investments that we made in 2022 along with the rebound in consumer borrowing levels. And in wealth, revenues were down 2%, largely driven by market valuations in China lockdown. Excluding Asia, revenues were up 3%. Corporate Other also benefited from higher NII in part as the shorter duration of our investment portfolio allowed us to benefit from higher short-term rates. And as you can see on the slide, in legacy franchises, excluding divestiture-related impacts, revenues decreased by about $1.3 billion as we closed 5 of the exit markets and continue to wind down Russia and Korea consumer. Going forward, we would expect legacy franchises to continue to be an offset to overall revenue growth as we close and wind down the remaining exit market. On Slide 8, we show an expense walk for the full year with the key underlying drivers. In 2022, excluding divestiture-related impacts, expenses were up roughly 8% in line with our guidance. Transformation grew 2%, with about two-thirds of the increase related to risk, control, data and finance program and approximately 25% of the investments in those programs are related to technology. About 1% of the expense increase was driven by business-led investments, which include improving and adding scalability to our TTS and Security Services platform, enhancing client experiences across all businesses and developing new product capabilities. We also continue to invest in front office talent, albeit at a more measured pace, given the environment. And volume-related expenses were up 1%, largely driven by market and cards. The remainder of the growth was driven by structural expenses, which include an increase to risk and control investments to support the front office as well as macro impacts like inflation. These expenses were partially offset by productivity savings as well as the benefit from foreign exchange translation and the expense reduction from the exit market. Across the firm, technology-related expenses increased by 13% this year. On Slide 9, we show our 2022 results versus the medium-term KPI targets that we laid out at Investor Day, which we will continue to show you as we make progress along the way. Macro factors and market conditions, including those driven by monetary tightening at levels we didnât anticipate at Investor Day, impacted some KPIs positively and others negatively. However, we were able to offset some of the impacts as we executed against our strategy. In TTS, we continue to see healthy underlying drivers that indicate consistently strong activity from both new and existing clients as we rollout new product offerings and invest in the client experience, which is a key part of our strategy. Client wins are up approximately 20% across all segments. And these again include marquee transactions where we are serving as the clientâs primary operating bank. For the third quarter year-to-date, we estimate that we gained about 70 basis points of share and maintained our number one position with large institutional clients. In addition, we have onboarded over 8,700 suppliers this year, helping our clients manage their supply chain to address the evolving global landscape. And in Security Services, we onboarded new client assets, which offset some of the decline in market valuation. And we estimate that we have gained about 50 basis points of share in Security Services through the third quarter of this year, including in our home market. In markets, we strengthened our leadership position in fixed income by gaining share while making progress towards our revenue to RWA card. In cards, loan growth exceeded our expectations in both branded cards and retail services. Card spend volumes were up 14%, end-of-period loans up 13% and most importantly, interest-earning balances up 14%. That said, in areas like investment banking, we lost share this year, but maintained our market position. And in wealth, while we have brought on new advisors and new client assets, given the impact of market valuation, this didnât translate into growth in client assets or top line growth at this point. So in summary, we made good progress against our medium-term KPI targets despite the significant changes in the macroeconomic backdrop since Investor Day. This highlights that our diversified business model is adaptable to many environments and we have the right strategy to achieve our return targets over the medium-term. Now turning back to the fourth quarter on Slide 10, we show net interest income, deposits and loans. In the fourth quarter, net interest income increased by approximately $710 million on a sequential basis, largely driven by services, cards and markets. Average loans were down as growth in cards was more than offset by declines in ICG and legacy franchise. Excluding foreign exchange translation, loans were flat. And average deposits were down by approximately 1%, largely driven by declines in legacy franchises and the impact of foreign exchange translation. Excluding foreign exchange translation, deposits were up 2%. Sequentially, average deposits were up driven by growth in ICG and PBWM and our net interest margin increased by 8 basis points. On Slide 11, we show key consumer and corporate credit mix. We are well reserved for the current environment with over $19 billion of reserves. Our reserves to funded loan ratio, is approximately 2.6%. And within that, PBWM and U.S. card is 3.8% and 7.6% respectively, both just above Day 1 CECL level. And we feel very good about the high quality nature of our portfolio. In PBWM, 45% of our lending exposures are in U.S. cards. And of that, branded cards makes up 66% and retail services makes up 34%. Additionally, just over 80% of our total card exposure is to prime customers. And NCL rates continue to be well below pre-COVID levels. In our ICT portfolio, of our total exposure, over 80% is investment grade. Of the international exposure, approximately 90% is investment grade or exposure to multinational clients or their subsidiaries. And corporate non-accrual loans remain low and are in line with pre-pandemic levels at about 39 basis points of total loans. That said we continuously analyze our portfolios and concentration under a range of scenarios. So while the macro and geopolitical environment remains uncertain, we feel very good about our asset quality, exposures and reserve levels. On Slide 12, we show our summary balance sheet and key capital and liquidity metrics. We maintain a very strong balance sheet. Of our $2.4 trillion balance sheet, about a quarter or just under $600 billion consists of H3LA and we maintained [Technical Difficulty]. And our tangible book value per share was $81.65, up 3% from a year ago. On Slide 13, we show a sequential CET1 wall to provide more detail on the drivers this quarter and our targets over the next few quarters. Walking from the end of the third quarter, first, we generated $2.3 billion of net income to common, which added 19 basis points. Second, we returned $1 billion in the form of common dividend, which drove a reduction of about 9 basis points. Third, the impact on AOCI through our AFS investment portfolio drove an 8 basis point increase. And finally, the remaining 56 basis point increase was largely driven by the closing of exits, RWA optimization and market moves towards the end of the quarter. We ended the quarter with a 13% CET1 capital ratio, approximately 70 basis points higher than the last quarter. As you can see, we hit our 13% CET1 target, which includes 100 basis point internal management book. That will allow us to absorb any temporary impacts related to the Mexico consumer exit at signing while continuing to have ample capacity to serve our clients. And as it relates to buybacks this quarter, we will remain on pause and continue to make that decision quarter-by-quarter. On Slide 14, we show the results for our Institutional Clients Group for the fourth quarter. Revenues increased by 3% this quarter, with TTS up 36% on continued strength in NII; Security Services revenues up 22%; Markets revenue, up 18% on strength in fixed income, partially offset by a decline in equity; and Investment Banking revenues down 58%, which is in the range of the overall decline in industry volume. Expenses increased 6%, driven by transformation, business-led investments, specifically in services and volume-related expenses partially offset by FX translation and productivity savings. Cost of credit was $56 million, driven by net credit losses of $104 million, partially offset by an ACL release. This resulted in net income of approximately $1.9 billion, down 18%, driven by higher cost of credit and higher expenses. ICG delivered a 7.9% ROTCE for the quarter. And average loans were down slightly, largely driven by the impact of foreign exchange translation and our continued capital optimization efforts. Excluding FX, loans were up 1%. Average deposits were roughly flat. Excluding the impact of foreign exchange translation, deposits were up 3%, and sequentially, deposits were up 4%. As for the full year, ICT grew revenues by 3% to $41 billion and delivered approximately $10.7 billion of net income, with an ROTCE of 11.1%. Now turning to Slide 15, we show the results of our Personal Banking and Wealth Management business. Revenues were up 5% as net interest income growth was partially offset by a decline in non-interest revenue driven by lower investment product revenue in wealth and higher partner payments in retail services. Expenses were up 7%, driven by investments in transformation and other risk and control initiatives. Cost of credit was $1.7 billion, which included a reserve build driven by card volume growth and a deterioration in macroeconomic assumptions. NCLs were up, reflecting ongoing normalization particularly in retail services. Average loans increased 6%, while average deposits decreased 1%, largely reflecting clients putting cash to work in fixed income investments on our platform. And PBWM delivered an ROTCE of 1.4%, driven by the ACL build this quarter and higher expenses. For the full year, PBWM delivered an ROTCE of 10.2% on $24.2 billion in revenue. On Slide 16, we show results for legacy franchise. Revenues decreased 6%, primarily driven by the closing of five exit markets as well as the impact of the wind down. Expenses decreased 38%, largely driven by the absence of divestiture-related impact last year related to Korea. On Slide 17, we show results for Corporate/Other for the fourth quarter. Revenues increased largely driven by higher net revenue from the investment portfolio. Expenses were down driven by lower consulting expenses. On Slide 19, we summarize our guidance for 2023. As Jane mentioned earlier, 2023 is a continuation of Phase 1. We will continue to execute and invest, laying the foundation for the future with an eye towards driving long-term shareholder value. With that as a backdrop, we expect revenue to be in the range of $78 billion to $79 billion, excluding any potential 2023 divestiture-related impacts, expenses to be roughly $54 billion, also excluding 2023 divestiture-related impact. Net credit losses in cards are expected to continue to normalize. And as we said earlier, we met our 13% CET1 target, and we will continue to evaluate the target as we go through the next DFAST cycle and close additional exit and announce others. On Slide 20, on the right side of the page, we show our revenue for 2021 and 2022 and our expectations for 2023, excluding the impact of divestitures. In 2023, we expect the revenue growth I just mentioned to be driven by NII and NIR. In TTS, we expect revenues to grow but at a slower pace, driven by interest rates and business actions. And for Security Services, we expect a bit of a tailwind from increased market valuation and onboarding of additional client assets. We also assumed somewhat of a normalization in wealth as lockdowns in China and market valuations start to rebound. And we expect investment banking to begin to rebound as the macroeconomic backdrop becomes more conducive to client activity. As for market, we expect it to be relatively flat given the level of activity we saw in 2022. Now turning to the NII guidance for 2023, we expect both ICG and PBWM to contribute to NII growth as we grow volumes, particularly in cards, and we continue to get the benefit of U.S. and non-U.S. rate hikes in our services business. As a reminder, the guidance for revenue includes the reduction of revenue from the exit and legacy franchises that we closed in 2022, and we expect to close this year in 2023. Turning to Slide 21. In 2023, the increase in expenses that I just mentioned reflects a number of decisions that weâve made to further our transformation and execute on our strategy. And the main drivers are, first, transformation as we continue to invest in data, risk and control and technology to enhance our infrastructure and ultimately make our company more efficient. Second, business-led investments as we execute against our strategy. Third, volume-related expenses in line with our revenue expectations. And fourth, elevated levels of inflation mainly impacting compensation expense, partially offset by productivity savings and expense benefits from the exit. And we are investing in technology across the firm with total technology-related expenses increasing by 5%. While we recognize this is a significant increase in expenses. These are investments that we have to make and I am certain that these investments will make us a better, more efficient company in the future. And finally, letâs talk a little bit about the medium-term targets. At Investor Day, we said the medium term was 3 to 5 years. That time frame represented 2024 to 2026. So while a lot has changed in the macro environment since Investor Day, our strategy has not, and we are on a path to the 11% to 12% ROTCE target in the medium term. We continue to expect top line revenue growth, material expense reduction and capital levels largely consistent with our medium-term CET1 target range to contribute to the achievement of our 11% to 12% ROTCE target. So let me walk you through where we stand today. From a revenue perspective, rates have moved much higher and at a faster pace across the globe, which accelerated NII growth. And that, coupled with the execution of our strategy, has allowed certain businesses to accelerate. At the same time, other businesses such as wealth and investment banking have slowed. Despite this, consistent with Investor Day, we expect a 4% to 5% revenue CAGR in the medium term, including the ongoing reduction of revenue from the closing of the exit. From an expense perspective, as we showed at Investor Day, expenses will need to normalize over the medium term. And we now expect to bend the curve on expenses towards the end of 2024. The three main drivers of the necessary expense reduction will be benefits from the exit, which will be included in legacy franchise the benefits from our investments in transformation and control and the simplification of the organizational structure. First, let me remind you, at this point, the ongoing expenses in legacy franchises are approximately $7 billion. Of the $7 billion, roughly $4 billion is transferred to the buyer upon closing or through a transition services agreement that typically lasts about a year. The remaining $3 billion relates to potentially stranded costs and wind down, which takes time to eliminate. Second, as our investment in transformation and control initiatives mature, we expect to realize efficiency as those programs transition from manually intensive processes, the technology-enabled one. And finally, we remain focused on simplifying the organization, and we expect to generate further opportunities for expense reduction in the future. From a credit perspective, we still expect net credit losses to continue to normalize and any future ACL build or releases will be a function of macro assumption and volume. So to wrap up, while the world has changed significantly and the components have shifted, we remain on our path to achieve the 11% to 12% ROTCE in the medium term. And Jane, the rest of the firm and I, are prepared to continue to show proof points along the way and demonstrate our progress. Thank you. [Operator Instructions] Thank you. Our first question will come from Glenn Schorr with Evercore. Your line is now open. Thanks so much, and definitely appreciate all these outlooks. They are very helpful. So my question on the outlook is if you take a look at the current medium-sized return on tangible and getting to your target, I heard many comments about the path to getting there is on track. Is it the expense spend at the end of â24, that is the material step up from here to there, if you will, and/or is credit like a really big determinant in the process? So Iâm trying to bridge the gap just in numbers from todayâs return on tangible targets. Thanks. Yes, sure. Good morning, Glenn, thanks for the question. So we did give you some guidance here we gave it to you both on the top line and the middle line for â23. And then importantly, when we talk about the medium term, itâs both the continued revenue growth, the 4% to 5% CAGR that I referenced, but itâs also bringing the expenses down from this â23 forecast. And I mentioned in the prepared remarks, the drivers of whatâs going to bring these expenses down. The combination of the exit of the businesses and the expenses going away associated with that with the benefits that we start to generate from the transformation spend and then org simplification that this type of strategic restructuring, if you will, in exiting all these countries will create an opportunity for. And so itâs a combination of revenue growth, expense bending of that curve and coming down. The cost of credit is kind of as weâve been talking about for some time now, which is it normalizes over the next couple of years at levels that are consistent with what weâve seen kind of prior to this COVID cycle that weâve been managing through. I appreciate that. Thank you. Just one quick follow-up on poly, not my norm, but I normally try to respect this type of process. But Mark, we consider your super important part of this transformation. there has been news out there that you talking to one of my other companies, but would you be able to make any comments? You mentioned just some moment staying on â sorry to put you on the spot, but I think a lot of people care. I appreciate that, Glenn, and Citi is an important firm. Iâm the CFO of this firm and this strategy is something that Iâm focused on with Jane, ensuring that we execute on right and in a way that creates shareholder value for our investors. And so weâre committed to getting that done. Hi, Mark. I wanted to dig into the revenue outlook for 2023. Youâve got about the midpoint, it kind of implies about a 4% revenue growth this year, kind of consistent with what you talked about for that 4% to 5%. So for this year, the 2023 guide, it looks like the NII is guided to be up about 3.5%. And the markets you are assuming kind of flat. So whatâs enabling you to get to the 4%? Where are the drivers that are above 4%? Is it some of those fee businesses? And just a little more color there would be helpful? Sure. So let me make a comment first on the NII. Just keep in mind with that number that Iâve given on the page is both the growth that occurs in some of our important services businesses, and that really comes from both the annualization of rate increases that we saw in the back half of the year, but also expected continue increases, particularly outside of the U.S. And given the makeup of our franchise, we will â that will contribute to the NII growth. And then keep in mind that weâre growing over the legacy franchise reductions in NII that we would see in 2023. So underneath that is some real momentum in the NII, notwithstanding a slower pace, the fact that it would be a slower pace than what we saw in 2022. From an NIR point of view, I did mention that we do expect to see some normalization in market valuation. And that would play out both in banking, normalizing certainly relative to what we saw this year with while itâs down 50% to 60% as well as some normalization in wealth and those would hit the NIR line, as you point out. Okay. And then â sorry, if this is clear already. But just in terms of the idea of the cost curve bending at the end of 2024. Is that going to mean that for the early part of 2024, expenses kind of rise above 2023 and then they kind of peak out plateau towards the back half of â24. Is that how we should envision it? Iâm not going to kind of get into â24 guidance. We will kind of get through â23, and Iâm confident about our ability to get to that roughly 54 number that I put out for â23. Iâm equally confident that we will bend this curve, and we will bring it down to the levels that it needs to be in order for us to get to the ROTCE target, but Iâm not going to kind of get into, John, the specifics of 24 except to say that by the end of â24, we will see that curve bending. My first question is â again, thank you for all the clarification on the slide. Great job, Jane and Mark, obviously. But as we think about what it means to bend the curve, I think, your investors are appreciative that you are accelerating the investments relative to your transformation. As we think about when Citi can hit that medium-term ROTCE, how should we think about whatâs bending the curve really means? And Iâm not looking for guidance necessarily, but as we think about going past that hump, whatâs the better way of measuring â should we â is it an efficiency ratio? I think you mentioned something like is it the 60% to 63% efficiency ratio against that 4% to 5% revenue CAGR that you think youâll be able to hit by 2025? Can we think of it that way? Yes. So at Investor Day, we did talk about it, and we remain consistent and committed to that. We talked about getting to an efficiency ratio thatâs less than 60% in the medium-term period. And so that certainly will be part of the metric that we deliver on as we bring our costs down. I think the other thing Iâd mention just you mentioned the how, and I think there are a couple of important aspects that the exits are obvious in terms of those costs going away, at least a portion of it is. The portion thatâs tied to stranded cost, Jane has been very, very clear with our entire management team of the importance of rethinking the organization and ensuring that the potentially stranded costs go away, and that means rethinking the way we do business and the way we operate different parts of our operations. I think the third piece is that technology, right? And so right now, a lot of what weâre doing is manual. And as we continue to invest in technology and technology is up pretty significantly this year, 14% or so, we expect it to be up 5% next year. That technology build-out, if you will, will allow for us to reduce a lot of that manual activity, and that will bring down the operational cost for running the firm. And so those are a couple of examples, I hope, of the how. But I think importantly, you will start to see it in an improved operating efficiency over that period of time and getting to the target that we talked about at Investor Day. And I would say you can get some confidence around the past on many of these by the urgency with which weâre executing the divestitures, for example, on getting those transactions closed. And weâve also tried to provide you as much clarity as possible about the timing of when these will be closing and the speed of the wind-downs that weâre executing. So that will help. As Mark said, itâs three big structural drivers of what will be in that curve. Thank you. And Mark, Iâm sorry, for misspeaking. I was looking at the wrong borrowing efficiency. I have like 15 slides open in the computer. The second question and maybe this to you Jane, I think that your investors have appreciated your sense of urgency with regards to the divestitures. I think the elephant in the room continues to be I think investors sort of expected an announcement on Banamex right now. And Iâm wondering if youâre still considering just selling Banamex or are you thinking about different options on the table, such as an IPO? So weâre in active dialogue at the moment. So Iâm obviously not going to comment in great detail here. We do continue to pursue a dual path as youâd expect, because both are very viable options here. And when we are in a position to give you clarity but we will do so. I think weâve been fairly clear about the timing. We are also separating out the two franchises, our institutional franchise from the consumer franchise that weâre selling because we see the institutional franchise is a very important part of the global network. As you can imagine, in todayâs environment, Mexico is key for many of our corporate clients around the world for their supply chains. And we play a very important role there. That is a lot of work in that separation. Iâm extremely pleased with the progress that weâre making in that underlying work. But we are pursuing the dual tracks and when we have something to announce, we will be delighted to do so. Hi. Iâm still trying to get over at this revenue and expense guidance. So youâre implying youâll have at a minimum flat operating leverage or positive operating leverage for 2023? Am I reading that correctly? So on the one hand you are not bending the cost curve until late 2024. On the other hand, youâre guiding for positive operating leverage in 2023. Am I reading that correctly? Mike, when you do the math, I donât think it will get to the positive operating leverage in 2023. But we are, as you see on the slide, targeting a range that does reflect growth in the top line. That growth will likely be a little bit less than the growth that 54 number would â roughly 54 number would suggest but we are on the right track. And we are getting there in a way thatâs consistent with the strategy that we talked about. And we do feel confident in our ability to deliver on the guidance that weâve put out here similar to delivering on the guidance we gave last year, recognizing there are a lot of things going on in the broader environment. Okay. And then a second follow-up â or a follow-up, and then Iâll requeue for my other question. Your CET1 ratio is 13% now. And I think thatâs two quarters earlier than consensus had expected. You said it was up 70 basis points. So doesnât that allow you to repurchase stock now? Or I understand that if you go ahead and sell Banamex, that could have a temporary negative capital hit. So Iâm just thinking like donât sell Banamex, donât have that temporary capital hit, start buying back stock at a fraction of your tangible book value. So whatâs wrong with my logic or what part of that can you comment on? Iâm going to jump in on the, donât sell Banamex, Mike. As you could imagine, so we are selling the consumer franchise. It does not fit with the strategy that we laid out in Investor Day. Itâs an emerging market consumer franchise, and we are clearly focused around the multinational clients and in institutions and high net worth individuals with cross-border needs as we laid out very clearly and businesses that have strong connectivity across the â between each other. So we are â we donât see Banamex having strategic fit in the consumer franchises in that perspective. And when we run all the math, it is in the shareholdersâ interest that we sell that franchise and deploy that capital to our shareholders or into some of the investments at higher returns. What youâre suggesting is a very short-term move. And I think as you can see from the actions weâre taking, weâre very focused on our medium and long-term and not taking the short-term path that we would regret in the medium and long-term. Hey, good morning. I guess just one question as a follow-up on capital. As we think about post the second half of the year, letâs say, youâve taken the hit from Banamex. But coming out of this test-test, any sense, Mark, if there is any reason why Citi would have an outsized negative impact from the Basel end game reforms. Just give us a sense, Iâm just wondering hopefully, we donât get another disappointment as we get our hopes it for buybacks in the back half and there is something idiosyncratic about the business mix that could come back to hurt the bank? Would love any perspective there? Yes. So look, as we pointed out, weâve built a significant amount of capital over the course of the year. We are ahead of the target we set for the middle of the year, middle of the year. We do have some exits that will have a temporary impact on that CET1 ratio. And we do obviously have a DFAST thatâs in front of us that we will have to see what the outcome is of that work. I think, look, the Basel end game and final views and decisions on that are still outstanding. And I think we will have to take those into consideration when they become available. That is an industry dynamic that will play out however it plays out. And similar to SACR, we will get after it in a very significant way to make sure that weâre able to handle whatever headwinds or tailwinds may come along with that. But it really is difficult at this point to opine on exactly what that means for the industry in light of the fact that there arenât final rules out just yet. Got it. And just back to your medium-term targets. I guess if we hit that bending the curve at the end of â24, it implies that this company should have an earnings power north of $10 by 25%, even at the lower end of the guidance. Am I missing anything there? Or like does that make sense? The only thing Iâd point out is what weâve described â what Iâve described, what Jane described is the medium term is â24 through 2026. And â weâve given you guidance for â23. We intend to get to those return targets in the medium term. I havenât given you specific guidance on any of those individual years, and we will kind of take that year by year. And so just factor in. I think whatâs important is youâve got a view on â23, and I think weâve given you additional clarity on how we intend to get to that medium term, and I think thatâs important. I did want to ask a little bit about the strategy with Personal and Wealth Management. I know Jane, earlier you talked about the fact that â which you have announced looking for a new had to move that business forward. Could you just give us a sense as to where you think the opportunity sets are greatest within that franchise for growth because there is a bunch of different pieces, some on the advice channel, some of the more fee channels, some of the more balance sheet piece. And you already indicated U.S. as an opportunity to expand into. So Iâd just like to understand, from your perspective, which pieces are the most important to execute on. And that could help us understand how youâre planning on shaping this business going forward? Thank you. Great question, Betsy. And Mark and I are both smiling here because I think the answer is all of the above. So if we break it down, where do we see the various elements of upside? There is an important recovery thatâs going to occur in Asia. And you can see from our results last year, and across the board with other competitors with an Asian bent, that was materially impacted by COVID in China and the lockdowns and a slower pulling out of COVID in that market compared broadly in Asia compared to the U.S. So we see some exciting growth opportunities there from the pure fundamentals in Asia across the board. Absolutely you are right in the U.S., we start from a smaller scale there. Weâve been bringing the different parts of that business together. The wealth of work franchises, one thatâs had particularly pleasing growth in it. And weâve also been seeing some good growth as we pulled a comprehensive offering together for our customers. The biggest upside there is the investment product. And I think weâve got a strong balance sheet franchise as it were, particularly the deposits, some of the margin lending and the like mortgages, but this is really about the investment offering in the state. Then finally, Iâd say there is also tremendous opportunity in the synergies, and weâve been showing you this in terms of linkages between our commercial bank, our banking franchise, the referrals up from the U.S. Personal Banking. Weâve had about 60,000 referrals this year in the U.S. alone. From that, market also provides important results and even TTS. So the client referrals, there are business synergies between them common platforms. So we really see an opportunity for these multidimensional growth drivers in wealth over and above the recovery in the investment space that everybody in the market should be able to benefit from. And we will continue investing in â appropriately in building out that front line as well. So, this is a very important part of our strategy. We are excited about it. Itâs the key pillar of the shift in business mix as we go forward as well, looking at the medium-term. And we are looking forward to the next phase of growth and focus here. And would you say that the investment spend required to execute on those revenue opportunities is likely to accelerate from here, or you have already done that investment spend and the investment is more sideways as opposed to accelerating? I think look, in this current environment, as we have said â Mark and I have both said since the â really, the middle of last year, this is something that we are pacing, but we are continuing to invest behind you. And you can see that growth in our client advisors. And remember that net growth in client advisors, it includes the divestiture we made in Uruguay, for example. So, itâs pretty strong. We donât have a huge amount that we need to invest because we have many pieces of the platform in place and itâs more been a story of integrating them, and then making sure that we are putting the right digital and other investments behind it, but itâs not such a large one in order to achieve the upside in the business. And we will pace that as appropriate with market conditions. Mark, anything to add? Only thing I would add â Betsy, you know this is â in a normal part of the cycle, this is a high margin, high returning business. And we have seen that in the past. And so we want to be well positioned for as the market turns, having brought on client advisors, having brought in new clients through client acquisitions, which were up 24% in 2022. And so I think we are well positioned for that. But as Jane mentioned, given where we are, we want to be smart about how we deploy the dollars. And so we will replace that as necessary, but ensure that we are ready for when things turn. And I would just add, it was a couple of years ago that we put â we announced the strategy and started executing on it. So, we have the benefit of the historic investments that we are seeing the drivers playing out well. And as I say, well, we should be well positioned when the market turns here. Hi. I just want to follow-up on the comments about markets to be relatively flat in â23. Obviously, a very good 4Q. And I know I was concerned about some of the RWA management and FICC in the recent quarters. And I think going back not to be an issue as you think about leadership and revenue. But as you think about â23, like the wallets have been strong in recent years. And to your point, your leadership was strong this year. How confident are you in kind of that flat market? And maybe whatâs driving that view? Thank you. Itâs a market business, right. And so you know very well kind of the volatility that can come with any markets business. With that said, we have got a very, very strong FICC franchise. We had a very good year, a very good year this year. I think we are well positioned with the client base, and we are well positioned to maintain our number one position as we go into 2023. Now, how that market and market wallet moves, I think is it was going to predicate on a number of things, including how the macro continues to evolve and how central bank activity continues to evolve and how currencies move and the like. But again, I feel like we are well positioned to hold our position, if not gain more share as that plays out. And so I think flat relative to a year that we have had up as significantly as it is, is a reasonable call based on what we know now. We have also seen some depression of areas of strength in this business as well. So, equity derivatives, for example, the real strength, this was an equity derivative year. So, there is some and the corporate world with the volatility thatâs out there from a macro geopolitical environment is another real strength of ours. And for better or for worse, we are expecting that strength to continue, certainly things so far. Mark, maybe just digging into NII a little bit, if you look at 4Q annualized, you have a decent step down. But when you take a look at your deposit franchise, your mix of business, versus your peers, where they are seeing probably lagging retail deposits in the U.S., pricing thatâs going to hurt second half NII. Look, you guys, you already have high betas, mostly institutional. You mentioned the benefit from non-U.S. rates and you are growing deposits. So, why sort of the â a similar trend in NII versus peers when you have a pretty different dynamic going on? Just trying to think that through because it doesnât look like the legacy drag is very big in your chart? No, I am just trying to talk about versus peers, some have guided similarly to down from 4Q annualized run rates, but you have a very different dynamic in terms of deposit growth, benefits from non-U.S. rates and a much higher beta. Yes. So, I think â I mean I think I would point to a couple of things on the NII side, just as it relates to us. One, importantly, that I mentioned in and you point out is when you think about our mix of deposits, we have got about 65% or so are in ICG and the balance, 35% in our PBWM business. We certainly skew to U.S. dollar, but we have got a 30% or so that is a non-U.S. dollar. And when I think about the potential or the forward curves and how rates will likely move next year, we will get the benefit of further rate increases on the non-U.S. side, right. And so if I think about our international presence, the betas tend to not be as high as they are here in the U.S. with our Corporate Clients segment. And so I think there are some re-pricing opportunities that we will continue to actively manage as we did here in the U.S. And so I do think itâs that international footprint, the globality of our franchise that plays to our strength in 2023. The other thing that is apparent to us as we forecast this out is the continued growth from a volume point of view. And that volume growth, you have seen the momentum already pick up on the card side with significant growth in interest-earning balances. And we would expect that to continue, particularly as we see NCLs normalize and as we see payment rates start to temper. And so I think those things will be two major contributors. Mix is obviously a factor. As you point out, we will be growing over some of the drag or reduction from legacy, but is that active management of the client engagement that we have across both portfolios, that I think will be important factors to us delivering the growth that I talked about. Thatâs all fair. But I guess maybe I didnât phrase my question right, but I felt it ex-markets, I think your forecast for 2013 would be less than the 4Q run rate ex-markets and yet you just... Well, just you shared a bunch of reasons why you have sort of a differentiated franchise. So, I am just trying to get a sense of whatâs driving the decline from 4Q levels. I think the thing you have got to pick up is really the legacy franchise and the NII. A large part of the legacy franchise revenues are NII revenues when you look at the mix of the products and the clients that we cover there. And so I think thatâs the important element here that we havenât quantified to a dollar amount, but that is explaining why it seems like muted growth relative to what you would have seen in the fourth quarter. Obviously, there is other factors, but thatâs important. Mark, can you share with us on your comments regarding and this is true for your peers as well. The normalization of credit losses going forward since the industry has experienced incredibly low levels of credit losses. So, when you look at branded cards or retail sales, or retail services, how do you see that progressing through â23? One of your peers pointed out that they think that by the end of â23 they may be at that normalization rate that they look to for their numbers. But I am just trying to see what the trajectory is for what you guys are thinking? Yes. Let me jump in and then I will hand it on to Mark. But I think we are expecting under the current trajectory to see the loss rates to reach the pre-COVID levels more at the year-end, early â24 level. If you think of branded cards, if I was to quantify sort of 20% of the way there now, CRS, we are about 40% of the way there now. Obviously, we have the benefit in CRS of sharing of the loss sharing with our partners that helps us. But I hope that gives you a sense around it. Probably the most important driver that we have been worried about it was very certain with what was happening with payment rates. And I think we have got much more clarity as they started that normalization path. So, thatâs driving a fair amount of more certainty around what the direction is happening there. Frankly, the big question more whatâs happening with spending than it is with the normalization right now. Itâs a bigger uncertainty. But Mark, any other observations? The only thing I would add is that, Gerard, you could see just depending on how this plays out. You could see kind of NCL rates tick up above normal levels and then come back down to normal levels in the timeline that Jane described. Again, just depending on how the macro factors continue to play out. But again, we â as we sit here and talk about these NPL rates, itâs important to point out as well that we are very well reserved across all of these portfolios. And so to some extent, if you put macro assumptions aside and volumes aside, the NPLs kind of get funded by the reserves that have been established. But the trend line is exactly as Jane described, just recognizing that you could see a tick up above normal levels and then it come back down. Also this is such an unusual market in the sense that you have got such strong labor market driven by frankly, supply shortage over as much as demand. And we have also got the consumers with still very high savings that they are dipping into, and we are seeing a bit more of the movements happening at the bottom end of all of this. But this is not going to be like a normal recession. Itâs why you are ticking here as that others will be about the manageability and the mildness of that likely if we do have one. And what kind of unemployment rates, are you guys assuming going into that kind of trajectory? Is it â we get the 5% unemployment by first quarter â24? I think a couple of things. So one, our base case scenario, if you think about what we just talked about includes kind of a mild recession in it, just and as we forecasted it, the downside would be something a bit more severe than that. I would say we are reserved for approximately a 5% unemployment rate, just kind of overall when you look at â when you average across the different scenarios that we have. Hi. Thanks. Just two quick questions here. First one, just on card, the card NIM has been kind of flattish. And I know that obviously, it has to do with just how you internally allocate the funding towards it. But can you just kind of talk us through whatâs happening either with rewards or either incremental rates on some of the new relationships? And should we see the card NIM expand from here? Yes. I am not going to get into Ken, kind of guidance on NIM. What I will say is that we have seen good traction in the early part of the year as it relates to acquisitions on the card side. We have made very good traction. And Jane, you may want to comment on kind of the relationships that we have with some of the partners and with American. And we have also launched a number of new products that I think is helping to fuel the growth that we have seen on the heels of those investments and some of the increase that we have seen in spend rates as well as some of the average interest-earning balance and loan growth that we have seen. But I really donât want to get into the NIM guidance at the card level or the aggregate at this point. Yes. I mean we have a fabulous cards franchise. And when we look at strong track record in the digital, the other innovations that are driving growth, driving the profitability, driving the returns both in our proprietary products as well as our partners, and we are really seeing all of those drivers performing very, very strongly at the moment. From custom cash, it was 28% of new accounts acquisition. So, an important new product refresh thatâs driving things 80% of customers engaging digitally. Innovations like America is just a fantastic partner of us, really taking that to the next level. And you can see that with the growth in spend in the category. So, I think there is a lot of reasons to be pretty excited about the growth in the return and the margins and the other trajectories here, and as I say, a prime portfolio, which is always a good thing. Great. Thanks. And my second question was, there was an article about changing management up in the wealth management business this week. And I just wonder if you can talk about that, but also just about the progress that you are making inside the wealth management relative to your â the KPIs and the goals that you have discussed at Analyst Day. Thanks. Well, sure. I mean 2 years ago, I asked MacDonald to put the wealth business together from the various components that we had around the firm. And now as we move to the next phase, but as we have said, strategically important business. I thought it was the right time to change the leadership also because Jim is going to play an important role moving forward, supporting Paco with the ICG strategy that we laid out at Investor Day. He has got a lot of relationships with investors, family offices, private equity, sovereign wealth funds. And he is going to be helping drive those along with other investors to make sure we bring the firmâs full capabilities to these clients. So, I felt the time was right to make the move. And we will be, as indicated, strictly moving to go out and have a look for our next leader of that business. And in the meantime, business as usual as we grow and follow the strategy that we have, and we are looking forward to the market turning, as I am sure everyone is and feel that we are well positioned to do so. Hi. Good afternoon. This is actually Sheng Wang filling in for Steven. Just on the topic of credit, one of your peers noted this morning that they would expect to see an incremental $6 billion or so of reserves if they assume 6% unemployment under CECL. Can you â just wondering if you could provide some similar sensitivity to reserve levels and how should we think about the provision trajectory versus the 4Q base based on your macro outlook and potential growth math headwinds? Yes. Thank you. I will go ahead and I will take that. I am not going to kind of do sensitivity scenarios with you here on the fly. What I will say is that as we build these reserves, we are building them against three scenarios. That base scenario that I mentioned, the downside scenario and upside scenario, and we weight those scenarios. And the base that we used this quarter built in a mild recession. And in that baseline, unemployment was, call it, 4.4% or so in terms of the unemployment assumption. We also had a downside scenario. Unemployment in the downside scenario got to a 6.9% or so. And then we had an upside scenario. The weighted average across the quarters was about the 5.1% that I mentioned. And those were factors that went into the reserve that we established in the in the quarter. And largely, when you think about the weightings we have put on those scenarios, the weighting skew towards that base and that downside. The reserve we built this quarter was largely in the consumer business, PBWM and specifically around cards. And that really had to do the change quarter-over-quarter with the change in HPI. But what I would say is that it also reflects, as I have mentioned earlier, a cards portfolio that remains of a very good quality and with loss rates that are well below what they would be in a normal cycle. And it does pick up the fact that there is volume growth that we saw in the quarter there. So, I am not going to kind of run scenarios for you, but hopefully, that gives you some perspective as to whatâs underneath the models that we have used to establish these reserves. And obviously, we do that on a quarter-by-quarter basis. I would also just jump in one of the areas that sometimes gets mis-put about the firm, is on the corporate credit side. When we look at our corporate client portfolio donât equate where we take credit risk with the global footprint. When I look internationally, 90% of our international exposure with multinational firms and their subsidiaries, and these are â this is investment grade. So, I think thatâs another area where as we look at the quality of the corporate loan portfolio, as you saw with Russia and others, we will be conservative in the reserving we take. But I think important to understand the nature of where we take that corporate credit risk. Thatâs really helpful. Thanks. And then as a follow-up, it seems like a part of your revenue targets for 2023 depends on some improvement in the environment. For example, stabilizing equity markets, IB rebound? And Jane, you also noted that the medium-term targets are designed to be achievable in different environments. So, if the revenue backdrop continues to be challenged like we saw in 2022, can you just talk about some of the levers you might be able to pull that might provide an offset? Well, it kind of depends on what the drivers are of a different environment, right. Because you could have â I donât anticipate this, but you could have continued pressure in investment banking, but you could also have continued volatility in rates or currencies and that could mean more upside than flat for the markets business. So, there are a lot of puts and takes that one can scenario out. I think whatâs really important is that we have a diversified portfolio of businesses that have strategic connectivity to them. And so what that allows for is that as the environment shifts in some way that we may not have predicted that we were often able to still drive significant performance as we did this year. And so without calling exactly how it vary from whatâs here, thatâs what gives us the confidence to â around the guidance and really to remain steadfast on the strategy that we have talked about and really push execution, and thatâs exactly what we are doing. And an important part of â23, itâs not just the impact of the cycle, but also you will see the impact of the different investments that we have been making. And you have certainly seen that. For example, in services this year, and we have been very transparent around the 70 basis points increase. We have seen in wallet share in the 12 months leading up to the third quarter. So, you have not only got drivers here in terms of whatâs happening in the market, but you have also got the strategic drivers, also kicking in more and more together, as Mark referred to the synergies. Itâs a great point, Jane, because it may not always show up in the top line, which is why we put those KPIs out there. There are often indicators of some of the upside thatâs on the come as the market evolves. Yes. So, one question and one follow-up. So, you have a â your slide says you have a CET1 target of 13% by midyear, but you are already there. And I guess if we go back to the Banamex thing, I guess is that kind of assuming potential capital impact from divestitures or why would you have a target six months out when you have already met it? Yes. Mike, I have to tell you that I am surprised that you are asking about Mexico, just given our history together, but I understand it. And what I would say is that a couple of things. One, we clearly see where we trade, right. And we are not happy about where we trade. And we think our strategy warrants us trading better than where we trade today. So, if we could buy back, right, we could do buybacks as soon as we are able to do buybacks, we will, right. I mean that is part of the way we deliver value for our shareholders. The second thing I would say is we did get to the 13% sooner. And that was, again, in accordance with executing against our strategy. And our parts of our business, particularly the markets business has done a really good job at delivering against the metric we put out of revenue to RWA. And we have been able to get there without damaging the franchise, which is what you see in the continued strength and performance in that business, particularly in fixed income. Whatâs ahead of us, as you rightfully pointed out, is that we have got a number of exits that have to take place, puts and takes across many of them, but Mexico in particular, will have a temporary impact on our CET1 ratio. And so we want to be mindful of that as we manage over the next two quarters, so that we can absorb that. And we also want to make sure that we are positioned to continue to serve our clients over the next couple of quarters and always, but certainly over the next couple of quarters, while we manage the headwind, temporary headwind from that exit. So, hopefully that gives you a better sense for it, but we are actively managing this. And we have not lost focus on the importance of returning capital to shareholders. Yes. I want to reiterate that as well. I mean itâs very important to us. And as Mark says, we know where we trade. We have made a number of moves to align ourselves to our shareholdersâ interest in compensation and management interest, all these various dimensions. And we just want to make sure that we hit what we say we are going to do and continue delivering against what we say we are going to be delivering. And with the CPA impact essentially in Mexico, we want to make sure that we are taking that into account. Alright. Thatâs very clear. And then lastly, your NII guide, excluding markets related is higher for 2023, but I think that implies a little step down from the fourth quarter level, not as much as JPMorgan was guiding down 10% from the fourth quarter level. I was thinking there might be some delayed benefits from being outside the U.S. What are some of the ins and outs there? Yes. You got a couple of points here. So, one is we wonât see NII momentum as we have seen in 2022, just as betas start to increase on the ICG side and get to terminal levels, thatâs obviously going to slow or put pressure on the pricing as we go into â23. But some of the other important drivers of the growth will be the annualization of the rate hikes that happened late in the year. And so that will be a plus in 2023. You will also see, as I mentioned earlier, some of the rate increases that we anticipate outside of the U.S. and given our mix, that will benefit us in 2023. And then there will be a volume will contribute to that NII growth, particularly as we continue to see good momentum, which we anticipate on the card side, the offset will be that the legacy franchise, right. And so as those exits occur as the wind downs continue, as I mentioned earlier, that revenue mix does skew towards NII. And so we will have to grow over that and we will grow over that to kind of get to the target that we have set. So, those are the puts and takes. Thank you everyone for joining us today. If you have any follow-up questions, please reach out to IR. Have a great day. Thank you.
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EarningCall_1637
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Greetings and welcome to the MIND Technology Fiscal Third Quarter 2023 Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. Itâs now my pleasure to introduce your host from Ken Dennard. Thank you. You may begin. Thank you, operator and good morning everyone. Welcome to the MIND Technology fiscal 2023 third quarter earnings conference call. We appreciate all of you joining us today. With me are Rob Capps, President and Chief Executive Officer, and Mark Cox, Vice President and Chief Financial Officer. Before I turn the call over to Rob, I have got a few housekeeping items to cover. If you would like to listen to a replay of todayâs call, it will be available for 90 days via webcast by going to the Investor Relations section of the companyâs website at mind-technology.com or via recorded instant replay telephonically until December 21. Information on how to access the replay features was provided in yesterdayâs earnings release. Information reported on this call speaks only as of today, Wednesday, December 14, 2022 and therefore you are advised that time-sensitive information may no longer be accurate as of the time of any replay listening or transcript reading. Before we begin, let me remind you that certain statements made by management during this call may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on managementâs current expectations and include known and unknown risks, uncertainties and other factors, many of which the company is unable to predict or control, that may cause the companyâs actual future results or performance to materially differ from any future results or performance expressed or implied by those statements. These risks and uncertainties are included in the risk factors disclosed by the company from time-to-time in its filings with the SEC, including its annual report on Form 10-K for the year ended January 31, 2022. Furthermore, as we start this call, please also refer to the statement regarding forward-looking statements incorporated in our press release issued yesterday and please note that the contents of our conference call this morning are covered by these statements. Okay, thanks, Ken. Now we are doing something little bit different this quarter. We have prepared an updated presentation covering our discussion this morning and we posted it to our website and invite you to refer to that at your leisure. As I usually do, I will begin with some observations regarding the third quarter and on the market environment. Mark will then discuss the financials in more detail. And I will wrap things up with some remarks about our outlook. As you mentioned on last quarterâs call, we expected our third quarter results to be down a bit sequentially due to the timing of orders, which we anticipated delivering in the fourth quarter. While our third quarter revenues of $4.9 million were slightly softer than we had predicted due to orders moving to the right, we believe that this sets the stage for our better than expected fourth quarters during which we anticipate returning to profitability. We continue to execute on our growing backlog and our order flow remains positively impacted by favorable macroeconomic trends. As a company, we believe MIND is uniquely positioned to capitalize on the tailwinds that we are seeing in each of our three key markets: exploration, defense and survey. The sustained global energy prices continued to drive robust order activity in the marine seismic industry. Many of our customers in the exploration space are reporting improving metrics and in some cases, looking to expand their fleets. Our GunLink, BuoyLink and SeaLink products continue to enjoy broad acceptance in this space and we expect our strong order flow in the exploration market to continue through the fourth quarter and into next fiscal year. Our marine survey business has also seen an uptick in interest resulting from these same higher energy prices as attention shifts towards alternative forms of energy, such as offshore wind farms. In addition to our single-beam and multi-beam side scan sonar systems, we are seeing much interest in our SeaLink towed streamer systems for these applications, recently introduced higher sampling rates for SeaLink, which produces higher resolution images and configurable systems have resulted in increased interest in these three dimensional high resolution systems. The ongoing global geopolitical and security situation, particularly in Europe and Asia, continues to highlight the need for our maritime security and surveillance technology. We have recently experienced increased order activity, particularly for multi-beam side scan sonar systems, which we believe is related to these demands. We believe our high speed systems are particularly attractive for missions in the defense space. We also think the recent demand bodes well for our program to utilize our commercially developed towed seismic arrays SeaLink as passive sonar arrays and anti-submarine warfare and other maritime security applications, particularly those utilizing uncrewed platforms. We have been encouraged by the response arising from our demonstration of this technology at the U.S. Navyâs Coastal Trident 2022 exercise in August of this year. Therefore, we are confident we will continue to grow our book of business in the coming quarters as we look to execute on the growing demand and favorable market conditions. Our backlog as of October 31, 2022 was approximately $19.9 million, which is up over 50% from the $13.1 million backlog we reported at the end of fiscal 2022. In addition to this backlog of firm orders, we continue to pursue a number of other opportunities for which we have high confidence. These orders reflect the continued positive momentum that we are experiencing in various markets. And we believe that our products are uniquely positioned to benefit from the strengthening macroeconomic environment. Thanks, Rob and good morning everyone. As Rob mentioned earlier, revenues from continuing operations totaled $4.9 million in the quarter, a 41% decrease when compared to the $8.3 million in the same period a year ago. Gross profit from continuing operations in the third quarter was $1.5 million down approximately 53% when compared to the third quarter of fiscal 2022. This represents a gross profit margin of approximately 31% for the quarter, which was down from the 38% we achieved during the prior year third quarter and the 41% reported in the second quarter of this year. As mentioned on last quarterâs call, we anticipated lower revenue levels in the third quarter due to the delivery schedules of some larger orders that we expect to be completed in the fourth quarter. The lower revenue resulted in less absorption of fixed costs, which drove gross margin down in the third quarter. Our general and administrative expenses were $3.6 million for the third quarter of fiscal 2023, which was down from $3.8 million in our second quarter of 2023. As we mentioned last quarter, our G&A expenses tend to taper down as the year progresses. Much of the expenses that we incurred earlier in the year were associated with front-end loaded payroll taxes, professional and travel fees. Our research and development expense for the third quarter was $843,000, which was in line with our second quarter. Consistent with prior periods, these costs are largely directed towards our strategic initiatives, including synthetic aperture sonar and passive sonar arrays. Our net loss from continuing operations for the third quarter this year was $3.3 million as compared to a $2.1 million loss in the third quarter of fiscal 2022. Our third quarter adjusted EBITDA from continuing operations was a loss of $2.7 million compared to a loss of $1.3 million in the third quarter of fiscal 2022 and a $1 million loss in the second quarter of this year. Although adjusted EBITDA from continuing operations was down during the third quarter, we maintain our expectation of generating positive EBITDA in the fourth quarter. As of October 31, 2022, we had working capital of approximately $12.8 million and cash of approximately $812,000. We continue to have no funded debt or outstanding obligations, aside from normal trade obligation. Also, our cost structure remains largely variable which gives us flexibility to respond to changes in market conditions. Thanks Mark. Despite the expected pullback in our third quarter results, we remain encouraged by our growing backlog of business and the robust interest and customer engagement that we are continuing to see. We think these factors and the market trends I discussed earlier are strong indicators that we are on the right path. If you look ahead to our fourth quarter, based on our backlog and current delivery schedules, we expect to generate revenue of between $12 million and $14 million during the quarter, that level of revenue we expect to generate positive earnings from continuing operations. We have significant orders that we anticipate delivering during the quarter. In fact, we have already delivered some, but given our robust backlog and other anticipated orders, we feel that our elevated revenue momentum will continue into next fiscal year. However, Iâd like to make it clear that there will be variation between quarters and not all quarters will necessarily reach the same level as our fourth quarter, but we do believe the general trend will be one to increase in revenue. Of course, this is not without challenges and risks. Supply chain issues, evolving delivery requirements, government contracting processes, technical and production challenges, are all things that we must deal with everyday and can impact production and deliveries. Nonetheless, we feel good about where the company sits today and believe these positive market trends will continue into future periods. We also believe we will enjoy increasing contributions from our development programs, such as synthetic aperture sonar, automatic target recognition, and passive sonar arrays. In early October, we announced the deferral of our third quarter preferred stock dividend. We took this action to address liquidity demands required to complete our near-term backlog as well as other expected orders. Timing uncertainty of certain receivables makes it prudent that we preserve our financial flexibility as we work to fulfill orders of varying sizes and timelines. Although liquidity continues to be a challenge, we are diligently working to reach a resolution and hope to do so in a non-dilutive or minimally dilutive way. We expect to resume payment of dividends, including any previously deferred at some point, but not yet made a decision as to the timing of that. We believe the best is yet to come from MIND Technology. We feel that our increasing order flow and improved financial performance in the coming months will indicate our ability to drive meaningful shareholder value. We are positioned to capitalize on numerous opportunities in the coming year and the favorable market conditions continue to support our business in a variety of ways. We are optimistic that our fourth quarter results will demonstrate our profitability. We will look to carry that momentum into our fiscal 2024. Thank you. [Operator Instructions] Our first question comes from the line of Tyson Bauer with KC Capital. Please proceed with your question. Just a quick way to view Q3 and Q4, should we really look at these as a composite, take them together as kind of a second half story and where you are as a company, which would imply kind of you are at a $9 million to $10 million per quarter rate. And at that level, it doesnât seem like that will quite be enough. Obviously, itâs a dramatic improvement from where you were, but we need 20%, 30% more. Is that in what you see going forward that we can achieve those to try to lessen some of that liquidity risk and other business risk? Yes, I think so, Tyson. I wouldnât exactly average the two, third and fourth quarter to give a run-rate. Itâs not quite right. I mean, there is certainly some aspect of that. We are seeing some stuff move from Q3 and Q4. But we still anticipated increase in Q4. So you are right, we probably need a bit beyond that, $9 million to $10 million, which â thatâs what we see going forward. May not be every quarter, but as a general trend, thatâs what we are seeing. Okay, sure. We view the level that you produce in Q3 kind of that base revenue, where thatâs derived primarily from services, parts, some reoccurring aspect of that revenue base? I mean, I guess itâs fair to say that most of that activity was of that nature. Again, there is some anomalies in Q3 just because of timing of things. So I wouldnât necessarily leave at that level going forward. Okay. And when we look at the fiscal â23 results and the backlog that still is absent of any contribution from your JV partner in Europe, which is expected for next year? Any sense or any color you can provide there to kind of give us some sense of the meaningful or the material impact that could have to get you that 20%, 30% more revenue? Obviously, might be, I am going to be very cautious with my comments here. I mean, we are progressing dramatically on that front. Obviously, we wouldnât be making this sort of investment unless we anticipated a significant return from that. So I will just going to leave it at that. Okay. You talked about backlog expected profitability before recruiting the deferred dividend. Where do you anticipate your cash and where do we look to be at the end of this fiscal year as far as your liquidity position with a strong fourth quarter? Yes. I donât want to project the cash balance at this point, but we are delivering throughout the quarter, we have already delivered things. So that will have an impact. Other things we have delivered later in the quarter. So you wonât see that at year end. There are a variety of areas we are addressing to attract liquidity, obviously, AR and by implication inventory as we liquidate and sell things, we are not having to buy things as we have so much in inventory already that already bought it. We continue to generate some funds from our legacy leasing assets that amounts are â and those amounts are decreasing, but there still is some activity there. As we said in the past, we have some opportunities to monetize some unencumbered assets, specifically real estate assets we have. And so we are pursuing all of those areas. Okay. And the discontinued ops, is that just kind of like clean up number of â because it looks like you donât have assets held-for-sale on your balance sheet. So did you go through the process and chose to write-off any remaining asset values there? Although you may have those that you could sell it at a later date, which almost reverses what you have just taken off? Yes, thatâs right. So we â the remaining assets from the leasing business are â have zero book value. So they have been written to zero, but there still are some assets that we are hopeful of being able to monetize. Okay. You talked about you have already made significant deliveries for the fourth quarter, any idea of percentage of expected revenue since you gave the expected revenue range that you have already delivered and have in pocket? And again, I donât want to be very specific. But there are substantial deliveries throughout the period. And I will leave it there. Okay. When you look at your working capital, and given the outlook that you just provided, and then you look at the market valuation of your preferred stock that is accumulating that preferred dividend? Can â is there a rationalization for that, it doesnât seem like the numbers really work out. And given the level of importance to your direct JV partner and really indirect relationship with Mitsubishi, what are we missing here? So, the question really is that you have got what, $9 million valuation on the preferred dividends at $5.60 a share. You have already had two deferred. You really canât do much as a company without becoming true or current on that preferred dividend that is deferred. The marketplace seems to have chosen to say hey, that working capital number, they have, that inventory number, that ongoing business number, we just donât believe it. Even though you have preference on those preferred shares, is there something that you want to add or that you want â I am going to throw you a little softball here, that would say, hey, the numbers just donât add up. As far as why we are getting value there, especially on the preferred side, compared to what you are seeing as a management team? Okay. I now understand. I mean obviously, maybe not obviously, but we would have different opinion as to what the market value ought to be both of the preferred and the common. Lots of reasons that contribute to the â while the price is where it is that we firmly believe that as we demonstrate the growth in the business, demonstrate the ability to generate, ongoing cash flow, then you know that view from the market is going to change dramatically. There is no reason for it not to, in my view. But you would share that even on a salvage valuation, if you really went that route, you are significantly ahead of where the market is applying evaluation on you. Thank you. And I always seem to play second fiddle to Tyson. I want to pick up on what Tyson was going with this. We have sat those of us who have held stock for several years have heard this, as a story thatâs about to break out, we are about to break out. I feel we are a little bit waiting for good dove on the beach. This year, the stock has lost 75% of its value. You have got the preferred trading at about little over 20% of its book value. I think what Tyson was being polite, and dancing around and giving me the chance to say is that this company is worth, I think a lot more dead than it is currently alive. And as a holder and someone who has been a patient holder, I would say this has to be the year this next year, fiscal â24 the year that you will be reporting the fourth quarter of in early â25. But you need to sell this company, if you canât make this business work. But you canât keep asking your investors to be patient, when being patient means you are losing, this was a $2 stock, itâs now $1.60 â itâs now a $0.40 something stock, itâs really getting to be old. And quite honestly, we are not seeing insider buying. One thing I would think might send a real message is if insiders were buying the stock aggressively indicating that they believe in this company, you can buy a lot of shares when your stock trades at $0.40 something a share. So, I would hope to see as soon as we get into the open period, insider starting to commit capital into the common, because that would be a real vote, that there is residual value here. And as I have said, in this next year, get this thing working, get it profitable, get it so itâs generating enough free cash flow that you can pay the dividend on a regular basis. And that moves back towards book value and the stock starts to move back at least towards where it was a year ago. And I would love to â give your thoughts on what, when â why arenât we seeing insider buying? And why are we continuing to kind of press this with the idea that itâs going to work if we havenât yet seen it work? Well, there is lots of reasons, but there was some insider buying earlier in the year, there has been some, not a great deal, but some. Obviously, there are restrictions from time-to-time as to what we insiders can do given what we know, that may or may not be public information. So there, I will just make a comment. There are some limitations there. Ross, I understand your frustration, we have shared as well. Thatâs why we think that where we stand now going into the fourth quarter is a big change. And we are starting to seeing that â see that transition. I hear your message, hear loud and clear. But we do think we are seeing that turnaround in this fourth quarter. You have said you are going to be $100 million revenue run rate business, even with the projections of the fourth quarter, which I assume is picking up $3 million, $4 million, $5 million from the third quarter. You are at the high end of your range, something they were above $50 million to $60 million run rate business. How long is it going to take once we kind of cross this Rubicon, which you are indicating we are crossing in this quarter we are currently in. How long is it going to take to get from that mid-$50 million run rate annually to the $100 million you have been talking about. You know your book, you are not buying if you guys arenât buying insider. As insiders, you are telling me that there is something out there that you know, thatâs going to be material, just surviving literally would be material given the way the stock is priced. So, how long is it going to take to get to that $100 million run rate. And as I have said, I just think that your shareholders, you can see it no one cares, and you got to create if you canât get people to care, then you have got to just say fine, I will give you â we will sell this business and we will let you move on. So, how long is it going to take to get to that your $100 million target? I donât want to give us a period of time. We talked about a 5-year period before, obviously, we have eaten into that. Some things happened in the marketplace. So, itâs not going to be next year, itâs probably going to be the year after. But itâs certainly very attainable, we still believe. And I think as we get to these higher levels, things start to build upon themselves. And it â I think you see the growth start to compound a bit as we are able to layer on some of this additional activity. I know that doesnât answer you specifically, but. No, I think we are at that stage where and you know it, you see it, we need action. And in lieu of action, what we really need is insider support. And we need to get the company to where we can get the preferred dividends paid, so then you can be moving forward off of that, and we can return the value to the equity. As Tyson is implying, I think if we shut this company down today, I think that the preferred holders would get paid, book value, and I think that the equity holders would make a â would make multiple bags on what was left. Letâs get it there. I think that you canât expect your holders to have patience. And so I think you need to execute and if you are the people you are working with, you are an important provider to them. You have skills and you have capabilities and technologies that no one else has. Thatâs very valuable. They are not letting â they are not going to let you fail. But they need to do more than just keep you alive. They need to let you prosper. Thank you. Ladies and gentlemen, this concludes our question-and-answer session. I will turn the floor back to Mr. Capps for any final comments. I would like to thank you everyone for joining us this morning and we look forward to talking to you again after our fourth quarter. Thanks very much.
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EarningCall_1638
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Good morning, and thank you for joining us for Lamb Weston's second quarter 2023 earnings call. This morning, we issued our earnings press release, which is available on our website, lambweston.com. Please note that during our remarks, we'll make some forward-looking statements about the company's expected performance that are based on how we see things today. Actual results may differ materially due to risks and uncertainties. Please refer to the cautionary statements and risk factors contained in our SEC filings for more details on our forward-looking statements. Some of today's remarks include non-GAAP financial measures. These non-GAAP financial measures should not be considered a replacement for and should be read together with our GAAP results. You can find the GAAP to non-GAAP reconciliations in our earnings release. With me today are Tom Werner, our President and Chief Executive Officer; and Bernadette Madarieta, our Chief Financial Officer. Tom will provide an overview of the current operating environment, while Bernadette will provide details on our second quarter results and our updated fiscal 2023 outlook. Thank you, Dexter. Good morning. Happy New Year and thank you for joining our call today. We're pleased with our financial performance in the second quarter as we continue to drive strong sales and earnings growth across each of our core segments. Our results reflect the successful execution of our strategies to counter the significant input cost inflation over the past couple of years through a combination of pricing actions, improving business and product mix and adapting our manufacturing and supply chain to global challenges. Specifically, we delivered sales of nearly $1.3 billion, a record high quarter, healthy gross margins in each of our core business segments and strong earnings EBITDA and earnings per share growth. Because of our first half results and confidence in our business momentum, we've increased our sales, gross margin and earnings targets for fiscal 2023. I'm proud of our performance in the first half of the year and how the entire Lamb Weston team continues to focus on serving our customers and driving sustainable, profitable growth. Before turning the call over to Bernadette, let me first provide some quick updates on the current operating environment. First, overall French fry demand in the U.S. remained solid although the total restaurant traffic remains below pre-pandemic levels. It's up versus the prior year quarter, and trends are up sequentially off the lows we saw in the summer, as gasoline prices spiked. Demand and traffic trends in the quarter varied by channel, as consumers reacted to broad-based inflation and the threat of a recession. QSR traffic was up versus the prior year, and trends improved sequentially versus our fiscal first quarter as consumers adjusted to less expensive dining options. As expected, casual dining and full-service restaurant traffic in the quarter was down versus the prior year, although trends also improved sequentially versus our fiscal first quarter. This year-over-year decline in casual dining and full-service restaurant traffic had a more pronounced effect on our Foodservice segment, which has a greater exposure to these sales channels and contributed in part to a decline in the segment's volume. The fry attachment rate, which is the rate at which consumers order fries when visiting a restaurant or other food service outlets remained above pre-pandemic levels. The attachment rate in QSRs actually increased versus the prior year quarter which helped stabilize fry demand. Overall, we feel good about how the category and away-from-home channels is performing in this difficult macro environment, but expect restaurant traffic demand trends will continue to be volatile through fiscal 2023. In contrast, retail fry demand remained solid in the quarter. It's been strong since the start of the pandemic as consumers pull back spending on dining out. Demand for our retail products sold under licensed restaurant brands, in particular, remained strong over the past year as consumers look to have the restaurant style fries they love while at home. While fry demand across all our channels is holding up well, we continue to struggle to meet that demand due to the impact of supply chain disruptions on run-rate and throughput in our production facilities. Over the past year, these disruptions have been largely related to the impact of shortages in certain commodities, such as starches and edible oils as well as factory worker shortages and availability. The availability of key commodities has slowly improved over the past couple of quarters as we broadened our supplier base and qualified substitute ingredients when possible. Yet it remains a concern, and we expect it will continue to affect our production volumes at least through the remainder of fiscal 2023. The availability of production team members has also steadily improved over the past couple of quarters, such that we're back to having staffing levels in most of our processing facilities at desired levels. However, run-rate and throughput constraints will continue until our newly hired colleagues gain experience to optimize production. We've also experienced production constraints after adjusting operating procedures to reflect changes in product mix and consumer demand, including higher demand for retail fries, premium fries and batter-coated products. These products generally carry favorable margins. For example, to produce batter-coated fries, which is a high growth and high margin segment of the category, we typically run our lines at slower speeds than we're producing uncoated straight cut fries. This results in reduced throughput. We also require more frequent and longer downtimes to clean and sanitize lines between production runs when batter is used, which affects our run-rates and line availability. Together, this results in fewer finished pounds produced relative to making uncoated fries, which ultimately leads to pressure on our customer order fill rates. In short, we expect the impacts of ongoing commodity shortages, the onboarding of recently hired production team members and adjustments to optimize business mix to continue to pressure volume performance, and our ability to meet customer demand through the remainder of fiscal 2023 and until our capacity investments in China, Idaho and Argentina become available over the next couple of years. With respect to pricing, we continue to drive pricing actions across our portfolio to counter input cost inflation. The environment remains generally favorable as a result of the solid category demand that I just described, coupled with constrained industry supply. Our global segment led the way in the quarter with strong pricing through a combination of inflation-driven price escalators, new pricing structures for customer contract renewals and working with certain customers to accelerate pricing actions for contracts up for renewal in the coming years and improvements in customer mix. We feel good about how Global's contract renewal negotiations played out this past year, and expect this segment to continue to deliver strong price/mix growth as more of these updated pricing structures take effect in the second half. We also expect to drive solid price growth in both the foodservice and retail segments in the second half of the year. Although the growth rate should decelerate as we begin to lap some of the pricing actions we took in fiscal 2022. With respect to the potato crop, we've been processing potatoes from this year's harvest for the past few months and continue to assess the overall quality of the potatoes in our key growing regions, including shape, color, level of defects and solid content as consistent with historical averages. Yields, however, are below historical averages and below the preliminary assessment that we provided during our earnings call in October. To fill our production needs, we have secured additional potatoes in the Columbia Basin and Idaho and are sourcing potatoes from other regions in North America, including the East Coast. This will add to our potato costs for the remainder of fiscal 2023, and we have included the estimated impact in our updated financial targets for the year. With respect to next year's potato crop, we've agreed to nearly a 20% increase in contract prices for potatoes grown in the Columbia Basin and have secured the targeted number of acres to be planted. Our discussions with growers in Idaho and Alberta on price and acreage are ongoing. Now with respect to our acquisition of our partner's interest in Lamb Weston/Meijer, we expect the transaction will close during our fiscal fourth quarter after completing the regulatory review process. I'm excited about welcoming 1,500 value team members and beginning to capture strategic commercial and operational benefits from the transaction, including, first, strengthening our global manufacturing footprint by leveraging Europe's low-cost infrastructure to serve key markets around the world as well as adopting best-in-class manufacturing practices to increase efficiency, improve quality and reduce costs. Second, enhancing our customer-centric operating model by offering a single voice to our global customers and seamlessly supporting multinational customers with a truly global supply chain. Third, improving our position to further capitalize on growth opportunities in Europe, the Middle East and Africa. And fourth, pursuing our global growth strategies without the operating restrictions associated with the joint venture. So in summary, we drove strong sales and earnings growth in the second quarter and in the first half by executing on our strategies to price the counter inflation, improve mix, generate productivity savings and drive value for our customers. The category is healthy with solid overall demand behind strength in QSR traffic and constrained industry supply. The quality of the recently harvested potato crop in the Pacific Northwest is good, and the impact from the shortfall in yields is manageable. And finally, we're confident about the strategic, operational and commercial benefits at the Lamb Weston/Meijer transaction has to offer, and we look forward to the transaction closing later this year. Now let me turn the call over to Bernadette to review the details of our second quarter results and our updated fiscal 2023 outlook. Bernadette? Thanks, Tom, and good morning, everyone. As Tom said, we're pleased with our financial performance and operating momentum through the first half of the year, which has provided us with a strong foundation to raise our annual sales and earnings targets. Let me review our second quarter results before discussing our updated outlook. Sales in the second quarter grew 27% to nearly $1.28 billion. That's a record for us. A 30% increase in price mix drove our sales growth as we continued to benefit from product and great pricing actions across each of our business segments. The increase reflects the carryover impact of product pricing actions that we initiated in fiscal 2022 as well as pricing actions that we began implementing during this fiscal year. The increase also reflects benefits from efforts to improve our portfolio mix. Sales volumes declined 3%, as we continued to experience the supply chain constraints and related shortfalls in order fulfillment that Tom described. This primarily affected volumes and service levels in our Foodservice and Retail segments. To a lesser extent, volumes in the quarter were also impacted by softer casual dining and full-service restaurant traffic as well as the timing of replacing losses of some low-margin business in our Foodservice and Retail segments. Gross profit in the quarter increased $176 million to $382 million, as a result of our sales growth and strong gross margin performance. Our margin expanded 950 basis points versus the prior year quarter and about 550 basis points sequentially to nearly 30%. Broadly speaking, pricing actions in each of our business segments, efforts to improve customer and product mix, and value created from our productivity programs have caught up to the cumulative effect of input and transportation cost inflation over the past couple of years. Input cost inflation, however, continues to be challenging. Once again, it was the primary driver of a double-digit increase in our manufacturing and distribution cost per pound in the quarter, largely due to higher prices for edible oils, ingredients for batter coatings, labor and transportation. Potato costs were also up as a consequence of the historically poor crop that was harvested last fall. While this is the last quarter that we will realize the financial impact from the 2021 crop, we expect our potato costs to continue to increase in the second half of this year as a result of higher contract prices and the need for significant open market purchases due to poor yields from the 2022 crop. We also continue to incur higher costs and operational inefficiencies associated with shortages of key ingredients and spare parts, onboarding newly hired production team members and other industry-wide supply chain challenges. While the impacts from these constraints have been slowly easing, we expect they will continue to be a headwind through the remainder of the year. Moving on from cost of sales. Our SG&A, excluding items impacting comparability, increased $45 million to $136 million, largely due to higher compensation and benefit expenses due to improved operating performance and higher expenses relating to improving our IT infrastructure, including designing and building a new ERP system. Equity method earnings from our unconsolidated joint ventures increased $16 million, excluding items impacting comparability and mark-to-market adjustments associated with currency and commodity hedging contracts. Higher pricing, especially in Europe, drove the increase. Demand continued to hold up relatively well despite the impact of significant consumer inflation and volatile energy costs. This sets Lamb Weston/Meijer up to deliver solid results in the second half of the year. Moving to our segments. Sales in our Global segment were up 34% in the quarter behind a 31% increase in price/mix. As Tom noted earlier, most of the increase was driven by price escalators and updated pricing structures. With the increase in price/mix, Global's product contribution margin more than doubled to $171 million in the quarter. In addition, Global's product contribution margin percentage approached pre-pandemic levels, which is a key milestone for our overall performance. While we were always confident that we would restore Global's margins, we knew it would take longer than in other segments due to the structure and terms of the channels' customer contracts. Sales in our Foodservice segment grew 14%, driven by a 25% increase in price/mix as we continue to realize the carryover benefit of pricing actions that we announced throughout fiscal 2022 as well as actions taken earlier this year to counter inflation. Sales volumes decreased 11%, primarily reflecting production constraints and to a lesser extent softer traffic in casual dining and full-service restaurants. In addition, because of these production constraints, we've had to make some tough choices on customer service, which has resulted in the loss of some lower-margin business. Foodservice's product contribution margin increased 25% as the benefits from pricing actions more than offset higher manufacturing and distribution cost per pound and the impact of lower volumes. Sales in our Retail segment increased 34% behind a 43% increase in price/mix, reflecting pricing actions across our branded and private label portfolios. Volume fell 9%, largely as a result of production constraints. It also reflects the incremental losses of certain lower-margin private label products. Through a combination of the team's strong execution of pricing and mix management, Retail's product contribution margin more than tripled to $66 million. Its production contribution margin percentage is now in line with our away-from-home channels. Moving to our liquidity position and cash flow. Our balance sheet remains solid with strong liquidity and a low leverage ratio. We ended the quarter with about $420 million of cash and $1 billion undrawn revolver. Our net debt was about $2.3 billion, resulting in a 2.4 times leverage ratio. That's down from 3.1 times at the end of fiscal 2022, reflecting our earnings recovery. In the first half of the year, we generated about $290 million of cash from operations or about $80 million more than the first half of last year, largely due to the higher earnings. Capital expenditures were about $270 million, which is up about $120 million from the first half of last year. This increase is largely related to construction costs as we continue to expand processing capacity in Idaho, China and Argentina. As a reminder, our annual maintenance capital expenditures have typically been about $120 million to $130 million as we generally target about 3% to 4% of sales. In the first half of the year, we returned nearly $100 million of cash to shareholders, including more than $70 million in dividends and $28 million in share repurchases. As you may have seen a few weeks ago, our board of directors approved a 14% increase in our quarterly dividend, reflecting the successful execution of our strategy to drive strong financial results and cash flow and our confidence in our ability to deliver sustainable, profitable growth over the long-term. So now let's turn to the updated fiscal 2023 outlook. Please note that our updated targets do not reflect the financial consolidation of Lamb Weston/Meijer as that transaction has not yet closed. We believe the transaction will be completed during our fiscal fourth quarter. So for the year, we've increased our sales target to $4.8 billion to $4.9 billion, which implies a growth rate of 17% to 19.5%. That's up from our previous target of $4.7 billion to $4.8 billion. We expect that higher price/mix will be the primary driver of sales growth in the second half of the year. Forecasting volumes in the second half remains difficult as we anticipate shipments will continue to be affected by supply chain constraints through fiscal 2023 and because of volatility surrounding a potential slowdown in restaurant traffic and demand as consumers face inflation and a weaker macroeconomic environment. For earnings, we're targeting adjusted net income of $540 million to $580 million. That's up from our previous target of $360 million to $410 million. Adjusted diluted earnings per share of $3.75 to $4, up from our previous target of $2.45 to $2.85. And finally, adjusted EBITDA, including unconsolidated joint ventures of $1.05 billion to $1.1 billion, up from our previous estimate of $840 million to $910 million. We continue to expect the increase in our earnings will be driven primarily by sales growth and gross margin expansion. We're targeting gross margins during the second half of the year to be between 27% and 28%, which is in line with the more than 27% that we delivered in the first half and up from the 23% that we posted during the back half of fiscal 2022. We expect the seasonal, sequential quarterly cadence for gross margins will be less pronounced than in previous years. Specifically, we do not foresee much of the typical seasonal step-up in gross margin from Q2 to Q3 or much of the typical step down from Q3 to Q4 for a few reasons. First, beginning in the third quarter, we expect our raw potato costs to increase to reflect the approximately 20% increase in the contracted price of the recently harvested potato crop. In addition, we expect higher potato costs as a result of significant high-cost open market purchases. Second, we expect continued significant inflation for other key inputs during the second half of the year, especially for edible oils and ingredients for batter coatings. Third, we expect a more muted step-up in global pricing from Q2 to Q3 due to the acceleration of pricing actions for contracts up for renewal in the coming years. And finally, we expect the year-over-year price increases in our Foodservice and Retail segments will decelerate as we begin to lap actions taken in fiscal 2022. With respect to SG&A, we expect expenses, excluding items impacting comparability of $525 million to $550 million. That's up from our previous target, largely due to higher compensation and benefit expenses, including increased incentive compensation expense due to improved operating performance as well as expenses for outside services, including support of our IT and ERP upgrades. Our estimates of other financial targets, including interest expense, capital expenditures, depreciation and amortization expenses and our effective tax rate are unchanged. Thanks, Bernadette. Let me sum it up by saying we're confident in our strategies and business momentum. And as a result, we've significantly increased our financial targets for the year. And we're also confident about the health and prospects of the category. And we believe that our capacity expansion and infrastructure investments will have us well positioned to support sustainable, profitable growth and create value for our shareholders over the long-term. Once again, I want to thank the entire Lamb Weston team for our success this quarter and their ongoing commitment to meet the needs of our customers. Good morning. Just kick off getting maybe a little color on the inflation outlook. I appreciate the comments in the prepared remarks. The release referenced double-digit inflation. It sounds like there's some moving parts, especially with potatoes stepping up in the second half, but you'll also be lapping some higher rates of inflation. So is the messaging that the absolute rate of inflation will step up in the second half of the year? Or would it be more comparable to what we saw in the second quarter? Yeah. Thanks, Tom. This is Bernadette. We don't expect the absolute rate to increase. We will, though, however, continue to see that double-digit inflation for the remainder of the year. And as you said, that's reflecting the higher cost for potatoes and then other key inputs for edible oils, labor and ingredients. So absolutely expect that double-digit cost increase to continue but not increase. Okay. Thank you. And then the bounce back in Europe. Where are we in kind of the return to normal? I mean did we exit the second quarter, what you would call, a normal earnings run-rate for that business? Is there still more work to be done? And as we think about the second half, should we look for another step-up in kind of the earnings power of that business as more pricing takes hold? Yeah, Tom. So this is Tom. The team in Lamb Weston/Meijer soon to be Lamb Weston has made terrific progress. Marc Schroeder leads that business, and the business has turned the corner. They've implemented a number of actions to stabilize the earnings of that business as we expected. They're showing great progress. And the run-rates are trending positively, and we expect that to continue for the back half of the year. And as we close that transaction, as we stated, we expect that to happen in Q4 to get through all the reviews and regulatory process. We'll provide some more color on that once the transaction is closed in the coming quarters. Tom, I was wondering if you could just provide a little bit more context around your comment now that the company is sourcing some potatoes, I think, from the East Coast you mentioned. Just kind of maybe where you're seeing that relative to last year, I know when you had to source a decent number from the East Coast? And then anything just in terms of your plant network. Is there ability to move those potatoes not all the way to the basin, can you process them through the JV in Minnesota? Can you process them through the Delhi plant? Just any additional color would be helpful. Thanks. Yeah. So the year-over-year this year, it's not as pronounced as it was last year because of the quality of the crop last year and yields. We got out ahead of it, the ag team in Lamb Weston has done a terrific job sourcing potatoes to meet our needs. They're still high cost. You got to freight them across the country and you have some quality issues when you're trucking that far. But it's not as pronounced as it was last year. And all those costs are reflected in our outlook for the remainder of this fiscal year. And good news, bad news is we had some experience last year, so we were able to rally quickly, and we understand how that all is going to impact the business. But again, that's all forecasted in our outlook. So we're doing everything we can to meet our customer demand, and that's the most important thing. Got it. That's helpful. And Bernadette, I just had 1 clarification on the gross margin commentary for the back half of the year. I think you're still expecting a sequential improvement in 3Q, obviously, not as pronounced as it would have been historically but it would still improve in 3Q? And then is there a step down to expect in the fourth quarter? I just wanted to clarify those two things. Thanks very much. Yeah. No, thank you. We do expect to see an increase. But as you said, it will not be as pronounced in the third quarter as we've historically seen. And then there will be a step down in fourth quarter, but again, not as pronounced as what we've historically seen. Hi. Happy New Year. Hi. Just a bit of a follow-on to that Peter's question and some of your response there. I guess just to understand the gross margin this quarter. I just want to get a sense of how unique the performance was this quarter. And I was sticking around the areas of like mix and perhaps even like limited time offerings to what degree that's influencing the gross margin this quarter that may not be sustainable? And then to what degree you're walking away from lower-margin business, and to what degree that's influencing your margin as well, perhaps there's other issues, too. But those are a couple of things I was thinking about just to get a little sense around and how that could affect the gross margin going forward. Yeah. No, thank you for that question. And as it relates to the gross margin going forward, LTOs, there isn't anything unusual that we would have experienced this quarter relative to prior quarters or going forward. Really, what you're seeing is that we were able to pull forward a lot of the pricing actions in Global earlier than expected. And then we're going to be lapping some of the Foodservice and Retail price increases in the back half of the year. So there'll be more of a muted effect related to that. So a combination of the higher potato costs, the inflation and then the deceleration of that price/mix growth, that's what you're going to see have an effect on those margins in the back half of the year. Okay. Thank you for that. And actually, I have a follow-on to that, which just be that you talked about pulling forward some of those global contract renewal discussions. So it sounds like you had a good renewal from this past summer, and that should start to kick in now. But it sounds like you also then pulled forward some -- maybe some from next summer. -- or even summers ahead. I guess just to get a sense of where you are then on contract renewals normally. It's like a third every year. Did you -- were you able to get more of that done is the question? Yeah. We were able to go out and have conversations with our customers and pull more of that forward than had been anticipated, more than what we would have typically seen with our contract renewals. So we expect that the global pricing will remain strong in the back half. It's just we've been able to pull that forward earlier than expected. And can you say how much of your contract renewals, how much more you've done this year? Or how much less you'll have for you going forward? No, I can't really speak to that. I'd say, overall, we've got probably about 25% that we'll need to continue to renegotiate. Good morning. So I guess first question maybe on the demand environment. Some of this was in the prepared remarks, but I'd love to just hear you expand a little bit on just maybe different parts of Global between the domestic QSRs versus international? Foodservice traffic trends? And just as your customers absorb some pretty sizable kind of price increases, just the confidence that you don't see any changes in fry attach rates from the consumption perspective. Yeah, Adam, overall, I feel really strong about the health of the category. And we've purposely had to make choices across our segments to support our customer base, and we've really focused on product/mix management across the portfolio and the customers. So the QSR segment continues to be really healthy. As we stated in our prepared remarks, the fast casual, casual dining is experiencing some weaker traffic. Although it's improving versus where it was in the first quarter, but we're also making choices and in terms of customer and supporting customers based on product mix and our capacity. And there are still challenges within our network to produce and get back to the levels where we were pre-pandemic. And the team, the supply chain team is working on that. And it's going to take us the balance of this year to continue to focus on things to improve that. So the category is healthy. And yes, our volume is a little soft in some areas. That's traffic driven. But over the long-term, when I look at the category and think about the next two, three, five years, and the investments we're making, we're going to be well positioned in a couple of years to bring on capacity and drive opportunities that right now we're making choices that we don't necessarily like we got to support our key customers going forward. Yeah. And just to add to that, Tom, in addition to the softness that we have in the casual dining. More of that softness though is just related to the supply chain constraints that we've been experiencing. But overall, absolutely, our demand has returned to the pre-pandemic levels on a run-rate basis prior to what we saw with war in Ukraine. Got it. And if I could maybe follow on the point on just capacity a little bit. You talked earlier about some of the product/mix impacting kind of throughput rates and kind of what you could actually produce from an end product perspective? I mean, do you think with the current product mix, if you were properly staffed and there wasn't raw material constraint around potatoes that the current capacity with this mix could produce the same volume of finished product that you did pre-pandemic? Or does the actual mix that you've kind of shifted to as it stands right now actually constrain your -- physically constrain your output going forward? Yeah, Adam, so I know the team is working on getting to pre-pandemic levels, but the reality is the choices and the mix that we're now producing really oversimplifying it, we have to slow lines down when we're making coated product. So we can't run as fast. And so, there is some capacity disadvantages to running premium products. That's just a fact. However, I think the mix of the portfolio bodes well going forward for the profitability of the company. Okay. And maybe just a final, if I could squeeze in. Of your total price/mix in the quarter, how much was mix? Can you share if you can -- or any reframing? Hi. I just have two. Given the changes in your sourcing from the West Coast to the East Coast that you did last year now again this year, do you anticipate that in future years, if we return to more typical yields, you'll be able to shift that back to the West Coast and therefore, there should be some kind of margin expansion in 2024 and beyond? Yes. I expect next year's crop to be normalized and then yields good and all the things that we're historically used to. And in terms of is that going to provide margin expansion? No, it won't. Materially, it won't. We're going to have inflation in our commodity costs next year. Again, I believe based on how the commodity markets are shaping up. And as I stated in the prepared remarks, where the potato crop negotiations, we settled with Pacific Northwest, you're going to be up 20% next year. And you stack that up over two years, that's a big lift. And it's going to be another difficult year, and we'll continue to adjust our thinking on pricing that through the market going forward, but it's not going to be material margin impact year-over-year just based on sourcing out of the East Coast. Got it. And then my second is based upon your guidance, even pro forma for the acquisition of the rest of the joint venture, you're still going to be below your leverage target of 3.5 times to 4 times, you're going to be, I think, in the high twos. I guess what is that, I mean, in terms of capital allocation. I know you increased the dividend, but how are you thinking about that? Yeah. No, we're excited about increasing the dividend based on our performance. As we think about capital allocation, we have not changed our priorities in terms of investing in the business for the long term. M&A, if there's M&A that's available and then we will reward our shareholders as well. But certainly, we're going to invest in the business first. It does remain in that range. And as we've said before, we're doing that because we want to make sure that we have enough financial firepower for M&A or other items that may come up. There are no further questions at this time. I'd like to turn the conference back over to you, Dexter Congbalay for any additional remarks. Thanks for joining the call this morning. If you want to have any follow-up sessions, please e-mail me so we can spend time and happy New Year, and have a good day. Thank you.
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EarningCall_1639
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Folks, thanks for joining us. My name is Simon Leopold. I'm Raymond James Data Infrastructure Analyst. Here in-person, live at our conference in New York, it's nice to see people face-to-face again, it's been a while. We've got with us this morning John McCool, who is with Arista, and is the Chief Platform Officer. John, thanks, good to see you. I think we saw each other not that long ago at Arista's recent analyst meeting. So, I've got an outline. We'll do sort of fireside chat, but if anybody has questions in the audience, try to get our attention. We'll repeat questions for the webcast. I guess I want to sort of start out with some of the high-level stuff and then drill down. But Arista provided, I think, a surprisingly good forecast for 2023, for 25% growth. Honestly, I went to the meeting with kind of a mid-teens number thinking, okay, will probably go up to 20%. So, 25% was a positive surprise. Maybe help unpack what sort of led into that? What are the contributors? What are the key drivers? Do you feel that's conservative? What's influencing essentially build-up to that model? Sure. Right. So, I think just starting with 2022, I think we've seen a good rollout of our 100, 200, 400-gig solutions in the cloud segment. And there's clearly a cycle there that we're participating and benefiting from that growth. We talked about, at our Analyst Day, not just the traditional network in the cloud, but also the use cases, specifically around AI clusters. I think this is interesting. It's been a long time since new things got connected to the network. And I had to think back to maybe IP telephony, where you had non-compute devices connected. And now we're seeing GPUs that I think people would have thought about a closed system, maybe around InfiniBand being connected to Ethernet. And these are large clusters that have to have a close affinity with each other to do their thing, so that's exciting. And then I think the -- we continue to drive the enterprise business with the campus offering as a new use case in the enterprise network, and that's building momentum and gaining new customers. And so, historically, Arista has sort of segmented the verticals. Maybe talk a little bit about what you're expecting trend-wise from each, and how big they are? So, the cloud, cloud titans have been the biggest. You've mentioned enterprise, but you've got some others. How do we sort of -- what's the relative contribution? Yes, I think about the cloud segment, that the cloud titans being the largest, and these can be 100 times the number of servers than the next portion down, we think about the service provider and web specialty tier, which is also growing. I think we've seen a lot of the smaller providers and the titans building up the same type of infrastructure, moving to 400-gig and building out their networks. And then, the enterprise segment, which we've built that up to be a substantial size. And when we think about the expectations for '23 in the cloud titan trend, how much of this is really working down the backlog that you've established during '22, in part because of supply chain constraints? And how much of this we could characterize as sort of incremental business, what's sort of the split? Yes, I think we've had good visibility with the increased lead time, which kind of, in some ways, distorts the backlog metric, because you have this variable time piece that makes that less clear. So, these are projects that we've been involved in with the 400-gig cycle. So, we have good visibility into those projects and the rollout in 2023. So, I actually received an investor question as I was walking in, that fits right here is, is it conceivable or possible that some of those cloud customers have been building up buffer stock or building up inventory? Sort of how smooth is the outlook? I would generalize the answer. I think, in this environment, it's been so supply constrained that the people are really chomping at the bit for deployments in what we can ship. And that continues not just around the cloud segment, but the enterprise as well. And then, one of the other sort of related debate is this question of quality of backlog. And so, it's the idea that, yes, you have the backlog, but couldn't it go away. How do you go about assessing that? I think, again, focusing more on rollouts and deployment, as well as the projects we're participating in, and getting focused on that, and when do actually people need the product, and then, when can we build it and when do we get supply. And I wanted to maybe unpack a little bit around use cases. And you mentioned one, the AI, machine learning. Is that exclusive to the cloud titans or is that a trend that's -- you're seeing in your large enterprise customers? And maybe what are some of the other use cases beyond that? Yes, I think we've looked at the cloud titans in our business as really leading the definition of new architectures. And over time, we've seen them apply outside of the cloud titans to the specialty cloud providers, as well as enterprise over time. So, if we look back, we entered routing probably five years ago, it was really the cloud titans that wanted to interconnect datacenters, but operate them as regional datacenters as one logical network, and drove us into the routing segment. We took the routing technology and brought it into the enterprise so we could do datacenter-to-datacenter, and then ultimately into service providers. This trend, I think, is early in the cloud providers, but over time I think we would see similar kind of architecture rolled in the enterprise. So, not there yet, very relevant in the cloud titans, but I think as an interesting use case it'll apply across a number of verticals. And I think if we look back, your enterprises are substantial part of your business, remind me percent, 35%-40% of revenue? Roughly, and then -- not for specific quarter, but -- and given that as kind of a reference point, and I'm having this discussion with every fireside chat, aren't we worried about a recession? Aren't we worried about slowing from enterprises? And candidly, that the feedback I've gotten has been quite varied. So, I would love to sort of get your take on the recession fear and what it might mean for Arista? Sure. I mean I think we are clearly watching for that. Everybody is talking about it. I think in the context of the enterprise with respect to where Arista is, in networking, market share is pretty distorted. There has been an incumbent that has extremely large market share in the segments that we focus on which is Fortune 2000 and up. And we come into the business really looking at differentiated offering focused on reducing operational complexity and expense. So, we have opportunities for share gain in that environment. I think somewhat independent of the overall market given where we are, especially in Campus where we know we have been in the business for three, four years, and they are still ramping. And I want to get into maybe something that's a little bit more closer to home in terms of your day-to-day job is talking about a product cycle area. So, we often get this question about the 400-gig cycle. So, classically it's where are we in that cycle? How long does it last? How is it different? And so, why don't we start there, and then, we will kind of unpack it a little bit. Sure. I think 400-gig today really the market is still pretty small, but dominated by cloud, cloud titan deployments. There is definitely enterprise and some media entertainment applications. But compared to the size of the cloud titans, it's still pretty small. We think a lot about the cycles. We have been in the networking side of the cloud for -- since our inception. And, it's only been one period of maybe a pause or a hold. And it's tough to say whether this is cyclical or -- and that what sort people think about the end of the 100-gig. It was pretty clear 400-gig technology was coming. And then, COVID hit at the same time. So, we had those two events. So, it's difficult to find a pattern in that data, but I think we are still pretty early on this. And we talked about this cycle as 100, 200, 400-gig, because the same chipsets and technology can be used across all three of those port configurations. So, we in fact have products with the same silicon architecture that have four times the 100-gig ports as the 400-gig ports. And we have customers that are deploying in all three of those flavors this new technology. Yes, I think that's interesting point because that's one of the reasons I think the investment community is a little bit confused because you have been shipping 400-gig capable platforms for years. There was a big break between 40 and a 100 gig. So, if you wanted to buy a 100-gig ready switch and deploy it at 40-gig, you wasted 60% of the bandwidth. So, that really pushed the market to 100-gig to take full advantage of that engine, so to speak. Here, you don't have that inelegance. You have -- you can use that same silicon for four 100s, you're not wasting any bandwidth, and it's a smoother migration path with this technology. Exactly. So, the other thing that I've observed in this industry over multiple product cycles is disruption invite share shifts. So, when there's a new product cycle, somebody says, âOkay, we were doing 100, we're now doing 400.â How are you seeing that change in that -- your networking competitors claim that 400 is sort of their insertion point and that they're catching up. What are you seeing in terms of the shift in competitive landscape as product cycles change? Sure. I think that was a mantra a few years back before 100-gig existed. I think we feel really secure in our foothold in the early 400 gig market, and leading that market, as well as what we've done on 100-gig as a market leader. So, I think we'll see what the 800-gig cycle brings, but I think we're feeling pretty good about where we are today. So, I think there's a lot of nuance to the different places people deploy networking gear. And so, transit WAN is relatively new. Let me put it maybe in the context of an enterprise, some generic enterprise somewhere in the planet. You have a core network that interconnects all your buildings' facilities. You have a datacenter that connects the servers where you run your applications. You'd have some interconnect of that backbone network to your hybrid cloud. And then, the last might be connection to some type of edge. If you were an insurance company you might have a lot of branch offices. If you were a fast-food restaurant, you might have a lot of other facilities that you're connected in. So, think about an extension of your enterprise into these smaller branch offices. That network has had a lot of Qt technology names over time. I think in the early days of networking, it was dominated by the concept of integrating services at the edge, specifically to run voice over IP. And then we went into a period where that T1 E1 links were the bottleneck, and you had the era of WAN optimization; so, how can I optimize the links? And then, as you started to get more redundant type of networks with LTE and IP backbones, cable modems, how can I optimize those links and get as maximum bandwidth and redundancy, and you had the era of SD-WAN. So, we have the building blocks to participate in that market. Some of those building blocks are access switches because you need them to connect when you're in the branch. And then, core routing technology to connect to the core. But what could be a differentiated solution or where could we have an impact? As you start to see hybrid cloud and the concept of transit through the cloud, that becomes an interesting insertion point for us. And we announced our intent to enter that market. The key piece of that is it kind of completes the picture for us of a total enterprise networking solution from the routing core, the datacenter access to the servers, the campus, and now connecting these edge locations. And so, it's not that this is a new category of technology, it's new use case for you. So, who are the incumbents in that? All the same incumbents we compete against today, the Cisco, the Junipers of the world, as well as some specific SD-WAN kind of start-up and smaller companies. And you've talked about, I guess, the amount of TAM expansion. Do you have those numbers handy, of how big that opportunity could be? And the way I've thought about it, and I'm okay being wrong, so just say, "Hey, Simon, you didn't get that right." I look at this opportunity as really being focused on more of the point-to-point datacenter interconnect for hyperscale, that this is not yet targeting sort of the typical telco metro routing applications where you're supporting consumer broadband, and 5G, and all that other kind of stuff. So, is that in the roadmap? Do we think about you going from this sort of datacenter interconnect use case to more of a broad, multi-service use case? Is that the intention? So, sell to the enterprise VP of networking that runs the entire architecture, and solve the problem of how I connect my branches. So, I want to pivot now to that enterprise campus part of that. So, in '22, we expected revenues would double. I believe it was last quarter, you guys had to rescind the forecast, blaming supply chain. You wouldn't have been the first, hopefully you'll be the last, but I doubt that. What occurred really during the most recent quarter that led to the change in the forecast? What kind of parts are you suffering shortages of? The supply chain thing is more generic than just the campus piece. But given where we are, and ramping that market, I think, had a bigger impact. If I look back over the last three years, we're out of the era of plant closures and mobility control orders that are keeping people away from work, and really impacted by the semiconductor supply chain. I think around the large devices that are typically on very advanced process nodes, things have gotten more steady. I think supply is still tight, but more predictable. But if you go to analog and power products that are used not just networking or even IT, they are used broadly in consumer applications, they are on 100 nanometer-types of technologies and older. There has been a lack of investment in those kinds of capacity across a broad set of suppliers. And they continue to be limited, and I think we foresee that happening in the 2023. What's your expectation for the duration of these supply chain constraints broadly? Because it sounds like most have said there has been some improvement, but not out of the woods. What's your prediction for when we are out of the woods? All these suppliers are working on increasing supply. They all have plans for new fabs and increasing the size of wafers to get better utilization in existing fabs. And that's improving slowly. I think some of the demand reduction on the consumer side has actually been the primary reason that there is some benefit here. Just some context, so I think when people think about improvement, they think we are getting back to normal. Normal days worse case lead time semiconductors was roughly 24 weeks. And today, things are ranging from 50 to 70 weeks. I think we have a long time before we see going back to that old normal. There might be some new normal. And predictability would probably be the new normal as you might have extended lead times, but things show up when you expect them, and there is no surprises. But it does appear that in general -- and I am not -- now Iâm stepping back broadly Arista and now Campus, that the company made a concerted effort to pay whatever brokerage fees you needed to pay to get products because you haven't missed on revenue. Your margins have come under pressure. So, how much of that reflecting on it was intentional on your part to prioritize revenue over margin? Is that the way you think about it? I think we think about it in terms of fulfillment of demand. So, we saw demand. We made some purchase commitments that were significant to the supply chain in advance of this, which I think what was helpful to get in line effectively. And then as you start to see missing shipments and you have the rest of the kit and you have capacity to build, broker buyers are a good way to augment that to fill in those gaps. So, that's the way we think about. Okay. I will take you back to the Campus topic that was just might go on little deviation there. But when Arista first announced entry into Campus, I definitely admittedly scratched my head. And I get the logic of âIf you have zero share, it's one only direction to go. It's up.â And I get the idea that you have got existing customers who would be thrilled to buy other products from you because they like your data center products. So, that to me was sort of the easy part that gets you established. What takes Arista to kind of the next level from a low single digit market share player, you start facing tougher comparisons. So, whether it's around feature differentiation or building channel, what's the strategy to take this up somewhere substantial? Sure. No, I think maybe I will step back for the investors just to think about how we think about it. This enterprise network has been hyper segmented over time. As networking grew, there were number of start-ups that focused on different technology areas, and focused on PoE and Access, and focused on Wi-Fi, and focused on routing. And if you are a network operator, you are consuming all these technologies. You have a different operating system. Each of those might have, at different times, their own security alerts. So, now I have to upgrade and patch all of them separately. I have a different management network. I have to train my people across all of them. Arista has taken a different approach. We started with a datacenter. We added routing, but we did think in a manner with a consistent management stack and software stack. So, one EOS release, that's our operating system, will run across all these various network pieces. So, when we entered Campus, I think people were looking for the knockout whiz-bang feature, some QoS magic or something. The magic was you could run it the exact same way as the datacenter, and you could upgrade it the same way. And you had a consistent management profile with an extremely strong high-quality operating system. That's it. We are going to approach this transit space with that same model. So, the consistency of the environment is actually the big value add. Now, it's interesting because everybody targets the same one big competitor who -- sort of the argument is, well, the incumbent is complex, hard to do business with. And the challenges I see it is the narrative from your closer competitors in market share whether it's Juniper, HPE Aruba, they seem to be telling a very similar story. So, everybody can sort of keep nibbling away at Cisco forever and maybe that's a business strategy. I want to see how you think about competing against those smaller players that have a similar narrative, right? That it's simple. It's one screen, common management systems. How do you think about that? Yes. I mean it is hard to compete against the narrative because it's very easy for me to say I have better quality, right? So, quality is an experience. Our sales teams look for an insertion point, and what we've given them is more opportunities to insert. When we only had datacenter, it was difficult, if you missed that refresh window you had to wait another three, four years. Well, now, you might have a Campus opportunity, or a transit WAN, or a management network, or some way to give the customer a way to experience the Arista effect, if you will. We found if we can insert, which is probably the harder part, we're in a really good position for the next larger win. So, you're absolutely right, competing with the narrative is difficult, you have to get a customer to have the experience, and then we win. And I tend to think of the Arista culture as having a certain aspect of being frugal in terms of sort of -- you don't spend money wildly, and often you're underspending on OpEx, and struggles hiring enough people. And what I've struggled with is when I look at companies that are selling into the enterprise and commercial market, they have to spend a lot of money on channel development, a lot of money on developing a sales force. And so far, you haven't sort of had to go down that path, but that's -- I see it as a risk. Internally, how do you talk about striking that balance of maintaining expense control, but being able to grow in those kind of markets? And given your past history, you know what it takes. Yes. I mean, we look in a new segment -- or let's say we have a new use case, to find that early success recipe with a handful of customers, and then we know we can scale it. And then we have the confidence to go spend accordingly to make the investment. If I see some of our sales teams and how they've expanded in the enterprise, they found some big accounts that they've worked on, maybe in a region, and then gotten a toehold there, and then they bring in a partner, invest in the training of that partner specific to a region or an area. And then that partner is able to go find other accounts that are smaller and probably out of our scope of view, right? So, that's been the affect. I think also if I think about that conversation about competing against the narrative, you have to have somebody that experienced it. So, having an anchor tenant, if you will, in the region where there's some reputational success that -- and now we've seen people leaving companies and moving in their careers to other companies that have an Arista experience is getting easier to explain that because they can sell for us that, "It worked over here, it'll work over there." Five years ago, we would into account like, "Who is Arista," right? Yes, we're using the channel to fulfill and also to deploy. So, yes, it's critically important. But we don't see ourselves as being kind of distribution-led, finding partners, and that model. It's really direct driven in terms of the value and the partner coming and helping with deployment and bringing other technologies to pull it all together. Now, the other thing I want to ask about -- Oh, I've got a question in the back. I'll repeat the question. But go ahead. Itâs basically -- let's see if I do it shorter. Basically, what's the Arista messaging on how the macro is affecting the business broadly, beyond my earlier question about potential for inventory builds, but how are you seeing the macro play out and change? Yes. And let me connect that a little bit back to the distribution and resellers. And we're very direct focused, and we're focusing on Fortune 2000. So, we have, I think, good line of sight to actual deployments and schedules of deployments. And especially around the situation where lead times are long, maybe even more visibility and some angst around those lead times. So, that's helpful. Look, I mean we're definitely watching, like everyone else, the impact of macro. We're not very retail or consumer-based in our deployments, so that helps. We're not a bid market company. So, we might be shielded a little bit from even some of the visibility. It's not that it couldn't impact us if there was a deep and wide recession. But as of now, we haven't been impacted. So, I want to make sure I ask you about software. And so, I want to preface this with, please never call me a hardware analyst. Exactly, right? No, I get it. And so, part of it is, Arista is -- from its roots, you don't build your chips. You have a merchant strategy. So, just to -- for it to help folks out, just the rough statistic, what portion of your engineering focuses on software verses hardware? I don't have a crisp number, but it's probably 90% plus. So, it's all about the software. And from a quality perspective, my team makes sure we don't mess that up with the⦠But you -- Arista has taken somewhat different tactic around sort of a software strategy than some of your peers, where they talk about recurring revenue and software licensing. And you haven't gone down that path. And maybe help us understand how you think about the software elements and monetizing them? Sure. Yes, I mean, we're -- we look at how customers want to consume, and what makes sense to be in a subscription or ratable model and what needs to be consumed perpetual. It is very clear that the expectation of the market is when we sell a box, that it comes with an operating system, and that operating system has a perpetual license. We sell services that allow for upgrades and whatnot through -- and service and support, that that's a component of that. But that model is widely accepted, and I think that's what people want. Not really a model where they want to kind of look at over three years that I use a certain feature and then I upgrade my license for that new technology. They -- we do sell like routing licenses for high-end routing features and applications and drive an additional revenue on top of that, and that's well received. But we have Wi-Fi licenses that are on a monthly basis because that runs in the cloud, and it's connected with service. So, where it makes sense, we're going to monetize, where the consumption is appreciated by the customer, we'll do that. But if it's something around the box and what runs and what comes out of the box and -- we also want to simplify that licensing experience. So, we've seen a lot of operational complexity of people not being able to run the networks because they don't know what features they use or what box has what license, it's very⦠Great. So, we've actually pretty much run out of time. So, this was fun, it went by quickly. I like to close with sort of one sort of question that, given the discussions you've had with investors recently, you have an opportunity to maybe try to expose something you think is either underappreciated or misunderstood that maybe we didn't get into but sort of how would you like to sort of sum that up? Yes, I think I'll just reinforce a point we talked about here on the enterprise side, where we talked about the different pieces and the WAN transit, and the Campus. I think it's important to think about how we position ourselves as an enterprise networking company, and an alternate, and really on a different competitive vector around the operational ease of use, and think about the enterprise business in that light.
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EarningCall_1640
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Ladies and gentlemen, welcome to our Balance Sheet Press Conference of Metro AG [indiscernible]. We would like to welcome journalists and analysts and investors to a joint hybrid event. My name is Sabrina Ley, I am in-charge of Investor Relations, and my name is Gerd Koslowski, and I am in-charge of Corporate Communications of Metro AG, and we will be your host of today's event. You know the agenda, we have Dr. Steffen Greubel, our CEO and Christian Baier, our CFO, present the figures and events of the year 2021, 2022, and they will also give us an outlook on the ongoing financial year. After that, we will be able to answer questions, and the event will be in German, but will be translated simultaneously into English. So you can select the right channel for listening to that. And the documents are also available in both languages. So questions can be entered into the Q&A and will be answered in the question they are asked. And for those of you who are virtually joining today, we will also be able to look at the website. On the left side, you can see the agenda and below in the download area, you can find the press release and the presentation for today. At the center, there will be the livestream and you can also enlarge the window to full screen mode. And those of you who signed up as participants for the event can also find the text field on the right side for the Q&A. We will share further information on how to use it throughout or after the presentation. But also during the presentation you can enter questions beforehand. And all those present here in the room will have the opportunity to ask questions live to the Board members. The entire event will also be recorded and will be available on the website later. Thank you, Sabrina and Gerd for the introduction. Good morning to all of you here in the room and those taking part on the screens. Welcome to the Balance Sheet Press Conference of Metro AG. So our financial year will be presented. Let me show you the agenda first. I would like to start sharing something about our strategy. We made a lot of good progress and we are currently also making good progress and we would like to share a few thoughts on that. And this is also shown in our results. The performance is very good of the past financial year. We have record sales results in spite of the very volatile environment. So on the figure side, we are making progress too. And we would also like to talk about our outlook also in the mid-term range. What kind of progress are we making? What can you expect in terms of future growth of Metro? And before we talk about the figures, let's briefly talk about this. This is a chart those of you who attended the Capital Markets Day will remember. We are in a very large market. â¬1 trillion is the total market size, and we have a growing market not taking into consideration the COVID pandemic, and we have a very large and structurally growing market for [out-of-form conception]. The structure is very fragmented, so a lot of very small players and very few large ones. There is not a single country where the top three players have more than 30% market share, and we have a one-digit market share and are still top-one or top-two. So a high fragmentation in the markets and this is really calling for consolidation and thus we want to grow and achieve this stronger position. Now let's look at our business model. We have a wholesale background. That's our origin, our heritage, and as METRO Cash & Carry, we were founded and got known for that. And additionally, we have the FSD, the delivery business for the hospitality market and all this is held together by a digital channel, digital offers. So I went through this very quickly because I just wanted to show you the multi-channel approach. That's the core of our business model. So on the one hand, we have customers coming to the wholesale stores, which we want to implement 100%. We still have some retail elements in that and we want to become even more professional in terms of wholesale here. And this multi-channel business is something we also want to play, which will be our answer to consolidating the market. And you can also see by way of illustration why we are so convinced of this model. A typical HoReCa customer buys in a store what you can see in the wholesales space on the left. If you convince those customers to also get deliveries, their sales increase in an over proportionate way. So additionally to the wholesale [and the] delivery. And if this customer then also becomes a multi-channel customer, so when they accept digital offers, when they buy from Metro markets, then the digital offers come on top and everything grows. So this is a multi-channel effect that's quite remarkable in a lot of countries. It's an 8x increase in Germany. In other countries, it's even higher sometimes. So what's so nice about it is that 86% in Germany of our customers are two channel â dual channel customers. And if we transfer them to the multi-channel model, then we make even better business. And we do that with our salesforce. They make this offer to our customers every single day and we convince more and more customers to go from single to dual channel and from dual channel to multi-channel. Now in a good market with a good market structure and a differentiating business model that no one else can do as good as we can. We set ourselves goals to grow again growth figure that haven't been seen in this company for a long time. We aim for a 3 billion sales for Metro markets. And we will triple our delivery turnover as a big driver and also increase the turnover in our stores of 1.2x at the end of the day. And at the center, you find the digital solution for our customers, which we'd like to spend. So the past year, I described the market, the business model, the goals, the strategy, and we also need to look at our portfolio. And in the past financial year, we continue to work on that. On the one hand, we acquired AGM, an Austrian player with a large FSD share, mainly delivering to hotels and tourism and that puts us into a market position in Austria at rank one or two. We really made an advance there because of this strategic acquisition. I think different topic, offer of payment POS technology, digital POS solution that we can melt into our DISH product range and gives us more strength. And we have so many users now offering â using this offer in combination with our other digital offerings and ordering systems. So this is not a startup, it's a traditional business, a profitable with a differentiated technology that we will now rollout with our salesforce starting in France and the technology will be presented at the Trade Show beginning of the year. Günther is another different business, professional kitchen products. They offer the equipment for large kitchens. And if we have that in our portfolio, you really bind customers to your business, and that offers another level of differentiation for our customers. So 150 million and profitable sales on an annual basis, we got into our portfolio. And on the other hand, we also wound down countries that in the strategy for different reasons were to cash [indiscernible] not profitable enough, and that was the case for Japan and Myanmar. These countries will be wound down by the end of this year. And we also decided to exit METRO and MAKRO in Belgium because we did not see a future for the business in Belgium. We really wanted to focus on those countries where we can make a difference, so we want to concentrate on those and bought the business in Belgium. So this is the portfolio which is much more strategic, profitable and more balanced than in the past year or two years ago. The past year was marked by volatility, external impacts that we had to overcome, that we needed to handle. Apart from the strategy, the implementation, the transformation, we also need to handle the current situation, COVID taking place for a longer time than expected. In the past year, there were not that many Christmas parties, the event business was canceled, and no Christmas market â we did not have a Christmas market for our employees last year. But now this year, the Christmas parties take place again. We see a very positive momentum in restaurants and HoReCa. So we see a very positive trend in our core market, the gastronomy. You all will notice when you try to book a table in a restaurant, you will have a hard time, so there is this positive momentum and the pandemic is coming to an end. The help we gave and politicians gave to restaurants was really good. And there was the attack by Russia on Ukraine that affected 10,000 people in our business, a lot in Ukraine. And we really focused on supporting the country. We created a solidarity program within the business and offered support in all different dimensions, financial ones, aid for refugees, for colleagues who had to leave the affected areas in a very unbureaucratic way and in a very generous way. And we try to upkeep the infrastructure in Ukraine so that we could also look after our employees, and we are still doing that. And just to remind you of the 26 stores we have in Ukraine, 21, 22 are still open, and are probably one of the core food supply infrastructure elements in Ukraine. And we get supplies from neighboring countries, also in terms of goods so that they can be up and running and open. So we had the war in Ukraine, COVID and all that has an impact on the supply chain. And we also see rising inflation and all that impacts our lives. And this is the volatility we had to manage. I think we did that in a very good way. Price increases were mostly possible to be passed on. We had a very special situation because the sales price inflation and the cost inflation were very different. So cost did not increase as fast as sales prices and that helped us a little bit, and this year that will change. But we assure that as an internationally active business with a lot of sourcing competences. We were able to handle the supply chain situation well. The goods availability did not deteriorate even though we had to manage with all these unforeseeable events. Now based on this, let's talk about the second item on our agenda and briefly look at the figures. And the positive news here, we grew 20% in terms of growth of sales. That's a record high for Metro. You have to look back in history for a long time to find similar figures. Because of inflation, we had some support, but you also need to implement these sales prices in the first place. On the volume side, we also had one or two-digit growth already, and that is also a result of our good work of the past year. So the first results are being visible. We have a bit more than â¬200 million adjusted EBITDA growth. And in spite of all the work on the portfolio and the strategy, we were able to really beat a lot of records in this past financial year, and we are a bit proud of that. Now if we look at the growth and break it down, it's a healthy growth that takes place in all strategically relevant channels and we can check it. By looking at the stores, we see a transformation store and the sale increases here by 13%. We are growing in FSD. That is the channel we want to expand. 80% of the gastronomy stores in all the countries, between 70% and 80% are using delivery. 20% are pickup of orders in Cash & Carry. And we have just turned it around. We have 80% in picking up and 20% in delivery. So we need to grow much more in this field and much faster and with a growth of 53% in sales, we were successful with that, and as a record share of the overall sales in the past financial year and hopefully will continue to be the case this year because this is the growth engine we really have focused on. More than â¬2 trillion is in absolute figures, â¬2.2 trillion additional in sales. On the digital side, that's the smallest element, so it needs to grow fastest. That's the METRO marketplace, METRO MARKETS, METRO AT or MAKRO PT with a 110% sales growth develops nicely, so doubling its sales. We are continuing to focus on that and Hospitality Digital is at the center of this framework. The offers for digitization of gastronomy is also developing very nicely. We have 53,000 new paying subscribers, so a very large number of customers, now 270 people in total who are registered. And this is one of the largest digital solution providers for gastronomy in all of Europe, just like METRO MARKETS, which is the largest marketplace for the gastronomy without anybody really noticing and we are a bit proud of that. Yes, we would like to continue to work on that because this is just the beginning and we really have to make more progress. Digital needs to grow fast. Now let's look at the different channels and go into them so that you can see where we currently working on in terms of implementation within our sCore strategy. Let's begin with the stores. We focus on our strategic customers. The hypermarket and retail elements are the pellets need to go from the source and we need to have a value position for wholesale 100%. So good prices, decreasing prices, when you buy larger quantities. You can see this on the right side. This is the benefit. You have 18.12%. I don't know whether you can see that on the screen. If a restaurant owner buys larger quantities, so Tier-3, like 4x of the tomato sauce or something like that. Then in the end of the day, inflation can be beaten, 18% price advantage is something that's quite remarkable in the overall price. So this is really a support for restaurant owners and chefs everywhere. So they need the product anyways, so it really goes into the right direction. We also see that in Romania where we have 18 of 20,000 products in this scheme. We are expanding that to 4,000 different products, some in Germany and from Serbia to Bulgaria, and we have Serbian colleagues here. They are enthusiastic about this pricing approach and we are really focusing on that. That's one of the core elements how we are transforming our business. And we want to be 100% wholesale and the own brands are on the second trolley play an important role and are also achieving record sales figures. Productivity is the currency how we convert sales into bottom line. So the sales per employee need to increase and productivity can be increased by using pellets, by reducing complexity also in the assortment. And in the end of the day, if we put everything together, all five elements, then we are 100% wholesaler. We're already, yes, not quite. We are on the way there. Are we fast enough? Not yet. We will have to accelerate definitely. And since pictures say more than words, let me show some pictures from the five countries I mentioned to give you an impression of what it looks like in real life. Delivery, which is, in the end is what we are also focusing on very much in our stores, the space that is available because of the decomplexification, if you can call it at. We are using this free space, so that we can organize delivery from the existing locations and the optimization of the stock and store can help us with that. So let's now talk about FSD. We have invested a lot into our focused value proposition, FSD. We have expanded the salesforce, 850 net were hired. So after employee turnover, we are larger by 850 and we are approaching the 8,000 employees of the salesforce. And it's very difficult in times of these two higher sales representatives. So this is a very remarkable achievement and we are very strong and I'm proud of that. So these salesforce representatives are very important to us to drive our multi-channel business. And FSD delivery has a higher own brand share, so addressed 100% to professionals own brands become very relevant. So the faster we go in FSD, the faster our own brands will grow as well and we also invested into the structure of delivery. So this out-of-store, what you just saw, we created 16 new areas for that and two additional depots. So dedicated delivery sites as of a certain volume that starts to make sense. We are established and we invested in this field so that this more recent channel in our portfolio can be filled with life. And here too, it helps us to look behind the scenes to understand the business better, [indiscernible]. He is the Head of our Depot Delivery business for the area of Düsseldorf and he will answer five questions of how delivery business works. Pedro? Thank you, Pedro and all the best. I think it shows very clearly what the FSD strategy is. Let's talk about our two digital core approaches. The METRO MARKETS platform, which started in Germany and in four countries and soon to P6, and the idea behind that is to have an extended chill for non-food, so online as a sales channel with a package logistics. So that not only product can be picked up in the store, but many more things can be delivered for people working in the gastronomy, and we did not only work on rolling out that internationally, but also improve the technology behind the system. And it's kind of a startup approach we started in 2020 and have achieved quite a lot, but we can achieve a positive EBITDA by 2026, and the multi-channel approach helps us to also benefit from digital customers joining us via this platform. On the timeline, you can see the expansion, we have increased the speed, we have added two countries after Germany and Spain went online. We now have 1,400 partners. It's a real marketplace. It's not only us trading, but 1,400 partners with more than 700,000 products and new countries and new geographies are added. It becomes more and more attractive as a marketplace for the gastronomy and we are adding two further countries this year. The Netherlands will join and by the end of the year also, France. And we wish them all the best for the final. I think we'll leave it at that for METRO MARKETS. You can see there's a lot of dynamics and a lot of commitment to drive this topic ahead. We are talking about a total volume of â¬120 million roughly. To give you some bearings, the 3 trillion in sales, 170 of that are here of the total volume and also generated by our partners. So this is something we need to keep in mind. The 120 million are the first step towards our goal. So at the center of our strategy framework, we have the digital solutions for our customers. With DISH, we see a very good dynamic development, and I already mentioned the figures. More than 50,000 new customer, paying subscribers were added and in combination of this new POS system look that is agnostic in a cloud and in the rollout and the connection to the existing tools already in place and the ordering tool. On the side of innovation, we have great opportunities to improve ordering processes, automate them fully, and our existing salesforce can also be used to promote this DISH offer, so that we become one of the leading digitization partners of the gastronomy. And for that we have a small video clip as well. And yes that illustrates well. Now after this visual presentation, let's look at figures. On the next page, you see some of our sCore KPIs, which we report on regular basis and we put this together for you as an overview. So we have the big pillars and our multi-channel positioning, sustainability, network optimization, and we've gone forward in all that our own brands with 19%, almost 20% we achieved an all time high, a significant increase year-on-year, and we still continue to work on making sure that our own brands are promoted. And looking over to that side, you see the good selection of goods. Availability 95% is stayed on the same level at least, but our objective is 98% and until 2030 if possible earlier. We work on making sure that the supply chains and all the processes are set up properly. We cannot be satisfied with 95% of course, but you also have to keep in mind the circumstances in the entire world. Keeping this in mind, we can be satisfied and our NPS values have also gone up year-on-year. FSD, I already said that 21%, itâs also all time high, share 2.2 million additional turnover and 21% share in that is a very, very good development. So we will achieve our goal till 2030 and headed for the right direction. The same for digital turnover share. For the first time 9%, it might sound a little low, and that is definitely the highest challenge because we want to achieve 40% digital till 2030. But when you compare this to the whole turnover in the entire group, then we are looking at 3 billion digital turnover, which is our sales, which is really a clear growth year-on-year. Network optimization, I said that before, we created additional out-of-stores depots and warehouse space. We still continue in that direction in order to make sure that we can tap it to the potential for FSD and salesforce. Additional, we hired additional staff who wanted to double our salesforce to have 6,500, but now we already hired 850 this year or in the past year. And this is exactly how we are trying to faster our multi-channel position. Sustainability, 37% less CO2 going to become climate neutral till 2040 and this is our commitment and we are very optimistic that we will achieve this and I think in the past business years, we've made just step forward. And more than 80% strategic customer share, HoReCa and Traders. So now let us look a little bit into our expectations into the future and I would like to start with the following overview. Of course, we see macroeconomic developments, which are still very high energy prices and all the crisis in the world of course had an impact at the sweet spot that a special situation last year cannot be expected for this year at one-on-one. So supply and chain issues. All these things just haven't disappeared. We learned how to tackle those things, but we will still definitely also have to make sure that we reflect this in our daily business. And unfortunately, cyber techs, is a new topic. It's something new on the agenda which has had major impact on our operations, but also on the financials. And those are things that we have to deal with as well and I think we'll come to talk about that later on. But we made major steps forwards. It's a topic that we really have to concentrate on in which institute a negative impact on our figures. However, we still concentrate on the sCore strategy and its implementation. We've had so much positive momentum from last year. We are so optimistic that the strategy is right for us so that the answer to any kind of external impacts, external factors, bad news, et cetera. We are able to overcome these crisis and at the same time, we will be able to implement or want to implement the sCore strategy even faster to be able to cater to all this. Of course, we still have to concentrate on making sure to gain additional market share. There is a lot of movement in the market, beat inflation, energy prices, et cetera. Competition is neutral, everybody's impacted by that and we learned well how to deal with it so that we will have a possibility to gain additional market share and tap into the potential of the consolidation of the market. If we now look at the facts and figures, this year we will achieve growth. We believe 5% to 10% would be our guidance for this year. We will be able to achieve productivity increases so that overall the turnover growth will however not suffice to make sure that we can compensate all the cost increases. We believe our EBITDA will be between 75 million and 225 million less â weaker because of the effects that I just explained like the cyberattack and the inflation induced another increases, which will be different from last year were we increased our guidance â exceeded our guidance even by â¬200 million. Now some positive news, however, let us come to â we will go back to positive EPS and be able to also distribute dividends, again. We have made major progress in the fiscal year and we also gave you perspective for the medium and long-term when we had the Capital Markets Day. And we would like to update this in particular also for the medium run. And you see our very good sales momentum from last year and currently, we can expect 5% to 10% growth rate and EBITDA to 5% to 7%. So we even exceed the conservative assumptions of last year from last report also because of the successes we've had. So we may say very optimistically that we are very â that our growth rate is actually realistic. But still we have to invest into our business model, FSD, digital, all that costs money and therefore the free cash flow that we will generate from the growth will be reinvested into our business. The long-term goals 2030 will remain the same. More than â¬40 billion and turnover more than â¬2 billion EBITDA and more than â¬0.6 billion in free cash flow, still there, still our goal. And so we will be looking into these new, say, we would believe and we are convinced that we will be able to achieve these goals and go forward in that direction. And a lot of these external influences will hopefully sometime in the future be overcome. So that will give us some imputes too. I would like to thank you for listening and for your attention, and I hope I've been able to give you some insight into where we are today in our transformation process and what we've already achieved. Having said this, I would like to hand over to my CFO, Christian Baier, who will give us some more effects and figures. Thank you very much. Thank you very much Steffen, and also good morning from my side to everybody here in the room today and those of you who joined us remotely. I first of all would like to guide you through the financials, but also talk about the main drivers, which gave us this momentum that Steffen has already explained. Looking at last year, we may say that we've had a guidance of approximately 3% to 7% sales growth and then EBITDA more or less comparable to the previous yearâs level. Now with different upgrades and better than expected business development, we were able to increase our guidance twice in the course of the year so that at the end of the year, we will achieve more than 20% growth in turnover and also additional EBITDA. We achieve this in particular because of a very strong volume-based development. We have a very high one-digit increase, which is a historical development that we haven't seen for many, many years, mainly driven by sCore. Now, as Steffen have already said, the mid-term ambitions till 2025 will be raised to 5% to 10% growth rate driven by inflation, but also owing to our good implementation of sCore. Now looking at EBITDA, â¬1.4 billion last year, we are almost on the pre-COVID level, so that we've made major steps for what also compared on our mid-term ambition and guidance, and therefore, we also see a growth of approximately 5% to 7% growth of EBITDA adjusted more than we had expected. However, performance is also driven by individual segments in the way that we go forward in that field. In particular, the field East and West, where we have our most important HoReCa countries, grew this and is a very important driver for the performance. Let us start with Germany, 6% increase in sales plus â¬18 million EBITDA, so a very good performance. So this is mainly owing to the fact that Pedro mentioned before a better operative implementation in the field of FSD and also a good cost discipline. On the sales side, also a very, very positive HoReCa development. Looking at the fourth quarter, we may say there is a slight reduction in EBITDA and we are already measuring the pace of our transformation program, increasing it, and also performing some reorganization which will have an impact on the fourth quarter. Looking at the segment West, we see a great growth rate of 28% and the EBITDA increase of â¬182 billion, also mainly driven by France, Spain and Italy, the most important players in these particular segments. In the fourth quarter, in particular, in Italy and France, with our proactive approach, we've been able to accelerate on the transformation speed. So some restructuring measures are helping us to reduce the costs and we still will end up at the upper part of our guidance and so that we may say that we achieved very positive result in that regard. Looking at Russia, we see an 8% growth and a slight increase of EBITDA. Across all the customer groups, we've seen a very satisfactory development. However, we have to say that due to the Russian war in Ukraine and the sanctions going along with this, we see a weakening of the consumer confidence and the volumes which are reducing in the current business year. Now, segment East, a lot of countries in Eastern Europe, like Turkey, Ukraine is developing very well with only minus 10% of sales, which is a good development there. We see a very, very positive sales increase, but also a very good development in the filed of EBITDA. Now, in the segment Others, there are a lot of things that Steffen already mentioned, like the digital METRO MARKETS, but also icings and HD Digital and there we see a duplication of our business model under Others. Now when we look at the EBITDAs, we may say that they go down by â¬58 million, mainly due to the fact that here in the UK, 10 years after our sale of the business there, we were able to buy back pension liabilities and see a very good chance in the market and also on the real estate side â and for real estate, we see that there will â we carried out already some reorganization measures. Now when we compare our strong financial performance in the market, you can see that in the main HoReCa countries which are listed here, we see that the market is recovering only very slowly coming to a pre-COVID HoReCa level, the green line. But we as Metro have been above the level of 2019. So that really makes us very optimistic that our own performance is very good, but at the same time that we are also doing very well compared to our competitors. Now on the Capital Market Day in January this year, we promised that we will also intensively look at the operative drivers of our business and report on those on a regular basis. Now look, when we look at the slide, you can see the strategic customer sales share and our own brand sales share are very important factors. Both topics are on an all time record high 71% with HoReCa and Trader customers. We are very well positioned to achieve our over 80% of our sales with strategic customers till 2030, and our own brand shares also very high, which with more than 35%. It's not only important for us in the terms of profitability and sales, but also that we can achieve a very high level of loyalty with our customers and our own brands. We also invest in our multi-channel business, Steffen Greubel already reported on the network side. And this is also now having positive impact on our sales share in FSD. And this is exactly where we want to achieve one-third of our sales in the long-haul. Now, the digital share of our sales is we've been measuring this since last year, but we see a very strong development coming up to 9%. There is still a lot to do in that field, but with the elements of our strategic process with M chart tool that [Pedro Markman] also explained on the marketplace side and in the field of HD, we are very optimistic to be definitely on the right track. Now let us come from the strategic and KPIs rather let us look at the P&L, and look at the development down to EBITDA. Last year, we had 12%, a very good growth rate in particular, keeping in mind that we had an extremely strong previous year. So that the growth was rather, but with the more than 20% growth rate, which we mentioned earlier on, we are doing well and we've seen this in all the channels. The markets have gone up by 13%. FSD has gone up by more than 50%, so that we see a duplication for METRO MARKETS. In EBITDA, we also see such a positive development and have a very stable margin. I would like to allude â draw your attention to the fact that Q4 with â¬100 million less EBITDA year-on-year was mainly driven by these proactive measures to foster sCore in France, in Italy and in Spain and the real estate subsidiary we have been able to implement reorganization measures, which will help us to become leaner for the future and be able to act more swiftly. Apart from the pension impairments, the pension buyback in the UK was made, so that Q4 I think is well explained and we are very optimistic on the basis of this performance. There are two things, however, that I should mention. We show transformation costs for the sale of a Belgian business. Just for you as a reminder, the transformation things that we are doing in Germany and Belgium are not separately reported on because it's just part of the ongoing business there. But when we have big portfolio measures like the sale in Belgium, then this will be still shown and reported separately. In Q4, we were also able to generate additional revenues from the real estate business, in particular the sale of Japanese real estate business that we have been able to close of the past one and a half years. Now looking at the P&L from the top to the bottom down to EBITDA, we see that one-off effects of the war had detrimental effects, first of all, impairments of our business in Ukraine and Russia and on the other hand side also significant negative results in other sales, which are only based on inter-company liabilities. And depending on the exchange rate developments, those are fully reversible. Now tax revenues and expenses, well, it was in the framework of our expectations. In some countries, like for example in France or other countries, we significantly generate more gains and therefore also have to pay additional taxes for distribution of dividends. In total, now we however, come to a negative result per share EPS of minus â¬0.92, the extraordinary effects because of the war in particular can be adjusted. And if we do this, which we're not doing here, a positive EPS would've been achieved. And this is exactly the goal that we have for the next business year because for the next business year, we say that we will not propose any dividend, but we expect a positive result per share in the current business here and also looking forward. And we are making major steps forward in our strategy, but we still have to continue in that on fostering our strategy and also making growth investments. And here you can see an overview of the growth investments in January and this something that we already presented in January. We concentrate on technology, our network and sustainability. These are the three pillars for growth investments. More than â¬100 million were invested in the field of technology to developed digital solutions like M-Shop, FSD platform, and on the other hand side also METRO MARKETS and Hospitality Digital to be able to develop these further. For the field of network, we expect to spend more than â¬200 million capital expenditures per year. Here you see â¬50 million for that year. And well is that in the framework of our expectations? Well, we expected further increases and it's still in line with our individual planning as per country. We see massive productivity improvements and capacity enhancement in the existing environment, but we also see that in this business year and the years to come, significant CapEx will have to be carried out in the framework of these â¬200 million, so that we are going forward. Well, sustainability, the third pillar, here we may say that a sustainable management and also the financial attractiveness of our investments, like for instance, into energy saving measures play in there. With the increased investment last year, we've been able to generate a positive cash flow still at approximately â¬200 million last year. The OCF, operative cash flow, is also reflected in the capital flow, it went down by â¬200 million, which has mainly to do with reductions in net working capital and higher tax payments compared to previous years, but that's only due to some time lapses, time effects. When you look at net working capital, you will see that two effects are important. First of all, our increase of inventories to make sure that we can have a very high availability at all times. And secondly, also inflationary influences on the stock keeping that we have the stock has a higher value, same for receivables in FSD where we've been able to grow substantially. At the Capital Day, we said that this definition of free cash flow is very comprehensive. So at the end of the day, one-on-one, translatable so to speak, into the net debt and where you see â¬3.5 million net debt which was now reduced by free cash flow, now we had â¬3.3 million of which the major part is rent, cash values and a very, very positive situation. We are at a net debt level above EBITDA 2.3x, so that's the multiplier. And we started to see at the beginning of the year. Now there is our portfolio of loans â¬500 million for dues soon and from the current perspective, we believe that we will not have to refinance it, but we will be able to use our cash flow and our balance sheet amount to cover this. Apart from that, we also have access to a facility of â¬1.5 billion on the credit side and so we feel that we are very good â we are well positioned financially. Now this is very important to make sure that we can also work on our priorities, our capital allocation in that sense and to make sure that we can reinvest our revenues into growth because we are deeply convinced that our sCore growth initiatives will pay out, which is also reflected in the growth of past business year. And secondly, we also would like to make sure that we reduce our debt, but not only just reduce net debt, but also increase our EBITDA growth in particular to make sure that our target ratio is net debt EBITDA is improved. And also the return cash to the shareholders is very important for us for the close business year and we will not distribute a dividend, but for the next business year, we definitely expect a very positive EPS and that's also a positive dividend that we will be able then to propose. Now, let us look at next year. In the framework of our medium term forecast, our guidance as Steffen Greubel already said, we will be able to grow by 5% to 10%. This is our expectation very consistently so, and we do expect also a reduction of inflation, which is still very high in the moment, but over about which will come down in the course of the year. Adjusted EBITDA, well last business year we had more than 200 more last year than expected than we had in the guidance and we believe that parts of that will decline by â¬75 million to â¬200 million that is what we expect. Because on the one inside with sCore, we've generated growth and we will also see an increase in productivity and on the other side, high cost inflation is to be expected in particular for energy, HR and also the effects from the cyberattack. Well, basically we may say that we can look optimistically into the future and expect a positive EPS, which results mainly from the overview you see here. So we will reduce â we will see productivity increases, market share increases, and a very high cost efficiency, which will support our positive EBITDA. And in October this year, we carried out a major real estate transaction and close this year [indiscernible] which will bring us â¬200 million EBITDA as well â gains as well developing the development of our current business here. And that is also very important for us looking into the future. With a normalization of the net financial result and taxes and depreciations, we expect result per share EPS between â¬0.40 and â¬0.80 for next year. Cash investments, we had â¬500 million last year, we expect to come to more than â increase â¬600 million and expect to have a stable free cash flow also and thus also a stable net debt. Now I'm happy to come back to what Steffen Greubel said and summarize as follows. In 2021/2022, we had a very strong year, also achieving our sCore goals more on the field of EBITDA and sales. And we are going forward positively in the field of operations and our medium term ambition and goal is we will also achieve oriented to volume growth in order to make sure that we can also achieve productivity gains for the current business year 2022/2023. We expect these 5% to 10% growth focusing at the same time also on making sure that for the years to come we can invest into growth right now, so that we can make sure that our medium-term planning can be achieved. And therefore, we would also like to make sure that we strengthen the situation in the coming business year to be able to also distribute the dividend next year. So that's it for us at the moment and we are happy to answer your questions be it here or be it virtually, so to speak. Thank you very much, Steffen and Christian. Ladies and gentlemen, you now have the opportunity to ask questions to the management board. We have hybrid setup, so we will mix questions from the audience and from online, and my colleague and myself will read them out. So we have clearly more listeners online, so we'll have a share of three-thirds and â two-thirds from there. So please introduce yourself when you ask a question so that people on screen can also understand that and restrict yourself to two or three questions each please. And you can also use the text box on the website, which we will then read out. And with that, we can start with the Q&A. And Ms. Becca, I think, you're here with us in Düsseldorf, you would like to ask the first question. Good morning. I have actually several questions, and it is Becca [indiscernible]. If I understood you correctly, with the de-leveraging, you would like to increase the rate 2.5x, 2.3x in comparison, don't you think in this market environment that's a bit high. Also, with regard to the increased interest rates, you want to invest â¬600 million this year. Could you tell us where there is a shift because that's more than in the previous year, and where do you want to invest most? And with the cyberattack, I'd like to know that seemed to have a massive impact on the balance sheet. Can you roughly tell us how much that would be? Well, yes, I'd be happy to answer the questions with deleveraging. In the past financial year, we made a lot of progress more than expected, so we had 3x the net debt-to-EBITDA and reduced that. So this is a value we only wanted to achieve in the long-term or expected in the long-term. So we think we're very well positioned here and we absolutely think that in the current situation we possibly can also slightly increase that again, which still is massively better than our expectations at the beginning of this year. Now, if you look at the total debt structure of the company, we had a really financial debt with commercial papers and bonds and some cash that is much less good situation than now and we have very limited impact by inflation on that now. On the cash side, we spent â¬400 million last year and expect about â¬600 million to be invested this year. And the main shift is, with regard to the network, which I explained before, we only spent â¬50 million last year and expect up to â¬200 million in investment in these net working capabilities because we think we should really expand our capabilities here because we come to the limits of our productivity and we need to build more infrastructure, which is very consistent with our planning within sCore. On the cyber side, it is very important to us to always be able to open all our services and stores at all times and we already were able to clean up the situation. That's the most important factor for us. And a lot of manual work is done here and there were increases in efficiency due to that. If we very roughly estimate what we're talking about, it's a low three-digit million amount in terms of sales that was caused by the attack and follow-up events. And on the EBITDA side that's included also in the guidance there would be roughly a low two-digit million amount. We then continue with a question from online. This question comes from [indiscernible]. And he is commenting and asking S&P has assigned a negative outlook to your credit rating in June. Are you confident that the rating will remain in the investment grade space and are you taking any specific measures to ensure it remains at its current or higher level? And in that context, are you planning to refinance the upcoming bond maturity in March 2023? Okay. Yes. Thank you. Let's switch to English. Thanks for your question from the perspective of S&P. For us, it's very important that not only in the last year, but also in the year where we are in. The credit metrics are very consistent with the investment grade rating and that's also what S&P has raised in their report the last time, when they published it. The last time when they published and gave that negative outlook, it was closely linked to the situation in Russia and therefore also related to all other companies that do operate in Russia in that setup. We are confident that with the performance that we are doing and from the metrics perspective, we are doing everything in order to be in that bucket on investment grade and feel very confident with the current setup that we have from a balance sheet perspective. In terms of the bond that's upcoming earlier next year, we at the moment do not expect to refinance it because we have a very strong position on the balance sheet. In case there would be opportunities, we will certainly be flexible also to do that, but doesn't seem required at this very moment. Yes. Then we have another question here from our online tool. It's from Stephen from the European Supermarket Magazine. You plan to achieve more than â¬3 billion in sales from METRO MARKETS by 2030 and more than 4000% increase on this year, â¬69 million. To achieve this, what are your short, medium and long-term goals for this business? Do you anticipate that METRO MARKETS will cannibalize other parts of the business? Yes. Let me take that one. Thank you very much Stephen for the question. So number one, let's get clear on the numbers. When we compare the â or when we see the â¬3 billion as the objective, we need to compare this as marketplace volume and the corresponding value to the â¬69 million that we would see in the P&L is â¬130 million. So â¬130 million corresponds to the â¬3 billion, so that's number one. And number two, we are confident with our growth, speed and also with adding additional countries, now also big countries like France to this initiative that we are going to achieve that number. And in terms of cannibalization, it's exactly the opposite. There is a multi-channel effect we see when Metro online customers are also coming to a store for instance, or a store customers are purchasing online or FSD customer are shopping online, all the combination, it is always fertilizing all the channels. So that's the multi-channel effect. So it's not a cannibalization, it's exactly the opposite. It's instead of cannibalization, it's fertilization. I guess that's very important to know and that's why we are also pushing so much the implementation of the digital channels because we see that effect very clear. Thank you very much. We then continue with another question online. This one comes from [Xavier] from Bank of America. Actually three questions. The first one is, can you provide us with the big blocks of OpEx inflation? The second one is just to better understand the EBITDA guidance. Second one is property gains and transformation cost for next year, how much do you expect? And then number three is, net debt trajectory and expectations for next year? Yes, very happy to do so. I think from that OpEx perspective, you should think about two main buckets. One is on the energy cost side and one is on the personal expense side. On the tax side, we are talking on both roughly a â¬100 million plus minus depending on how the situation will pan out, both key elements that really drive for us continuously working on energy savings, continuously working on productivity improvements in order to basically counter that also in the longer term perspective. The cyber effect I've mentioned, and then obviously we see certain elements, also in the segment Other, where we have talked about in the past where now transaction effects from the past are running out and the next year is the one where basically there is still a little bit of a negative effect in the segment Others and I think that's when you put those four elements together, you come to the topic that is weighing overall on the profitability. On the other hand, sCore itself is improving and pushing forward from the sales growth perspective, also the EBITDA base. With respect to property gains, I just read property gains and transformation costs in 2023, property gains with now at a â¬200 million that we have generated, we will probably see slightly more than this, but it will be a number that is just hoovering around the â¬200 million plus a tiny little bit. From that perspective, we have done our major transaction and have concluded it already in this year. With respect to the transformation costs, as mentioned before, all the operational transformations that we are doing, like mentioned before in Italy or in France, this is what we account for in our guidance. So that's included there only in case there would be major portfolio transactions that would then be included from a transformation cost perspective. Your third question on net debt trajectory expectations for 2023, this basically comes together with our definition of the free cash flow in a comprehensive manner. We see that broadly neutral to slightly negative, so therefore, we should expect, also the net debt development broadly neutral stable on that end. I mainly have questions on the portfolio management. On the one hand you withdrew from Belgium and currently, we hear about possible withdrawal from India. What's the current status of negotiations and another risk factor seen for the business as the business in Russia? Could you go into more detail why you're staying there in spite of the very risky situation and what would it cost to withdraw from the Russian market? So let me start with the portfolio question. We always said that we have a close look at the portfolio and we're very active in the past financial year and on the portfolio in this regard. We are very advanced in the process of regarding India and are at a certain maturity level in the process. It's too early to share any information, but we've discussed it greatly. And looking at Russia, there are two dimensions. If we look at the daily business, there are difficulties, you might have seen that also in the past financial year. At the end of the day, there are challenges on the demand side that were noticeable. And this is also reflected in our portfolio and it is still a large and profitable business for us. And we've reported in a very consistent way also, but our rational why we stay in Russia and the Ukraine obviously, and it's a very lengthy answer. I could give you about 20 minutes explaining it, but let me give it to you in a very short headline way. So on the one hand, it has a certain meaning to us as a company. He said it has a certain importance. We have a responsibility for 10,000 employees who've been working for us. We have more than a 1 million customers, so we feel a certain level of responsibility for us as a company. And if we decided to give up this business, we would leave them behind. And the question is often whether it's still okay to be present there, but we're in the food business, that's a very specific topic, particularly in Russia. And we're sure that as soon as we communicate that we would give up the Russian business, in fact, the ownership would be taken over by someone in Russia. And behind this business, we represent values, we own all the locations and we think it would be more âbetter to pay taxes and not giving the business away. So we concentrated very much as I said on supporting Ukraine, but it's a multi-variable business. We have a look at the situation every single week whether it's justified to stay in that market, we don't take it easily, but we decided to consistently look at it and to stay in Russia so far. So currently, we don't have any changes in our opinion on that. Hello. Thank you very much. [Indiscernible] I found a few items in the report on Russia and the repercussions. Do you also know what kind of share Russia has on the cash flow? Yes. There are several elements here and the EBITDA of Russia has a relevant share for us as a group and as the investments are listed in there, it is more or less comparable with the cash flow from Russia and as in many other parts of the business in our group, it's a very profitable business. Then we continue with a question from [Alex Xie] from JPMorgan. Many thanks for the presentation. Appreciate the post pandemic demand for eating out yet with cost of living crisis, I would expect HoReCa players to avoid stocking up high volumes in advance given the low visibility. How to square this up with your strategy to drive volumes with wholesale discounts? Shouldn't it be difficult these days? Thank you. Yes. Thank you very much Alex Xie for the question. So let's talk a little bit about the market and why we also think that our market, the market of out-of-form consumption might be a little bit different than what you would compare to a retailer to the grocery retail market. The structure of the market is that roughly 40% of the households of every economy we are in are usually accounting for 65% to 80% of the market size. So that means our â the guests of our customers, so to say, are sort of not completely representing the average of a population and thus the markets of out-of-form consumption are a bit more protected about the implications of higher inflation, rising energy costs and so on. So that's going to be a â that's a very particular topic that is out there and in the moment, we are seeing that the necessity to compensate all the negative effects coming still from the COVID that people like to go out, they like to go on vacation, they like to be out there, they like to enjoy a social life outside home that this is overcompensating the necessity to maybe save money because of higher inflation or costs and given the particularity of the market of our customer structure or the guest structure in gastronomy, I guess here, that gives us a little bit more on better and a more optimistic outlook looking forward. When we talk BMPL, it's indeed a possibility for our customers to fight the inflation. So indeed 18%, this is something where really gastronomy [indiscernible] could sort of compensate that. And for us, it's not only the pricing and the value we are generating for the customer, it's also productivity. Because when things are really turning quickly, we'll be able to put them on a pallet. If things are on a pallet, it's easier to handle them. If it's on a one touch pallet, that's how we call it. So it comes from the truck and it goes basically on the shop floor, then it's even more productive. And that's the entire logic of the wholesale transformation, therefore, BMPL is not only grade value for the customer, but it's also grade value for us in terms of productivity. And by the way, because you are asking about the volumes and the discounts at the end, this third tier, this is roughly sitting then if you would compare on discount levels, right? This is roughly sitting. This is most probably most â for some of the articles, the best price really in the market. And we see that this is also attractive for a lot of customer groups. Not only the ones we are targeting, mainly the strategic customers HoReCa and Traders, but also smaller companies, it's attractive for them and they are really stocking up to enjoy the additional discount. Yes. Our next question here also from online, and that goes exactly in the same direction from Stephen again, European Supermarket Magazine. The HoReCa channel has seen phenomenal growth this year due to the reopening after the pandemic, but the cost of living crisis is leading customers to cut spendings in this segment. Are you seeing signs of this in your operations? How are you insulating your business against this? I mean, thank you Stephen. I could now replicate what I've said and I would be exactly consistent. So we are in a particular situation in that market. Maybe a little anecdote on top of that because that's usually, I mean, people will ask on the street, what do you say first? And then you always say 50% say, yes, they are saving on going out. They also did that during the financial crisis with Lehman. Yes, during the financial crisis, 2008 or something like that. And then they also did and asked after the crisis. So they asked also, what do you save? Or where do you save? People answered 50% in going out and in going to restaurants and so on and so forth. Then they asked after and only 3% answered, yes, we did that really. So the answering of appall and the reality in behavior might be also somehow different. So I think that's just the anecdote that would compliment that I think that our market is protected a bit better from all those inflation effects. Thank you. We now go back to EBITDA guidance for next year, and the question comes from Anna from BNP Paribas and she's asking, you've guided EBITDA down by â¬75 million to â¬225 million for next year. You know that inflation and the cyberattack are the main drivers of this, but are there any other factors we should be aware of thinking about? Let me just maybe reiterate the point made before, it's that inflation on energy side, on the tax side. Itâs the cyber effect that we are seeing. And it's also the perspective in the other segment where basically now we have talked to you about a couple of topics that we are preponing from reorganization in Germany, France, Italy, for example. There is now an effect which will not come back next year, but there are topics that are basically fading out from former transactions and therefore in the Other segment, you should think about a net of roughly â¬50 million as a negative effect from this. So this is the composition of the topics that are somewhat headwind, and the remaining piece is then coming from EBITDA growth that is intrinsic in the sCore execution. Ms. Becca speaking, you said you want to gain market share in order to make sure that the inflation effect can be compensated. Can you tell us where this gain in market share should come from? Do you think that certain competitors will leave? Or would you want to do this by buying other companies? Thank you, Ms. Becca. At the end of our day, our strategy is organic basing on selective inorganic growth. We are always open when it comes to inorganic growth, but in general, we have an organic growth, right because the market is extremely fragmented. And if we want to gain market share, others will lose market share. I think that's the background of the question, right? We believe that in particular, the smaller, less organized, non-digital players in the market, which don't have the right processes, et cetera, will be affected more because a restaurant owner, for example, are encountering major problems. They are having a very high demand, but a lack of personnel. And many restaurants were used for example, to have 20 suppliers. They just cannot afford it any longer in their purchasing processes. So we believe that consolidation will take place. First of all, we as a big company will be able to offer multi-channel solutions and the HoReCa customer will have a major advantage because it'll simplify their purchasing processes. We saw that in the video we had before. In the second step, they will hopefully be able to fully automate the processes and therefore we believe that the smaller competitors will more or less disappear. And we continue with the question from online, Anna from BNP. On the mid-term guidance raise, it has increased to capture higher inflation, yet higher inflation is also one of the reasons for the EBITDA for this year. So short-term, this seems to conflict with the mid-term ambition and the raise. Will there have to be some heavy lifting done in the years to come specifically 2023, 2024 and 2024, 2025 to reach this guidance? Yes. Thank you, Anna for that question. And as Steffen has said before, sCore for us is the answer to exactly those challenges from an inflation point of view. So we are working hard on the productivity improvements in order to ensure that we are actually also increasing our EBITDA and that's why we have upped our guidance in order to take into account some inflation effect there in order to make this also an attractive development. We are very confident in getting there. Just to remind all of us, this is a four-year period that we started in January of this year for the years 2021 to 2025, and we are very confident in order to really achieve that growth from that perspective. Yes, there is heavy lifting with respect to productivity improvements, but there is also big conviction on this, but also on the sales perspective where Steffen has mentioned how strong we do still continue to see through tough microeconomic environment, also the hospitality industry and therefore, we are confident to also be getting on to that level of the upped medium term guidance. Next question from [Stephan Schuler, WAZ], which has already been answered. I hope Mr. Schuler, you do not mind. It was also about the business in Russia. There is another question coming from Stephen from the European Supermarket Magazine on the cyberattack? Yes. I can certainly take those questions. Stephen, I think was answered in a different language before with respect to investments into cybersecurity. We have continuously invested over the last decades in order to be well protected on that very setup. And that has enabled us in the past also to fend off successfully and very regularly attacks, which is unfortunately the reality in the current world. Now with that unfortunately successful cyberattack that we have seen, we certainly do further upgrade and harden our systems from all perspectives with respect to not only training, but also security measures that we do very heavily in order to basically fend off these effects that I've quantified before from a sales impact perspective at a low triple-digit sales impact â¬1 million in this very quarter and from an EBITDA perspective with a mid-to-high double-digit million EBITDA negative effect. [Indiscernible] How was the start into the business year 2022, 2023? Can you say something about the development Q1 sales and our cyber will be reflected in Q1 and whether there are any one of any extraordinary effects you expect like real estate income, et cetera? I think the second part of the question was already answered, but maybe the first part? Yes, I'm happy to answer that question. The two elements, impact of the cyberattack on sales and profit. I think we talked about that. The one of the extraordinary, in fact we already talked about the transformation costs are included in our guidance. So we do not expect any major changes. It's in the guidance if there are major portfolio changes, which will have to be reported on as transformation cost. And on the real estate income side, we have these â¬200 million that we expect and maybe a little bit will come on top, but that's more or less the value we expect. But Steffen, maybe you would also love to talk about the start into the business year 2022, 2023. Yes. You have to make a distinction between the weeks so to speak and the difference that were â the weeks that were impacted by the cyberattack and those which were not. If you added all up in the first two months, we went forward, well we had a growth rate, which is still not on the level we want to achieve. The 3 million digit amount was also there, but what we see in the weeks where we can â were able to work in quiet so to speak. We had this two-digit growth. If you added all up bottom line, I think we may say that we are at a very reasonable one-digit growth right now and we want to make sure that we can also compensate the effects looking into the future. Again, question here. Are there any questions here from the audience? Otherwise, we will continue with our online question. Matthias Inverardi of Reuters asking, when mutual in view of the arising energy prices get any state subsidies to limit the costs and will this also have an impact on your ability to pay distributive dividends? Thank you very much Mr. Inverardi for your question. The guidance and also our expectations down to the EPS include the expectations we see in the market, energy costs, personnel costs, and any other topics. And in that framework, we expect a positive EPS, as we already mentioned before between â¬0.40 and â¬0.80. Regarding the subsidies for energy prices, we believe â and we are very active in Europe here, but the market is also very heterogeneous. We see different, a very landscape, very different conditions. We of course try to hedge ourselves in the particular countries. If there's a situation where the company of our size can benefit from subsidies in the various countries where we are active, then we will definitely do so and our look into that in an adequate manner. At the moment, we plan it in a way that our â¬100 million, incremental energy costs, which we mentioned earlier on will be covered by our guidance in any case in the various countries. Thank you very much. Then there is another question for [indiscernible]. May coming back to â for clarification, what's the sales process in India? What does it look like? What is your expectation for India? I can only repeat myself. We are very deep in the process in India. That's all I can say. And if we have a better answer for you, we'll do so. Then we continue with a question from, I hope I pronounce this correctly, [indiscernible] from Credit Suisse. What are you trying to do differently from your competitors going into 2023? I mean, I think, let me take that one and thank you for the question. I mean, I cannot completely touch what we are doing differently because I do not know in a such a fragmented market with thousand of competitors what every single company is doing exactly. But I can just say that we are focusing very much on the strength of the execution of our store strategy because this strategy is very unique. We have the stores, we have the FSD, we have the digital. When you combine that, that is per se differentiating because no other competitor has it. And I've shown you the potentials and the possibilities we can do with the implementation of the strategy. And as Christian said, our answer to any shortcomings, to anything that is happening out there in terms of negative news, in terms of externalities, is always to be faster in the execution of the multi-channel strategy. And that's what we're going to do faster. We're going to be tough on implementation and fast. Thank you. Then we continue with another question or set of questions from Xavier from Bank of America. The first one is about the development in Germany where we commented that sales performance is driven by Rungis Express and HoReCa. Can we get some more color and what does it mean for the performance of Traders and SCO? So the other customer groups respectively. The second one is can you give details about Q4 EBITDA margin declines in the respective main blocks? And then number three is the gross margin development, H1 versus H2. It increased initially in H1 and then it came down in H2. And how does this match the expectations for the next year? Yes. Thank you very much Xavier for the questions. Let me take the first one and then let me hand over to Christian to take the two subsequent ones. So number one, indeed it's true. In the section Germany, we are enjoying a very good HoReCa growth. It's almost 50% compared to the last year. So that's very strong. And on the same hand, the SCO business, so this is small companies also a lot of complementary consumption is losing. You can say it's roughly 14% and the Trader business that's especially driven by tobacco is also declining by 8% roughly, yes. Let me compliment that because that's the customer view. I always would have also a wholesale versus retail view in that one. And what we are seeing in also other countries than in Germany when we are having our stores a 100% wholesale like we do have in Romania with 18,000 articles on BMPL and a lot of pellet presentation, it's also attractive for every individual customer segment. That means that also SCOs and that means that also Traders are then growing because of that value proposition. So it's very important to look at wholesale versus retail and then we are confident that this is very valuable and very well sort of perceived by all the customer groups for the entire company. SCO was still on a slight growth different than we do in Germany. Yes. Thank you, Steffen. Let me take â the point on the Q4 EBITDA margin, I interpret this as related to the entire group and not only to Germany. There we are talking basically the five elements that I've mentioned before, all of them individually roughly in the low double-digit million amounts. So we have basically sped up the reorganization in our organizations in Germany, in France and in Italy, there is, for example, an early retirement program that is being done just to give you a touch and feel for what we are doing there. And also we are doing broadly the same on the real estate entity Metro properties. So these are four elements then, and then there is the fifth element that we mentioned before, we have basically now had the exclusion of the UK pensions from our balance sheet. We basically did funding out by out there in order to drive this any risk in the future out of the balance sheet and there are costs related to that. So from that perspective you talk about that broadly â¬100 million on an absolute margin or EBITDA perspective that we have seen in Q4. And I think otherwise you would've seen pretty much consistent development on the margin from that perspective in Q4. But that also translates to your third question with respect to the gross margin, there is certain elements on the percentage gross margin that over time with the implementation of this sCore strategy that we will forego and we are foregoing this in a proactive conscious manner because we are absolutely convinced that it's the right thing with buy more pay less in other wholesale products, that we are actually able to drive down the percentage margin. But in order to have the best gross margin in absolute terms and the best EBITDA in absolute terms, this is appropriate. So we are improving gross margin in absolute terms, but over time with buy more pay less, for example, we are reducing the percentage and together with that there is productivity improvements below gross margins and then the whole equation works out with EBITDA and also cash flow improving over time. Yes. I look around the hall [indiscernible] if you have any questions please ask them or we'll continue with questions. We have a question from Fabienne or again, a set of questions that just jumped from my screen. Okay, sorry. I think we need to switch to a different questions because we just went through a challenge here. Okay, sorry, just jump from my screen. I think it was a question on a free cash flow expectation, volume expectation for next year? So let's take this and maybe then we find the latter parts later on in the conversation. So free cash flow perspective in that new comprehensive setup, we expect a roughly stable to slightly negative free cash flow then also translating in the same way to the net debt side of things. And then you ask for reminding, with respect to volume, price effect in the 20% growth that we have seen in the last fiscal year, it's broadly 50/50. So we are talking about a very, very high single-digit volume increase, nine plus percent and probably in inflation that is in there between 10% and 11%. So this makes up the consistency of that. And if we then find in a few seconds later on the last part of your question, we will also address it. Then we continue with another question from Alex Xie from JPMorgan on the mid-term guidance, especially on the raise of the guidance. Is it fair to say that the upgrade is mostly driven by an already stronger than expected FY2022 while outlook for the outer year has broadly unchanged fundamentally? Thank you. So I mean that's exactly true. That's exactly true. We have made a great start in the last year. So we were already having overachieving the elements that were planned for in the last year and thus actually we also upgraded consequently the mid-term guidance and we do expect that the inflation will come back, I would say to rather normal levels in the mid-term. And as a result, we still have the same expectations on the fundamental trends of the market for the coming years. However, when you combine those two effects, we still expect a higher absolute base to the additional inflation that we are having. Mr. Greubel I would like to know what you view of the composition of the Board is with [indiscernible], you won a team member and Metro in the past also paid highs I think, when they left the company. Are you now quite confident that the team will stay the same for the near future? That is very precise answer. Okay. Then we're happy to continue with another question from [Fabienne from Kepler]. On sCore, is it fair to say that the stronger FSD share negatively impacts working capital due to longer payment terms as well as EBIT margin? Yes. Thanks for getting back to that second part of the question, Fabienne. With respect to that perspective. So FSD is the key driver also from a growth perspective, let alone the other two elements on digital and the store obviously, but that will drive our growth significantly forward. With respect to the working capital at this very stage, it might look like it, because obviously, we are having customer receivables that we are increasing, there are these longer payment terms from our customers. I think over time what we will be seeing when we are building also Depot, so we are concentrating inventory in one place, over time there should be different levels of inventory. So that will also slightly come down. And also at this moment, we are heavily investing in inventory in order to be available for our customers and that's I think very important. So overall, yes, partially networking capital property slightly worse over time, but massively over and outweighed by the strong growth that we are seeing there. With respect to the EBIT margin, also there over time we would not expect this to have any relevant dilutive effect at this very moment. Yes, when we compare it to the group margin of 4.7% EBITDA, there is a certain drag from an FSD perspective, but we are making giant steps in developing the profitability, even forward on the FSD side and therefore in the medium term and especially in the longer term, we do see if executed well all business models, especially between store and FSD, broadly on the same level on profitability. Thank you. And then we continue with a question from Anna from BNP on the cyberattack. And specifically if our ability to take orders in Q1 has been impacted given that this is our most important quarter? Yes. Thank you, Anna. And as mentioned before, we have continuously stayed online in the stores, in the delivery M-Shop has always been fully up. So there has been an impact because it was cumbersome in many places like execution of certain orders, but we have always been online for our customers to fulfill their needs. Although it required a significant efforts from all our teams and the great thank you for their intensity being applied on the IT side and also on the operational side. The team is doing a tremendous job in this very Christmas season. Thank you. We are now getting to the end of our Q&A session. We have three or four questions here in the system that I will not repeat because I believe they have been answered. If the people who asked the question disagree are very welcome to call Gerd or me, respectively. And the one that we are adding now is from Thomas from the Tech Bank. Can you provide details on the profitability of private label products versus branded products? And can you comment on the price increases of private label versus branded products and if that had any effects on demand? Yes. So the profitability of private label products is at least at the same level given the same quality or even a bit better than the branded products. And of course, I mean the inflation of raw materials that is hitting the production of the own brands as well as the brands. So that's obviously the case. Helpful is that we understand because we are also developing a lot of the own brands with our chefs for the needs of the professional customer. What is the exact composition and the recipes and we can also influence to compensate here and there the effects coming from the inflation, which also gives us a better possibility to then also negotiate with the branded products because we know exactly what is inside. So I think overall it always makes sense to push the own brand products for the described reasons, but you can assume the profitability relatively is a bit higher, but the volume obviously is a bit lower because the price positioning is also under the A brand so that the customers are really ensuring a value out of that. And it's an additional measure to compensate for the higher inflation. And of course, the high inflation also drives the own brand performance. We don't only see that in wholesale, we also see that in retail by the way. Well this takes us to the end of the Balance Sheet Press Conference for the past financial year. We would like to thank you most cordially for going with us through this very heterogeneous year. We are still there for you. You can contact us Investor Relations as well as the press center. And on behalf of all of us here on stage, we wish you a Merry Christmas, Happy New Year. We will meet you there and are looking forward to a very close and intense collaboration with you. All the best and Merry Christmas.
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EarningCall_1641
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Good day and welcome to the Jianpu Technology Inc. Third Quarter 2022 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Colin Cheung, Head of Corporate Development and Investor Relations. Please go ahead, sir. Thank you operator. Hello everyone and thank you for joining us today. Our third quarter and first nine months 2022 earnings release was distributed earlier today and is available on our IR website at ir.jianpu.ai, as well as on PR Newswire Services. On the call today from Jianpu Technology we have Mr. David Ye, Co-Founder, Chairman and Chief Executive Officer; and Mr. Oscar Chen, Chief Financial Officer. Mr. Ye will talk about our operations and company highlights followed by Mr. Chen, who will discuss the financials and guidance. They will be available to answer your questions during the Q&A session that follows. Before we begin, Iâd like to remind you that this conference call contains forward-looking statements as defined in Section 21(e) of the Securities Exchange Act of 1934 and the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on managementâs current expectations and current market and operating conditions and relate to events that involve known or unknown risks, uncertainties, and other factors, all of which are difficult to predict and many of which are beyond the companyâs control. These risks may cause the companyâs actual results or performance to differ materially. Further information regarding these and other risks, uncertainties or factors is included in the companyâs 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. Finally, please note that unless otherwise stated, all figures mentioned during the conference call are in renminbi. Is it now my pleasure to introduce our Co-Founder, Chairman, and Chief Executive Officer, Mr. David Ye. David, please go ahead. Thank you Colin. Hello, everyone. And thank you for joining us today. During the third quarter, we reported another set of resilient results against the backdrop of a challenging macro environment. Our revenue growth remained solid at 26% year-over-year. Our adjusted net loss reduced by 82% year-over-year to RMB9.4 million, and our adjusted net loss margin improved significantly to 3.5% from 24% a year earlier and 12% in the previous quarter. These results were primarily driven by our balance and the diversified the revenue structure, continued operational efficiency improvements, and disciplined cost optimization measures. The results further demonstrate the resilience and the [indiscernible] of our asset light platform model, our team's capability to navigate through the challenges and uncertainties as well as our commitment to progressing our vision of becoming everyone's financial partner by empowering the digital transformation through our technology and product innovations. Let me now go through the key operational highlights for the third quarter. First, we have further strengthened our competitive positions as an independent open platform and continued to gain market share with the balanced and diversified revenue structure. In the third quarter, we continue to empower the financial industry with the solutions based on our technical capabilities, individual marketing, and acquisition, data analytics, operational and risk management. Leveraging our market leading position with further geographical and demographical expansion, our recommendation business suspend robust revenue growth of 30% year-over-year in the third quarter. In terms of the credit card recommendation services, we have leveraged our strong partnership with banks and the unique omnichannel capabilities to further expand into more product and services. For instance, we worked with several digital savvy banks to promote rural revitalization credit cards to less affluent geographic areas, helping some banks acquire and engage with new users, with a new open resident category. In addition, we customized our digital solutions by building ecosystem for banks to improve their cardholder retention and engagement. We improve their operational efficiency. We also continue to cooperate with the leading banks to expand and explore the digital currency electronic payment on DCEP initiatives. Financial institutions have been encouraged to extend more lending to support the real economy. In particular, the small and medium sized businesses sector. We are taking advantage of such policy shift, adjusted our product coverage of our loan recommendation services to target more SMEs and increasing new urban citizens. And we continue to expand our geographical coverage to service users and financial needs, in less affluent cities and less developed areas. In the third quarter, revenue from our loan recommendation services grew by 76% year-over-year in the third quarter. Over 60% of our loan recommendation revenue was contributed from [730] [ph] and less affluent areas in the first nine months of 2022. Overall, we continue to achieve a solid total revenue growth of 26% year-over-year in the third quarter. At the same time, our business mix has become more diversified. Moving on to my next point, we have seen continuous gain in operational efficiency. Anticipating the challenges and uncertainties of the macro economy and regulatory environment, we further prioritize efficiency over growth. With our platform business model, [technological] [ph] and product innovation capabilities, we have seen tremendous efficiency gains. Our overall ROI or revenue from recommendation services, advertising and marketing services divided by the corresponding cost of acquisition and promotion, improved by 12 percentage points year-over-year in the third quarter and 6 percentage points year-over-year in the first nine months of 2022. We have also seen sequential improvements [indiscernible] in the first quarter, second quarter, and the third quarter of 2022 were 125%, 126%, and 135% respectively. Third, our ongoing cost optimization measures led to a significant margin improvement. Our total operating expenses, including sales and marketing, R&D and the G&A, decreased by 19% year-over-year in the third quarter of 2022. As a result, we recorded further margin improvement and a sharp flow of net loss in the third quarter. Specifically, our operating loss and non-GAAP adjusted net loss narrowed significantly by 47% year-over-year and 82% year-over-year in the third quarter. Our non-GAAP adjusted net loss margin improved significantly from 24% a year earlier and a 12% in the previous quarter to 3.5% this quarter. We maintained the strategy of optimizing company resources and streamlining operations, which yielded further results, through a reduction in the fixed cost base, including office rentals and other back office costs and resources. Going forward, we will maintain disciplined cost control and strive to improve our productivity and margin further. Finally, I will now take a few minutes to discuss the outlook with the macro environment and our businesses. With regard to the macro environment, China's real GDP growth remained moderate at 3.9% year-over-year in the third quarter. As the ongoing pandemic, prevention and the control measures continued. Specifically, growth in the retail sale weakened to 2.5% in September. Meanwhile, the residential mortgages and household consumption loans recorded a moderate growth rate from 4.1% and 5.4% year-over-year respectively at the end of September 2022. The Chinese government and the regulators have recently unveiled various measures to stimulate the real estate industry and ease certain pandemic control policies. However, the reason the resurgence of the pandemic indicates a more complicated macro outlook with uncertainties likely to persist in the first quarter of this year. In the longer run, we believe the government will maintain a more relaxed, physical, and monetary policy to revive the economy. Besides with the government's emphasis on the quality development of the economy, we believe China will be able to regain the growth momentum in the coming years. While the COVID control measures, they continue to impact some of our operations in the next few quarters. The potential slow recovery in consumer sentiment may also constrain the growth of our business. Normally, the fourth quarter would be our strongest quarter of the year [leaving our] [ph] historical seasonality pattern, but we will take a cautious view that the upcoming fourth quarter may not follow the historical pattern and expect our growth rate will be dampened in the near-term. At the same time, we believe our industry leading position, technological capabilities, and strong execution will enable us to successfully navigating through these challenges. Well, our diversified revenue structure optimized operational efficiency and disciplined cost control measures will help us to continue enhancing our overall productivity, efficiency, and supporting our growth in the future. And now I'll hand over our call to CFO, Oscar Chen to go through our financials. Thank you, David, and hello, everyone. As David mentioned earlier, we delivered another solid quarter with strong revenue growth, margin improvement, and narrowing losses in the third quarter of 2022. Our third quarter results reflects our persistent efforts in business and the geographic diversification, digital transformation capabilities, as well as our disciplined cost control. Our total revenues for the third quarter of 2022 increased by 26.4% to RMB268.8 million from RMB212.6 million in the same period of 2021. Our market leading position in the recommendation business [sustained] [ph] with total recommendation services revenue increasing by 30.3% to RMB211.6 million from RMB162.4 million. in the same period of 2021 on the back of 11.9% and 75.8% year-over-year increase in credit card and the loan recommendation service revenues respectively. The increase in revenue is primarily driven by an increase in number of loan applications and credit card volume, [due to] [ph] our geographic diversification and omnichannel marketing strategy. The average fee for credit card has a slight sequential and year-over-year increase to RMB116.4 in the third quarter of 2022. The average fee per domestic loan application increased by around 48% year-over-year to RMB16.5 in the third quarter of 2022. This resulted from a more optimized product mix. Revenues from our big data and system-based risk management services decreased by 18.8% to RMB25 million in the third quarter of 2022 from RMB30.8 million in the same period of 2021. The decrease is mainly due to the impact of COVID-19 of our operation with customers as well as product adjustments. Revenues from advertising and marketing services and other services increased by 66% to RMB32.2 million in the third quarter of 2022 from RMB19.4 million in the same period of 2021, primarily due to the growth of insurance brokerage services and other new business initiatives. Let me now move on to the cost and expenses. Cost of our promotion and acquisition increased by 22.1% to RMB180.2 million in the third quarter of 2022 from RMB147.6 million in the same period of 2021. In the first quarter of 2022, we have seen the continuous turn of efficiency improvements. ROI of recommendation services, advertising and marketing services, and other services have shown encouraging improvements with an increase of 9 percentage points, compared with the second quarter of 2022, reflecting our continued efforts to achieve a good balance between growth and efficiency. And at the same time, the ROI improvement also benefited from our growing scale. The highlight of our new business initiatives improved by 23 percentage points year-over-year and 77 percentage points sequentially in the third quarter, reflecting the economics of scale â economies of scale of our platform business model. Cost of operation increased by 5% to RMB21 million in the third quarter of 2022 from RMB20 million in the same period of 2021. The increase was primarily attributable to an increase in software development and maintenance costs, related to big data and system-based risk management services. As we continued excluding our cost optimization initiatives, our R&D expenses and G&A expenses decreased by 11.2% and 41.6% respectively in the third quarter of 2022, compared with the same period of 2021. Our sales and marketing expenses had a slight increase of 1.2% year-over-year in the third quarter of 2022, measured as a percentage of total revenue. Sales and marketing, R&D and G&A expenses in total were [32%] [ph] in the third quarter of 2022, compared with 49.7% in the same period of 2021. A decrease about 18 percentage points. In the third quarter, we also recorded an impairment loss of RMB13.3 million, which was an impairment of the goodwill and intangible asset of an acquired subsidiary. With our continued efforts in optimizing our cost structure and improving the productivity of our business, loss from operations was RMB31.9 million in the same quarter of 2022, compared with RMB60.6 million in the same period of 2021. Operating loss margin was 11.9% in the third quarter of 2021, compared with 28.5% in the same period of 2021. Our net loss and a non-GAAP adjusted net loss were respectively RMB25.1 million and RMB9.4 million in the third quarter of 2022, compared with RMB60 million and [RMB30.8 million] [ph] in the same period of 2021. Given the growing scale and improving efficiency, our net loss margin and the non-GAAP adjusted net loss margin improved significantly by [19 and 20] [ph] percentage points respectively compared with the same period of 2021. As of September 30, 2022, we maintained the balance sheet with cash, cash equivalents, and short-term liquidity of RMB700.5 million. Hi, management. Thank you very much for taking my questions. I would like to have two questions, if I may. The first one is about the impressive sequential improving trend of your ROI. So, could you please elaborate more about the underlying drivers of such good improvement and how the trend will look like into next year? That's my first question. And the second question is related to the outlook guidance because you mentioned that the fourth quarter may not follow the historical seasonality pattern, why is that? And could you please provide more color of the outlook towards next quarter and probably first half of next year? So again, the first one is more related to the ROI. And the second one is about the outlook guidance. Thanks. Hi, Calvin. This is Oscar. Yes. Thank you for your questions. I will take your first question regarding the ROI and also the sequential trend of efficiency gain of our business. I think there are a couple of reasons behind the improvement. Firstly, I think the improvement of operating efficiency is a natural outcome of our platform business model. At the scale growth, the economies of scale would kick in. During the last three quarters, our revenue grew at 33% year-over-year. The growth of our business helped us to get more bargaining power. And we managed to get a better economics in terms of average fee per low application and credit card volume as we just discussed. And I think the second reason is our diversification and omnichannel strategy also helps the efficiency gains, particularly in our low recommendation business. As we expanded our footprints into more cities and areas and cover more users from different demographic. Our technology further enhanced the efficiency of our acquisition recommendation and the distribution capabilities. And [secondly] [ph], I think the most important is our strategy for this year to manage our growth, which is to balance between the growth and efficiency and we closely monitor the growth rate and the unit economics or contribution margin for each business segments. For more mature business, we prioritize efficiency over growth. For some new business, we may consider to sacrifice profitability to a certain extent to achieve high growth. So, in the third quarter, our recommendation â in the third quarter of 2022, our recommendation business grew at 30% with 10 percentage point improvement of efficiency. And our new business initiative grew at 66% was over 20% percentage points of efficient gain, compared with the same period of 2021. So, I think that's yeah, these are the major reasons for our improvement of ROI and the daily efficiency from operations. Going forward, considering the challenges and uncertainties, I think we will stick to our existing strategy to manage our business further. That means we still want to achieve the balance between the growth and efficiency and we may consider uncertainties when we prioritize efficiencies further. Hope that answers your question, Colin. Hi, Colin. I'll try to answer the second question [indiscernible]. The fourth quarter may not follow historical peak high season this year. Yes. So, Jianpu [indiscernible] we have about 10 years of full-year operational history. In the past 10 full years, we definitely have seen the fourth quarter normally account for over 30% of our annual businesses for many reasons as a platform, we're connecting our users, our consumers, our admins, with financial institutions. So, typically in the fourth quarter or before the Chinese New Year, our users, they're looking for more loans, credit card, looking for more financial product and services, and also financial institutions typically extend more credit [or loan] [ph] of other financial products to users. So, that's why we have seen the, I would say, pre-Chinese New Year or end of the year, holiday effect almost every year, right. This year, of course is different. As we all know, the COVID-19 prevention and the control measures still are impacting most of the regions and also impacting a lot of the business activities across sectors, industries and across regions. So, that's why we would definitely have a very cautious view for the fourth quarter. So, given the COVID prevention and the control measures and other uncertainties and challenges, we definitely [will not see] [ph] fourth quarter peak this year. Weâll definitely see the growth will be dampened in the next, I would say, a quarter or two, but we are confident we should able to maintain our growth and also further improve our efficiencies and productivity in a couple of months. Thank you. Okay. I guess there are no further questions. Then I'll like to thank you everyone once again for joining us today. Of course, if you have any further questions, please contact us at IR@rong360.com. Thank you for your attention, and we hope you have a wonderful day. Goodbye.
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EarningCall_1642
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Good morning and welcome to the Dollarama Fiscal 2023 Third Quarter Results Conference Call. Neil Rossy, President and CEO; and J.P. Towner, CFO, will make a short presentation, which will be followed by a question-and-answer period, open exclusively to financial analysts. The press release, financial statements and managementâs discussion and analysis are available at dollarama.com in the Investor Relations section, as well as on SEDAR. Before we start, I have been asked by Dollarama to read the following message regarding forward-looking statements. Dollaramaâs remarks today may contain forward-looking statements about its current and future plans, expectations, intentions, results, levels of activity, performance, goals or achievements or any other future events or developments. Forward-looking statements are based on information currently available to management and on estimates and assumptions made based on factors that management believes are appropriate and reasonable in the circumstances. However, there can be no assurance that such estimates and assumptions will prove to be correct. Many factors could cause actual results, levels of activity, performance, achievements, future events or developments to differ materially from those expressed or implied by the forward-looking statements. As a result, Dollarama cannot guarantee that any forward-looking statement will materialize and you are cautioned not to place undue reliance on these forward-looking statements. For additional information on the assumptions and risks, please consult the cautionary statement regarding forward-looking information contained in Dollaramaâs MD&A dated December 7, 2022 available on SEDAR. Forward-looking statements represent managementâs expectations as at December 7, 2022 and except as maybe required by law, Dollarama has no intention and undertakes no obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. Thank you, operator and good morning everyone. This morning, Dollarama released strong third quarter fiscal 2023 financial and operating results highlighted by a nearly 15% increase in sales and a double-digit percentage increase in each of comparable store sales, EBITDA, and EPS. Our solid performance across our key metrics speaks to our commitment to providing the best year round value on the everyday products we offer, combined with our ability to provide a convenient and consistent shopping experience. We continue to see sustained demand for a vast selection of affordable products from coast to coast, notably in the consumable product categories, which has fueled an acceleration in same-store sales. Three quarters into the year, the trend is clear. Our value promise in a high inflation environment is even more relevant as consumers juggle the pressure on their wallets and adjust their spending strategies. We believe that the combination of convenient locations, great value, and strong store team execution will keep those new customers coming back. Last quarter, we provided an update on the rebuilding of our inventory, which has continued in Q3. Higher inventories not only reflects the ongoing replenishment of our safety stock and the purchasing of seasonal items earlier than in the past, but also continued store network growth and strong same-store sales. In terms of product selection, our buying team has been working hard to procure compelling products in all categories and across all our price points, which is now clearly reflected in our stores. This includes the further introduction of items at our new price points of between $4.25 and $5. A gradual rollout which is proceeding as planned. We also remain extremely disciplined when executing on our price follower strategy. Product by product always making sure we are delivering the best year round value possible. We continue to increase proximity and convenience for our customers as we pursue our profitable growth strategy through the execution of new store openings for fiscal 2023. We opened 18 net new stores during the quarter, bringing the fiscal year-to-date total to 41. As has been the case over the last few years, we expect a busy Q4 on the real estate front and remain on track to reach our full year target of 60 to 70 net new stores. We are mindful of ensuring that our distribution and warehousing network is up to the task to support our long-term store objective in Canada. This includes expanding warehousing capacity in tandem with planned store growth and ensuring we are maximizing the efficiency of our logistics operations over the long-term. Subsequent to quarter-end, and as announced this morning, we were pleased to enter into an agreement to purchase industrial properties located near our existing centralized logistics network, just adjacent to our distribution center here in TMR. The purchase price is $87.3 million subject to closing adjustments. The strategically located property will provide us with additional flexibility to support our long-term logistics needs as we pursue our target of 2,000 Dollarama stores in Canada by 2031. As a reminder, in late fiscal 2022, we signed a long-term lease for its seventh warehouse in Laval. Construction for this new 500,000 square foot built-to-suit facility is expected to be completed by the end of fiscal 2023 as planned. Dollar City has continued to perform well, generating strong sales and profitable growth since we acquired our 50.1% equity interest well over 3 years ago. There is an extremely strong team in place executing on Dollar Cityâs business plan and delivering compelling value to markets with an appetite for our value proposition. In a few short years, Dollar City has cemented its presence in El Salvador and Guatemala has pursued its growth in Colombia at a good cadence and successfully entered Peru in May of last year, a fourth market of operation. From the beginning, our objective was to bring our tried and true concept to these compelling growth markets and scale up the business over time, executing our concept in a low risk manner that would not distract from the execution of our plans in Canada. After a decade of experience on the ground, I am proud to see that our strategy and its execution, has been on point. As such this morning, we were pleased to announce an increase to Dollar Cityâs long-term store target from 600 stores to 850 stores by 2029 and its 4 current markets of operation. The over 40% store increase compared to the previous target primarily reflects the inclusion of anticipated growth in Peru, which was not included in our previous target and additional anticipated growth in Colombia. These are two attractive Latin American retail markets with each have a growing appetite for Dollar Cityâs localized value proposition. As we look to the fourth quarter for Dollarama, which is historically our busiest in terms of sales, we expect inflationary pressures to persist through to our fiscal year-end. In this context, we will stay true to our brand promise of providing our customers with convenience, as well as compelling value on every dollar they spend in our stores. Thank you, Neil and good morning everyone. We are very pleased with our financial and operating performance in Q3 with Canadians from all walks of life continuing to seek value and lower prices on the goods they need, which is driving traffic to our stores. Starting with our top line, our strong sales performance reflects our growing store network and the continued acceleration in same-store sales growth, which came in at 10.8% for the quarter. With a 10.3% increase in customer traffic and a 0.4% increase in basket size, there is no doubt that our value proposition which is proven to be relevant through the economic cycle remains so in the current inflationary context. This is supported by a third consecutive quarter of higher than historical demand for consumable products, while also registering a good performance on general and seasonal merchandise. Finally, we are benefiting from our pricing strategy, including the introduction of new price points up to $5. EBITDA increased by 11.3% to $386 million or 29.9% of sales and diluted earnings per share increased by 14.8% to $0.70 per share. Our strong earnings growth reflects the continued acceleration in same-store sales, active management of our gross margin and SG&A, as well as the higher equity pickup from Dollar City. Gross margin was 43.3% of sales compared to 44.4% of sales in the third quarter of last year. The decrease is primarily attributable to sales mix, as well as higher logistics costs. In the mix, we have a larger proportion of sales of lower margin consumables, while the ramp up in logistics costs, as previously discussed, is a question of timing as we process exceptionally high volumes of goods through the back half of the year due to our inventory rebuild. Our inventory increased just over $1 billion at quarter-end, representing a 68% year-over-year increase. A large proportion of that represents in-transit inventory. It also reflects the purchasing of goods earlier than historically in the context of global supply chain disruptions and the fact that we are now seeing a compression in transit times. This means that we have some inventory being received earlier than expected. This combined with store network growth accelerated SSS and planning for historically highest fourth quarter sales explained the significant increase year-over-year. We are now in a good inventory position and safety stock position for the coming quarters. SG&A came in at 14.1% of sales, compared to 14.2% of sales last year. As previously mentioned, we are seeing stronger wage growth in the inflationary context offset by ongoing productivity initiatives and the positive impact of scaling from strong sales. Our share of Dollar Cityâs net earnings was $9.2 million, up 26%, compared to $7.3 million last year, reflecting a solid financial and operational performance, as well as the entry into Peru continuing to ramp up. In the third quarter, Dollar City opened 18 net new stores, representing year-over-year growth of 12.8% and bringing their total store count to 395 stores, with 235 locations in Colombia, 83 in Guatemala, 61 in El Salvador, and 17 in Peru. This compares 350 total stores at their year-end of December 31, 2021. The ordinary course put right for Dollar Cityâs founding group commenced this past October. If exercised, we must purchase some of their shares at fair market value. This would be within a framework of conditions which include, but are not limited to transaction size and key person ownership thresholds. We have no indication of the founding groupâs intention to exercise this right at this time. Should it be exercised in the near future, we believe we have the financial flexibility to increase our ownership stake, which may have a short-term temporary impact on our capital allocation strategy. On the capital allocation front, our NCIB activity was more moderate with the repurchase of just under 1 million shares in Q3, which is simply due to more cash allocated to inventory rebuild in the quarter. The Board also approved a quarterly cash dividend of $5.53 per share. At quarter end, our adjusted net debt to EBITDA ratio was 2.79x unchanged from the prior quarter and within our comfort zone is 2.75x to 3x adjusted net debt to EBITDA. We expect to continue to be active under our NCIB program in Q4. In October, we launched and successfully completed the bond offering of senior unsecured notes for proceeds of $700 million as part of the active management of our capital structure. Iâd like to congratulate the team for accomplishing this in a challenging credit market. Proceeds from the issuance were used this past November to repair bonds and short-term debt maturities. On the back of our continued ESG effort, which includes our first climate strategy published last summer, we were pleased to have our MSCI rating upgraded from BBB to A this past October. With significant progress made over the last 24 months, we continue to move ahead with our sustainability commitments, which we view as a journey wherein we must continuously raise the bar. Turning now to the outlook for the remainder of the year. On gross margin, the change in sales mix and the timing of higher logistics costs are reflected in the narrowing of our gross margin range for fiscal 2023 to between 43.1% and 43.6% of sales. This represents the middle of our previously disclosed guidance range. Guidance on SG&A net new stores and CapEx remain unchanged. On CapEx, our property acquisition agreement is expected to close in early fiscal 2024 and as such should be reflected in next yearâs CapEx envelope. Looking at the assumptions on which our guidance ranges are based, these also remain unchanged except for same-store sales. With stronger than historical demand for lower margin consumable products and our very strong SSS performance, we have increased our SSS assumption for fiscal 2023 from a range of 6.5% to 7.5% to a range of 9.5% to 10.5%. This assumes that demand trends year-to-date hold that we do not return to a COVID lockdown scenario and that weather for the most part cooperates. Thank you. [Operator Instructions] Thank you for your patience. The first question is from Irene Nattel with RBC Capital Markets. Please go ahead. Thanks and good morning, everyone. I was wondering if you could please give us a little bit more color around what you are seeing now in terms of consumer demand trends with consumables versus non-consumables and also reaction to the higher price points? Sure. So, the reaction to our higher price points have been no reaction at all from the perspective of verbal feedback or any reaction that we would fear when introducing a higher price point. I think it was very well received. They saw the value in the goods that we had at the prices that we offer. And so, it was business as usual from that perspective. As far as our category performances, certainly the impact of trade-down and consumables pushed our SSS in Q3 and our Q3 Halloween and back-to-school performance was good. But again, when you layer on the positive impact from consumables, you end up where we were in Q3. Okay. So, but just to â sorry, drill down a little bit more the sort of the normal historical Dollarama categories, you didnât see any consumer hesitation and what are you seeing in terms of early holiday consumer behavior? So, no consumer hesitation across all the classic categories, simply a lift in our consumable category. For Christmas, itâs too early to call. There is a bunch of timing elements that have to be considered this year. Last year, we saw consumers shop earlier than usual due to restrictions and lockdowns. And this year, we are seeing the normalization of that pattern and returning to a purchasing pattern more in line with pre-COVID, where sales seem to come closer to the date of the actual holiday. Thatâs great. And just one final one if I may and this goes to gross margins and shipping container costs. Certainly, we have seen a very nice sort of rolling over of those. How should we be thinking about gross margins as we look ahead to F â24? Yes. So, in terms of next yearâs gross margin, Irene, you are right, we are seeing a normalization of the supply chain environment and compression in lead times as we mentioned earlier. And that normalization of supply chain is reflected in lower container costs, which are trending back to pre-COVID levels. So when you think about next year gross margin kind of have to put what is definitely a tailwind from lower container cost against a currency that has moved slightly higher and some mix impact of consumable demands remain. So when you put it altogether keeping in mind that we are always a price follower and our priority for next year will be to maintain our relative value proposition as itâs always been. When you put it altogether, I think we are in a slightly favorable gross margin environment coming in fiscal 2024. I am going to add a little color as well which is while we have tailwinds for transportation and overseas FOBs, we still have major headwinds from domestic vendors and domestic manufacturers, the very opposite of each other. So, they also tend to cancel each other out somewhat. Good morning. I just have a question first on the SG&A side of things. We saw a little bit of improvement, but despite gross on top line growth. So I wanted to ask if you can comment a bit more on what drove the high SG&A? And also going into next year, does the SG&A picture look a bit better as you start to lap some of these minimum wage hikes and then labor shortage continues to improve? Thank you. So, the wage growth environment remains slightly higher than we expected at the beginning of the year. Thatâs offset through scaling and productivity initiatives that are ongoing. In addition in Q3 and so far in Q4, when you have traffic increasing by double-digits like we saw in Q3, it does mean that we have to allocate more hours in the stores to handle number one inventory rebuild, and number two, the higher traffic. So, when you put it altogether, it was slightly favorable in terms of gross margin â SG&A leverage this quarter. But there is definitely a wage environment that is more accelerating compared to the same time last year and we are managing through it. Okay, that makes sense, J.P. Thanks for that. And maybe just another one on gross margins more of a near-term question. I appreciate you tightening up the full year range. But even with that range, the implied gross margin for Q4 is still pretty wide, down anywhere from 180 basis points to only a 30 basis point depending on the bottom or top end of the range. So, can you maybe share with us some of the puts and takes on margins and itâs particularly in Q4? Thanks. Yes. The way you have to think about that is mix. Number one, mix for consumables, we expect that to remain so far in the quarter. Then number two, of course, the seasonal performance is a key driver of our margin. Neil alluded to it in his prior remarks. So itâs really going to be a question on balance of how do you think about mix for consumables Christmas seasonal? And at the end of the day, those two things will evolve over the coming weeks and will drive our gross margin for Q4. Okay, thatâs helpful. And maybe, Neil, maybe a longer term question for you, I just want to get your thoughts on, does the expected increase in immigration in Canada longer-term provides some upside to your store target longer-term? And then secondly, when do you plan to give us another update on your store targets for Canada? I know, you gave one a couple of years ago. So maybe we are still 1 or 2 years away from getting an update from you? Thank you. Well, so the focus right now, Chris, is really on executing on our current store target. We released our updated store target less than 24 months ago. So, Iâd say itâs too early to think about what the next store target could look like or may look like. As far as immigration, I mean, Iâd be speculating there is a bunch of things going on. And I donât think it will be a key driver, positive or negative of our network growth in the next 8 years reaching to our 2,000 store target by 2031. Dollarama would be very happy to see an influx of more immigrants into the country thus helping stimulate the economy and certainly help with the labor shortage. Yes, good morning. J.P., hoping you can quantify the impact of logistics and freight costs in the quarter. I think it was a tailwind in Q1 and then an even bigger one in Q2, but that was going to revert, what was the impact in Q3? Okay. And I guess related to the whole sales mix topic, I am just curious is Dollar City seeing the same sort of shift in consumable sales? Obviously smaller base and different sort of position in terms of growth trajectory, but are they seeing the same sort of shift in behavior? We could copy paste our Canadian comments and apply them to Dollar City. They are seeing very similar trends in Latin America. Yes, okay. And then one other one, I guess, just with regards to price points and sort of the distribution of goods across the range, you guys have always put a lot of emphasis on maintaining a good proportion of products at sort of $1, $1.25 type price points. But clearly, that becomes more challenging just given the broad cost pressures in your overhead. I guess, on the flipside, the market is giving you some license, I think, Neil, you touched on that earlier. So, I am just curious sort of how you think about those dynamics today and all the different sort of pieces at play? Well, I think, weâve always tried to have a mix that catered to the range of our customers. So, in every category and in every product, where we can, we would like to have $1, $1.25 offering, a $3 offering, and a $5 offering in a perfect world, each with its own distinct reason to upgrade so to speak. But in many categories, itâs not possible. Depending on the cost of raw materials of any given item, it definitely has an impact on the discussion, but it continues to be our philosophy that, for example, if Iâm buying our version of a cotton swab, you will find $1.25 version in our stores, you will find a $2.50 version and you will find a $4 version or a $4.25 version. So, they are all distinct and itâs not about the quality of the actual as well, but it maybe how much cotton we put at the end. It maybe the more expensive one is on a wood stick instead of a paper stick or a plastic stick. There is always ways and reasons for the relative retails you see and having that range for our customers, who of course all have different powers of â fiscal powers to feed and take care of their families. We tried to provide the biggest range we can. Alright. Understood. Appreciate that. And one â sorry, one, just last quick one, the property acquisition, can you just â is that just for additional warehouses or is there, sort of an expansion of the distribution center thatâs part of this plan as well? So, itâs so conveniently located and the opportunity to buy land in and around our current environment is very, very much as one of the reasons we took advantage of the opportunity. Itâs going to be bandwidth for distribution. And it also allows us if required to add warehousing in the future. So, on both fronts, it provides that flexibility at the closest location to our current distribution facility, which makes it the most efficient space we could acquire. So that was the reason behind it. Yes, hi, good morning, Neil and J.P. Given that you just gave the number, I donât want to ask about upside, but just wondering to what extent the 850 takes into account saturation in Peru and Colombia. Maybe how should we think of the opportunity outside of the existing territories for Dollar City? So, the way to think about it, George is this is not saturation point in Latin America. This is an update to our 2020 time â 2029, sorry, store target. If you think about the target, then the increase, half of it would come from the addition of Peru in our revision and the other half would be densification of our existing countries and mainly in Colombia. So, this is not saturation, itâs just an update to our existing forecast to reflect good execution and good cadence and store openings. Thanks for that. And Neil, you have mentioned a couple of times the difference between pricing in Asia with the vendors in North American vendors, I just wanted to explore that a little bit and get your thoughts on that? Are you maybe perhaps seeing an early indication that at least North American prices have peaked? We have definitely not seen North American prices peak although every week, I think they have peaked. And every week, they havenât peaked yet. But â and I cannot truthfully explain, why there is such a massive discrepancy between the trends coming from our goods overseas and in Europe and in other parts of the world, to whatâs happening with our North American vendors, but there is a massive discrepancy and that trend has not stopped yet to my amazement. And so, we are simply fighting the fight on our buying side, doing the best we can to manage the cost of the goods that we buy domestically and make sure that the values we provide our customers are the best relative values possible. Because the one thing I know for sure is that those pressures that are being put on Dollarama are being put on every other Canadian retailer. And as you know, as the one thing that we can control is that our job is to provide the best relative value to our customers. I canât control what other retailers do and I canât control even though I love to what our vendors come in with as far as costs. So, we take it as we get it and we try to be as reasonable as we can and as competitive as we can, so that our customers donât question when they come into our stores who the best relative everyday value across the country would be. Okay. Thanks for that. Just one last one for J.P., the working capital is up $400 million plus year-to-date. Can you maybe give us your view on where you think it shakes off for the year? And is there any chance as you look to next year that we can maybe see a reversal there? So, in terms of working cap, I mean, most of it, vast majority of it is driven by the rebuild of our inventory position in the first half and in Q3. When we look at Q4, we think that we are at an inventory level that starting to be in-line with our expectations in terms of safety stock and inventory available for stores. So, I wouldnât anticipate similar pressures in Q4. And then for next year, itâs too early to see through given all the supply chain normalization thatâs going on. Hi, thanks for taking my questions. Looking at Dollar City and the increase there, wondering if management feels comfortable with the rate of expansion as I know there are other companies using elements of the Dollarama approach to grow in adjacent countries. And just wondering if management fields any thoughts about whitespace being left behind perhaps given your cautious approach to growth? I think weâre extremely comfortable with our strategy, thatâs the strategy. The slow and steady wins the race tends to be very Dollarama-like approach, weâd rather be cautious and mindful to each market we consider to the rollout and how we do that rollout, so that it makes sense. And if there are opportunities left on the table, I guess the way we look at it is if we do the very best job in any country of operations, sooner or later, we are going to win that race. And so, if somebody tries to zoom-in and do it hastily unless they are in a way better than we are, which is possible. Itâs unlikely that their execution will be at the same level. And in the end, the customer will go to the store thatâs doing the best job. Okay. Thank you for that and just changing topics here. There was a day less of Halloween, how should we think about the impact? Was it meaningful? Yes. So, Halloween this year fell into Q4. But the impact is, I mean itâs rounding, I wouldnât qualify it as meaningful, one way or the other. Okay. And how should we think about the labor impact, wondering if itâs stable, or if itâs getting tougher, if there is any color that you can provide on what you are seeing. I mean itâs a labor market, thatâs the same for all retailers currently. And so, we are doing our best to attract, retain talent. And so far, we havenât had to curtail opening hours or anything like that. So, we are very pleased with the execution at the store level. And the work that store operations and HR are doing to make sure that we have the best people to serve our customers in our stores. And while we have our COO in the room, Johanne, I am going to say that, itâs harder than itâs ever been just like sourcing itâs harder than itâs ever been because of incredible fluctuations of cost of goods. And in the labor market itâs the very same for our ops people. So, the amount of effort our ops people have to put into doing a great job with our employees, so that they feel like they are getting the attention they should, the training they should, the support that they should, is a huge focus for us, because as you know, we are nothing without goods in our stores and without a team thatâs executing on the ground. And so, itâs very, very important to us that we are doing the best job we can to attract and retain that talent. And I think Johanne and the team have done an outstanding job. Good morning. Neil and J.P., on this land parcel that you built that â sorry, that you bought for $87 million, like â it seems like a big number. I am not really that familiar with Montréal industrial market. But can you talk a little bit about what you bought? Like, what was the size of the property? Whatâs on the property? How was the location, etcetera, etcetera? So, you are asking questions that I am not sure I am allowed to answer. But I can say that it is expensive. It is not a deal. I would agree with you 100%. But I would also tell you that when you want something thatâs one â the one and only thatâs right next to your primary point of execution, the heart sort of the operation, getting goods to the stores, acquiring that land was something that we felt was worth the premium. I would tell you that the efficiencies that we get from that co-location, also, obviously have great value to us that they wouldnât another buyer. So, if you were just prospecting or you were trying to build something on spec, it wouldnât make sense to pay what we paid. But for Dollarama, for the strategic needs that we have, and with the efficiencies we will get from that co-location, it made sense for the business. As far as size, etcetera, I will be honest I am not sure what I can say at this point. So, I am going to say nothing. That deal is not closed. The deal will close, Peter, in the first half of next year. And thatâs when you will see the CapEx trickle in our financials. Yes. Okay. Understood. And I understand the benefits for you. Just switching gears here, on Dollar City, which is starting to become meaningful for you, now that you have quite a presence in Colombia and I think you have had over a year in Peru, can you talk a little bit about â a little bit more in depth on both of those markets and how they differ and how they compare to Canada and what the returns are like, and is the product profile differences, is the consumer different, maybe just ramble a little bit on each of those markets now that they are becoming significant? Sure. So, the market all of the markets that we are in, for the most part are similar to Dollarama from a mix perspective. There is a slight tropicalization to the assortment. But for the most part, they are very, very similar, because people are people and we tend to consume the same type of products. Peru has had a terrific start, very promising so far. We are excited about the country. Colombia, of course, a more complex country, more challenging from the perspective of the geography, and a more competitive environment of course, because itâs a more established larger country. So â but it has much more runway of course, itâs a much larger scale country. So, we are excited by both countries. And from a product perspective, both countries have been very accepting of our assortment, which is continuously changing, of course. And our buyers, which are amazing partners, do the buying domestic goods and sourcing of all the domestic goods in each of those countries, because each country has its own strengths and weaknesses with regards to consumables for the most part. They have put buyers into place in each of those countries catering to the specifics of those countries. And they are doing a fantastic job. J.P., you have anything to add? Okay. And then just lastly, your partners in Dollar City, and this put arrangement, could you just go through the details a little bit, like, what is the maximum possible obligation for Dollar City to take up ownership? Should they decide to go that route? So, the way itâs designed, the philosophy is that, number one, we have a fantastic partner there. And we want to keep them aligned for, as long as possible. And so the way the agreement works is, they cannot put all their shares to us, itâs only a portion. And the key person there being the CEO, is with us for a long time. So, weâre talking about shares of more passive investors. Thatâs number one. And number two, as I mentioned in the script, if it were to happen, we would temporarily for short-term, change our capital allocation to absorb that put option being exercised. Good morning. If I can just go back for a moment to the benefit upon sales from the shift to consumables, I think your latest disclosure, about 44% of your sales last year were consumables. Can you provide maybe a range of where you think that could come in this year, just so that we can understand the magnitude of the shift? Yes. In terms of percentage, itâs something that we disclose annually. So, we will see how Q4 evolves. But the way things are shaping up so far, of course, we have a stronger penetration of consumables. But keep in mind, Brian, and thatâs really important when we think about the business and our categories that general merchandise seasonal, in the ânormal yearâ we would consider that performance is good performance, is just that now we have good performance across all categories, plus the impact of trade down. So, you have to put all that together when you think about the mix for this year. But for sure, consumables is going to be slightly more than it was last year. Okay. Maybe changing gears, the NCIB, I appreciate your comments, you are going to be active in the fourth quarter. I am just wondering with the rising costs of debt and the proposed government tax in 2024, if there is any maybe change to your approach over the mid-term with respect to your NCIB? Yes. So, on the mid-term, we are reviewing in the coming months how debt should be used for the year to come, letâs call it fiscal 2024, to make sure that we have optimal capital allocation going forward. And I mean, we have been clear in the past about after tax cost of debt and earnings yield being kind of two guiding principles. So, we will keep that in mind as we think about next yearâs capital allocation. And we will do whatâs best for shareholders from a return perspective. Okay. And then last question, if I can J.P., just you have got less exposure hedged on your FX for merchandise, relative year-over-year basis. Is this just a data point in time or is it a change in your approach to locking in hedges with Canadian dollar weakness? No, itâs no change in approach to hedge strategy remains the same. There is some timing element to this. So, you shouldnât read too much into the quarterly difference in hedge exposure. Hi. Good morning. In light of the market share gains that you are making, I was wondering to get more insights on your on your customers? How are you collecting data, if at all? And have you ever considered establishing some sort of a loyalty program to enable you to gather more data on your customers? So, our loyalty program is the best value. And the way we think about that is when you look at results year-to-date, I think and you look at us as performance, I think that the best value for us is kind of the focus. And we are probably not the right segment, just not only in Canada, but globally. The Dollar Store segment is not the best segment for a loyalty program. The focus is on the relative value proposition. And itâs working well. We like the results. And then are you collecting any data on your customers? Like, is there any way for you to see, what proportion of customers are earning an income above $100,000 are shopping at your stores? So, we do frequent customer surveys to learn more about our customers, but we are not collecting customer data per se. I would say the focus for now is getting better with our analytics of the data we have. And thatâs transaction data, not customer data. So, we know which unit gets sold at what time and what the total bill is and the transaction size. So, when I get better, I am taking all of that data that we have on a daily basis to continue to optimize our merchandising and all the initiatives that weâve discussed in the past. And thatâs really the focus. We have a lot of data and we want to leverage it as much as much as possible. And that transaction level data. Yes. Hi, great quarter. I just want to follow-up on the discussion on Latin America. Can you just give us some detail, like what is the average store size in Latin America compared to what you have in Canada? And in Canada, you disclosed what it costs to open a new store and including inventory? Can you give us the same metrics for Latin America? Yes. So, in terms of the store size, you would see slightly smaller stores in Latin America than you seen in Canada. And in terms of the cost of opening a store as at fiscal 2022, so last year, it was about the same. Dollar City maybe a little bit more expensive, but not taking materially different. And we are within the 2-year payback in Latin America as well. Okay. Thatâs great. Thatâs helpful. During the quarter, I mean you had a really strong basket growth. Can you breakdown or just give us some incremental color on how much of that that basket growth was split between price increase and incremental products in each basket? Yes. We have â or the reasons that are obvious, we are not going to go there into our pricing and volume strategies, but we are very pleased with the traffic and the basket size that we saw in Q3, thatâs for sure. Okay. And then just last one, I believe in Q2, you mentioned a 70 basis point tailwind, it related to inventory going through your DC and it sounds like, you had about a 30 basis point headwind this quarter on that. So, like, do you expect to be able to offset some of that potential upcoming headwind going forward? Yes. I mean in traditional Dollarama fashion, we are doing our best to offset as much of the cost pressure as possible. So, weâve done that in Q3 and we will continue to do the same thing and work actively to be as efficient as possible in Q4. Thank you. There are no further questions registered. This concludes the question-and-answer session, as well as todayâs conference call. You may disconnect your lines now and thank you for your participation.
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EarningCall_1643
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Good morning, ladies and gentlemen. Welcome to VersaBankâs Fourth Quarter and Year-End Fiscal 2022 Financial Results Conference Call. This morning, VersaBank issued a news release reporting its financial results for the fourth quarter and fiscal year ended October 31. That news release, along with the Bankâs financial statements, and supplemental financial information, are available on the Bankâs website in the Investor Relations section, as well as on SEDAR and EDGAR. Please note that in addition to the telephone dial-in, VersaBank is webcasting this morningâs conference call. The webcast is listen-only. If you are listening on the webcast but wish to ask a question in the Q&A session following Mr. Taylorâs presentation, please dial into the conference line, the details of which are included in this morningâs news release and on the Bankâs website. For those participating in todayâs call by telephone, the accompanying slide presentation is available on the Bankâs website. Also, todayâs call will be archived for replay, both by telephone and via the internet beginning approximately one hour following completion of the call. Details on how to access the replays are available in this morningâs news release. I would like to remind our listeners that the statements about future events made on this call are forward-looking in nature and are based on certain assumptions and analysis made by VersaBank management. Actual results could differ materially from our expectations due to various material risks and uncertainties associated with VersaBankâs businesses. Please refer to VersaBankâs forward-looking statement advisory in todayâs presentation. I would now like to turn the call over to David Taylor, President and Chief Executive Officer of VersaBank. Please go ahead, Mr. Taylor. Good morning, everyone, and thank you for joining us for todayâs call. With me today is Shawn Clarke, our Chief Financial Officer. Before I begin, I'd like to remind you that our financial results are reported and will be discussed in this call on our reporting currency of Canadian dollars. For those interested, we provide US dollar translations for most of our financial numbers in our standard investor presentation, which will be updated and available on our website shortly. On to our results. A record fourth quarter across each of our key performance metrics capped off a record year for VersaBank. In our digital banking operations, continued strong year-over-year growth in our point-of-sale loan and lease portfolio, drove our loan portfolio to an all-time high of just under $3 billion. That was up 42% as we maintained our overall net interest margin without trading or taking any additional credit risk. This drove record revenue, record net interest income, record net income, save for one outsized quarter in 2017 due to a large tax recovery. Additionally, the cybersecurity services component of DRTC had a strong fourth quarter and remains profitable. Importantly, we achieved net income despite the significant transitory expenses incurred during the year on our account of strategic growth initiatives, the returns of which we expect to begin to realize in fiscal 2023. All of this positions VersaBank for continued growth in 2023, comfortable in the knowledge that our bank has a track record of performing even a little better during economic slowdowns. I'll discuss this more in a few minutes. Looking more closely at our performance, the fourth quarter was highlighted by the highest ever levels of revenue, net interest income, and net income, even with the dampening effect on our bottom line of the transitory investments and multiple strategic growth initiatives we made throughout the year. Combined, these investments totaled $1.8 million, the vast majority of which will run off during the current quarter. As Shawn will discuss, we will also experience a temporary elevated provision for taxes in Q4, which further dampened our net income by $1.1 million, and which we expect to reduce early in fiscal 2023. Fourth quarter performance was driven mainly by continued outsized growth in the Canadian point-of-sale financing business, which increased 11% sequentially to the end of the year, and 74% higher than fiscal 2021. Again, I will note that we achieved this growth with essentially no impact on net interest margin and without relaxing our stringent credit policy. Similarly, for the full fiscal year, the outsized growth in our Canadian point-of-sale drove record revenue, net interest income, and net income. And like the fourth quarter, record net income was dampened by expenses related to the transitory strategic investments, which for the year totaled $5.2 million. As well, the $1.1 million elevated tax in Q4. Again, these investments will substantially dissipate throughout Q1 of fiscal 2023, and our tax provision will reduce early in 2023. I'd like to provide a quick update on our planned acquisition of Minnesota-based Stearns Bank Holdingford, a fully operational OCC-Chartered National US Bank. As I discussed on our last quarterly call, this acquisition is transformational next step in VersaBank's long-term growth strategy that will enable us to bring our track record of innovative digital banking solutions to address unmet needs to one of the world's largest banking markets. Specifically, this acquisition will enable us to broadly roll out our Receivable Purchase Program in the underserved US market, which has been so successful in Canada, where we call it our point-of-sale financing business. Although the process has taken a little longer than initially thought, Iâm pleased to report that earlier this morning, we submitted the requisite filing to the OCC and the Federal Reserve, seeking approval of this acquisition. With these filings complete, we can now move ahead with our applications to our Canadian regulators. I'm also pleased to announce that Tom Ridge, former Governor of Pennsylvania and inaugural Secretary of the US Office of Homeland Security, has agreed to become Chair of our new US subsidiary, VersaBank USA. We are targeting to close this acquisition early in calendar 2023. On the topic of US Receivable Purchase Program, our first partner, a large North American commercial transportation financing business, focused on independent owner operators, has continued to expand their business with us, with loans now nearly $50 million. That number would've been even higher. However, we are somewhat constrained in this limited early rollout ahead of completing the US bank acquisition. Recently, we added a second partner, the retail finance division of a $40 plus billion US-based financial services company, and expect to begin taking on loans shortly. And we continue to be very encouraged by our discussions we're having with other potential partners in the United States. They're repeatedly confirming our beliefs that we are a valuable alternative for point-of-sale financing in this $1.8 billion and growing US market. And finally, before I turn over the call to Shawn, an update on our revolutionary digital deposit receipts. As I discussed last quarter, there have been tremendous amount of turmoil in the sector and heightened regulatory awareness and scrutiny, which has been further exacerbated by FTX debacle. The downside of this, of course, is that it has a negative repercussions and very broadly in our industry. The upside, at least for us, is that all of these events further underscore the importance of regulation, and our belief that we share with some of our regulatory pundits that licensed banks are the right entities to be issuing digital currencies. With the rapid evolution of the market and the regulatory environment, we made a decision to substantially change our model such that our DDR accounts, our Digital Deposit Receipt accounts, which are essentially e-wallets, are hosted by VersaBank as opposed to being hosted by external third party. We are now able to do this through the addition of our Viewer software, a tool developed exclusively for our bank. To prove out the new model, in November, we initiated an initial pilot program for the new offering, which we are calling CAD V. The pilot is restricted to VersaBank's directors, executives, all of whom reside in Canada. With this progression to a new model will further extend our time to launch, our DDR program is, as it always has been, a long-term opportunity to grow low-cost deposits. We still have access to abundant low-cost deposits to fuel our growth in Canada. In fact, I will discuss in a moment we expect to return to robust growth in our bankruptcy deposit channel, resulting from the challenging and potentially more challenging economic environment. Finally, I will note that we continue to see some digital currency offerings trickle out here and there, and each and every time we do, we're even more confident with respect to the significant competitive advantages that our offering brings. Thank you, David, and good morning, everyone. Before I begin, just a quick reminder that our full financial statements and MD&A for the fourth quarter and full fiscal 2022 year, are available on our website under the Investor Relations section, as well as on SEDAR and on EDGAR. And as David mentioned, all the following numbers are reported in Canadian dollars as per our financial statements, unless otherwise noted. Starting with our balance sheet, total assets at the end of the fourth quarter crossed the $3.3 billion mark, up 35% from $2.4 billion at the end of Q4 of last year, and up 6% from $3.1 billion at the end of the third quarter of this year. Cash and securities at the end of Q4 were at $230 million or 7% of total assets, down from $272 million or 11% of total assets at the end of Q4 of last year, and up from $218 million or 7% of total assets at the end of Q3 of this year. The year-over-year decrease was the result of the bank deploying cash into higher yielding lending assets and low risk securities over the course of the quarter. Our total loan portfolio at the end of the fourth quarter expanded to another record balance of $2.99 billion, an increase of 42% year-over-year and 6% sequentially. I'll rate this out into its component parts in a moment. Book value per share increase 7% year-over-year and 2% sequentially to another record at $12.37. These increases were both a function of high retained learning resulting from net income growth, partially offset by dividends paid, while the year-over-year increase was also impacted by our common share offer in the US last September. Our CET1 ratio was 12%, down from 15.2% at the end of Q4 of last year, and down from 12.51% at the end of Q3 of this year, while our leverage ratio at the end of Q4 was 9.8%, down from 12.6% at the same point last year, and 10.38% at the end of Q3 of this year. Both our CET1 and leverage ratios remain comfortably above our internal regulatory ratio targets. Turning to the income statement. Total consolidated revenue increased 33% year-over-year at 14% sequentially, to a record $24.3 million, with the increase being driven primarily by higher net interest income derived from our digital banking operations, resulting from the strong growth in our loan portfolio that was discussed earlier. Consolidated net income for Q4 increased 9% year-over-year and 12% sequentially to a record $6.4 million, with the exception of Q1 2017, during which we recorded a one-time tax recovery resulting from the amalgamation of the bank and PWC Capital in that same period. Net income for Q4 was reduced by transitory costs totaling $1.8 million, as David mentioned earlier, including the period related to our investments in several strategic growth initiatives, including the US bank acquisition, the launch of the US version of our point-of-sale offering, our Receivable Purchase Program, and preparation for the launch of our Digital Deposit Receipts. We expect these investments to begin to contribute to profitability over the course of fiscal 2023. Net income was also reduced by $1.1 million in incremental tax provisions, which we also expect will reduce in fiscal 2023. Consolidated earnings per share decreased 4% year-over-year to $0.23, with the decrease due primarily to the impact of the issuance of 6.3 million common shares, concurrent with the bank's listing on the NASDAQ in September of last year. On a sequential basis, however, consolidated EPS was up 15%. The impact - for context, the impact of the transitory strategic investments in higher income tax on our 2022 EPS metric was $0.06 per share and $0.04 per share, respectively. A primary driver of growth in our loan portfolio was once again our point-of-sale financing business, which increased 74% year-over-year and 11% sequentially, surpassing the $2.2 billion mark. This growth continued to be driven primarily by strong demand for home finance, home improvement, HVAC, and auto receivable financing. Our point-of-sale portfolio continues to expand as a proportion of the overall portfolio as per our strategy, representing now 75% of our total loan portfolio as of the end of the fourth quarter, up from 71% at the end of the third quarter. Our commercial real estate portfolio decreased 7% year-over-year and 6% sequentially to $759 million at the end of the fourth quarter. As you now have noted for several quarters, management has taken a more cautionary stance in respect to the commercial real estate portfolio due to expected volatility in the valuations within this asset class in a rising interest rate environment, as well as concerns related to higher construction costs resulting from supply chain disruptions and a very tight labor market. That said, we remain very comfortable with the risk profile of our commercial real estate portfolio based on our criteria of working only with well-established, well-capitalized development partners with excellent track records, and restricting transaction to modest loan to value ratios. Turning to the income statement, for our digital banking operations, net interest margin on loans, that is excluding cash and securities and other assets, decreased 28 basis points or 8% year-over-year, and four basis points or 1% sequentially to 3.03%, due primarily to a shift in the bank's funding mix and rising interest rates over the respective periods, as well as the successful execution of our strategy to grow our POS financing portfolio. These factors were partially offset by generally higher yields earned on our lending portfolio during the period, also as a function of rising interest rates. Net interest margin for the quarter, which includes the impact of cash, securities, and other assets, increased eight basis points or 3% year-over-year, and five basis points or 2% sequentially to 2.81%. Non-interest expenses for the quarter were $13.8 million compared to $10.4 million for the same period last year, and $13.2 million for Q3 of this year. The year-over-year and quarter-over-quarter increases were substantially due to transitory costs related to the strategic growth investments I described earlier. Investments associated with the acquisition and integration of the operation of the US bank, are anticipated to be realized substantially by the end of the first quarter of 2023. The year-over-year and quarter-over-quarter increases were also impacted by higher salary and benefits costs due to increased staffing levels to support expanded revenue-generating business activity across the bank, as well as higher costs associated with employee retention in this very tight labor market. Cost of funds for the fourth quarter was 2.45%, up 114 basis points year-over-year, and up 51 basis once sequentially, due primarily to our funding mix being comprised of a larger proportion of wealth management deposits relative to our lower cost and solvency professional deposits, and the impact of course of rising interest rates. Insolvency professional deposit balances contracted slightly in Q4 compared to a year ago, despite adding more partners, and as we continue to - as we continue to experience historically low bankruptcy activity, which remains well below pre-pandemic levels. During the same period, our wealth management deposits grew 65%. Looking ahead to 2023, we do expect insolvency deposits to grow moderately throughout the year as a function of an increase in the volume of consumer bankruptcy and propose restructuring proceedings, amidst the challenging current and forecasted economic environment. Our provision for credit losses or PCLs in Q4 was again demonstrative of prudent risk mitigation strategies inherent in our lending and credit risk management processes, as well as the outstanding credit quality of our current loan portfolio. PCLs in the current quarter were 205,000, compared with a recovery of credit losses in the amount to 279,000 for the same period last year, and of PCL of 166,000 for Q3 of this year. The recovery we recorded last year was attributable primarily to changes in the bank's lending asset portfolio mix, and changes in the forward-looking information used in the bank's credit risk models, offset partially by higher lending balances. Sequential change this year was a function primarily of higher lending asset balances and changes in the forward-looking information that we use in our credit risk models, offset partially by changes in the bank's lending asset mix. Our PCL ratio remains one of the lowest in the Canadian banking industry at an average of 0% over the past 12 quarters. And as David will discuss in a moment, this superior risk profile is expected to serve us well should an economic downturn materialize over the course of 2023. Gross impaired loan balances at October 31, 2022, were $0.3 million, all of which were repaid on November 1, â22, compared to $1.4 million last quarter and nil a year ago. Turning now to DRTC sales that we generate almost exclusively through our cybersecurity services business, Digital Boundary Group, increased 33% sequentially, decreased 8% year-over-year to $2.8 million, due primarily to the timing of service engagements in those respective periods. Gross profit, however, increased 48% sequentially, and decreased 19% year-over-year to $1.7 million. The sequential increases were driven primarily by higher pricing charged on services, as well as meaningful improvements in DBGâs operational efficiency. DRTC generated a net loss of $0.5 million in the current quarter, compared with a net income of 0.5 million in Q4 of last year, and net loss of $0.7 million in Q3 of this year, attributable to higher gross profits from DBG being partially offset by higher salary and benefits expenses associated with employee retention in a highly competitive labor market. I will note here that the net loss for DRTC includes costs associated with strategic technology development investments for our digital banking operations. The operations of DBG on a standalone basis continue to be profitable. Finally, before I turn the call back to David, in August, we received approval from the TSX to undertake a normal course issuer bid for up to 1.7 million common shares, or just over 9.5% of our public float at the time of application. And further, in September, we received approval from the NASDAQ to proceed with an NCIB on that exchange as well. As of October 31, of this year, we have repurchased an aggregate 195,300 shares under the NCIB program. Iâd now like to turn the call back to David for some closing remarks. David. Thank you, Shawn. While we entered 2023 with considerable momentum and confidence in our ability to continue to generate strong growth in our loan portfolio that is in line with pre-2022 levels, we began the year with nearly $3 billion in loans in our Canadian digital banking operations, and annual revenue run rate of nearly $100 million. At the same time, both Shawn and I discussed, we expect our non-interest expenses to decline meaningfully, as the expenses associated with the acquisition of the US bank and the setup of our Receivable Purchase Program in the United States, come to an end. We expect that that will contribute to profitability margins on revenue that are in line with those prior to making these investments. To be clear, this is just the starting point for fiscal 2023. Despite forecasts for moderation in consumer spending, we expect to generate continued strong growth in our Canadian point-of-sale business. While we expect it would be tough to repeat the 74% year-over-year growth that we saw in 2022, we do expect business with existing partners to expand along the additional - and to add additional partners, which should contribute to growth of this portfolio, in line with the very healthy pre-2022 levels. We also expect the investments we made in 2022, will provide meaningful additional upside to growth. We continue to be very encouraged by the limited launch of our Receivable Purchase Program in the US, confirming both the value proposition of the offering, and the market opportunity, as we continue to plan for broad launch upon completion of our US bank acquisition, We expect to see strong profitable growth in revenue and gross profits in our cybersecurity business, as both DBG continues to expand its business activities with existing clients, while adding new clients. As it grows, we expect our cybersecurity business to be increasingly accretive to the bank's overall earnings. On the deposit side, we expect our low cost insolvency deposits to return to growth, expanding throughout fiscal 2023, as a function of an increase in the volume of consumer bankruptcy over the same timeframe, attributable primarily to the more challenging economic environment. We also expect to continue to expand our diverse broker network, which we source through personal wealth management deposits, mainly GICs, and expand our business with existing partners. Recent data from one of our major banking partners is bearing this out. Finally, and very importantly, as I noted earlier, VersaBank was designed specifically to perform well in any economic environment. And as I noted earlier, the bank has a track record of performing even a little better in economic downturns. As our banking peers are hunkering down for difficult times, our low-risk model enables us to capitalize on opportunities that might not have otherwise been available to us. Yes. Listen, I wanted to ask, there's been a lot of discussion on net interest margins this quarter with earnings season. You made reference a little bit to it, David. I know that the mix of this bankâs a little different than what most banks in Canada have. Can you talk about a couple of things? One is, you make reference to the deposit mix, specifically bankruptcy deposits, and we haven't really seen a whole lot of traction on that. Maybe that's been surprising to some. Can you give us a sense of what you see in 2023 from that perspective? And then I have a second question on loan growth. The loan growth expectation on point-of-sale, I think it's not a surprise to anyone. Is there anything that you're seeing in the mix within point-of-sale that you can comment on? Or is that mix still relatively similar to what the growth in 2022 was? Thanks. Sure. Good questions, Greg. With respect to our deposit mix yes, the deposits we received from the insolvency industry, are even a little lower than the previous year, and I think that is the result, well, I know that's the result of the various support payments that our government made to help Canadians softeare that were suffering with the pandemic. So, we're coming off a 35-year low of insolvencies, and there's a bit of a lag effect from that turning into deposits when the insolvencies increase. So, I expect that now, of course, the store payments have ended and interest rates are going up and it's becoming more challenging an environment for - particularly for consumers and small businesses, that unfortunately, we'll see a lot more insolvencies in Canada. It will get back to sort of normal levels, maybe even exceed that, and that does bode well for us. It means that insolvency deposits will start growing again, and could very well get well to $1 billion mark. Theyâre already on $600 million right now, I mean coming off of 35-year lows. So, the mix should, throughout 2023, increase in percentage to insolvency deposits. Now, with respect to loan growth, weâre not really seeing much of a reduction in our point-of-sale growth presently, although I do expect the higher interest rates will dampen the loan growth into 2023. The mix is primarily - small and primary, about two thirds of it has been in home improvement and home type financing. And we love that business and it represents a low-risk segment of the market. So, in 2023, slightly a little more emphasis on the home improvement side than there has been, but it is already a big business for us, and of course, we welcome it and that it is the lower risk segments of the point-of-sale market. And then with respect to the US market, this is an opportunity to grow in point-of-sale as well. I suspect the mix is a little bit different in the US, but any general comments on what you're seeing in trends in the US market so far with respect to growth opportunities in that segment? Well, there seems to be a tremendous growth opportunity. I guess a huge market I think - one figure we have is 1.8 trillion as opposed to Canada, maybe 10% of that 5% of that maybe. So, a huge growth from size, and any one of the industries that we finance in Canada, we'd be happy to do in the States, it just by chance, the first one where we - the customer we got was a large tractor trailer financing company. And coincidentally, that was the very first customer we got in Canada too, and not the same company, but the same industry. It was a tractor trailer financing. So, I don't really have a good sort of visibility on what segments weâll grow most rapidly in. It's just the market is so big and our product seems to be so attractive to these point-of-sale finance companies that once we've got our US bank, we expect really big growth in the States. Okay. Thanks for that. And then just a final one from me, and then I'll pass it on, with respect to timing on bankruptcy deposit growth. Thank you for the reference point of $1 billion. Are you getting any indications from the trustees that you deal with in that side of things on timing? Is this something that you expect happening in the first half of the year or as I suspect, more so in the second half of the year? Well, there's - we're all seeing the cracks in the economy right now. The trustees are seeing increased volume already. Other banks are reporting larger and larger provisions for losses. Their arrears rates are going up. So, it's just the way you'd expect. Weâre seeing the leading indicators. And so, I would say, second half of 2023, it'll be growing like - unfortunately for Canadians, it'll be growing like gangbusters. These deposits start pouring in the door as States are being wound up. So, towards the end of middle say 2023, you probably start seeing the type of growth we used to experience in this area. Good morning, David. Thank you for a great quarter. I've got several questions, but I'm just going to ask two and then go back in the queue. The last time we talked, you were thinking that you would have approval for your digital dollar project by the end of October. Obviously, that deadline is coming down. What are your current thoughts on that? And secondly, have you ever given any thought to off-balance sheet structures to hold some of your loans to be more capital-efficient and drive a higher ROE for the bank? Well, Stephen, thanks for logging in. And I wonder, if you have just seemed fog and rainy weather that's just gone through London here. I imagine you saw just a bit earlier than we did, or where you're located. So, what happened with the additional deposit receipt is the model that we had worked on, we called DCAD that used a third party to hold the wallet, didn't seem to sit well with the various regulators that we were discussing it with. So, we pivoted over to a different model, but using all the same technology where we were host - we would host, and we are hosting right now, the wallets ourselves, and hence the name change to CADV. We think this is the model that will have legs and frankly, I wouldn't be surprised every other bank will want too, in that it has a lot of advantages over the original one. Yes. For one thing, the data for the deposits are maintained both on the stellar blockchain, and also in our tried and true what we call deposit management system, DMS. So, from -- to alleviate sort regulatory fears, say something should happen to a blockchain, which I really, really doubt that would ever happen, but if it were, the data is maintained simultaneously on our existing deposit system. So, sort of in reaction to feedback we got from various regulators and what we noticed happening in the world, we pivoted over to this what we think is the best of the best that's out there, where a bank itself is the host of the wallet and the digital deposit receipt isn't really a token. It represents a real deposit with a real bank that goes through all the normal AML procedures and all that. But it did take time. It is fully functional now amongst our directors and our employees, but we'll tactically wait to lift the curtain up and to make it available to our other depositors. So, with respect to utilizing off-balance sheet techniques to fund our loans, presently we have a lot of capital. So, we're just using our own capital to fund the loans and leases as we're generating them. As time progresses, though, we are contemplating portfolioing these assets so they would be readily available for sale for two reasons. One, increases the bank's liquidity, and the other one, as you say, it improves the bank's return on common equity. Okay, great. I've got two more questions, but I'll go back in the queue and we'll see if we get back to me. Thanks. Good. Hey, on the effective tax rates, that $1.1 million in additional taxes for the quarter, what was that specifically related to? And are we going to go back to that 27% effective tax rates say going forward? I think that's a good question for our CFO who's been on the line waiting for a good question to answer. So, Shawn, I'll leave that one to you. Thank you, David. I hope I'm off mute here, folks. Good morning, Brad. That little high tax rate there we're seeing in the year, a function of kind of three core variables, Brad, that weâre pointing to, and we do expect this to diminish over the course of 2023. We don't think we'll get back to our statutory rate at 27%, but we do think we'll be selling to 30% as these - the various elements are rationalized over the course of the year. Theyâre comprised primarily of non-deductible expansions associated with our stock options, Brad, as well as some non-deductible losses. We think this is going to be one that we'll be able to utilize early in the coming year, as well as there's a - you're probably familiar with a FAPI tax here in Canada, which we'll pay, and itâs a function of the foreign exchange gains realized over the last, particularly over the last quarter on our current US lending operations through VersaFinance. So, those three elements, those miscellaneous items underneath that, but those three items, contribute to about 90% of the increase that we noted in our public disclosure. Okay, great. Iâve got several more here, if you guys have time. Nowadays, what type of rate are you getting on your point-of-sale loan financing, and what's the incremental cost to fund those? Well, the rates are running in Canada about 2.5% over the same term government Canada bond. So, say the government Canada bond is say 4%, Brad, at least 6.5, 7 is the yield on the point-of-sale in Canada. In the United States, you add about a 1% to that on the net interest margin. With respect to incremental costs, there may be a little bit of hiring necessary to take on the US market, but not very much in relation to the scale of the operation. Itâs very, very scalable. And for the most part, all the operations will be handled at the tech center, which I'm sitting in today, at the - in London. So, there's no need to duplicate what we have here in London to take on the US market. So, marginal increases, tiny increases maybe in a few staff members to take on the US market, but other than that, the systems are capable of many times the volume that they're presently dealing with. Okay, great. If I heard that correct, in the Canadian market, you're getting 250 basis points over treasuries, and in the US market, you're getting 350 basis points over treasuries for this point-of-sale product? Okay, great. And can you update me on kind of the timing of the CADV rollout as you kind of see things play out next year? Well, I think here -- so early in 2023, we'll be in a position to take CADV to the open market. But that all depends on the regulator's perception. Right now, thanks to a certain fellow in Bahamas who created a whole lot of nervousness in this area, even though, of course, our digital deposit receipt is an entirely different animal than what was being promoted out of Bahamas. So, I mean, technically, we'd be ready to go first probably 2023, but we are cognizant of the caution and concern that various regulators have about this use of a blockchain, and that's about the only similarity. Weâre simply using Stellar to account for our actual deposits with our bank. So, not a whole lot of similarity to all the things that have gone wrong, or even what the so-called stable coins where they've placed deposits with another financial institution as collateral for their coin. Ours is -- represents a real deposit with a real bank, and in fact, the data is duplicated, so think earlier on our own DMS deposit system and on Stellar so that in effect, our depositor has the ability to use Versaview, our view software or view app, and look at their deposit, just like they would with any other bank using an internet app. But you can look at it on Stellar. The bonus is, of course, is, should you choose to move your digital deposit receipt from your wallet to somebody else's wallet, say to affect a payment, you can do it. So, what we've in effect done is turned an old school bank account into the most modern type of checking account, where our CADV has become checks, certified checks, in fact, because they're drawn on our bank and move to somebody else's e-wallet, say Amazon's e-wallet, to effect a payment. When I say that, some folks say, but there are already rails that do that, David. There's already ways of doing payments, but nowhere near as efficiently, nowhere near as cost effective. Transactions on Stellar is in the order of fractions of cents and takes place instantaneously anywhere in the world, versus if you try to move money even from Canada to United States, you might be waiting three days and be charged a hefty fee for that. So, we think it's a fantastic revolutionary adaption of blockchain technology, and we're hoping that our regulators, and this is all throughout the world, will understand what we're doing and endorse it. It's about as low risk as you can imagine. As a bank, we pay attention to all the things that others don't seem to have paid attention to, like say anti-money laundering and terrorist financing to - letâs not repeat the list. Anyway, Brad, we're keenly excited about putting it out in Canada, and hopefully, our regulators in the new year after we've had some good solid interaction with them, will endorse it too. Great, thanks. A couple more here. On Digital Boundary Group, you had a strong revenue increase in the quarter of $1.8 million. Is that sustainable, or is that an anomaly or a seasonal boost in revenue, or do you think that's more reoccurring? I think that's more reoccurring in that we received a large contract with one of the largest corporations in Canada to do app testing, and it's very profitable. It's a specialized type work that DBG is doing for this large corporate. And the only constraint really is finding enough app testers. So, we're actively trying to hire as many as we can to bolster that business. So, yes, we're excited. DBG, I think round numbers was $10 million in revenue, $5.86 million in gross profit. That should just keep going up the same trajectory. App testing, like I say, is a wonderful business for us and all the other products we have in DBG such as sophisticated penetration testing. There's always an - thereâs an increasing demand for it. Absolutely. You said $10 million in revenue. I'm showing $5.7 million for the year. What is that $10 million? Is that expectations? Yes, what we show is - no, we show gross profit on our statements and total revenue - Shawn's on the line, I think it was $9.8 million for the year, Shawn, total revenue? That's right, David. Yes, Brad, you're right. You're looking at gross profit of 5.7 as published, and David was talking about revenue, topline revenue of sales, sir. Oh, so it's in the income statement. When I see non-interest income of $1.8 million, that's not revenue? You said that's net? On the quarter, Brad, youâre right, $1.8 million and that is - that's gross profit at DBG. And the challenge there is integrating that with the bank statement. So, it's the most intuitive way we can merge the two income streams to have it somewhat sort of align with how the bankâs statements are structured. So, you're right. What you're looking at is gross profit. It would be the $3 million? Okay. So, you're saying core revenue of Digital Boundary Group was $3 million, and the $1.8 million you report in the income statement is the lower gross profit part of that? That's right. About $2.8 million on the quarter, Brad, for sales, and then two point -- or $1.8 million as you meant for gross margin or gross profit. My apologies. Okay. And if that's something you could present going forward, that would definitely be helpful so I can differentiate that. But let's see. Lastly here, when I add back that $1.8 million and $1.1 million, roughly $0.10 a share, it comes up to 1.1, ROA, 11% ROE kind of on a core basis. So, I imagine that's a good starting place as I think about profitability next year, early next year. How much leverage should I think you have in this model? if you continue to grow 20 plus percent, do you get to 15% ROE? I know you do eventually, but what's the timing of something like that? Well, we do get to 15. That's the number we use in our planning. And a good question is on the timing. Presently, the point-of-sale business in Canada is still growing rapidly, which is quite surprising to me in that it's driven by the actual cost per month of the item that the person's purchasing, and interest rates, of course, have a huge bearing on that. So, you would think it would dampen down, but presently, it's still growing rapidly in Canada, like I was saying earlier, not to the extent that we - the year we just completed, 70 odd percent growth. In the States, the model looks really attractive from the real-life customers we've been dealing with and pitching to. So, the major constraint to get into that 15% ROE is how long it takes us to be granted the acquisition of the Holdingford bank. That's what's holding us back in the United States. We are -- we created a sort of interim company we call VersaFinance to hold these assets. And itâs quite cumbersome. So, we've actually been backing off until we've got that US license. So, that's the gating item on rapid growth and a huge improvement in ROE. Now, I'm just saying that, as you noted, we end the year at a run rate of about $100 million in revenue, and fixed costs are - Shawn will know better than I, but on a - without any extraneous items, they're probably running around 55. Yes, so we're already starting the year with a $45 million pretax. If we did nothing else, I mean, if we didn't grow a bit, and we are growing rapidly still in the Canadian market, so it's - we really are heading into 2023 with a full head of steam. And then, if it turns out that the bankruptcies increase, they seem to be already, well, that all - that helps our margin too, because the - what we pay on the - on what are really operating accounts, is a lot less than we pay on GICs. So, I hate to be so optimistic when all my colleagues are looking at their boots and weeping at times. But our - so I was saying earlier, our little bank is designed for this type of economy and looking really good. You didn't hear us complaining about loan losses or cracks in the portfolio or any of those things. In fact, the only loan we had in arrears paid off the next day, not just a crazy anomaly in accounting that you show a loan compared to one day, the next day it pays off. We're going into the market with a really solid portfolio, a full head of steam of existing loans and customers growing. And if the recession kicks in, as everybody thinks it does, that just means an abundance of economical price deposits for us. Thanks. Hope to see you again sometime in the winter months. I might be spending a little time in my place in Florida, so it won't be too short a ride to go up to where you are. Yes. Hey guys, thanks for having the chance to ask my last two questions. So, I noticed in your financials that your average price per share on the buybacks that you did was $9.88 Canadian, right, which is actually higher than the current price. And I noticed that during the year, you granted just under a million shares of options at CAD15.90. I guess my question to you is, with the stock currently trading at $0.77 on the dollar book value, why not get a little more aggressive than just buying 195,300 shares to at least offset the stock option dilution? Well, good question Stephen, and the answer is, it took quite a while to take the normal courses for bid into the United States, and it wasn't anything other than just paperwork and regulatory approvals required. It now is in in place. Raymond James is out printing it for us. They've, of course, been blocked out, like we all are. But after the blockout, you'll see RJ in there, and we've got about 1.5 million shares that we can buy. And as you say, itâs fantastic price. We might be able to buy them out at 77% of book. So, we'll be looking to pick up as much as we can. Awesome. And then my last question is on net interest margin and changes in interest rates, right? So, in the short run, the impact for a bank like VersaBank is not fully reflective of what the longer-term impacts are of a shift in interest rates, as you know. So, I noticed that sequentially you had, I think it was five basis point rise in your net interest margin, right? I would assume that over a year since the bank of Canada rate rose 3.5% so far, that there's a bigger impact as assets continue to reprice. Can you quantify in dollars, for every 1% rise in rates, what the immediate impact is, and then what's the, Iâm going to say, one term, sorry, one year impact is on net interest margin, please? Well, short answer is that there's hardly any impact on us on a rising interest rate environment in that we're so precisely matched. We only run about 1.4 years asset duration and about the same in liabilities. So, we move very, very precisely with the interest rate environment by design. However, we do make out much better on the cash that we're holding for liquidity purposes. So, that's why you would see the margin on our loans the same, pretty well the same, maybe decline even a tiny bit, the margins on the loans. But the actual overall net interest margin of the bank improved to 2.81, which in Canada, that would be by far, the highest net interest margin of any bank. All of them are posting decline. So, there will be great continuing of time, and as I expect it will a little bit more in Canada. There's a positive impact on our profit and loss, our net interest margin, and that we earn more on our liquid securities. Yes, yes. And we can go there - we can cross the border too, it seems. I crossed at the Blue Water Bridge not long ago and got a nice welcome. I don't think it's that many customers coming in right now, so I was well received. Yes. Well, we'll get back. It'll get back. Look forward to seeing you, Stephen. We'll have to have a nice lunch. Well, I'd like to thank everyone for joining us today, and I look forward to speaking with you at the time of our first quarter fiscal release. Obviously, weâre a very excited team of bankers here at VersaBank, as opposed to maybe our colleagues in our industry, in that we designed our bank, as we've sort of talked about in a little more detail on this call, we designed our bank to take advantage of what, for other bankers, are challenges. For us, it tends to be an opportunity. And that was demonstrated I think quite readily in how fast we recovered to have a record year in 2022, particularly with the growth in our point-of-sale business that came off the pandemicâs huge decline in volume. So, that's sort of what you can expect with this - how this bank is set up to run, that when recessions come, our competition tends to be let's say a little more myopic having to look at their own portfolios, and our source of deposits from the insolvency industry, which is - now we've probably grown our client base of insolvency professionals to most of the industry, most of the large insolvency practice in Canada now bank with us. So, weâre in good shape to take advantage of what might be a tougher time for others. Again, thank you. Thanks for dialing in, and we'll look forward to talking to you next quarter. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating, and ask that you please disconnect your lines.
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EarningCall_1644
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Good day, and thank you for standing by, and welcome to the G-III Apparel Group Third Quarter Fiscal 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. Good morning and thank you for joining us. Before we begin, I would like to remind participants that certain statements made on today's call and in the Q&A session may constitute forward-looking statements within the meaning of the Federal Securities Laws. Forward-looking statements are not guarantees, and actual results may differ materially from those expressed or implied in forward-looking statements. Important factors that could cause actual results of operations or the financial condition of the company to differ are discussed in the documents filed by the company with the SEC. The company undertakes no duty to update any forward-looking statement. In addition, during the call, we will refer to non-GAAP net income, non-GAAP net income per diluted share and adjusted EBITDA, which are all non-GAAP financial measures. We have provided reconciliations of these non-GAAP financial measures to GAAP measures in our press release, which is also available on our website. Also disclosed in our press release for your reference are last year's GAAP and non-GAAP results by quarter. Thank you, Neal, and thank you, everyone, for joining us. In the third quarter, we delivered topline results that met our expectations. Our strategy continues to deliver on key priorities to drive profitable growth for our shareholders despite increasing macroeconomic headwinds, which softened consumer demand as the quarter progressed. Net sales for the third quarter were $1.08 billion, an increase of 6.2% compared to last year's third quarter net sales of $1.02 billion. Non-GAAP net income per diluted share was $1.35 in the current period compared to $2.18 in the third quarter last year. During the quarter, our higher inventory levels were due to our accelerated production calendar, which was in anticipation of longer supply chain lead times. As these lead times improve, we will continue to adjust our production and receipt calendars. Our inventory consists of current purchases and is guided by our order book. As expected, our overall inventory position is now enabling us to immediately service the reorders for coats, dresses and other in-demand categories. During the quarter, our higher inventory levels resulted in storage and processing complications within our distribution centers that were above our expectations. This, alongside with port congestion, resulted in significant one-time charges of approximately $0.40 per diluted share in the third quarter. These charges, along with elevated warehousing costs, contributed to our earnings being lower than our guidance for the quarter. We've secured additional third-party warehousing space, which should eliminate almost all of these charges in the future. Currently, third-party warehouses make up approximately 70% of our total warehousing space. Now I'd like to discuss the extensions of our licensing agreements with the Calvin Klein and Tommy Hilfiger brands. They're an important part of our business. In our 8-K filed last night, we announced staggered extensions by category beginning in January of 2024 and continuing through December of 2027 for these brands. Just to be clear, we do not expect significant reductions in sales, net income and cash generation from these businesses for the next three years. These agreements will allow us time to accelerate our long-term strategic priorities. And we will continue to direct resources toward our growth areas, including further leaning into building our own brands, continuing to acquire new businesses, expanding our private label business and developing appropriate licensing opportunities. Currently, we've been pursuing a number of near-term initiatives across our existing, owned, and licensed brands, and private label business, including category expansion, geographic growth focused on Europe and digital expansion. We believe we can deliver growth because we've built a powerful foundation and have become a well-diversified company with expertise across a range of global brands with a broad range of price points for a broad range of customers, multiple points of distribution with strong retail relationships in North America and around the world with partners that include department and specialty stores, value retailers, wholesale clubs, digital pure plays and marketplaces in addition to our own omnichannel platforms. Dominance in designing, manufacturing and sourcing across a broad range of more than 20 categories, including apparel, footwear and accessories for women and men; a strong and growing geographic presence with leadership and offices in eight countries across North America, Europe and Asia; and a well-developed, flexible supply chain infrastructure with broad global sourcing relationships. Over the past five years, we've leveraged our strong balance sheet to focus on a brand acquisition strategy, which has evolved our portfolio to a significantly higher penetration of brand ownership. These brands are our most profitable sales because we do not pay royalty fees, and they provide highly accretive licensing royalty income. Three of our recently acquired or launched brands, DKNY, Karl Lagerfeld Paris in North America, and the remaining global Karl Lagerfeld business have added $1 billion in annual sales to our business. We see even greater growth ahead with these businesses and the rest of our own portfolio, including Donna Karan, Vilebrequin and Sonia Rykiel. A proven track record and diversified foundation has and continues to enable us to acquire or license and quickly scale brands by leveraging the resources that already exist in this company. We're confident in our ability to drive profitable growth and maximize shareholder value in the future, and we look forward to keeping you updated on our progress. Now I'll briefly update you on the progress we are making against our strategic priorities. Our first priority is to drive our power brands across categories. We're especially focused on driving our owned brands. From a category perspective, we continue to see strength across all of our divisions. With full ownership brands, we can now leverage newly created categories. Karl Lagerfeld Europe, for example, just introduced the full jeans category into their collection, and we plan on expanding the business by introducing it into North America next fall. Additionally, we've also been able to drive higher AURs, which help offset significant inflationary pressures this year. Our second priority is to expand our portfolio through ownership of brands and drive their licensing opportunities. Our current owned brands are led by DKNY, Donna Karan, Karl Lagerfeld, Vilebrequin and Sonia Rykiel. With full end-to-end control of these brands, we have and continue to grow them by developing new categories, increasing distribution and digital penetration. We've also built strong marketing capabilities that continue to develop awareness and global recognition. Our owned brands combined are expected to represent annual revenues of greater than $2.5 billion over time while generating higher operating margins than the company's historic average. As brand owners, we have the ability to license out our brand names to best-in-class partners in categories that we do not produce. These agreements bring in a revenue stream that is highly accretive to our profit, currently generating $65 million annually. We have always actively worked with our licensees to build bigger and better businesses. Companies that operate exclusively under a licensor model are valued based on a low teens multiple of their revenue stream. With our own brands, we've created a strong licensing revenue stream already and see powerful opportunity to continue to build this profit center and enhance value for our shareholders. Our top owned brands, DKNY, Karl Lagerfeld Paris in North America and Vilebrequin, also with the purchase of the entire Karl Lagerfeld brand, demonstrate our proven track record of building our own portfolio. As we look to the future, we continue to believe there is significant growth potential in the brands that we own. Our current, strong financial position will enable us to acquire additional brands. We continue to prioritize the expansion of our revenues and profits through brand ownership. Our next priority is to extend our global reach by expanding our European-based brand portfolio. Amsterdam-based Karl Lagerfeld Europe continues to perform well. Having launched the jeans categories I previously mentioned, we're planning on bringing it to North America. We also made progress on key digital initiatives and are on track to open 12 company and partner-operated stores and shop-in-shops this fiscal year. Saint-Tropez founded Vilebrequin, our status swimwear brand's robust momentum continues with another quarter of strong double-digit growth and remains on track to register a record year of sales and profitability. It continues unique collaborations to address a range of customer segments, including streetwear brand, [Bape Black] and previously with Palm Angels and Off-White. Additionally, the brand has begun limited edition Capsule Collections featuring the artwork of acclaimed contemporary artists. Their latest collection is currently being exhibited in the Miami Art Basel. We completed the acquisition of the restaurant and beach club in the South of France and are currently rebranding it to the Vilebrequin La Plage. The brand is also opening its first Cabana Club in new retail location in the totally renovated Boca Raton Beach Club this winter. Both advanced Vilebrequin's leading luxury swimwear position by touching all aspects of beach lovers and created an immerse customer experience and brand recognition. The Paris-based, Sonia Rykiel, the European team relaunched with core categories and established a physical presence in Paris and New York. We also opened in major department stores, including [Crompton] in Paris, [indiscernible] and Isetan in Tokyo. Since our Karl Lagerfeld acquisition, our existing European management teams are working to develop synergies to strengthen our European operations overall. Areas they're focused on include leveraging their vendor base and creating a unified back-end structure for all of our digital businesses. Ultimately, this new infrastructure further develops our European platform and will allow us to continue expansion with any brand. Our next priority is to maximize omnichannel opportunities and leverage data. We've expanded our pure-play presence and developed strong capabilities to drive demand on our retail partners' digital platforms with strong double-digit sales growth led by Amazon and our largest retail partners, Macy's. We've also increased sales with Zalando, Fanatics, Nordstrom's and Hudson Bay. We've started to develop our vendor direct shipping capabilities, which provide additional opportunities to grow our digital business. The digital businesses of our owned brands are in their infancy. They present a tremendous opportunity, and we believe that these businesses can grow to become significant contributors to our overall business over time. In our own retail operations, Karl Lagerfeld Paris had another solid quarter in North America with a significant rebound in traffic fueling strong double-digit growth. DKNY remained challenged, mostly driven by the lack of tourists, primarily from China and our European stores. We are well positioned across both businesses to capitalize on holiday demand during this key selling period and remain focused on driving omnichannel growth wherever the consumer chooses to shop. In conclusion, having met topline expectations for the quarter, we made progress on all of our priorities. We experienced some one-time logistical challenges that negatively impacted our results in the third quarter, which we believe are mostly behind us. As our bottom line net income per diluted share was below our guidance and with some uncertainties ahead, we're adjusting our order book for the fourth quarter and full-year. I'll now pass the call to Neal for a discussion of our third quarter financial results as well as guidance for our fourth quarter and full fiscal 2023 year. Thank you, Morris. Net sales for the third quarter ended October 31, 2022, increased approximately 6% to $1.08 billion from $1.02 billion in the same period last year. Included in our sales for this quarter were $55 million in sales of the Karl Lagerfeld business, which became a wholly owned subsidiary on May 31, 2022. Accordingly, the results of the Karl Lagerfeld business were included in our results for the entire third quarter. Net sales of our Wholesale segment increased approximately 5.5% to $1.07 billion from $1.01 billion last year. Net sales of our Retail segment were $29 million for the third quarter compared to net sales of $26 million in last year's third quarter. Our gross margin percentage was 32% in the third quarter of fiscal 2023 compared to 34.2% in the previous year's third quarter. The reduction in gross margin percentage is attributable to the decrease in the gross margin percentage in our Wholesale segment. The Wholesale segment gross margin percentage was 30.7% compared to 33% in last year's comparable quarter. Our elevated inventory levels resulted in storage and processing capacity pressures within our distribution centers. We have been seeking and have now procured additional third-party warehouse capacity to handle our higher inventory levels. Going into the third quarter, we were not able to secure additional warehouse space in the time frame we had planned. Several negotiations took longer than expected, and in certain situations, we did not want to enter into expensive long-term commitments for such capacity. The lack of additional space in our warehouses, along with port congestion and the logistical challenges related to trucking, all contributed to us incurring approximately $27 million of demurrage charges in the third fiscal quarter, resulting in a one-time 250 basis point negative impact to our gross margin percentage. Demurrage charges are paid to steamship carriers for delays in picking up freight from their terminals and were the most significant contributor to the decrease in our gross margin percentage for the quarter. We expect that the additional warehousing space we have now secured should eliminate almost all demurrage charges in the future. The gross margin percentage in our retail operations segment was 54.9% compared to 49.8% in the prior year's quarter. SG&A expenses were $240 million or 22.2% compared to $182 million or 18% of net sales in last year's third quarter. Warehouse costs increased significantly as a result of our higher inventory levels and the timing of receipts. SG&A also grew by approximately $30 million as a result of the inclusion of the acquired Karl Lagerfeld business in our results for the quarter. Looking ahead, we expect to continue to have elevated warehouse costs associated with higher inventory levels through the second quarter of next year. We also expect that the addition of the Karl Lagerfeld business in our results of operations will increase the percentage of net sales represented by SG&A expenses as the Karl Lagerfeld business model includes a higher amount of direct-to-consumer business, which has a higher SG&A rate. GAAP net income for the third quarter was $61 million or $1.26 per diluted share compared to $106 million or $2.16 per diluted share in last year's third quarter. Non-GAAP net income for the third quarter was $65 million or $1.35 per diluted share compared to $108 million or $2.18 per diluted share in last year's third quarter. Net income per share was negatively impacted by higher-than-anticipated demurrage costs equal to approximately $0.40 per diluted share. These charges, along with elevated warehousing costs, contributed to our net income per share being lower than forecasted. A full reconciliation of our GAAP to non-GAAP results are included in our press release issued last night. Turning to the balance sheet. Our inventory was about 2x last year's third quarter levels, which was a historical low base due to the supply chain issues and strong consumer demand that occurred last year. A better comparison would be to consider comparable wholesale inventory levels to the pre-pandemic third quarter in which we are up approximately 60%. Inventories are up primarily as a result of the increased shipping times, higher freight costs and the pull forward of the production calendar. Our inventory increases are all from current purchases and will be viable into next year. We have already and will continue to temper our buying into next year to also take account of our inventory levels. We ended the quarter with a net debt position of $728 million compared to $238 million in the prior year. This increase is predominantly related to the Karl Lagerfeld acquisition, which we funded with cash on hand as well as the increase in our inventory position. We had cash and availability under our credit agreement of approximately $440 million at the close of the quarter. We believe that our liquidity and financial position provide us the flexibility to take advantage of acquisition opportunities and invest in our future growth. We expect our availability to grow significantly as we normalize inventory levels. As for our guidance, for the full fiscal year 2023, we now expect net sales of approximately $3.15 billion and net income of between $147 million and $152 million or between $3 and $3.10 per diluted share. This compares to net sales of $2.77 billion and net income of $200 million or $4.05 per diluted share last year. On a non-GAAP basis, we expect net income for the full fiscal year of 2023 of between $142 million and $147 million or between $2.90 and $3 per diluted share. This guidance compares to non-GAAP net income of $208 million or $4.20 per diluted share for fiscal 2022. Full-year fiscal 2023 adjusted EBITDA is expected to be between $265 million and $270 million. This compared to adjusted EBITDA of $350 million in fiscal 2022. Let me add some context around modeling of the line items. As a result of our third quarter results, we are now expecting that our full fiscal year 2023 gross margin percentage will be lower than fiscal 2022. For the upcoming fourth quarter, we continue to expect that our gross margin percentage will exceed the prior year's fourth quarter. For the full-year, we expect SG&A to delever primarily as a result of the inclusion of the acquired Karl Lagerfeld business and higher warehousing costs. We are anticipating interest expense to be approximately $55 million, which includes approximately $7 million of non-cash imputed interest. We are estimating a tax rate of 24.5% after the inclusion of some discrete items during the year. We have not anticipated any potential share repurchases in our guidance. That concludes my comments. Thank you, Neal, and thank you all for joining us today. Our team remains steadfast and is focused on executing our strategy for long-term value creation. We continue to actively work on new initiatives to evolve our business for the future and as always, deliver for our shareholders. Our diversification is a testament to the stable business model and solid foundation we've created, enabling us to navigate any environment. As we continue in the fourth quarter, our order book is strong, and we are delivering on the balance of the holiday season. I'd like to thank our entire G-III organization and all our stakeholders for their continued support, and wish everyone a happy holiday season. And thank you. [Operator Instructions] And our first question comes from Edward Yruma from Piper Sandler. Your line is now open. Hey. Good morning, guys. Thanks for taking the question. I guess first, Morris, on the quarter in terms of some of the demurrage costs, just so we understand a little bit better. So is there any impact to quality of the inventory? Were there any flow issues associated with it? And then I guess as a broader, longer-term question, Morris, how do you think we should â how should we think about the longer-term organic growth profile and profitability profile of the remaining businesses once the previous licenses are complete? Thank you. Thank you, Ed. Thanks for your question. The demurrage and supply chain issues and quality of the inventory certainly deserves a solid response. If anything, our inventory is in tremendous shape. We implemented new quality control systems overseas that further enhance our quality of product. In difficult times, COVID times, we found it difficult to transport inspectors from one location to another, which were normally done pre-COVID. And we put on the ground solid inspectors to make sure that we got what we bought at the very least, in most cases, better than what we anticipated. So no issue on quality. The integrity of the inventory, number one, it's all new. It's freshly produced. It's freshly delivered. It's wrapped and ready to go. And it was anticipated on arriving early with no interference on container space, transportation times and anticipated delays at the port. So it worked better than we had anticipated. What had occurred is we misplanned our warehousing capacity. We searched for warehouses for the better part of six months, either warehouses that we would take control of or partnered with third-party providers. There are several deals, no less than four deals that were at the finish line, ready to be signed that fell apart. Unique situations in different parts of the country. So the lack of capacity caused some unexpected â a tremendous amount of unexpected demurrage and container charges. So that's really the inventory issue. It's storage. It's not the scale of the inventory. The inventory was bought with good and appropriate intent. It flowed faster than anticipated. The time on the water accelerated, which further exacerbated our situation. But it's all great inventory that was anticipated for this time period. There's early spring inventory that sits there that's ready to go when the door is open at our retailers. There's all current inventory. Our levels of dated inventory, inventory that's greater than a year old, is at a record low. So there is not troubled inventory. This isn't inventory that's sitting in the store that is anticipated to move only when it's marked down. This is full price, great quality, anticipated and planned inventory. So I'm more disappointed in our miss in planning housing and moving the inventory than I am at the inventory level. And Neal⦠Yes. With respect to the operating margin going forward, look, we've commented on this before. The brand that we own traditionally will run an operating margin that we would expect to be in the 15% to 20% zone. Our blend is down in the high â in the low double digits, around 10%. And of course, that's after we pay a royalty. So to the extent that we can continue to move the portfolio into brands that we own, we will continue to have elevated operating margins. And certainly, about a third of the portfolio today is owned. So we're getting â we're seeing that benefit. We still have some more room to go with the recent acquisition of the Karl Lagerfeld European business. I think we'll continue to see elevated operating margins on that business as we go forward, and that's where we stand. So coupled with that, addressing the organic opportunities, as you know, we bought DKNY and Donna Karan. We brought DKNY to market in record time. It's one of the most relevant brands to our sector today. We bought it... 2016 and with virtually no distribution in North America and created just an amazing brand out of it or reinforced the presence, the earlier presence of the brand. What we have on the shelf that we are now activating is Donna Karan. Donna Karan, there are very few brands in North America certainly that are known by their first name. There's Ralph. There's Calvin. There's Tommy, and there's Donna, and there's not very much more. So Donna is an incredibly well-recognized brand. We were not certain where we would market that brand. And this current situation has brought us to bringing Donna Karan to market in the same sector that we best operate in. So you'll have more news to follow. This is the situation that just was signed on Tuesday. Negotiations started over two years ago and not our doing, but the culmination that just got done on Tuesday in a form that was acceptable for us for the period of time. We have transition time. As I stated, there's no concern about the next three years. We're a responsive company, and we signed on Tuesday. On Wednesday, we started to work and get everything into play. So you can expect quick movement. You can expect marketing. We don't have a challenge of talent. We have the best talent in the industry housed here. We do not expect to make any changes. This is the operating army that we have that knows what to do. We execute quickly. We take on challenges, and we pivot when the world tells us to pivot. So this is pivot time. This is the troops that are armed and ready to go. And thank you. [Operator Instructions] And our next question comes from Will Gaertner from Wells Fargo. Your line is now open. Hey, guys. Good morning. Thanks for taking my question. Just a quick one. Can you guys remind us on the split of Karl between wholesale versus retail, what that split is? Well, on the acquired business, we're about 60% DTC. So that's full price outlets and the e-com business. That's where the European-based business runs. Domestically, we are probably one-third of the business forecasted would be our outlet business. If the split that you might be asking for is regions, geographic regions, it's equally split pretty much from Europe and North America. Got you. And just with the licenses rolling off over the next couple of years, how are you thinking about investment in that business and production all of that? How is that sort of â can you just frame out how you're thinking about that over the next couple of years? So it's business as usual. These are brands that we are challenged to protect and reinforce retail presence in, and we continually plan on doing that. So what's essential in protecting the positioning, we will absolutely do. We have been guardians of the brand for over 15 years. We've done a flawless job in building it. It's something that this team is extremely proud of, deservedly so. And now we will not do damage to the brand as we transition the brand. Hi. Good morning. This is Mauricio Serna on behalf of Jay Sole, and thanks for taking our question. I guess I wanted to ask about Karl Lagerfeld, the performance in the third quarter. You called out $55 million in revenue. Just was wondering if that was within your expectation or was that actually above that? And also the number that you mentioned, $30 million of incremental SG&A, is that for the quarter or the year? Just wanted to make sure I understood that. And lastly, if you could remind us roughly how much do Calvin Klein and Tommy Hilfiger represent of your EBITDA, that will be very helpful. Thank you. Sure. Thanks. Thank you for your question. The Karl Lagerfeld European business operated slightly ahead of our expectations, more bottom line than topline. Their op margins are right around the 10% level at this point. And we see that with some good potential to improve go forward. The SG&A that I called out, the $30 million, that was just in the third quarter. And then with respect to the Calvin businesses and the Tommy businesses, it's about $1.5 billion of total business. And we really view that as an operating margin at about 10%. Hey, guys. Thanks for taking my question. Two parts. So can you just talk about the cadence of the licensing expiring? So we have the multiyear period, but is it... Sorry about that. Can you talk about the cadence of the licensing expiration? So we have the dates, but just in terms of sales size, is it equally weighted or is it more weighted towards the end? That's one. And then two, if you were looking to potentially fill that business with new license agreements, is that something that you have capacity to do before those expire? Or should we be looking at it as you have to kind of bring on new business as the other ones go out? Thanks. So the earliest, call it, retirement date, is a denim license with Tommy Hilfiger, which is insignificant in scale, and we have it replaced. Our ability to replace brands through license or acquisition is pretty vast. There are several non-competes that led â we've agreed to and that for strategic reasons, I prefer not to disclose. But there's a huge world out there, and the limitation is no more than three or four brands. And the capability that we have can bring on brands immediately. And the deal that we have is we can operate them simultaneously if they're not deemed to be competitive. The ones that are competitive, the situation is we can agree to them. And we can launch them as we exit the PVH deal. And I'll give Neal the opportunity to respond on the depth of the calendar and the influence on our business. Yes. So Paul, thanks for the question. The 8-K that was filed, indicates all of the specific dates that fall off. We've mentioned that for the next three years, we're essentially intact. And you can see which businesses fall off, and then you can see the periods. Our plan is to replace these businesses. So rather than getting to the specifics of how much dollars is going to fall off when, that's really not the way we're looking at it just yet. So I'd rather not be focused on that. Our concept is to replace these sales. And thank you. [Operator Instructions] And our last question is going to come from Noah Zatzkin from KeyBanc Capital Markets. Your line is now open. Hi. Thanks for taking my questions. I guess first, just how do you see the promotional environment playing out relative to three months ago when you were looking out versus your expectations then? And then if you could just provide a little bit of color around the order book. And then lastly, just on the license expirations, just to dig in a bit more. If we think about the business in 2024, 2025, 2026, are you planning the business for steady growth continuing through 2023 onwards via replacement and owned opportunities? Or are you contemplating kind of choppiness as the licenses roll off? Just any color on the kind of trajectory over the next five years or so would be helpful. Thank you. So Noah, let me try to respond to your question. As far as promotions, there are far less promotions and promotional activity than we anticipated. The retail sell-throughs are pretty strong surprisingly. The retailers are holding price in our sector, and there are no major giveaways. We are in the mid-tier department store business and not a major provider to the next tier of business. So promotions are not aggressive. As far as â I'll leave one open for Neal, but let me respond to the choppiness of the license. I can give you a story that really relates to my last response. We can operate multiple brands in classifications. So while we're exiting, it wouldn't be unique for us to sign on other brands or deliver other situations that would not grow our business for the next three, four years. The question is â the bigger question is the permanence and how effectively we replace the scale of the business that we will be giving up. And we're pretty comfortable that we have a replacement formula, which we'll disclose to the marketplace in the coming months. As I said, this is all new. Not totally unexpected. So formulating a strategy is a work in progress that we will bring to you in the coming months. But we're energized. As I said before, we're ready to go. We have found the most difficult component in building a new brand is finding the right people. We have that done. We have the right people. There is not one bit of change that needs to be made. Scouting for talent in this environment that's acclimated to the culture that we have, that will remain the same, and it will be reinforced with brand ownership. We have a tremendous advantage. It was much more difficult in creating and blending a culture when we acquired DKNY. This one, believe it or not, this is an easier process. Our talent, our capital, everything we need is in place to just march forward and do well for ourselves and for the shareholder and certainly for our employees, who have been incredibly loyal to our company. So we're armed and ready. And Noah, with respect to the order book, it's coming along. Certainly the fourth quarter is very much intact. Our first quarter spring book, we're actively working. We are seeing that retailers' appetites again, continue to be closer to buy time. So there is certainly some pressure there. And candidly, if you look at the past few years, you've got some very hard compares with respect to COVID, the turn on and off of ordering cycles. But we're very comfortable with what's being developed now, and we'll continue to develop that spring order book into summer. Thank you, operator, and thank you for being part of our call. And hopefully, we've explained some of the sensitivity in our business. And wishing you a happy holiday. Thank you all.
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EarningCall_1645
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Take your seats. We'll get started. So, I'm John Hodulik, I'm the Media and Telecom analyst here at UBS, and very pleased to have with me today Bob Bakish, the CEO of Paramount. So, we've got about 40 minutes. I've got a bunch of questions. If anybody has any questions, they can log into the app, and I'll work them into the conversation that I've got here. So, Bob, we always started this late in the year. Can you just give us a sense for what the priorities are for the company as we look out into '23? Yes, sure. So, look, we're really excited about the company overall, and what we have going on. If we think about 2023, and you look at what we do, it really all starts, and I could argue, ends with content. So, we obviously have continuing to make broadly popular content as a significant priority. The good news is '22, as we -- [throughout] [Ph] the year, where we demonstrated the power of our content engine in film, in television, and streaming. And we look to very much continue that in '23. If there's any difference, it's probably that you'll see us lean even more into franchises, so that's priority one. Priority two, obviously streaming, we're building a [scaled] [Ph] asset in the most important, really the network of the 21st Century. We look to continue to build on our momentum. Paramount+ had an extraordinary year in '22, and we look to continue that in '23. And first, it's not only about the top line and subscribers; we've always built this with an eye of building a real business and profitability in mind. And we look to continue to make headway on that in '23. Third objective really is our earnings and cash flow. We obviously have -- continue to have a significant position in the traditional ecosystem. And we look to continue to take share, which we've been doing in '22, look at optimizing our investment levels, both through organic [visions] [Ph] and some transformation work we're doing, which I'm sure we'll touch on. And really extract significant earnings and cash flow from that. So, those are our three objectives broadly speaking. We're obviously doing it in, not a perfect environment, but we're also really going to use that as a catalyst to go further faster, which you'll also see in '23. Great. Maybe starting off with the ad market, we started off the conference with the ad panel, where they lowered some numbers a little bit and followed that up with [indiscernible] you talked about some incremental weakness as we look in from the fourth quarter to the third quarter. Just, can you give us a sense in terms of what you're seeing in the ad market, the overall health of it? And maybe what are some of the sort of macro drivers that you're seeing affect your business and from an advertising -- Yes, sure. So, look let met start with, we love the ad business, and it's an extraordinary business. It's a way to obviously create significant incremental monetization around your investments. But that said, the current market is challenging. And we're in it every day, and we see it. And that challenge is both on the linear side and on the digital side. Again, no surprise, it's probably when you heard, yesterday; I didn't actually look at Jeff's remarks, but given that in our third quarter call, we talked about our fourth quarter performance being in line with the third quarter. And again, as we've transacted in the market, as we've seen the state of the scatter market, as we look the our international networks, which are impacted by the economy but also by what's going on in the FX, on the exchange rate side, we do now see the fourth quarter coming in a bit below the third quarter. And as we had navigated leading into this point, we had looked for some improvement in certain sectors. We haven't seen that. But nonetheless, again, I go back to the main point, we love the ad business; point one. Point two is, while challenging, advertising is cyclical. I've managed through a number of these cycles, as recently as through the beginning of the decade. This too is a cycle. This too will turn. The only question is when. And not being an economist, I can't tell you exactly when, but I know for sure it will turn. And when it does, you really see the power of the portfolio of assets that we have, with the number one broadcast network in the United States, which is gaining share, the number one fast service in the United States, Pluto TV, which continues to do extremely well on the MAU and engagement side. We've got a cable network portfolio at scale which leads serving many specialized audiences. And of course, Paramount+, which, from day one, had an ad-supported tier, which is a material part of this service and provides access to very high-quality reach for advertisers. So, that set of platforms, all wrapped around popular content that advertises, and our agencies want to be associated with, combined with the fact that we have team that executes very well. In fact, and we'll talk about, some of the org changes. One change we are in the process of making is actually making us even easier to do business, particularly for the holding companies where we're going to have single points of contact versus multiple people they're dealing with. And a track record of delivering for folks. So, you have seen the value of that in spades as we come out of this cycle. And again, we continue to be very excited about the ad business. So, yes, let's talk about the cost savings that you referenced. And there's been a fair amount of press around some of the changes you guys have made. I mean, could you just walk us through what you're doing in terms of these changes, and how much cost savings are -- you don't have the give us exact numbers, but maybe in terms of orders of magnitude, how much cost saving -- because this has been a multiyear process for you guys, but just how much cost saving is sort of left in the business to respond to the weakness you guys are seeing? Yes, sure. So, we both focus on the top line and also on the expense lines. And when we brought the companies together, Viacom and CBS, we very quickly got to work at creating one company, and unlocking certain economic benefits; single ad sales teams, single affiliate team, and then put in place single streaming team, et cetera, and that all yielded both strategic benefits and economic benefits. As we sit here today, we are embarking on a set of initiative which we were planning on doing anyway because they're strategic, but we are definitely accelerating and using, really, the current market as a catalyst. That includes, and I'm sure read some about this, we're doing a set a work around Showtime, both on the network side and the streaming side, which is really about consolidation economics, if you will, and unlocking cost synergies with the broader portfolio. We're doing a bunch of work on the studio side, which isn't about changing the creative-facing capabilities of the studio, but it's very much about creating support scale and associated economics. We're doing work around the marketing side. The fact of the matter is, and I'm just talking about ad sales, we have an incredible portfolio of owned and operated assets that people pay very good money to leverage to reach audiences. We're going to lean into that even more. We think there are some efficiencies there. And in general, we're just going to look at marketing expense and unlock some opportunity. International; we run a truly, well I'll say, globe-spanning company. We have operations on the ground in 30-plus markets. We're taking the next step in really globalizing certain aspects of that. We got a portfolio of free-to-air networks, we got a portfolio of cable network, got -- we're obviously going to market in streaming. We're going to unlock some global benefit while continuing to, of course, have the benefit of on-the-ground execution, so we think there's some economies there. And lastly, ad sales, I referenced it, but we are, when we created one ad sales organization representing the company, it still had, I don't want to call it silos, but we'll leverage a line of business representation. We're now taking the next step and streamlining it to single point of contact and leadership by a holding company. And that's something that's been embraced by the agencies, they're very happy about it, and so again, both economic and strategic benefit. So, you'll see us executing. We're in the middle of executing on all of that. And in -- it creates both economic, i.e., expense benefit, but also continues to strengthen our positioning for the future really as one Paramount transacting with important counterparties all around the world. Great. So, I think we can dive in some of the segment. We'll start with D2C. And Paramount has definitely seen some strong subscriber growth. Of the companies we cover, I think it's the best. I think if we look at fourth quarter, I think our numbers have you as with the most growth. I guess the question is sort of what's driving the growth in the D2C segment? And how has that trend continued into the fourth quarter? Yes, sure. We are happy to talk about the momentum we are seeing in the streaming business. We obviously set out to build a scaling asset, I don't know, 18 months ago in this sector. And I think at the time people questioned our relative allover success. If you look at '22, Paramount+ has had an incredible run. In fact, if you look at just November for the most recent data, for November we set our records on net subscriber additions on active users and on total hours of content consumed globally. And we didn't just set the record; we beat the prior record by double digits on all those metrics. And strong double digits on one of that. So, really happy with the momentum we are seeing. We look under covers what's driving that momentum starts with content, whether it's the CBS fall slate whether it's the NFL, Paramount Movies, most recently Smile, Signatures Originals, currently we were talking about Tulsa King, New Criminal Minds is also performing very well. And we are seeing a very strong content slate which has resonating with consumers. But it's not just the content, it's also how we are connecting it including through marketing and distribution. We are seeing the impact, for example, of our new deal with Walmart, Walmart Plus that started in Q3, but continues to ramp. We are very happy with what we are seeing there. It's performing materially above the initial business plan which I thought was a low call. But, it's definitely working for us and stuff we are doing around the world. We launched Paramount+ in December in France. I guess it was last week, I got a note from the CEO over the weekend. They were very happy to see how that's performing. And we are going to launch in Germany on Thursday, Austria and Switzerland. So, all this is driving really strong Paramount+ performance. I said we set a record in November by a material amount, and we now look at the fourth quarter as the biggest quarter in Paramount+ history. We feel very good about it. And we are really proving that this is a cornerstone service for the world consumers, and we are going to continue to keep driving it forward. So, when does Top Gun drop? I mean you had a record quarter in November. Isn't that in the next couple of weeks? So, the next two things to drop in addition to the more episode of what we got going on is connecting is 1923 with Harrison Ford and Helen Mirren. And if you haven't seen the trailer, I would encourage you to. I think that's December 18, trailer is up now. And the big upside surprise for me was Helen Mirren. I mean I thought the Harrison Ford thing would work, but Helen Mirren is badass like she is great. And that one is really going to work. And then there is Top Gun: Maverick which anywhere it shows up, it crushes. And it's going to show up on the platform on December 22 as a gift kind of for the holidays and families et cetera. So, we feel very good about how we are going to finish off this quarter. And by the way, '23 looks great too. All right. You just keep going, okay. And little bit around the profitability of the business. First, churn, that's something that I think investors worry about when they look at the sort of long-term -- the value the customers and overall -- how has that been trending? So, happy to say that we continue to see a great churn trajectory. We are seeing improved churn both quarter-on-quarter and year-on-year, really a couple of things driving that; one being the content slate. We have compelling content. And importantly, when we first launched it was very lumpy. Not surprisingly. You are getting a service up of the ground. And now, we are getting a much better year around approach to content and that clearly helps too is you have the benefit of a growing sub base. And importantly, larger part of the sub base has been around for awhile. And if you look at cohorts of subscribers by age or tenure, you will find that if they stick around for a couple of months, then they really don't churn. And so, we are seeing that kind of flow-through benefit. And then there is way we going to business with partners. And again, whether it's the Walmart Plus thing or what we are doing internationally with Sky and CANAL+ on the hard bundle side, they also as those sub bases feather in, they have very compelling churn characteristics, i.e., very low churn because they are really part of a tier. So, we likely see on churn, we are not all the way there yet. We see a lot opportunity ahead, but it's tracking great. How do you balance streaming profitability with subscriber growth? You are doing very well in the subscriber growth. Are you still sort of set up to have peak losses next year? And then, how do you see that evolving beyond that? So, in reverse order, yes, we had for long time -- not long time for a while said '23 will be peak streaming investment. Therefore, loses. And we continue to feel that's the case. At the same time, we will build a streaming business plan for only the top line and subscribers. We knew from day one that we need to turn this into a business. And we have focused on creating a business with TV media like margins. We believe that our multi-platform asset portfolio is a real advantage here. You think about using content across linear platforms and streaming that create cost advantages. You think about marketing and leveraging platforms that creates cost advantage. If you think about films releasing them theatrically and then falling like fast follow 45 data streaming that really optimizes our ally in the film business. So, we are building model, which is designed with profitability in mind and is moving in that direction. We are building it out over couple of years. We have Paramount+ running for 18 months unlike some people who have run it for over a decade. So, it takes little while. But we are very focused on streaming profitability and building a financially compelling business here and we are very much tracking in that direction. What do you see is the sort of main drivers for getting the profitability in line with TV margins you guys have seen in the past? I mean I think that was the longer term focus. I mean are there specific drivers like -- how do you -- pricing [technical difficulty] role in this? Oh, sure. The good news is there really are multiple levers on the past profitability. And again, they are built partially off on a multi-platform model. But they are also built on how we are going to market. If you think about it, we are building a scale asset. So, obviously subscribers matter to building profitability. Things like global amortization of your content are tied to having a broad footprint. So, subscribers, one, ARPU and subscriber price increases as the second one. There is no question that streaming continues to present an enormous and extraordinary value for consumers and is also no question that we are nowhere near the top of the pricing that. We're very much value priced; Paramount+ at $9.99 for premium, and $4.99 Essentials, which is the ad-supported tier; really great value to consumer. We will move the price up, no question about it, and you got to build that into your models. Point three is ad market. Okay, the ad market is little challenged at the moment, but certainly on multi-year basis, it is a very powerful financial driver. We included advertising in Paramount+ for two reasons initially. One being we wanted to get the widest possible TAM. So, we wanted to provide that lower cost option. And two is it is significant incremental money. And so as this cycle plays out, you will see that kick in once again. Last one which is on the revenue side which is tangentially related to it is licensing. We haven't ping-ponged on this. We certainly are pointing our major franchises including new, original versions of it as exemplified by, say, Criminal Minds this month at our streaming owned [technical difficulty] assets. But at the same time, if you think about library product and kind of like see it -- I don't know, N minus 3, [technical difficulty] that's our incremental revenue [technical difficulty] model. Then go to the cost side of the equation. We learn more about content performance on our streaming assets everyday and the content portfolio is growing in size. That's provides inherent opportunity to continue to optimize that expense. In close link to that is marking, as I said, again we were learning about what works there. As the service gets bigger, marketing inherently gets more efficient. And again, we're continuing to create new ways to lean into our owned and operated portfolio to market Paramount+, if you watch CBS as an example, you will see in the end cards, everything says on CBS on Paramount+, that is something that we are advantaged and doing. Also related to that is the churn benefit, we call that expense or revenue, but clear that coming down is additive to the path for profitability. And finally, distribution and expansion working with partners, you look at the financial expression of the deal we're doing with Sky, it has ARPU benefits, it has churn benefits, and it has marketing benefits, because they're marketing it. And so that model of hard bundles, which I would argue we pioneered, and we continue to lean into also has benefits and more broadly. And as recently we had some conversation about this, we never went out there saying we got to be owned and operated 100% all around the world, we believe in the power partnership, including the potential for JV partnership, look at Sky Showtime. That was an opportunity that we are now operating, where we could plug our entire content amortization into it, but do it in partnership with someone. So, effectively, we split the cost of entering the markets and operating in the market. So, that too creates a superior inflow for path to profitability. And some people have recently pulled back on some of their markets. We look at and say there's extraordinary expansion opportunity. But again, we don't have to do it alone. And then that's, that can be more capital friendly. So, as we look to '23 and beyond, don't be surprised if you see us doing that more, and it's all accretive to the financial model. Quick follow-up, what are the triggers for a price increase? It would seem now you've got so much subscriber momentum, so much demand, tons of content hitting including TOP GUN, one of the biggest movies we've seen in a decade. What's stopping you guys from raising prices now or in the first quarter? I mean, is it more focused on churn? Or is it just the health of the consumer, that's holding you back? Yes, so I think two things on that. One is, under the umbrella, we're going to be intelligent about it, which you would of course expect. One is definitely time to content and looking at when you're, you feel best about the stickiness of your content, maybe you're in the middle of maybe something's just came out, maybe you're in the middle of a season, maybe it's in-demand Sportsnet, whatever it is. So, yes, we'll think about that. And the second thing is we've actually, we've done a bunch of work on this. And it turns out that the impact of price increases, you don't really see massive impacts when you raise price, because what you can do, you can manage through that with promotional pricing. And it's really the initial entry point pricing that dictates your net subscriber additions. So, you can raise price, maybe simultaneously absolutely prior to through that, and again, you look at where we are on a price relative to other folks, we feel very comfortable with our ability to unlock. That last thing I'd say is, there is benefit in the fact that we run a premium tier and an ad supported tier, and you will probably see us raise price at different points in time, so that we can catch any churn down et cetera should that to be the case raise price on premium first, and then follow-up on the ad supported side. Makes sense, let's talk about content spend, obviously for the last decade, we've seen content spend up into the right, it looks like a number of companies are sort of starting to reevaluate if not, if not the actual level, certainly the growth. I mean, maybe sort of, more generally, just what do you think of, are we -- is the industry spending too much on content versus what people are willing to pay for? And then it boils down to Paramount. How do you see your level of spend relative to your growth aspirations? Well, we're very much -- I'll do it in reverse order, we're very much executing on our plan. We spent about $2 billion on streaming content in 2021. We've got it to $6 billion in 2024. And we continue to be on that trajectory, that's part of a broader content investment, if you will, across our company, which is around $16 billion, $17 billion range today, and again goes to the value of I'm doing this on a multiplatform basis and being able to window and share some of it or dual illuminate some of that depends on what product you're looking at. And that funds frankly tremendously popular content, whether it's the NFL, whether it's Top Gun: Maverick, whether it's Tulsa King, whether it's FBI on CBS, really an extraordinary portfolio of content that not only the U.S. consumer, but the world's consumer likes to see. So, we love the performance of our content engine. And we're very comfortable with our investment plan, and we see it paying dividends and the performance of our platforms again, you don't get the number one CBS Broadcast Network for 40 years running by accident, you don't have the fastest growing fast platform by accident. You don't have what is certainly one of, if not the fastest growing sponsor by accident, comes to the content. That's point one. Yes, there's been some content, people call it cost inflation over the bunch of years. And we've certainly seen that, there is talk of, and in fact, evidence of moderation in that regard. Now, it's hard to really call the industry if you will, because we only run our company, but there's no question that, a very large competitor of ours has cut someone there. They're cutting a bunch of projects, and other both, and that's for my global basis, and another guy that's doing it both in the U.S. and internationally. And there's people talking about doing more. So, may be, again early evidence, it's the case and certainly if it happens, we will benefit from it. But we'll have to see what actually happens over the next say 12 months. Yes, you talked about the consolidation, economics of Showtime earlier in your remarks. Can you first of all, anything if you could tell us about that process, maybe a reference to the timing, or is there a lot of savings that you could create, or maybe just the justification of combining those plans, Showtime and Paramount+ together, if it makes sense? Yes, sure. So, I mean, on some levels, it's pretty simple. If you look at the journey of cable networks over the last six years, on since I run, what was Viacom and is now Paramount Global post-merger, we have progressively consolidated cable network operations. When I started as CEO at the end of 16, everyone had their own built out organizations. By that I mean Nickelodeon and Comedy Central and BT et cetera. Today, the story is very different on the basic cable side, we basically have, with the exception of BT all the basic cable networks aligned under one group, and we've done material called expense synergies as part of that. So, the Showtime piece is really the next leg in it, it doesn't make sense to run Showtime as 100% standalone organization, certainly the brand is valuable, certainly it stands for a certain type of program with consumers. And it's going to continue to and we'll lean into that, but we don't have to do it as a standalone, we're doing as part of an integrated strategy. And that's both true on the call traditional television side and on the streaming. And by the way, I would point out an early win here from the new team, which is George & Tammy, which is a show that we launched, I think was over the weekend on Showtime. And lo and behold is the highest rated premiere in Showtime history. And that's an example of Paramount coming together as one company and supporting a brand. We didn't develop that show for Showtime. We developed it for something else. But when you look at the actors in it, and you looked at sort of the storyline, et cetera, we said this totally works for Showtime and gave it an audience boost at launch by dual illuminate also on CMP first episode and Paramount Network. So, early days, but we're happy with what we're seeing there likewise, doesn't make sense to have a fully built out streaming infrastructure separate for Showtime and Paramount+. So, we're going to bring that together. And there are economic benefits associated with it. But I want to be clear, the brand still matters. And if anything, I can promise you the slates can matter even more. In fact, another thing we're going to do there is lean more into franchises. And you'll see, we haven't announced anything on that, but you will see that as we move into '23. So, it's hard, it's transformation, it does affect people, but it unquestionably will produce a superior financial result and strategic results. And we're really excited about what's going on. There are high overlaps between Paramount+ subs and Showtime subs number one, number two is that so does all this coming together in '23, that sort of plan but for combining all this? Certainly, there's more to come in '23 and you'll be hearing about that on your question of sub-base overlap, it's actually relatively minor, Showtime tends to be, I'm going to be very generalized but more coastal, more upscale. And Paramount+ tends to be more popular, more kind of the whole country, et cetera. So, we think that is accretive from an overall consumer proposition standpoint. And in fact, if you use Paramount+ today in the version with Showtime inside because, remember, Showtime was totally separate, then we introduced a price bundle. Now, there's an option where you can have Showtime inside the Paramount+ app, that's the version I use, that's the version I encourage all of you to use. And you really see the value of broadening that experience further. And Showtime being right product, being right there in the carousels, whether it's George & Tammy this weekend, or it's some films, or it's Billions, or what have you, it really works very well in the advert experience and we'll continue to look for ways to create value therein. So, the D2C industry is increasingly shifting from a dual revenue stream approach as from, originally, subscribe -- just subscription revenues now to add-supported. And actually, we have Netflix speaking a little bit later today. And then something you guys have been doing for a long time. Can you talk about the ad ARPU at Paramount+ today, and the underlying trends, and just how big could those numbers get? Yes, we'll start with, we believe in the ad business from day one. When we acquired Pluto, people were like, "What's this? Free streaming, ad-supported; that doesn't make any sense, it's all premium?" And the answer that I give is very simple, like, well, free television always existed. What makes you think it's not going to exist in streaming and not be a material segment? You're wrong. This is what we should do. And we did it. And lo and behold now, others are following us. We got the best asset, $1 billion-plus ad sales business in three years. But that was because believe in advertising. Then fast-forward to Paramount+, at launch, ad-supported tier; Why? Because we said, well, we want to maximize the TAM, we want to give consumers choice. There are, inevitably, some people who will be interested in paying less and watching ads, and there's inevitably some people who don't want to watch ads and will pay more. Why wouldn't we craft the product that way? Again, people were like, "Hey, that's not SVOD, what are you doing," et cetera. Fast-forward to today, everyone is in it; validating our proposition. So, again, we like the ad business. We think there is -- put aside the current market which has its challenges, but in general there's a great ARPU opportunity. There's a great growth opportunity as you add subscribers, potentially ad fill rate, and work on pricing. And what I'd point out in the streaming ad sector, we transact as [EyeQ] [Ph], not as Paramount+. And EyeQ is the combination, principally, of Paramount+ and Pluto. The "so what" of all that is, on a CPM basis, it is value proposition in the market. It's probably mid high-teen versus -- so, mom and dads are going out $50-$60, and that is very intentional on our part. We want to build a big business; we don't want to just clean the top. And it also gives us plenty of room to raise price over time, particularly as the market strengthens again. So, we really like advertising, we totally -- we believe, from day one, it applied to streaming. And I think we're seeing that play out. All right. You guys saw a pretty rapid slow-down in revenues at Pluto. And then, obviously, the -- it seems like that ad market has deteriorated 4Q for 3Q. I mean, how are trends in that business [thus far] [Ph]? So, Pluto, it's an extraordinary asset, leads the space, continues to have real momentum on the monthly active user side, growing those. And importantly -- maybe more importantly at this point, really growing engagement time spent is becoming part of -- or at least the Pluto viewers' part of their habitual consumption. So, we love what we're seeing there. Yes, we saw a significant deceleration in ad revenue, not surprising in the current market given the size of Pluto; it's the biggest of them. And given the fact that the digital and the programmatic market in particular was negatively impacted as people were looking to manage margins in the short-term, and we're looking at places they could do that. And on a short-term basis, the common wisdom is you can always do that in marketing. In the long-term basis, you can't, but for a couple months, couple of quarters you probably can. So, is Pluto impacted by that? Yes, for sure. I would point out that we, again, transact in multiple places in digital and we have a single point of sale particularly on the direct side. And -- but also on the programmatic side. We don't sell Pluto, we sell EyeQ. And that combination, if you look at that growth rate, that's improved 4% in the third quarter, our total DVC advertising. So, it's still growing, although clearly a deceleration from where it was, but that will -- that ship will right itself. Right. Is competition having any impact, whether it's on the [indiscernible] on the engagement side or the monetization side because you've seen a big investment from Tubi, Warner Bros. is talking about launching their own fast services. Do you -- as we look out in '23, that the -- that competitive aspects of the fast market changes? Well, look, competition has been a reality in the media business for a long time, it's a reality in the advertising market, it's a reality in the fast market; that's true. There also has always been benefits to having a scale first mover position. Not so easy to replicate what we do in the ad sales side, both the combination of platforms and the way we execute and the related capabilities we beat -- we've built. So, we feel good about that. And also, you got to look at pricing again, in particular in the fast segment, we like where we're priced, and we think that has some advantages. So, we -- we fully expected other people will enter, and they are entering, but -- so, look, we've competed for a long time, well, we believe in the superiority of our proposition, and we'll continue to demonstrate that. Okay. So, in the remaining time, I got some questions on the TV Media segment and then some more of consolidated questions. First, we already talked about the ad market. Could you give us your view of what you're seeing in terms of cord-cutting? Maybe now and if you can, with your crystal ball, sort of look out to '23? Look, the TV ecosystem is under pressure, had been -- plenty has been spoken about that; that's the bad news. The good news is very are very much a cornerstone supplier. I'd hate to be in this ecosystem without a broadcast network and carrying NFL, as an example. And we are no longer in just the business of licensing linear feeds to video bundle operators. We are now in the multifaceted product business with distributors, including for broadband-only. So, we license [technical difficulty] we provide on-demand product share, we're in the advanced ad business [technical difficulty] data effectively to our ad [technical difficulty] with our distributors. And we're in the streaming [technical difficulty]. So, the free streaming business, Pluto, and the paid streaming business, Paramount+. And we provide an opportunity for distributors to create value therein, including through if they're going to do it in the vMVPD space, like Charter is doing today, that's fine. If they want to do it in the broadband-only space, which most of our -- you could think of them as MVPDs, but they all operate broadband business, so we're transacting with them in there, and -- the mix of Pluto and Paramount+, and typically both. So, and then as we do that, we have deal structures in place which help mitigate some of the decline aspects. And by that I mean built-in price escalators, actually our broadcast deals with stations are all fixed fee so they're not per sub-deal, so you have some isolation there. And again, you have this broader business. And if you look at the value of that, sure, you could look at TV Media in an isolation, but I'd also encourage you to look at our affiliate and subscription business overall. And you'll see that grew something like -- it grew 80% in the third quarter. So, this multifaceted product line is in demand and is growing even given the current state of the TV ecosystem. Let's pivot to the film business; can you just give us a sense for the momentum you're seeing in the film business, and what the upcoming slate looks like? And then a little bit on the profitability of the business, one of the things that sort of surprised me yesterday was Jeff's show was talking about Universal and the profitability -- he said the film business has gotten more attractive because of COVID and the new windowing that we're seeing, and then in the different outlets of which show the content. I mean, do you agree with that, and talk about your -- just what you guys have on deck for us? Yes, I'd say a couple of things. I'd say, first, we're thrilled with the performance of Paramount Pictures. Again, you look at '22, the six number one films at the box office. And importantly, those number ones were all different kinds of films; you had everything from two horror films with -- that we low-budget, relatively speaking, with Scream as one fencepost, and Smile as the other. By the way, Smile, $17 million movie that grossed over $200 million by two-and-a-quarter at the box office, and is now on Paramount+ 45-day fast-follow. So, Paramount Pictures is crushing it. And we just -- as you look at the slate for '23, it looks very good. You got everything from Mission Impossible 7, which is like a complete thrill ride, I mean it is -- the movie is insane. And I think we'll clearly benefit from Top Gun and Tom's popularity, et cetera, but it's a really good movie. We just, over the weekend, dropped the trailer, on the internet, for the next Transformers movie, and it set the record by a reasonable amount for a Paramount Pictures trailer drop in history; and in case you're wondering, the one that was now number two was Top Gun: Maverick. So, just as an illustrator of what's coming, that one's exciting, and then we got another PAW Patrol movie, another Turtles movie for the younger for family set, we got a Dungeons & Dragons picture, which is not our franchise, we've doing in collaboration with Hasbro that we're excited about, and we've obviously seen a bunch of it; it looks good. So, the Paramount slate and its run is going to continue into '23; very excited by that. So, that's sort of point one. Point two is, and again partially related to Jeff Shell's comment; it is unquestionably a strategic asset. I mean -- and again, take a title like Smile, the ROI on that project is off the charts, because we believe in theatrical, we want to be there. We said that in the depth of COVID, we held titles; all that. And we've proven -- I mean, is the theatrical market below 2019? Yes, it is, but it's still a very big market. And we found that we -- that our titles are performing strongly. And we can get -- we can sort of cream the economics there, and then bring the title to streaming 45-day fast-follow. And that's where this asset is incredibly strategic, because if you don't own a studio you're not going to be able to do that. And certainly the product has ongoing value on a licensing basis, things like PayTo and library, et cetera, which we continue to participate on a co-exclusive non-exclusive basis; it's a good business. So, we very much like what's going at Paramount, we very much believe in the business, particularly the theatrical streaming hybrid, not the day-and-date thing, it never made sense to me. And we're really excited about what we're going to do in '23. And I'm sure you guys are all going to enjoy it. Great. And my last question just on M&A, I guess first part is what's the path forward for Simon & Schuster at this point? And then talk about just consolidation in the sort of traditional media space, do you think that takes a step forward as we look out into '23 or do you think further consolidation is going to going to be -- take longer? So, a couple things, so, consolidation has been the rule in business for a long time, certainly been in the rule in media. In fact, our company is a byproduct of consolidation, most recently ViacomCBS. So, it's hard for me to bet on anything other than consolidation will happen in the future. When it'll happen, what the combination is, who is in the top, who is getting acquired; who the hell knows? But consolidation will happen, and streaming will be part of that. On Simon & Schuster -- and, by the way, that's not a new view, that's what we've believed for a long time. On Simon & Schuster, look we are obviously disappointed in the court's decision. That said, we've collected our breakup fee, which we've disclosed of $200 million. And we haven't changed our point of view that it's not a core asset, because it's not a video asset. Our company is a video company. And when you get into books and video, there are not synergies. So, it continues to be non-core asset. We're going to do something in the marketplace with it as we move forward. To be discussed when and what that is exactly. But again, we were disappointed. And the only good news is the company's financial performance is materially higher than when we auctioned it because, obviously, the capital markets have gotten tougher, interest rates have gotten tougher, and you think, "Okay, the asset value gone down." But we've had such a material increase in financial performance, we feel pretty good about it. And again, layer on the fact that we collected a breakup fee, it'll all be fine eventually, but the suboptimal journey.
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EarningCall_1646
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Welcome, everybody. Michael [indiscernible] with Wells Fargo. If you donât know me, welcome. We are very pleased to have Magellan Midstream Partners here with us this morning to kick us off. We've got Aaron Milford, CEO sitting right next to me and other management in crowd who donât want to get up here. So, if there's any hard questions, I'm sure he'll be called upon. But this is a breakout session. So, it just meant for you all ask your questions. But if you don't, I will. So, fair warning. I think I'm going to turn it over to Aaron to start with a few opening remarks, and then we'll open it up to Q&A. Thank you, Michael, and we appreciate the opportunity to speak this morning. Thank you guys for being here early. It seems a little early and starting the day off, hopefully with a good session here. What I'd like to start with is really make the big three main points about Magellan before we get into the Q&A. And the three main points are mainly meant to be thematic. And the first point I would make is at Magellan, we deliver crude oil, gasoline, diesel, jet fuel, all the fuels, frankly, that are necessary to run our economy. And we think those fuels are essential to having a functioning and efficient economy. So, that's the first point. We're essential. Second point. We think we're going to be essential for a really long time. Even with the backdrop of energy transition, electric vehicles, batteries, alternative fuels of all varieties, we think that transition is going to continue. But as it continues, we're still going to be essential. We're still going to need crude oil, gasoline and jet fuel to run our economy. So, as that happens, we think that the demand for the fuels that we deliver are going to -- is going to remain really steady for a really long time. And as the energy transition moves forward, whatever that may look like, we're still going to be essential even out in 2050 because we're still going to be needing the fuels that we deliver. So, we're essential and the essential nature of what we do leads to a very steady demand profile we think, for a very long time. You put those two things together, essential and steady, it generates an opportunity for us as a company to provide and earn discretionary free cash flow. And as we earn that discretionary free cash flow through time, we have the opportunity to allocate that capital in a way that we believe creates value for our unitholders and investors. And if you think about that equation, we think that's a very powerful equation through time, essential, steady cash flow generating. So, we're very optimistic about what the next 30 to 40 years looks like. I know there's probably more pessimism about our business, but we're pretty optimistic, frankly. So, that's the theme. We're optimistic because we're essential, we think demand is going to be steady. And we're going to be generating what we think will be a substantial amount of free cash flow through time that we get to allocate back to investors to create value. It's really that simple. That's the equation. Thank you for that, and we're happy to take questions. So, one wants to be the -- first question. All right. I guess it's going to be me to start. Since you start high level, maybe I will as well, I think it was a year ago, maybe or your last Analyst Day, where you spent quite a bit of time going through the EV scenarios and potential penetration rates and impacts to potentially to gasoline demand long term in the US. Has your thinking changed at all since that -- since you put out that analysis? Have you seen anything in the market that would sort of push you one way or the other? I mean, I think since then, Russia invaded Ukraine, I mean some big geopolitical things have happened. On the other hand, it feels like every commercial I watch on TV for a car is in EV. So it feels like the industry -- auto industry is really pushing EVs pretty aggressively right now. So, to get kind of your latest thoughts on that. So the short answer to your question is, the perspective that we shared in April of this year at our Analyst Day that, energy transition will continue, but our opinion is that it will continue most likely at a much slower pace than what the average person may believe. It went into the reasons why we can do that here if there's interest. And our overall perspective on that hasn't changed. You're right. There is a lot of marketing, a lot of headlines, a lot of energy behind EVs and their promotion. You're seeing more of it, but I'm not sure that it's a markedly different perspective or sort of pushed than what we've seen the last few years. The question is really going to be, what is the actual adoption rate and what pace does that occur? It's interesting when you look at EV ownership and adoption, I think what you hear is EV sales have doubled. Sure. They've doubled the 4% of the cars that are sold today. And I don't mean that to be dismissive of EVs and folks that like them and want them. I don't mean that. But the penetration is still, we think, going to be very slow. And they're expensive. I think, I read an article the other day that the average EV buyer owns 2.7 cars. They're not using their EVs very much for the most part. You can see that data in California as well, where you have a much higher penetration of EVs. But when you look at the actual vehicle miles traveled with EVs, it's fairly insignificant overall. So, it's not that we're again dismissing EVs and what they can bring. We just think their impact on our business is going to be measured over a very, very long time. And adoption rates that are built into demand curves today that you see from third parties, we think are a little bit on the aggressive side. I think most of them range from a 60% to 80% adoption rate by 2050, so may have a little higher in 2030, but it's up in 2050. If you hit -- and those are really aggressive rates, 60% of the new cars, we say, even 20%, 30%, eight years from now, EVs, we think it's going to be very difficult. Part of the reason it's going to be difficult is the utility of the cars is not as high as a gasoline car today, frankly, or a diesel vehicle. But you can use them for what they allow you to do, there are limits to them. So there's a lot that has to happen from an infrastructure perspective to really bring the utility curve, the actual machine that you're buying up to what is available today at half the price. We'll see where it goes. But our view hasn't changed. It's going to be much slower, we think than many believe. And we're going to continue to be a pretty important part of the economy. I would be remiss if I didn't make one other comment. We also operate as a company primarily in the heartland. We like to refer to it as the heartland those from New York may differ with that opinion, but we call it the heartland, but it's in the Mid-Continent part of the United States. And if you look at our EV adoption rates to this point, they're about half of what they are on the coast. So when you think about where we operate and you overlay that to whether or not you agree with us or not on the longevity, where we're at is even going to be slower than what the average is in the United States. So I'll leave it at that. Short answer, no change in perspective. So maybe to bring it -- that's a very long-term question, maybe just to bring it a little bit closer to home next year, 2023. There's certainly some expectation that we could be in recession, mild recession, deeper recession, nobody really knows. I guess my question is, -- how -- I guess a couple of questions. One, when you're planning for next year as a management team, are you taking a view on what you think -- like what -- if we'll be in a recession, it will not, how bad it will be? And then can you talk about in prior recessions, how your refined product demand and volumes have sort of held up or not? Yeah. And to the first part of your question, are we taking a view of how deep or the likelihood of recession, the short answer is not really. We're evaluating the economic environment. It has an impact on our business overall. But I wouldn't say that we're just laser-focused on that question. So that really comes into our thinking more from a contextual perspective on what we think 2023 might look like, but it's not specific to a recession. And part of that is no one really knows. We can all guess, each recession is a little different in how it impacts the economy. But in terms of what has -- what does a recession look like to Magellan in the past and what it looked like in the past, if you go back to 2008, 2009, think about that a recession that occurred. Our gasoline volumes were down between 7% and 8% for a few months and then came right back. So for us, recessions can have an impact on volumes in sort of that maybe high single-digit sort of impact, but they tend to be very temporary. And the minute the economy starts coming back, we're one of the -- if you think about what we deliver, it's transportation fuels. The minute the economy starts recovering were one of the first to come right back because we support people's lifestyles and essentially their businesses. So it tends to be fairly short-lived. So it's one of those things that we'll be cognizant of. The impact in the grand scheme of things is usually quite modest, and it tends to come back very quickly. We're definitely seeing, as I think most people are wage inflation. We think we're managing that prudently. We're also seeing certain specialties, anything that's technology driven, and I don't mean just maybe the typical IT you think about, but I'm thinking about technicians, the folks that work on all the equipment that we have out in the field it takes a little longer to find them. We tend to have really good jobs is to pay really well that people like to have, frankly. So it takes us a little longer to find people, but we're usually typically able to find the folks that we need. So it's not a risk of can we run our business, it's really more of a function of how much more is it going to cost us. But when you look at our expenses overall, we came into the year thinking our expenses, so not just personnel, but expenses generally would increase maybe 2% year-over-year. I think that's going to turn out to be something in the mid single-digits or around there, 4% or 5%. So it's going to be higher than what we thought. But it's not going to be anywhere near the headline inflation that you're seeing elsewhere in the economy, and there's a lot of reasons for that. Part of it is we're really trying to be cognizant of how we manage. And we started in 2018, 2018 pre-pandemic, really looking at our business and how we run it efficiently. So those things that we started doing then are really paying off now in terms of being able to control overall expense increases. The personnel remain a challenge. Yes. I don't disagree with you. That's the reason in passing way I sort of try to mention each recession is a little different and how it impacts different areas can be different. Will this one looks like 2008, 2009? I don't know. But you're right. If it's a recession at sort of a headline number, but that's being driven by very specific sort of areas of the economy will be less impacted. For us, it's got to be a very broad almost industrial slowdown. So that's a good point, but each one is different. We gave -- I gave 2008, 2009, just as an example, as a reference, so you can think about what that felt like and what happened to us. Sure. So generally, volumes are steady. If you look at what we're expecting for this year, we came into 2022 with an expectation that when you looked at our base business and some of the expansion projects, we're getting some small expansion projects in markets that we already serve that our overall volume growth would be around 4% a year. And yes, I said volume growth would be over about 4% a year. I think we're tracking on a year-over-year basis. And I think we're in that neighborhood. So when you look at the year 2022 versus 2021, we expect to see overall volume growth. So we think the base business is still fairly steady. On the last earnings call, I did mention that we still do continue to see some weakness in some of our metropolitan areas. If you go back and look at 2019, pre-pandemic demand, we're still a little behind that demand in the metropolitan areas that we serve, not all of them, but some of them. And I think we're at the point now we're far enough pass the pandemic did in some of the cities that we serve, I think we're just seeing some behavioral changes that have happened. Now how that changes going forward. If people get back into the office to their lives, kind of, go back to what it looked like in 2019. It's possible, and there's an opportunity for us if that happens. But outside of the spotty areas, those very specific areas, demand has rebounded from the pre-pandemic, and we think it's going to be a very steady profile. And then as we do things like expand our pipeline to El Paso, expand our pipeline to Colorado, expand pipelines to Albuquerque. And if you think about our network, we just slowly add incremental capacity to new and underserved markets, we think there's the opportunity for us to a little bit of growth as well. And I'll just wait out. I think most -- probably everyone in this room knows that you have inflation protected contracts where you have the ability to raise your rates based on a formula tied to PPI. And that number is going to be pretty darn big to come up here. And -- but you also have said that you may bank some of that for future years may not pass that full increase to customers in one fell swoop in your tariffs. So I guess the question that on everyone's mind is where are you on that? And what is the evaluation process? And when will you tell us? So we give guidance for 2023 typically in February with our fourth quarter. So that's when I would expect we would have more detailed discussions around assumptions that we're making for 2023 and the guidance that we provided at that time. As we sit here today, we haven't made any decisions exactly what we're going to do. And there are a couple of reasons why we wanted to get the conversation started. We started the conversation in many ways, and we wanted to start the conversation. Because first of all, the indexing, set the stage here just a little bit. I know many of you are failure with Magellan. But on the refined product side, about 30% of our markets are deemed less competitive, and therefore, we have to follow this regulatory regime of indexing. There's an index that comes out. We all talk about it. So that's 30% of our markets that whatever the index is we have to move on. I'm going to come back to this, our ceiling rate by that amount. Then 70% of our markets are market space. They're deemed workably competitive. So we can do -- we have discretion with what we do with rates in those markets. There's really two different market dynamics with 70% of our markets paying more market base, we can do have more discretion with it. So the question that was asked is, what are you going to do with index rates. If you look at PPI, call it, 14% round numbers and do the math right now that would be the highest index rate increase, since this index was put in place in 1992. It's never been as high ever. There have been some high years, but not this high. We talked a moment ago about what we expect on the cost experience side this year, maybe being up 5%. So we're going to have the situation where we can move our index rates by 14% by nature of the regulation. Our costs are going up 5%. Now, let's say, you're one of our shippers. How do you think through that, right? So, we want to be cognizant of our shippers. How are shippers doing? Are they doing well? And if they are, and depending on what's happening with the competitive environment that's out there, we may take the full index in some markets. But there may be some markets we don't, frankly. And it's going to be a function of competition in those markets, because even in the indexed markets, I know some of you may think that we have a monopoly in these markets. We don't. There's at least one other competitor in every market we serve. And I would tell you, there's excess capacity in that market today. But we've differentiated our self with our network, how we â the service we provide, so people like using us. And we want to make sure that it continues. But we have to be cognizant of competitors in these markets and what they're doing. So, it will be what our competitor is doing, what can the market sort of tolerate. And then on the regulatory side, it's also important to keep in mind that shippers can protest, shippers can complain, that's always been the case. There's always been a couple of mechanisms for them to do that. And if they look at your earnings, so to speak, and they say the pipeline company is charging too much. They have the ability to protest â so you put all that together, highest index ever, shippers can protest competitive dynamics. We want to make sure that, we're operating thoughtfully over the long-term mindset. And so we're going to be thoughtful about whether or not and what markets we follow the index and where we don't in that 30% of the market, and 70% will have the discretion to do what we'd like. The takeaway should be â two things. One is, it's going to be a healthy tariff increase for our company and likely everyone in our industry. It's going to be healthy. It may not be the full index. But if it's not the full index, we'll have the ability to catch that up in pretty short order next year, year after that as we are able to see how the market evolves. So it's not like it's lost. The opportunity is not lost, but we're really thinking long term and trying to be thoughtful about, again, competitors, customers and sort of the regulatory regime that we operate in, and make sure that we're comfortable we're doing the right amount of move now as we can be. So it doesn't necessarily answer your question of what we're going to do. I understand â but at least hopefully, you can understand the thought process that we're going to use when we do tell you what we're going to do in likely February. Got it. Yeah. That's helpful. So this is like maybe just stay on refined products for one more question. Quarter-to-quarter, your long-haul versus short-haul shipments will vary. I think clearly, I think you make more money when you have longer haul shipments generally speaking. Can you just talk through kind of what drives that quarter-to-quarter? And specifically, you've had some refinery shutdowns over the last few years. Like what's changing in the industry that would push that one way or the other? So I think there's a couple of time horizons we have to think about. The first one is the quarter-to-quarter what I'm going to call the short-term time horizon. Because when we put our guidance and our plans out there, we have an expectation about what sort of the average move in our system is going to look like, much like you guys probably do, we model it out origin destination and that results in a rate that we earn. And that's what we build into our guidance. From quarter-to-quarter, we can do better than that guidance. And generally, what drives that will be market dynamics or disruptions. We've had fire Toledo. You think well, how has Toledo impact Magellan? Well, to the extent Chicago barrels need to start backfilling Toledo, they used to be sort of supplying Mid-Continent. It creates sort of a hole in the Mid-Continent, right? And we're there to backfill that hole, they usually from further away than Chicago. We've had some issues at Whiting. Weâve had just some short-term disruptions. We've had inventory tightness in the group, which encourages barrels to be valued higher in the group versus maybe the Gulf Coast from time to time when that happens, that tends to pull barrels from the Gulf Coast into the Mid-Continent. And as that happens, the average haul so to speak, elongates. And that's where you're seeing sort of the longer haul dynamic. And that's what can happen over the short-term. We don't know what disruptions are going to happen or not happen. But when they do happen, we tend to get longer â longer hauls out of it. As you think longer-term, with the expansions to El Paso that we're doing with the expansions to Denver that we're doing, even Albuquerque, as we build into our own guidance and our own financial models, the haul in our system should get longer, just as a base â as a base event. But you're still going to have the potential for disruptions to even exceed that at times. So that's the dynamic. The short-term nature is all about disruptions and markets trying to rebalance and we're in the middle of most of those markets, and it usually provides opportunities. Longer-term, as we tend to expand towards the extremities, particularly West on our system, the hauls will get longer. So that's in a nutshell. Okay. Perfect. Questions out there? So maybe let's -- let me talk a little bit about the Permian on the crude side. So yes, I guess, like high-level question I'd have is, I mean you're involved in the basin. I think there's no secret that there's a gas takeaway issue or at least it's tight, it's going to be tight for at least over the next, I don't know, 12 months plus. Do you see that impacting oil production ultimately being a constraint on oil production, or do you think the Permian is going to do what it's going to do. That's kind of like the first question. I think first of all, we don't take necessarily a house view on Permian oil production. We look at a lot of the external forecast. I mean you probably look at and apply our knowledge over the top of it and sensitize a little bit, but we're basically starting in the same place. You all are, which you would call for Permian oil production been 400,000 to 600,000 barrels a day on an exit rate basis year-over-year. So from the year-end 2021, year-end 2022, 400,000 to 600,000 barrels a day Permian growth, we think that's probably a reasonable expectation. Natural gas takeaway and the impacts on drilling can be significant. But it's hard to know if they're so significant that it's going to dramatically impact that trend over the horizon that we're thinking about, frankly. Maybe more of a shorter-term issue, but we've got contracts and people need to move oil. So in the short-term, there's probably less of an issue for us. But longer-term, I just don't know if that's going to â there's going to be too much of an incentive to solve the problem over sort of the intermediate to longer-term macro view that we would have. And I guess as you think about right now on the oil side, Permian takeaway, there's plenty of excess -- there's some excess capacity. It seems like there will be for some time. I think your Longhorn tariffs are in like the $1.50 to $2 per barrel range, roughly. As those -- I think on the last call, you said you had some contracts that were rolling over in that 2024 to 2026 timeframe when the market could be tightening up, I mean I guess no one really knows, but based on the current run rate of growth in the Permian, do you think it would start to get tighter by then. How do you think about what that will do from a tariff re-contracting perspective once you get out in time? Well, it's certainly -- we certainly feel better about having contracts that are going to be up for negotiation in that 2024 to 2028 timeframe depending on what pipe you're talking, not just Longhorn but Permian in general. We certainly like the idea of re-contracting them based on what we see then re-contracting right now. So, that we think that's positive for us. What that actually -- what that ultimately looks like, it's really going to be, frankly, very hard to predict. That's a long time in the crude business. But we do think the tightening is a real possibility and most expectations are that it will get tighter. What's going to be interesting is, as it gets tighter, are we going to see higher rates, or are we going to see folks expand pipes again? That's how we got into sort of this oversupply was really aggressive investments out of the Permian to build capacity to export it with the idea of being that we need to be able to capture the peak. The peak never occurred. So, we have a lot more capacity than we need. So, we're happy that that will be out in the time. It looks like it's going to be sort of green or faster than it is today, for sure. And we're certainly really happy that we've got between 70% and 80% of our capacity under contracts with good counterparties, depending on which pipe you want to look at for the next several years. So, we like that combination of things, for sure. But what does it mean for rate? It's hard to say. If you look at forward curves, they would all suggest rates are going to be better than they are now, but not back to what we originally were able to earn when we originally reversed Longhorn, they're not looking that robust, but they're certainly a lot better than they are today. Questions out there? All right. Maybe a question on capital allocation. So, I think you've kind of differentiated yourselves from your peers, I would say, in terms of maybe having more of a balanced approach between buybacks and distribution growth with more buybacks than most of your peers. It seems like, at the same time, many in the industry are now actually leaning more heavily towards distribution growth and even further away from buybacks than they have been over the last couple of years. I'm curious for your kind of A, feedback you've gotten from investors on what you've done in 2022? And do you -- is that -- are you going to stay the course in 2023, or do you -- is that something you're evaluating? Well, it's something we continually evaluate. The general feedback to our approach on share buybacks has been positive. Sure, we have a subset of investors that would like to see us grow the distribution a little more. frankly, we understand that. We have some investors that would hate us to grow the distribution a little more at the expense of buybacks, we understand that, too. So for us, it's not really making a decision. Do we want to be more distribution heavy or buyback heavy? It's really a function of where -- what is the most valuable or the best way to return capital when we have the opportunity to do so. It's just so happened that, in our opinion, the last, really, almost two years, 18 months, it's made a lot of sense for us to buy our units back and that's the reason we've been doing it at such a clip. Well, at the same time, at least growing our distribution a little bit. We can debate whether or not 1% is meaningful or not, we think that stable and slightly growing distribution is a good thing to have in all environments. So we're trying to -- we're doing both a little bit, but it's certainly the emphasis on buybacks. We've also tried to be really clear that, when we're thinking about, how we're going to allocate capital, the first step for us is, what is the opportunity set to invest capital in projects to generate really good returns. If we have those, that's what we want to go do. The reality has been of late, we haven't had near the opportunities that we've had, say, over the previous decade. So the opportunity set is just smaller. So, okay. So now, we have a smaller opportunity set. How do we want to return capital between distribution -- distributions, capital or stock buybacks, unit buybacks? And we're going to evaluate which of those we do based on the fundamentals to receive value and buying units back. If we do, that's probably where we're going to stay focused. And it's very much what's happening at the time and what do we think the most valuable thing for us to do over the long term is for our unitholders, and that's what we're going to do. So we don't have a -- we want to weight the distribution more than the buyback. We're not trying to make that sort of a policy decision. It really is much more, what is the most efficient, most effective way to return capital to unitholders, if we don't have opportunities and that can change. It can ebb and flow. So, if it ever changes, it's just making different decisions because we think the time is called for it. But the idea is, invest in really good projects. We can't do that most efficient way, most valuable way to return capital to unholders. That's the equation. I didn't even ask you about the balance sheet because it's so clean that there's no questions to ask. I think, we've hit the end of our session. So thank you very much, and we appreciate it.
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EarningCall_1647
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Hello and welcome to the Streamline Health Third Quarter 2022 Earnings Conference Call and Webcast. [Operator Instructions] As a reminder, this conference is being recorded. Itâs now my pleasure to turn the call over to Jacob Goldberger. Please go ahead, sir. Thank you for joining us for the corporate update and financial results review of Streamline Health Solutions for the third quarter 2022, which ended October 31, 2022. As the conference call operator indicated, my name is Jacob Goldberger. Joining me on the call today are Tee Green, Chief Executive Officer and Chairman of the Board; Ben Stilwill, President; and Tom Gibson, Chief Financial Officer. At the conclusion of todayâs prepared remarks, we will open the call for a question-and-answer session. If anyone participating on todayâs call does not have a full text copy of our press release announcing these results, you can retrieve it from the companyâs website at www.streamlinehealth.net or from numerous financial websites. Before we begin with prepared remarks, we want to be sure we are clear for everyone on the record how certain information, which maybe provided today, as with all of our earnings calls, should be viewed. We therefore submit for the record the following statements. Statements made on this conference call that are not historical facts are considered to be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These are subject to risks, uncertainties, assumptions and other factors that could cause actual results to differ materially from those we may discuss. Please refer to the companyâs press releases and filings made with the U.S. Securities and Exchange Commission, including our most recent Form 10-K annual report, which is on file with the SEC for more information about these risks, uncertainties and assumptions and other factors. As always, we are presenting managementâs current analysis of these items as of today. Participants on this call should take into account these risks when evaluating the topics we will discuss. Please note Streamline Health is not undertaking any commitment or obligation to publicly revise any such forward-looking statements made today. On todayâs call, we will discuss non-GAAP financial measures such as adjusted EBITDA, booked SaaS ACV, and unaudited figures related to our acquisition of Avelead. Management uses these measures to help provide better insight into our financial performance. However, certain items of income and expense are not included in these measures. So these calculations may differ from those which another entity may utilize in calculating their own non-GAAP measures. To help you compare these results on consistent terms, please refer to our website at www.streamlinehealth.net and our earnings release for a reconciliation of such non-GAAP measures to the most comparable GAAP measures. Thank you, Jacob and thank you all for joining us this morning. Following my opening remarks, Ben Stilwill, President will provide an operations and sales update, followed by a financial update from our CFO, Tom Gibson. As a reminder on August 16, 2021, we acquired Avelead and their financial performance will be included in our GAAP results from that date. With that, I will get started. Beginning with the financial overview as of October 31, 2022, bookings for the 9 months ended October 31, 2022 totaled $15.9 million, $14.1 million of which was attributable to our SaaS products. As a reminder, we estimated we would average $3 million to $5 million of TCV per quarter in fiscal 2022. Our continued booking success is a credit to the strong direct sales channel we built and the value our products provide our clients. Macro headwinds associated with our hospital clients, staffing and backlog of IT projects continue to hinder conversion of our new bookings to revenue. However, we successfully grew total revenue 13% to $6.2 million during the third quarter and our SaaS revenues were up 14% or $0.4 million. Last quarter, we began reporting a new metric, booked SaaS ACV, which is the annualized contract value for all agreements that are being recognized into revenue as well as bookings that have not been implemented. As of October 31, booked SaaS ACV was $14.9 million as compared to $10.3 million as of January 31, 2022. Subsequent to the end of the quarter, we successfully closed two large deals. And as of November 30, 2022, our total booked SaaS ACV was $15.9 million. We remain confident in our achievement of $17 million of booked SaaS ACV by the end of fiscal 2022. As of October 31, 2022, we had $11.7 million of cash on our balance sheet. As previously announced on October 25, we closed a registered direct offering that resulted in gross proceeds of approximately $8.3 million. Notably, more than 30% of the offering was raised from insiders, including each member of the companyâs Board of Directors and key members of the companyâs management team. We have begun to make the initial principal payments on our term loan. As of October 31, the balance of our term loan was $9.8 million. We believe our cash on hand is sufficient to achieve positive adjusted EBITDA less capitalized software development. Finally, on November 29, 2022, we expanded our relationship with Bridge Bank to allow access to an additional liquidity through a $2 million non-formula line of credit. Late in the quarter, we announced a strategic alignment of our business to enhance growth and profitability. By combining the Avelead and eValuator operations, we expect to accelerate our progress within our innovation and service functions while increasing the effectiveness of our sales force as the eValuator and Avelead software solutions share a common call point. In addition, with the operational benefits from the alignment, we expect to realize a total $3 million of annualized cost savings, $1.5 million of which was executed on November 1 and the balance of which we expect to execute through the course of the next fiscal year. The cost savings was attributable to the elimination of redundant management positions, voluntary reduction of executive salaries and certain other contractors. We remain confident in our growth prospects going forward. The macro environment for our hospital clients result in a higher demand for our products and services. Our team is dedicated to delivering improved net revenue to our hospital clients through automated pre-built solutions like RevID and eValuator, which enable them to capture and bill accurately for all the care they have provided. This has never been more critical to our industry than it is today and we believe our bookings will continue to accelerate as a result. In conjunction with the alignment, Jawad Shaikh was appointed Chief Strategy Officer and Ben Stil was promoted to President of our organization. Jawad has made a seamless transition to focus on thought leadership and strategy, while maintaining his successful relationships with our channel partners and large hospital systems. Prior to his promotion to President, Ben was CEO of the eValuator business. Ben developed a world class client success organization, which has become a primary differentiator for us in the market. I am thrilled to have him lead the operations of our combined organization going forward. Ben? Thank you, Tee. I am very excited to lead our team into this next chapter of the Streamline story. And I appreciate the opportunity to speak with you all this morning. Building on Teeâs comments on the macro environment, our individual client conversations lately have been focused on their increasing denials and the need for automation within the revenue cycle. Just last month, one of our clients expressed the need for automated solutions like RevID and eValuator to reduce revenue leakage so that they can afford to invest in their patient care priorities, including expanding outpatient services in their community. Within innovation, our primary focus remains on improvements to the back-end architecture of our Avelead suite. By making these investments today, we can ensure that the Avelead tools are ready for significant growth led by our deployment of these tools within large organizations. We will implement value-driving client features into Avelead tools similar to the dashboards and reporting tools of eValuator that our clients have come to expect. Additionally, we are making improvements to the Avelead architecture that will reduce the effort associated with our implementations and improve the user experience. We continue to make incremental improvements to the eValuator system as well, expanding our rule set and overall making the solution more effective over time. As Tee mentioned, the client-centric service organization we developed within eValuator has been a true differentiator for us, driving additional value for our clients and ensuring their success on our platform. We are maintaining our cadence of monthly education and quarterly executive client meetings to establish the value of the tools we are providing. In light of industry-wide administrative staffing shortages, we have also expanded our consultative services, whereby we staff our solutions for our clients. This is an extension of the new eValuator concierge we mentioned last quarter, an auditor who starts off directly integrated within the clientâs team, allowing us to rapidly learn about and react to potential pain points as well as position us with the insights we need to speed adoption and maximize client resources. As we have discussed previously, administrative staff within hospitals remain underinvested and understaffed at this time, especially within their IT departments. This has delayed implementation timing for our solutions. As a result, our implementation teams are working hard to ensure that we are never the bottleneck. Within eValuator, we have been very successful and I am confident that as a result of our investment into the Avelead products, we will be able to say the same about RevID and compare it in the near-term. Our combined growth team, led by Chief Growth Officer, Amy Sebero, has accelerated through the realignment. And we were thrilled to report TCV SaaS bookings in excess of $14.1 million as of October 31 in line with our expected average of $3 million to $5 million of TCV SaaS bookings per quarter. We are maintaining the organizationâs overall structure with four regions for direct sales and augmented by select channel partnerships. Under Amyâs leadership, we have expanded infrastructure beyond individual Regional Vice Presidents to include dedicated business development resources, a talented sales enablement team and a more intentional approach towards marketing. If you go to our website and LinkedIn page today, you will notice that we have a new look and feel, not only as it pertains to logos, but the presence of thought leadership via podcast and other content. As of today, our RVP positions are fully staffed. As Tee mentioned, we remain confident in our achievement of $17 million of booked SaaS ACV by the end of fiscal 2022 and expect to exit fiscal 2023 with $30 million of booked SaaS ACV. Before I turn the call over to Tom, I would like to thank all of our hardworking team members who are supporting our mission to ensure our healthcare providers are paid for all the care they provide. I am very excited to lead our talented team and believe strongly that our innovation plus service equals growth formula will yield tremendous results for all of us as we continue to execute and expand. Thank you, Ben. Congratulations on your recent appointment, it is indeed well deserved. As Tee mentioned in his opening remarks, we acquired Avelead on August 16, 2021. All operations of Avelead are included in our reported GAAP numbers from that date. We also provide pro forma numbers that assume we owned Avelead from the beginning of the prior period. We solidified our balance sheet during the third quarter with an $8.3 million registered direct capital raise. More than 30% of the raise was funded by insiders. And we completed this offering without an underwriter. I want to thank all the investors that participated in this most recent round. Subsequent to the third quarter, the company expanded its bank relationship to include a new $2 million non-formula revolving credit facility. Between the capital raise and the extended bank relationship, we believe we have a clear path until the company generates cash from operations, a metric that we define as adjusted EBITDA less capitalized software development costs. Total GAAP revenues for the third quarter of fiscal 2022 were $6.2 million, a 13% increase over the comparable period of last year. For the 9 months ended October 31, 2022, total GAAP revenue increased 60% to $18.1 million. $5.8 million of the revenue growth was attributable to the acquisition of Avelead. During the third quarter of fiscal 2022, SaaS revenue grew $0.4 million or 14% compared to the third quarter of fiscal 2021. During the 9 months ended October 31, 2022, total SaaS revenues increased $3.8 million or 72% compared to the first 9 months of fiscal 2021. $3.6 million of the growth in SaaS revenue was attributable to the acquisition of Avelead. Total revenues for the third quarter of fiscal 2022 and year-to-date were $6.2 million and $18.1 million compared with pro forma revenues of $6.1 million and $16.6 million respectively for the year ago periods. We have been impacted by headwinds that face our hospital clients, hospitals are overcoming personnel shortages and significant IT backlog of projects, a hangover effect from COVID. These headwinds impact our contract implementation timeline also known as first recognized revenue. We do not know how long these delays will impact our clients and accordingly, our recognized revenue. We have $4.5 million of annualized contract value that is unimplemented as of November 30, 2022. As these contracts are implemented in the coming quarters, our investors will see double-digit growth on a sequential and year-over-year basis. We are expecting to see revenue growth in the fourth quarter of 2022, which will accelerate in fiscal 2023. Third quarter 2022 operating expenses totaled $9.4 million compared to $9.3 million for the prior year period. The company increased its spend and innovation during the quarter by approximately $400,000 and experienced higher severance, bonus and travel and entertainment expenses than that of the previous year. The third quarter of fiscal 2021 included $1.9 million of acquisition-related costs. For the 9 months ended October 31, 2022, total operating expenses were $27.1 million as compared to $20 million during the prior year period. $9.7 million of the expenses for fiscal 2022 were attributable to the acquisition of Avelead. We have higher cost in fiscal 2022 from higher headcount, severance, bonus and travel and entertainment as compared to fiscal 2021. Some of this higher cost will be normalized by the previously announced alignment. Net loss for the third quarter of fiscal 2022 was $3.1 million as compared to a net loss of $4.3 million during the third quarter of fiscal 2021. Net loss in the third quarter of fiscal 2021 included $0.6 million of interest expense and expenses related to the valuation adjustment on the acquisition liabilities associated with Avelead. Net loss for the 9 months of fiscal 2022 was $9.2 million as compared to a net loss of $6.9 million during the first 9 months of fiscal 2021. In fiscal 2021, we had the benefit of the PPP loan forgiveness in the amount of $2.3 million offsetting the loss from operations. Adjusted EBITDA for the third quarter of fiscal 2022 was a loss of $1.2 million compared to an adjusted EBITDA loss of $0.3 million in the third quarter of fiscal 2021. Adjusted EBITDA for the 9 months ended October 31, 2022 was a loss of $3.6 million compared to an adjusted EBITDA loss of $1.7 million for the 9 months ended October 31, 2021. The higher EBITDA loss can be explained by investments in the architecture of the Avelead technology, higher headcount salaries for our upgraded sales function, administrative costs such as performance bonus and travel and entertainment in fiscal 2022 as compared with fiscal 2021. Certain of these costs have been curtailed with the previously announced alignment. We have targeted bonuses for certain company staff for the successful combination of Avelead and eValuator business units and to achieve certain fiscal 2022 performance targets. Moving to the balance sheet, as of October 31, 2022, we had $11.7 million of cash on hand compared to $9.9 million at January 31, 2022. The company completed a registered direct offering during the quarter, which resulted in gross proceeds of approximately $8.3 million. The company completed the acquisition of Avelead using approximately $12.5 million of cash and $6.5 million of restricted stock at closing. Under the acquisition agreement, the company will provide additional consideration on each of the first two 12-month anniversaries of the closing date. These are paid to the sellers in cash and stock and are valued on the balance sheet at approximately $8.6 million. These liabilities are referred to as acquisition earn-out liabilities and are an estimated present value of the future amounts that will be paid in cash and restricted common stock. The first payment was made on November 22, 2022, subsequent to the end of the quarter and totaled approximately $5 million in total value. The first payment consisted of $2 million in cash and $3 million in restricted common stock. Subsequent to the closing of the Avelead acquisition, we entered into a 5-year $10 million term loan with Bridge Bank. There was no repayment of the term loan required in the first year following the close. $500,000 is required in the second year following the close, which equates to $41,667 monthly, which began this quarter in the balance of our term loan as of October 31, 2022, was $9.8 million. As Tee mentioned, we recently expanded our relationship with Bridge Bank to include a $2 million non-formula line of credit, which we can draw on if necessary. We believe that our cash on hand is sufficient to achieve a positive adjusted EBITDA less capitalized software development. But we are pleased to have access to this additional liquidity. As Tee mentioned, we have introduced a new metric that provides an annualized contract value for agreements that are being recognized into revenue as well as an annualized contract value for agreements that have not been implemented. We refer to this figure as our booked SaaS ACV, where ACV stands for annual contract value. We believe booked SaaS ACV will provide a proxy for our annual recognized revenue as if all executed contracts are live and recognizing revenue. Please note that the recognition of revenue from our signed contracts are subject to the timing of implementations. Implementations may sometimes be delayed by clients due to competing projects or be timed after a larger implementation of another system. Generally, we have recognized revenue from evaluated projects in 90 to 120 days from contract signing, while Avelead products due to the complexity of the implementation may be 100 to 150 days. Our booked SaaS ACV as of November 30, 2022, is $15.9 million and $4.5 million of that booked SaaS ACV has not been implemented. We remain focused on continuing growth of SaaS revenue. On its current cost structure, we believe our overall business will achieve breakeven at a booked SaaS ACV of $17 million. We are confident that we will reach this level of bookings in Q4 of 2022 and have this revenue fully implemented by Q3 or Q4 2023. The company is realizing incremental gross margins above 80%. Since I have joined the company in September 2018, we have not experienced our current level of growth nor the near-term visibility to cash generation. I am proud of the progress weâve made to date and want to commend our staff on our recent success. Thank you, Tom. We continue to enable healthcare providers to proactively address revenue leakage and improve financial performance and have taken major steps forward to drive recurring revenue streams that better position our company for growth and to deliver significant shareholder value over the long-term. The alignment has enabled us near-term visibility to cash flow without losing momentum in growth or innovation. Before we begin our Q&A session, Iâd like to thank the entire Streamline team once again for all their hard work and dedication. Their contributions are essential for us to support our healthcare providing clients and ensure they have the necessary tools to free up time and resources to provide quality care for the communities they served. Thank you all for your support of Streamline Health and our vision. Thank you. [Operator Instructions] Our first question is coming from Brooks OâNeil from Lake Street Capital. Your line is now live. Thank you very much. Good morning everyone. I appreciate all the commentary, but I have to confess, I am a little confused about a couple of items. So I just want to ask a couple of questions. The first one really relates to a comment, Tom, made here at the end of his prepared remarks. I think he said you could get to or you could achieve breakeven at $17 million of booked SaaS revenue. But I think he also said that $4.5 million of that booked SaaS revenue would not be implemented. And hence, I guess, my sense that perhaps you wonât be generating revenue related to that $4.5 million. So could you help me understand exactly whatâs going on there? And how I should be thinking about that? Good. Good. Thank you for your question. So today, we stand at $15.9 million of total booked SaaS ACV with $4.5 million of that unimplemented. Once we reach $17 million of recurring revenue, which that means yes, all will have to be implemented. We will be at breakeven for the business. And I think you also heard in my remarks, I think we will be fully implemented on that $17 million of booked SaaS ACV by Q2 or Q3 of 2023. Okay. Thatâs great. Thatâs really helpful. And then so maybe a little bit broader question. When you guys evaluate the environment right now, would you say generating contracts is your biggest challenge? Or is getting these contracts implemented a bigger challenge today than the demand environment you see in the marketplace? Yes, Brooks, Tee Green. Thanks for the question. And the environment is certainly changing from a year ago trying to get the attention of the finance department, CFOs, the backlog of contracts and just things they had to get off their plate coming out of COVID. And now youâre seeing the CFOâs office entertaining contracts ROI analysis, more and more questions about how they can use the technology to improve operations. And then you get contract red line back and forth, and weâve actually got contracts signed. And then the IT departments backed up. So that is from the service side of our business, we are trying to evaluate how do we create whether you look at it as incentives or additional services that we can help our health systems get through their IT backlog. So that is something weâre seeing across the country. I donât know what magnitude it is, but when you talk about $4.5 million of backlog, that backlog related to IT resources in the health system. So those will be things that will have to flush through the system like everything else has had to done they are way understaffed. So weâre certainly looking at other ideas and other partners that can help facilitate smoother quicker implementations. Obviously, every day, our clients donât implement our technology is real dollars, they are losing. And the CFOâs office knows that, is getting the CEOâs office to prioritize that. Sure. And let me just ask a little follow-on is my sense is historically, you guys have done a fantastic job implementing eValuator, but perhaps it takes a little longer and itâs a little more complicated to implement a RevID. Do I have that right? And do you think you can narrow the gap between those two over time? Yes, you have it accurate, but there is reasons for that. And if you go back several years ago, we couldnât implement eValuator very well. So we had to rebuild that innovation platform, and that enabled our service platform, led by Ben and his team to build the processes that weâre efficient and delivered the ROI and evaluated to our clients. And thatâs why youâre seeing growth in that side if youâre seeing the service on the implementation side, so smooth and efficient. It starts with having a rock-solid innovation platform. So we knew coming in to Avelead, we had to do some architectural improvements on RevID to get it to the same enterprise eValuator is. And so weâre still in that process. So each sprint, each quarter, it gets better and better. But I would expect mid-2023, we should have the RevID platform in the same shape we have the valuated platform. Great. Thatâs perfect. Let me ask two more, hopefully quick ones. One is, my sense is Cerner and Epic are two of the big electronic medical records vendors out there. Can you talk about where you stand with those two? And anybody else you consider significant would be interesting to hear a little bit about it as well? And then secondly, can you just talk a little bit about whether you feel today you have what we might describe as a complete solution combining your two flagship products? Are there obvious things that you think could be added to your platform that would make your solution more complete and more high-demand system for healthcare? Sure. And you are correct Cerner and Epic are the grill is in the industry. Thatâs for sure. Fortunately, we have a really strong tight partnership with Cerner coming from the Avelead, RevID side. Weâre working on getting the eValuator in the Cerner toolbox, which will be really exciting for us. Epic, thatâs a different animal where they have the Epic integration App Orchard. there is a new term now for their integration platform. I donât remember what it is. But â so yes, weâre continuing to work with â and we want to work with all the Epic customers. But does Epic actually endorse and resell products from third parties like us? No, but Cerner does. So thatâs very positive on the Cerner side. The Epic path what weâve learned over many, many years working in this world is you have to have Epic customers that use your platform and are seeing great results, which they are and will, and that enables you to get more Epic clients. And thatâs the way that the Epic model works by referrals is you have to have solid Epic customers that enable you to talk to more Epic customers. And then the complete solution, your second question, the â we have components of the revenue cycle. It is a very, very large industry. Our focus, Brooks, is on pre-build. So we are not trying to [indiscernible] on the entire 360 revenue cycle. So it is a niche, it is a very valuable niche that weâre trying to penetrate. Now having said that, are we looking for future opportunities like Avelead? Absolutely, we canât wait to continue to uncover that. Good morning and thank you for all the details, the quarter end â for taking the questions. Maybe first up, regarding the â I guess, there is two different pieces, obviously, that are impacting or creating a little bit of a headwind. One, youâve got the hospital spending environment; and number two, youâve got the implementation side. It sounds like the bigger headwind from those two right now is coming from the IT side. But could you provide a little bit of an update on hospital spending? It seems like the CFOs are on board. They want to get the product in or the products in plural. What do you think itâs going to take to kind of maybe just take that next step from a contract signing standpoint? Or have you kind of reached that point now where youâre signing the contracts as you get them presented, now itâs more a function of that IT side? Yes, Matt, Tee here. Thanks for the question. The hospital spend has certainly changed or pivoted more to what we do. And what I mean by that at the macro level is hospitals coming out of COVID are woefully understaffed, especially in the administrative side of the business we consider the revenue cycle side. And so they have to look at technology thatâs going to make them more efficient and use vastly fewer resources, meaning human capital because they are just not there. Billers, auditors, coders, they all â many just left, and they are not coming back. And so where CFOs may want to do some advanced clinical purchases. Right now, they have to shorten the revenue. In the way to short the revenue is they have to do things right in the beginning, so they donât create work downstream on staff that they donât have anymore, which here come to Streamline with pre built technology like eValuator and RevID. So we think weâre in the suites and I forgot the most important part is we deliver a tremendous return on investment immediately, almost within a few months of implementation, there is real value. So I think when you look at â even take our name out of it, if you just look at what the finance departments are looking at implementing, you have to â does it enable us to run our hospital with fewer people? Yes. Does it deliver a tremendous return on investment immediately? Yes. Is it quickly implementable if we have IT resources? Thatâs the second part of the question, right? Yes. So when you look at stream, we check all those boxes. And so I think thatâs pretty encouraging for bookings. Now you get to your other side of the question, the CIO side of the business, they donât have resources either, unfortunately. A lot of people left and went and did side consulting jobs and started working with the smaller IT companies. So we do have some work to do in the CIO world, meaning how do we â we know we provide tremendous value from a CFOâs perspective. How do we prove we provide tremendous value to the CIO? So what are some of the things that we could do? One, how quickly our platforms can be implemented? How secure they are? How interoperable they are with Cerner and Epic? How much we can do in their environment without their resources? So those are some of the things weâre working on. Thatâs really helpful. Thank you. Maybe a question for Tom, you are mentioning the $5.9 million ACV as of 11/30 and implied that basically itâs $4.5 million thatâs not implemented yet. How many customers make up that $4.5 million? Is it just a couple that have several facilities or is it multiple? And I guess it just kind of might speak to how quickly you can kind of get those turned on once the resources are available? Yes, there is two Avelead products, RevID and Compare customers, and then there is five eValuator customers. With the eValuator customers, no matter how many facilities they are, they usually only have one HL7 feed, maybe two, that we have to connect to in order to get them live. So if itâs a six facility hospital system or a two-facility hospital system, that is not â that doesnât add a lot of complexity to the implementation. Does that help? Yes, very much so. Thank you. And then I guess the last one for me. As we look out to FY â23 and your commentary that youâll be able to get that $4.5 million of current backlog, if you will, implemented, whether itâs Q2, Q3. I mean that implies that youâre exiting next year, somewhere in that $5 million per quarter in SaaS revenues. Is that kind of the way we should be thinking about things? Yes. Matt, Iâm sorry, I had to get off mute. Yes. Thatâs the way to think about that in kind of the middle of the year. Thank you. We reached the end of our question-and-answer session. Iâd like to turn the floor back over for any further or closing comments. Thank you all again for your interest in support of Streamline Health. If you have any additional questions or need more information, please contact me at Jacob.goldberger@streamlinehealth.net. We look forward to speaking with you all again when we discuss our fourth quarter and fiscal year 2022 financial performance. Good day. Thank you. That does conclude todayâs teleconference and webcast. You may disconnect your lines at this time, and have a wonderful day. We thank you for your participation today.
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EarningCall_1648
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Good afternoon. Thank you for attending the SGH First Quarter Fiscal 2023 Earnings Call. My name is Matt, and Iâll be your moderator for todayâs call. All lines will be muted during the presentation portion of the call, with an opportunity for questions-and-answers at the end. [Operator Instructions] Thank you, operator. Good afternoon, and thank you for joining us on todayâs earnings conference call and webcast to discuss SGHâs first quarter fiscal 2023 results. On the call today are Mark Adams, Chief Executive Officer; Jack Pacheco, Chief Operating Officer; and Ken Rizvi, Chief Financial Officer. You can find the accompanying slide presentation and press release for this call on the Investor Relations section of our website. We encourage you to go to the site throughout the quarter for the most current information on the Company. I would also like to remind everybody to read the use of forward-looking statements note that is included in the press release and the earnings call presentation. Please note that certain of the statements made today may constitute forward-looking statements and that these statements are the Companyâs present expectations and that actual events or results may differ materially. We will also discuss both, GAAP and non-GAAP financial measures. Non-GAAP measures should not be considered in isolation from, as a substitute for or superior to our GAAP results. We encourage you to consider all measures when analyzing our performance. A reconciliation of the GAAP to non-GAAP measures is included in todayâs press release. Over the past two-plus years, we have been on a journey to transform SGH from a memory module company into a more diversified set of specialty businesses, spanning compute, LED lighting and memory. While each line of business is unique, SGH benefits from what they all have in common. First, they all developed advanced technology solutions at the system or subsystem level in order to address specific customer requirements. And second, they are all built on SGHâs core competencies in engineering, design and world-class manufacturing. SGHâs diversified business model has driven higher quality revenue with more attractive gross margins. Our diversity has helped us perform steadily in a challenging macroeconomic environment. For example, in our Q1 earnings, our enterprise-related businesses were able to offset declines in our more consumer-facing businesses. In the first quarter of our fiscal 2023, revenues totaled $465 million, which exceeded the midpoint of our guidance range. We also achieved record non-GAAP gross margins of 27.8% and non-GAAP earnings per share of $0.79, both of which came in above the high end of our guidance range. I also want to highlight that with the integration of Stratus Technologies into Intelligent Platform Solutions, or IPS, the services portion of our Q1 business now represents approximately 16% of overall SGH revenues and 32% of IPS revenues, a record achievement and a clear demonstration of the increasing value we are providing our customers. Now, let me turn to a brief review of each of our businesses, starting with IPS. Our IPS group designs and delivers complete hardware, software and services for high-performance computing or HPC and artificial intelligence or AI applications from the data center to the cloud and at the edge. In Q1, IPS brands Penguin Computing and Stratus Technologies performed well. And IPS revenue came in at a record $211 million for the first quarter, up 46% sequentially and up 78% compared to our Q1 fiscal â22. IPS represented 45% of total SGH revenue, the largest component of our business in Q1. As weâve indicated on previous calls, we see the IPS business stronger in the first half of fiscal 2023, driven by large customer hardware installations. In particular, heading into our second fiscal quarter ending in February, we are seeing strong continued demand, driven primarily by installations at some of our hyperscale and federal customers. As you have been hearing from other technology companies of late though, overall visibility for demand out into calendar 2023 remains uncertain. In November, Penguin Solutions participated in the Supercompute 2022 show, the Annual International Supercomputing Conference, where we demonstrated our strength in HPC and AI-enabled solutions. We made several key announcements, including the launch of Penguinâs new Scyld Cloud Central control plane, which provides management and orchestration across an organizationâs on-premise and cloud-based resources to create flexible hybrid HPC and AI environments; a partnership with Google Cloud that gives our customers more choices for rapid cluster deployments with Penguin services; a pay-as-you-go model; and point-and-click integration with dozens of common HPC and AI applications, tools and libraries; and the acquisition of Colorado Code Craft, a small private company specializing in safeguarded remote work and collaboration software solutions. The addition of Colorado Code Craft solutions is expected to enhance Penguinâs virtual desktop infrastructure or VDI capabilities and expand our IP portfolio. The integration of Stratus Technologies into IPS remains on track. With the addition of Stratus, IPS has a comprehensive portfolio of edge HPC AI and cloud solutions and services to meet the end-to-end needs of an even broader customer base. Penguin and Stratus are now actively working together to identify new business opportunities and revenue synergies. In addition, one of our top priorities is to increase our recurring services businesses as a larger component of the solutions we offer our customers. Now, turning to our LED Solutions Group, which produces application-optimized LEDs for products like specialty lighting, video screens, gaming displays, outdoor and architectural lighting. Cree LED faced continued headwinds in China with COVID-related policies contributing to supply chain constraints and impacting demand for the entire industry. In addition to continuing softening in China, we are also seeing demand weakness in the U.S. and in Europe. For the first quarter of fiscal 2023, LED Solutions revenues totaled $63 million. In Q2, we expect revenue to be lower, driven by declining demand and further channel inventory reductions. Given this challenging macroeconomic environment for the LED business, we have been proactively containing costs and adjusting our ongoing operating expenses accordingly. While optimizing our business for the current environment, we continue to invest in developing innovative technologies for Cree LEDâs key target markets of specialty high-value applications, including entertainment and horticulture, premium video applications such as fine pitch outdoor lighting designs and high-performance general lighting applications such as architectural and street lighting. During the first quarter, the team launched spectrum-optimized photo-fill LEDs across high- and mid-power platforms for horticultural applications and introduced a new XLamp CMB product family with higher power, higher performance COB or chip onboard devices. Cree LED remains a technology and brand leader with strong intellectual property, and we remain confident in the long-term operating performance of the LED business, once macroeconomic headwinds recede. In our Memory Solutions Group, revenue came in at $192 million or 41% of total SGH sales. As expected, sales declined from Q4 of fiscal â22 levels, primarily due to a reduction in the worldwide memory pricing and softening demand. Our core specialty memory business, which is focused on enterprise end markets, remains relatively stable. Demand remains solid in the Networking and Telecom segments. On the technology front, we continue to see growing interest in SMARTâs new family of DuraFlash PCIe NVMe and SATA products across various form factors. Longer term, we remain focused on expanding our memory business into enterprise compute applications to meet the growing demand within the data center and in the cloud for AI and machine learning capabilities. Customer interest in our Compute Express Link or CXL products continues to grow as we have multiple designs underway in order to support memory expansion and acceleration for data center and cloud service provider applications. We also expanded our DDR5 module lineup for blade storage and computing applications and recently introduced a new family of data center SSDs for hyperscaler, hyper-converged, enterprise and edge computing data center applications. The global weakness in PCs and mobile phones impacted our business in Brazil. Looking into Q2, we expect further softening, which is historically also a seasonally lower demand quarter. As one of the largest memory companies in Brazil, we continue to invest for the long term. Our Manaus factory has completed a number of key product certifications, and we see ongoing demand in Brazil for locally-produced SSDs with customers preparing to move to the latest Gen 4 products in calendar year 2023. We are also seeing initial shipments of memory for 5G mobile phones with the expectation of increasing market adoption in calendar year 2023. Iâll stop here and hand it over to Ken for a more detailed review of our Q1 financial performance and our guidance for next quarter. Ken? Thanks, Mark. I will focus my remarks on our non-GAAP results, which are reconciled to GAAP in our earnings release tables. Now, let me turn to our first quarter fiscal â23 results. Despite the macroeconomic headwinds, we reported a strong quarter in fiscal Q1 helped by the diversification of our business, strong execution and the strength of our IPS segment, which includes our recent acquisition of Stratus. Net sales were $465 million. And non-GAAP gross margin came in at a record 27.8%, above the high end of our guidance. Non-GAAP diluted earnings per share were $0.79 for the first quarter, also above the high end of our guidance. In addition, beginning in the first quarter of 2023, we will be disclosing our overall SGH revenue and cost of sales by product and services. Our services revenue includes longer term services as well as point-in-time services such as logistics and implementation services. With the addition of Stratus in the first quarter of 2023 our overall service revenues reached $75 million, up from the $33 million in the year ago quarter. First quarter revenue by product and services were as follows. Product revenues were $390 million, and service revenues were $75 million. First quarter revenue by business unit was as follows. IPS had a record $211 million; LED, $63 million; and memory, $192 million. This translates into a sales mix of approximately 45% IPS, 13% LED and 41% memory. Non-GAAP gross margin for SGH in the first quarter of 2023 was a record 27.8%, up from 27% in the year-ago quarter, helped by the inclusion of Stratus within IPS but offset by lower sales from LED. Non-GAAP operating expenses for the first quarter were $74.4 million, up from $61.1 million in the fourth quarter of 2022 and from $57.9 million in the year ago quarter. Operating expenses were up primarily due to the inclusion of Stratus, which accounted for $18.7 million of our operating expenses in the first quarter Operating expenses also benefited in the first quarter of 2023 from $2.6 million in financial credits in Brazil, which was up from $2 million in the fourth quarter of fiscal â22 but down from $5.9 million in the year-ago quarter. This credit is expected to provide approximately $1 million to $2 million of benefit in our second quarter of fiscal 2023. Non-GAAP diluted earnings per share for the first quarter of 2023 was $0.79 per share compared with $1.08 per share in the year ago quarter. Adjusted EBITDA for the first quarter of 2023 was $63 million or 14% of sales compared to $77 million or 16% of sales in the year-ago quarter. And now, turning to working capital. Our net accounts receivables totaled $306 million compared with $410 million last quarter. Days sales outstanding came in at 33 days, down from 14 days (sic) [down 14 days from] last quarter, primarily due to the timing of collections for IPS. Inventory totaled $416 million at the end of the first quarter, up from $323 million at the end of the prior quarter. This increase outlined during our last earnings call was driven primarily by inventory required to support our IPS revenue in the second quarter. We would expect inventory to come down significantly by the end of the second quarter. Inventory turns were 7 times in the first quarter versus 8.5 times in the prior quarter. And consistent with past practice, net accounts receivables days outstanding and inventory turnover are calculated on a gross sales and cost of goods sold basis, which were $843 million and $725 million, respectively, for the first quarter. And as a reminder, the difference between gross revenue and net sales is related to our logistics services, which is accounted for on an agent basis, meaning that we only recognize the net profit on logistics services as net sales. Cash and cash equivalents totaled $325 million at the end of the first quarter compared with $363 million at the end of the prior quarter. First quarter cash flow used in operations totaled $74 million compared with cash provided by operations of $20.9 million in the prior quarter. The primary reason for this was the prepayment of the $101.8 million earn-out note from the Cree LED acquisition. We accounted for a majority of this prepayment in our operating cash flow given it was a contingent consideration. In addition, in the first quarter, we increased overall inventories to support expected demand for IPS in the second quarter of fiscal 2023. In the first quarter, we repurchased 182,000 shares spending $2.8 million during the quarter. In aggregate, we have spent approximately $53 million under our $75 million share repurchase authorization through the first quarter, repurchasing approximately 2.8 million shares. For those of you tracking capital expenditures and depreciation, capital expenditures were $11.6 million in the first quarter and depreciation was $8.9 million. In the first quarter of 2023, in conjunction with the acquisition of Stratus, we also expanded our existing term loan credit facilities by $300 million. We used the net proceeds to retire the $101.8 million outstanding CRE LED earn-out note, and along with cash on hand, paid for the $225 million purchase of Stratus. The Term Loan A facility bears an interest at SOFR plus 2.25% based on a total leverage grid. For the second quarter, we would expect our total cash net interest expense to be approximately $8 million based on current SOFR rates. Turning to our second quarter 2023 guidance. We expect that net sales for the second quarter of fiscal 2023 will range from approximately $410 million to $460 million or approximately $435 million at the midpoint. Our guidance for this next quarter incorporates the continued strong demand in our IPS business offset by lower demand in our memory and LNG businesses. Our GAAP gross margin for the second quarter is expected to be approximately 25% to 27%. Non-GAAP gross margin for the second quarter is expected to be approximately 26% to 28%. Our non-GAAP operating expenses for the second quarter are expected to be approximately $75 million, plus or minus $3 million, and up slightly from the first quarter, in part due to the timing of nonrecurring engineering costs to support our IPS business. GAAP diluted earnings per share for the second quarter is expected to be approximately $0.13, plus or minus $0.15. And on a non-GAAP basis, excluding share-based compensation expense, intangible asset amortization expense, debt discount and other adjustments, we expect diluted earnings per share will be approximately $0.60, plus or minus $0.15. This also includes the benefit of approximately $3 million from an asset sale accounted for in nonoperating income. Our GAAP and non-GAAP diluted share count for the second quarter is expected to be approximately 50 million shares based on our current stock price. Cash capital expenditures for the second quarter are expected to be in the range of $12 million to $15 million, in part due to expenditures to migrate Cree LED into its own U.S. facility. We continue to manage our operations in a prudent manner as we navigate a challenging environment while also continuing to invest in our long-term growth. Our forecast for the second quarter of fiscal 2023 is based on the current environment, which contemplates the global macroeconomic headwinds and continued supply chain constraints. Please refer to our non-GAAP Financial Information section and Reconciliation of GAAP to Non-GAAP Measures tables in our earnings release for further details. Thanks, Ken. We remain very excited about the future of SGH. As we have mentioned, our fiscal â23 is front-end loaded with some large IPS installations. And like many technology companies, we have limited visibility into the demand environment in the second half of our fiscal 2023. With that in mind, I want to reiterate our commitment to our shareholders that we will remain vigilant in how we operate the Company in the near term while investing for long-term success. I do want to highlight that this quarter, despite the macroeconomic headwinds, whether Chinaâs COVID environment weakening consumer demand or increasing interest rates, our team accomplished record non-GAAP gross margins. We credit our CapEx-light model, our diverse set of businesses and our continued focus on delivering value-added differentiated products and services that enabled our solid operating performance in these challenging times. Hi. Good afternoon. Thanks for letting us ask some questions and congratulations on the results. Maybe first question, Mark. It looks like you expect mix in the February quarter to be fairly consistent with the November quarter, and margins down a little bit. Is that just sort of like on service versus hardware mix within IPS, or is there another consideration there? And then, I have a follow-up question. Yes. Let me take the first part of the question, which is around just the relative performance of the business. As we go into our second quarter, obviously, we have a very consumer-focused business -- facing business in the Brazil mobile phone and PC business, which has historically been a little bit softer in the quarter anyway. And then the LED business is demonstrating very similar characteristics. So, the overall trend line in the business from Q1 to Q2 is kind of on the same trajectory. Relative to mix and margins, Iâll let Ken chime in. Hey Brian, thanks for the call. Yes, if we look at the trajectory from Q1 to Q2, thereâs very little movement in the margin profile, but itâs as Mark highlighted, thereâs a couple of factors. One being weâre expecting the LED business to be down slightly Q1 to Q2, and margins will come down given the fixed cost on the back end. And then two, you hit it earlier, which is on the services piece. We have some of the services that are more onetime in nature, so we would expect services revenue overall for the Company to be down slightly. And so those are both mixed related items based on the revenue profile. Okay. Thatâs helpful. And then for the follow-up, are you a little surprised or are you anticipating the softer memory prices and kind of your pass-through to your customers? Do you think that will have become more of a headwind in either the February or May quarters in the Memory Solutions business? And also, I know youâve alluded to consistently that the fiscal first half is stronger for IPS based on the way some of those projects are sort of setting up. I know itâs kind of hard to make a firm commitment here. But do you think sort of that first half-second half mix could be something like a 55% revenue first half versus 45% second half? Just trying to get some idea of sort of how severe that first half-second half dynamic could be. So, Iâll take the first part relative to the memory market. As you can see from the pure semi players in the memory space, the pricing environment is pretty challenging. And we see that in Brazil. We see it both in terms of the top line revenue and also the overall demand environment from a broader macro. So, itâs kind of a -- itâs very challenging in a consumer-facing business like that. In the Specialty business, actually, we have seen some of the pricing pressures youâre referring to, but less so more stability, not perfect, but more stability in the pricing in memory versus consumer when you look at the specialty pricing. And our margins actually are pretty good in the Specialty Memory business. Gross margins are pretty good as itâs -- our pricing -- the revenue kind of stabilizes the gross margin contribution for our services that we provide. The value-add we provide actually drive gross margins slightly up in that sense. And so, I would say consumer pricing doesnât feel great right now in the memory space if I just listen to the larger semi people in their reports. But in our business, itâs less impactful, and the Specialty business has been more stable. Yes. Brian, in terms of the IPS breakout, itâs still a little bit too early to call the second half. But if you ask me today, itâs probably in that 55-45 or 60-40 range as we see it today. But as I mentioned, we donât have clear visibility as we look out 2 quarters. And we had pretty good visibility into Q2 and pretty good visibility in Q3, and weâre still building the backlog and the bookings as we head out into Q4, into 2024 as well. Got it. But I guess in terms of component availability, if you did have kind of "turns" business, youâd probably be in a better position to fulfill that now than six months ago. Yes. Thatâs right. I would say if you looked at the supply chain today, the supply chain today is much better than it was six months ago. Thereâs still some components out there in shortages within specific semiconductor and other parts, but definitely much better today than it was six months ago. Yes. Thanks for taking my question. Congratulations on the great results. Iâll stay on the IPS and visibility into the second half of the year. Can you give us a little more description of maybe what youâre seeing as far as RFQs go from both the public and private sector? And then also, are there service contracts that are up for renewal as you go out into the second half of the year? Thanks for the questions, Kevin. I think the way I would suggest is that the RFQ process is fairly stable. I wouldnât say itâs increasing, but fairly stable. Where I think the visibility gets challenged, both in federal and commercial, is the implementation, the project schedules that we just canât see. Weâre just trying to be careful and cautious on better understanding that three quarters out. And so, weâre giving you some guidance on Q2 here, but weâre just trying to be careful in this environment to make sure that the deliveries that we have and weâre looking at the back half will go off as planned. And so, weâre just monitoring that kind of week-to-week, month-to-month. Thatâs the kind of game weâre in right now. As it relates to the service piece of the business, a lot of the services we have, not all but a lot of them, are kind of on schedule. Iâll let Ken talk to that in a second, but theyâre on schedules. And thatâs where we get a little bit more color and predictability on the recurring nature of those services, and thatâs really a strength of the business that weâre continuing to look to build. Yes. So, Kevin, thanks for the call. If we look at the services component and you look at those that have higher visibility, and I would exclude things like implementation services or logistics services that come in but can come in, in any period in a different size, itâs probably in the neighborhood, I would say, in that $50 million range, plus or minus, that are more on an annual recurring basis or we have better visibility even looking out to a year. So, I think thatâs one of the things that weâve highlighted over the last 1.5 years here is trying to build more recurring revenue base. And with Stratus, along with what the team at IPS and even within the memory business has been doing, we have a lot more services, which hopefully provides more stickiness and more value and demonstrates the value weâre providing to our customer base. Okay. Maybe turning to the specialty memory. There are two exciting things happening in the memory market with DDR5, and also CXL. Youâre still staying as a custom solutions for those products. Is that correct, first? And then, what do you see as activity for custom versions of DDR5 and CXL? Look, I think, Kevin, the long-term view of specialty memory for us is really, really pretty positive. Obviously, all of us have seen the cyclicality in the broader memory markets, and weâre kind of in that place today where thereâs just a lot of oversupply, pretty much demand-driven. And then the capacity and the memory players are adjusting accordingly. In the short term, again, as we said, pricing will be a challenge. Demand in the consumer space will be a challenge. But as youâve noted, thereâs a number of trends that speak to a positive demand over a longer-term horizon and that being 5G and mobile, that being enterprise and high-performance specialty computing driven by AI and machine learning. And then, just broader need for high-performance memory, high-bandwidth memory, enabling compute, the challenges that are out there in terms of even high-performance computing that we get pretty good exposure with the Penguin business. We see the demands on memory. And as youâre referring to controller-based memory, compute Express Link, CXL-like applications. A lot of the DDR5, CXL, 5G, the demands are good, automotive, all of those will be long-term tailwinds on the demand side. But right now, weâre in a market that just is oversupplied, and itâs kind of -- theyâre not able to call the turn, so to speak. And so, weâre going to be careful on how we see it in the short term. But we like the Specialty business. We think itâs performed much better over the last couple of years under Jackâs leadership, and weâre pretty positive about that in terms of the long-term prognosis. Itâs just the market conditions weâre in are hard to call. Yes. Thank you. And congrats again, and happy New Year. Just a question on the good progression in the services revenue. I think based on my numbers, the service revenue has really grown, almost probably doubled or tripled over the last several quarters, and now youâre starting to break it out. Can you talk a little bit about how Stratus is helping, contributing to that? And then Ken, you mentioned kind of two components of the services, the long-term service contracts. And then you have the point in time, I believe, is what you mentioned. Can you maybe elaborate further on kind of what youâre seeing within the mix of services and how youâre kind of catering the business on a go-forward basis? Well, thanks for the question, Raji. Iâll answer the first part, and Iâll let Ken talk to the back half of the question. Stratusâ business, the value-add has been their ability to maintain high availability, fault tolerant-type availability. The industry called it five nines, which is 99.999% above time. And they do that through a lot of remote monitoring, proactive system management capabilities that they have, and they also have a pretty good software platform for doing so. And so we are definitely evaluating how we can take advantage of that to scale beyond just their platform, Stratus into more IPS-specific customer environments. And so, the combination of two has really put us in a really good position to drive continued value-added services. Relative to the nature of these agreements, Iâll let Ken comment. Yes. So Raji, I think we mentioned it. If we look back at the transcript, now a year ago, we had about $33 million of services, and in this quarter, itâs closer to $75 million. And within that, there are, what I would say, longer-term contracts. Those can be up to a year, sometimes even longer than that, where weâre providing a variety of services for our customers, some of which Mark has mentioned just before. And thatâs the number I provided to Kevin just a few minutes ago. Thatâs probably -- those longer-term services are probably in that $45 million to $50 million range a quarter, and then there are more kind of onetime or point-in-time type of services that can occur in every quarter. And so, thatâs a rough split of services component, but it just shows or hopefully showcases the value that we continue to provide our customers. Itâs beyond the hardware, and those services really provide some stickiness with our customer base. Yes. I appreciate that. And for my follow-up, on the gross margins, the gross margins I believe have kind of hit close to a record, given the strong mix of services at nearly 28%, and youâre guiding at 27%. I know that the IPS segment is lumpy, and therefore, the margins associated with that revenue stream are also lumpy. But when we go into the May and the August quarter and the November quarter, are there potential offsets to that IPS lumpiness? You talked about obviously more longer-term services revenue, or should we be kind of modeling more seasonality in the margins in the second half, given the kind of a drop-off in IPS? Just kind of curious how you think of short term and long term. Thank you. Sure. So Raji, I think as you look at the transition from Q1 to Q2, part of that is the mix that I mentioned around services overall, and weâd expect the overall services component to come down a bit Q1 to Q2. And the other piece that we I think highlighted on the transcript was that the LED business is expected to be down a bit. And therefore, given some of the fixed costs we have on the back end side, even though we have no front-end manufacturing, we have some fixed costs in the back end side, so we would expect margins for that business to come down as revenues come down into Q2. And that is what is driving the margin profile down a bit Q1 to Q2. But still, if you look back even a couple of years ago, this business was doing 19%, 20% gross margins. And in Q2, weâre guiding to 27% on a non-GAAP basis at the mid. So, very healthy margins, much different business today than it has been in the past. As we look out in time, there will still be some lumpiness as it relates to IPS. I think weâve talked about that on a number of our calls based on how much hardware we have, how much services we have, which can be point in time for that business as well. But I feel like we are hopefully at a much healthier state in terms of the margin profile just based on what weâre guiding to for Q2, which is, as I mentioned, 27%, plus or minus a point. Got it. And just if I could just squeeze one more and then Iâll step back in the queue. The challenges in the Brazil business, it looks like -- I know you donât break out the Brazil business anymore with respect to specialty. But it looks like Brazil is coming down 40%, 50%, something in that range, and more pressure in the PC consumer. Iâm curious, you did then also talk about some trends in 5G and other areas. So, Iâm curious, how youâre thinking about the Brazil market, consumer? Are we -- do you think weâre approaching a bottom? Is the inventory kind of cleared out there and then weâre going to have a little bit of a rebuild and more of a secular push to 5G as Brazil catches up to the rest of the world? Iâm curious how youâre thinking about the Brazil business. Thanks again. Yes. I think the way we look at it is the consumer memory business is most aligned with the challenges in the broader memory supply and demand dynamics, just given the end markets and the amount of memory those markets consume in terms of the overall industry supply. And so, we think that as we sit here today, as the supply and demand balance hopefully normalizes, that business will recover, in addition to, we think weâre pretty well positioned down there. And yes, you looked at the memory competitors or the suppliers of memory semiconductors and their revenue is down significantly, and you see that in our consumer business. But the dynamics of us with 5G with SSDs coming out of them in house and starting to be able to build that business up as PCs and servers get back into a positive demand, itâs kind of hard for us to say that this next quarter is the bottom. But coming through the holidays and to your point about inventory, I would just say weâre hoping that weâll bounce around the bottom here and hoping itâs where we start to see an uptick. Itâs -- but the visibility for us is as tough as it is for the pure memory guys. Great. Thanks for taking my question. Maybe start off with the clarification one. How much does Stratus contribute to revenue in fiscal Q1 versus your expectation of $35 million to $40 million? It looks like the organic business performed better than you expected. And Iâll ask a few more questions about that. Sure. That revenue came in closer to that $45 million number for Q1. It did very well and the margins were... And I would just also comment, Sidney, that weâve got two parts of the business that weâve talked about in the past. One is the data center, which is primarily service-driven, and there are some upgrades along the way. And then thereâs an edge business. And the growth Ken just highlighted there in his response, the growth really came from upside in their edge business, which is something more broadly, weâre really encouraged about as a long-term play in the fault tolerant high-availability edge products. Great. Maybe just double click on the entire IPS revenue, revenue of $211 million for Q1. Can you give us a rough breakdown by end market between federal spending versus hyperscale customers versus commercial? And are you seeing different trends between these end markets in terms of the ordering patterns? Iâd say weâre not going to break out as you ask at that level, but we can give you the -- the second part of your question more on the trends. I think it goes back to what weâre seeing as stable demand as far as we can see. But certainly, weâve given -- Ken has given guidance for Q2, and the kind of building of our funnel has been relatively stable. Again, my comment still holds from my earlier -- from the earlier question that in these types of market conditions, itâs more around customer project management in terms of what they do in their budget process and do they push things out, do they move things in, what have you. We see continued investment across the commercial enterprises, and not breaking those out in any particular format. And the government, which had been somewhat muted a little bit during the COVID -- the highest point of COVID over the last couple of years, we think this year has been -- will be positive in the first half, maybe in the Q3. But again, itâs really hard to see whatâs going to happen, and so it has to do with really our customer environments and how theyâre going to play their capital dollars and their investments. Okay. Thatâs helpful. Maybe switching gears to the LED business. You talked about the business being impacted by headwinds in China and maybe in the U.S. and Europe as well. How do you expect the reopening of China going to impact that business positively, I guess? Will you start seeing the benefit in the February quarter or more in the May quarter? And if you can touch on the profitability of the business, what are you doing to contain costs, that would be great. Yes. Well, as weâve talked about, weâre not calling the bottom to show up here in February quarter. Weâve kind of guided that -- this is actually because of the holidays and Chinese New Year in the same quarter, given our fiscal quarters, weâre not seeing a bounce in this quarter. So, I would be muted a little bit in terms of our call on the bottom here in the quarter. Weâd like -- we think that with distribution burning a fair amount of inventory in Q1 and still in the Q2, and as you said, China is starting to open up a little bit, we could see some of that hopefully in our third quarter. And then, as far as the things weâre doing to manage our costs, headcount freeze, that type of thing, when weâve looked at the type of support we have in our back-end facilities and maybe weâre optimizing around the number of lines weâre running and the schedules weâre running there, capital, looking at capital deployment and then how we can move that out in line with the market dynamics and just a number of things. And itâs actually been a pretty meaningful number. But as youâve highlighted and that people highlighted in the call, LED business has gotten hit very similarly to Brazil. So, weâre balancing out really good efforts on the cost containment with not trying to hurt the business for the long term because we do think it will bounce back at some point here. Okay. Maybe one last one for me. Given the high interest rate, how should we think about interest expense going forward? And what portion of your debt is hedged at this point? Yes. So, this -- Iâll answer that. If you look at our net interest expense in the formal script, weâd expect that to be at about $8 million. So, thatâs both the interest expense and interest income on a cash basis, about $8 million, and thatâs based on todayâs SOFR rate. So, one of the things that we canât predict is where those rates will go. But what we have been doing a good job is with the cash on hand, getting better and better interest income over time. But for now, I would assume itâs at that $8 million range of cash net interest expense per quarter, and that can fluctuate depending on what the Fed does. If you look at the kind of floating versus fixed on the debt, itâs about 70% floating and 30% fixed. The biggest piece of the fixed is that convertible note. Thatâs at a fixed rate of 2.25%. And then our TLA, which is about $570 [million] in size, thatâs at SOFR plus 2.25%. Thank you for your questions. There are no additional questions waiting at this time, so I will pass the conference back to Mark Adams, CEO, for any closing remarks. Well, again, thank you for joining us today. Iâd like to thank all of our employees worldwide for a great first quarter, especially in these market conditions. Iâd like to thank all of you for attending today and look forward to seeing you at various conferences. And for those of you who will see us at CES, weâll see you then. Have a great day. Thank you.
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EarningCall_1649
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Good day and thank you for standing by. Welcome to the Quanex Building Products Q4 and Fiscal Year 2022 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operation instructions] Please be advised that today's conference is being recorded. I would now hand the conference over to your speaker today, Scott Zuehlke, SVP, CFO, and Treasurer. Please go ahead. Thanks for joining the call this morning. On the call with me today is George Wilson, our President and CEO. This conference call will contain forward-looking statements and some discussion of non-GAAP measures. Forward-looking statements and guidance discussed on this call and in our earnings release are based on current expectations. Actual results or events may differ materially from such statements and guidance, and Quanex undertakes no obligation to update or revise any forward-looking statements to reflect new information or events. For a more detailed description of our forward-looking statement disclaimer and a reconciliation of non-GAAP measures to the most directly comparable GAAP measures, please see our earnings release issued yesterday and posted to our website. I'll now discuss our financial results on a consolidated basis, followed by comments on the results for each operating segment. On a consolidated basis, we reported net sales of $307.5 million during the fourth quarter of 2022, which represents growth of 5.4% compared to $298.1 million for the same period of 2021. We reported net sales of $1.22 billion for the full-year, which represents growth of 13.9% compared to $1.07 billion for 2021. The increases were primarily attributable to higher prices related to the pass through of raw material cost inflation. Net income increased by 18% to $24.7 million or $0.75 per diluted share during the three months ended October 31 2022 compared to $20.9 million or $0.62 per diluted share during the three months ended October 31 2021. For the full-year 2022, net income increased by 55% to $88.3 million or $2.66 per diluted share, compared to $57 million or $1.70 per diluted share for full-year 2021. On an adjusted basis, EBITDA for the quarter increased by 3.8% to $38.7 million compared to $37.3 million during the same period of last year. For the full-year 2022, adjusted EBITDA increased by 20.3% to $152.5 million compared to $126.8 million in 2021. This equates to adjusted EBITDA, margin expansion of approximately 70 basis points year-over-year. The increase in earnings for the three months and 12 months ended October 31 2022 was mostly due to increased pricing and surcharges related to the pass through of raw material cost inflation and higher volumes in the North American Fenestration segment. In addition, we had a return to provision tax benefit of approximately $6 million in fiscal '22 related to updates to taxable differences, or non-cash compensation, bonus depreciation and GILTI which is Global Intangible Low Tax Income. Looking ahead, we expect our effective tax rate to return to a more normalized level of approximately 25%. Now for results by operating segment, we reported net sales of $178.2 million in our North American Fenestration segment for the fourth quarter of 2022, which represents growth of 14% compared to the fourth quarter of 2021. For the full-year, we reported net sales in this segment of $687.5 million or 18.9% growth compared to last year. The increase in revenue for both periods was primarily driven by an increase in price and raw material surcharges along with increased volume throughout the year. We estimate that around 30% of the Q4 revenue growth in this segment was due to an increase in volume and the remainder was due to an increase in price. For the full-year, we estimate that around 40% of the revenue growth in this segment was due to an increase in volume and the remainder was due to an increase in price. Adjusted EBITDA of $21.1 million in this segment for the fourth quarter, which was 4.9% higher than prior-year. Adjusted EBITDA was $90.8 million in this segment for the full-year or 20.5% higher than 2021, which equates to margin expansion of approximately 20 basis points year-over-year. We reported net sales of $68 million in our North American Cabinet Components segment in Q4 of 2022, which was 2.1% higher than prior-year. For the full-year, we reported net sales of $275.7 million in this segment, which represents an increase of 12% year-over-year. The increases were driven solely by price as volumes declined throughout the year. Customers continued to work down their backlogs as demand softened. The increases in hardwood index pricing as well as discretionary pricing actions offset the volume decline that resulted in revenue growth for both periods. Adjusted EBITDA was $5 million for the quarter, which represents a decline of 8% versus prior-year. Adjusted EBITDA for the year was $17.1 million or 20.6% higher than 2021 and represented margin expansion of 40 basis points year-over-year. Price increases, better availability of green lumber, improvements in lumber yield and labor efficiency are the main drivers of the positive results for the year. We reported revenue of $62.1 million in our European Fenestration segment in the fourth quarter, which represents a decrease of 10.9% year-over-year. After adjusting for FX, revenue actually grew by 5.2% during the fourth quarter. For the full-year, we reported revenue of $262.1 million, which represents an increase of 4.2% compared to 2021. However, excluding foreign exchange impact, this would equate to an increase of 14.2%. Revenue increases for both periods were driven by increased pricing as volumes declined. Adjusted EBITDA came in at $12.3 million for the quarter, which was 2.5% higher than the fourth quarter of 2021. Moving on to cash flow in the balance sheet, cash provided by operating activities was $48.1 million for the fourth quarter of 2022 and $98 million for the full-year 2022, which represents increases of 54.4% and 24.7% respectively compared to the same periods of 2021. We generated free cash flow of $34.5 million during the fourth quarter 2022 and $64.8 million for the full-year in 2022, increases of 48.9% and 18.8% respectively. We were able to repay $25 million in bank debt during the fourth quarter and we did not repurchase any common stock during the quarter since we were restricted due to the LMI acquisition that we closed on November 1. Our balance sheet continues to be strong, our liquidity position is solid and our leverage ratio of net debt to last 12 months adjusted EBITDA decreased to negative 0.2 times as of October 31 2022. Pro Forma for the $92 million that we borrowed to fund the LMI acquisition, our net leverage ratio was 0.5 times. Going forward, we will maintain our focus on growing the company through organic, inorganic and innovative growth opportunities as they arise while continuing to preserve our healthy balance sheet. As stated on earnings release, our long-term view continues to be optimistic as the underlying fundamentals for the residential housing market remain positive. However, like last year based on current macro indicators and recent conversations with our customers, we are taking a measured approach to 2023 guidance. As such, we believe it would be premature to give official guidance at this time. We intend to revisit the guidance when we report earnings for the first quarter. Nevertheless to help for modeling purposes, you can use the following assumptions for now, which reflect our current view and may change by the time we give official guidance. Revenue and adjusted EBITDA may end up relatively flat in 2023 versus 2022. This accounts for the contribution from the LMI acquisition but also includes the negative impact from FX in Europe and assume softer demand or reduced pricing in our divisions, mainly due to rolling back surcharges as raw material costs subside. From a cadence perspective for Q1 of 2023, net sales should be up approximately 2% to 3% year-over-year on a consolidated basis. Net sales in our North American Fenestration segments should be up approximately 11% to 12% in Q1, driven by the contribution from the LMI acquisition. Net sales are expected to decline by approximately 12% to 13% in our North American Cabinet Components segment, due to softening demand and lower index pricing for hardwoods. In Europe, net sales may be down by approximately 9% to 10% in Q1 due to softer demand combined with negative foreign exchange translation impact. From an EBITDA margin perspective, on a consolidated basis, we think there is opportunity for slight margin expansion in Q1 of 2023 compared to Q1 of 2022. I'll now turn the call over to George for his prepared remarks. Thanks, Scott and good morning, everyone. Before I provide my prepared remarks on the operating environment, I would like to take a moment to comment on our interesting and challenging fiscal 2022. The year began with fears of new COVID variants, and that was followed by continued high demand, labor shortages and material supply challenges. As if those items weren't challenging enough, the idea of a Russia-Ukraine war became a stark reality. The resulting fears of a global energy crisis translated directly into inflationary pressure from virtually every aspect of a business. While foreign exchange translation impacted our international business units. In our fourth quarter, rising mortgage rates continued to impact demand and commodity raw material costs began to decrease rapidly, which put pressure on index pricing for the first time in over three years. Despite all these challenges, we were able to report another year of record revenue in earnings in yet another difficult year. In the face of these abnormal challenges, what has become normal is how the Quanex team continues to perform well. I'm extremely proud of the results we posted. And we'd like to highlight a few of these points. First and foremost, the Quanex team had a record year in 2022 for safety performance, despite high levels of overtime and scheduling challenges caused by material shortages throughout the first half, the team remained focused on protecting every person who entered our facilities, and we continue to systematically improve our safety performance. Above all else, this is what makes me the proudest. In addition, our focused efforts on improving return on investment capital continues to pay dividends and translate into improved performance, cash flow generation and a solid balance sheet. In conjunction with third quarter results, we introduced a refreshed look of our go forward growth strategy. We call it the road to $2 billion in revenue. The refreshed strategy includes a renewed focus on both organic and inorganic growth that will revolve around our core process competencies and material science. Whether we're building out our current markets or expanding into different adjacent markets, we will use the same diligence that we have demonstrated with our operational performance, and we expect the same positive results for our shareholders. The first move in executing on this refresh strategy was the acquisition of LMI Custom Mixing, which we closed and announced on November 1. LMI, which will now be referred to as Quanex Custom Mixing is a state-of-the-art custom polymer mixer that produces high quality customized rubber compounds used in a variety of applications in complementary and attractive diversified industrial end markets. As our executive team evaluated this acquisition opportunity, it became clear that this was a business we wanted, that we wanted to own and grow for the following reasons. It fits squarely within Quanex's material science and process engineering expertise, it expands our product portfolio into a new attractive category with significant growth opportunities. It allows us to vertically integrate and realize cost savings through the supply of compounds to our existing IG spacer business in North America, which is located on the same site as LMI's Cambridge, Ohio plant. It is a familiar complementary operation that represents low execution and integration risks. The acquisition is immediately accretive to adjusted EPS, and adding this business improves our consolidated margin profile. We're about a month and a half into integrating this business and we are confident in our ability to realize the expected synergies and to grow this business. With all that said, I would like to thank all of my Quanex teammates for their dedication and efforts during fiscal 2022 and then for delivering spectacular results in a very challenging environment. Looking ahead into 2023, we do anticipate that softer volumes, along with index and surcharge rollbacks will pressure revenue across our legacy divisions. However, we do believe that the underlying fundamentals will favor housing recovery sooner than later as the demand for housing remains high, with inventory levels still low. Affordability will be the key and as material cost pressures subside, demand could be spurred again. It is also worth noting that despite pressure on the residential new construction market in 2023, we derive approximately 70% of our revenue from the repair and remodel market, which should fare better than new construction in the near-term. From a profitability point of view, even though pricing for commodity raw materials is trending lower, inflationary pressures remain significant in areas such as labor, medical benefits, packaging and freight and chemical feedstocks. As such, it will be necessary for companies to continue to fight for price in these areas, and Quanex will be no different in that regard. Current levels of inflation are simply too high to be offset completely through productivity gains. In addition, as commodity prices drop and index pricing rollbacks occur, we couldn't be in a position to benefit from a margin standpoint due to timing lag. In summary, we expect 2023 to be a year in which revenues will be challenged, but the opportunities to hold or slightly improved margin percentage is real. We plan to stay focused on safety, operational excellence, optimizing ROIC and integrating and growing Quanex Custom Mixing. We will continue to invest in new product and process development. And we will also work to identify inorganic opportunities that align with our road to $2 billion strategy, all while making sure our balance sheet remains healthy. Despite the challenges we expect in 2023, Quanex is well positioned to continue creating shareholder value. And with that operator, we're now ready to take questions. To start with just piggybacking off your comments, George on LMI. Maybe dig into that a little bit more, they're co-located with their process at all around that acquisition. And you talked about many of the things that they bring to the table, is mixing compounding an area that you would like to grow and scale? Or is this more of a sort of a one-off opportunistic. And a quick follow-up there. Yes, no it absolutely is a process and area that we expect to grow. Currently, they supply EPDM and a few other materials. And then we think by combining the two companies, not only can we invest and grow in their current product portfolio, but we'll give them now the opportunity to add our silicone and our butyl capabilities that we had within Quanex already. And a lot of that Custom Mixing, excuse me, that Custom Mixing to be able to offer multiple solutions to customers through many different channels so that we think that there's a great opportunity to continue to expand that business. And to answer your first question Dan, there was not a process run. This is a business that we were familiar with and have been for a long time. In fact, the parent company of this LMI business was a company that we acquired Edgetech, which is our IG spacer business from way back in 2011. That's actually how George came to the company. Indeed, absolutely. That's helpful. So, longer term, what kind of sort of growth margin profile are we looking at for LMI. And near-term, you mentioned accretive, I know you're not giving guidance, any range around kind of what EPS accretion could look like in the near-term? From a growth standpoint, we think this business can grow at a rate that's above our legacy, our core business. So if historically, that was in the low to mid-single-digit range for our legacy business prior to COVID, we think this business can do better than that. From an EPS accretion standpoint, yes, that's just -- that's information we haven't disclosed publicly. Got it. And maybe just one more, and I'll jump back. But the free cash flow has been and conversion has been improving. Do you see that trend continuing, you see the working capital likely be a benefit in fiscal '23 or more neutral and any expectations for CapEx? Yes, good question. Obviously, working capital has definitely been a hit to free cash flow in 2022, I think to the tune of close to $30 million. A lot of that had to do with the value of our inventory going higher because of inflation. Looking ahead into fiscal 2023, we're hopeful that working capital won't be a negative. But I'm not sure, it'll be a positive. So I think keeping it somewhat flat when you model is probably the prudent choice at this point. Yes, I would say around the same level as last year, maybe a little higher. So call it $35 million. Maybe a little more, we'll come out with more firm guidance, hopefully in the next quarter. One moment for our next question. Our next question comes from the line of Reuben Garner from The Benchmark Company. Your line is open. So recognizing and not providing guidance, Scott, maybe if you can help. I mean, that seems like a pretty robust outlook with some things working against you like FX and some of the surcharges rolling off. Can you talk about what the kind of underlying organic volume assumption for the year is that gets you to that kind of flattish revenue? I think the contribution from LMI was in the range of $80 million. So I mean, it seems like a pretty modest volume reduction, all things considered with what we're hearing or what's happening with the new housing world, at least. Yes, I mean, obviously, the reason we can even talk potentially about being flat next year versus 2022, is because of the LMI acquisition contribution. Outside of that, we fully expect demand volumes to come down, the FX impact could be significant. So I mean, there's that as well. I think in addition, specifically in the North American Fenestration segment, I think we're still finding opportunities to gain share in a couple of our product lines, where labor outsourcing is still a big driver for our growth, and even with falling demand, in terms of volumes, the labor pressures for everyone still exists. So those opportunities still arise. So we think that there's opportunity to maybe offset some of the market volume with share gain. And then we're working on adjacent materials as well, that we continue to talk about. So it will be a challenging year. And we're working really hard to do everything we can to offset that. And the only thing I'll add there is, as these index pricing mechanisms kick in, and raw material costs go lower, and you're having to roll back price, obviously, that hits revenue. But there are also a lot of other costs that George mentioned in his prepared remarks that are continuing to go up. So we're going to fight hard. We're going to try to push price where we need to, but the reality is with raw materials coming down, revenue is going to be challenged. So last time, we saw kind of the housing start run rate that we're seeing in the last few months, I mean, you guys were doing more like $800 million to $900 million in revenue, $1.2 billion is a big jump up from that. I know that there's some pricing over that time period, but is the share gains kind of the biggest difference between, I recognize that's just a new housing start number, but clearly some of the rates are going to impact some R&R spending, I think the biggest between what maybe you guys did in revenue a few years ago, and where you kind of are pointing us to for '23? I think on a big picture level, what I would say is share gain is a piece of that and the model of continuing to optimize our processes to solve our customers labor issues does continue to resonate. I think we've seen in certain areas, especially during supply chain, as people are mitigating risk from Asian supply, bringing things back domestically, that's been a benefit, and we anticipate will continue to be a benefit. And although we don't talk a lot about it, because no one segment, or one product line is maybe significant in the big picture, we have products like the vinyl fencing, our solar, our flashing tapes, that all continue to grow within our product line, again, individually, they're not significant enough to call it out. But independently, they are continuing to roll up and have been great adjacency products for us. Great, and I'm going to sneak one more in if I can. So same kind of line of questioning on the margin from pretty impressive outlook to be able to kind of hold where you are, what would I guess lead to the most pressure relative to that outlook? Is it volume worsening? Or is it more risk on the price costs front? Scott, you mentioned some -- still seeing some inflation in some areas, as what's the bigger kind of item to watch for '23 on the margin side? I think they're equally both, Reuben. You obviously followed our business well, volume will drop, and we'll put pressure now. Now, we've said all along, and you've seen it in the past, we're able to adjust the volume drops, I think fairly efficient when compared to others. But volume would be a pressure on that margin. And then continued inflation, I mean we're still seeing it, even though our commodity raw material prices may be dropping, as I mentioned in my script, we're still seeing pretty high levels of inflation in a lot of areas of our business. And I know, my individual business leaders are really working very hard to offset that. But we're going to have to go out and try to get price to offset that. Now, why the positive or somewhat positive look on our margin profile, we've talked a lot about as those indexes and surcharges roll back. As we were chasing the tail and the lag on the way up, we're seeing some of the benefit on the way down. So that should help alleviate some of the pressure. And that's why we're probably a little more optimistic on the margin perspective in the year. Thank you. One moment for our next question. Our next question will come from the line of Julio Romero from Sidoti. Your line is open. I guess to start on the refreshed growth strategy. It sounds exciting. Obviously, you didn't put a timeline on the targets. So maybe just talk about what investors should expect from maybe the cadence of inorganic growth? And if deals should be kind of tuck-in or transformational? Great question. I think really, we didn't give a lot of specific guidance there for a very specific reason, I think we've created enough opportunities. And we're looking at these adjacencies by opening it up, what we're effectively doing, as we're telling people, we're not a Window and Door Company, and we're not a Cabinet company. We're a manufacturing company that has a very broad set of operational capabilities and material science knowledge. And we're starting to see a lot of different looks both from internal organic product development as well as external. So I think as we evaluate inorganic opportunities and M&A, I think that they could be either transformational or bolt-ons similar to the size of like an LMI. And the reason I don't give better guidance is because a lot of these markets are new, we're still evaluating them. We're looking at it, the favorability of each of these markets and as this progresses, we'll try to give better clarity on markets that we may like more than others. But it's relatively new. But I think we've positioned our balance sheet very well to be able to handle both transformational and bolt-ons with and staying within a very healthy balance sheet perspective, which has been our goal all along. Great. I appreciate the color there. Maybe on the organic growth side, maybe a follow-on to Reuben's question a little bit. I mean, I was hoping you could expand more on the share gain opportunity, specifically the runway for maybe reshoring from some of your customers as your customers mitigate risk from overseas suppliers. If you could talk a little bit more about that runway and the multi-year opportunity there? We're seeing it in a few different areas. I think the LMI business and any sort of compound mixing, because of the long freight, the expense of the freight, excuse me, lead times. I think that that's going to spur on opportunities. And we saw opportunities within the Cabinet segment where that one's probably been the one that's been most hit with both tariffs and just supply chain challenges from coming overseas. And the amount of inventory that our customers have to carry to protect on that has really pushed on the need. So I think it's areas that require a lot rate, a lot of complexity, numerous SKUs are the ones that are going to be the most advantageous for us to identify as a potential sourcing alternative to our customers, and we're looking for those, and then developing products within those. One moment for our next question. Our next question comes from the line of Kenneth Zener from KeyBanc. Your line is open. Good morning, so I will echo the understanding that you guys aren't giving guidance at this time. But maybe could you clarify the price piece with rollbacks versus getting price to offset some of those other rising costs. And then, separately, when we think about the North American Fenestration business, it really is three distinct businesses with the vinyl extrusion and spacers. Could you just talk about the operating leverage across the three distinct businesses amid lower flattish volume environments? I'll start with your second question. And then I'll let Scott go back to the first. So as we look at the operating leverage of the different businesses and actually now there's the fourth one because the Quanex Custom Mixing will roll up into that but I would say the more leveraged businesses tend to be the vinyl extrusion and the spacer extrusion business and screens and some of our other accessories tends to be very variable cost driven, more manual process in general, so any volume drops will probably impact the spacer, the vinyl extrusion a little more than the other product lines. On your pricing question, the raw material surcharges or rollbacks, or index pricing rollbacks, versus anything we try to push. The only thing I can really say to that without getting too specific is raw materials are typically 50%, 55% of the costs. So that, of course, a big portion of that is the major raw materials that are indexed. So those are the ones that we really don't have control over coming down. So that would leave us with several other areas to try to offset the rollbacks with increased price. In the additional inflation, where we have to go back out from get price, obviously, that's going to -- it's going to take work for us and every other company because you know there's this expectation and if raw materials are dropping, I guess everything else in the world is dropping and that's really not the case, I mean. So we're going to have to be very detailed and very methodical and lining out and transparent with our customer base. We're doing everything we can to try to offset inflation with continuous improvement and improvement internally, but at some point, that rate of inflation is still pretty high and we're going to go -- have to go out and get it. I suspect it is going to be a fight but we have the data and the detail that will support price increases. Great, very helpful. Thank you, Scott and then if I could just add one more, could you just talk through the specifics of the European business and how you guys are able to perform I guess better than expectations, even outside of the FX headwind. Just following up from a comment from last quarters call, you just talked about the impact of elevated prices in Europe and how your products, energy efficiency proposition contributes to performance, can you maybe like quantify that or in case energy prices stay elevated, what's the run rate? Or I guess, the runway for '23, maybe even '24 and what about if prices retreat? Thank you. Yes specifically, in terms of quantifying those opportunities, that's going to be relatively difficult. And we're just not prepared to do that at this point. But from a product or macro level, what I would say is, you're exactly right, our spacer product, and our vinyl extrusion systems that we make under the Linear brand in the U.K. are both what I would position is at the very high end in terms of thermal performance and operating performance within a window. So as energy costs continue to rise in Europe, and they have and they will, and that will also transition at some point in time to North America. Windows systems with our components in it will continue to grow. As energy costs go higher, the decision to replace windows, it makes that payback for a homeowner, when they do their internal rate of return. And do I want to make this purchase a lot less difficult, it becomes a fairly easy payback. So in addition to the quality of the product that we serve, we feel very strong that these markets will continue to grow just because of the energy cost, and that as it relates to the spacer business specifically in Europe, I think it's worth noting that that facility that we have in Germany that manufactures that spacer, that's kind of our hub for international spacer shipments. So our Germany facility is supplying product to probably 60 different countries in Asia and emerging markets, in the Middle East and in Africa, that has an opportunity to continue to grow because of their elevated energy costs. So we think the product line serves itself very well to perform in the future as it relates to energy performance. One moment for our next question. It looks like we have a follow-up from Daniel Moore from CJS Securities, your line is open. Yes, just one follow-up on capital allocation. Obviously, you were blacked out, buying back stock. Given the acquisitions some year, however, [ph] the cooker should we expect that that's picked back up, number one. Number two, maybe you talked about this previously. But if there are larger, more transformative deals that come your way, just talk about where you would be willing to take leverage up to for the right opportunities? Thanks. On your second question, first, we've been pretty transparent and telling investors that if there were to be a bigger transformational deal out there, I don't think that this management team and this board would ever be comfortable with doing above two and half to three times net leverage. And only if there is a clear runway to get that back down to between one and two times leverage in a relatively short periods of first year, year two. George, do you want to talk about that? No, I think that that's absolutely fair. And I think what we have done and we've worked on as that pathway to de-lever is we're coming off a fourth or fifth straight year of free cash flow in excess of $50 million. So I think we've done a very good job of developing a cash generation machine here that gives us comfort level and what we can pay back. And so obviously, each of those situations. Now in terms of capital allocation, I think it will be no different on a go forward basis than we have in the past on if we are able to be in the market. And there's nothing going on, then we will opportunistically buy back our stock as a priority. I think we'll continue to focus here in this year on repaying down the debt and we'll balance the needs of the organization. But I think we've been very transparent that when we can, we will be opportunistic in our buying of stock. Thank you all for joining today. And I would like to take a moment to wish everyone a safe and joyous holiday season and a very Happy New Year. We look forward to providing an update on our next earnings call in March. Thank you.
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EarningCall_1650
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All right. Thanks, everyone. We're going to get moving with our next session. It's my pleasure to introduce Bruce Flatt, CEO of Brookfield Asset Management. Brookfield is one of the largest global alternative asset managers with $400 billion in fee-generating AUM. The firm is uniquely aligned with several secular growth trends within private markets, including within real assets, global energy, transition, private credit along with many others despite what's obviously been a very challenging environment for the markets. Brookfield has seen significant fundraising momentum resulting in about 20% fee-related earnings growth over the last 12 months. So well on your way to sustain sort of the growth targets that you talked about at the Investor Day a couple of months ago. So thank you for being here. Always great to chat and looking forward to this. So why don't we start with a question on private market allocations and for the audience is probably going to be an old question, since I ask it essentially in every one of these. But if you look at the new paradigm, the new kind of the regime change that we're in today with higher liquid fixed income yields that we really haven't seen since Global Financial Crisis. To what extent does that change institutional appetite for private assets? So first, I'd say, we were not in favor three years ago and two years ago, nobody wanted to talk to us. And nobody was interested more or less than what we did because we weren't tack. We weren't growth. We weren't many of the things that were out there. And if you fast-forward that to today it's very different. And a lot of the things that you said in your remarks, a lot of the things that we do are what people want to invest into it. So some of my comments are this way because of what we do and because of the global business we have. So if you're a single industry private equity player that has a $2 billion fund I don't think you're going to have the same comments from me. What we do for people is on the low end earned 8%, 9% and on the high end are in 20% or 25%. Take all of our products we are in 8% to 25% on 50 different funds. And those -- I guess, the short answer is, those returns in a low-ish interest rate environment, which I'll call right now are exceptional. And they're not -- they're needed in these institutional clients. And so I don't think it slows. The first answer is. And second, I think, what people are finding out even more. And we've witnessed this for a long time, but the distractions of the public markets are terrible for people that have long-term wealth creation in mind. So through sovereign plans if they need money for liquidity they should have it in fixed income and liquid markets equities. If they don't need it for liquidity it should all be in private because the problem with the public market is it distracts you from value. There are two things. You all know this. There's the value of an asset and there's the price that it trades for. Sometimes it's higher, sometimes it's lower. Once in a while it's the same. But that price movement distracts from what really matters to wealth creation longer term. And therefore the short answer is any -- these institutions for both return reasons and focus and distraction reasons they continue to put more and more money into private and they will continue to -- even though rates are higher today. And there's spread. What's happened today is base rates are higher, but also spreads are much higher. Sure. No, we'll get talking to that about that a little bit more. So when we think about fundraising for Brookfield, one of the things that I mentioned earlier, you guys have been very successful in fundraising of your flagship vehicles this year. As you look forward to 2023 and really even 2024 what fundraising opportunities are you most focused on outside of the flagship funds to in order to sustain this, kind of, 15% to 20% FRE growth target that you've outlined in the past. It's a very long-tail business. The funds are raised over periods of time they're deployed over three or four years. So you always have that out. So what we're now focused on is, whatâs our, let's call, it the tale of three years from now, four years from now, five years from now, this business generally grow. It will grow at 15% to -- the Asset Management business grows 15% to 20% a year for the next five years. So what we're focused on is year six to 10. And the good thing is Global Institutions, back to my comments earlier, they want Core, Core-Plus products in real assets. They want opportunistic products in infrastructure. There's enormous amount of money still coming in despite all of the 'denominator effect and all that'. I just closed $21 billion for our latest infrastructure fund in six months fundraising and we'll do the balance of the fund this year. We did our transition fund, which is a quiet eye first time fund. We did $15 billion. So, that was done for six months last -- this year, early this year. So I would say, it's -- for the type of products that are different we're going to go with our opportunities -- next Opportunities Fund strategy, the Oaktree strategy, which I can't think of a better time. It was 2020 when we raised the last fund at $16 billion. It was an excellent time, but this is going to be really, really good. Yes, yes. Let's talk about the transition business. It's one of the things you just mentioned. Decarbonization is just one of the major secular themes out there and BAM's investment pace here has been pretty robust. I think about half of the fund that you just raised has been already deployed or committed. What's your outlook for further deployment opportunities here? Look we got lucky. Two of our biggest businesses are infrastructure and transition. And these are enormous businesses which trillions and trillions of dollars of capital has to go into digitization, deglobalization and decarbonization. These are really, really important to the world and it's trillions of dollars. Specifically on decarbonization, it's really simple what we're doing in our transition fund. We are taking money from clients, which not many people can do this. And we're putting it in -- we're providing it to companies to help them get to lower carbon within their operations or their businesses. Some of it's really simple. All we're doing is building wind and renewables, wind solar and providing them power on a take-or-pay basis to decarbonize our operations. That's really simple. But then after that there's a whole bunch of other things. And we're the largest builder of renewables for Amazon today in many countries in the world and we continue to do that. It's very profitable and it's a very large opportunity. So, we put half the fund to work already. I think we'll be raising another fund next year for sure maybe this year and there's a lot of opportunity and more money is needed. But the difference is this is hard, like we've spent a long time building our renewables infrastructure businesses there. We run the backbone of the economy. These aren't simple things. Many countries companies won't take people as a counterparty if you don't have that. Like in the United States, you have to have FERC license to operate in power. We own Westinghouse Electric. We run half the nuclear plants in the world. So it just gives you the moat that we have is just different from others. And therefore, rose -- look the goal is of capital raise money, put it to work and get a good return. How do you do that? You have to differentiate yourself and our differentiation has always been to try to be and run the operations better and it just gives us scale. You've got some of very deep moat in this business as you pointed out. Obviously that helps from a competitive advantage perspective, is there's a lot of newer players or other players coming into the space with a similar theme, right, like clean energy, decarbonization, like it's around the same. But if I think about the evolution of this product over time and almost think of that either as real estate or infrastructure, should we be thinking about sort of variation of the transition business into Core, Core Plus credit? Like is that a whole new ecosystem that you can build around? Yes. Like our infrastructure just to go back our infrastructure the first fund we started was our -- we call it opportunistic, but it's opportunistic infrastructure. So we are in 14%. I think our average for 15 years its 16%. So we promised 14%. That was our first strategy, but now we have Core-Plus, we have Debt Fund, we have Secondaries. And essentially why that's really important and I'm going to get to transition, but why that's really important is, when we go talk to a company sometimes they don't want to be taken over. So we can go how about door B. And we'll provide you a minority interest into our Core-Plus Fund, because they're running it. And we're just a partner with them. â¦a good partner and a helpful partner, but we're just a minority partner or we can lend the money. So it allows us to do a lot more things with the companies. In transition, it's just -- this business, is just at its infancy and enormous amount of money are needed. And I think all of those things that I just mentioned will get built out by us and by others too. Obviously there's a -- there's -- where there's money there's always competition. I've heard that somewhere -- long-term greedy. Infrastructure business, let's talk a little bit about that. It's again, lots of secular growth opportunities you guys are -- have a really fantastic footprint in this part of the business. In terms of deployment, you've announced two very large deals this year. One is the $30 billion partnership with Intel for semiconductor facility in Arizona. And then, there's another one for â¬17 billion I think with Deutsche Telekom in Germany. So, these are really sizable mandates. So help us think about, are there more of those type of deals we should be thinking about? How does that ultimately make its way through Brookfield's Asset Management business like where in the P&L does that hit with period of time? â¦Digitization and Deglobalization. And look, semiconductor chips are in medical products and many different things are coming back to the Western world. That takes -- this is $30 billion, it's one plant. This is -- it would -- won't be 2% of chips in the world, $30 billion in one plant in Arizona. So -- and on the Tower side, it's Deutsche Telekom Towers in Germany and Austria period. That's it. So these are big, big businesses. We bought 160,000 towers in India -- very large amounts of money. And it's not stopping. The investment by telecom companies into 5G and therefore they need datacenters. They need towers. They need everything around that ecosystem. They can't afford it on their balance sheets. Intel is one of the best on de-globalization, Intel and all of the other companies that make semiconductor chips. They -- they're A-rated, A- rated, plus rated companies, but they just can't build 10 plants at $30 billion. And therefore they need money from outside. And that's what we're here for. So I think there's a lot of room with these trends for the infrastructure space and for the transition space. Got it. Got it. Great. Let's shift gears a little bit. I was hoping would spend some time on real estate. It's increasingly become the biggest source of debate in the market. Now public revalues are down. As we all know 25-plus percent or so year-to-date with probably office and retail to maybe incrementally more scrutiny. Now just maybe one of those you talked about earlier there's price and value and maybe that's where, this is one of those systems where there is a big disconnect. But what is your investment performance outlook for your real estate book? How is it holding up from just a financial and fundamental perspective? And I guess as cap rates continue to rise and economic growth potentially deteriorate, how do you think that portfolio will perform. And that goes for both the on balance sheet, I guess, BPG and BPY plus whatever is in real estate. Look, I -- we've been in the real estate business a long time. We've been through many cycles. We've been through a lot worse than this one, I can tell you. And the only thing I could say is, if you own great, great real estate which we happen to across the board and you have it in great places and you run it properly it endures time and just don't ever get in a situation where you have to sell it. And we're well financed across our whole book. We have great real estate. And what I can tell you is high-quality real estate both retail office, industrial all of the food groups, hotels, today are in excellent shape. Rents in Manhattan, since we're in Manhattan, rents in Manhattan on premier quality real estate are 50% higher than pre-COVID, 50% higher than 2019. Now if you have an obscure office building not to denigrate Third Avenue, which is built in 1960 and has poor air systems, it's a no bid for leasing. So there's a huge disparity. And that's not like unlike always. The fact is the story has always been buy the best building on the best corner, pay a little more if you have to and you'll be fine. And remember, most real estate was financed with term financing, so interest rate doesnât changes. And in fact what's happening today in fact, infrastructure every day is youâre getting adjustments with inflation and real estate too. Rents are going higher partly because of inflation, if you need to build a new office, building rents are â you need â well, costs are much, much higher, so I'm actually â I'm quite positive because I think we'll find great value in this market with some of the stress. A lot of the stress is in core products and therefore we probably won't touch it, because it's just not worth it. But there's always what times like this always bring about is more opportunity to put money to work in amazing opportunities. And I'm â I think in all of our businesses in the next 18 months, we're going to find some phenomenal things to do just because of the environment and we have significant cash and capital available from our clients to be able to put to work. And I'm actually quite excited about it. Is there anything you think is starting to bubble up on your screen as far as areas of stress within real estate that you are likely to participate in. So clearly not the lower quality stuff, but higher quality that you would view as kind of premier assets for one reason⦠No, not yet. Most real estate is in pretty good hands. Look, retail malls were shut down. Their sales if you have a good multiday, it's 35% above 2019 sales, 35% above 2019. So like we had the worst. Everyone went home and never went to an office building remember, they were leased so they're still paying the rent. Retail malls were shut down and hotels nobody went like â you couldn't have had anything worse, 2.5 years ago and the business survived and the cash flows are higher and it's growing. And we should just remember price and value. People for some weird reason today I think price is lower than the value, where they're unsure, so they price it here in the public market. It might even priced here, but it's priced here today. Value is the discounted cash flow also was based on a stream of income. And I would say the markets are wrong generally, but you have to be selective because some it's just bad real estate and you won't do very well with it. Yeah, yeah. You mentioned deployment at this point on your last answer. So let's talk a little bit about that. I think as of the last quarter you had about $39 billion of dry powder that will turn on fees upon deployment. That is going to drive $390 million or so in revenues. Lots of it is in credit. And I think you mentioned that this is going to be one of the best opportunities for Oaktree and their team. So talk just a little bit about what they're doing and how fast do you think they'll be able to put capital to work over the next call it 12 to 18 months? Yeah. So we have two, I'll call it two pools of credit money today. Balance sheet credit money, which is our insurance business and that's $50 billion, and all of the pool of money in our Oaktree franchise. And both of those are seeing â we're seeing and we are putting money to work today in very significant amounts, buying first lien paper, buying mezz paper, putting all of our credit money to work and with returns which are excellent. Will they get better at some point? Maybe we've got lots of capital to go after this. And one just has to invest when you find some really good returns. But just take our insurance business, we bought a book, we bought three pools of insurance money 24 months ago on the assumption that interest rates would go up some time. They happen to go up quicker than we thought. And we've locked in 3% over here. And we put all of the assets we liquidated all of the equities and all of the fixed income instruments beyond 18 months. So we're sitting on an enormous amount of cash. We're now putting that into incredible fixed income opportunities. And I think on the distress side Oaktree is going to have an unbelievable next 24 months putting money to work both in the fund they have today, but in the next fund that we raised. In addition to that the Direct Origination Credit business is evolving around the world. And I think there's going to be a lot more opportunity for that in our Oaktree business. Got it. You mentioned insurance. So why don't we go there next. Clearly, the earnings run rate continues to surprise the upside. A lot of that I think is a function of interest rates to your point. So, I think, kind of go from $400 million to $550 million in just a few quarters on an annual basis the spread income that you guys are generating on that book. How do you think that's going to evolve from here? I know part of that is also resides on you guys managing some of that money, which is not really part of the current run rate. So you're, kind of, holding rates steady from here on, what's kind of the build in earnings power of the book? Yeah. Look it's very -- it's very powerful right now. Because remember what I said earlier, we bought a portfolio in most -- somebody that do themselves an insurance business wouldn't do this. We bought these books, liquidated everything, put it into cash sat on no return for 1.5 years. Nobody does that. Unless you're an investor. So our view is take as little risk as possible in insurance and earn our money doing what we do which is invest. And right now we're taking a cash portfolio and putting it into things at 8%, 10%, 12%, 14% yields. And that's very positive to that business and it's very positive for our earnings stream that comes through. Let's talk a little bit about retail. It definitely been a top deserved for the last week or so. You guys have pretty meaningful ambitions to build that business out. You don't have a whole lot of retail footprint today in some of those products, but the goal is to build. So thinking through the volatility we've seen in the market does that change your view on what the opportunity set is here for Brookfield? So when you asked me a year ago I was trying to say we had more than we actually had because everyone was talking about retail. Letâs full glass -- Look here's what I would say. Our business is in 30 countries of the world. We raised funds from 2000 institutional investors around the world. We have an insurance book and an insurance business with a large and growing number of insurance companies and helping them do the same things that we do. We have many different channels of retail in our listed vehicle. And we started into dappling into retail. And I guess our goal of all of these distribution channels is to build them methodically with the right products when it makes sense and be disciplined about it. And we just haven't got there yet. And we're still learning and we're still in the infancy of it. We've hired a lot of people. We're spending a lot of money on it and we will get there one day. But I think what's going to happen now is that all of these products will evolve and people will learn from the things and we always do. And I guess I was -- until we learn everything, we'd like to just do slowly and methodically. Yes. Thatâs sounds great. All right. Let's shift gears a little bit. Maybe we can talk about some of the recent news flow for the firm with one of the big announcements which -- by the way you hinted to that I think at our conference here last year about the spin-off of the Asset Management business as a way to unlock value. You're kind of in the middle of that. I think both BAM, the asset manager and [indiscernible] trading when issued market supposed to close I guess in the next couple of days here. So once this transaction closes, what are the incremental opportunities do you see for standalone Brookfield Asset Manager that could present themselves that maybe weren't open to you guys as part of the bigger conglomerate? So just for everyone benefit if they don't know this, Brookfield, today the listed vehicle will be called Brookfield Corporation and we're dropping the asset manager down and we're distributing in basically a stock split. We're distributing 25% of the shares of the manager to our owners, to the shareholders. And we've done this seven times before. Spun things out to our shareholders, because we believe the owners own the business, why do an IPO give it to our owners. This oneâs bigger. It's a very large business. It generates $2 billion of cash flow grows at 15% to 20%. It has no debt. We'll pay out 90% of it. We're going to own 75% of it upwards in the parent company in Brookfield Corporation. And it really does two things for us. For those that want to be in a great manager, you can now buy that security on its own and not take the risks or rewards, which you get by being in this other entity. And in this other entity, it now frees us up to not have to explain to people no, no, no, we're a manager. We're not a manager. We're asset heavy. This one is asset light. If you want asset light, itâs there. If you want to be with us in asset heavy, 18 months ago or 30 months ago, we weren't in the insurance business. Today we're in insurance business and it's going to become very large 10 years from today. So we changed the complexion of that business and we've changed the complexion of that business five times over 30 years. This one will be an Asset Management business and it's going to be an Asset Management business for a long time, so to get to the answer for you to believe it. But this Asset Management business will now be able to have a group of people totally focused on asset management that will have a security in the marketplace that we incented properly with it, without all of the other things along over here. And we may be able to use it to do things to grow the business, may. Don't know, but may. It opens options A if it reach properly, and B if the opportunities come along that we think are as good as what we have and we -- because it has some cash but probably not enough. It would have issue with security to be able to do it. It would have to be better than what we have today. In the corporation, it opens up a whole bunch of things. We often get opportunities to come along that are far bigger than our funds that we've been loath to do them in the corporation and confuse people, but now that's what this entity is going to do. And it's going to fund all of the businesses we have in the manager. It's going to support all the funds. It's going to support the manager, it's going to do all the things it's done before. So we get the benefits of everything because we own 75% of it. But what it's going to do is it's going to possibly take on other businesses, insurance being one but use the insurance float and all of the other capital that we have to be a home for businesses which are larger than what would ever fit in the funds. Yeah. So I guess to just follow-up on that point, when it comes to the manager strategy seems pretty simple. And if it awards you guys would ultimately standalone currency or higher multiple maybe there are some deals you guys could do that will enhance the franchise down the road et cetera. When it comes to the corporation, is your capital return angle to that at all if the stock trades at a meaningful discount to what the intrinsic value is because again you will actually be able to see a lot of intrinsic of value because a lot of it is going to be the public market, the only piece that's not as really insurance and real estate. Yeah. Look it's just capital allocation. And if it trades cheap, we're going to have lots of capital and we bought stock back. So it offers â we'll have the opportunity to do that. And â so we'll have to see â but look, we're in the business of making money for our owners full stock. And now that vehicle out there will have lots of freedom to do what it wants and buying â including buying stock back if it trades cheaply. Yes. Perfect. Okay. We have a couple of minutes left on the clock. So if anybody in the room has a question for Bruce let us know. Thanks for the time, Bruce. Really love what you're doing with the spin. I feel like it definitely isolates the asset manager and kind of helps really kind of give a better valuation to that. But I guess to follow up on Alex's point, like if you look at the when-issued market, it's basically implying that BPG is valued at like 75% of what you guys have it at. So how aggressive could you actually be on the repurchases to basically kind of address that question between the value and the price dynamics, such that it doesn't create a permanent valuation footprint in the marketplace. Thank you. So look, I don't know. I actually haven't looked at the when-issued market. And I doubt it's reflective of what most people think the securities are worth. I'd say in the next â as things settle out over the next six â three, six months, I think we'll be able to tell where, what people think of that security. Until then I don't know. But the bottom line is we're highly incented as management and as owners of the business just like all shareholders are to ensure that our securities at least trade at a fair representation. And if not, it's the greatest opportunity we can do because we know the businesses. So unlike many management of some companies that don't understand the arithmetic of what's in the company, we price our assets every single day. And so if it trades for a period of time, at a big discount, we'll obviously keep buying back stock. Great. All right. Well I think we are going to leave it there. Bruce, thank you so much. Great to see you.
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EarningCall_1651
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Welcome to the Braze Fiscal Third Quarter Fiscal 2023 Earnings Conference Call. My name is Laila and I will be your operator for todayâs call. At this time, all participants are in listen-only mode. After the speakersâ presentation, we will conduct a question-and-answer session. Thank you, operator. Good afternoon and thank you for joining us today to review Brazeâs results for the fiscal third quarter 2023. Iâm joined by our Co-Founder and Chief Executive Officer, Bill Magnuson; and our Chief Financial Officer, Isabelle Winkles. We announced our results in a press release issued after the market closed today. Please refer to our Investor website at investors.braze.com for more information and a supplemental presentation related to todayâs earnings announcement. During this call, we will make statements related to our business that are forward-looking under the federal securities laws and safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements include, but are not limited to, statements regarding our financial outlook for the fourth quarter and full fiscal year ended January 31, 2023 and for our fiscal year ended January 31; 2024, the impact of our planned sales initiatives; our planned product and feature development; our competitive landscape and the behavior of our competitors; our anticipated market opportunity; the impact of current macroeconomic trends; our anticipated customer behaviors; our growth plan; our vision; and our long-term financial targets. These statements are subject to a variety of risks and uncertainties that could cause actual results to differ materially from expectations and reflect our views only as of today. We assume no obligation to update any such forward-looking statements. For a discussion of the material risks and uncertainties that could affect our actual results, please refer to the risks identified in todayâs press release and our SEC filings, both available on the Investors section of our website. Iâd also like to remind you that todayâs call will include certain non-GAAP financial measures used by management to evaluate our ongoing operations and to aid investors in further understanding the Companyâs fiscal third quarter 2023 performance in addition to the impact these items have on the financial results. Please refer to the reconciliations of our non-GAAP financial measures to the most directly comparable financial measures calculated in accordance with US GAAP included in our earnings release under the Investor Relations portion of our website. The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with US GAAP. Thank you, Chris, and good afternoon, everyone. We delivered a strong third quarter, generating $93.1 million in revenue, up 46% versus the prior year and 8% compared to the prior quarter. For the first nine months of the year, we've grown revenue 53% compared to the same period last year, demonstrating the high ROI and long-term value of the Braze solution. We also realized solid customer growth, increasing our total customer count by 116 sequentially and by 38% in the last 12 months. While our number of large customers, which is defined as those generating at least $500,000 in ARR increased 53% year-over-year. Notable recent new business wins and upsells include FanDuel, Panera, and Vizio, among others. For Panera bread, a North American fast casual bakery cafe concept with over 2,100 locations, will be powering email and mobile campaigns for their award-winning app and industry-leading MyPanera loyalty program that has over 50 million members. Additionally, Panera will be leveraging content cards to build a personalized messaging inbox spanning web, mobile and in-restaurant kiosks. We also signed a multi-year cross channel deal with a large global brand in travel and hospitality, again demonstrating our ability to land with some of the largest enterprises in the world and power best-in-class Omni channel engagement across verticals and geographies. Travel and hospitality is a category where we continue to make great strides and we look forward to updating you on our progress in this important vertical in the coming quarter. I also want to highlight an American multinational fast food chain with tens of thousands of global locations that has renewed and meaningfully grown its seven-figure investment embrace. We're excited to expand our footprint with this customer across new use cases, channels, and geographies. This reason upsell means Braze will soon be powering marketing, promotional and loyalty campaigns across email and mobile in all of their lead global markets. Continuing our tour of some of Braze's important verticals, Cyber Week is a critical time of year for many retail and e-commerce brands and this was reflected in our messaging volumes over the period this year. From Black Friday to Cyber Monday, we executed over 31 billion total messages across our many channels, up 43% from the same period. last year. More importantly, we again achieved 100% global uptime through this year's cyber week, notwithstanding record high volumes. In our view, this robust messaging growth is a proof point that customer engagement remains an imperative for today's businesses. In fact, we continue to see signs that first-party engagement is rising in importance for brands as both rapid time to value and robust return on investment are prioritized during this period of economic uncertainty. That said, we did continue to see some of the macroeconomic headwinds reported by many of our software peers, including elongated deal cycles and increased scrutiny on software investments, particularly with new business. In contrast, upsells were particularly strong, achieving a new high watermark in the quarter, led by success with our global strategic accounts. And despite the challenging environment, our pipeline is robust and demand for customer engagement solutions remained strong. As we continue to experience these success stories, both with new and existing customers, we remain relentlessly focused on the continuous improvement of our products and services. At our recent Forge customer conference, we outlined our Start Anywhere, Go Everywhere framework, in which we recognized that Braze customers exist across the full spectrum from small pre-launch startups up to the world's largest multinational enterprises and that we are committed to meeting our next generation of customers wherever they are in the transformation of their customer engagement practice, getting them up and running quickly and helping them rapidly realize high ROI. The brands and teams that use Braze range from ambitious small businesses that may only have a single dashboard user through a diverse array of rapidly scaling companies with agile, interdisciplinary teams, all the way up to complex multinational enterprises with marketing and engagement teams that span across hundreds of people and they're all leveraging the same Braze software. Some customers even start by simply migrating their existing email or push notification strategies into Braze, but once those early campaigns are live, rapid results build the case for further expansion and Braze is built to help teams quickly leap forward in sophistication while expanding across new channels and use cases, all while enhancing the customer experience of their products and building first-party relationship assets. Meeting the distinct needs of this diverse set of customers requires ongoing innovation and nimble, efficient execution. With the Braze philosophy of Start Anywhere, Go Everywhere, we are committed to ensuring their accessible starting points into Braze paired with a smooth on ramp to get up and running quickly while also investing to promote the continued growth and maturation of our customers' usage of Braze over the long-term. The Start Anywhere, Go Everywhere mentality also informs the evolution of our addressable market in tandem with that of the profession of marketing and customer engagement. Many of the job titles and teams that rely on Braze today were not around when we were founded in 2011 and their continued rise in prominence is an important indicator that Braze's moat extends into our customer community and is reinforced by the mutual evolution of our product, along with the maturing skill sets in our space, that continue pushing customer engagement strategies to new heights. As businesses evolve to better serve their customers who then reward them with stronger first-party data and more valuable relationships, we will continue to see brands progress the maturity and sophistication of their customer engagement practices. We further believe this strategy could expand our total addressable market in the long-term through adoption among data engineers, product teams and creative groups and we are investing in R&D accordingly.. To illustrate the impact of our R&D, I'd like to briefly highlight recent product innovations and integrations that we announced at our Forge events in New York and London in October and November, respectively. We introduced a number of updates to help customers more quickly bring new data sources into Braze and efficiently use them over time. A great example is cloud data ingestion, which allows customers to directly connect their data warehouse into Braze, quickly importing and activating customer data with just a few clicks. Customers are already unlocking new use cases and solving difficult problems like identity resolution by sinking audiences into Braze that are created from queries in their data warehouse. For example, a quick service restaurant might want to message all users who ordered special menu items in a promotion from a previous year, but haven't sent that data to Braze or a financial services company might want to message users with low account balances but need sensitive account balance details to stay on-prem. Early access customers report significant weekly reductions of developer hours, which can now be redirected to product improvements. By greatly reducing the operational requirements of managing data pipelines, these efficiencies can also improve relationships between the marketing teams that use Braze and the engineering teams they often rely on to help bring new ideas to life. Early examples of customer case studies include a streaming service running a multitude of data syncs for everything from account updates originating in their back end to targeting based on sensitive information such as credit cards. And a gaming company that is aggregating all of their purchase data from different channels, in-store, online and platform marketplaces and syncing it with Braze via cloud data injection for targeted messaging to recent purchasers and their biggest spenders. Snowflake is our first partner for this turnkey integration, and we plan to expand to the other major data warehouse partners, Redshift and BigQuery, enhancing the data flexibility of Braze for our customers. Just as we are working to improve the ease with which data and engineering team members interact with Braze on behalf of their marketing teams, we are also building features and interfaces for them to use directly. One recent example is the introduction of feature flags, which enable customers to easily launch and test new features with limited audiences or within targeted geographies before committing to a broader rollout. We also launched a programmatic API for our existing data feature catalogs, which enables our customers to co-locate new data sets within the Braze infrastructure, making it easily available for real-time personalization use cases within Canvas. And by leveraging a broader data architecture built on Snowflake, MongoDB, Kafka and others, Braze provides businesses with the most flexible customer engagement platform for data activation. We believe these product innovations help build on the value generated by the ever closer collaboration between product developers and marketing experts in service of a better customer experience. A central tenet of our product vision at Braze is that we help our customers reach their users on the channels that they care about most. This is why we built our product to be omnichannel, and as customer behavior evolves, we continue to expand the breadth of Braze's vertically integrated channel set. As such, we also recently announced native channel support for WhatsApp, a platform used by over two billion users in 180 countries, which is currently in early access with a handful of customers. Once early access is concluded in early 2023, marketers around the world will be able to create, orchestrate and send WhatsApp campaigns directly from the Braze dashboard to strengthen customer relationships with content-rich messaging. Braze is directly integrated with the latest version of Meta's recently overhauled WhatsApp cloud APIs, and our solution is designed to be marketer friendly, allowing customers to build WhatsApp campaigns and a native composer and manage the channel similarly to how they use SMS. In addition to the usability benefits afforded by our direct integration, our WhatsApp offering is further differentiated by its seamless integration into the Braze platform's orchestration capabilities. With Canvas Flow, our visual development environment for customer engagement programs, customers can harness all of the power and sophistication of Braze to seamlessly incorporate WhatsApp messaging into their marketing mix and easily orchestrate 2-way WhatsApp conversations with end users. For another example of channel expansion, we look to Braze Audience Sync, which helps customers drive efficiency and reduce costs in the ad buying ecosystem by allowing them to leverage the real-time first-party data flow managed by Braze to optimize their usage of expensive advertising channels through enhanced targeting, suppression and look-alike audience development. Customers have historically seen strong success with Audience Sync integrations through Facebook and Google. So at our forge event in London last month, we were excited to announce early access for Audience Sync with TikTok. This integration will enable brands set dynamically and securely sync first-party user data from Braze directly to TikTok for audience classification. Brands can send custom audiences to TikTok for fine grand ad targeting alongside first-party messaging as well as optimize their ad spend through precise real-time suppression less and versatile look like audience creation. Lifesum, a digital health company in EMEA is currently using the beta version of TikTok Sync to target TikTok ads to users and convert them into paying members while suppressing ads to active premium users. It took them just one day to get up and running and the integration has proven very valuable in extending their paid social reach, while improving cost efficiencies. Before turning the call over to Isabelle, I'd like to take a few moments to highlight our inaugural environmental, social and governance report published last month. As I've stressed on past earnings calls, Braze believes its responsibility as global citizens and technology leaders is to be a positive force for our employees, communities and shareholders. This report was the product of our social impact department and includes our first greenhouse emissions audit, first materiality assessment and it outlines our inclusion first approach to diversity, equity and inclusion. The report can be found under the governance section of our investor website. Thank you again for your continued interest in and support of Braze. We remain committed to delivering industry-leading engagement solutions for our customers and efficient growth at scale for our shareholders and we look forward to continuing this journey to become the de facto standard for customer engagement with you over the coming months and years. And now I'll turn the call over to Isabelle. Thank you, Bill, and thank you, everyone, for joining us today. As Bill mentioned, we reported a strong third quarter with revenue up 46% year-over-year to $93.1 million. This was driven by a combination of existing customer contract expansions, renewals and new business. Our subscription revenue remains the primary component of our total top line, contributing 96% of our third quarter revenue. The remaining 4% represents a combination of onetime configuration and onboarding fees as well as other professional services, which are subject to similar annual contract terms as our subscription-based revenues. Our customer count increased 38% year-over-year to 1,715 customers as of October 31, up 116 from the prior quarter and up 468 from the same period last year. Our total number of large customers, which we define as those spending at least $500,000 annually grew 53% year-over-year to 148 and as of October 31, contributed 56% to our total ARR. This compares to 97 large customers contributing 51% to our ARR as of the same time last year. Compared to last quarter, this reflects an increase of 9 from 139 large customers that contributed 55% to total ARR as of July 31. Turning to dollar-based net retention. As a reminder, our dollar-based net retention represents a 12-month trailing statistic and sources of upsell dollars include growth to existing contracts through increases in pre-committed volumes of monthly active users and messaging entitlements and the addition of add-on features and recurring professional services as well as signing new business units as we continue to further penetrate our existing customer base through both geographic and brand expansion. Our renewal rate, combined with upsells from our successful land and expand motion drove strength in our dollar-based net retention statistics. Measured across all customers, dollar-based net retention was 126%. Dollar-based net retention for our large customers, those spending at least $500,000 annually was 129%. Expansion was again broadly distributed across industries and geographic regions. Our global footprint continued to expand in Q3 and revenue outside the U.S. contributed 43% of our total revenue in the third quarter, up from 42% in the prior quarter and 40% in fiscal 2022. Moving to our remaining performance obligation. In the third quarter, our total remaining performance obligation was $409 million, up 34% year-over-year and generally flat sequentially. Current RPO was $283 million, up 42% year-over-year and up 3% sequentially. The year-over-year increase was driven by contract renewals and upsells and the signing of new customer contracts. While total RPO was generally flat compared to last quarter, we did experience a modest decline in the RPO value beyond one year. This is attributable to slower new business growth a higher percentage of shorter duration contracts than in the prior periods and fewer renewable dollars available in the quarter. Overall, dollar-weighted contract length remains at approximately two years. Now I'd like to review the income statement in more detail. As a reminder, some of the metrics I will discuss are non-GAAP. We have provided a reconciliation of GAAP to non-GAAP financials in our earnings release and accompanying earnings presentation. Non-GAAP gross profit in the quarter was $64.9 million, representing a non-GAAP gross margin of 69.7%. This compares to a non-GAAP gross profit of $45 million and non-GAAP gross margin of 70.3% in the third quarter of last year and 69.3% in the second quarter of this year. Non-GAAP gross margin percent declined 60 basis points year-over-year due to several factors, including higher hosting and infrastructure costs, higher third-party messaging fees, increasing headcount costs as we continue to invest for growth and onetime hosting migration costs we incurred as we continue to optimize our tech stack. Turning to operating expenses. Non-GAAP sales and marketing expense was $46.2 million or 50% of revenue compared to $28 million or 44% of revenue in the prior year quarter. This reflects our investment in head count and increased travel and entertainment expenses as the easing of COVID-related travel restrictions allowed for more in-person events including our New York forge customer event, in-person employee training and customer meetings. Non-GAAP R&D expense was $17.5 million, or 19% of revenue compared to $11.1 million or 17% of revenue in the prior year quarter. The dollar increase was primarily driven by headcount to support the expansion of our existing offering as well as to develop new products and features to drive growth. Non-GAAP G&A expense was $18.6 million or 20% of revenue compared to $10.9 million or 17% of revenue in the prior year quarter. The dollar increase was driven by investments to support our overall company growth and public company expenses. Non-GAAP operating loss was $17.3 million compared to a non-GAAP operating loss of $5 million in the prior year quarter. Non-GAAP net loss attributable to Braves shareholders in the quarter was $13.8 million or a loss of $0.15 per share based on 94.5 million weighted average basic shares outstanding during the period. This compares to a loss of $3.3 million or a loss of $0.16 per share based on 20.7 million weighted average basic shares outstanding in the prior year quarter. Although the global macroeconomic environment has been challenging over the last two quarters, this environment has also presented a unique opportunity to execute on our post-IPO investment plan. In the 4 quarters since our IPO, we have successfully built out teams across functions and geographies in order to capitalize on the significant market opportunity ahead of us and the unique hiring environment over the last several months, particularly in R&D. At this time, we feel the investments we have made to date position us well to continue to drive sustainable growth while delivering on our commitment at our Analyst Day in October to focus on our path towards profitability. While headcount will continue to increase moderately as we close out FY '23 and look ahead into next year, we have recently chosen to slow our recruitment activity for net new hiring. Therefore, while this investment momentum will continue into the beginning of next year, you should expect the rate of OpEx growth to moderate as we increase our focus on driving operating leverage across the business. Now turning to the balance sheet and cash flow statement. We ended the quarter with $477.6 million in cash, cash equivalents, restricted cash and marketable securities. Cash used in operations during the quarter was $23.9 million compared to a use of approximately $2.5 million in the prior year quarter, driven by higher net loss and increased cash used in working capital. Combined with higher capital expenditures, free cash flow was negative $28.1 million in the quarter. As we have stated in previous quarters, we expect our free cash flow to fluctuate from quarter-to-quarter given the timing of customer and vendor payments. Before we turn to our forecast, I'd like to take a few moments to discuss what we are seeing in the marketplace. As Bill remarked, our pipeline remains strong, and we continue to see solid demand for customer engagement solutions. However, like many of our peers, we continue to experience macroeconomic headwinds across geographies and industry verticals. These challenges manifest in elongated sales cycles, slower new business growth and fewer multiyear contracts. As such, we are continuing to approach our forecast prudently and guide on a risk-adjusted basis. For the fourth quarter, we expect revenue to be in the range of $95 million to $96 million, which represents a year-over-year growth rate of approximately 36% at the midpoint. While we're not providing specific gross margin guidance, we expect gross margins will be impacted by seasonally higher activity during the fourth quarter. Fourth quarter non-GAAP operating loss is expected to be in the range of $18.5 million to $19.5 million. Fourth quarter non-GAAP net loss is expected to be $17.5 million to $18.5 million with fourth quarter non-GAAP net loss per share in the range of $0.18 to $0.19 per share based on approximately 97.5 million weighted average basic shares outstanding during the period. For the full year 2023, we expect total revenue to be in the range of $352 million to $353 million, which represents a growth rate of approximately 48% year-over-year at the midpoint. We're pleased to be able to raise our full year revenue outlook. But given the dynamics I discussed, we believe it's prudent to do so only modestly. Fiscal year 2023 non-GAAP operating loss is expected to be in the range of a loss of $71.5 million to $72.5 million. Non-GAAP net loss for the same period is expected to be in the range of a loss of $64.5 million to $65.5 million. Fiscal year 2023 non-GAAP net loss per share is expected to be a loss in the range of $0.68 to $0.69 per share based on a full year share count of approximately 94.8 million weighted average basic shares outstanding during the period. In summary, we are very excited about the future of Braze. We are focused on growing our business, meeting customers where they are on their journey and empowering them to realize world-class customer engagement. Our priority remains capitalizing on our long-term market opportunity, delivering revenue growth at scale and realizing our long-term margin targets in the coming years. So Bill, what have renewal conversations been like at this point? Glad to hear upsells are strong, but are you experiencing the usual contract increases that Braze historically received at renewal? Thanks. Thanks for the question. We're moving through renewal conversations at a pretty steady clip, especially here in Q4. And actually, through Q3, we had our lowest amount of available renewable dollars. But we saw those renewal conversations acting for -- across the whole year. We saw those renewal conversations acting pretty similarly to Q2, we're seeing it in Q4 as well. And as I mentioned, it was a new high watermark for upsells in the quarter. We've got a lot of really robust increases in terms of the new use cases that people are running, expanding into new geographies, expanding into new brands. So a lot of the cross-sell and upsell motions that we're used to are still intact. I would say one of the things that we're seeing that's impacting them to the downside is that there are still -- there's a lot of turnover happening within teams as layoffs are happening in other parts of the economy, there has been a lot of M&A type disruption activity. And so those types of things that we've seen in new business deals that are causing either deal elongation or the delays on decision-making. Those are happening for certain types of expansions within renewals, and so we are seeing that, especially in the more complex multinationals. But as you heard in the prepared remarks, a lot of the upsell strength actually came out of our global strategic group this quarter as well. And so I think we're seeing robust signs of great renewal cross-sell and upsell motions across the customer base and around the world, but the portions of upsell that are acting more like new business because they're expanding to a new team and new set of stakeholders, maybe accessing a brand-new net new budget, those are acting more like new business, and we're seeing some of the similar effects that we referenced earlier. Appreciate the color there. And for Isabelle, we're seeking questions about the sequential step down in RPO in the quarter. Should we think about a mix higher of percentage of shorter contracts to continue? And how could RPO will fluctuate with more seasonal dollars available for renewal in 4Q? Great. Thanks for the question. So yes, you can -- there are more available renewal dollars in Q4. Because we do a number of early renewals, some of those have already been pulled forward, but there are still more today in Q4 than there have been in the other quarters. So that will help. We don't guide on the quarter specifically for RPO. But yes, it is true that there will be more. And I'm sorry, what was the first part of your question? Yes, we do absolutely expect this trend to generally continue. We think it is part of the dynamic that we are seeing in the context of the macroeconomic environment around us. And we believe it's prudent to expect all of these dynamics that are related to the macro to continue to persist. [indiscernible] potentially as Braze has continued to grow in its own prominence in the market, that we've been successful at moving more and more of our installed base from one year to multiyear contracts at renewal. That's something that we'll continue to prioritize in the future, and we continue to see that be robust customers that were on multiyear contracts before, in general, are recommitting to multiyear contracts. But one thing that we haven't seen as robust in Q2 and Q3 as we have through prior year periods are those people who signed a 12-month deal upfront, more of them are opting to continue on a 12-month deal just because of the environment. But we expect much like we did through a lot of the jitters that were in the economy during COVID. It moved buyer sentiment toward those shorter contracts. And we saw a reversion of that and people got more comfortable with longer-term contracts once we got out of the depths of the COVID year in 2020. And so we're not overly concerned about that for the long-term health of any of these customer contracts, but you certainly see the impact on RPO. I wanted to ask about greenfield versus displacement activity in kind of this market environment. I think we think of mobile and push being very kind of greenfield use cases while e-mail is often a displacement and often could be even a vendor consolidation message. Can you just talk about where you're seeing greater demand or greater success across these different go-to-market motions in the market right now? Yes. I think that across -- I would think about it more on the lens of established businesses versus emerging businesses because even within -- and when I say that, I'm not specifically talking about young companies versus older companies, but rather new lines of business and new focuses. And so canonical examples would include streaming companies who -- well, those are certainly displacements of other vendors that may have been sending e-mail for them in the past the use cases are new because the direct-to-consumer investment is net new within the business. And so those operate more like greenfield. And I think that broadly, when you look across our customer base, that, that characterization of mobile and push being more often greenfield than e-mail being greenfield is broadly true. But at this point, in the maturation of mobile, the vast majority of businesses have something up and running at this point. And so I think that displacement is something that our teams are very good at. Even if you go back to the early days, we -- we've always operated in a highly competitive market. And so we've been replacing mobile push vendors since 2013 as well. And I think that throughout our lifetime, it will continue to be a mix of the two with both greenfield and replacement because our vision for Braze and the customer engagement platform and attacking these problems in a customer-centric way, that's not channel siloed means that we're always going to go into an environment that is going to be heterogeneous. There's going to be certain channels and use cases that are not being covered or maybe not being handled in an advanced way or maybe they're not being coordinated with other places. So we can often simultaneously bring in more operational efficiency and better agility and execution on existing use cases, but unlock completely net new use cases. which are going to result in, in many cases, increased volume, even if they don't, they definitely result in increased ROI for the business. And we're always focused on the hybrid of those. I think it's very rare that we go in even in a replacement, and we're simply just doing the same use cases before, but with a new technology stack. Great. And maybe just another go-to-market follow-up question. It sounds like you guys have a new initiative, maybe I got this wrong Start Anywhere, Go Anywhere, and it's maybe a do go-to-market tactic. And we know you guys have been working on some things to ship sales training. Is that part of that? And could you just elaborate a little bit more on what that change is and how that's helping to maybe drive accelerated ramp to productivity on the rep side? Yes, of course, and they are definitely related. Start Anywhere, Go Everywhere is something that I referenced in my keynote at Forge in New York. And for our customers, it's a commitment that wherever they are in their journey, whether they're a one person team at a prelaunch startup who is ambitious, but maybe not yet sophisticated in modern customer engagement, all the way up to fast scaling start-ups with agile and your disciplinary teams and spreading across the large enterprise where you've got big global teams spreading across functions and maybe reporting to different places, different brands and geographies. Regardless of the complexity of the team structures we have amazing proof points throughout the entire Brace customer base that the same software platform can come into those organizations. It can empower those teams to drive really great results and really deliver ROI to those customers across the board. And one of the aspects of that is making really a commitment to the customer base that wherever you live in that spectrum, we're going to meet you where you are. We're going to make sure that you get up and running quickly. and that we're going to bring you up this on-ramp toward more mature and more advanced customer engagement strategies over the lifetime of your engagement with Braze. And that is also then reflects back internally because from a sales perspective, it means that have the confidence to go and sell to a really wide array of customers. Indeed, we already have examples throughout our customer base, all up and down both the present day sophistication curve as well as the kind of team size and brand size spectrum. Any company that really wants to take customer engagement seriously and invest in it is a great customer to take on bras and to bring it into their environment and have it drive additional ROI. It also has implications for our integration and onboarding teams, it has implications for our product teams. You heard me talk a lot in the past about how a huge part of our product investment is to make sure that we're controlling complexity for our customers so that they can seamlessly move across channels, and they can grow with us all the time. It's also about making sure that, that on-ramp is very smooth for them so that the integration results in an intuitive environment for them to work in, and it's one that gets delivered very quickly. Those are also aspects of the macro environment right now, where investments are being made and investment decisions are being made on -- with a return expected on a shorter time horizon and with lower volatility in it. And so that idea that you can start anywhere whether that's in a single channel or a small set of use cases or with a small team, and we'll get you up and running will get you to that very positive ROI. And then from there, you're able to compound your gains through the agility that Braze brings and through the increased surface area as you add more use cases, you have more channels, you bring in additional teams, you bring in additional brands, and that's where they go everywhere part comes into play. So first off, I know you guys, during the course of the year, mentioned some sales productivity to efforts that you guys are trying to undertake I know that's kind of hard to unpack that with the macro and everything going on. But I'd be curious to get an update on how those efforts have gone so far. Yes, absolutely. So we've been happy with the impact of the changes that we've been making over the last 6 months. We've really looked at the entire life cycle of a salesperson here at Braze. So I rolled out a new 6-week intensive boot camp inclusive of in training and doing role playing with managers, new certifications and a number of other initiatives that have been really impactful in terms of bringing up -- bringing our new account executives up to speed more quickly. We measure that through time to first deal that they're closing and then continuing to look at the existing sales team, maybe even those that were fully ramped, but recognizing that with the macro environment shifting that buy our priorities have shifted with our product continuing to expand that the surface area that they need to understand is greater and also that we are forging into new areas of our addressable market, which means that we're engaging with new competitors that maybe they would have been unfamiliar with in the past and that the nature of those competitive dynamics certainly change along with the impacts on buyer sentiment that comes the macro. And so I think there was a recognition early on that there were some basic things that we wanted to make sure that we were getting fixed and adapted, and we talked about those earlier this summer, the switch to the in-person training, the relooking at the onboarding and the boot camps. Now we're getting to the point where we're digging a layer deeper, and we're seeing really great feedback from the field teams, people empowered to navigate these new competitive environments and navigate the sale of these net new products as we continue to push ahead the pace of innovation. And I think that's going to be an always on priority for us for sure. It has been most acute through this year because of the convergence of a large number of new sales plus a changing macro environment and a changing competitive environment, plus the expansion of the product. And obviously, we're not going to see all of those moving parts in every year, but we expect this to continue to be a dynamic environment. And so it's one that we're investing more in for the long term. Great. I appreciate the color, Bill. And maybe just a follow-up. I know on the hiring going forward is simply that's going to slow down a bit. Or areas maybe where you're still going to be hiring more aggressively? Or is it just kind of a broad-based slowdown? Any way to kind of unpack that a little bit. Yes. So I'll break that into the hiring over the last few months and then what we're looking at going forward. So we've experienced one of the most robust R&D hiring environments that we've ever seen in our history. And so that's an area where we've been very excited to continue to build out the R&D teams, and we actually have our kind of new hires and our hiring budget for R&D already signed up and they'll be starting even over the next few months looking kind of further into the future than we're used to from an R&D perspective. And so that's been awesome to see and you're seeing the fruits of that investment through all the announcements and product at forge and a lot of innovation that will be coming in the coming quarters and throughout next year, which I'm really excited about. We also are still hiring for a number of net new functional leaders throughout the business. Some of those are -- many of those are concentrated in a newly centralized group around go-to-market strategy and ops. Our aforementioned sales productivity team lives within that new centralized go-to-market strategy and ops group as well. We brought together within that groups around things like market strategy, looking at territory planning, pricing and packaging, et cetera. So that those can all be co-located together. We're excited that that's going to be able to improve alignment between those groups, speed up a lot of their kind of operational cadence and be able to ultimately drive better results through a more coordinated strategy. And so that's a transition in terms of the centralization of that we started embarking on a couple of months ago, and it's one where we're still hiring leaders to make sure that we've got all the right functional expertise in place as we kick off next year. And then there's going to be a number of other places where we're still looking to selectively take advantage of this great hiring market to bring in really good talent into the company. All that being said, we're definitely making sure that we prepared for whatever the macro throws at us. We've had great robust hiring results over the last few months. And so we are lowering the level of recruitment activity that we have on a number of other roles just to make sure that we've got better line of sight through the fog that's ahead of us before we start to really step on the gas again. I'm on for Gabriela. When investors hear about there being a general slowdown in marketing spend and ad spend that obviously makes folks nervous about Braze. So why are you confident that Braze won't be impacted to the same extent as some of the more traditional players in the space? So there's a variety of reasons and a lot of them come down to the nature of the kind of workloads or the use cases that Braze runs for our customers and also the ROI that's associated with that. And so when you look across the Braze customer base, what you're going to see is diversification across a lot of differences I've already spoken earlier in this call about the diversification that we have across company size, across geographies, across verticals, those -- and then also across use cases. And a lot of those use cases are also not what I would call discretionary marketing. They are customer communications that are required in order to operate businesses. And even when those customer communications could be purely promotional by their nature, which is certainly the case for a lot of the Black Friday and Cyber Monday message volumes that we mentioned. Even within those -- even within those buckets, which you might be able to call discretionary marketing, those are in almost all cases, the highest ROI marketing that a brand that works with Braze can do. Because the investment that they've made that they're capitalizing on is in building up the first-party audiences that they already have. And so if you think about Braze as an activation investment that sits on top of a much larger investment in building out first-party audiences and first-party data sets. The ROI function there that pretty clearly starts -- you start to see pretty clearly the difference in ROI versus digital advertising, where in digital advertising, you're not only paying for the activation, but you're also renting the relationship from whoever the ad market place is. And so the fundamental difference in the ROI function between activating your first-party audiences versus renting a third-party audience and then trying to activate it from there, I think, makes Braze's ROI be really robust even through kind of intense scrutiny Similarly, when you look at the role that Braze pays from an activation standpoint, you see that Braze actually amplifies the ROI that people get out of those advertising investments that they make. And they also improve the return that they get through the organic growth even if they've cut off all of their digital advertising. I think a lot of the coverage in our space breaks down marketing into two broad buckets. They'll talk about either acquisition, which is generally associated with digital advertising or with retention, which is more associated with platforms like Braze. Activation is another really important stage there as you go from acquisition to activation, which is roughly -- let's make a great let's establish that habit. Let's make sure that things like 7-day and 14-day retention remain high, so that you don't have people immediately bouncing off of a product after you spent dearly to acquire them. And Braze's role to play in that aligns perfectly with the priorities that so many brands are we focusing on right now, which is how do we make sure that our organic growth is activating at high levels. How do we make sure that the premium acquisition investments that we are making have the maximum ROI that they can and then how are we retaining those people in the long term. And so in many ways, it's exactly when the scrutiny shows up on the digital advertising spend, that brave really starts to shine versus all of those other expenditures? That is very helpful. And then just for the follow-up, can you talk about the momentum that you're seeing with partners? Are you starting to see meaningful interest and pipeline coming from that channel? And maybe Isabel can touch on how this can help with S&M leverage over the long term. Yes. So our partner ecosystem goes -- is fairly broad. And so I'll speak specifically to the global systems integrators in response to this question because I think -- it's been a topic over the last few quarters, and it's certainly one that we're really excited about, both for the long-term leverage that you mentioned through sales and marketing efficiency as well as through the pipeline contributions and also just the opportunity to work with a lot of brands that are -- that work with GSIs and without those relationships, those that was -- those were opportunities that we were never previously really able to access. And so what we've seen over the last 18 months has been an incredible increase in the amount of mind share that we have across the major global systems integrators and the big agency holding companies. The opportunity for Braze to really go into those organizations, establish joint business propositions with them. We're certifying a large number of the consultants and the integrators and the staff that those companies have on hand. And many of them are really looking ahead during this period of macroeconomic uncertainty to really figure out when demand comes roaring back, what are what are the investments they're making today to make sure that they're prepared for tomorrow. I think that when we look across our experience with the GSIs through 2020, even in the early part of 2021, that they were all overcommitted even relative to the staff that they could put on projects since they didn't have the room necessarily to be making forward-looking investments in new technologies. And we were often squeezed out to our detriment because they had pre-existing relationships with the legacy marketing clouds. What we've really seen over the last year, especially, is that sentiment shifting enormously. The -- as brands have really led the way, as Braze has continued to move and penetrate deeper and deeper into our global strategic accounts and into our enterprise footprint, it's become very clear that this is the next generation that our partners should be ready to be trained for into service to their customers and to their future customers as well. And so that incentive alignment and the momentum that exists there is absolutely tremendous. I think that those types of opportunities are not immune to the same new business headwinds that we in the prepared remarks. But we're seeing a lot of really amazing early signs of pipeline generation there. And ultimately, we believe that as the environment comes back to normal, that we will have made an enormous amount of progress mind share and literal bench strength that is trained and ready to sell on bras, which will ultimately help us with our efficiencies in the long run. And so just to follow up on your specific question on sort of the impact that we're seeing. We absolutely still think that this is going to be a key driver increased leverage out of the sales and marketing organization. However, as Bill said, between the macro environment and sort of other dynamics, we are still very much in the early days of this. So -- we look forward to providing sort of more updates as this continues to play out. We continue to be really excited about the leverage and the opportunity that this will present. But I wouldn't look for -- with the macroeconomic environment that we're seeing around us, I wouldn't look for specific direct financial impact in the near term. The revenue upside relative to the guide this quarter was a little skinnier than what we've seen. And I think if you look at the 4Q revs guide at the high end, it implies sequential growth of 3%, which is a little bit below than the like mid-single digits, I think you guys have done in the last couple of quarters. So -- first, can you talk about the macro environment embedded in this guide? And if there's been any changes in guidance methodology? And then there's a part two sorry, there are two parts. But if you drag, I guess, that 3% sequential growth into next year, you're going to end up at growth below 30%. So understanding you're not giving guidance today, but any comment on seasonal trends versus macro and linearity? And as we look into next year, just anything to keep in mind. Great. Thanks, Taylor. So first, I'll just talk about the guidance for Q4. So no material change to how we think about sort of the prudent risk adjustment associated with our guide. So the macro continues to provide a certain level of uncertainty and challenge, and we think that like many of our peers, this is likely to persist. And so we think it's prudent to continue to include that backdrop as we think about the guide. I won't go into any kind of detail for next year. We'll get back to everybody when we have more visibility as to how Q4 is actually going to land and we'll be part way through Q1. So we'll see everybody back here in March for that announcement. But we do think that there is -- we are certainly planning for this macroeconomic environment to persist. And that is going to continue to affect the dynamics that we talked about in terms of new business. So we're very pleased with how upsells continue to track, and you can see the dollar-based net retention is holding steady. But there are -- there's a lot of uncertainty out there. And so we just think it's prudent to incorporate all of that as we think about next year. I've got one for Bill, and then I'll follow up for Isabelle. Bill, in terms of the expansion activity that's happening, can you talk about the cadence of the upselling that you're saying after you land a customer, if that's changed at all compared to previous quarters versus the expansion and the upselling activity that's happening with your longer-term customers? Directionally, I think we have been seeing newer customer cohorts do expand more quickly. There's a variety of reasons for that. One of them was a sales organization, structural change that we made a couple of years ago where we switched from the traditional hunter farmer model across all of our account territories. We actually shifted more of them over to the named account territories because of the confidence that we have in our ability to land and expand And so there were more cases prior to that, where the hunters were incentivized to land a bigger deal. Now we've made sure that our sales team is incentivized just get started because we know that we can grow customers more effectively over time. The other thing that drives side is there's just more options in terms of how you can expand your on Braze now. We have more channels. We have more interesting ways to bring in new data sources got really robust APIs that bring more engineers into the fold and move other sorts of things like transactional use cases on the Braze faster. Another aspect of that has just been our internal focus on making sure that we're driving time to value results, making sure that customers are getting up and running, that they're sending their first campaigns that they're sending their first campuses quickly. All the investments that we put into usability as well as the just kind of operational rigor and excellence that we've built out in our integration and onboarding teams over the course of the last couple of years have all sped up those things. And so I think there's a bunch of structural changes that we've made that really support that in general, new customers cohorts are upselling and expanding faster than prior customer cohorts did. There are obviously some headwinds on that as well in some cases, especially in the enterprise and especially given Braze's increased prominence and our track record and the customer reference we have. We do move in and we take out whole opportunities where we'll be cross channel across a bunch of brands and across a bunch of geographies all at the same time. And as you kind of deploy across multiple geographies in enterprise, that can take a long time. There's also, as I mentioned before, there are parts of cross-sell and upsell that are -- that act more like the business because they involve working with teams. Those are experiencing similar headwinds. And so that -- as we mentioned, for new business -- and so that can be a kind of a takeaway from that. So there's a lot involved there, hopefully, that helps you understand the dynamics that are at play, but it's certainly a goal of ours to make sure that and this is in line with Start Anywhere, Go Everywhere that we can get customers up and running quickly on early use cases. We get them working with Braze's vertically integrated data flow and in the Canvas environment. And from that as a springboard, they're able to quickly and easily move throughout the rest of the brace product and be able to really expand and grow with us very seamlessly over time. Thank you, Bill. And then the follow-up I have for Isabel. Thank you very much for the transparency on what you're seeing in terms of contract durations. I wanted to ask about pricing and discounting in the current macro environment, if that's changing at all compared to recent quarters? And maybe your comments on what you're seeing, if you're seeing anything in terms of how your competitors are behaving in terms of pricing if they try to navigate these macro headwinds? Yes, absolutely. So we're continuing to maintain our discipline around discounting. We continue to see ourselves as a premium product, high ROI and that is reflected in our pricing. So do we see the pricing sensitivity out there in the market? Absolutely. But we continue to work with the salespeople and continue to train them to talk about the high ROI that the product delivers and the value sell into the customer. So that is incredibly important for us and it has been a discipline that we have implemented over the last several quarters and years, and will absolutely continue. From a competitive standpoint, I won't claim to know exactly what's going on behind the scenes at all of our competitors. But there is likely more pricing pressure on them. And certainly, for those that are kind of the pre-IPO guys, they are likely looking to kind of build their books right now and they can likely as a nonpublic company is there potentially trying to win on price. It's probably not the right strategy for the long term, but we're going to continue to be disciplined. I'll ask just one, just given the time, I see a bunch of hands still up. Bill if a customer comes to you and says, "I need to cut costs, which I guess could mean lean out MAUs, narrowing channels, sending fewer messages. What are the levers you can pull to try and preserve contract value? Like what's the playbook in that scenario? Yes. So this comes up not just because a customer is looking to cut costs, but sometimes the customers own projections around how their volume growth will transpire over the course of a term might be too high, and so we find them at renewal underpacing utilization and things like that. And so this is something that our sales team is used to work and definitely an aspect of how the business runs with our contracts and the way that we sell entitlements. And so there's a lot of different levers. In any given your contract term, we've -- when you look out over the last several years, we've added one or two channels every single year. We add new data connectors. We've added new predictive capabilities got -- there's a lot of ways that the product surface area has expanded over time. There's also usually when you look out over an annual contract entitlement, even if they didn't hit their growth numbers in a given year, they still expect to grow into the next year. And we want to make sure that they're set up with predictable costs across whatever the term period is. There's also the unlocking of new use cases and the engagement with new teams. And so in many cases, when we land with a customer, even if they move over a specific channel, they often -- or they sometimes don't even move like all of the e-mail happening in their organization over to us. or they might not move all of their SMS or what have you, maybe they started with a specific use case, but they've proven out the value of those other ones. And so we find ourselves consolidating other vendors quite a bit when we go into that conversation. And so they're looking to decrease their spend overall across their basket of marketing technologies, but brave because of the gravity that our platform has to pull in new use cases and new channels over time. Often, we can consolidate out other vendors as they're working to find spend efficiency. Another area that we see people finding spend efficiencies as they lean into their usage with Braze more is through the Audience ink products that I mentioned during the prepared remarks, where we help them optimize the digital advertising and acquisition spend and our customers have seen tremendous results there. I think there's a lot of low-hanging fruit just because a lot of low-hanging fruit in that entire category because first-party data has historically not been activated to the that it can or should be for a lot of digital advertising and acquisition strategies. And so Well, in addition to the kind of internal to Braze contract levers that I mentioned before, there's also an entire category of just taking a step back, looking at their entire marketing spend and helping them optimize that in order for them to be able to maintain or, in many cases, in those situations still increase their Braze investment. I'll keep it one as well for the sake of time. I wanted to follow up and double click into the upsell momentum this quarter. Given increasing macro pressure on marketing budgets, what is driving the upsell momentum? How sustainable is it? Is it a function of how the product is priced by an MAU basis? Is it vendor consolidation? Is it this first-party data category just being less sensitive to budget cuts? Just trying to double-click into what is actually driving that up so momentum? Any color there would be helpful. Yes. So I think first of all, your list of options are all accurate. I will endeavor to kind of organize them by the magnitude of the impact. I think, first and foremost, the -- when you -- if you were to stack rank the ROI of the investments made in any given marketing organization, that those that are operating on top of first-party data and first-party relationships are always going to be head and shoulders above the investments being made on top of third-party audiences. And I talked through some of the reasons for that before, but the high level is that those first-party relationships are a giant asset. And the only thing that they really need to pay for is the ability to activate that asset. The investment in many cases, has already been made. And so when you're looking to optimize ROI, that's an easy place to start. Another important aspect of it is the vendor consolidation, which I just talked about through -- when I talk through the way that a renewal often runs as well as continued use case expansion. And then there are a lot of businesses out there that are also still growing. You'll we actually had in this quarter the sequential messaging and MAU growth from the prior quarter to this one, were both higher this year than they were last year. And so we are seeing robust growth in terms of the amount of just digital activity happening out there amongst our customer base. And so even though there is pressure on spend, and we are seeing certain areas where there are headwinds and growth for certain categories. Remember that BRACE is a highly diversified product that sells across all different verticals, all different company sizes and all the geographies around the world, and there are a lot of areas where growth is still robust, and we're seeing great upsell motions through those. Congrats on the quarter. One quick one for you, Bill. What are you hearing from customers when you're talking about marketing budgets and customer engagement budgets for next year what are you hearing? Are they thinking about resetting them lower? Is it -- does it seem to be more resilient from their point of view? Any color would be helpful. Yes. I think we're seeing broad-based sentiment where businesses are just trying to become more efficient in the spending that they're doing -- we're seeing technology leaders getting involved in a lot of the kind of marketing decisions as well and helping to rationalize the footprint of products that are out there. I think there's probably been a lot of shelf were purchased across people's environments over the last couple of years. It's one of the reasons that -- we've always been really focused on time to value, making sure that no integration gets left behind and that we are getting all of our customers up and running early in their annual contract life cycles. But we're definitely hearing from a lot of brands that they're kind of cleaning out the craft, if you will, from a lot of their software spend. We also are seeing that sentiment obviously shift or varying a lot by market, by industry and by geography. And I don't think that I could say that there's a broad-based like we want this to be higher or lower or the same as last year. It's really a focus on efficiency and making sure that when they're making new investments that those are delivering value to them quickly. Great. Isabelle, can we go back to the earlier question about sequential growth, as you probably followed, investors just went through this with the Zoom Info. So I'm just wondering, is sequential growth that you guided to a good starting point for how to think about next year. And if not, why would sequential growth not be a good indicator. Thanks for the question. So again, I'm not going to answer specifically how to think about how sequential growth going into Q4 relates next year. I think there's enough uncertainty out there. We are extremely confident with our long-term prospects. And right now, we are continuing to see the dislocation associated with the challenging and uncertain macroeconomic environment. What I will say about Q4 and the guide is we continue to approach this with a similar methodology to prior quarters and embed an appropriate amount of risk adjustment. And so as we continue to navigate this uncertain environment, that type of risk adjustment is appropriate and necessary. And we look forward to having more clarity coming out of Q4 and being part of the way through Q1 to give more specific guidance for FY '24. I was curious as to what you're seeing in terms of the competitive landscape? I know Salesforce just recently announced their customer data cloud, Genie and then Twilio Engage is now generally available. So just curious if there's any changes as to who you're running into and if there's been any impact on win rates? Yes. I think amongst the more established players in the space and the legacy marketing clouds. We haven't seen much difference over the last several quarters, even as they've made new product announcements. And I'm not going to speak too much to those specific competitors. But I think that when you look at the pace of product innovation in Braves and just the pace of customer pickup of new use cases and how we continue to advance our customer community. Then all those things come together to create a really robust offering that's really current with the skill sets that people have that's allowing them to really take advantage of the new investments that they're making in their data ecosystems and the new skill sets that they're investing in within their own teams. When we look across the legacy marketing cloud space and some of the -- some of the other fast follower, even start-up competitors that we have. We just don't see the same level product vision. We don't see the same level of R&D investment and they're built on architectures that are antiquated for the environment that we're trying to operate in. And so even as we continue to see like our legacy market cloud competitors try to overlay their older marketing cloud software platforms new shiny things that are meant to be able to more tightly integrate them together or what have you. The foundations of those products are still the same and so they still continue to have the same issues. And as we continue to push forward, we certainly respect a lot of the kind of incumbent and scale advantages that they have within the market, and those are really important for us to navigate. But from a product R&D standpoint, I feel really good about where we are positioned relative to the competition, especially when you look at just the velocity of what we're -- what we are actively announcing and releasing. All right. So I'll make a quick last one here. new customer add in the quarter was much healthier than last quarter. Was there any specific change to the go-to-market to better execute on the new customer acquisition front, maybe anything on the product bundling that you are doing to entice new customers? Just want to get a better understanding of new customer add in the quarter? Yes. So I'll first clarify that the new pricing and packaging that we're experimenting with is part of Start Anywhere, Go Everywhere didn't have a big impact in the quarter -- so it's something that we're piloting with a small set of account executives and we're excited to see that play a bigger role into next year, but you didn't see that in Q3 specifically. And then in terms of net new customer adds, I think that, as we've mentioned before, the pipeline is very robust and healthy. We've been seeing a lot of great new opportunities showing up, both inbound as well as a lot of our outbound execution, paired with the resumption of in-person events and a lot of other really exciting things that have happened in the pipeline. And you saw that translate into a healthy number of net new customer adds in Q3. Obviously, part of that is also tied to the work that we're doing from a sales productivity investment standpoint getting our new account executives up and running more quickly, helping our more tenured account executives, navigate landscape, more adeptly, and those things have helped with that new customer adds as well. But we also, as we mentioned in the prepared remarks, we're seeing those new business headwinds. And so it's been a difficult environment to fully predict exactly where metrics like that are going to land in a given quarter. I just want to thank everyone for your continued support. Thanks for joining us today and for the great questions after the prepared remarks, and we will see you again next quarter.
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Hi, good morning. Also good afternoon for those who joined from Europe. This is Nam Kim. Today, I am very pleased to introduce Dr. Siva Sivaram, President, Strategy, Technology of Western Digital. Dr. Sivaram has more than 35 years in semiconductor technology and in manufacturing. He has held executive position at Intel and Matrix Semiconductor and SanDisk previously. We also have Gabriel Ho from IR team. So hi, Dr. Sivaram and Gabriel. Great to have you here today. Thank you. Thank you. I will ask you, Dr. Sivaram, a list of questions, then later open up for Q&A. Investors can take questions or send the question to our team through e-mail, so we can read your question at the time. So the first question I would like to ask is this, WDC, previous SanDisk, we did Toshiba, you guys invented the NAND Flash technology, floating gate-based NAND technology, then you moved to charge trap in 3D NAND structure. However, some companies still, like Intel, now slowly dying, but still use the floating gate-based 3D NAND. As a technology expert, what drove your decision from floating gate to charge trap? Do you think floating gate-based 3D NAND can be sustainable? If not, then why is floating gate-based NAND seems easier to have a multi bit per cell, like a QLC versus charge trap? So I just want to have your opinion on this between floating gate and charge trap? So Nam, when we make technology decisions like this, you look at it from both sides from market and broad-based applications that we can develop, and with cost and ease of process development in the fab. You have to look at both sides of it when you make it. As you said, we originally invented NAND flash technology. The floating gate technology has been around for a very, very long time, where you use an oxide layer where you store a charge. 2D NAND was fully always floating gate. But the number of electrons that were available for multi bit processing was getting lower and lower and lower. So by the time we reach the limit of 2D NAND, we had maybe 10, 12 electrons effectively per state for us to work with. It was getting to be very, very narrow. When we move to 3D NAND, you have this technology where you are now replacing the broad-based applications, all the way from consumer to mobile to client to enterprise, each one having different needs. One needs to be low cost, one need to be high density, one need to be low power, one -- these kinds of many differences. We go look at the application as to how we are going to develop. So in doing a 3D NAND, you stack many, many layers, oxide, nitrite, oxide, nitrate layer and then you etch them all together. The ease of processing with charge trap is a lot better than floating gate. You are able to provide higher density, more layers, more bits, even 3 bits, 4 bits per cell is much easier to do it on charge trap than on floating rate, which is running lower and lower on electron count available and on a very complex process. So that's why the entire industry moved to charge trap, only Intel decided to stay on floating gate. I cannot talk to as to why they decided to stay that way. But Intel has a very long history of staying with floating gate. In their NOR flash, they had the ETOX process, they had for a very long time. So I cannot talk to them, but all of the rest of the industry has moved to charge trap, which is the technology there for the long-term for all of us. It's not -- floating gate is no longer a viable technology for 3D NAND. Okay, okay. Understand. And then now on another question on something people are always curious about. Industrial drivers are always interested in storage transition from HDD to SSD. I think that what you see is the most qualified company to answer this question, if you make those product and understand technology very well. I understand a lot of cloud companies are currently trying to use more and more SSD as there are so many benefits like power consumption, footprint and speed. And at the same time, 3D NAND capacity is required for making HDD as extended mass authority tools. So what's your view on SSD penetration in the mass storage and cloud in the future? I know many people believe the cost per bit is key criteria, but I feel we need to think more broad issue other than cost per bit. So can you share your view on where we are and how long it takes to replace some degree of HDD with SSD? Or can SSD ever replace HDD in mass storage space? And because people are used to thinking about what happened in client in PCs, where slowly people replaced their hard drive storage with solid state. These days, when you go buy a PC, laptop, you buy only solid state drives. There's a very, very small percentage of hard drive still sold. So people think in this replace mentality mostly. Let me give you the statistic. In 2021, last year, in data center storage, the mix was 88% HDD, 12% SSD. The projection for 2026 today, five years from the 2021 bid, is 83% HDD, 17% SSD. So it is not like flash is not growing. The overall TAM is growing and flash percentage is growing, but HDDs also growing. So the difference in cost, especially when the large capacity enterprise. So today, for example, our leading products in hard drive are 22 and 26 terabyte drives. In that kind of densities, the cost difference is still almost 8x to 9x. And to replace that kind of volume is going to take a long time. So in my mind, these are two parallel lines. They're going to stay parallel for at least through the end of this decade. Then is going about flash. Clearly, there's -- but you're going from 11% to 12% to 17% to 19%. You are not becoming 70%, 80%. It will grow, because both are going down in cost and capacity is growing, overall data needs are growing. So SSD will remain mostly in fast applications, HDD will always in colder large data applications. Okay. But critical reason is not just a price difference, right? I think SSD, you have some endurance issue. So it is beyond the price parity, right? It's not that. No, that's not fair to say to the SSDs. So if you were to use, for example, the number of drive rights that the hard drive uses and use that on SSD, SSD will live the same amount of time. It is capacity available as cost is an important factor. And how fast HDD is also growing. HDD capabilities, the existing fleet and incumbency, those are all very useful for HDD. People know how to run with HDD. Last year, AWS had made a speech in the AWS major conference. The King of storage is HDD. That's the way even the enterprise guys in data center people are still thinking. Okay. Okay. Good point. And then we've been seeing recently many emerging SSD technologies, such as computational storage, like SSD plus SoC. With the rising AI and high performance quality in data center, what's your view on SSD in the future? Do you think today's SSD technology needs to be changed? What do you think can be changed in five years on SSD in the cloud space? Yes. So just like when the markets grow, there is segmentation honestly. Each big cloud player uses the SSD in their own unique way. And someone just uses it for search, someone uses it just for streaming, someone just uses it for database, they are different. Now that's upfront each. They manage their fleet very differently. But more interestingly for us, there are some vectors where things are changing. Massive SSDs, new category. So when I now come and say, I can have a 50, 60 terabyte SSD, that's one category. Ultrafast SSDs, with very fast -- very low latencies. Now we are talking, starting to talk single-digit latencies, different kind of SSDs. Computational storage that you are talking about, where standard functions like encryption or sort of data -- video format converting. These kinds of standard functions can be embedded closer to the data as opposed to having to move all the data back up to the compute and do it. So you are now starting to see more compute functionalities in the SSD. Now you have a question, whether I do it in each SSD or I put the SSD in a fabric and have a large compute close to an array of SSDs. These kinds of configurations are also growing. So SSDs in a fabric; SSDs with different attach; SSDs, which are very large with the lower I/O speeds; SSDs that are extremely fast, which are smaller; many different segmentation of SSDs are starting to come in. SSDs that are used in storage versus SSDs versus boot SSDs that are used in compute, many kinds of SSDs are coming up. Yes. Okay. Okay, got it. And then let's talk about CXL. I think investors also has a lot of interest on CXL. This is new things coming. There's been a lot of discussion on CXL, but public seems more focused on DRAM side. This is a great way of pulling DRAM for different hosts. Can you explain in detail how CXL can benefit NAND industry and WDC? When do you think CXL will contribute to your business meaningfully? Yes. This is by the way, CXL is an area of very immense interest for us. As you said, CXL now allows accelerators, whether it is data processing units or TPUs or whatever to directly access DRAM in a coherent fashion. And that CXL 1.0 just starting to ship, CXL 2.0 is already out there and people are starting to figure out, CXL 3.0 coming up in the next couple of years. What it allows us, first and foremost, is tiered memory. So pooling of the memory and tiering of the memory is the first step that CXL allows us to do, which means we automatically think as to, okay, if I had low latency flash, can I make that into a peer buffered in the front by DRAM. So can I have a larger cache of DRAM, cache SSD in the back of it? And SLC NAND is still very cheap. So you can have a, for example, 1 to 2 microsecond SLC flash. Can I put that as a tier behind DRAM? The DRAM in the 100 nanosecond or so as a pipeline [ph] access. And behind a slightly segmented SLC flash, would have very, very fast access is an important application that's coming up very soon. But I think what we are more excited about is other non-DRAM, nonvolatile memories will now become popular. Because when you have other memories that will develop, along with flash, now you have a very finite gradation in the way memory can be used. There's SRAM, there's DRAM, there's a fast -- there's other memory, plus SLC, plus MLC. You can have a full gradation of storage that we can use. So we are very excited about CXL 2.0 and 3.0. I don't expect it to be in revenue -- in volume revenue till probably 2025 -- 2024, 2025. Okay. Okay, got it. According to your slide during your Analyst Day a few months ago, WD Kioxia JV has a smallest die side and best CapEx efficiency. Can you share how you achieve this, and what is the key to doing this? This is an important area. Everybody, when you go, they always talk about, I got more number of layers. People always come and say, I got 168, I got 232, I got data. We don't think that way. For us, more layers is bad, not good. You want to get the same bit growth and cost reduction with the fewest number of layers. We want to do with the fewest number of layers, and we do that by, in our own mind thinking, the Z axis, the number of layers, you multiply as a lever the X and Y axis shrink. If I can get more X and Y axis shrink, then I can multiply by the Z axis, I get an overall multiplication. Z axis, the number of layers is very expensive. It's linear. So every layer now needs to add cost. Adding -- you need to etch deeper, you need to do more depositions. It does not -- there's no leverage there. The leverage comes from X and Y shrink. So we are very conscious about X and Y shrink. We make sure we remove overhead. We make sure that we are the maximum whole density possible. So we do X shrink, Y shrink, Z careful held at a fixed number and then logic. I want to make sure I go from 2, 3, 4, 5 bits. And so if you keep that mentality, we come back and say, optimize for the lowest CapEx per percentage increase in bit growth. So for the same bit growth increase, I want to minimize the CapEx. And that is done by I do a maximum amount of reuse. I try to reuse from the previous node as much as possible. If I go too high, then I cannot reuse. I need the latest tools. This is how we have dramatically reduced the CapEx compared to anybody else in the industry. Our -- I showed this slide in the Investor Day. We are probably almost 30% lower than the nearest competitor. Okay. Okay, got it. And then how much do we have left on current charge 3D NAND technology? I mean each company has a different road map. I think you point to a very interesting angle here. However, do you think 300,000, 500,000 layer 3D is possible? I mean, people keep increasing number. So where are we in terms of layer? And what will remain challenging from here? I mean, people are talking about over 300, 200 layers, 300 layer. One of your competitors say they cannot chip 1,000 layer, so ⦠But then you focus only on the next two generations, because there is so many engineering problems to be solved in the short-term that the technology that I'm going to develop for next year, the following technology and maybe the one after that we have some vision for. The rest of them are all, "Hey, do I see some major problems in that?" And we don't see it. In 3D NAND, we don't see a major problem with -- I've done two tier. I can now go to 3 tier, that can be done. We have done -- what we have done with respect to lateral shrink, we have now seen we can do X3, X4. We have talked about X4.5, X5. These are also in the card. And we are also seeing, as we said, in the future wafer bonding. Yes, yes, yes. And the other thing I noticed recently was surprised that NAND wafer processing time has reached about 6 months today in the case of 160, 170 layer. It seems even worse than DRAM in increasing the number of wafer processes that -- now I remember NAND wafer processing time of the last number of months a long time ago, I wonder how NAND supplied like WDC will try to deliver this issue. I mean in the DRAM [indiscernible], they use EOB [ph] to cut down some processes there. So how will you deal with increasing wafer processing time from here? So I wanted to be objective. In logic, the quick cycle time is important for prototyping. We need to make sure that we get it done. In memory, normally, as long as the fab runs full, cycle time is not so important in the old days. But of course, for yield improvement, defect improvement, those kind of things like time is important. As long as the fab runs full, we are not like, "Oh, I need a prototype, et cetera." During development, cycle time is very, very important because you want to make sure that you can ensure that you have changes you make, you can get it back. So we have developed a lot of techniques around it. How do I just process the CMOS, simulate the back end, get the data out of it? How do we just process segments of the array, make sure that we can get the data that you can. So when I put all that together, even now our cycle times are on the order of 80 days, 90 days, so 3 months is where most of the cycle line is. Now having said that, your point is correct. Later on when we go to wafer bonding, when the industry goes to wafer bonding, you can do two in parallel. So the CMOS gets processed separately, array gets processed separate. So you cut the processing time one-third, two-third. The array takes two-thirds a time, CMOS takes one-third the time, they are done separately, and then they come together, right? There are many such techniques, but we do need to worry about it because the number of steps is long. The theoretical time it takes to do the steps is very long. I mean, you may imagine, on a 238 layer, I have to deposit 238x oxide nitride, oxide nitride, oxide nitrate, right? So it takes a long time. Yes. I mean you briefly touched about wafer bonding. I think this day, this is a hot topic because it could be the next big move in this industry. So can you explain what wafer bonding is for those who are not familiar with this term? And what were the benefit and challenge of this technology? And when its time line for NAND wafer bonding in the industry? So wafer bonding is not a new technology. Wafer bonding has been in very high volume production for optic sensors. CMOS sensors have been doing the back end processing and on the CMOS and growing them together. What you do is have exposed copper on both ends of the wafer. And when you bond them together, the copper attaches to each other on either side and you provide the continuity. So now instead of one wafer being processed per die, now you have two wafers being processed. In NAND, the most important problem is CMOS, when you make the transistor and then you subject it to all the back end thermal processing, all the heat cycles at the back end the transistor is degraded. What we do now is you process the CMOS separately so you can have very high density, very narrow advanced CMOS, make the array, the 3D superstructure. So you make the parking lot separately, skyscraper separately and join them together in one go and polish one side of it, and that's how you get the device. And this is -- the technology is known, but adapting to a high volume manufacturing like NAND is very difficult to do. It's very advanced in the way you lay out, you allow for how to make sure the two join with the perfect yield. How do we allow for redundancy. So it is going to be a mainstream very soon. We think that this is one of those big steps that NAND will take very soon. So what does it mean to cost structure and like CapEx? For example, I think maybe some of your competitors may moved to wafer bonding maybe later stage, maybe some of your competitors moved already. Do you think the [indiscernible] the better? Each one to their own. So we know our market, we know our application. Wafer bonding, as you can see, you add one more wafer cost, right? Obviously, you had one more wafer cost. However, in terms of yield and in terms of how fast do I go to two tier versus three tier, those kinds of things may make the overall cost cheaper just to spend a wafer cost, let's say, $50 per wafer. So you are just adding $50 extra, but in a $3,000 wafer, but you may get saved somewhere else. So this analysis will be done by each company separately on their own. And for their application, their densities, if you are making lower density products, you may not be able to do it. You do high density products than you may want to do early, et cetera. Okay, got it. I think -- yes, I'm excited to see this thing happen in a few years. And then the NAND [indiscernible] regarding the more challenging in DRAM, mainly because there are more players, certainly, it is a very tough time today. Many believe the market needs to be further consolidated. What's your view on this? Or what need to happen before the market for the stabilize? Do you think NAND can be ever like a DRAM, which generate like 40%, 50% normalized operating profit margin? Nam, you've been in this business a long time. I've been in this business a long time. You remember how bad DRAM used to be. DRAM was an extremely cyclical market that nobody could sustain so many players and is getting a lot streamlined the fact that hynix bought Intel, took one player less in the marketplace. Various export kind of things are rationalizing the market more also. But even better, I'm seeing more and more the different players are playing a much more rational game than trying to just go get market share. It's not -- everybody is not trying to grab market share. People -- there is some rationality. You saw how many people announced reduction in CapEx spending, reduction in wafer start. All of that, every player is starting to do it. It is a much more rational marketplace. Should there be more consolidation? As a player, I would always like for it to be more, but that's not for me to decide. It is an open marketplace where it will happen when it will happen. But in the long-term, rationality of the players is the best way that this industry continues to be more profitable. Yes, yes. And then I know WDC has been recently doing well with enterprise SSD for cloud customer. However, some of the cloud players like AWS, making their owners [indiscernible] their third-party controllers, the DIY type of enterprise SSD. Now I know you guys can still do business with the NAND wafer. However, cloud guys engagement on building their own SSD can devalue NAND supplies of business, I wonder. So clearly, today, only a few hyperscalers do this. So what should be on cloud values, cloud company building their own SSD? Is this going to be a threat to SSD suppliers? So we look at it slightly differently. There has always been a lot of players trying to make SSDs with somebody else's NAND. There is Taiwanese players that do it, there is high-end players that do it. They have always taken third-party controller, their firmware by somebody else's NAND and integrate it to make SSD. It has always been around. Cloud players, of course, have a lot more money. They have a lot more resources. They also know exactly what their workload are. So they would like to make their own, and that it makes sense. However, as you know, NAND -- the most important thing is technology changes every 18 months. With every 18 months, we introduced new changes to the process, new changes to the device, new architecture changes. And so it is now becomes important for the cloud player to follow very, very, very closely and then adapt to it. Otherwise, they can't be cost competitive. If they are willing to do it and they are willing to buy NAND from us, we are happy with that also. Because then they have to pay for a differentiated NAND. Now in the end, it will reach an equilibrium. For somebody who runs very, very, very high volume on one kind of SSD, they may just do themselves, where we will supply NAND to them. For others, we will continue to make enterprise class SSD. Even today, each cloud player asks for something slightly different. It is not a standard SSD that you supply to everybody. Each one wants their little twist on the SSD. So we are customizing them for them anyway. So whether we are the customizer or they are the customizer in the end, they have to pay for that. Okay. And then a couple more question before we go into Q&A. Auto, including in the current data center will be potentially a huge demand driver on memory in the future. So can you talk about opportunity in auto space for memory supplier like WD in a bit more detail? And when do you think auto will take a meaningful portion of the NAND market? Yes. So I want to be very clear when we say auto. In the transportation sector in general, cars by themselves are not a big consumer. There are a fixed number of cars that are being produced. But autonomous is a big consumer of NAND [ph]. As every means of transportation becomes more autonomous, whether it is trucks, whether it is long haul trucks, whether it is fleets of delivery trucks, our cars become more and more autonomous, and more autonomy is included, then given the number of sensors and processing we think there's going to be multiple ways this is going to increase storage. Storage in the cars, in the vehicles themselves, storage in local data centers, meaning edge data centers, and then storage in their own central cloud data centers. All of those places storage is going to increase. So we are going to be directly related to the degree of autonomy in the vehicle. So when you can predict to me how much autonomy is going to be, I will also plot for you how flash increase in the transportation sector is going up. As you know, autonomy has been delayed more and more and more. We said, by 2020, everything will be autonomous, and we said by 2025 -- autonomy is playing out very differently than the way we thought it would. We are no longer saying self-driving cars all the time anymore. But we are talking about a hybrid autonomy. And in those things, as they develop, we will be a big presence. That's where the big growth will be. Okay. And one of your SSD competitor recently talked about SSD as service? SSD supplier can study customer storage usage can provide cloud customer service, so your customer can reduce CapEx with a more subscription type of business. It's going to be a new business model for sure. In this case, memory suppliers can have higher value increase on recurring revenue. Do you think that this can make sense? I know when AWS like hypescaler even make their own SSD, what's your opinion on SSD as a service business model? So clearly, we want to experiment with many different business models. But the one thing we never want to do is we don't want to ever compete with our customers. One of our hard drive competitor has tried this model, trying to go run a storage as a service as a competition to their own customers. We have not done that, don't do that. We will work with our customers with any business model they work. If anything, clearly, big cloud customers have a stronger balance sheet than us for them to carry it than we can, but we will explore. If there are second and third tier players that would like to do it with us, we will obviously explore this opportunities, both on the hard drive side and on the flash side. It's the same idea. And in both cases, we know a lot more about our drive than anybody else does. We actually, in our hard drives, we offer a fleet monitoring service, where we can get the real-time health of our fleet. And we can apply it across so that we can extend the life, et cetera. These models are always been around. How we monetize it is going to be different by different customers, different service agreements that we have with our customers. Okay, okay. In the smartphone market, NAND content has risen to like 5, 12 gigabyte, in some case, 1 terabyte. How much room to grow do you think we have in consumer devices like smartphone? Clearly, I don't think I need more than 1 terabyte. What's the long-term outlook and growth prospect in this smartphone market, which accounts like 40% of NAND demand today? If smartphone market become ex growth, what's going to replace a smartphone as your main demand driver? Yes. So there are two things that you said, and I want to make sure we think through both of them. I remember when I first got my 16 gigabyte phone, I was like, wow, 16 gigabyte in my cellphone, now I buy a terabyte. Certainly on my laptop, I'm much older than you, my first laptop had a 20 megabyte hard drive. And we now talk about -- there are people who actually buy 16 terabyte hard drive for their desktop computer. So I'm never going to say what the ceiling on how much storage goes into each device. Now having said that, you're absolutely right. I mean, mobile phones as a general market in unit growth is starting to be a mature market. But the growth of data, on the other hand, has not slowed down. So whether it is endpoint devices, edge devices or cloud devices, overall data is still continuing to grow. So cloud growth is very big. As you know, we continue to have a large cloud growth projected. Edge data are growing up very, very fast. And of course, end point devices, there are so many IoT devices that need, whether it is, surveillance, or we said, automotive that you just talked about, smart video, multiple new consumption mechanisms are coming up everywhere, industrial and smart TV, and so many places where there is demand for storage that I don't see -- and consumer devices are still continuing to grow, whether it is USB, SSD, or microSDs, they still continue to go. So the breadth of opportunities is there to replace any one market that stabilizes. Yes. One last question, maybe this is a near-term question before we go to Q&A. Unlike a competitor like Micron, Kioxia and so on, WD hasn't mentioned any production cut. So I just want to ask why overall demand is obviously very weak and supplies inventory keep rising at a very high-level at this time. What's your criteria on production cost, I'm just curious? Yes, so this is also depends on individual vendor on their particular situation. We have announced big CapEx reductions, and we announced it early enough. So 6 months, 8 months, hence, there will be production output reduction. We have also talked about slowing down the ramp of BiCS6. That reduces the bit growth. We have not done immediate reductions, but we have done our own way of rationalizing supply. It depends on when do I have short-term demand, when can we place bits short term, long term, what is my current inventory position, those things help me make that decision. I know our partner has already announced a reduction in wafer starts. We have indicated other means of reducing bid growth. Okay, got it. Okay. Now my question is over now. And I will let investor have a chance to ask a question. Jim, do you have any questions? Yes. So we had a few come in. One, just to clarify, you obviously covered auto, the auto storage question a little earlier, but we had an autos question come in ahead of that. And maybe there was just a couple of points to clarify. So one, which I don't think you covered, was what portion of SSD is autos today? And the second was, do you have to have auto grade qualification to sit in the [indiscernible] chain? So that's the first one. So that first question, Jim, automotive has different applications under the hood versus in the other parts of the car. And we do automotive certification of NAND, and that is a substantive part of our revenue. We don't break out that revenue and talk about it explicitly, but we do participate in that marketplace. Most of those devices are eMMC devices. Automotive still does not use sort of a PCIe SSDs in different segments. We have a lot more of eMMCs and UFS drives that go into automotive. And we are qualified and we are shipping those in volume and to multiple customers around the world. Great. Thank you. And then a second question from the floor. Again, you touched on it just at the end here, but there was a question on Kioxia obviously announcing they started cutting wafer input. What is that -- does that mean there's no change on your side, on the wafer side and the underutilization charges in the fab only apply to Kioxia? So to the second question, the underutilization charges only will apply to Kioxia. They will not apply to us. Now having said that, the reduction in wafer starts is always an opportunity for us. We will apply it at the appropriate time if needed. When and if needed, we will do the same. But for us, we have gone a different route. The route we have gone, of course, as I said, is we have reduced overall CapEx substantively and we have reduced the rate at which we were converting bits from BiCS5 to BiCS6. Both of those lead to lower bits going out into calendar '23. Okay. So maybe a final question to Gabriel. A lot of investors are worried about [indiscernible] environment. So what's your message to investors? Any update on -- anything you want to add? Yes. Thank you. And I think the market condition, so we are not updating the guidance or reiterating the guidance today. But I think -- what I think [technical difficulty] he came on board 2.5 years ago, he separated the 2 businesses. And I think that cash tree brought in [indiscernible] I think actually from HDD side. And we are [indiscernible] on the flat side team that actually added a lot of activity on the businesses. If you look at this past fiscal quarter, in the September quarter, it was an incredibly difficult environment, and we were able to, I think, actually meet, I think, the revenue at the upper end of the guidance range. And also on the product line side, I think he added, I think a lot of the -- I think one thing we would like to talk about is the 26 terabyte hard drive is a result, I think, of that lobbies, activity and product road map improvements that we have done there. And near-term, the business environment is challenging, but I think next week, as the demand continues to improve, maybe later part of the fiscal year, we see the opportunity to improve the gross margin further. And then on the other side, on the flash side, we also have like 5 pillars, not a bit, to place the bits. And that's part of the reason I think, at this point in time, we are not reducing the wafer input because I think we see a lot of market where client SSD, retail side and then also emerging position on the enterprise SSD, along with gaming, I think these are all the pillars where I think we are able to place the bits and continue to generate cash flow. So I think that's just some points to consider. Okay. Thank you. Okay. I think this time, I like to wrap up. Thank you for joining this call, everyone. Dr. Sivaram and Gabriel, thank you so much for your time. We certainly learned a lot today. So thank you. And then okay, next session is the NVIDIA with Mr. Ian [indiscernible]. Brett Simpson will host the session. Let's have a quick break, and please dial back. The next session will start at 11 AM.
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EarningCall_1653
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Greetings, and welcome to the Oxford Industries Third Quarter Fiscal 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note that this conference call is being recorded. Thank you, and good afternoon. Before we begin, I would like to remind participants that certain statements made on today's call and in the Q&A session may constitute forward-looking statements, within the meaning of the federal securities laws. Forward-looking statements are not guarantees, and actual results may differ materially from those expressed or implied in the forward-looking statements. Important factors that could cause actual results of operations or our financial condition to differ are discussed in our press release issued earlier today and in documents filed by us with the SEC, including the risk factors contained in our Form 10-K. We undertake no duty to update any forward-looking statements. During this call, we will be discussing certain non-GAAP financial measures. You can find a reconciliation of non-GAAP to GAAP financial measures in our press release issued earlier today, which is posted under the Investor Relations tab of our website at oxfordinc.com. And now I'd like to introduce today's call participants. With me today are Tom Chubb, Chairman and CEO; and Scott Grassmyer, CFO and COO. Thank you, Jevon. Good afternoon, and thank you for joining us for the third quarter of fiscal 2022 OXM conference call. As most of you know, our purpose as a company is to evoke happiness in our customers with the products, services and experiences, we offer through our portfolio of brands. When we are successful in evoking that happiness, our businesses deliver profitable growth and, of course, sustained profitable growth is what allows us to accomplish our objective of driving long-term shareholder value. And we certainly did that during the third quarter, delivering our sixth consecutive quarter of record adjusted earnings. Strong top line growth across all our brands, combined with the acquisition of the Johnny Was brand in September fueled a 26% sales gain. Sales in the aggregated group of Tommy Bahama, Lilly Pulitzer and emerging brands grew 19% and with Johnny Was contributing an additional $23 million of sales for the quarter. At the same time, adjusted gross margin improved an impressive 120 basis points. All of these factors, along with our repurchase activity helped drive a 23% or $0.27 increase in adjusted earnings per share from $1.19 last year to $1.46 this year. The biggest contributor to our increased earnings was our largest brand, Tommy Bahama, which delivered 20% top line growth and a $9 million increase in adjusted operating income for the quarter, with excellent results in all channels of distribution. Lilly Pulitzer are also had a successful quarter with sales growing 16% and positive comps in both retail and e-commerce. Finally, our newly constituted Emerging Brands Group had a revenue increase of 22% during the third quarter. We have also recently advanced a number of strategic initiatives. I will highlight just three among many. First, during September, we added the Johnny Was brand to our portfolio of lifestyle brands. The brand has clearly defined positioning, which drives emotional connection and strong engagement with its very loyal customer base. Johnny Was has priced a bit higher than our other brands and sits in the very attractive affordable luxury portion of the market. The brand has an excellent balanced distribution model with 40% of sales coming through e-commerce bolstered by a fleet of 60 plus carefully located stores with attractive unit economics and a brand enhancing and mutually profitable wholesale business, currently generating annualized sales of over $200 million with operating margins in the mid to high-teen range, Johnny Was has a profitable growth trajectory ahead of it. The brand is led by an excellent management team that has been in place for many years and is well aligned culturally and strategically with OXM. The Johnny Was an OXM corporate teams have been working hard on the integration and laying the foundation for future growth in the brand. I'm grateful to all of them for their extraordinary efforts and the successes that they have achieved so far. In November, we were also pleased to announce our first Tommy Bahama branded hotel, the Tommy Bahama Mira Monte Resort, which should open in late 2023. Tommy Bahama is a long time player in the hospitality business with a restaurant business that's over 25 years old and does more than $100 million in business annually. Our customers have long viewed a resort hotel as a natural extension of our hospitality business. One of our most successful restaurants is located in the Coachella Valley in California, where we've been operating a bar restaurant and store in Palm Desert since 1998. We also opened a Marlin Bar in Palm Springs in 2018. For those of you who are familiar with the Coachella Valley and/or our Tennis Fans, the location of the Tommy Bahama Miramonte Resort will be an Indian wells, which is also home to the BNP Paribas Tennis tournament. We have a fantastic partner in the Low Group and have been discussing this opportunity with them for a number of years. We are glad to see it coming to fruition. We look forward to the opening in the hotel and hope that all of you will be able to visit. Third, we continue to make excellent progress in our ability to attract and retain customers and drive customer engagement. As of the end of the quarter, our customer base, excluding Johnny Was customers, increased by 16% versus last year's third quarter. Including, Johnny Was, as of the end of the quarter, we had 2.5 million identifiable unique customers who have transacted in the last 12 months. We not only brought in more customers, but they spent more with us as well with average annual spending increasing across all of our brands. We believe that most of these gains are attributable to our digital marketing efforts, which have been a strategic priority for us across the enterprise this year. Included in those efforts have been the establishment of a marketing center of excellence whose principal function is to service the brands within our emerging brands group. This team was built during this fiscal year and began posting some very impressive results during the third quarter particularly during the Black Friday, Cyber Monday weekend. With a little less than three weeks to go before Christmas, we feel very positive about the holiday selling season and our ability to deliver a strong fourth quarter. Scott will elaborate more in a minute, but our inventories are in excellent shape to support holiday season as the result of more normalized levels as well as bringing in inventory early to avoid any supply chain snows (ph). Finally, as I do every quarter, I would like to thank and express my gratitude to our incredible team of people. Whatever their role within the company may be their commitment and dedication to evoking happiness in our customers is simply unparalleled. A great example of this occurred during the aftermath of Hurricane Ian, notwithstanding the fact that it struck one of the most important markets we have in the entire company and notwithstanding the challenges the hurricane had on their personal lives. Due to the commitment and resilience of our people, we hardly missed a beat and we were operating on a business-as-usual basis within a very short time. This is just one example among many of how focused our people are on serving our customers. We are very grateful to all of them and wish all of them and all of you a very happy holiday season. I'll now hand the call over to Scott, who will provide more details on the quarter and our outlook for the balance of the year. Scott? Thank you, Tom. We're thrilled to deliver our sixth consecutive quarter of record sales, gross margin and adjusted earnings in the third quarter of 2022. Excellent performance was driven by revenue expansion in all of our brands and distribution channels versus the third quarter of 2021. Consolidated net sales were $313 million for the third quarter, which included $23 million of sales for Johnny Was, growing 26% above last year's third quarter sales of $248 million, which included $4 million of sales from linear apparel. This growth was strong across all distribution channels with increases of 22% in full price bricks-and-mortar, 26% in full price e-commerce, 32% in wholesale, 17% in restaurants and 15% in outlets. We also had increased sales of $9 million in the Lilly Pulitzer e-commerce flash sale. Meanwhile, adjusted gross margin expanded to 63.4%, which is 120 basis points above last year's third quarter. We benefited from lower freight costs, which included less air freight due to the early receipt of inventory and from lower freight rates. Also, we increased IMUs. This was partially offset by the impact of Lilly Pulitzer's larger flash sale this year due to extremely lean inventories last year. Adjusted SG&A expenses were $171 million in the third quarter of 2022 compared to $131 million last year. This increase was driven by the addition of Johnny Was operating expenses as well as increases in our other businesses for employment costs, advertising costs, favorable expenses and other expenses to support sales growth. The result of all this yielded $33 million of adjusted operating income compared to $27 million in the prior year period with improved operating income driven by the strong results in Tommy Bahama and the inclusion of Johnny Was for half the quarter. This level of operating profit, combined with a $0.07 benefit from our share repurchase program led to EPS growth of $0.27 to $1.46. I'll now move on to our balance sheet, beginning with inventory. With employees up 61% year-over-year on a FIFO basis, we're in a good position to capture the sales momentum we built throughout the year. Two strategic actions contributed to the inventory growth. $25 million of additional inventory from our acquisition of Johnny Was and the early receipt of $20 million of incremental inventory to mitigate supply chain disruptions, increased product costs and raised inventory balances as well. Comparing back to 2019, our 25% revenue growth for the first nine months of the year significantly outpaces our FIFO inventory growth of 14% over the same period, even with the earlier receipt of product. From a liquidity standpoint, we had $15 million in cash and cash equivalents versus $188 million of cash, cash equivalents and short-term investments at the end of the third quarter of fiscal 2021. We also had $130 million of borrowings outstanding under our revolving credit agreement at the end of the third quarter of fiscal 2022, increasing from no borrowings at the end of the prior year period. The change in our liquidity position was clearly driven by our funding of the Johnny Was acquisition, which we believe will yield significant long-term benefits to our shareholders. As of today, we have returned $134 million of capital directly to shareholders in the last 12 months via dividends and open market share repurchases. A $100 million of this came from repurchasing, 1.1 million shares or over 6% of total shares outstanding at the inception of the program in Q4 of 2021. $5 million of these repurchases occurred in the fourth quarter of 2022. This represents the completion of the $100 million share repurchase program. Looking forward, I'm pleased to announce that our Board of Directors declared a dividend of $0.55 per share for the fourth quarter of payable in January. I'll now spend some time on our outlook for the remainder of the year. For the full year, we are raising our sales guidance to a range of $1.395 billion to $1.41 billion, up from our prior range of $1.375 billion to $1.405 billion and compared to sales of $1.142 billion in fiscal 2021. Accordingly, we expect adjusted EPS for fiscal 2022 to be between $10.60 to $10.75, up from our previous guidance of $10.25 to $10.60 and compared to $7.99 in 2021. We expect sales in the fourth quarter of 2022 to be between $366 million and $381 million compared to sales of $300 million in the fourth quarter of 2021. More than 60% of the sales increase is expected to be from Johnny Was sales. These updated guidance figures also reflect strong holiday sales to date while contemplating the uncertainty as we believe shoppers are returning to pre-COVID holiday shopping patterns after shopping earlier in 2021. We also anticipate modest gross margin improvement in the fourth quarter. These higher sales and improved gross margins are expected to be partially offset by increased SG&A, higher interest expense and a higher effective tax rate. The fourth quarter 2022 include a full quarter of interest expense. After the third quarter only included about a half quarter of interest expense as we were debt-free until acquiring Johnny Was in mid-September. We expect the effective tax rate to be higher this year as Q4 of the prior year included certain non-recurring favorable items. After considering these items, Fourth quarter adjusted EPS is expected to be between $2.01 and $2.16 versus adjusted EPS of $1.68 last year. The fourth quarter will be the first full quarter of operations for Johnny Was as part of the Oxford family. We're excited to have added a business with annual net sales in excess of $200 million, the opportunity for double-digit top line growth in the future, the expectation of approximately 65% gross margins and mid to high-teen operating margins, excluding any inventory step-up charges and amortization of intangible assets. Thank you. Ladies and gentlemen, at this time, we will conduct our question-and-answer session. [Operator Instructions] Our first question comes from Ed Yruma with Piper Sandler. Please state your question. Good afternoon, guys. Congrats on the quarter and thanks for taking the question. I guess two questions for me. First, more remodeling question. How should we think about Johnny Was from a seasonality perspective? Are there particular quarters where revenue or profitability has outsized impact? And I guess, just a more short-term question. You guys seem to have been very successful over the Black Friday shopping season with actually a less promotional strategy than years past, which is very different than obviously the rest of what we're seeing in retail. I guess, how do you contemplate kind of the remainder of the holiday season? And does your guidance contemplate maybe potentially having to be more reactive to what looks like an intensifying promotional holiday? Thanks, Ed. It's always good to hear your voice. And I'll answer the one about BFCM and the remainder of the season, and then Scott and Jevon can chime in with additional thoughts on that as well as the seasonality of Johnny Was, which is a great question. But I think what's happening this holiday season in the aggregate is very much what we thought would happen. We thought that the season would sort of normalize. And you'll recall well that for us and for many others in the market last year, customers started shopping super early and super hard. So they shop during October, which is still third quarter. They shopped hard during the first part of November. And then they shop through the holiday season, but it was much more tilted towards the first part of the season than it would have been in a normal year. The second thing that was very unusual last year is that for the first time in many years, the market was just not very promotional at all, primarily because people were short of inventory. This year, we expected things to normalize, and they have -- we planned accordingly. So the Black Friday, Cyber Monday five day period ended up being really the kickoff of the holiday season, which is the way that it's traditionally worked. And the level of the promotions in the marketplace, much greater than last year. I'm not sure they're really that much greater than they were back pre-pandemic. It's -- there's a lot -- we expected that, and that's really how it's playing out, and we expect it to continue to be like that for the remainder of the holiday selling season, and we built our guidance based on that assumption. And Ed, as far as the seasonality, Johnny Was it's really not that season. It's pretty level quarter-to-quarter where other businesses seem to have the spring spike in the lower third quarter. Johnny was as pretty level each quarter throughout the year. Thanks. It's Tracy Kogan filling in for Paul. First, I was hoping you guys could give us some color on the regional performance and performance in some of your bigger states. And then what are you guys seeing from your wholesale partners? Are you seeing any cautiousness at all, like we've heard from some others or is it really -- are they continuing to place big orders because sell-throughs are good. Thank you. Yeah. Thank you, Tracy. So on the regional performance during third quarter, it was really -- it was kind of good everywhere, but very happily for us, some of our biggest markets were actually the strongest of the strong. So Hawaii was really good. The Desert was really good. West Florida, even with the hurricane that happened down there still was just fantastic. So the regional lineup really worked well for us during the quarter. Again, there wasn't really anywhere that was particularly weak. But the strongest of the strong, we're really in the places that we would like to see it at most. So that was really a great outcome for us. And then in terms of retailer cost, and I think going into spring of 2023, they are definitely very cautious. Most of the big retailers and really most of the small ones to had cut back their open-to-buy dollars pretty meaningfully for spring of 2023. We actually think that's a healthy thing for the marketplace. It means they'll be appropriately inventoried, and we'll sell more at full price. In terms of our own bookings, I think we're getting much more than our share in that environment. So bookings, depending on the brand or sort of flattish to down very modestly, which we think in the environment is actually we're really getting more than our share of the open to buy dollars. And we think that's based on the performance and the strength of our brands and just yesterday, I was looking at last week selling from our -- some of our major wholesale partners where we get good reporting out of them on a weekly basis. And it looks really, really good. And over the long term, that's what we need to do to have successful wholesale businesses. And I think we're doing that quite well at the moment. Hi. Congrats on the quarter. Thanks for taking my questions. Just on the strong improvement at Lilly, could you just provide a little bit of color on kind of the change in marketing strategy and how that kind of played out in improving trends through the quarter? And then second, across a lot of your peers, we're seeing kind of stronger performance from brick-and-mortar relative to DTC, but you guys had a pretty even split in terms of growth rates. So just -- have you seen any different behavior among consumers shopping brick-and-mortar versus e-commerce or has the behavior largely been the same? Thank you. Yeah. Thank you, Noah for the question, and thanks for being on the call. And what I would say is, I think brick-and-mortar is having a great year. We're really happy with what we're seeing there. And while it is true that when you take the Johnny Was impact out of the picture. It was really sort of evenly balanced in terms of year-over-year growth in e-com versus brick-and-mortar. But if you think back to last year and then even the year before, it was much more tilted towards e-com. So the fact that brick-and-mortar is having the growth that it is this year, I think, is a different trend line than what we've seen before. We've been really happy to see it. It's wonderful. We expect to see that really continuing through the holiday. And actually, as we get closer to Christmas, kind of think that bricks and mortar will continue to get stronger. So great to see that. Love to see e-com still growing too, and it's a good picture all the way around. And then in terms of the improvement at Lilly, it was really about changing the partners that we were working with in the digital marketing arena and then sort of using that as the jumping off point to make sure that we were attending to all the fundamentals in the right way. In our digital marketing arena, I think that work is well underway. Obviously, it's well underway, and we've seen some great results to date, but there is also more to come there. There's more work to be done and also, I think, more room for us to improve our performance there. But we were delighted to see the positive comps in Lilly during the quarter in both bricks and mortar and e-commerce. Thank you. There are no further questions at this time. I'll hand the floor back to Tom Chubb for closing remarks. Thank you, Diego, and thanks to all of you for your interest in our company. We hope you enjoy the holidays, and we will look forward to talking to you again in the new year.
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Thank you very much, and welcome back to our conference. Good afternoon. We are honored to be joined today by Mike Gorenstein, President, CEO, and Chairman of Cronos Group. I, of course, I'm Andrew Carter. I cover cannabis and outdoor living here at Stifel. And so, I think with that, Mike, I think we'll just get right into it. We know who you are, but step back, tell us a little bit about Cronos. What was different and kind of the different approach you employed here to kind of start attacking the global cannabis category, starting in the first fully federally legal market, Canada. Yes, thanks for having me again, Andrew. Yes, I think we certainly started off different with a different view, maybe longer term, bigger picture, and now we're kind of very happy that we â the patient took that approach. I think it's probably well documented. I started off in the U.S. and was sort of looking at ways to get in the industry. Saw some of the regulatory challenges in the U.S. and saw Canada as an early opportunity to really go build a platform in the federal legal market where we could focus on innovation, focus on, sort of getting everything right and then moving to other markets as they open. So, our focus is much less driven on capacity and more about, what IP can we build, how do we get the right products for specific consumers and how do we make sure that something that's transportable and borderless. And I think that's, kind of led us to where we're today. Got you. Of course, the business itself though does start in Canada. You've carved out a nice nascent position. You have â by most data, like one of the stronger brands. But start out like you did say you took a different approach, talk about what the limitations are of the market and at this stage over four years since legalization, what has surprised you in the market's development? Sure. So, I think there's a couple â there's limitations and there's like, there's things that are certainly huge opportunities and I try to think of it kind of relative to the U.S. versus a Europe. But one of the limitations of a very restrictive marketing regime that's pretty close to what the U.S. tobacco marketing regime is. So, your ability to differentiate around packaging is â it's still there, but it's still a little bit more limited. You do have with some formats kind of real issues around what you can do for how much you can put in pack, what the concentration is. So, specifically on edibles that's been an issue. And then I think probably the biggest overall limitation is the actual market structure. Having a pretty high excise tax and then also having provincial monopolies that take a large amount of the margin, but also, sort of control how distribution works so it takes a little bit longer to ramp up. So, I think that those are certainly things that would be market limitations. And then maybe the biggest kind of surprise or thing that I wouldn't have predicted is, we knew that everyone would rush into Canada. We got in earlier than we saw the momentum pile up because it was a very attractive opportunity to get a head start on a global growth industry that we haven't seen in â really in generations. It's this obvious. But I thought you would've seen, sort of winners emerge faster in companies, it's just taken a lot of time to happen. So, there's a lot of overcapacity that should have had that work its way out of the system faster than it did. How long do you think that that correction will last? Because in terms of the â we've seen the irrational dynamics, we're actually starting to see some bankruptcies, but then we turn over and see someone buying the assets. So, is this a just a slow burn or is there any kind of gravity here for around economic reality? Yeah. It's funny that question about why people are buying them, if that worries me. I think when you're a standalone company and you're sort of struggling and fighting for survival, there are things that you'll do to stay alive maybe longer than you would do if say you're a larger going concern and you have a division or a unit or a brand or facility that is just cash burning and you can't really figure out how it becomes a positive contributor. I think what we've seen is that depending on the competitor when they do buy a brand or a facility, tend to see something actually exit the system faster when that happens because it just gets rationalized quicker. So, yes, I think it's starting to speed up. I mean, look, there's a lot to work through, but I think that the pace has moved a lot faster than it had been in prior years. And that's probably not just related to cannabis, it's just the amount of money circulating. Not to get into a big interest rate, money supply discussion, but I think as that tightens that's where you see exit much faster. You don't have capital injections like you used to. Fair enough. And then I guess then kind of a second thing to build upon that is, everyone bandies about favorable changes. I mean, there's a couple things you mentioned in there. Some are Health Canada, federal driven, some are provinces driven. Could you give us kind of your view of, kind of the review that I believe Health Canada is kind of undertaking now? Some of the industry demands, I think excise tax, they want that to go to ad valorem versus the fixed rate, marketing restrictions, packaging restrictions, any outlook for that changing and kind of what the government approach here will be? Yes, I mean, something's been promised and I think that there would be review. And I think, look, we are reaching or getting closer to reaching a point where the benefits of legalization. I don't think there's a debate that those are positive for Canada. And I also think that when you look at the contributions of GDP a lot of the ways those have showed up historically, it looks like cannabis has been doing extremely well. You think about all the construction and all the different the services that have involved in building up the industry, but there do need to be structural changes for that to continue. And so, I think there's a lot of, you covering it from your position, probably more aware of the challenges than you would think depending on the group of government, how aware they are. So, there's a lot of information government think is positive, but as far as speed of change, I am always the most pragmatic or hesitant to really predict when it will happen. And we want to make sure that we're able to operate well and get to the position we need to be in regardless of whether it's changed. So, I think that there will be change at some point, but it's very difficult to predict timing. And so, that's at the federal level, what I will say, and I think could happen maybe sooner, is at the provincial level, what you're seeing is a lot of the retailers. Historically, it's been mostly LPs that are speaking up or retailers are starting to get to a point where they're very frustrated and these are not larger companies or small mom and pops that are worried about going out of business. And I think that is probably the biggest wake up call for change that we've seen from a regulatory perspective yet. And I think there is likely to be some response to that before maybe the federal level, but that's a prediction that is just my gut. Want to circle back to that. But the first thing you said around the Health Canada review, you mentioned a lot of economic reasons for the changes to drive to kind of sustain the tailwind of positive contributions. Does Health Canada look at it that way or is it like, for instance here, both know here in the U.S., the FDA looks at tobacco purely from a public health standpoint and some of the economic issues aren't as considered? How does Health Canada look at and... Yes, I don't think Health Canada looks at, I think the broader government looks at that. And my point is, I think it's a measure for success. So, if you're looking at say like the headline GDP number from cannabis and cannabis services, your view might be this has been a great success. But Health Canada, there is actually a proxy there because one of the goals that is behind legalization is moving â Canada realize you're not going to deter consumption of cannabis. It's going to happen regardless. But why not make sure that you can do it in a more responsible way, keep it out of the hands of children, have more transparency to the supply chain, put out a product that's safer but if you don't have legal sales taking share from the illicit market, you don't accomplish those goals, right. So, all the things that were set up there is a proxy for what the sort of units that are being moved, sits at. So, I think that is something they are interested in. There's all types of competing goals that all tie into it, like packaging and environmental, right. So, I think there's different things that tie into it. Healthcare specifically though, they are concerned about health, there are other groups that concern themselves with finance, but if you see a flourishing industry, I think that idea of switching away from the illicit market, which the Health Canada does care about, I think it shows it's succeeding. The second point you made, kind of about the â was more to the Crown corporations. Every province say, Saskatchewan you have to go through the middleman. You mentioned that there is potentially some momentum for changes there from retail. First off, are the retailers getting on the same page in order to make like it known? What would be helpful solutions and what do you think would be helpful solutions at this point that actually could be achieved? Well, I think there's a lot, again, it depends which province we're talking about, but I do think that, it's much easier at the local level to react than it is at the federal level. And I think that there's much more sensitivity for how some of those small businesses are performing, put life savings into what they thought was an opportunity to basically create generational wealth and now are looking at wealth destruction. So, I think that sometimes the way things are ordering, the way the systems work and what the margin structure is, what's available to retailers, there's a lot that's logistic based and a lot that's financial based. And I think both of those can be huge catalyst to help retail and I think provinces are listening because when you're hearing it from both sides, it's hard to ignore. Right. Next thing I would say is, we spoke a little bit about the rational dynamics that's really born out on the price compression that's expected in every markets, but it continues, you've largely stayed above the fray, but you're also not immune to it. Like, this year you made the decision to go more forcefully in the 28 grand bags. So, first off, I'd ask, what drove that decision? And kind of also secondly, itâs â youâve noted that this is a more differentiated product, rather relative to what else is in the â I donât even know if you can call it deep discount segment, but maybe this is the right discount segment or maybe itâs the right segment to attract consumers. Yes. I think that the flower market, weâve always thought that the way to win in flowers is really genetics. And thatâs one, and then weâll probably get into it a little bit later, but pre-rolls, right? And when you think about it, what we want to see is that we have genetics that are performing well. This is actually the second year in a row that another SKU weâve had the number one flower SKU. So, I think itâs important to do that, but also in order to be able to compete, this category does become more and more commoditized when you look at just flower. It is, the closer you are to the plant, the harder itâs to differentiate. Genetics are not. And so, we do still want to maintain that difference. The idea of being able to be borderless, knowing weâll be able to take what weâre doing here and win when we go to Israel, when we move in other markets, thatâs still really important to us. But there is a reality that if you want to be able to compete and thatâs where consumers are moving. The heavy user thatâs rolling at home, that isnât worried about portability that is a segment that you have to look at what a consumer wants. And I think thatâs, sort of where flower has been trending for a large part of it. What I will say though is, part of whatâs difficult from our structure to, sort of understand how things flow to us is that GrowCo, we donât consolidate GrowCo, so you donât necessarily see some of the results we have. But the fact that we own 50% of that and weâre purchasing the flower from GrowCo the margin, itâs a â that overall does contribute to the bottom line is probably better it looks. Got it. Yes. So, thatâs actually an interesting segue to kind of jump into GrowCo. So, first-off to that, itâs been kind of a multi-year initiative you have. Step back and first-off, talk to us about that, but also Iâd like to hear kind of the confidence you had to make that, kind of your sole supplier and close, kind of the Stainer indoor facility and making this kind of your primary source of biomass. Yes. So, look, the reason that we were in Stainer is when we had the first license in Canada, with the PEACE NATURALS, a lot of the locations that you see and a lot of the LPs that are out there, itâs really, it was very difficult to get a license. You started off with the eight licenses, the first kind of like era of Canada, and then it eventually evolved. Everyone has a license now, but getting a municipality was favorable. Being able to find labor force that was able and was willing to move into cannabis was important. And it was really difficult to get a license. So, the locations that were picked werenât necessarily ideal for agriculture, right? It wasnât necessarily great for logistics and transportation. And when we looked across and we thought about skillsets, who eventually is going to win? I thought that we had the best IP or the best in genetics, and our growth process were really strong. We did a ton of R&D. But the idea again, is a portable platform was always to find whereâs the best place to do things, whatâs going to be the most efficient? And I thought it was only a matter of time before the people that would dominate in ag would dominate in the flower category in cannabis, right? So, we kind of did a tour, we looked at who was successful in Canada, and we found the Mucci Group. They are one of the â I think the largest strawberry farmers in North America, one of the largest in cucumbers, lettuce, tomato. And they just had infrastructure that was there. And ultimately we looked at them and said, hey, we have the cannabis know-how, weâve got all this data, we have genetics, but the infrastructure they have and the ability to focus on managing the labor and the nuances of an ag operation, that takes a lot of resources and a lot from, where we want to put our focus, which is really on the products and on innovating and branding and distributing them. So, we set up pilots. We had them working at Stainer for a while to kind of learn the process. We moved into GrowCo based off a lot of learnings that we had. We purpose built it. And once we got it up and running, we kind of saw pretty early like, hey, this is looking really good. We could purchase product from them for cheaper than we were producing it on our own. And thatâs excluding the 50% ownership. So, quality is great, consistency is there, and I think the results have kind of proven out. But I think thatâs a model youâll see in other countries as well. I think that if you can dominate in multiple plants, thereâs something that unique about cannabis that you canât learn how to do. And weâve always believed that you picked your spot within the value chain and then you find experts to participate in others. Got it. And then kind of â so you mentioned the early success, I believe you said it is paying down the debt loan it has with you. I guess, thereâs two prongs to their business. A, they supply you, youâve got primary, kind of exclusive rights to that without the inventory risk. But the second thing is, has it surprised you how strong that their third-party sales have been just given how much capacity is out there in general in Canada? It hasnât because itâs high quality and their cost structure is, lets them â still, again, same reason that we would buy from them, right? Others can look at it and say, wait I can get a better quality product for cheaper than I can produce it myself. When you start getting in this stage, weâre now where survival matters and getting the profitability matters. We donât have the same ego and empire ability that the industry was plagued by in Canada before. Itâs just what makes economic sense. So, yes, I think it works. One of the reasons we also didnât want to fully own the supply chain was really probably two. One would be we wanted to make sure that the direct operators were as focused and motivated as I would be with Cronos. But also I think itâs a lot easier for someone to buy from a company where someone else â itâs not fully controlled by a competitor, we have a vested interest in it, but thereâs someone else day-to-day managing the P&L. So, I think that does give confidence to third-parties and not surprising all, we always thought the model would work. Got it. And I guess, how far could they go? I mean, there are, like you said, there are a lot of â thereâs a lot of capacity out there, but theyâre underwater relative to this. Could there be a step change in this business as sales to others that youâd participate in maybe support capital? Or just kind of how do you think about that potentially playing its own, kind of game of being a stronger supplier from an agricultural standpoint? Yes. Look, I certainly think there can be but also, look, we are generally going to be conservative in the way that we approach anything there. I think that we like that theyâre cash flow and paying down debt. I think thatâs important. I do think as you see other suppliers go out of business that does make the opportunity bigger. I donât know that thereâs going to be any acquisition opportunities. And part of the reason thatâs so successful is because of the infrastructure that they have purpose built. So, it certainly could expand at some point in the future, but itâs not immediate priority for us. Got it. Letâs talk about more what the core priorities are, which is the product development. I guess, the first thing to talk about here is, weâll get into the edibles, but kind of what gets underpinned here is Ginkgo and what thatâs done. Could you explain kind of from the start, the Ginkgo and actually also you made an announcement this morning as well, you might â this might be a good time to bring it up? Yes. So, again, going to innovation and differentiation, I think flower certainly one thing that we talked about, but flower, again, itâs genetics. Another way genetically to differentiate is using fermentation. So when someone prefers one screen to another, sometimes itâs the taste, sometimes itâs the look. But I think the biggest driver is what the effect is. Itâs not like alcohol or tobacco. We have pretty consistent effect brand to brand or product to product. Cannabis sometimes uplifting, sometimes it makes you go to sleep, sometimes it makes you laugh for a couple hours, makes you super hungry. And I think thatâs really based off of what the actual ingredient, what the cannabinoids are. And being able to control for that with flower is difficult, but being able to make those individual cannabinoids, the rare cannabinoids is really key. So when I look at what happens when you have a sub product that stands out on shelf, how do you do that? If you want something that makes you sleep, CBN is sort of emerged as a cannabinoid that that helps with that. We like CBC for a lot of reasons, I think itâs more of an energizing effect the way we formulated it. But to Ginkgo is a platform that lets us just across every value-add product, launch something differentiated and be able to start targeting effects. And I think that when you look five, 10 years from now people will realize indica sativa is a really misused framework thatâs based off of the organs of genetics, not effects. People will be able to shop and say, I want this product because it delivers X effect to me. Like, hey, Iâm having trouble sleeping. Hey, I want something that wakes me up. I want something thatâs good for a movie versus a hype. And Gingko is a huge part of letting us deliver that experience. And I think the CBC gummies are released today. I expect that to perform extremely well. Question like, in terms of, I guess, one of the potential challenges here is communicating to the consumer. Obviously, the molecules a molecule, itâs the same thing coming out of the plant. But whatâs â is there a lot of consumer education or feedback of fermented cannabinoids versus the kind of the plant-based? There really isnât. A lot of that has to do with the way the regulations are set up. We would love to communicate some of the ESG benefits. Youâve got â we released the study, itâs probably 99% reduction in energy that carbon footprint that goes into making the product. But itâs â thereâs a lot of things that youâre communicating to consumer when you get to the point of sale. And I think really the effect is what theyâre most interested in right now. And so we havenât seen a lot of questions around that. I think that when the consumer likes the value theyâre getting for the price theyâre paying and they like the differentiated effect, thatâs where their focus is. So itâs something that we try to be open about and try to communicate. But I think the actual product itself is where the focus has been for consumers today, which we thought we would be communicating more about it and thereâd be more questions that theyâre just having. Got it. And then youâve had a pretty successful edible launch so far. I guess, can you talk about like a, kind of the points of differentiation your product, itâs obviously something that you can prove out Canada, itâs something you could take to the U.S. kind of whatâs unique about this. I mean, the Ginkgo obviously helps that. And then just kind of help us understand and how youâre building the architecture of sours and fields? Sure. So if you think about like the ground floor of the gummy platform that we have, right? Thatâs really sours and texture certainly matters. We spend a lot of time thinking about texture. I think the biggest differentiator for us right now is taste. I think the color certainly helps. So we have dual colors and we have really three tastes, three flavors that are in the actual gummy. On each side, the different color, depending on which skew you have multiple flavors. And when you put them together and eat it all at once, it actually gives you a third flavor. So we actually were pretty deliberate about the way we would do that. So you have a flavor curve when you eat it all at once, or you can pick each side. Thatâs kind of like the ground floor kind where we are today. And then, the next one that we launched, we now have three different skews in the market and thatâs fields. So sour is sort of like your ground floor, your base. The next level up is fields, and thatâs where we start introducing other rare cannabinoids in. So itâs not just THC or CBD. But we now CBG, CBN, CBC on the market. And having that platform where you can see thereâs different colors, thereâs different formulations that can go in. Letâs start getting okay, maybe you have picked the flower or sorry, the flavor you like, what about the effect? How different of an effect can you get? And so I think itâs the beginning of us opening up some of the Ginkgo platform and the innovation pipeline we have. And thereâs more floors to come, but today thatâs where we are and itâs being received extremely well. Behind edibles, kind of whatâs your hierarchy? I mean, you have to think about Canada a little bit differently than the U.S. so kind of walk us through that. I believe itâs pre-rolls first and then try to do something in â and then actually doing something vapor. Yeah, pre-rolls is certainly first for us, itâs like edibles. Itâs something that we put a lot of resources in, spend a lot of time on, and what we do have pre-rolls that have been out. Certainly thatâs not the offering that we are satisfied with. We look at the ways to innovate. And thereâs a lot to come on pre-rolls. I think pre-rolls would be the largest of the platforms weâre talking about here. I think itâs going to just keep taking share from flower over time. And I think itâs not hard to imagine why weâre focused on it, why we think we have a right to win. Ginkgoâs thought of as a cannabinoid partnership, but just from knowledge of how to take a highly regulated plant and put it into an adult consumer product. I feel like the insights weâve been able to get from Altria have been extremely helpful. But yeah, I think eventually you can as a convenient product, youâre going to be able to deliver cannabinoids cheaper in a pre-roll than in flavor because you donât have to worry about how well manicured it is. Youâre able to make it consistent by infusing it with cannabinoids and itâs portable. So, I think pre-rolls is really the future. I think thatâs where a lot of the value will move to. And itâs much easier to differentiate in the pre-roll than it is in flower. And then in terms of vapor, I mean, where does that kind of â where does that rank as a priority? Itâs important to us. I think itâs another way of being able to differentiate with flavor and with cannabinoids. I would say thatâs as far as big innovations to come, we put that after pre-rolls and we still have innovations to come in edibles. Actually we came back, we adjusted the portfolio. So, turned, I think weâre doing very well on vapor, certainly still opportunity. But the dynamics of vapor, thereâs kind of two things to think about as far as innovation. One is the â whatâs your formulation, whatâs the kind of branded cartridge. And the other is whatâs the hardware? And given the way that the structure is in Canada, itâs pretty difficult to introduce and iterate with hardware. Hardware, I think thereâs a lot of room for improvement in hardware. Tech is certainly out there to do it, but itâs â the incentives are a little bit different because of the way the model is controlled in Canada at the provincial level than in say, the U.S. or eventually Europe. Got it. I do want to move, so yeah, Iâd be remiss we didnât move on to the U.S. and kind of the perspective on the potential regulatory changes. We have some news, obviously safe didnât make the NDA. You â I think weâve spoke about this before, you actually think the scheduling review is a much bigger deal than safe. So, letâs chat about that because kind of the news is out on safe and weâll see if anything happens with it. Yeah, no that perspective really on you were more excited probably about the scheduling or view that was announced in October than the incremental benefits from something like a safe. Yeah, I think what safe feels like, itâs just something people have been focused on so long that now thereâs a lot of investor sentiment thatâs tied to safe passing. But if you really dig into whatâs the biggest benefit of safe, to me it feels like it is sentiment. Itâs not really something that is going to drive fundamentals, right? The iterations weâve seen is safe, are not changing capital markets access. Itâs not for NASDAQ or NYSE. Youâre not affecting 2AE, maybe itâll change things around payments certainly remains to be seen what the language says. And I think as far as credit, youâve got pretty debt laden companies that are not cash flow. And I donât know that youâre going to see a wave of credit [come if safe passes] [ph]. What you really need is, again, getting rid of 2AE, you need to have, I think borders start to fall down. So you have a competitive supply chain in the illicit market. You want to be able to bring in innovations. And I think that comes with rescheduling. And while I think the criticisms of rescheduling and maybe why it was a little bit dismissed by the investor community is rescheduling is not a perfect framework. Itâs not comprehensive, but to me what it is, itâs an ultimatum. Itâs sort of a countdown clock, which says, okay, Congress said you cannot come up with a comprehensive framework that you want to put in and you canât compromise. This isnât going to stay illegal. Itâs going to move to what might not be optimal for accomplishing the regulatory goals. But it will open the industry up and it will become legal because keeping it illegal has failed. And I think that becomes clear. We have, close to 40 states now in some form or another of legalized cannabis. Itâs essentially legal, but the federal regs have to catch up to it. So, to me that is actually something that we now have almost like an outside date, something that you have to race against. And rescheduling is what opens things up. So, I think, well, people might fear interstate commerce, certainly for us in the way weâre structured, itâs very exciting for us and being able to go in and directly participate is what weâve been waiting for. So, rescheduling very exciting or de-scheduling. Got you. And then I guess weâll kind of finish on that note, kind of talk about Altria, just to clear all confusion. The warrant expires in March, I believe thatâs â that expires that does not affect the agreement, but just confirm that here today and just talk about the agreement, what they bring to the table, and kind of the long-term plans for utilizing that to attack the U.S.? Yeah, so exclusivity is completely intact. Board seats everythingâs intact. The warrant really is, itâs just an option to be able to take control. And that depending on if thereâs significant changes, they would really be would they exercise? Assuming that they do not, we would be operating day-to-day the same way we have been. And thereâs really no change whatsoever. As far as you know, where that relationship is itâs fully exclusive partnership. They have amazing infrastructure in the U.S. and unmatched distribution capabilities. And then, convenience stores, a network of farmers that understand how to take genetics, how to pass through their systems. We can process it in the combustibles and to vapes and other oral products. And I donât think itâs a secret that while itâs certainly â cannabis is adjacent to nicotine, there is certainly unit declines. So, while, itâs still extremely profitable, while there is EPS growth. Unit declines is something that the entire tobacco industry faces from their legacy products, and finding ways to be able to absorb cost by adding more units that are adjacent makes sense. So, we like the idea of being able to use all three distribution, use manufacturing expertise, use that network of farmers that great expertise in regulatory. So, we think itâs a pretty perfect fit and couldnât think of a better partner in the U.S.
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Good day, everyone, and welcome to the Genesco Third Quarter Fiscal 2023 Conference Call. Just a reminder, today's call is being recorded. Good morning, everyone, and thank you for joining us to discuss our third quarter fiscal 2023 results. Participants on the call expect to make forward-looking statements reflecting their expectations as of today, but actual results could be different. Genesco refers you to this morning's earnings release and the Company's SEC filings, including its most recent 10-K and 10-Q filings, for some of the factors that could cause differences from the expectations reflected in the forward-looking statements made today. Participants also expect to refer to certain adjusted financial measure during the call. All non-GAAP financial measures are reconciled to the GAAP counterparts in the attachment to this morning's press release and in schedules available on the Company's website in the Quarterly Results section. We have also posted a presentation summarizing our results. With me on the call today is Mimi Vaughn, Board Chair, President and Chief Executive Officer, who will begin our prepared remarks with an overview of the period and the progress we are making to drive the business. And Tom George, Chief Financial Officer, who will review the quarterly financials in more detail and provide guidance for fiscal '23. Thanks, Darryl. Good morning, everyone, and thank you for joining us today. We are pleased with our overall results, particularly sales and gross margin performance. Against last year's record third quarter, we grew revenue 4% on a constant currency basis, achieving significant improvement over the first half of the year, and comps were up 3% with every business posting positive gains. At the same time, gross margins were better than we expected as we lapped last year's unusually strong gain. The progress made with our footwear-focused strategy to increase digital penetration, strengthen consumer connections, grow our footwear brands and reshape our retail cost structure has put the Company in a better position to both outperform and favorable economic backdrop like we experienced last year and effectively navigate the more difficult consumer and market conditions we're facing today. The third quarter played out largely as we had anticipated with many consumers coming out to shop when there was a reason to buy and retreating to conserve cash during the in-between periods. This was a real change from the strong selling environment a year ago when the back-to-school selling season extended into late September and October, driven by higher consumer savings levels and pent-up demand and students bought anything that was in stock and available. Like they have since the beginning of the pandemic, our teams were prepared for whatever came their way and did an excellent job capturing demand when the consumer emerged and shopped. At the same time, the diversity of our multi-division business and consumer segments proved beneficial. Robust spending by Schuh's customers in the U.K. and J&M's more affluent customers in the U.S. drove healthy top line gains. We entered the pandemic in a position of strength, navigated the heart of the pandemic well and emerged stronger. That said, current market conditions presented some challenges that weighed on third quarter profitability, including the return to a more normalized markdown and promotional cadence, wage and operating cost inflation and anniversarying some one-time major expense benefit. Overall, I'm pleased with our execution as we manage through the impact of all this. Other key highlights for the third quarter, in addition to the revenue growth and sequential top line improvement include, both store and digital comps were nicely positive, highlighting the strength of our omnichannel offering and channel choice we give consumers. Digital sales, a key strategic growth priority were up almost 75% compared to pre-pandemic levels, maintaining essentially all the pandemic growth, representing 18% of retail sales and sustaining strong double-digit profitability. Gross margin was better than expected as we did not partake an aggressive discounting despite an increasingly promotional environment in the U.S. Adjusted EPS of $1.65 compares to last year's level of $2.36, but represents a 24% increase over pre-pandemic levels, and while at the same time investing in our business, we returned capital to shareholders, repurchasing about 3.5% of shares outstanding during the quarter. So turning now to discuss each business, starting with retail. Back-to-school is a major driver of Q3 sales for both Journeys and Schuh. After getting off to a slow start in late July, Journeys' sales sharply accelerated in August and early September, as consumers reverted to more typical back-to-school buying behavior. Both fashion, athletic and casual footwear sales grew as our expert Journeys merchants delivered compelling assortments that resonated with our teen consumers. Casual continued its run, outstripping the growth of fashion athletic. We did, however, the ongoing evidence of the Journeys consumer being squeezed by inflation and pressure on their wallet, making fewer trips to shop, trading down to more excessively priced products and pulling back on non-footwear add-on purchases. The breadth of its assortment, careful planning for this potential shift and strong vendor partnerships allowed Journeys to meet the needs of this more budget-conscious consumer. The relentless efforts of our store associates and positive in-stock inventory position drove better conversion and higher transaction size as they made the most of customers crossing Journeys' lease line. Following a largely full price selling back-to-school, at the end of this key shopping event, sales slowed later in the quarter. In addition, the business lapped very strong growth a year ago, thanks in part to last year's incentive to shop early for Christmas beginning in October due to limited inventory availability and earlier holiday messaging. One specific highlight of the third quarter was Journeys' double-digit digital growth, fueled by effective use of paid search, paid social and a fleet of influencers that continue to drive Journeys' brand awareness. Importantly, research conducted during back-to-school and in November reaffirmed that the majority of Journeys' team customers increasingly believe shoes are the most important part of an outfit, with Journeys maintaining its position as one of the top considered retailers for shoes. Shifting to the U.K. Schuh built on its strong first half with a solid third quarter as sales increased on a constant currency basis against very strong gains a year ago. Like Journeys, Schuh's strength is identifying the right fashion trends and securing the right product and brands for its youth consumer. The fashion trends driving shoes business largely overlap with the ones driving Journeys. The quarter started with another good back-to-school and despite strengthening U.K. economic headwinds, Schuh maintained its momentum, continuing to take share from competitors by out assorting and out executing. Overall, Schuh is benefiting from better access to higher-tiered products from several key brands, effective marketing strategies like the introduction of its loyalty program, high levels of customer engagement, such as its student events and Schuh's brand purpose pillars which are resonating with its youth consumer, all of which are helping Schuh perform well on a year-over-year basis despite the economic turbulence exchange rate pressure and lapping significant one-time gains. Turning now to discuss our brands. We're excited about the potential of Johnston & Murphy and very pleased with the traction we're gaining as we reposition the brand for growth. Our efforts to re-imagine J&M for a more casual, more comfortable post-pandemic environment are delivering strong results with Q3 sales up nearly 20% and operating income that doubled compared to last year. The growth has been broad-based across channels, with stores up 14%, online up 20% and wholesale up 31%. Intensified consumer marketing and fresh new innovative product with technology differentiating J&M's offerings are reaching new customers and fueling market share gains. Casual and casual athletic now make up most of J&M's footwear assortment and is a measure of the progress we've made. Dress footwear, for which J&M is best known, now makes up less than 10% of overall sales. This strategic shift has allowed us to position the brand to now reach a broader and younger consumer base, all while maintaining and building upon our premium footwear positioning and price points. We are excited about the new direction we've set. We were able to double the size of the brand in its last reset, and believe we now have the opportunity to do that again. Finishing our brand review, solid consumer demand for licensed brands footwear was overshadowed by pressure on gross margins and expenses due to high freight expense and elevated inventory levels in the channels we serve. We believe these issues are temporary affecting this year and early next and remain positive on the longer-term outlook for this business. Now a brief update on ESG. Following the issuance of our inaugural ESG report, we continue to get credit for the forward strides we're making. With this foundation and now that we've set the baseline for Genesco's global carbon footprint, we'll be working over the next several months to create a strategic road map for key priorities where we aspire to make further improvements. We're advancing these efforts, and we'll share our continued progress. Moving on to the current quarter. We experienced a very noticeable slowdown in traffic and sales in the last few weeks of October, that carried into the first few weeks of November. Not only where we up against last year's early holiday shopping, but warmer weather hampered the start of fall and winter merchandise sales. Sales have improved since, and we are pleased with the results over Black Friday weekend. However, as we consider the remainder of the quarter, we recognized the consumer, pressured by inflation is having to make harder choices on where they spend their money. And while we believe our inventories are at appropriate levels, given the heightened promotional environment, we have increased our planned promotional activity at Journeys and elsewhere over the holidays in order to be competitive as consumers search for bargains. We're well prepared for the important holiday season with trend-right assortments and exciting marketing campaigns, and our teams will extend every effort to capture consumer demand. The promotional activity we've added should also give sales a boost. That said, the choppiness in traffic and sales, the additional promotions and continued cost pressure we've been experiencing will weigh on results. Taking all this into account, we're adjusting our fourth quarter expectations. Based on this more conservative outlook, we're lowering our full year guidance range to be between $5.50 and $5.90 per share, somewhere close to the middle of the range is where we anticipate the year will come in. This change in outlook is reflective of the current environment. We believe this is a moment in time and the strength of our brands and retail concepts and the strategies we're executing will show their resilience through these challenges. Driving this are the six strategic pillars that emphasize continued investment in digital and omnichannel, deepening our consumer insights, driving product innovation and reshaping our cost base. I'd like to highlight some of the actions that were taken to strengthen our business as we move forward through Q4 and into next year. First, despite near-term consumer headwinds, we're excited about our ability to grow sales both online and in store. After absorbing much of the pandemic's digital growth, we'll begin adding to these gains by utilizing our first-party data, the ability to now better personalize marketing and leveraging the new customer growth we've achieved. With digital at almost 20% of our retail business and its healthy double-digit profitability, returning to historical levels of double-digit growth contributes meaningfully. Starting with J&M last year, Schuh earlier this year and Journeys' plan for next year, we're in early days of launching our loyalty and affinity programs, which are outperforming expectations driving increases in repurchase frequency and higher average order values for members. Going forward, we'll capitalize on the strong recruitment base to excite and engage our loyal customers to induce them to concentrate bigger shares of their wallets with us, creating a tailwind for growth. We also plan to launch new omnichannel services in North America next year, another catalyst for additional growth. We will be adding to our store fleet for the first time in some time opening in strategic places like off-mall locations for Journeys. And finally, the shift in J&M's assortment into casual apparel and footwear categories, combined with our increased marketing investments and campaigns, will drive our branded platform and J&M to new levels of sales and profits. Second, while we're increasing promotions to meet the competitive environment this holiday season, we believe the promotional environment will begin to normalize next year as industry inventories become more appropriately balanced with consumer demand. Given the substantial declines in marine freight costs and the reduced reliance on air freight to overcome supply chain delays, we also expect to benefit from these lower shipping costs as we sell through inventory purchase this year and alleviate pressure on cost of goods in our branded business. Finally, I'd like to touch on the operating costs that have been weighing on our P&L. We recognized that we must aggressively double down on our ongoing efforts to battle the wage and other cost inflation we're experiencing. The considerable leverage we've been gaining in occupancy and other areas has not been enough to overcome these headwinds. We are committed to addressing our cost base, and we'll have more to share, which Tom will discuss later. In summary, our businesses are in strong and differentiated strategic positions in the consumer marketplace. We compete in growing and fragmented markets providing a runway for growth and opportunities to take market share. Within our existing consumer segments, we can increase awareness, convert shoppers to buyers, build loyalty and drive repeat purchases. Our business has proven to be resilient during past recessions, and the actions we successfully took during the pandemic provide a road tested playbook. Despite the current environment, our consumer, ultimately, wants new and fresh product and the core fashion brands we carry. To close, I'd like to acknowledge and thank our terrific people for their outstanding work and diligent efforts throughout this challenging environment. The work you've done has positioned us well for the holiday season, and I look forward to continued success with you as we finish out fiscal '23. Thanks, Mimi. As Mimi said, we were pleased with our results for the quarter. We have solid capabilities, to not only navigate the current challenging environment, but also we are confident in the ability of our footwear-focused strategy to drive strong results over time. Consolidated revenue in Q3 was $604 million, up 1% to last year. On a constant currency basis, sales were up 4%, and we had gains in all divisions. Schuh's dollar sales were below last year due to significant foreign exchange pressure from the strengthening dollar. On a comp basis, Journeys' total comps were up 1%, Schuh total comps increased 3% driven by stores and J&M continued its strength versus last year in both stores and digital, with total comps up 20%. Overall, total company comps were up 3% for the quarter, with store comps up 2% and direct comps up 6%. We ended the quarter with 30 fewer stores versus a year ago, as we optimize our store footprint and drive productivity in our existing store estate. Digital sales were up almost 75% versus pre-pandemic levels. E-commerce sales accounted for 18% of total retail, which was flat to last year and up from 11% in fiscal year '20. Wholesale was up for both J&M and Licensed Brands, as J&M continues to have success with new product offerings in key accounts. Gross margins were down 50 basis points to last year, but were ahead of our expectations driven by better results for Journeys and J&M. The main driver of the year-over-year change was the return to a more normal promotional environment compared to essentially none last year and increased freight expense. By business, Journeys' gross margin was down 40 basis points. Schuh's gross margin was down 80 basis points, pressured also by greater-than-expected additions to its loyalty program. New members use their sign-up coupons right away, but ultimately, the program should provide long-term growth as we already have seen new members purchase Schuh at a greater frequency than non-members. J&M's gross margin was down 160 basis points, driven by freight logistics cost pressures and an unfavorable inventory reserve reversal comparison. And Licensed Brands' gross margin was down 100 basis points, pressured by incremental freight and logistics costs. Altogether, increased freight and logistics costs put approximately 55 basis points or $3.3 million of pressure on overall Q3 gross margin. Adjusted SG&A expense was 44.3%, 270 basis points more than last year. It is worth noting that last year we received meaningful one-time COVID rent credits and government relief during the quarter to the tune of $7 million. Without last year's one-time credits, total SG&A deleveraged 150 basis points, driven by marketing, selling and other salary costs and surface freight expense, while occupancy cost declined and leveraged 80 basis points. Regarding wage pressure, the competitive environment and legislated increases in minimum or living wages continue to pressure our store selling salaries and warehouse costs. In addition, the competitive environment for talent, in general, is increasing our other compensation costs, especially for IT talent to drive our initiatives. In summary, deleverage from these expenses more than offset leverage from occupancy and lower performance-based compensation. Rent credit aside, we are achieving great success driving occupancy costs lower. Across the Company, for the first nine months of fiscal '23, we have negotiated 168 lease renewals and achieved a 16% reduction in straight-line rent expense, with a shorter average term of roughly 2.5 years. This is on top of 192 renewals, with a 17% rent reduction last year. With over 48% of our fleet coming up for renewal in the next couple of years, this continues to remain a key opportunity and priority. In summary, third quarter adjusted operating income was $26.3 million, a 4.4% operating margin compared to $45.2 million or 7.5% last year and 5% pre-pandemic. Additional freight and logistics costs this year and the significant COVID rent and other credits benefit last year had a major impact, while a more normal markdown environment, marketing investments and the competitive wage pressures for talent drove the remaining impact on these results. For the quarter, our adjusted non-GAAP tax rate was 19.6%, which compares to 22.7% last year. This all resulted in adjusted diluted earnings per share of $1.65 for the quarter, which compares to $2.36 last year and $1.33 in fiscal '20. Our share count is down roughly 15% from pre-pandemic levels. Turning now to capital allocation and the balance sheet. Our net cash position at the end of Q3 was negative $57 million, a $324 million decrease versus last year. During the past 12 months, our strong cash balances enabled us not only to reinvest in our business for growth, but also to accomplish the formidable task of re-inventory and, at the same time, return significant capital to shareholders. In terms of specifics, we purchased roughly $200 million in net inventory and $125 million of our outstanding shares during the past year. While net inventories are up $200 million year-over-year, we believe it's more meaningful to compare this year's inventory levels to pre-pandemic Q3 fiscal '20, since outsized stimulus demand and supply chain limitations resulted in unusually low inventories last year. Inventories in Q3 this year were $563 million, 19% higher than fiscal '20 on a quarterly sales increase of 12%. We are pleased with the quality of this inventory. We'll adjust receipts as necessary going forward, and do not believe we will need to take incremental markdowns to right-size inventory levels. Over the last year, we repurchased 2.2 million shares or almost 15% of outstanding shares at an average price of $56.28. More recently, for the third quarter, we repurchased $21 million of stock at an average price of $46.01 and now have $34 million remaining on our current authorization. Capital expenditures in Q3 were $11 million and depreciation and amortization was $11 million. We opened three stores and closed 11 during the third quarter to end the quarter with 1,404 total stores. As a reminder, traditionally, the period between the end of Q3 and through the commencement of the holidays reflects our lowest cash levels of the year as this is the time for our peak working capital requirements. Looking out to the end of the fiscal year, we expect to end the year with ample cash and a balance sheet that remains a strategic asset. Finally, as we have discussed, rising operating costs have significantly pressured our business this year despite our ongoing cost reduction efforts. After leveraging expenses last year, we are facing cost pressures in the current inflationary environment across our business, but particularly, as I mentioned, in areas related to attracting and keeping talent and wages in our stores, distribution centers and corporate center. We must also continue to invest in marketing, data analytics and technology in order to drive sales and advance several strategic growth initiatives. In the recent past, we have implemented effective multiyear cost reduction programs to reshape our cost structure and reinvest for growth. We are looking to thoughtfully identify further cost savings, efficiency and automation opportunities, and we will have more to share when we report our Q4 results. Now turning to guidance. As I said, we are confident in our longer-term strategy, but in the near term, we continue to see the impact inflation is having on consumer discretionary spending. While third quarter sales came in above our projections and the end of November was stronger than the beginning of the month, we think it is prudent to take a more cautious view on Q4 given the current environment. We now expect full year fiscal year '23 revenue to be 1% to 2% below last year's levels, with the midpoint of the range similar to our prior guidance. Also note that this guidance reflects a roughly $12 million negative foreign currency impact versus our previous guidance. In addition to a more conservative sales outlook for Q4, we are experiencing increased pressure of gross margins due to the heightened promotional activity and excess inventory in the market, which is forcing us to become more promotional ourselves. As a result, we now expect full year gross margins to be down between 100 and 110 basis points versus last year. Finally, the takedown in our Q4 sales projection will cause us to deleverage SG&A expenses slightly more than we expected, resulting in deleverage on a full year basis in the range of 100 to 120 basis points versus last year, but still showing improvement over pre-pandemic levels. This all leads to an expected operating margin a little bit above 4% for the fiscal year and EPS ranging from $5.50 to $5.90. Again, somewhere close to the middle of the range is our best expectation of where we will land. Note that this new guidance is based on a weighted average share count of approximately $12.7 million for the full year versus our prior estimate of $12.9 million, reflecting our share repurchase activity during the third quarter, but assumes no additional share repurchases for the fiscal year. Furthermore, we expect some improvement in the tax rate at 25%, down from the prior guidance of 26%. While we acknowledge the challenges facing consumers these days and the headwinds those pose in the near term, we remain excited about the future of our business and the strategy we are driving forward. Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] And our first question is from the line of Steve Marotta with CL King. Please proceed with your question. I wanted to ask you a little bit about consumer buying patterns in the fourth quarter. You mentioned that this year was a typical back-to-school. And being the armchair contrarian that I am, if the fourth quarter is a normal historical holiday shopping pattern and obviously, November then would be difficult based on the compare and with evidence that Black Friday and Cyber Week was a little bit better, is it possible that December could be a little bit better than what people are expecting as well? Steve, thanks for your question. And just to talk a bit about the consumer patterns that we've seen and give you some of our thoughts on how we thought about the remaining months in the quarter. Listen, back-to-school was more typical. What we have been seeing is that when there's a reason for the consumer to shop, particularly the Journeys consumer, they turn out and they do shop, and they're conserving cash in between. There's no question that we believe that the consumer is waiting this year to shop much closer to the holidays, Christmas and Hanukkah are in the same time frame this year. And I will remind you, as you appropriately called out that we were running on fumes after selling out in November, and we had limited receipts in December and January. And so, we will see. I think that we were pleased with the overall performance of -- over Black Friday. We know that we've got a great in-stock inventory position that when the consumer comes out to shop, that we will be able to provide them with the merchandise they're interested in or our sales teams are ready to go and can really make the sales happen when the consumer arrives as we did over Black Friday weekend. But given the choppiness that we have seen, we thought it was just appropriate to be conservative for December and January. One other thing I would call out for January is that last year, we actually didn't have any product to be able to provide for returns and exchanges. And this year, we will be in a position to do that. Christmas is on Sunday this year, and there should be a good week of selling afterwards. And so we're ready. We've got the inventory. We've got the people, and we will see where we go. That's very helpful. When we think a little bit about next year, and I know you're not providing guidance understandably, so -- but can you talk a little bit about how you're thinking about next year and planning for next year? There's, obviously, a lot of chatter within the industry that, from a wholesale standpoint, wholesale orders are down pretty significantly year-over-year for the first half, and then we'll see what happens for second half. Are you planning similarly? Do you think it's going to be a tail that you have? And then I have one follow-up as well. Sure. So, the way we're thinking about it is, right now, there is a large amount of inventory in the system, and we are seeing a lot of promotional activity. And therefore, everyone is pulling back on receipts and trying to work through the inventory that's in the system. And so, we do think that, that will continue somewhat in the patterns -- into the patterns of next year. But overall, as we are thinking about our ability to grow sales, both online and in stores, which is a very large part of our business, growth will be really important for us. We have an opportunity to convert consumers who are aware of Journeys that aren't buyers. With digital at almost 20% of our business, we plan to drive digital with its healthy double-digit profitability returning to historical levels of growth will really drive our business. We're in early innings for loyalty. We talked a little bit about the success we're having with Schuh and with the J&M loyalty program, and so we're introducing loyalty for Journeys next year. We will have a little bit of growth in our store base. And right now, our Johnston & Murphy business is really doing well with continued growth in casual apparel and our footwear categories. So, we're really planning to drive growth next year, and that will be a key overall. We do a lot of business in back-to-school and holiday. And so that will be a time when some of the cost pressures from additional freight expense and some of the pressures that we've been seeing ought to abate. And so, it's going to be a real focus in the front part of the year, and then real opportunity during back-to-school and Christmas. That's very helpful as well. And Tom alluded to potential realignment from an expense standpoint. Can you talk a little bit about -- I know you probably don't want to get into magnitude at the moment, but the impact -- when could it have the impact? Could it be rather immediate? Is this going to be multiyear? Is it something that could move the needle next year? Maybe just talk a little bit about it again without providing any sort of detail that you're not -- that you can't do right now? We have a really good track record of reducing costs. I'll hand it to Tom in a minute. Most recently, during the pandemic, we cut costs dramatically and quickly when we had to do that. Rent is our big expense. We've had a multiyear effort with a lot of success year after year of reducing our overall rent expense, and selling salaries really have been a journey. We've done a lot to use analytics and data to be able to put -- to create efficiency really, and put the right ratio of our store people to customers and drive efficiency that way. And so, we think there will be opportunity there that we'll get into. And so, I think we've got a great track record, and we will, certainly, get after the cost pressure that we've been seeing. Yes, Steve, let me reinforce that. We do have a good record of reducing cost in the Company. We've got good discipline around that. We've been looking at this closely with this tsunami, so to speak, of inflation that hit us and -- especially around talent retention, being able to attract and retain talent. We've got increased cost in our DCs on an hourly basis, increased costs in our selling salaries in the store, increased IT costs to be able to execute on the digital initiatives. But we feel good we're going to be able to identify some cost and be able to take some cost out of the business going forward. And let us get through holiday here and spend some more time with it when we report our fourth quarter earnings, we'll be able to give everybody some more detail around the order of magnitude and the cadence. I've got three as well. I'll just do them one by one. So, first question is really a follow-up to Steve's first question. It sounds like November was tough, although you're not giving us a number. So I guess my question is. Does the Q4 implied kind of Q4 sales outlook assume sequential improvement over the balance of the quarter as you lap easier comparisons? Or are you basically kind of taking where you are for November and extrapolating that over the balance of the quarter? Yes. So, I will let Tom talk a little bit about that. But Mitch, we clearly see, again, that when there is a reason to shop that that Journeys consumer comes out. And so again, we are optimistic. We saw that happen during back-to-school. We had tremendous results in August when there was a reason to shop. We had very good solid results when there was a reason to shop over Black Friday weekend. And so, we are looking -- again, we believe that Christmas and the holidays will be more back-end loaded. What we have done is we've taken the trend in the back part of November, with the pickup in the back part of November, and we've actually been more conservative than what that trend was running just given some of the choppiness. I did highlight with Steve's question that we think there's opportunity for Christmas week. There's an extra day of selling. We do think there's opportunity after into January as well, with a good and soft inventory position, we ought to be able to drive sales. Yes. I think, Mitch, I'll just add to that. We did see the back half of November, including Black Friday. We saw some better -- some improvement in our business, but with a good -- roughly 2/3 of the business to go in the quarter, we think it's still -- we should be more cautious with that much business to go. So, we've been more cautious on the trend going forward. Mimi points out some of the differences relative to last year relative to pre-pandemic, and we feel that there's opportunity there potentially to outperform that. But it's early -- there's a lot of business to deliver here. So, we think it's best to take a more cautious view on the balance of the quarter at this point in time. Okay. That's helpful. And then a question on the wage inflation, the pressure there, I'm just wondering if you see any potential light at the end of the tunnel there? I mean I don't know that minimum wage rates are going to go down, but maybe if we end up in a slightly less competitive labor market, could that potentially help that situation? And then I have one last question. On wages, we have been really -- I think that the biggest pressure of late has been just competitive pressure. I think we all came out of the pandemic, and we're looking to hire people because our businesses -- to drive our business. And we have seen some good abatement in that overall pressure to bring talent on board in the last few months. And just given where the economy is right now, we think there should be less competitive pressure going forward. I think what I'd add is we see opportunities for further automation, both in the stores and in our distribution centers as well. So that can -- obviously, that's going to require some capital. But at the same time, we see that's going to be able to improve some of our operating expense lines going forward. I mean it's going to take a while to implement that. And I'll give you some more details around that when we do the fourth quarter. But I think there's some light at the end of the tunnel there. Okay. And then last question, just on the gross margin. So hopefully, my math is correct, and Tom, correct me if it isn't. But for Q4, I back into a gross margin rate of like 46.5% to 46.9%, which is down a couple of hundred bps year-over-year, but it's actually pretty flattish on a three-year basis. And I'm wondering, just given how difficult the environment is, I totally get that you would expect more promotions year-over-year. Are you basically thinking that promotional levels are going to be similar to kind of pre-COVID? Or is there a reason to think it would be worse than that? And if so, why wouldn't the kind of the implied Q4 gross margin not be worse? Yes. I think the way you're looking at the gross margin for the implied gross margin for Q4 is consistent with what we're thinking about. And we are assuming that the fourth quarter this year will be -- from a promotional perspective, will be similar to the fourth quarter of our fiscal year-end '20. All right. Thanks, everybody, for joining. I think there are no more questions in the queue, and we look forward to talking with you on our next call. This will conclude today's call. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.
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EarningCall_1656
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Ladies and gentlemen, thank you for standing by. I am Galley, your Chorus Call operator. Welcome and thank you for joining the Hepsiburada Conference Call and Live Webcast to Present and Discuss the Third Quarter 2022 Financial Results. All participants will be in a listen-only mode and the conference is being recorded. The presentation will be followed by a question-and-answer session. [Operator Instructions] At this time, I would like to turn the conference over to Ms. Helin Celikbilek, Investor Relations Director. Ms. Celikbilek, you may now proceed. Thanks, Galley. Thank you for joining us today for Hepsiburada's third quarter 2022 earnings call. Iâm pleased to be joined on the call today by our CEO, Murat Emirdag; and our CFO, Korhan Oz. The following discussion, including responses to your questions reflect managementâs views as of todayâs date only. We do not undertake any obligation to update or revise this information except as required by law. Certain statements made on todayâs call are forward-looking statements and actual results may differ materially from these forward-looking statements. Please refer to todayâs earnings release, as well as the risk factors described in the Safe Harbor slide of todayâs supplemental deck, todayâs press release, the 6-K, our Form 20-F filed with the SEC on May 2, 2022, and other SEC filings for information about factors, which could cause our actual results to differ materially from these forward-looking statements. Also, we will reference certain non-IFRS measures during todayâs call. Please refer to the appendix of our supplemental slide deck, as well as todayâs press release for a presentation of the most directly comparable IFRS measures, as well as the relevant IFRS to non-IFRS reconciliations. As a reminder, a replay of this call will also be available on our Investor Relations website. Thank you, Helin. Welcome everyone and thank you for joining us today. I will begin a summary of our quarterly highlight and continue with an update on our operations. I will then turn the call over to Korhan for an in-depth discussion on our financial figures. Now, let's have a brief look at our third quarter platforms. Next slide. In the third quarter, we showed consistent progress in our results despite continuing challenges in the macro environment when inflation in Türkiye has continued to rise, reaching about 80%. On an unadjusted for inflation basis, our GMV growth was 66% in the third quarter and 68% in the first nine months of 2022 compared to the same periods of last year. Adjustment for inflation, our GMV declined by 9% in the third quarter bringing the first nine month GMV growth to minus 1%. On an adjusted for inflation basis, revenue growth was 7%. We delivered 8.4% gross contribution margin in Q3 with a 4.5 percentage points year-on-year improvement compared to the same quarter growth last year. Fueled by the continued momentum in active customers and older frequency, we achieved 26% older growth during the third quarter contributing to 29% growth in the first nine months of 2022. Before I touch upon our EBITDA performance, I would like to summarize our recent development and point out its effect on our financials. As we close, we have reached a Settlement agreement related to the both putative class action lawsuits in the U.S. Hepsiburada agreed to pay $13.9 million to resolve the these lawsuits in entirety. The Settlement remains subject to approval and or entry of judgment by the respective course. As part of prudent management, we have booked a provision expense for the total at approximately TRY258 million corresponding to $13.9 million. These expenses had one-off impact on our financials. TurkCommerce is expected to contribute $3,975,000 towards the Settlement amount. Once all the relevant processes are finalized, the relevant amount will be accrued accordingly. Despite this one-off, our EBITDA as a percentage of GMV improved by 4.6 percentage points year-on-year to negative 5.8%. Excluding these one-off, EBITDA as a percentage of GMV would have been negative 3.5% in Q3 2022 on an adjusted for inflation and negative 1.8% an unadjusted for inflation basis. On the cash flow front, following the positive free cash flow in Q2, we are glad to have delivered another quarter with a positive free cash flow. Let's move on the next slide to look at our progress on our path to profitability. Next slide. As a continuation from the second quarter, we continued our progress on our path to profitability this quarter as shown on the slide. I must emphasize that this performance was made possible through our commitment to continue to optimizing end-to-end customer experience, expanded our selection of merchant base and improving the effectiveness of our marketing through smart use of data science capabilities. Let's move on the next slide to look into our operational metrics. Next slide. All four growth drivers continue to have healthy rise both on a year-on-year as well as quarter-on-quarter basis. Active customer base grew by 11% on a yearly basis, reaching 11.8 million in the third quarter. Order frequency reached 5.4, up 4.4 a year ago. Continued momentum in key growth drivers was attributable to few factors including our hybrid 1P-3P bidding model, attractive value proposition and expansion in selection. Additionally, we have improved the effectiveness of our marketing through the use of data driven marketing tools and a sharpened focus on retention and engagement with accuracy in acquisition. We have also developed our gamification capability such as sweepstakes offerings, which encourage interaction with our regional customer segment. Our platform has become home to nearly 95,000 active merchants. After the third quarter, we held Hepsiburada merchant summit in three large cities to showcase our valuable services for them. This summit also served to bolster our merchant relationship prior to peak shopping season. To rising number of merchants as well as our efforts to ease the product leasing procedure have contributed to the 89% rise in SKUs to 145 million in the third quarter. Meanwhile, we continued our leadership in NPS in the e-commerce sector in Turkish, thanks to our excellent customer experience on the back of our technology, robust logistics capabilities, and our broad opportunity solutions. Also worth mentioning is our performance in gaining members to Hepsiburada Premium program. In only five months, Hepsiburada Premium members exceeded 500,000. Hepsiburada Premium members have access to a range of benefits that include free delivery and cash back subject to certain conditions and free access to an on-demand streaming service among others in exchange for a monthly subscription fee. This program has been instrumental in driving higher engagement and order frequency. Now, I would like to switch gears and even update on our robust logistics capabilities, which are essential enabler for our customer and merchandise propositions. Next slide. Our last mile delivery service, HepsiJet, serves through a nationwide network across Türkiye with nearly 2,000 carriers. As of the third quarter, HepsiJet offers its customers the ability to live track their parcels prior to delivery. In the third quarter, HepsiJet delivered 62% of orders from the Marketplace operations compared to 57% quarter ago and 53% a year ago. Regarding the next day delivery performance, HepsiJet delivered 84% of the orders from 1P operations on the next day. HepsiJet oversized cargo delivery arm HepsiLojistik large delivered nearly 73% of such oversized parcels in our warranty operations during this period. HepsiLojistik large offers delivery by appointment for customer convenience. Meanwhile, HepsiJet logistics and another 138 client to portfolio during the quarter, providing the fulfillment services to 651 clients in total. On the next slide, I would like to give an update on our financial services. During the quarter with over 9 million users, around 44% of GMV passed through our Hepsipay wallet. Hepsipay has continued its rapid penetration within the Hepsiburada product platform and marked a milestone by reaching 10 million users in November. Meanwhile, our Buy Now Pay Later solution had been used by over hundred 15,000 customers as of the end of the third quarter since it's launched in January, 2022. We continue to diligently manage credit risk while maintaining our focus on growth optimization. Post third quarter, Hepsipay announced new added features and reaching the shopping experience with improved customer verification and e-wallet capabilities. In addition to the existing ability to transfer money from credit or debit cards, Hepsipay users may now also top up their e-wallets by transfers from their bank accounts without needing to use a card. On the next slide, let's take a look at our progress with respect to other strategic assets, integral parts of our ecosystem. Next slide. Our strategic assets are cornerstones of our diverse ecosystem and suggest solely support to our growth potential. One of those is our adtech tech solutions. Our HepsiAd portfolio includes search ads, display ads and sponsored ads, which were used by more than 10,000 merchants in Q3 to 2022 in line with the previous quarter. HepsiAd continues its focus on enriching product capabilities. In our international operations, we have been serving the Azerbaijan market since early this year, having chosen it as a proof-of-concept market. Through these efforts, we focus on testing and optimizing our playbook for cross-border execution. We will continuously evaluate our other international opportunities ahead. Our online grocery business, Hepsiburada Market continued its focus on enhancing unit economies and customer experience with this new operating model. Under this model, Hepsiburada Market serves as a location where marketplace platform with minimal operational involvement. It perfect order ratio in grocery was 82% in the third quarter up by 3 percentage points compared to the second quarter. Our flight ticket service, Hepsiburada Seyahat continued its focus on unlocking synergies in traffic and customer engagement for Hepsiburada's wider scale of operations over time. With asset like business model to expand product portfolio, it enabled sales of nearly between 9,000 tickets in the third quarter up from 9,000 during the same period last year. Overall, we remain committed to diligence operating our strategic assets to help fuel further monetization and growth for the overall ecosystem. And yet again, we need to focus on discipline cost and cash management. Now let me say a few words on our guidance for the full year. Next slide. Having recorded 66% GMV growth in the first nine month compared to the same period of last year and considering the performance in our growth drivers, we are raising our GMV growth guidance once again from around 60% to around 70% for the full year. In line with our focus on the path to profitability, we expect to deliver this GMV growth while keeping our EBITDA is a percentage of GMV guidance within a range of negative 2.5% to negative 3% for the full year. A kind reminder that our guidance for GMV growth and EBITDA is a percentage of GMV remain on an unadjusted for inflation basis. As a final note for today, as I announced in June, I will be transitioning to a new role and Nilhan Onal will be coming on board as CEO as of January 1, 2023. I would like to say that I am grateful to have had the opportunity to lead Hepsiburada for nearly four years, and I am extremely proud of what we have accomplished as a team. Together, we have developed an integrated technology ecosystem with strong capabilities, not just in e-commerce, but also in fintech, logistics, advertising, cross-border operations, and more. During my time at Hepsiburada, we have played a pivotal role in the digitalization of commerce in Türkiye and fortified our strong position as the household brand of Türkiye. Looking ahead, I remain excited about Hepsiburada journey in the future. Thank you, Murat, and welcome everyone. In the third quarter on an unadjusted for inflation basis, we generated TRY10.7 billion GMV corresponding to 66% year-on-year growth. Adjusted for inflation, the GMV became TRY11 billion, indicating a 9% decline compared to Q3 of last year. This decline was mainly due to the below inflation rise in our average order value, similar to the second quarter performance, while we recorded continued order growth. The full impact of inflation does not necessarily get reflected on our GMV growth due to several reasons, including customer tendency to substitute for budget-friendly choices and partial holdback in purchase decisions in certain categories. We also believe that other factors such as inventory carryover and competitive market dynamics might affect selling prices in certain categories. Meanwhile, the share of marketplace GMV was around 68%, which was 70% year ago and 64% in the second quarter of this year. This GMV mix may fluctuate from one quarter to another since it's impacted from several factors, including but not limited to, macroeconomic environment, customer behavior, campaign calendar and inventory dynamics during the quarter. On the next slide, I would like to discuss our revenue performance. On an unadjusted for inflation basis, our revenue grew by 93% in Q3, compared to the third quarter of last year. When adjusted for inflation, our revenue increased by 7%. The reason behind 7% revenue growth despite the 9% GMV decline is mainly due to our strategic decision to focus on improving the profitability and therefore cutting back on campaigns and discounts compared to the same period of last year. The 2 percentage points shipped in GMV mix in favor of 1P also had an impact on this result. 7% revenue growth was mainly achieved by nearly six-fold growth in our marketplace revenue, 10% increase in our delivery service revenue, and 85% increase in our other revenue against 7% decline in 1P revenue. The decline in our 1P revenue reflected the trend in GMV from 1P operations. This was mainly due to the customer tendency for substitution with affordable alternatives and the increase in share of non-electronic category's contribution compared to the same period of last year. And so the marketplace revenue, significant growth reflects our focus on path to profitability and CapEx on campaign and discounts, which are deducted from revenue. The 10% increase in delivery service revenue was mainly attributable to the rise in unit delivery service charges in January and also in July 2022. Now I would like to discuss our gross contribution performance in the next slide please. Our inflation adjusted gross contribution margin was 8.4% in the third quarter with an improvement of 4.5 percentage points compared to the same quarter last year. This was mainly attributable to the lower customer discounts in retail and marketplace operations and higher revenue from delivery service and other revenue streams. Compared to the second quarter of 2022, our gross contribution margin improved by 3.4% points in the third quarter given our focus on inventory management and the slowdown in the monthly inflation rates. Next slide please. Net total OpEx as a percentage of GMV was 14.2% in this quarter, slightly less compared to the 13.3% in the third quarter of last year. This was mainly due to 3.8 percentage point decline in advertising expenses and 0.7 percentage point decrease in shipping and packaging expenses against 4.3 percentage point writing of G&A and other expenses. The decline in advertising expenses was the result of enhanced marketing efficiency, including sharpened focus on retention and engagement across customer lifecycle as well as enhanced return on marketing investment in general channels. The decrease in shipping and packing expenses was on the back of decline in shipping expenses of Hepsiburada Market. As discussed, it business model has been pivoted to reduce dependence on owned delivery resources and keeping the operational involvement at minimum. The rise in our G&A expenses, which includes the other OpEx as you see on the chart, it results of several factors including salary increases, talent onboarding and the litigation settlement provision expense of TRY257.9 million. Murat has already explained the details of the settlement, so I will not take more of your time. Excluding the one of impact of this provision, G&A expenses as a percentage of GMV would have been 5.4% in the third quarter. Accordingly, the total net OpEx as a percentage of GMV would have been 11.8% on a 2.5 percentage point decline year over year. Let's have a look at our EBITDA margin bridge in depth on the next slide. As a function of a formation, drivers are adjusted for inflation EBITDA in the third quarter of 2022 was negative TRY0.6 billion compared to negative TRY1.2 billion a year ago. This corresponds to a negative 5.8 percent EBITDA as a percentage of GMV in Q3 2022 indicating a solid 4.6 percentage point year over year improvement. EBITDA as a percentage of GMV continued its improvement also squarely by 0.4 percentage point from the previous quarter. This performance was mainly attributable to improvements in our gross contribution margin and lower advertising spending. Excluding the one of impact of provision EBITDA as a percentage of GMV would have been higher by 2.4 percentage point in the third quarter. Next, I would like to say a few words on our cash flow dynamics. We generated a positive free cash flow of TRY331 million in the third quarter compared to negative TRY1.3 billion a year ago. Thanks to the positive cash generation from our operating activities. Net cash provided by operating activities was TRY542 million in the third quarter, which is mainly due to lower net loss and the decrease in the change in networking. CapEx was around TRY211 million around 60% of which consisted of the cost of tech related employees who are mainly employed for the development of web and mobile platforms. Remaining CapEx mainly consisted of purchase of property and equipment and software and rights. We continued to operate with negative networking capital at the -- and change in networking capital in Q3 was TRY629 million. Now I would like to share some highlights on our cash position and bank borrowings. As of September 30, we have TRY4.3 billion cash, which is mainly in time deposits and in financial investments. This total is $234 million equipment, and at September 30, around 73% of this total was in U.S. dollars. Our strong cash position combined with our cash generating capability enables us to continue to have the liquidity to fund our operations. Furthermore, our USD position keeps the Company resilient against potential currency fluctuations. Compared to the year end, the decline in total cash was mainly due to the decline in negative networking capital and U.S. dollar Turkish Lira appreciation at a rate lower than inflation. On the liability side, we have TRY332 million bank borrowings and these liabilities, which declined from TRY616 million at the end of 2021. Please note that all of our borrowings are in Turkish Lira. Next slide. As I end my presentation, I would like to leave you with a few highlights on our quarter-on-quarter momentum. Overall, our third quarter results show the improvement on several lines including gross contribution margin, advertising expenses, enhanced EBITDA, and net loss compared to the second quarter of this year. The litigation settlement provision expense had one of impact on our financials at mainly EBITDA and net loss balances. This process was achieved in a macroeconomic environment with continued challenges. Looking at acknowledging the challenges and uncertainties, we are confident to increase our GMV growth guidance from 60% to around 70% on an unadjusted for inflation basis, while keeping our EBITDA as a percentage of GMV guidance within a range of negative 2.5% to negative 3% for the full year 2022. We believe we are on track with our plans on our path to profitability, and we will continue to execute the discipline, cash and cost management. Ladies and gentlemen, at this time we will begin the question-and-answer session. [Operator Instructions] Ladies and gentlemen, there are no questions at this time. I will now turn the conference over to management for any closing comments. Thank you. I'm sorry, I apologize. We do have a question Mr. Unal Cem with Goldman Sachs. Please go ahead. Thanks, Murat and Korhan for the presentation, and also on your new roadmap. My question will be related to the new e-commerce loss, and I'd like to understand how do you expect to see the impact on the profitability post significant reduction in advertisement and the promotion budgets as indicated by the new e-commerce loss in 2023? And how do you see this to impact competition and your market share as well as the GMV growth going forward? And also, did you start to see -- did you already start to see some kind of easing in aggressive discount and advertising spend from the competitors within this fourth quarter? And also going forward, if there will be any kind of improvement in the cash on lower spending, how do you plan to spend this excess cash? Thank you very much. Thank you, Jim. I guess I will leave the floor to Korhan for cash, but I will answer the other questions first. With respect to like first to your comment with respect to competitive landscape, I guess, we believe it's fair to say that the market continues to be competitive, where the cost of marketing and cost of growth remains still high. So I guess it is still valid based on our observations. And with respect to regulatory changes, like you mentioned, we expect the loss to be in effect by January 1, 2023. So, it is yet to be observed within New Year, but we believe the new regulatory framework will bring a more open, transparent and fair operating environment for all players. With that said, as we discussed, we are already getting ready and prepared for the publicly shared time line as of January 1, 2023. And as you also mentioned, the first impact of regulatory framework is seemed to be the restrictions on marketing spending and promotional discounts. And as a team, we are already actively working towards that timeline, which is January 1, 2023. With that said, maybe just as a side note, as you can see from our numbers and also provided in announcements, we have been actively working on increased marketing efficiency, and we are already actually implementing those efficiency points into our execution as we speak, regardless of the regulatory framework. Thank you, Cem, for the question. On the cash side, there will be a reduction in the payment terms for the merchants and we are in a position to calculate the impact because the newcomers and the existing merchants will differentiate for the first six months and going forward. To create excess cash, it depends on the GMV and how we distribute our promotions among the months and so on. So, this is under progress and in the coming quarters, we will be talking more about our cash flow projections. Thank you. [Operator Instructions] Ladies and gentlemen, there are no further questions at this time. I will now turn the conference over to management for any closing comments. Thank you. Thank you. Before we close our call, thank you all once again for participating in our results announcement call and for your kind support over the years, much appreciated. I would like to take one more minute to thank our founder, board of directors, the executive and the management team for their trust and relentless support to me to Hepsiburada's mission over the years. And I also would like to express my gratitude to our customers and business partners, the investment community and to the rest of the Hepsiburada community who have been part of this amazing journey. Ladies and gentlemen, the conference is now concluded and you may disconnect your telephone. Thank you for calling and have a good afternoon.
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EarningCall_1657
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Hello and welcome to the Electrovayaâs Q4 Year-End 2022 Financial Results Webcast and Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. Thanks very much. Good evening, everyone, and thank you for joining today's call to discuss Electrovaya's Q4 and fiscal 2022 financial results. Todayâs call is going to be hosted by myself; and Dr. Raj DasGupta, CEO of Electrovaya. Today, Electrovaya introduced a press release concerning its business highlights and financial results for the 3- and 12-month period ending September 30, 2022. If you'd like a copy of the release, you can access it on our website. If you want to view our financial statements, management discussion and analysis and annual information form, or AIF, you can access those documents on the SEDAR website at www.sedar.com, searching for Electrovaya. As with previous calls, our comments today are subject to the normal provisions relating to forward-looking information. We will provide information relating to our current views regarding market trends, including the size and potential for growth and our competitive position within our target markets. Although we believe that the expectations reflecting in such forward-looking statements are reasonable, they do obviously involve risks and uncertainties, and actual results may differ materially from those expressed or implied in such statements. Additional information about factors that could cause actual results to differ materially from expectations and about material factors or assumptions applied in making forward-looking statements may be found in the Company's press release announcing the Q4 fiscal 2022 results and the most recent annual information form and management discussion and analysis under risks and uncertainties as well as in other public disclosure documents filed with Canadian Securities Regulatory Authorities. Also, please note that all numbers discussed on the call are in U.S. dollars unless it's otherwise mentioned. Thank you, John, and good evening, everyone. Fiscal year 2022 was pivotal for the Company as we passed several major milestones, which I believe will set Electrovaya on course to being one of the leading lithium-ion battery players. First of all, we have continued to see strong and growing demand for our Infinity battery products from some of the world's largest companies. Growing deployments of batteries to these customers have continued to demonstrate our capability to deliver and also that these products provide these customers unique benefits, including higher levels of safety with lower overall life cycle costs due to superior battery cycle life. These lower life cycle costs are despite the fact that these batteries are being sold at higher prices than typical battery products. In the fourth quarter of fiscal year 2022, we demonstrated that our scale-up plans from both, a supply chain and manufacturing standpoint could meet growing demand. In this fourth quarter, we had record revenue of $10 million, which was also EBITDA positive, two key milestones which position us to meet our guidance of $42 million in fiscal year 2023. One thing that I think is unique about Electrovaya in the clean tech and battery space in general is that we are managing this growth at near breakeven levels and we will be positioned to move to a cash flow positive position in 2023. We are achieving this despite expanding our research and development efforts for our commercial and solid-state battery products, growing our headcount and planning investments for increased capacity. We've been frugal and extremely effective in our execution of this strategy, which I think more people will appreciate in these times of high interest rates and a focus on corporations who can both, grow and do so profitably. The revenue in the fourth quarter was achieved while managing a growing operational team and additional equipment, however, still operating within a single shift. We have established systems that will enable us to grow further. This included achieving ISO 9001 certification in July and adding some key quality and operations staff. Furthermore, we are embarking on some innovative automated assembly methods, which should come on line in fiscal year Q3 to support assembly of high-voltage battery systems in addition to new customized battery systems. With these enhancements, we expect the Mississauga facility itself to be in a position to support in excess of $70 million in revenue annually with minimal additional capital spend. However, we see the need to support further growth, and this brings me to our Jamestown, New York expansion plans. As we announced in October, Electrovaya plans to establish our first Gigafactory in Jamestown, New York. This facility will be central to our strategy in increasing capacity and enabling Electrovaya to enter new markets. Our highest priority is to establish our cell assembly at the facility, thereby augmenting our current contract manufactured products. This vertical integration should have a positive impact on our gross margins. Furthermore, cell and module output will be eligible to access Inflation Reduction Act incentives, further increasing the financial benefits of reshoring these activities. Finally, from just an assembly perspective, this facility can mirror our Mississauga facility operations, thus increasing the final system capacity by a significant factor. I would expect us to have final assembly up and running in Jamestown first, and we are targeting start of operations during the first half of calendar year 2023. The cell assembly capacity is capital-intensive, and we are in late-stage discussions with two government-backed entities to help support these investments through low-cost loans. From a business development standpoint, we continue to make progress growing our relationship with Raymond Corp. through increased dealer engagement, potential new leasing opportunities, and finally, new large accounts becoming customers. Our customers tend to be large corporations, most of them Fortune 500 companies. Generally, most of our revenue is generated by a select few of very large end users but this list continues to expand. The Company continues to focus on developing additional OEM relationships in the material handling and other sectors. I expect us to be successful in announcing some further relationships in the near future. We have also received some initial orders for our high-voltage battery systems. As I mentioned earlier, we are investing in a new automated manufacturing line, specifically designed to meet the needs of these types of systems. This will come online in the calendar year -- Q2 of 2023 and will enable the Company to start deliveries into new markets, including electric bus, truck and other applications that utilize high-voltage battery systems. High-voltage battery systems will also be used for stationary energy storage systems, and we recently announced that we plan to develop batteries for this market, which will also be based on our Infinity Battery Technology platform. We've already proven that this technology enables significantly longer cycle life with superior safety performance through mature deployments in our material handling and other applications. These factors are also highly valuable for this rapidly growing and maturing market as many developments are now taking the overall life cycle cost of the solutions into account, a metric that is very much in the Company's favor. Finally, when taking into consideration the Inflation Reduction Act incentives, our solutions will become ever more competitive. Given the size of these projects, we would definitely require our Jamestown site to have cell assembly operational prior to making deliveries. So, we are now looking at projects in 2024 and 2025 periods and beyond. Last but not least, I'd like to briefly discuss our efforts with regards to our solid-state battery technology development. We have continued to make good progress in this area. Back in April, we had published results relating to what will be referred to as our solid-state hybrid battery. This approach had elements of both, conventional lithium-ion technology with liquid electrolytes and also our solid-state battery electrolyte. More recently, we have made good progress with regards to a full solid-state battery and are considering both approaches with regards to commercialization efforts. We have started introductory calls with some high-profile automotive companies, and we hope to be in a position to start sampling cells in the first half of calendar year 2023. Finally, we have continued to invest and grow our team at Electrovaya Labs, which is solely focused on the development of this solid-state battery technology. Given Electrovaya's successful execution of the implementation and commercialization of ceramic separator based cells, I'm optimistic that we are in a good position to be successful with our solid-state battery efforts. I will now turn the call over to John to review our fiscal year 2022 fourth quarter results in greater detail. John? Thanks, Raj. Revenue for Q4 2022 was $10 million compared to $4.1 million in the fiscal fourth quarter in 2021, an overall increase of 140%. This has been a record for the Company and now sets a target for us to beat going forward. On a sequential basis, revenue in Q4 increased significantly from Q3 by 132% and was in excess of the first three quarters combined. For the full year, revenue was $19.8 million compared to $11.6 million in the prior year, an increase of 71%. It is anticipated that sales will continue to grow in fiscal '23 as production continues to scale to meet demand. The impact of supply chain issues and inflationary pressures was evidenced by the gross margin for Q4 of 24.5% compared to 35% for Q4 in the prior year. The decrease also arose due to some customers being locked into historical price levels from the summer of 2021. Company has taken steps to reduce these inflationary pressures through several price increases and locking in pricing from key suppliers for 2023 deliveries. We expect to see an increase in the gross margins in calendar '23. We recently amended our credit facility. The working capital facility was increased from C$14 million to C$16 million. The increase supported working capital requirements in order to accelerate production to meet current sales demand. Company believes its available liquidity, along with collection of $6.3 million of accounts receivable and conversion of $4.5 million of inventory into sellable finished goods as well as receiving an additional $3.8 million of inventory in process from which deposits have been recorded in the prepaid expenses is adequate working capital to support our anticipated growth. Finally, as we released last month, the Company completed a private placement for approximately $11 million. This has been used primarily to reduce debt, provide startup funding for Jamestown and strengthen the balance sheet as we head into '23. Thank you, John. For my concluding remarks, I'd like to summarize some of the key value propositions that Electrovaya brings to the table. Electrovaya is both, a technology and manufacturing company. We have successfully commercialized a unique approach to lithium-ion batteries, which is our Infinity Battery Technology platform. This proprietary technology platform has been shown to enhance the safety and significantly improve the cycle life of a battery regardless of the chemistry used. Our growing revenue and scale for the technology platform demonstrates the success in execution, something that we hope to repeat in a broader market context. I'm optimistic that we have much further growth potential with the Infinity platform and the number of applications and demand for solutions that would benefit from this technology is immense. We've continued to focus on additional technology development. With the Infinity technology platform, we continue to make incremental improvements with regards to energy density and performance. We are also looking at other ways to monetize the unique performance attributes of our products. This includes renting or subscribing battery systems, which we are currently trialing at a Fortune 100 company. We are also looking to add additional smarts to our cloud-based remote monitoring system, EVISION, where we will be in a position to provide additional service like demand response. Our material handling battery systems have been shown to have minimal degradation even after four years of continuous operation. Given this performance, the rental and subscription route could become very profitable. We are also expecting our OEM partner to be able to implement larger quantities of leased products with higher residual values, something that we believe could drive demand for these products. We are continuing to add talented engineers and scientists to our team, and I'm very encouraged to see how excited people are with the work they are doing and its contribution to the overall energy transition. Remember, an Electrovaya Infinity battery is often doing about 10 times as much work as a passenger electric vehicle battery, a figure which also translates to a very high impact in the reduction of greenhouse gas emissions. With regards to R&D, we have a growing number of funded projects to support our solid-state battery developments. We have continued to file patents. And I believe our growing IP portfolio is adding fundamental value to the Company. This is also a testament to our core commitment to technology development. Finally, the market for our products is growing quickly, while also getting more adept at differentiating battery technologies. This is good news for the Company as we need to spend less effort in convincing customers of the need for solutions that have a focus on safety and cycle life. They are starting to have their eye out for these metrics themselves. In North America, there's also a growing focus on developing local supply chains for this critical industry, and I believe Electrovaya is likely to benefit. That concludes our remarks -- my remarks for now. I would like to pass this on to the operator for a question-and-answer session. Yes. The Gigafactory effort is going to go in phases. So our first phase, the CapEx is approximately $45 million, and all-in, we're looking at about $75 million. Now the timing of when we go from the first phase to the last phase, really depends on how quickly the demand ramps up. And of the $75 million, how much do you think will come from these low-cost loans from the government agencies versus how much equity you have to put in? This is John. So, we're targeting close to 90% to 95% of this being covered by loan -- low-cost loans and government grants or other incentives. So, we are targeting very little equity investment from ourselves. Understood. So, should we assume that there is some sort of loan expected to close in the near term to facilitate the build-out? Yes. We're currently in discussions with two government-backed debt lenders. So, we're in late-stage discussions. We haven't finalized anything just yet, but we are optimistic we'll have some -- a term sheet with them early 2023. Okay. Thank you for that. And just moving on to this rental or subscription model, a couple of questions on that, I guess. One is, are you renting this to the distributors or to the end customers? And then what's the model over here? Are these based on an annual contract potentially? And is there any contribution from this rental model in our outlook for 2023? So, it's a relatively small experiment, approximately $0.5 million worth of assets. It's direct to the customer. So, this is a Electrovaya direct to customer relationship. The rental fee or subscription fee is rather -- I would say, it's advantageous to the Company, the fact that we would probably recover the capital cost within a year or less. So, it's a model that could be interesting. I don't think you've included it in your financial models, nor have we included this type of model in our financial projections. We will continue to be more focused on selling these battery systems rather than this route. But this is an interesting thing to consider. When you own the battery asset, it enables you to do additional things. We can potentially use these assets as energy storage assets. As we recover the cost of the battery systems, they become also very profitable. Understood. And then, John, maybe can you give us a sense of what we should be assuming for operating expenses next year relative to fiscal 2022? Yes. I think you're going to see an improvement in the gross margin right off the top as we kind of have taken those steps. From an operating expense standpoint, we're still going to invest in the people here and in the R&D side of things. Obviously, we have -- we're strengthening our balance sheet, and we reduced some of our debt. So, our interest costs, our finance costs are going to go down. But what we don't want to do is hamstring the business by cutting costs all over the shop. We understand that in order to scale -- and we're holding our projections of $42 million for next year, so that's a 100% increase from this year. In order to scale, we're going to have to spend money. But the key would be choosing the most appropriate routes to spend that money. At the end of September, our cash in the bank was just over US$600,000. Our debt was C$60 million, and we had a promissory note for another C$6.8 million, that has since been paid back. And as of today, we are looking at, I think, our debt is about C$13.5 million. Thank you, and congratulations. I probably could ask 10 questions, but I'll try to discipline myself a little bit. With regard to the newly announced stationary battery development program, I was wondering as this new market unfolds, do you think it will increase the Company's buying power for key components and improve its supply chain strength, or is the stationary and the material handling battery approach so different that there's not been any synergies between the two? Great question. There is a lot of synergies. In fact, the cell materials themselves will be identical, whether they're used in material handling products or in energy storage products. But you're correct. The energy storage, if we're successful in this market, the size of projects is much larger. So, it would entail: A, having the Jamestown facility up and running with a good capacity; and B, it would also enable us to buy materials at larger volumes. And I would expect some costs reduced due to that scale. Okay, great. Thank you. Could you add some color on the automation that you referenced that's going to come, if I understood it correctly, I think itâs in the fiscal third quarter '23? Is this automation the primary reason for stating that the revenue growth in Canada would go from $42 million to, I think, $70 million? Or does that also assume maybe some increase in shifts? Because you mentioned you're still running a single shift. So, this automation is really specifically targeted for our high-voltage battery systems. So, our high-voltage battery systems require a different type of module design. And we're installing an automated module assembly system here, which will enable us to build these packs more quickly. And the system that we're installing actually has some flexibility so we can make customized battery packs more easily. With regards to revenue, we haven't included high-voltage battery system revenue in our forecast for calendar -- for fiscal year 2023. That -- our models are strictly based on our material handling products. That said, I would expect high-voltage products to become hopefully, a significant portion of our revenue in fiscal year 2024. Fiscal year 2023 though, we are proving out the systems, we'll be working out new OEM agreements and really getting our product to -- in customer hands. So, there's lots of demand for high-voltage battery systems. We do have prototype systems in vehicles today, but we want to have this production line in place so that we can take these larger contracts. Okay. And is it fair to think -- you mentioned the ability to have customized battery packs. Is that -- is it fair to think of that as providing you flexibility so that you could work with different OEMs and whatever their requirements are for fitting a battery pack into the vehicle design? Yes. Sure. You're precisely correct there. So each OEM, it will be nice to have a single pack, which works for everybody. It unfortunately is not going to work out that way. So, we do need to have some flexibility in the module assembly to make packs for multiple types of applications. So, you're correct with that. Okay, great. All right. I said I'd behave. So, I'll just ask one more question. Can you discuss -- I thought this is interesting. Can you discuss the -- perhaps the advantages or disadvantages of the hybrid solid-state battery versus the fully solid-state battery? Or maybe the better way to look at it is, why might it be possible to commercialize both approaches? So, that's a good question as well. So, the hybrid system that we've already -- again, these products are in development, they're not ready to be commercialized. But thus far, the hybrid system appears to have slightly better rate capability. So, your charge, discharge rate is going to be a bit higher. And I think that will remain an advantage for the hybrid systems. That said, a full solid-state solution has some additional benefits, you get your liquids altogether. It probably will be -- have a higher level of safety than the hybrid system. But again, it's a little too early to say. So, rather than us focusing on one and giving up on the other, we're developing -- we're continuing to develop both systems and we'll see how it goes. Thus far, the team has been making great progress. We haven't published results since April. But I hope to put some new numbers out as soon as the team feels they're ready. Hey Raj, can you comment on what you -- what happens between prototype to commercialization in the high voltage, and particularly on the transportation side? Are there public milestones that you'll be able to announce? I know you said you had some pilot programs, but what should we look for to track that progress over the next 12 months? Yes. So, we've already received some purchase orders for high-voltage battery systems. That said, we are only announcing what we would determine as material-sized purchase orders or OEM agreements, and we're not there yet. We're working on it. So, I would expect you would -- as a milestone would be announcement of some sort of OEM agreement for our high-voltage battery products. That would probably be our next step there. And to put that in a framework, time framework, I mean, obviously, the automotive platforms can be very long transportation platforms. But you think this is something that you don't have to go out and do 1 million miles on a prototype bus, right, in order to scale and ramp in a commercial way? It really depends on the type of vehicle or type of application, how quickly it can be implemented into the OEMs platform. So some product -- some vehicles have start-up production dates which are slated for, let's say, 2025. And in order to get into that SOP, you need to hit various samples and there's quite a bit of testing and due diligence done prior to being able to go into mass production. Other applications that time frame can be quite a bit shorter, but perhaps the volumes will be less in those other applications. Now for high-voltage applications in general, number of applications are quite broad. So there's electric buses and trucks. Those OEMs will take a little longer. But we're also looking at some other, for instance, energy storage or airport equipment, those time lines are a bit shorter. So, it really depends on the application. Got it. And you were very strategic in targeting the material handling business because it really had the margin and the profitability that you wanted, right, say the Infinity platform. Trying to understand as you go forward and you build out these other markets, again, maybe there's going to be broader applications. But how should we think of margin profiles, let's say -- when they have volume, not obviously start-up and things? But when you look at the long term, in, say, stationary or high voltage for buses or trucks? Is it going to be comparable, or will there be a difference in how we should model that? So first of all, material handling still is our number one priority for both -- for fiscal year 2023. It's going to be accounting for the vast majority of our revenues. And even fiscal year 2024, we do forecast significant growth in that sector. And we have a lot of demand for our battery products in that market. So, that will remain core to Electrovaya's strategy. The other markets, whilst they may not form as much of a size, especially in the near term, they're strategic in nature, especially as you're looking at higher volumes of deployments. That said, these other markets, the customers are more cost sensitive than material handling. And thus, potentially the margins will be lower. But the size of deployments could be very large, especially with the case of energy storage. Energy storage projects are now becoming very large in size and it could be an interesting application for Electrovaya in the coming years. Yes. Last question is, as you look at your historical margins -- gross margin specifically, is -- and obviously, you've been -- supply chain issues and pricing that you've had to work through when you go through the outsourced to in-source process here over the next 12 to 24 months, do you think that creates new long-term higher gross margins overall for you, or is it something that you're kind of trying to keep pace with using these innovations to fight off the natural progression of the business at volume and margins? Us reshoring and vertically integrating the cell production is going to have a very positive impact on our overall gross margins. So, if you think about it, the cells, they are our single largest cost center. And by bringing that in-house, we're going to automatically increase our margins by the factor that our contract manufacturer currently takes. We're also going to reduce significantly our shipping and logistics costs from Asia. And then thirdly, which was a nice surprise is the Inflation Reduction Act offers significant incentives for cell and module production. So, this looks like a $35 per kilowatt hour incentive for cells and another $10 per kilowatt hour incentive for modules. So, it's a significant benefit for reshoring. But I'd like to also point out, we would have gone ahead with this vertical integration, despite the Inflation Reduction Act. Thank you. Weâve reached the end of our question-and-answer session. I'd like to turn the floor back over for any further or closing comments. Well, thanks everyone for taking the time. And that concludes our call. Thank you for listening. We look forward to speaking with you again after we report our first quarter 2023 results. Have a wonderful evening. Thank you. That does conclude our teleconference and webcast. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today.
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Greetings. Welcome to the Guidewire First Quarter and Fiscal 2023 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. [Operator Instructions] Please note, this conference is being recorded. Thank you, operator. I'm Alex Hughes, Vice President of Investor Relations. And with me today is Mike Rosenbaum, Chief Executive Officer; and Jeff Cooper, Chief Financial Officer. A complete disclosure of our results can be found in our press release issued today as well as in our related Form 8-K furnished to the SEC, both of which are available on our Investor Relations section of our website. Today's call is being recorded, and a replay will be available following the call. Statements made on the call today include forward-looking ones regarding our financial results, products, customer demand, operations, the impact of local, national and geopolitical events and our business and other matters. These statements are subject to risks, uncertainties and assumptions that are based on management's current expectations as of today, which should not be relied upon as representing our views as of any subsequent date. Please refer to the press release and the risk factors and documents we file with the SEC, including our most recent annual report on Form 10-K in our quarterly report on Form 10-Q to be filed with the SEC for information on risks, uncertainties and assumptions that may cause actual results to differ materially from those set forth in such statements. We also will refer to certain non-GAAP financial measures to provide additional information to investors. All commentary on margins, profitability and expenses are on a non-GAAP basis, unless stated otherwise. A reconciliation of non-GAAP to GAAP measures is provided in our press release. Reconciliations and additional data are also posted to the supplement on our IR website. Thank you, Alex. Good afternoon, everyone, and thanks very much for joining us today. We're off to a solid start in the fiscal year with steady and consistent execution towards our goal to modernize the technology platforms supporting the global property and casualty insurance industry. ARR and subscription revenue both finished ahead of our expectations and notably, subscription and support gross margin came in better than our expectations. You have heard me say before that we feel privileged to serve a critical and essential industry, one that helps families and businesses manage risks so that they can better plan and grow Insurers need an agile core platform that effectively engages, consumers that supports faster innovation with new products and distribution channels and that enables them to grow efficiently. Guidewire Cloud Platform delivers this agility, and I'm pleased to share the progress we continue to make in expanding its depth, adoption and deployment. The momentum around Guidewire, our ecosystem and our cloud platform was on full display at our recent connections conference held in October in Las Vegas. With nearly 2,800 people attending in person, we saw record attendance more than doubling from the prior year and representing broad participation across customer segments, partners and regions of the world. At Connections, we announced Flaine, our sixth platform release. Flaine built on our previous releases to deliver improved self-service tooling for faster production deployments and introduces a new approach to release updates. Cloud customers can now update their implementations to new releases far more easily, which will structurally change how customers approach upgrades allowing them to stay on the latest Guidewire version and take advantage of platform and application innovation more continuously. We also released our digital framework Jutro which enables customers to launch new digital experiences built on InsuranceSuite quickly and easily. Together, these product capabilities provide much greater speed and agility to our customers, and help us manage our customers' cloud deployments far more efficiently. But the real highlight of Connections was hearing customers share their cloud visions, journeys and outcomes with Guidewire. USAA, which has served U.S. veterans and their families for 100 years and has over 13 million members, is halfway through a multiyear modernization journey to increase engagement, innovation and efficient growth. Guidewire Cloud Platform is a key foundation of this journey and already USAA has been able to introduce a touchless claims experience for members and launched its new small business insurance line of business in less than nine months. Tryg, the largest property and casualty insurer in Scandinavia with over 5 million customers move to Guidewire Cloud platform with the goal of fully automating the claims process to further drive efficiency and customer satisfaction. Tryg has already been able to reduce the amount of time spent per claim by 26% and the percentage of claims leakage by 58%, while also significantly increasing customer satisfaction. Aioi Insurance, part of the Nissay Dowa Insurance, the eighth largest insurer in the world was able to replace its core system with Guidewire Cloud platform in 12-months, and through greater flexibility, security and optimization, they were able to double their new business capacity by reducing manual steps and cutting claims acceptance time and half. As we continue to increase platform maturity with each release, we are driving healthy adoption across existing and new customers. Over 20% of our core InsuranceSuite customer base has already adopted Guidewire Cloud Platform and we added another four cloud wins in the first quarter. Buda Group, a Swiss Tier 2 insurer, founded over 125 years ago, chose to upgrade to InsuranceSuite on Guidewire Cloud Platform for a major part of its book of business to achieve greater operational excellence. Boda Group initially adopted InsuranceSuite self-managed, but before deploying, elected to upgrade to Guidewire Cloud. Santa Lucia SA, a Tier 2 insurer in Spain, selected InsuranceSuite on Guidewire Cloud Platform for their largest line of business, funeral insurance and end-of-life support. Santa Lucia decided to modernize policy, claims and billing on GWCP because of our market-leading presence, combined with our platform adaptability and flexibility. This is our first InsuranceSuite cloud customer in Spain, and we're excited about the future potential in this market. Builders, a midsized mutual insurer specializing in workers' compensation and construction operating in 22 states, selected full InsuranceSuite on Guidewire Cloud platform to replace their legacy mainframe-based system and to establish a new technology framework that improves their customers' experience, increases productivity and supports future growth. Finally, RVOS Farm Mutual Insurance based in Texas adopted InsuranceNow for its functionality, configuration, upgradability and self-service capabilities. In addition to these cloud decisions, we also saw three insurers including one in Japan and one in South Africa, ought to begin a modernization with Guidewire on-prem. While the vast majority of sales activity over the past few years has been cloud, we do see cases where an insurer decides it makes sense to begin on-prem. Our technical approach facilitates this path and our perspective is that as long as the customers understand the strategic direction we are following and acknowledge that an eventual transition to cloud will come, we can support this approach. In one of the deals in existing Tier 1 on-prem ClaimCenter customer selected PolicyCenter for a new modernization project, to support specialty lines. In another, the selection was based on the native integration of data and analytics into ClaimCenter, which will enable the creation of a better claims experience through real-time modeling and targeted straight-through processing. This example supports our strategy to deliver a fully modernized score platform with data and analytics embedded throughout the insurance life cycle. We also saw HazardHub continued to accelerate in the quarter. This was highlighted by a meaningful deal at Frontline Insurance Company, a large home and commercial property insurer operating in Florida, Alabama, Georgia and the Carolinas. Frontline will use HazardHub's granular risk scoring for their direct-to-consumer business, Open House, to inform customer acquisition and core underwriting strategies. We are very pleased with the continued success of this product as it offers us a new faster sales cycle and a more flow-based business that might in the future, complement our core system sales dynamic. Turning to operations. At Analyst Day, we talked about our focus on driving improved platform efficiency as we expand breadth and adoption. In the first quarter, this translated into progress in subscription and support gross margins. This is an area we will continue to stay focused on and expect to improve steadily as we deploy more customers in the cloud, roll out new self-service capabilities and generally improve the efficiency of our cloud platform, while at the same time, always continuing to ensure that our customer implementations are resources managed to ensure that the greatest possible degree of success. In the first quarter, we executed a number of new InsuranceSuite production deployments on Guidewire Cloud Platform, including DEFINITY Insurance, a Tier 2 insurer in Canada known for industry-leading innovation, a two-time winner of Guidewire's Innovation Awards, migrated to Guidewire Cloud platform with over $2.5 billion in personal lines and production. Already, it is seeing 40% faster consumer transactions, 12% faster broker transactions and an 8% increase in quote volume. We also saw a Tier 2 insurer with over 90-years of history, offering auto, homeowners and other personal lines to members in 23 states go live with ClaimCenter on Guidewire Cloud Platform. This deployment lays a strong foundation to build on as this customer embarks on further transformation. In addition, a large farm mutual insurer in Texas went live with InsuranceSuite on Guidewire Cloud Platform. This is a company with over 100 years in operation and Guidewire Cloud platform will help them maximize operational efficiency as they pursue further growth. And finally, let me just close by discussing our partner community and ecosystem. Our system integrator community has been and will remain critical to our differentiation and long-term success. SIs are currently involved in over 60 Guidewire Cloud projects and growing this total will remain a strategic focus for us. The number of Guidewire consultants at systems integrators grew to over 20,000 at the end of Q1, up by 28% year-over-year. We also continue to see cloud momentum build in this community with a number of cloud certified consultants, sustaining growth of over 100% year-over-year and passing 5,800 at the end of Q1. This gives our customers a valuable bench of cloud trained professionals to draw on as they start down the path of modernization or embark on cloud upgrades. We are also seeing momentum in our solution partner community. In the first quarter, 19 more solution partners joined Guidewire's Marketplace, bringing the total to nearly 180. We also announced a few important new strategic partnerships at Connections. We partnered with One Inc., a digital payment solution for P&C insurers that offers comprehensive digital payment options and automated inbound and outbound payments. Our collaboration will make it possible for our cloud customers to deploy these solutions significantly faster than they were able to in the past. We've also partnered with Appian, a leading workflow automation platform, to enable our cloud customers to rapidly create and manage cloud-based digital experiences and business process automation. And we partnered with Ernix, a leading dynamic pricing engine, to accelerate insurers' speed to market in defining, updating and optimizing insurance products that are already in market. In summary, Q1 was a great quarter and a solid start to the fiscal year. We continue to expand our platform in critical areas. We continue to sell new modernizations and cloud upgrades. We continue to expand our ecosystem and deliver successful production go-lives and continue to make steady progress on cloud operating efficiency. All of these critical elements of our plan that reinforce each other and demonstrate steady progress towards strategic cloud leadership in our market. Thanks, Mike. First quarter ARR ended at $673 million ahead of our expectations. Q1 is always our slowest quarter, but we are pleased to see some exciting cloud wins, most notably meaningful progress in EMEA. Total revenue was $195.3 million, just above the high end of our outlook. Cloud strength continues to be visible on subscription revenue, which was $79 million, up 38% year-over-year. Subscription and support revenue was $99.1 million, up 25% year-over-year. License revenue was $41 million, up 2% when compared to Q1 last year. Services revenue was $55.3 million, up 18%. Services revenue benefited from ongoing increases in the number of cloud implementation programs. Turning to profitability for the first quarter, which we will discuss on a non-GAAP basis, gross profit was $83 million. Overall gross margin was 42%. All of our margin disclosure for the quarter and for the comparison periods reflect our updated allocation methodology for headcount-related costs for IT, payroll and procurement. As a reminder, and as we discussed on our Q4 earnings call in September, we moved headcount-related costs of IT payroll procurement to G&A expense. Previously, we allocated these headcount costs out to other expense lines. Subscription and support gross margin was 49% compared to 45% a year ago. This was ahead of our expectations due to increased cloud infrastructure efficiency and slower-than-expected hiring. And services gross margin was negative 9% compared to positive 10% a year ago. As discussed in prior quarters, we are working through some complex early cloud projects and have been leveraging subcontractors at higher than normal levels. We are making steady progress through these programs and expect services to return to positive margin in the second half of the fiscal year. Operating loss was $35.9 million. This included $2.9 million of severance expense, half of which impacted sales and marketing expense. Also, as previously mentioned, G&A expenses were negatively impacted by the reallocation adjustment. This had an $11.3 million impact on G&A expenses in the quarter. Overall stock-based compensation was $35.1 million, up 9% from Q1 of last year, which is generally in line with our growth in overall compensation expense. We ended the year with $868.5 million in cash, cash equivalents and investments. In Q1, our Board authorized a $400 million share repurchase program. And as part of that, we initiated a $200 million accelerated share repurchase program that we expect to complete in Q3. Turning to our outlook for the fiscal year 2023, we are maintaining our ARR outlook of $745 million to $760 million. Per our usual approach, our ARR outlook assumes foreign currency exchange rates as of the end of our last fiscal year. We are adjusting our outlook [Technical Difficulty] we now expect to be between $886 million and $896 million. The only change, we now expect subscription revenue to be $342 million, an adjustment of $2 million. All other components of revenue are largely unchanged. Turning to margins and profitability, which we will discuss on a non-GAAP basis, we expect subscription and support gross margins to be 49% for the year, an increase of 3 percentage points when compared to our outlook last quarter. We now anticipate lower cloud infrastructure costs, and we redeployed some headcount from COGS to R&D, as their work transitioned from supporting specific customers to building platform capabilities that will benefit all of our customers. This adjustment reflects increasing confidence in our margin trajectory as we execute toward our mid- and longer-term margin targets. We expect services margins in the mid-single digits for the year with significantly better services margins in the second half of the year. This improvement reflects the successful completion of ongoing arrangements with investments from Guidewire, the ramp of new services hires replacing subcontractors and the redeployment of some Guidewire services resources from non-billable to billable roles. As a result, we now expect overall gross margins to be just under 52% for the full-year. With respect to operating income, we expect an operating loss of between $28 million and $18 million for the fiscal year. We now expect stock-based compensation to be approximately $138 million, representing a 1% growth rate year-over-year. We expect stock-based compensation expense growth to slow as we temper overall hiring. There is no change to our cash flow from operations expectations. Turning to our outlook for Q2. We expect ARR to finish between $695 million and $700 million, which represents 16% growth at the midpoint on a constant currency basis. We expect total revenue of between $221 million and $226 million. We expect subscription revenue of approximately $83 million and services revenue of approximately $52 million. We expect subscription and support gross margins of approximately 50%, and we expect services margins of approximately negative 2%. We expect an operating income of between negative $4 million and breakeven in Q2. At this time, we'll be conducting a question-and-answer session. [Operator Instructions] And our first question comes from the line of Dylan Becker with William Blair. Please proceed with your question. Hey, guys. Thanks for taking the question. Maybe Mike, double-clicking on the Connections conference about a month or so ago. The cloud messaging there was very apparent and you guys emphasized the plans of getting 100% of that customer base to the cloud over time. So I guess how is the initial feedback been from a customer perspective following that event? And how important are those conferences being in person as you think about building out that pipeline progression with some of those initial reference points? Yes. Dylan, thanks for the question. I would say -- let me take the second half of it first. I think these in-person events are critical for us. There's just nothing that you can do to replace the ability to connect with customers and the ability to connect customers with other customers, to be able to hear firsthand their experience, the things to do, the things not to do. That event is just invaluable just both for us and the community. When you add to that the opportunity to connect with the different partners, different application partners, the new fresh innovation that you're seeing in the ecosystem, it's just great to be able to get people back in person, and we were really excited, so like I said in the prepared remarks, a set a record in terms of in-person attendance. So really, really great to see. I think -- I was pretty direct, I guess, in terms of our intention to get 100% of the customer base to the cloud. I think at first, people saw that as a sort of a more direct statement of that strategy. But I think as it sunk in over maybe a couple of hours or 24 hours and then certainly over the past few months as we've engaged with customers following the event. I think everybody understands and appreciates why it's important for us to be so clear about where we're taking the company and where we intend to take 100% of our customers. These implementations in these projects have to last for 20-30 years, the decision time frame that people have when they're thinking about how to approach it is not measured in months, it's certainly measured in years. And it's not to say that we're going to abandon any one. That's not the intention. But I thought it was necessary to be crystal clear that there's just so much more of the innovation, the thrust of the creativity and the physical investment in the product going into cloud that I really wanted to make sure that every single one of our customers sees that and thinks about it and thinks about how they can take the appropriate steps right now to ensure that they're aligned with that eventual outcome. And so the initial feedback was a bit of, wow, that was interesting that you said that. But I quickly got the follow-up that, yes, thank you very much. We actually had 1 customer who, as I said in the prepared remarks today, we do occasionally sell even today, even in this quarter, an on-prem deal but we had a customer had a long conversation. They had done an on-prem deal previously in the year. And they said after Connection in my keynote and the sessions that they were able to participate in, they were sitting down to make a more concerted effort about making a plan to get to cloud. And so it was, I'd say, received on the whole very constructively, is the summary way to answer your question. So hopefully, that helps. And thanks for the question. Yes. No, absolutely. Great to hear. And maybe piggybagging off of that as well, too. I think there was an important implementation in the quarter at Massif and maybe one of the largest ones you guys have done to date, particularly in Europe and some where you guys called out strength from an ARR perspective, so I guess wondering, first, how important is that implementation relative to kind of a market validation perspective and then also driving kind of some nice initial margin leverage here. Maybe how are you thinking about some learnings of moving that complex book of business as some of those other customers are kind of thinking about their own migration road maps. Yes. So thanks for that. Thanks for the question about them. One thing I would say is our attitude is every single one of our customer implementations is just as important as every other. I'm 100% committed to ensuring that we're doing everything we can to make sure that every single implementation is a success. This was an important -- it's funny like when I first was talking to the board and talking to Marcus about joining Guidewire, this was one of the most memorable parts of the way that they talked about the company is that there -- because of the nature of these projects, we have to make such a huge commitment to ensuring that they are successful. And that's sounds emotional, but it's really strategic, right? Because if you think about what do you want from a core system vendor, you want somebody who's completely committed to ensuring that the project is successful. And for them and for us, if these implementations last 20, 30 years. And this is going to, in the end, be sort of economically positive for both of us. But we are committed to everybody being successful. So you talked about Massif. That project is going well. It's critical to us that we have a success in Europe at scale. It's critical to us that we have a success in the market in France. And so we are very focused on that just like we are many of our other customers. So I wouldn't call out anything in specific there, but it is certainly one of the programs that we pay close attention to, maybe not so much because we care about it being successful more, but just because it's big and complicated and requires that level of focus. Great. Thank you very much. Mike, I wanted to maybe just check in with you on what you're hearing from customers in terms of -- how they're thinking about macro last quarter? Obviously, how deal composition maybe changed a little bit. Any sense from your conversations with customers on any incremental caution? Or what were you hearing from them as far as how they're thinking about core systems and IT budgets? I would say the answer to that question has not changed over the past few quarters. I'd say that the insurance industry is a very stable industry relative to maybe the other, I don't know, buying behavior you see from other tech companies that are more horizontally focused. We consider that to be a sort of lucky characteristic of Guidewire's focus. That said, there still is the concerns associated with tracking inflation closely and making sure that the system, the rate changes, the claims expense, all those tons of things are balanced. There's a deal that we're working on in the pipeline right now, where there's some changes to the operating model associated with inflation that's having an impact on when exactly the Guidewire deal will flow through the system. But I wouldn't characterize these things as macro headwinds, but more just normal course of business and selling core systems to the insurance industry. So summary is thing doesn't seem to be helping things, but it isn't hurting things for us. And I really feel like our destiny is in our own hands if we execute effectively and we provide the value that we think we need to provide, we're going to be able to hit the targets and grow the company based on the forecast that we've laid out. Got it. Fantastic. Thank you for the context there. And Jeff, just one quick one for you. Really nice uptake on that subscription and support gross margin line. How much of that is kind of seasonal? I think typically, Q1 does see kind of a bit of an uptick versus actually getting some solid progress on the efficiency front. Yes. That's one of the highlights from my perspective of the quarter. I wouldn't categorize it as seasonal. There can be some quarterly fluctuations, but that was a result of some real hard work that we've done over the last year and in collaboration with the finance team, the cloud operations team, the product development team to drive much more efficiencies through how we manage our cloud infrastructure. So a real positive element there that we've been working on for some period of time. And there's still a lot of -- we're still learning a lot in terms of how customers consume our products and what this will look like, but some positive signs there that we all felt really confident in. As we look ahead, we were able to kind of adjust our target for subscription and support gross margins up a few percentage points, which was positive as well. Some of that benefit was a result of, as we saw some of the efficiencies of the platform, we were able to repurpose some headcount and move them back into product development where they were doing more platform-specific work rather than customer-specific work. And so that also was a benefit that's flowing through our guide as we look for the full year. Hi. Thank you for taking my question. Wanted to just follow up. You mentioned hiring plans and how they've slowed down a bit. Just curious to know if there are certain areas you're aggressively trying to hire in to kind of fill potential like implementation needs things of that nature? There's no specific area. The pace of hiring has definitely slowed down. And I think that there was a period of time over maybe the last year, I'd say, maybe a little bit further out where we were concerned about attrition. And so when you're concerned about attrition, you try to make sure you get all the appropriate roles filled you're really focused on gearing up hiring and recruiting to make sure you can compensate for any attrition that you do see. That didn't materialize as significantly as we thought it might. And at this point, there's -- we're not really seeing any gaps or strategic gaps or anything like that. It's just sort of a slow and steady approach to managing the company and ensuring that we're making, as Jeff and I have said, steady improvement on the margins. So nothing out of the ordinary. Wonderful. Thanks so much for taking my questions. I wanted to maybe start out with coming out of Guidewire Connections. One of the pieces of feedback we got from the partners is cloud demand is definitely really strong and customers are very much interested in migrating to the cloud. But one of the things that some partners told me that is maybe holding them back, is that they've built so much customization and custom apps on-premise and that makes it harder to kind of migrate to the cloud version. Can you talk to what kind of steps you can take to make that migration path a little bit more painless? And then I've got a follow-up. Super question. So this is something we spend a lot of time thinking about, obviously. These things end up being super, super complicated. And so somewhat the answer to your question is 1,000 little details. But I'll give you some examples. Number one, I think when we started the journey, we had a sort of view for the types of customizations, types of configurations, characteristics of the implementation that we thought were acceptable and not acceptable when those implementations landed on our cloud platform. As we've gained experience, we've been able to hone those requirements. And so maybe a lot more of those things that we thought at first were inappropriate or not something we could support that maybe they could be things that we could support them in certain ways. And sort of that experience enables us to really hone what the requirements are for things like integrations or customizations that are running on the platform. The other thing that we could do is facilitate the conversion of those customizations to something that will work more effectively on cloud. An example here is we have something called Advanced Product Designer, which is sort of a new way to build out an insurance product on our platform. And when you use advanced product designer to build out that product on our platform, you just get a whole bunch of features for free, right? We're able to build APIs, to be able to integrate that product into different applications. We're able to make a digital interface for that product much more efficiently. But for a customer that's already built their products in the on-prem version of Guidewire, they were looking at having to rebuild that product using Advanced Product Designer, so we built something called APD retrofit, which is a mechanism for us to take most of the product definition that exists on-prem and convert it efficiently to an APD based product, which enables that customer to more smoothly transition to the cloud and take advantage more of the benefits of the cloud version of the product. And so that's one example that is relatively important and strategic, but you want to think about lots and lots of these things that relates to the various components of an implementation. And those things will just build and build and build over time as we get more and more experience, and we do more and more of these migration projects. So hopefully, that helps give you a little bit of color. But to the -- what the partners are telling you is real. There is a difference between the on-prem implementations and what we really want to see and what the customers want to get out of the cloud implementation. And that, I would say, is just something that needs to be accounted for in the planning through each one of these migrations. Got it. No, that's super helpful. I appreciate that example. And then, Jeff, just a quick follow up to continue on the margin question. So we saw a continued improvement on the subscription gross margin side, right? If we did the kind of backing out math above 40% for the first time in a while. Anything just onetime to call out? I know you said not seasonality, but accounting or anything like that? Or is there any reason we can't kind of straight line the sort of margin improvement we've been seeing for the past couple of quarters and kind of get it from that glide path from 40% to, call it, 60% over the next several years? Thanks. Yes, nothing really onetime in nature. Sometimes it can take a little bit longer for Q4 is our largest deal, those customers to get provisioned up and running and start using some of the product infrastructure resources. So if you look at our guide for the year, our guide for the year is consistent with what we delivered in Q1, but in terms of onetime in nature, nothing in particular to call out, this has just been a lot of progress that we made over the last 12 months. You may remember, it was about a year ago when we -- in Q1 last year, where we had a little bit of surprise in some of our cloud infrastructure costs, and we've done a lot of work to get that in a much healthier place. So yes, in general, as you look over the longer term, and if you look at our long-term models, it is implied that there will be steady progression as we track towards those targets. Yes, hi, guys. Thanks for taking the question. Mike, I was hoping you could dive in a little bit more on to use Guidewire on-prem as a stepping stone of the cloud. I think it was three insurers that opted for that during the quarter. Why is that the right approach today? And then two, when they talk about the modernization side of it and the eventual migration to cloud, when a customer has made that decision today, are they still thinking about this as a maybe multiple years down the road? Or does it accelerate the time line to perhaps the next 12 to 18 months? Yes. Thanks for the question. So first of all, I want to make sure everybody understands that. I think that this is a sort of a positive attribute of the choices we've made about the technical architecture. Obviously, in a perfect world, you would want everybody that goes straight to cloud. But every single customer is different, the circumstances around their overall enterprise environment are all very, very unique, and there's a lot of different variables that are at play in terms of a customer making this sort of decision. And now in one case, you could say like a customer has just got the rest of the enterprise all on-prem, Guidewire is on-prem, and they want to add a core component of the insurance suite to that implementation. And that just makes sense for them to do that modernization on a Guidewire core, but without making the overall lease to cloud, and that may be driven by the overall strategy -- the cloud -- overall cloud strategy of that customer. Other circumstances, there's going to be some regional differences around people's proclivity to accept cloud as a safe and secure place and we're constantly working on that and we're constantly making progress. But like I've said a couple of times, I mean, these decisions are 20, 30-year decisions. And if we can get ourselves established and we can make sure that the customers are crystal clear about the real strategic direction of the company and acknowledge clearly that eventually these implementations will move to our cloud. I see it as a positive characteristic. I'll also refer to you to Boda that we called out in the prepared remarks. This is a customer that made a decision to go on-prem and in the process of that implementation made the decision to move to cloud. And so this happens. And so even though we are doing these deals, and it probably seems -- and even to me, sometimes seems like as a bit of a head scratcher. There is real logic behind this, and I do think that it's a positive characteristic of the architecture and the strategy of our company. Especially as you think about Guidewire, I know it's tough sometimes, but if you think about Guidewire over a 10- or a 20-year time horizon, this makes a lot of sense. Hey, thanks for taking the question. Just in terms of capital allocation, I mean you announced the buyback. You've clearly been active around. Can you just provide us with an update on how you're assessing the trade-offs and uses of cash in the current environment? And then just the second part, I'll ask upfront. On the free cash flow side, negative for Q1, but you're holding on to the cash flow from operations guide for the fiscal year. Can you just remind us anything we should be mindful of in updating models around seasonality on the free cash flow side? Thank you. Yes. So on the capital allocation side, we're obviously executing on our $200 million accelerated repurchase program once we complete that, which we expect to complete in Q3, we'll revisit the authorization for the other $200 million. We continue to think that where Guidewire is trading today that there's no greater use of our cash at this point in time than buying back some of our shares. But it's important for us to maintain flexibility to allow for inorganic activities should those arise in this environment. So we think that the $400 million share repurchase program that we have authorized allows us to kind of walk that line and do both. So we feel that, that's the right posture for us. With respect to cash flow, we obviously guide on an annual basis. There can be a lot of movements on a quarter-to-quarter basis. The results in Q1 were very much in line with our internal expectations and how we thought this year would play out. And in fact, some of the -- we slightly adjusted our operating income expectations, and that has an impact on cash flow. So slightly more confident into the range. There can be a lot of movements in terms of collections at the end of the year that causes us to provide a somewhat wide range there, but no adjustments to how we think about the full-year. Hi, great. Going back to the subscription gross margin topic. Given the updated guidance for the year and again, the backlog back of the envelope as just on the subscription line. I think it implies an incremental margin pretty close to 60%, and last year was also pretty close to 60%. So obviously, you just hold [indiscernible] proven over time, but I also think the midterm framework implies reaching a next tire level. What are some of the elements that are going to inflect that? Or is it not even necessarily discrete elements, but maybe just more a function of how your business evolves over time given some of the installed base and kind of vintage dynamics you highlighted at the Investor Day. Yes. I'm not sure I followed completely your analysis. I'm not sure that I've looked at it the exact same way. But in terms of the key levers that we're focused on, you've heard us talk repeatedly about building our cloud operations team in advance of the demand to ensure that every 1 of these early cloud programs are ultimately successful. This is critical to our long-term strategy. And as we think about the build-out of that particular function, we've indicated at Analyst Day that largely, we've built out the team to support $1 billion of ARR and now we need to grow into that profile without necessarily expanding significantly the existing cloud operations team. But we saw in this quarter towards the end of this quarter, we were able to repurpose or reallocate heads and employees that were working on customer specific things and so impacting cost of goods sold. And now they are focused where they should have where they were originally focused on building more platform capabilities that will address all of our customers. There's other things like that, that we can do, specifically as we continue to march through migrating the customers that went live on Guidewire Cloud Classic to GWCP and recognizing the efficiency uplift associated with that. So those are the things we're focused on. And we think we have all the levers in place to execute to the margin targets that we set forth at the Analyst Day. Hey, guys. Thank you for the questions tonight. So I appreciate the comments about the resiliency of your customer base in terms of spending in earlier comments about the efficiencies that your customers see when they adopt your platform. Maybe just stepping back and trying to quantify the value proposition that you sell to your clients. And how you quantify that for them in terms of payback? And maybe where there are differences in that conversation when talking about new deployments versus some of the customers are electing to remain on-prem because they have substantial investments in legacy bespoke systems. That would be helpful if you could walk us through that math how you talk to customers about the payback and the value proposition. Sure thing. I don't know whether or not I'm going to give you the math behind it. I'll give you this objective explanation. Maybe we could connect later to talk about the math of this on a micro sense. When we do a new deal, as you heard me describe a deal where we're replacing a mainframe system, the value proposition associated with that has a lot to do with the risks that the company faces in operating a system that, in some cases, is like greater than 30 years old and has a very small number of people who are able to configure it and support it. And so when you talk to these companies, there's not really a math behind that as much as it is just an overall risk calculation that they think about in terms of the ongoing operations of their company. Certainly, there's a lot of value that an insurance company can gain from just simply being able to create engaging digital experiences on top of core systems for doing things like quoting policies, with agents, with consumers, it is personal lines or commercial lines, it's like being able to connect with buyers with convenient, digital processing flows is basically necessary in order to be able to compete in the modern insurance market. And we see this all the time. And so you could basically do the math of saying, we're going to be able to implement Guidewire create a digital experience and grow this much, but you can also do the negative math, say that if we're -- we don't get up the mainframe system, we don't do a digital experience, we don't create an API to connect into the broker system. We're not going to get any more business at all. And so you just have to do something in order to connect in a modern way to these new channels. On the claims side, being able to create a efficient claims operation to be able to manage claims efficiently, just as a direct benefit to operating expenses as an insurance company. Trade is probably one of the best examples in our customer base and maybe the industry of the kinds of impacts that you can gain from really effectively automating claims experiences. These are real structural costs for insurance companies, and you cannot do that on these legacy systems. And so that's sort of the category of net new business. That's great. Now you talk about the Guidewire installed base. Some of the Guidewire installed base is challenging for them to run Guidewire, right? Everybody in the world really is looking at data center expense, IT operations expense. It's just complicated to manage and run these systems to keep them updated. All this kind of expense and effort, it doesn't contribute to the strategic thrust of an organization. And so by moving something to cloud, by transferring the burden of IT, of the servers, of the database, of the updates, if you transfer all that to Guidewire, there's an economy of scale that we can deliver to our customer base and managing all of that for them and there is a value proposition there. And then there are a small number of Guidewire customers that are doing this super, super efficiently. And so for us, with that cohort of customer, we're really talking about, what's the incremental benefits that we're able to add to the application and the platform beyond. These are things that we just can't do in an on-prem modality, but we can do as a cloud service. And so those characteristics create value both in terms of agility, but also operating efficiency for that carrier. So anyway, without giving you all the numbers of that because it probably changes for each insurance company and each line of business and each sort of segment of the core systems, that's how we generally think about the overall value proposition for Guidewire Cloud. Sorry, does that help you? It did. I think that's a good overview of thinking about the kind of consistency of the transition of the growth and the drivers relative to other software companies. And one more quickly, if I could. As we think about growth this year versus the last couple of years, if you have it top of head, how should we think about the contribution from NRR versus net new? Are you seeing any shift there? Yes. I mean I'd say we've, over time, built up a pipeline of ARR that flows in from what we call our backlog from ramp deals. And so that's a pretty meaningful part. We are starting to see some -- a bit more new RFPs or new modernization programs for a little while, that was sitting on the sidelines because those folks were making the decision to kick the can down the road while they sat on the sidelines and waited for a bit more cloud maturity. So we're starting to see that come back to market, which is exciting for us. But no material shift in terms of the overall model. I mean I think we're still going to get a lot coming from our installed base and our customers. A significant amount coming from deals that we sold in prior periods as those ramps flow through the model. And then we're always very focused on new modernization programs. I had a quick question on cybersecurity. The standardized multi-tenant nature of Guidewire Cloud allow you to invest more into security compared to some of your peers. And I was wondering if you disclosed any of those investments in the past? Or maybe you can give us some examples that highlight your security superiority versus peers. Yes. I think the way we think about this is that the centralization of the management of a system facilitates a greater degree of security for that system. And that's simply because we can patch Guidewire and the various implementations that are running on Guidewire Cloud more efficiently than we are able to patch and maintain the systems that each of our customers are individually running. Your comment about multi-tenancy is sort of exactly right. It's like the changes that we can make once can be applied to many customers. And so therefore, the effort that we put in to securing that system can be sort of leveraged by a greater number of customers, the greater number of tenants. And so the system overall can be more secure than what any of the individual customers are able to achieve on their own. There's been a few conditions that have come up and examples of this where we were able to ensure that the Guidewire Cloud implementations were quickly patched for vulnerabilities in a way that it was just a lot more cumbersome for us to get those patches, those updates pushed out to all of the on-prem customers that were impacted by this. And I think in the end, you see this throughout enterprise software is that the centralized systems just get this benefit of a central focus on security, a sort of idea of a limited number of code lines in order to patch and secure. And you just, over time, you create something that's a lot more secure than the variability that exists within all of the individual implementations. This is certainly something that we talk about with our customers as a benefit of the cloud model and they understand that. I think that there's also a degree of risk that they're thinking about in terms of making sure that we are as at least as secure in our approach to managing the system as they are with their individual implementations. And so depending on the size and scope of the customer that we're talking about, that conversation will either be quick and easy for a small insurance company where what we can apply with the resources of Guidewire far outstrips what they're able to do on their own. But we have some of the largest, most sophisticated customers in the world from an enterprise software perspective. And so those conversations are pretty in-depth and we work very, very closely with those customers to ensure we're creating the most secure, reliable services we possibly can. So I hope that gives you a flavor for how we think about this and why I think it's certainly a benefit of the model here at Guidewire. And we have reached the end of our question-and-answer session. And I'll now turn the call back over to Mike Rosenbaum for closing remarks. I just wanted to say thanks, everybody, for participating on the call today. We're thrilled with the continued momentum in the cloud and new and existing customers. We see that as a great validation of the strategy and it's given us increasing confidence in the long-term opportunity at Guidewire. And look forward to catching up with everybody throughout the quarter. So thanks very much.
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EarningCall_1659
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Yes, get started. We are thrilled to have Amy Weaver, the CFO of Salesforce here. Amy just joked with me that she is taking the sofa. And after a tough year in tech, you might just like lie down and have a conversation with me and relax. You are welcome to do that. Thanks for coming. As many of you know, we did have Bret Taylor schedule to keynote. But given that change, Amy was gracious enough to come in for Bret. And when Mike Spencer told me that Amy was willing to do it, thatâs a fantastic trade I would take any day of the week. So thanks for bending your schedule to accommodate our conference, Amy. Yes, good. Well, there is a few things on peopleâs minds these days with Salesforce. So I think we are going to have a good 30, 40-minute conversation. But letâs hit one that I think is on the top of everybodyâs mind and thatâs Bretâs departure. But I think there is a slightly broader context where we have seen a few others. We have seen Stewart announced yesterday, he is going to leave the CEO of Tableau. So is there a broader context? Or is this a series of individual decisions that just happened to coincide at the same time? Maybe you could address that right off of that? Sure. I certainly expect that Bretâs departure would be the top question as certainly was at our earnings call last week. So as everyone heard, Bret announced on the earnings call last Wednesday that he is going to step down. A few things about this, he is working through Q4. He is deeply involved in all of our largest customer deals and as Bret has said he is going to be running through the finished case on January 31. So glad to still have him aboard. As he said, itâs been a tumultuous few years. And I think when you go through tumultuous times, you do a lot of deep thinking about whatâs important to you, what is going to bring you joy where your passion is and he decided that itâs really going back to its more entrepreneurial roots. He has founded two companies very successfully in the past and I am certainly excited to see what he does next. Now yesterday, we announced that Stewart Butterfield is going to be leaving. And as people know, Stewart is the Co-Founder and CEO of Slack. And I want to be clear right upfront. I know people love to try to connect the dots. I know there is all these areas. These are either completely unrelated events. The timing turned out to be very close within a week, which is unfortunate, but there is absolutely no relation between the two of those events. Now with Stewart, when he was talking about leaving, Stewart actually joked in his flat post to the company that he has absolutely no desire to return to his entrepreneurial roots. So he is going to -- he has a very young and growing family. He wants to spend a lot of time with them. He said only roots were going to be carving. So he will be leaving sometime we think in the next month, I am not sure of the exact date. But that actually does open up a really exciting door for us and that is with the Annie Jones. And some of you may have met her in the past. We want to get her out on the road and meeting all of you as soon as possible. Letting Annie as an Executive Vice President at Salesforce, she has been with us three, four years now. She came from running product at Sonos. And before that, she has a decade of Microsoft, absolutely top-notch executive. Not only am I excited what she is going to do with Slack from a product perspective, from a leadership perspective, but I love the even deeper connection with Salesforce and having her right in there. So, great opportunity for us going forward. Okay. We may take some questions later on, Bret, but letâs move on maybe to the results last week. So Amy, I have got a ton of questions to ask you about the numbers. But just given that it was last week, you, Mike and the team, I am sure have been on a lot of calls with investors, analysts. Did you just want to give a couple of minutes to frame the results, the highlights to you and to the extent that there were a number of common questions, maybe address them, and then we will dig a little bit deeper. Sure. Iâd appreciate that. With all of the focus, last week on Bret, I think we -- it was easy to overlook some very solid results in Q3. So, let me run through a few things of where we ended the quarter. So for the quarter on revenue, it did well guide beat our consensus. We did that both on a nominal and a constant currency basis. And this was in the face of some challenging economic times. I think it really speaks to the durability of our revenue model. Some great wins during the quarter, including the one and I have three things and they were so excited that we do business with Rivian, which they think is about the coolest company out there. Radiant bought in Slack to -- theyâve got 14,000 employees in their corporate offices and on their plant floors. They brought it in, they are going to be end-to-end, all of their onboarding, all of their training. They are using Slack in addition to the Swarm IoT issues so that they can keep their production running seamlessly, a great win during the quarter. Op margin. This is the time I am very excited to talk about operating margin. Operating margin came in at 22.7%, our highest operating margin in companyâs history. And I think there is a lot of things going into that. We have really slowed down our hiring earlier in the year, which has paid off. We have really refocused our T&E. So, it is close to purely customer-facing. And we are seeing benefits from real estate decisions that we have made in the past. And all that is coming together to really strengthen our operating margin position and you really saw that play out during the quarter. And then finally, on therapy, we met our CRPO guide on a constant currency basis. But next op margin, what I was most excited about this quarter was actually capital allocation. So back in August, I announced our first ever stock buyback authorization from our board. Our board authorized $10 billion, 23 years as a company, this is the first time we have done that, thrilled to announce that and we jumped right in. And we put $1.7 billion towards that in the third quarter, buying back around 11 million shares. So, I think there were some really solid things that came out of the quarter and thanks for giving me a chance to address it where it kind of flew under the radar last way. You got it. Well, letâs -- maybe letâs talk a little bit about the fourth quarter guidance. So itâs rough out there. Every software company is seeing some deceleration. So, Salesforce is not immune obviously. But the slowdown on the revenue line to 12%, 13% constant currency and CRPO to 10% feels like a more rapid decel than we have seen in previous quarters. So maybe you could talk a little bit about the assumptions that you use to embed in that fourth quarter guidance. I think what everybody would love to have a sense of is how are you assuming about the macro environment January quarter through October quarter, similar, assuming it gets a little worse, maybe you could take that one? Sure. So letâs go back a bit. Letâs go back to last summer. So in July, we saw a marked shift in customer buying patterns. Now, I talked to a number of sales executives, in fact, who said that they wouldnât wait for the long weekend on July 4, they came back and they felt like they were walking into a new world in terms of how the customers were buying. Now I should say within our quarters, we are very backweighted to the third quarter of the month. So I donât know if something magically changed around the July weekend or whether this was changing and it really hit us in the face in July, because thatâs when we have the most sales. But what we noticed is that customers who typically saw on a very steady, very predictable manner were shifting. And what was happening is sales cycles were elongating. There were additional layers of approval. As everyone was having to go get their CFO to sign-off on the deal, which frankly, I could appreciate. But other deals we are having to do to Boards of Directors at the last minute for amounts that were lower than we would typically see. We also started to see some deal compression and this we are really in the larger enterprise deals. And these deals that would be expected to come in at $20 million, you are right at the end that they are compressing to $15 million to $16 million. So we started to see that in July, we got to August and needed to guide for the rest of the year. And thatâs when we really needed to make a decision. Was July an anomaly or is this the new normal in the trend? And we decided that this was likely to be the next trend and you saw that in our guidance and we cut our guidance pretty significantly in August. We were right, it was the trend. And we have seen these trends continue throughout the year. In fact, if anything, I would say that they have become incrementally more challenging throughout the third quarter and itâs what I am anticipating as I am going into Q4. Now on the revenue side, we affirmed our guidance. So this is the guidance that we gave in August. We have confirmed that we are going to do that for the full year. This is in the face of $100 million of foreign currency pressure. So, you could actually think about this as raising our guidance by about $100 million. So I feel comfortable with what we did. I think itâs the appropriate guidance. But those are some other things going on in the background. And some of those are the factors that we are going through all of our minds we were coming out with the guidance. Oh, sorry, before this, I am not going to miss an opportunity again to talk about operating margin. We have raised our operating margin for the year. We have taken it up to 22.7%. Again, that will be a record for the company. And I really want to point out the comment to that in the face of revenue being lower than we had expected at the beginning of the year. We are leaning in and we are not turning back from that. So on the -- letâs unpack the 4Q a little bit, because I think where some investors struggling is that Salesforce is so big. Itâs so heavily weighted to ratable subscription growth and itâs almost -- it almost feels inconceivable that the growth rate could go from 19% in October to 12%, 13%. So, how does that happen? So to me, it must be a combination of a number of things. Your CRPO guide suggests that bookings will slow, no surprise given this tough environment. Maybe it also means that bookings are a little bit more back-end weighted, so you donât get that revenue contribution in 4Q. It could also be -- maybe sort of add-on business intra-quarter sort of light, maybe some of the upfront rev/rec parts of MuleSoft, Tableau, also would see it. Am I hitting on all the key points that helped the bridge? Okay. So I think youâve hit most of the key points on that. Also in terms of deceleration with the subscription model, of course, this is a wonderful time to have a subscription model. Subscription models keep you at very even pace. But you do start to see this over time. And like I said, we started seeing this sharp difference in buying behavior in Q2 that builds up and you are going to see that playing out in revenue. It is -- that increases currently over time, which I think is part of what you are seeing on Q4. Now going into some of the areas that you mentioned, one of the areas that we have seen a significant decline on is what we call create and close. So create and close and other transactional areas that create and close is how we would refer to the business that comes in within the quarter, arises the opportunity within the quarter and closes within the quarter. So this is really outside of your typical pipeline where you are generating things over months or years. This is typically from expansion of the current installed base. So these are enterprise customers who have hired another 10 salespeople. They are calling up and they want another 10 seats. That has sharply declined. And when that happens, it tends to happen when customers are not adding headcount or even going down the other way. So we saw it in that the other type of transactional business that we see on a quarterly basis is small and medium business. Clearly, these are deals that are shorter. They come up quickly and small and medium business in times of the economic uncertainties pullback. And then finally, sorry, I am getting spam calls, we are right in the middle of the -- Iâll decline that one. And finally, the third area is Slack self-serve. So these are the projects that people can come in individually sign up online for Slack do it themselves within the quarter. All three of these areas can lead to a lot of variability within a quarter. And again, when you are seeing different buying behaviors and when you are seeing economic uncertainty, thatâs where you see the hit. Okay. Amy, is it also true that you do have some parts of the portfolio that are not durable subscription-based, for instance, maybe the Marketing and Commerce Cloud business, is a little bit more usage based? Is that also potential factor? Yes, there is a slight usage. I would point more our businesses where I thought you were going with MuleSoft and Tableau, they have a different revenue recognition. So our core businesses is they are beautifully smooth subscription models that you see you have Tableau are different. Both of them have a license component. So typically, when you are looking at a deal that comes in from MuleSoft and Tableau, youâre looking at the total contract value. So it could be a three-year contract, youâre going to take half of that recognize it immediately in the quarter. And then the rest will be treated like a subscription contract. What that means is if there is a hit in those businesses, youâre going to see it earlier, and itâs going to be more significant. That data line that we break out in our revenue is always in the best of times to worst of times is always going to be lumpier than the rest and youâre going to see it earlier. Okay. And on that trade and close business or maybe more broadly on the seat-based business, I think a lot of investors listening in and here in the audience are watching layoffs in the tech space and they are worried about the potential for headcount growth seat growth to through minimum. So I donât know whether you want to get into too much detail, but on a typical seat-based contract, I presume there are minimums where maybe you can toggle up and down to that level. But if youâve got a client thatâs cutting 25% of their heads, presumably there is a bit [Technical Difficulty] Okay. When we think about next year, you decided not to give next year guidance on this call. So is it as simple as the environment just very fluid right now, and you just felt it prudent you and Mike to get through the fourth quarter and then give it. But any thoughts you could give us on next year at all, maybe what the underlying assumptions that you and Marc and the team are thinking about when we might see some stabilization in IT spending growth or does that require too much of the economists have right now? Okay, the two things in there. First, looking at the guide that we gave for Q4, which we did give what I am assuming is continuing challenging times. I am not seeing a change in -- Iâm not seeing improvement, I will say, in customer behavior in the short-term. And if anything, I would view it as something that could be incrementally worse than the trends that weâve seen recently. So looking into next year and the decision not to guide, we have traditionally given revenue only at this time. Itâs an early look into next year. As weâre looking at it at this time, we are looking at three factors: first, increasingly unpredictable customer behavior. Our sales team is a machine. They can tell you when a deal is going to close down to just about the minute. Similarly with the elongating cycles, the additional approval, the deal compression, that has become much harder to pinpoint, especially on where itâs going to hit on the quarter. So weâre looking at that, we are looking at questionable economic situation, and weâre looking at foreign currency. That is extremely volatile. When you put all of that together, given revenue guidance right now did not see -- was not our choice and we will do that in February. February also has the advantage that youâre giving full guidance. Given revenue without giving your cash flow, your op margin, getting you a real view of how we see the company operating, I think is more powerful, and I look forward to doing that after Q4. Amy, I know youâre bursting to talk about margins. So letâs talk about that subject now. So obviously, revenues are critical, if not the most important input to margins. But I guess the notable positive thing from the sales force quarter is that despite the revenue pressures, given the macro, you still put up a very good operating margin performance for 3Q, you raised your guidance for the full year, and you still reiterated your guidance next year for margins to be up. So there is a good story going on below the revenue line around OpEx control. So I think everybody could benefit from perhaps attacking that a little bit and talking Amy, about what perhaps are two of the three main margin drivers that you and the team are leaning into? So going back a bit on margins is weâre really starting to see decisions that we have made over the last few years paying off. It takes a while to get things into the system to start benefiting from the new efficiencies and the discipline. But I go back two years ago, we had announced Slack, I just become CFO giving a first guidance. Slack -- wonderful acquisition, so excited about it. But I also know this one, it could be highly do to our operating margin. And it was very important to me from the very first earnings call to say we would not move backwards. We were going to fully absorb the Slack acquisition. I think itâs important for acquisitions that we were able to do that. So we came out with that -- since that time and by the end of the year, we will improve our operating margins by 300 basis points in the face of 75 basis points of dilution from Slack. So Iâm really proud to say weâve done that. In terms of what is driving that, if there is not one silver bullet. What I believe truly is itâs a change in approach by the company. It is a focus on discipline, itâs a focus on execution and itâs a decision. The op margin at the end of the day is the one number you control is a decision youâre making as a company. And this is across the entire leadership payment starts with Mark that involves every one of us deciding that this is important to us, we know itâs important to our shareholders and needing to get that discipline and as I mentioned briefly earlier, earlier this year, what we did is we started a much more measured buying -- you donât buy employees, hiring experience with employees, so dramatically turned down the number of employees we were bringing into the company starting around April. Weâve continued that through today, which has really paid off. I mentioned on real estate. So real estate youâve seen some of our bigger write-offs that weâve done over the last few years as weâve announced this in earnings and in our filings. But a lot happens behind the scenes. There are the less we donât renew. There is the opportunity to walk away without cost from other buildings to negotiate different terms. Weâre really starting to see those the benefits come in. But overall, I just think it is simply a focus on discipline. It is processes, it is a system and itâs a commitment And Amy, on the media speculation recently about a fairly modest headcount, I think Salesforce confirmed that said it was relatively small. Can you elaborate is it so small that, that in and of itself is unlikely to really have a big margin impact near-term? And what was it about? Was it around perhaps eliminating some lower performers or maybe you could unpack what the nature of that headcount trim was as modest as it was? That was modest. I do not see that as having any sort impact on our operating margin. It is entirely within sales small. Headline can run very quickly as people love stories. That was relatively modest at the beginning of November I am not expecting difference from that. If we look at headcount and we can really look at the changes we put into our higher end to earlier in the year. And Amy, can we look at the 25% guidance that you offered for fiscal â26 as I know youâre not going to raise the guidance so soon afterward. But is that a starting point? Is there any structural reason why Salesforceâs margins can ultimately be higher than that? Well, I want to be clear. We said we would be at least 25%. There was a plus sign, and that was very carefully put on there. We are leaning in, it will be above -- or it will be 25-plus and we are fully committed. Okay. One of the potential margin impacts that Iâve been thinking about a little bit recently, Iâd love your comments. Is that I think Bret and some of his team, Steve Fisher and others are working aggressively on a replatforming project, where a lot of or most of Salesforceâs acquisitions might still be running at least partially on a separate tech stack that and team want to sort of graft onto a common sales force platform. Can you talk a little bit about that -- how big is that project and at some point in time, might it have a margin impact thatâs positive. So this is something really excited about. This is really a project of a few people, Steve Fisher, primarily David Schmaier, Srinivas Tallapragada and our Co-Founder, Parker Harris. And let me pause just for a second on Steve Fisher because he is a really important addition to the team. Steve was very early on with Salesforce -- joined, I think, around 2004 to 2014. A might be wrong on this, but I think he goes back to high school arena. I think they were coding together when they were 16. It stays instrumental to building out our initial architecture for the company. He looked at eBay in 2014 and just rejoined us last year. And whatâs really important about this is weâre bringing back this person who was so instrumental in our architecture, knows the company can announce. Heâs able to come in with fresh eyes and immediately jumped in and said, we need to be uniting everything. We need to be bringing together all of your acquisitions. And we need to be doing this in a way that is seamless and ideally invisible to the customer. What this is going to do is it allows in a faster innovation. It seems like Genie, which we announced at Dreamforce is really a very, very advanced version of CDP, bringing together all of the customer data into a customer data lake where they can access that and use that for better views into their customers. Steve and Srini in particular have also been really instrumental in Hyperforce. So Hyperforce is our initiative to allow Salesforce to run on any hyperscaler or public cloud anywhere in the world. We have launched this already in India and in Germany, and we will have 10 more locations by the end of the year. And this is really providing a number of benefits. First, internationally, allows us to expand very quickly, very seamlessly. And if youâre building out your own first-party data center, this can take six quarters. We can get up and running on the public cloud in well under a quarter, a matter of weeks, really. It also very important, it allows our customers to choose where their data is going to be relevant. And as we know, the sensitivity around data is only increasing. And there is parts of the world where thatâs really just becoming a stake. We want to be at the table and you want to be able to do that. It gives consistency and it is compliance. And all of the replatforming all of this attempting to the details, it allows us to move faster in a helpful stat and visibly to our customers. Okay. Perfect. Amy, another lever that a number of companies, your peers are using to both improve the revenue growth outlook and the margins is priced. So Microsoft is clearly doing it. Adobe is very overtly doing at Oracle, the list goes on. When you think about that lever to drive growth and margin protection next year, whatâs your framework? And maybe to put it another way, to what extent are you and Marc and the team leaning into price as a growth and margin lever? So on pricing, we are always reviewing and tweaking pricing. But one thing that we have done this recently is pulling together suite of products and selling them together. Well, I am going correct you there, though. I think it was David Schmaier, who did that comment. I came up in the Q&A with David and Parker. But on that point, when we look at our customers and what our customers are graveling with, they are being able -- and I am sure maybe you can relate to this, they are able -- they being asked to do more with what their ask being asked by their CFOs to spend less. They are being asked by the CEOs to operate at a higher level of efficiency. And we need to look at how do we help our customers, how do we pull together certain groups of our products, put them together and help them achieve both efficiency and time-to-value. So, we did this in five areas. We pulled together is we in sales, in service, in marketing, in analytics and in automation. So, for example, in automation, it is MuleSoft Composer, it is RPA. And it is -- I am forgetting the third one⦠Any point platform has anything that I got in mind. Any point platform. All of this is making them very, very easy for our customers to solve specific needs and we price those differently. Now, this is early days, but I am excited by what I am seeing so far. And we will continue to innovate for our customers. Interesting. Amy, one of the other metrics we are all looking at, even though Salesforce and a lot of other large SaaS companies have discouraged us from focusing too much on old school deferred revenue and billings metric forâ¦? Yes. One thing I am noticing is that the DR growth at Salesforce and the CRPO growth were tracking pretty closely together for a while. But in the last couple of quarters, well, CRPO growth has hung in there relatively well on the macro. The DR growth in billings has become a little bit disaggregated. So, it feels from the outside that there is a change in invoicing terms. Do you mind addressing that whatâs happening? Yes, sure. Let me -- so, there is a few things in that. Let me start with just cash flow in general. So, for the year, took down -- moderated our expectations. We -- in August, we had guided 16% to 17% operating cash flow for the year. On the earnings call, I said itâs probably going to be more at the 16% level for the year. So, on that impact. That impact is from lower balance, maybe a little bit of FX in there as well. But primarily lower billings. We have not changed how we are doing it, and we have not changed the terms. So, I want to be very, very clear on that. And as the side, itâs already talked about billings without talking about collection. One thing I watch like a hawk is our collection area. I want to know any trends, what people are seeing are things that they are for people prepaying they not. We are not seeing any differences. And I think thatâs good for Salesforce. Itâs also economic indicator that companies are paying their bills and they are paying their regular schedule. But coming more to your question of why is there a divergence. Now, in general, those are going to track in the same way. But there are differences. And I will give you an example. One of it has to do with end of quarter timing. As I mentioned earlier, Salesforce, I think itâs very natural. The sales come in at the end of the quarter. In fact, itâs really the last few days of the quarter that you see a significant, significant portion. You closed that deal on a Thursday or Friday, you get the credit for the CRPO, the bill goes out Monday morning. That bill point to show up in next quarter. Timing of renewal, invoice timing -- timing of renewal will follow that. ProServ is another area. We will show 12 months for the CRPO. But if you are building on a milestone basis, itâs going to be lumpier. Itâs going to be triggered at a different time. So, well, directionally, they should go together, there is a lot of reasons that you are just going to see a separation. We have seen a lot [Technical Difficulty]. The product roadmap and acquisitions. Before I do, everybody, you have got a QR code in front of you. If you did want to submit a question to me, I have got an iPad in front of me. You can scan the QR code, type in your question and if itâs a good one, I will ask. So, feel free to do that. I will give you five minutes. Okay. Amy, on the product roadmap, when you think about where that massive group of engineers are leaning into the Salesforce where there is an exciting growth opportunity two years, three years, five years out that inorganically -- I am sorry, organically, you want Salesforce to invest in. What are a couple of those exciting areas that the engineering team are leaning into? I would probably go back to our biggest revenue opportunities, which I think tracks very well with our product areas. So, at Dreamforce Investor Day, I talked about three areas of revenue -- three revenue pillars, where I see great opportunities in the next few years. These were the Customer 360 industries and international expansion. So, if you start with -- or you start with Customer 360, this is really the multi-cloud opportunity. And this is continuing to build out opportunities to connect the cloud. Do I look at Genie, I look at the data lakes, I look at how we can attract our customers to continue to invest all the way around the circle. There is lower attrition. There are higher sales. Itâs really a terrific opportunity for us. And thatâs what you are seeing with this platform as well. The second area is really industry. So, we now have 13 industries up by one since Investor Day with automotive cloud. Industries are performing very, very well. In fact, in the third quarter, session of our 13 industries had an ARR above 50%. So, IC industry has a huge opportunity for us and recently talking to Jujhar Singh, who is the phenomenal leader of industries who joined us from Microsoft several years ago. He has wonderful opportunities about how do we dive in, how do we continue to build out each one of these clouds for the future, and the third is really international expansion. So, in the third quarter, the U.S. grew at about 16%. Now, if I am talking about constant currency, EMEA was 23%, APAC was 30%. We have terrific opportunities there and that where Hyperforce really comes in. And as our engineers continue to lead in and they continue to expand our opportunities and roll this out around the world, I think those three pillars line up fee the fly with both product roadmap and our revenue pillars. So, on the inorganic side can you -- I think everybody in the room understands that acquisitions have been an important super successful part of the Salesforce, can you articulate what the acquisition strategy is? I think you have done a good job offering a framework on more shareholder-friendly acquisitions. But what exactly does that mean? And is it possible, Amy, that just given the fluidity in the environment these days, but maybe there is predilection to sort of slow down that acquisition strategy, just let the environment settle first before you think about doing a deal -- you donât mind addressing that. Sure. Let me try to hit all three of those, if I miss something, remind me. So, we are very happy with our current product portfolio. I think we have the terrific with the products and I donât see gauging hole that needs to be fit. M&A has been a very important part of our past, and I think it will be part of our future as well. We have acquired -- I think on the earnings call, I said 60 to 70 companies, I think itâs more like 80 companies. Most of these are small. They are mostly tuck-ins. They might be for a couple of million dollars up to a couple of hundred million dollars. And thatâs generally to fill in a particular product feature or bring in particular talent. And we have had a steady drumbeat of those. We have had five public company acquisitions that get more attention. I am looking forward. We have learned a lot from all of these. And there are three areas that we need to evaluate every acquisition for. I think the first is strategic fit. The second is what is really the opportunity and surges financial alignment. So, for strategic fit, is that we start with our customers in mind, do our customers need that is it a best-in-class asset with an absolutely unmatched ecosystem. It has to start there. Then what is the opportunity, is there something that Salesforce is bringing to the table, can we drive further growth, can we monetize the product. And then the third is the financial alignment, and this is where I am laser-focused. And itâs several things. What is the timeline to value accretion, is that player, how quickly is that going to be helping us. Second, can we prioritize the use of cash and debt for consideration. Can we stay away from having to use equity. And then the third is what is the valuation and are we getting this right. And I think looking forward and you heard this from Marc on the earnings call as well, clearly, we always want it on everything. But we know we can only do acquisitions in a responsible way, and we canât do it at the expense of our Op margin. Okay. Amy, we have got two questions from the audience. One is sort of related to margins and that is to what extent is Salesforce trying to essentially flat-line the share count via share buyback. Whatâs your intention there? I think publicly, you have said that you want to sort of moderate the dilution, but would you contemplate going so far as to offsetting it completely. And part two of that, is there any consideration to basically ratcheting down the stock-based portion of comp to actually reduce that stock-based comp dollar number. Right. So, on this going back to the authorization to buy back stock. Again, a $10 billion authorization, we have already put in place $1.7 billion of that in the first quarter. This will not fully set off SBC at this point, but we are always looking at what we are going to be doing. I donât expect it in the short-term to be fully offsetting. We are constantly looking at that. And as you said, you can moderate that from two directions. One thing on that we did call out before. As I think through how much is going to be -- how much of our free cash flow is going to be dedicated to buying back stock, you can think roughly 30% to 40%, we are early days. We have had one quarter, so itâs hard to talk about what itâs. But looking forward, on average, I think you should expect 30% to 40%. Got it. Let me sneak in the last one. One of, if not one of the largest, actually Force.com or platform customers, Viva announced to the investment community a few days back that they may not renew the agreement with Salesforce that comes up in 2025. So, could you comment on that? And I think what everybody would love to know is the quid pro quo from that agreement is that it would allow you to enter the pharma space with your core CRM product. Is that part of your ambitions beginning in 2025? Let me just say at this point, Viva has been a terrific partner, itâs incredible to see their success and wish them very, very well on that journey. And I think thatâs all I will say at this time. Okay. I think we have only got one minute. So, why donât we leave it there. Amy, again, thanks for changing your schedule to accomplish us. Itâs been an honor to have you here. And I think everybody has appreciated your comments today.
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EarningCall_1660
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Good day and thank you for standing by. Welcome to the Schnitzer Steel's First Quarter Fiscal 2023 Earnings Presentation. 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. Thank you, Carmen and good morning. I am Michael Bennett, the company's Vice President of Investor Relations. I am happy to welcome you to Schnitzer Steel's earnings presentation for the first quarter of fiscal 2023. In addition to today's audio comments, we have issued our press release and posted a set of slides both of which you can access on our website at schnitzersteel.com. Before we start, let me call your attention to the detailed Safe Harbor statement on Slide 2, which is also included in our press release and in the company's Form 10-Q, which will be filed later today. As we note on Slide 2, we may make forward-looking statements on our call today such as our statements about our targets, volume growth, and margins. Our actual results may differ materially from those projected in our forward-looking statements. Additional information concerning factors that could cause actual results to materially differ from those in the forward-looking statements is contained in Slide 2, as well as our press release of today, and our Form 10-Q. Please note that we will be discussing some non-GAAP measures during our presentation today. We've included a reconciliation of those metrics to GAAP in the appendix to our slide presentation. Now, let me turn the call over to Tamara Lundgren, our Chairman and Chief Executive Officer. She will host the call today with Stefano Gaggini, our Chief Financial Officer. Thank you, Michael. Good morning, everyone, and welcome to our fiscal '23 first quarter earnings call. I hope you all had a good holiday break and like me are looking forward to a safe, healthy and prosperous New Year. Today on our call, I'll review our quarterly financial results, the trends affecting our business and progress on the strategic activities we have underway to address evolving industry dynamics and create long term value through the cycle. Stefano will then provide more detail on our financial performance, our capital structure, and our capital investments. I'll wrap up and then we'll take your questions. So let's turn now to Slide 4 to get started. Almost 10 years ago, we created a sustainability framework based on three pillars; people, planet and profit. In mid-December, we issued our ninth annual sustainability report, which highlights our company's commitment to creating a more sustainable future by supplying our customers with high quality, low carbon recycled metals and finished steel products. In our 117th year of operation, our work and our purpose have never been more relevant than they are today. In fiscal '22, we advanced our sustainability goals by supporting our employees and communities, implementing best-in-class environmental processes and infrastructure, expanding our platform and introducing net zero carbon emissions product offerings. We delivered the second best safety results in our company's history with 90% of our facilities free of any lost time injuries. While we still have work to do to keep achieving year-over-year improvement, we are seeing excellent momentum so far in fiscal '23. We also achieved 100% net carbon-free electricity use across the company's operations for the second consecutive year and we reduced our Scope 1 and 2 greenhouse gas emissions from recycling operations, by 24% against our 2019 baseline. We are meeting these goals primarily through investments in state of the art emissions control systems for our metal shredding operations and more efficient operating equipment and in fiscal '22, we introduced GRN Steel, our line of net zero carbon emission steel products. The launch of our GRN Steel product line provides our customers with net zero steel solutions as they build out tomorrow's essential infrastructure. We were honored this year to be recognized by a number of organizations for our leading performance and sustainability. These achievements would not have been possible without all our employees living our core values of safety, sustainability and integrity and operating with the agility, resilience and collaboration that have underpinned our success. I'm very proud of what our team has accomplished and I encourage you to visit our website to view our latest sustainability report. So let's turn now to Slide 5 to review our Q1 results. Earlier this morning, we announced our results for our fiscal '23 first quarter, which reflected an adjusted EPS loss of $0.44 per share and positive adjusted EBITDA of $8 million. Our first quarter results were impacted by an extended shredder outage at our Everett facility and a regulatory issue limiting operations at our shredder facility in Oakland, both of which were resolved by mid-November. These disruptions, together with tight supply flows from a significantly lower price environment, weaker economic activity and the delay of several ferrous export shipments resulted in much lower sequential fares, sales volumes and margins. Finished steel volumes and prices also declined during the quarter, primarily due to lower wire rod demand, while rebar to scrap metal spreads remained robust. Since the end of the quarter, we've seen a strengthening in sales prices and demand for recycled metals in both export and domestic markets. With the operational disruptions now behind us and with our expanded cost reduction and productivity program expected to deliver increased benefits, we anticipate significant improvement in our second quarter results. Our balance sheet remains strong and we continued our uninterrupted record of returning capital to our shareholders through the issuance of our 115 consecutive quarterly dividend. Let's turn now to Slide 6 to review price trends and supply flows. Demand and prices for both ferrous and non-ferrous metals weakened throughout the quarter, influenced by slower growth, inflationary pressures and steel inventory destocking. By November, both ferrous export and domestic markets were down by 15% to 20% or approximately $50 per ton, compared to August levels. The export markets were most impacted by higher energy cost and a stronger dollar. The domestic market was impacted by an average steel mill utilization rate of below 80%, which has persisted for 25 consecutive weeks. While ferrous scrap prices declined throughout the quarter, they remained above their tenure average, reflecting the underlying structural drivers of demand for recycled metals. Since the end of the quarter, ferrous export prices have strengthened with reported December prices of approximately $400 per ton delivered depending on the region. Demand in Turkey has improved since the end of the first quarter, and South Asian activity remains steady. In the U.S. domestic market, ferrous prices also improved in December, reversing seven consecutive monthly declines as lower prices began to significantly impact supply flow. Turning to non-ferrous, as you can see in the upper right chart on this slide, base metal index prices for copper and aluminum improved towards the end of the quarter. Drivers included the weakening of the U.S. dollar during November, China's return to the global markets for semi-finished and clean non-ferrous products and supply concerns. These concerns are valid as the significant drops in ferrous and non-ferrous prices have led to considerably tighter supply flows across all regions and channels, exacerbated by inflationary pressures which have increased collection costs and reduced consumer scrap generation and most recently by challenging weather conditions in most regions in the country. Turning to finished steel, while demand in prices came off their near record highs, metal spreads continued to be robust, up 15% year-over-year. The construction markets are seeing some softening due to interest rates and inflationary pressures on construction costs, although the Dodge Momentum Index is signalling growth in the non-res, commercial and industrial sectors. The increased demand related to the U.S. infrastructure bills has not yet materialized, but we do expect to see this demand commence later in the calendar year. With the increased focus on low carbon steel in the Biden administrations by clean directive, our Oregon steel mill is well positioned to meet this rising demand. So now let's turn to Slide 7; we believe the structural demand for recycled metals remains very positive, supported by the transition to low carbon technologies, the increased focus on decarbonisation, the anticipated structural deficits for copper and aluminum and the expected funding related to the infrastructure bills. Decarbonisation is a powerful structural driver of demand as recycled metals require less carbon to produce than mined metals and many low carbon technologies are widely acknowledged to be more metal-intensive. We can see how some of these trends have translated into higher ferrous scrap metal usage in the U.S. and globally by looking at the charts on this slide. EAF steelmaking capacity, which uses scrap as its primary raw material, has been expanding and is projected to increase even further. These trends are also reflected in the increased demand for manufacturers and retailers to maximize the use of recycled materials in their manufacturing processes and products and to reduce the environmental impact of their activities. To support this demand in late November, we acquired ScrapSource LLC, a scrap management company based in Dallas Texas. ScrapSource is an asset-light business in the metals recycling space, focused on providing metals recycling management, services and solutions. ScrapSource currently services over 500 customers representing manufacturers, fabrication facilities and service centers across North America. This lean business model provides opportunities for us to significantly scale our national sourcing platform, enhanced services to our national manufacturing and retailing customers, increase supply flows to our operations and create expansion opportunities in new regions. So let's turn now to Slide 8 to review additional strategic actions we have underway. We're focused on four strategic priorities; first, technology investments in advanced metal recovery systems at our major recycling operations to enable us to extract more non-ferrous metals from our shredding activities, increase throughput and improve our margins, expand our product offerings and our customer base and reduce material going to landfills. Second, volume growth. Our multi-year focus on increasing our ferrous and nonferrous volumes has led to an annual 6% volume growth rate since fiscal '16. We've achieved this through a combination of organic growth, acquisitions and improved recovery of non-ferrous materials through our shredding process. Third, expansion of our products and services to meet the evolving demand for recycled metals such as the launch of our net zero GRN Steel products, the acquisition of Scrub Source and the reverse logistics services we provide to manufacturers and retailers. And fourth, productivity initiatives that we undertake as part of our continuous improvement culture and which are particularly important in the face of significant inflationary pressure. In Q1, we achieved nearly the full run rate of benefits from the $40 million of cost reduction and productivity initiatives that we announced in October. In December, we identified additional initiatives that aim to reduce SG&A cost by approximately $20 million on an annual. Thank you, Tamara and good morning. I'll start with a review of our consolidated results and provide an update on our ferrous sales in the market dynamics. Adjusted EBITDA in the first quarter was $8 million or $10 per ferrous ton. Results reflected the detrimental impact of the operational disruptions as our Everett and open facilities, which is estimated to be approximately $18 million or $21 per ferrous ton, resulting from a combination of incremental operating cost and lost income due to the impact of the disruptions on supply flows and sales volumes. Weaker demand resulting from slower growth and mill inventory destocking led to a sequential decline in average net selling prices for ferrous and non-ferrous recycle metal. The lower price environment also contributed to tightest scrap flows, which combined with an increasing collection cost, resulted in a significant compression in metal spreads. This compression in spreads substantially offset the lower sequential adverse impact from our average inventory costing method, which was a detriment of approximately $2 per ferrous ton in the first quarter. During the quarter, our steel mill remained a significant contributor to performance, despite a sequential decline in net selling prices and volumes of finished deal. As mentioned by Tamara, during our first quarter, we successfully implemented the $40 million annual productivity initiatives that we announced in October, which are focused on production cost reductions, operating efficiencies and yield improvements to help mitigate inflationary pressure on operating cost, including for labor, energy, logistics and waste disposal. We achieved a nearly full quarterly run rate of those benefits in the first quarter and expect to achieve the full run rate in our second quarter of fiscal '23. To further mitigate inflationary pressure, we have identified new initiatives that aim to reduce SG&A expense by approximately $20 million annually compared to the last six months run rate. We expect to achieve approximately half of the SG&A savings run rate in the second quarter and substantially the full run rate after that. These SG&A actions are focused on achieving savings to a combination of reduction in force, lower professional and outside services, decreased lease cost and reductions in other discretionary expenses. Turning to the ferrous dynamics in the quarter, average net ferrous selling prices were down 12% sequentially and by 24% year-over-year. Our ferrous sales volumes were down 33% sequentially and by 26% year-over-year, including the aggregate impact of the operational disruptions in Everett and Oakland estimated at over 100,000 tons. In addition, the reduction in ferrous sales volumes also reflected the tighter scrap supply flows and the delayed shipment until December of several bulk cargoes with approximately 100,000 tons. Our top sales destinations for ferrous experts in the quarter were India, Bangladesh and Turkey. The share of domestic sales was higher than typical, adjusted over 50% in the first quarter, reflected the temporary impact on export sales from the operational disruptions and several export shipment delays. Now let's move to Slide 10 for an update on non-ferrous sales and the market dynamics. Average net selling prices for non-ferrous shipments in the first quarter declined 14% sequentially, reflecting full the decline in market selling prices that occurred over the summer while the prior quarter had benefited from forward sales made at higher prices. Non-ferrous sales volumes declined sequentially by 12%, primarily due to tighter flows resulting from the drop in prices. Year-over-year non-ferrous volumes were up 6% including the contributions from both Columbus recycling and Encore recycling acquisition. We sold our non-ferrous products to 15 countries with the major export destinations being Malaysia, China and India. The share of export sales of non-ferrous were 60% in the first quarter, up subsequently from 55%, reflecting improved export economics and container availability for overseas shipment. Our product mix is highly diversified with sales of zorba representing 29% of our non-ferrous volumes, aluminum 27%, copper 14%, twitch 13% and with stainless, Zurik and other non-ferrous metals making up the balance. The increasing share of twitch in our non-ferrous product mix is a direct result of our investments in advanced technologies to produce more furnace-ready materials. Now let's move to Slide 11 to provide an update on our advanced metal recovery technology investment. We continue to make progress on the deployment of our technology program focused on increasing metal recovery and the volume of non-ferrous material from shredding operations. Once fully operational, we expect non-ferrous volumes recovery from shredding to increase by approximately 20%. Further benefits come from our ability to generate more furnace-ready, higher valued products and creating product optionality. Our program is comprised of seven primary non-ferrous recovery systems at our major shredder facilities. They will be the main drivers of the projected increase in recovery volumes. Of these primary systems, three are major aluminum and four are major copper recovery systems of which one was operational in the first quarter. We completed construction of two more of these major systems in Massachusetts and in California, which began commissioning in November. Our initiative also includes aluminum separation systems on each coast, both of which are now operational and four supplemental copper separation systems of which three are operational with construction completed on the other one, which is in our ramp up phase. We continue to target completion of construction of all systems by the summer of 2023, subject to construction equipment delivery and permitting timelines. The contribution to performance from these technologies in the first quarter of fiscal '23 was positive and on an increasing trend, although not yet in material to results after consideration of the costs incurred on systems that are undergoing commissioning and ramp up activities. As more of our major systems become fully operational, we expect a quarterly benefit profile to gradually increase during fiscal '23 and continue to target substantial achievement of the estimated full run rate benefits to EBITDA of $10 per ferrous ton by the end of calendar year 2023. We expect the overall capital investment to be in the range of $130 million, of which approximately $119 million have been spent to date, leaving just over $10 million to complete the projects in fiscal '23. Now let's move to Slide 12 to discuss our steel mill performance and West Coast markets. Demand for finished steel in the first quarter in our West Coast markets moderated compared to the summer highs, particularly for wire products. After achieving record levels in the second half of fiscal '22, average selling prices for finished steel decreased 9% sequentially over higher year-over-year by 4%, supporting resilient metal spreads at our mill. Finished steel sales volumes of 118,000 tons were down 6% sequentially. Despite the planned maintenance outage during the quarter, our average rolling mill utilization of 81% was higher than the U.S. average of approximately 75%. Now let's move to Slide 13 and discuss cash flow, capital structure and outlook for the second quarter. Our first quarter is typically lower operating cash flow due to the cash payout in November each year of intensive compensation occurring in the previous fiscal year. In addition, operating cash during the first quarter was impacted by the delay of several federal shipments and related cash collection. These two items drove the substantial majority of the almost $70 million detriment from higher networking capital in the period. As the chart from the top left shows, we have a multiyear track record of generating strongly positive annual operating cash flow through the cycle. Looking beyond the first quarter, we expect this annual trend to continue for our fiscal '23. CapEx spend in the first quarter totaled $48 million. For fiscal '23 as a whole, we expect our CapEx to be in the range of $130 million to $140 million. Around the third will be for growth projects, including the completion of our technology initiatives with the remaining for maintaining the business and environmental related capital projects. Excluded from this annual range is the CapEx associated with the repair and replacement of the shredder enclosure building at our Everett facility during fiscal '23 as these expenditures are expected to be substantially recovered through insurance over time. As Tamara mentioned on November 18th, we completed the acquisition of the operating assets of Scrub Source. The purchase price was $25 million. On a pre-synergies basis, the acquisition price reflects a trailing 12 month EBITDA of $4 million. We expect the cash flow return on investment to be well above our cost of capital and do not anticipate post-acquisition capital expenditures. Net debt increased to $354 million at the end of the first quarter, with the sequential increase reflecting our operating cash outflow, CapEx spend and the acquisition of ScrapSource. Availability under our credit facility remains sizable with a borrowing capacity of $800 million in a maturity of August 2027. Net leverage was 28% at quarter end, primarily reflecting our investments in acquisitions since the beginning of fiscal '22. The ratio of net debt to adjusted EBITDA was 1.5 X. We returned capital to shareholders through our quarterly dividend while we did not repurchase shares in the first quarter, buybacks remain part of our balanced capital allocation strategy, and we have repurchased approximately 3.5% of our outstanding stock in the last 12 months. Our effective tax rate was a benefit of 26% on our first quarter results. Although there are still almost two months left in the quarter, I'll now turn to our outlook for the second quarter of fiscal '23, which is based on market conditions and information we have today. We expect our ferrous volumes to be up approximately 35% sequentially, driven primarily by the resumption of full operations at our Everett and Oakland facilities at the completion of the shipments that were delayed at the end of the first quarter. Non-ferrous sales volumes are expected to be up 5% sequentially. Finished steel sales volumes are expected to be down approximately 5% sequentially due to normal seasonality as well as softer demand for wire rod products. We expect our consolidated adjusted EBITDA per ferrous ton to significantly improve from the first quarter and approximate $30. Looking at some of the underlying dynamics, there are various factors contributing to the expected improvement in sequential performance; first of all, the resolution of the operational disruptions we face in the first quarter. Second, the recognition of the ferrous shipments delayed from the first quarter, which however were contracted at lower prices before the ferrous market rebounded. Third, a benefit to metal spreads from the recovery in ferrous and nonferrous market prices since November, the magnitude of which, however, is tempered by the continued tightness in scrap flows, including from winter weather that typically reduces scrap available. And fourth, we anticipate seeing the partial benefits of our expanded productivity initiatives flow through during the quarter. Offsetting these positive factors are unexpected lower sequential contribution from our steel mill due to a decline in finished steel prices and sales volumes. Also, retail parts sales at our Pick-n-Pull auto stores are subject to normal seasonality in the winter. In the second quarter, we expect our effective tax rate to approximate 25% and the average inventory accounting effect to be neutral. We also anticipate our operating cash flow in the second quarter to be positive based on higher profitability together with the benefit to working capital associated with completing the shipments that had been delayed at the end of the first quarter. Thank you, Stefano. As we move forward in fiscal '23, our strategic growth investments and our productivity initiatives are expected to deliver additional material benefits. We have a strong balance sheet with low leverage and interest expense, a track record of delivering positive operating cash flow, an ability to invest in the growth and productivity of our company and an uninterrupted record of returning capital to our shareholders through our dividend. We are well positioned to benefit from the global focus on decarbonization, the increased metal intensity of low carbon technologies and the continued growth in U.S. and global EAF steelmaking capacity. In closing, I'd like to thank our employees for their dedication to continuously serving our customers and communities, supporting our suppliers and demonstrating the critical and essential role of our business and industry in the economy. You have demonstrated once again why we have continued to be a leader in the recycling industry for over a century. [Operator Instructions] And it comes from the line of Emily Chang with Goldman Sachs. Please go ahead. Your line is open. Good morning, Tamara and Stefano, and thank you for the time this morning. My first question is just around the M&A front. It's certainly been a little bit more active here over the last 24 months or so. How should we be thinking about your appetite for further bolt-on transactions? Are there any gaps in the portfolio you would like to address whether that's geographic, product type or service type that perhaps you'd like to solve with some of this M&A activity? Sure. Well, thank you, Emily. Thanks for joining us this morning and Happy New Year. So we have been -- we have been developing and we have an active pipeline and have for several years. Last year, as you know, we made two significant acquisitions in the Southeast, because the Southeast remains the largest growth region for steelmaking and manufacturing in the U.S. So we now have 24 metals recycling facilities, including one new shredder in the Southeast. The acquisition of Scrub Source, what is intended to grow and expand our recycling services portfolio, ScrapSource's is a services and solutions provider in the metals recycling space and it supports industrial manufacturing customers primarily in the U.S. as well as servicing the international operations for a select number of U.S. customers with facilities in Canada and Mexico and that's a part of the industry recycling services to manufacturers and retailers that are -- that's growing at a higher rate due to secular sustainability trends. And the acquisition is part of our strategic initiative to expand our recycling services and it has the same core business as our own national accounts business. So I anticipate that we will continue to expand that business because it's an asset light business and it provides a service. It responds to the industry's demand the manufacturer and retailer demand to reduce the environmental impact of their activities and understand the environmental impact of what they do. So I think that you can expect to see us grow that space as well. Great. Understood. That's very clear Tamara and then my second question, that's more directed for Stefano, but as you think about some of the recent transactions, leverage has increased a little bit, certainly still at a reasonably comfortable level for Schnit. but how should we be thinking about what the optimal leverage or sort of net debt to EBITDA ratio should be and how should we expect to see as Schnit is generating positive free cash flow of that to be allocated towards deleveraging? Yes, good morning, Emily. As we have noted in our prepared remarks, the net debt has increased as you mentioned, but I would want to point out that a reason right for that increase during the quarter obviously was from our working capital increase that we saw from seasonality as well as those delayed shipments and we would expect that to be absorbed and to be a benefit to working capital and therefore leading to a reduction in net debt in the second quarter accordingly. So that that's one Q1 aspect that would not be expected to continue into Q2 and actually to reverse. While we don't have a target for debt to EBITDA or overall leverage ratio, we continue to feel that our balance sheet is very strong with net debt reducing as I mentioned, the expectation going forward. We have a strong track record, multi-year track record of being able to generate strongly positive cash flow, operating cash flow through the cycle. and we would expect that to continue in the current year and certainly targeting free cash flow that would allow us to reduce net debt and use that free cash flow for our capital -- balanced capital allocation overall. [Operator Instructions] All right, ladies and gentlemen, this concludes our Q&A session. I will turn the call back to Tamara Lundgren for final remarks. Thank you, Carmen and thank you all for your time today. We look forward to speaking with you again in April when we report our second quarter results. In the interim, stay safe and stay well, thank you. And with that, ladies and gentlemen, we thank you for participating in today's program. You may now disconnect. Have a good day.
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EarningCall_1661
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Welcome, and thank you for joining the Wells Fargo Fourth Quarter 2022 Earnings Conference Call. [Operator Instructions] Please note today's call is being recorded. I would now like to turn the call over to John Campbell, Director of Investor Relations. Sir, you may begin the conference. Thank you. Good morning. Thank you for joining our call today where our CEO, Charlie Scharf; and our CFO, Mike Santomassimo, will discuss fourth quarter results and answer your questions. This call is being recorded. Before we get started, I would like to remind you that our fourth quarter earnings materials, including the release, financial supplement and presentation deck are available on our website at wellsfargo.com. I'd also like to come that we may make forward-looking statements during today's call that are subject to risks and uncertainties. Factors that may cause the actual results to differ materially from expectations are detailed in our SEC filings including the Form 8-K filed today containing our earnings materials. Information about any non-GAAP final measures referenced, including a reconciliation of those measures to GAAP measures, can also be found in our SEC filings and the earnings materials available on our website. Thanks, John. I'll make some brief comments about our fourth-quarter results, and then update you on our priorities. I'll then turn the call over to Mike to review fourth-quarter results in more detail and some of our expectations for 2023 before we take your questions. Let me start with fourth-quarter highlights. Our results were significantly impacted by previously disclosed operating losses, but our underlying performance reflected the continued progress we're making to improve returns. Rising interest rates drove strong net interest income growth. Our continued progress and our efficiency initiatives helped to drive expenses lower excluding operating losses. Loans grew in both our commercial and consumer portfolios, and charge-offs have continued to increase but credit quality remains strong. Our capital levels also remained very strong. And our CET1 ratio increased to 10.6%, well above our required minimum plus buffers. We also continue to make progress on putting legacy issues behind us. Our broad reaching agreement with the CFPB in December is an important step forward that helps us resolve multiple matters, the majority of which have been outstanding for several years. Over the past three years, we have made significant changes in the businesses referenced in the settlement, and many of the required actions were already substantially complete prior to this announcement. While our risk and regulatory work hasn't always followed a straight line and we have more to do, we've made significant progress, and we will continue to prioritize our work here. In addition to our risk and regulatory work, it's also critical for us to continue to invest in the future as we build off the great market positions we have. We are confident our processes will enable us to continue to prioritize our risk and control work. At the same time, we invest in our future. And as I look back at '22, I'm enthusiastic about the progress we've made this past year and feel even better about the opportunities ahead. Let me start with the changes we've made during the year to help millions of customers avoid overdraft fees and meet short-term cash needs. These efforts included the elimination of non-sufficient funds fees and transfer fees for customers enrolled in overdraft protection, early payday making eligible direct deposits available up to two days early, extra-day grace, giving eligible customers an extra business day to make deposits to avoid overdraft fees. And in the fourth quarter, we launched Flex Loan, a new digital-only small dollar loan that provides eligible customers convenient and affordable access to funds. Teams from across the company came together to roll out this new product in record time. The rollout has been smooth and though it's still early, customer response is exceeding our expectations. These actions build on services we've introduced over the past several years, including Clear Access Banking, our account with no overdraft fees. We now have over 1.7 million of those accounts, up 48% from a year ago. We continue to transform the way we serve our customers by offering innovative products and solutions. We continue to improve our credit card offerings including launching two new cards, Wells Fargo Autograph and BILT. Our new products helped drive a 31% increase in new credit card accounts in 2022, while we continued to maintain strong credit profiles. We launched Wells Fargo Premier, our new offering dedicated to the financial needs of affluent clients by bringing together our branch-based and wealth-based businesses, to provide a more comprehensive, relevant and integrated offering for our clients. We continue to enhance our partnership within our Commercial business to bring Corporate and Investment Banking products such as foreign exchange and M&A advisory services to our middle-market clients. Our different approach to technology is helping us better serve our consumer and corporate clients. We rolled out our new mobile app with a simpler, more intuitive user experience, which has improved customer satisfaction. In 2022, mobile active customers grew 4% from a year ago. We launched Intuitive Investor, making it easier for customers to invest with the streamlined account opening process and a lower minimum investment. And total active Intuitive Investor accounts increased 56% from a year ago. We completed the development of Fargo, our new AI-powered virtual assistant that provides a more personalized, convenient, and simple banking experience, which is currently live for eligible employees and set to begin rolling out to customers early this year. Last month, we announced Vantage, our new enhanced digital experience for our commercial and corporate clients. Vantage uses AI and machine learning to provide a tailored and intuitive platform based on our clients' specific needs. Over the past year, our industry-leading API platform team continued the development of payment APIs for commercial and corporate clients invested in solutions to support our financial institution clients, ramps up in group product offerings in consumer lending and began developing commercial lending solutions. We are investing heavily in modernizing the IT infrastructure and the way we develop code. We're implementing a cloud-native operating model that allows us to innovate faster. We've also been investing in modernization in the areas of payments and corporate lending, taking out legacy applications and digitizing processes end to end. These enhanced digital capabilities are just the start of initiatives we have planned as part of our multiyear digital transformation. We also continue to evaluate our existing businesses. As we announced earlier this week, we plan to create a more focused Home Lending business aimed at serving primarily bank customers as well as individuals and families and minority communities. This includes exiting the correspondent business and reducing the size of our servicing portfolio. I'm saying for some time that the mortgage business has changed dramatically since the financial crisis, and we've been adjusting our strategy accordingly. We're focused on our customers, profitability, returns, and serving minority communities, not volume or market share. The mortgage product is important to our customer base and the communities we serve, so it will remain important to us, but we do not need to be one of the biggest originators or services -- servicers in the industry to do this effectively. Across all of our businesses, we must evolve as the market regulation and competition has evolved. And while it may seem counterintuitive, we believe the decision to reduce risk in the mortgage business by reducing size and narrowing our focus will actually -- this will actually enable us to serve customers better and will also improve our returns in the long term. Changing gears now, I'm proud of all we did last year to make progress on our environmental, social, and governance work. We are balanced in our approach to these issues and believe that thinking broadly about our stakeholders will enhance returns to shareholders. And we provide many examples on Slide 2 of our presentation. So, let me just highlight two examples here. We published our first diversity, equity, and inclusion report, which highlights the progress that we've made on our DE&I initiatives. We'll continue to make progress in our commitment to integrating DE&I into every aspect of the company under the new leadership of Kristy Fercho, who joined Wells Fargo in 2023 to lead our Home Lending business and was named the company's new head of diverse segments, representation, and inclusion in the fourth quarter. We've commissioned an external third-party racial equity audit, and we plan to publish the results of the assessment by the end of this year. 2022 is a turning point in the economic cycle. The Federal Reserve has made clear that reducing inflation is its priority, and it will continue to take actions necessary to achieve its goal. We are starting to see the impact on consumer spend, credit, housing, and demands for goods and services. At this point, the impact to consumers and businesses has been manageable. And though there will certainly be some industries and segments of consumers that are more impacted than others, the rate impact we see in our customer base is not materially -- I'm sorry, the rate of impact we see in our customer base is not materially accelerating. This plus the strength with which consumers and businesses went into this slowing economy is a helpful set of facts as we look forward. Our customers have remained resilient with deposit balances, consumer spending and credit quality still stronger than pre-pandemic levels. As we look forward, we're carefully watching the impact of higher rates on our customers and expect to see deposit balances and credit quality continue to return toward pre-pandemic levels. While we're not predicting a severe downturn, we must be prepared for one, and we are stronger company today than one and two years ago. Our margins are wider, our returns are higher, we're better managed, and our capital position is strong, so we feel prepared for a downside scenario if we see broader deterioration than we currently see or predict. We still have clear opportunities to improve our performance as we make progress on our efficiency initiatives and continue to make the investments necessary to grow the business through technology and product enhancements. Two years ago, we shared a path to higher ROTCE by returning capital to our shareholders and executing on our efficiency initiatives. While high levels of operating losses in the second half of '22 impacted our results, our underlying business performance demonstrated our ability to improve our returns. In a moment, Mike will highlight the key drivers of our path to a 15% ROTCE, which we believe is achievable based on the strength of our business model and our ability to execute. While we're focused on improving our returns, making progress on building the appropriate risk and control and infrastructure for a company of our size and complexity will remain our top priority, and we will dedicate the time and resources necessary. I want to conclude by thanking our employees across the company who are working hard each day to continue to make progress in our transformation. I'm excited about all that we will accomplish in the year ahead. Thank you, Charlie. And good morning, everyone. Slides 2 and 3 summarize how we helped our customers, communities and employees last year, some of which Charlie covered. So, I'm going to start with our fourth-quarter financial results on Slide 4. Net income for the fourth quarter was 2.9 billion, or $0.67, per diluted common share. Our fourth-quarter results included 3.3 billion, or $0.70, per share of operating losses primarily related to a variety of previously disclosed historical matters, including litigation, regulatory, and customer remediation. $1 billion of impairment of equity securities, or 749 million after noncontrolling interest, predominantly in our affiliated venture capital business, primarily driven by portfolio companies in the enterprise software sector. Both, slowing revenue growth rates and lower public market valuations of enterprise software companies impact the valuations. It's important to note that even after recognizing this impairment, the current value of these investments at the end of 2022 remained above the amount of the initial investment. $353 million of severance expense, primarily in Home Lending. While we've reduced headcount in this business throughout 2022, this charge includes the actions we plan to take in 2023 related to the mortgage announcement we made earlier this week. These reductions were partially offset by 510 million of discrete tax benefits related to interest and overpayments in prior years. We highlight capital on Slide 5. Our CET1 ratio was 10.6%, up approximately 30 basis points from the third quarter, reflecting the benefit from our fourth-quarter earnings, the annual share issuance for our 401(k) plan matching contribution, and an increase from AOCI. Our CET1 ratio remained well above our required regulatory minimum plus buffers, which increased by 10 basis points to 9.2% at the start of the fourth quarter as our new stress capital buffer took effect. As a reminder, our G-SIB surcharge will not increase in 2023. While we have not repurchased any common stock since the first quarter of 2022, we currently expect to resume share repurchases in the first quarter of this year. Turning to credit quality on Slide 7. Credit performance remained strong with 23 basis points of net charge-offs in the fourth quarter. However, as expected, losses are slowly increasing from historical lows, and we expect them to continue to return toward pre-pandemic levels over time as the federal needs to take actions to combat high inflation. Credit performance remains strong across our commercial businesses with only 6 basis points of net charge-offs in the fourth quarter. Total consumer net charge-offs increased 88 million from the third quarter to 48 basis points of average loans, driven by an increase in net charge-offs in the Credit Card portfolio but remained slightly below consumer net charge-off levels in the fourth quarter of 2019. Nonperforming assets increased 1% from the third quarter as lower residential mortgage nonaccrual loans were more than offset by higher commercial real estate nonaccrual loans. Our allowance for credit losses increased 397 million in the fourth quarter, primarily reflecting loan growth, as well as a less favorable economic environment. We are closely monitoring our portfolio for potential risk and are continuing to take some targeted actions to further tighten underwriting standards. Let me highlight trends in two of our portfolios. The size of our Auto portfolios declined for three consecutive quarters, and balances were down 5% at the end of 2022 compared to year-end 2021. Meanwhile, originations were down 47% in the fourth quarter compared to a year ago which reflected credit tightening actions and continued price competition due to rising interest rates. Of note, our new vehicle originations surpassed used vehicles in the fourth quarter, reflecting a combination of credit tightening actions that we've implemented and the industry dynamic of higher new vehicle sales growth. Turning to the commercial real estate office portfolio. The office market is showing signs of weakness due to weak demand, driving higher vacancy rates and deteriorating operating performance, as well as challenging economic and capital market conditions. While we haven't seen this translate to significant loss content yet, we do expect to see stress over time and are proactively working with borrowers to manage our exposure and being disciplined in our underwriting standards with both, outstanding balances and credits down compared to a year ago. On Slide 8, we highlight loans and deposits. Average loans grew 8% from a year ago and 3.1 billion from the third quarter. Period-end loans increased for the sixth consecutive quarter with growth across our commercial portfolios and higher consumer loans driven by credit card and residential loans, partially offset by continued declines in our Auto portfolio. I'll highlight the specific growth drivers when discussing our operating segment results. Average loan yields increased 181 basis points from a year ago and 85 basis points from the third quarter, reflecting the higher rate environment. Average deposits declined 6% from a year ago and 2% from the third quarter. Compared with the third quarter, we saw declines in each of our business. Lower consumer balances reflected customers continuing to reallocate cash in higher-yielding alternatives, particularly in Wealth and Investment Management and continued consumer spending. As expected, our average deposit cost increased 32 basis points from the third quarter to 46 basis points, driven by higher deposit costs across all operating segments in response to rising interest rates. Average deposit costs are up 44 basis points since the fourth quarter of 2021, while market rates have increased substantially more during that same time. As rates continue to rise, we would expect deposit betas to continue to increase in customer migration from lower yielding to higher yielding deposit products to continue. Turning to net interest income on Slide 9. Fourth-quarter net interest income was 13.4 billion, which was 45% higher than a year ago, as we continue to benefit from the impact of higher rates. I'll provide details on our 2023 expectations later on the call. Turning to expenses on Slide 10. The increase in noninterest expense from both, a year ago and from the third quarter was driven by higher operating losses. Excluding operating losses, other noninterest expense was flat from a year ago as higher severance expense was offset by lower revenue-related compensation and continued progress on our efficiency initiatives. Our operating losses in the fourth quarter included accruals related to the December 2022 CFPB consent order. As part of that settlement, we agreed to one incremental remediation and one new remediation related to overdraft fees. The accrual related to these two remediations was approximately 350 million. Our operating losses in the fourth quarter also included accruals for other legal actions. And reflecting these accruals, our current estimate of the high end of the range of reasonably possible losses and accessible for legal actions as of December 31, 2022, is approximately 1.4 billion. This is down approximately 2.3 billion from September 30, 2022. While we still have outstanding litigation resolved, this estimate would be the lowest level since the second quarter of 2016, though, of course, new matters will arise and existing matters will develop over time. The estimate for December 31, 2022, will be updated at the time of our 10-K filing in February and may change. While we acknowledge the elevated level of operating losses, the past two quarters has been significant. They are important steps in putting historical issues behind us as we've been able to absorb the cost while increasing our CET1 ratio as I highlighted earlier. Turning to our operating segments, starting with Consumer Banking and Lending on Slide 11. Consumer and Small Business Banking revenue increased 36% from a year ago, driven by the impact of higher interest rates. Deposit-related fees continued to decline as we completed the rollout of the overdraft fee reductions and new product enhancements that we announced early last year to help customers avoid overdraft fees. The majority of the revenue impact of these changes was reflected in the fourth-quarter run rate. We continue to focus on branch rationalization as digital adoption and usage among our customers have steadily increased. In 2022, we reduced branches by 179 and branch staffing levels by 10%, and we expect to continue to optimize our branches and staffing levels in response to changing customer needs. While industry mortgage rates declined in the fourth quarter, they were still up over 330 basis points since the beginning of the year, and weekly mortgage applications as measured by the Mortgage Bankers Association were at a 26-year low at quarter end. The economic incentive to refinance is extremely limited. And refinance applications for the industry were down 87% in December compared to a year ago. Reflecting these market conditions, our Home Lending revenue declined 57% from a year ago, driven by lower mortgage originations and gain-on sale margins, as well as lower revenue from the resecuritization of loans purchased from securitization pools. We expect the mortgage origination market will continue to be challenging and gain-on sale margin or remain under pressure until excess capacity industry has been removed. As we announced this week, we will be exiting our correspondent business, which we expect to be substantially complete by the end of the first quarter. We don't expect this action to have a significant impact on our 2023 financial results. Credit Card revenue was up 6% from a year ago due to higher loan balances driven by higher point of sale volume and new product launches. Auto revenue declined 12% from the year ago driven by continued loan spread compression from rising rates and credit tightening actions in certain areas, as well as lower loan balances. Personal Lending was up 9% from a year ago due to higher loan balances, partially offset by lower spread compression. While originations grew 19% from the year ago driven by strong consumer demand in investments and the business, we have remained disciplined in our underwriting. Turning to key business drivers on Slide 12. Mortgage originations declined 70% from a year ago and 32% from the third quarter, with both declines in correspondent and retail and originations. Refinances as a percentage of total originations were over half of our volume a year ago to -- declined to 13% in the fourth quarter of 2022. I already highlighted the drivers of the decline in Auto originations. So, turning to debit card. Spending was up 1% compared to a year ago. Holiday spend for debit card was flat compared to the 2021 season with lower transaction volume, offset by higher average ticket size. Entertainment was the only category with double-digit spending while growth -- while categories such as home improvement, general retail goods, and fuel were all down compared to 2021. Credit Card spending increased 17% from a year ago, and while the year-over-year growth rate slowed from the third quarter. Almost all categories continue to have double-digit growth. Average balances were up 22% from a year ago. Payment rates have started to moderate, but we're still well above pre-pandemic levels. Turning to Commercial Banking results on Slide 13. Middle market banking revenue increased 78% from a year ago, driven by higher net interest income due to the impact of higher rates and higher loan balances. Asset-based lending and leasing revenue declined 4% from a year ago, driven by lower net gains from equity securities, partially offset by loan growth. Average loan balances were up 18% in the fourth quarter compared to a year ago, while growth in the first half of 2022 was driven by higher realization. Utilization rates stabilized in the second half of the year. Average loan balances have grown for six consecutive quarters and were up 5% in the third quarter, with growth in asset-based lending and leasing driven by continued growth in client inventory, which are still below pre-pandemic levels. Growth in middle market banking was driven by larger clients, including both, new and existing relationships, which more than offset declines from our smaller customers. Turning to Corporate and Investment Banking on Slide 14. Banking revenue increased 22% from a year ago driven by stronger treasury management results due to the impact of higher interest rates, as well as improved lending results. Investment banking fees declined from a year ago, reflecting lower market activity with declines across all products and industries. Commercial real estate revenue grew 16% from a year ago driven by stronger lending results to a higher loan balances and the impact of higher interest rates. Markets revenues increased 17% from a year ago, driven by higher trading revenue in equities, rates and commodities, foreign exchange, and municipal products. Average loans grew 10% from a year ago after growing for seventh consecutive quarter, average loans declined from the third quarter as utilization rates stabilized across most portfolios. On Slide 15, Wealth and Investment Management revenue was up 1% compared to a year ago, as the increase in net interest income driven by the impact of higher rates was partially offset by lower asset-based fees due to the decrease in market valuations. The majority of win in advisory assets are priced at the beginning of the quarter, so asset-based increased slightly in the first quarter, reflecting the higher market valuations at the end of the year. Expenses decreased 6% from a year ago, driven by lower revenue-related compensation and the impact of efficiency initiatives. Even as loan growth in securities-based lending moderated due to demand caused by market volatility in the interest rate environment, average loans grew 1% from a year ago. Slide 16 highlights our corporate results. Both revenue and expenses were impacted by the divestitures last year of our Corporate Trust business in Wells Fargo Asset Management. We sold these businesses in the fourth quarter of 2021, which resulted in a net gain of 943 million. Revenue also declined from a year ago due to lower results in our affiliated venture capital and private equity businesses, including the impairments in equity securities I highlighted earlier. The increase in expenses from a year ago was driven by higher operating losses. Turning to our expectations for '23, starting with Slide 17. Let me start by highlighting our expectations for net interest income. We are assuming that -- we are assuming the asset cap will remain in place throughout the year. Moving from left to right on the waterfall, based on the current forward rate curve, we expect our net interest income will continue to benefit from the impact of higher rates, even with deposits repricing faster than they did in 2022. However, this benefit is expected to be partially offset by continued deposit runoff and mix shift to higher-yielding products with these declines, partially offset by modest loan growth. We also expect a headwind for lower CIB Markets net interest income due to higher funding costs. This reduction is expected to be partially offset by an increase in trading gains and noninterest income, so the impact to revenue is currently expected to be small. Putting this all together, we currently expect net interest income to grow by approximately 10% in 2023 versus 2022. Ultimately, the amount of net interest income we earned in 2023 will depend on a variety of factors, many of which are uncertain, including the absolute level of interest rates, the shape of the yield curve, deposit balances, mix, and pricing in the loan demand. Turning to our 2023 expense outlook on Slide 18. Following the waterfall from left to right, we reported 57.3 billion in noninterest expense in 2022, which included 7 billion of operating losses. Excluding operating losses, expenses would have been 50.3 billion, which is -- which was in line with the guidance we provided at the beginning of last year. If you also exclude operating losses from the guidance, our 2022 expenses were impacted by inflation and higher severance expense. However, revenue-related expenses were lower than expected by market conditions. So, we believe a good starting point for discussion of 2023 expenses was 50.3 billion, which excludes operating losses. We expect expenses in 2023 to increase by approximately $1 billion due to both, merit increases, including inflationary pressures and an approximately $250 million increase in FDIC expense related to the previously announced surcharge. These increases are expected to be partially offset by approximately 100 million of lower revenue-related expense, primarily driven by decreases in loan lending. Based on current market levels, we expect revenue-related expense in Wealth and Investment Management for 2023 to be similar to 2022. We've successfully delivered on our commitment of approximately 7.5 billion of gross expense saves over the past two years. And through our efficiency initiatives, we expect to realize an additional 3.2 billion of gross expense reductions in 2023. A piece of this is related to the announcement we made earlier this week to create a more focused Home Lending business, but expense savings from reducing our servicing business will take more time to be realized. We highlighted on this slide the largest opportunities for additional savings this year, and we believe we'll have more opportunities beyond 2023. Similar to prior years, the resources needed to address our risk and control work separate from our efficiency initiatives. And we will continue to add resources as necessary to complete this important work. And while we continue to focus on executing our efficiency initiatives, we're also continuing to invest and expect approximately 1.7 billion of incremental investments in our businesses in 2023. As Charlie discussed, investing in our businesses is critical to our growth across the company and better serve our customers, but we'll also continue to be thoughtful and evaluate the level of investments throughout the year. So, putting this all together, expenses, excluding operating losses, are expected to be relatively flat in 2023 compared with 2022, even with inflationary pressures, a higher FDI surcharge, and increase incremental investments in our businesses. As 2022 demonstrated, operating losses can be significant and hard to predict, and therefore, we have not included them in our expense outlook for 2023. However, we currently anticipate ongoing business-related operating losses, such as fraud, theft, and other business-as-usual losses to be approximately 1.3 billion this year, which is the same assumption we provided last year. As previously disclosed, we had an outstanding litigation -- have outstanding litigation, regulatory, and customer remediation matters that could impact the amount of operating losses. It's important to note that while we made substantial progress executing on our efficiency initiatives, we still have a significant opportunity to get more efficient across the company. This remains a multiyear process with the goal of achieving an efficiency ratio along with our peers based on our business mix. Given how critical continuing to invest to our -- continue to invest in our story, on Slide 19, we provide details on our primary areas of focus for 2023. As we've highlighted, continuing to build the right risk and control of infrastructure remains our top priority, and we will continue to invest in this important work. Charlie discussed many of the investments we started to make in digital payments, and we plan to continue to invest in these areas this year to make improvements for both our consumer and commercial customers. We also plan to continue to invest to expand our client coverage and investment banking, Commercial Banking, and Wealth and Investment Management and to continue to transform our technology platforms, including moving more applications to cloud, consolidating our data centers, and increasing investments in cyber. Finally, by investing in our operations and branches, we expect not only to improve the customer experience, but also improve efficiency, reduce operational risk, and drive and account growth. As we show on Slide 20, in the fourth quarter, we reported an 8% ROTCE. But as I highlighted at the start of the call, our fourth-quarter results were impacted by several notable items, including higher operating losses, elevated impairments of equity securities, severance, and discrete tax benefits. As we show on this slide, you will -- if you exclude these notable items, our fourth-quarter ROTCE would have been approximately 16%. However, we don't believe this accurately reflects our longer-term expectations for the following reasons. Net interest income was higher than our long-term expectations due to interest rates, funding, penalties, mix, and pricing, Also, net loan charge-offs were at historically low levels. If rates, funding balances, mix, and pricing were closer to our long-term expectations and charge-offs were higher, our ROTCE would be lower. Depending on what adjustments you make here, we may all get to a slightly different answer. So, to be clear, because the interest rates are higher and freight costs are lower than our longer-term expectations, we believe we have more work to do to improve our returns. On Slide 21, we highlight our path to higher returns. Since we first discussed our ROTCE goal in the earnings call for the fourth quarter of 2020, we have executed on a number of important items. We executed a $20 billion of gross common stock repurchases, 16 billion in net issuances, including our 401(k) plan. We increased our common stock dividend from $0.10 to $0.30 per share. We delivered approximately 7.5 billion of gross expense saves and reduced headcount by 11% since the end of 2020. So, we've made good progress over the past two years on things that we can control, and we believe we have a clear line of sight to a sustainable ROTCE of approximately 15% in the medium term. In order to achieve that, we need to continue to optimize our capital, including returning capital to shareholders and redeploying capital to higher-returning products and businesses. Adding more focus on our Home Lending business should also be a positive contributor to higher returns. We also have additional opportunities to execute on efficiency initiatives. Additionally, we expect to benefit from the investments we are planning in our businesses, which I highlighted earlier. While some of these investments will be dependent on the market environment, we expect them to increase ROTCE. At the same time, we will continue to prioritize building our risk and control infrastructure. In the longer term, we believe that running a company in a more controlled and disciplined manner will continue to benefit returns. And our goal is for our four operating segments to produce returns comparable to our best peers. In summary, although the high level of operating losses we had in the fourth quarter significantly impacted our results, the underlying results in the quarter continue to reflect an improvement in our earnings capacity. As we look forward, we expect to continue to grow net interest income. And our expenses, excluding operating losses, are expected to be relatively flat even after inflation and incremental investments in our businesses to drive growth. Both our credit performance and capital levels remained strong in the fourth quarter. And we expect to resume share repurchases in the first quarter. We will now take your questions. [Operator instructions] Please stand by for our first question. Our first question of today will come from Ken Usdin of Jefferies. Hi. Good morning. Good afternoon, I should say. Mike, just a follow-up on the NII outlook for the year. So, you obviously had a good high end to the year at 13.5% FTE. And just looking at what the guide implies a step down -- a little bit of a step down from thereafter, can you just kind of walk us through just how you expect the betas to move through and then like what doesn't necessarily follow through from here in terms of some of the moving parts? Thanks. Yes. Sure, Ken. Thanks for the question. I'll just kind of walk you through some of the drivers there. And then, obviously, also the timing of when we expect to realize some of those matters as well. And so, as you look at the key things, you look at stick loan growth, we've got -- we're expecting kind of low to mid-single-digit loan growth throughout the year. So, not superfast pace, but at a moderate pace of loan growth. We are expecting some moderate declines across the deposit base stabilizing later in the year, but some moderate declines as we look over the next few quarters. And then we would expect the betas to continue to move up a little from here. And then when you think about the pacing of it, the first half of the year will certainly be higher than the second half of the year if all of these things play out. And so, you shouldn't expect a really big step down in the first quarter for sure. And then I think that provides the opportunity potentially in the second half of the year if things -- if we don't see that step down in deposits or the betas are a little bit better than what we expected. And then I'd just point out is even as we looked at the fourth quarter, betas were a little bit better than what we had modeled. And so, we're all in a little bit of uncharted territory here, but I do think that there's some opportunity potentially in the second half of the year as we look at the forecast, but it will be dependent upon how we fare over the next quarter or two. Okay. Got it. And so, second question, I heard your commentary about the 1.3 billion of op losses and the fact that the RPO is down to way down to 1.4 billion. Just how do you kind of help us understand your range of confidence? Obviously, last year, op losses ended at 7 billion as you made progress. Well, I think if you look at what we've said over the last quarter or two, there's been roughly in the third and fourth quarter 200, 250 just BAU op losses that have happened, just broad normal stuff that you should expect to continue. So, that gives you sort of a bottom end. And then I think the rest of it is -- will be a little dependent upon how we work through the rest of the issues that we've got to work through for next year. But I think as you look at the RPL going from 3.7 billion to 1.4 billion, as those big items have moved to be more probable and estimable for us, we booked them. And hopefully, that gives you confidence that we're putting some of the big things behind us. But we still have stuff to work through, and there'll be more over time, I'm sure. But we've put a lot of big things behind us. Thank you for taking the question. I think maybe a question along the same lines there. So, the tone around the regulatory issue certainly sounds better than like 90 days ago and that reasonably possible losses seems to have a better quantitative thinking as well. But what -- maybe, Charlie, what are the major touch points sort of on your plate right now? I know all roads ultimately lead to lifting of the asset cap, but maybe would be curious to hear your thoughts on just sort of the biggest things left in your mind. Yes. Well, let me just -- so, listen, we still have a series of consent orders, of which, and I always point this out, the asset cap is a piece of one of them. So, all roads don't lead to the asset cap. The roads in this respect lead to us building the proper control environment, which will satisfy ultimately all the consent orders. And I've tried to be clear that we are making progress on that work. It is a lot to do. And our tone hasn't changed relative to the confidence in the progress that we're making there. So, we're going to continue doing it. And hopefully, it's done to the satisfaction of the regulators, but they'll have to decide that. And as we continue to tick off the to-dos on that work, the control environment gets better and better. And we become a better run company that doesn't have those kinds of operating losses that you've both seen in the past. Okay. All right. Perfect. And then, Mike, when you talk about resuming share repurchases in the first quarter, maybe you can give us sort of a sense for sort of magnitude and maybe just an even higher level, sort of how you get comfortable repurchasing in the face of what same sort of still uncertain rules out there. Well, I would start with where our CET1 ratio is at the end of the year at 10.6%. So, we're well above our current regulatory minimum and the buffers that are included there. So, we have plenty of flexibility regardless of any outcome that comes out of the new rules that will be proposed. And keep in mind, that will take some time to come out and get implemented and phase in. And so, there's -- it's not going to happen in a day. And I think we'll go back to what we've been saying the last number of quarters as we think about the buffer that we'll put on the reg minimum, buffers of 9.2%, we'll be managing somewhere in the 100, plus or minus, a little basis point range. And depending on what happens with loan growth and RWA growth that we see in the quarter, that will help guide the share repurchases. Hey, Mike, I wanted to clarify your answer to Ken, about the first quarter NII. I think you said you do not expect a big step down in the first quarter. Maybe you could just frame first quarter NII a little bit for us relative to the 13.4. What are some of the headwinds, tailwinds? And what might you expect at this point? Yes. Thanks, John. Well, first, you have to normalize for a couple less days in the quarter. So, that's going to be a step down of, call it, 150 million to 200 million step down just there from the flex days. And then as you look at -- it should be relatively stable to the fourth quarter, but there could be some -- little bit of wiggle room in there. Okay. Got it. And then, Charlie, maybe a bigger question, just kind of where are you on the efficiency journey when we think about 50 billion of core expense for this year. And the timeframe for ROTCE, what will it take? Is there an efficiency ratio we should keep in mind? Or is that too hard to forecast? Maybe a little bit on that would be helpful. No, it's a good question. I think -- so, first of all, I think when -- just make a -- just a couple of comments around the expense guidance we gave. Embedded in that expense guidance, we're still continuing to reduce the core expenses of the company. But as you can see on that slide, we're anticipating that we will spend more money on investments that are around technology, digital, building out products, and things like that, that offset that some extent to get to an overall flat expense base. Mike did say in his comments, and I just want to repeat it, that we're not going to spend this money at all costs. We're going to see how the year continues to pan out. It's money that we would like to spend. We're planning to spend it, but there's a lot of discretion in the expense base. So, we think it's prudent, as we sit here today, to plan to spend it, but we're going to constantly be looking at our performance and make judgments on what that should be. And so, as we look at the efficiency of the company, we do expect to continue to get efficiency ratio improvement in the place. And if we don't see revenue growth and if we don't see payoffs from the things that we're doing, then we will spend less money. And so, that's the way we're approaching it. We're either going to get the efficiency ratio to continue to improve because we're getting real payoff on some things, or we will reduce on a net basis. But overall, there's still gross expenses that should come out of the company, which gives us the latitude to continue to grow the investments inside the company. The timing to get to 15%, listen, it's a great question. As we talked about it, it's medium term, which is obviously not long term or short term. But I would say it's -- without putting a specific time frame, it is -- it should be something that we have in our sights as we look out over the future. It's not something that's theoretical. It's something that we believe we should get to. And just the problem and we're just trying to stay a little bit away from, quantifying exactly where we're starting from just because everyone will make their own adjustments. And it's just -- I think what we're just trying to do is be really clear that we don't want to take credit for the outperformance in NII. We don't want to take credit for the outperformance in charge-offs, and that we still have to continue to drive improved performance each and every year at the company. Hi. Good afternoon. So, Charlie, I was hoping to ask a follow-up to that last line of questioning around expenses. You indicated that the expense work, it's going to continue beyond 2023. And the one metric that we've been tracking is headcount. And in terms of the benchmarking analysis that we've done, headcount is down more than 10% since the 2020 peek or roughly 30,000, but it's still elevated versus your money center peers. I was hoping you could just speak to what inning you're in currently in terms of optimizing headcount. And whether -- as we look beyond '23, whether there is a credible path to actually driving investments lower, you had talked about balancing investment with the need to drive those efficiency gains. I just want to think about the expense trajectory beyond '23, whether further reductions are achievable given some of that inflated headcount still? Yes. Listen, I think -- I mean, I think that your point on headcount versus peers is one that we've made. And so, yes, we are all different in terms of the businesses that we're in and what we do. But we do -- and some insource and some outsourcing things. But when you look at it, we still have higher headcount and higher expenses than people who are more complex than us. You know, some of that is explained by the work that we're doing and the expenses and heads that are building out the control infrastructure, but there's a lot more beyond that. That's the work that we're doing to peel that back piece by piece by piece. We still have a huge amount of manual processes inside the company. We have duplicate systems, and that is -- that's the work that we're on. So, when I say that we still have gross expenses to be reduced in the company, we -- there's -- that's exactly what we're talking about. On the -- the question is when we get to a net basis, where does that come out? As I said before, I think that's a decision that we want to be able to make at each and every point in time when we look at what the overall performance of the company is. So, again, I just want to repeat what I said. We're not going to spend under any environment at all costs. That's not the way we're thinking about it. If we don't see net improvements in performance of the company, we've got the ability to ration back the discretionary spend so that we do continue to see improved performance of the company. What we'd like to see is that these things are paying off. We're seeing real sustainable revenue growth based upon these things and the ability to invest. And so, that's just kind of how -- that's the framework that we're using to make the decisions. And as we get to each point in time, and it's not even just an annual decision. I mean, Mike and I and the operating committee are going to have these discussions regularly about how are things panning out, what does it look like, and how do we feel about our willingness to continue to invest in these things? And have it -- it's got to be living and breathing. That's helpful color, Charlie. And for my follow-up, just also as it relates to the discussion around the buyback. You guys are uniquely positioned in that you aren't migrating into a higher G-SIB bucket. Because of the asset cap, you're not going to necessarily see quite as much expansion in terms of balance sheet. And you've conveyed a high level of confidence around a 15% ROTCE, where your stock is trading today, at least on price intangible, reflects a pretty healthy degree of skepticism and your ability to get there. Just given the strength of your capital position, why not get a bit more aggressive with the buyback here? Just recognizing the significant amount of capital you'll generate, some of the concerns around AOCI seem to be abating. Would be helpful to get some perspective as to whether you might be willing to step it up meaningfully closer to 100% type payout here? Well, so just -- it sounds like you're drawing conclusions to the pace at which we said we're going to buy stock back, which I don't think we have actually said. What we've said is that we haven't been buying stock back. We're absolutely -- we anticipate we're going to begin buying it back. As we think about how much we have available in that capacity, what Mike said was our CET1 went up to 10.6%. Our required minimum buffers are at 9.2%. And we -- it said that we'll manage 100 basis points above the 9.2% plus or minus. So, we do have substantial capacity but the ongoing earnings capacity of the company. And so, that is -- that's -- our framework is to target a reasonable CET1 ratio. If in the future to raise the levels of capital because of Basel III in-game or whatnot, we've got earnings capacity to be able to do that. But we do have the flexibility. And now that we've got resolution with CFPB and things like that, to be able to go buy stock back. And we'll be making that decision based upon our views on the value of the stock and liquidity in the market and things like that. Okay. Fair enough. More of my effort to assess the cadence and the magnet, but it sounds like you guys are quite comfortable leaning in here. So, thanks for taking my questions. Good afternoon. I wanted to see if you could just give a little bit more color on the net interest income side. Maybe if you can talk a little bit more about the noninterest-bearing deposit mix shift that you think could continue here. It looks like that could be a pretty material offset to your interest rate benefits. So, I just wanted to see if you can perhaps talk about that and then maybe also help quantify the runoff that you expect to continue on the deposit side in terms of balances overall. Thanks. Yes. John, it's Mike. I think overall, as I said earlier, we do expect a moderate decline in balances and some more mix shift changes as we go throughout the year. And so, you should expect that to continue. And it's all the stuff that should be expected as we're in this environment, and that's what we're seeing. And if you look at each of the businesses, we're seeing it kind of most acutely happen in the wealth business as people move into cash alternatives, out of deposits, and that's what's happening in a lot of wealth management businesses these days as people move that cash around. And then across the rest of the consumer businesses, it's part people looking for higher yields, but it's also part people spending more. And so, you're seeing some of that decline come down as overall balances continue to decline as the stimulus has worn off and people continue to be out there spending. So, it's a little bit of a number of drivers there. And I think as I said earlier, the -- as you think about the NII pacing for this year, this first half of the year will certainly be higher than the second half of the year, given the trends that we expect to happen. And if those are a little bit better than what we're modeling, then I think that provides some opportunity as we look at the second half of the year. And then also on expenses. On the fee side, can you perhaps give us your expectation there around overall growth that you expect in noninterest income and maybe some of the major drivers of where you see growth and if you could possibly size it up perhaps around the investment banking area, etc.? That would help. Thanks. Sure. And so, as you break apart fees, the biggest line item there is the investment advisory fees, and that's going to be somewhat dependent upon where the market goes. So, if we start to see recovery in the equity markets at a more substantial pace, that will obviously be a big benefit for that business. When you look at some of the other line items, deposit fees, as I mentioned in my commentary, most of the decline that we were expecting to see as a result of the overdraft policy changes and new products that we implemented is in the run rate. You may see some pressure there related to earnings credit on the commercial side, but the run rate decline for overdrafts is really in there. When you think about investment banking fees, that's going to be somewhat market dependent. We've seen -- it's too early to know how that's going to shape up in terms of the overall industry volume there. But as we continue to make the investments in our investment banking business over a longer period of time, we would expect to see some growth there, both in how we go after that opportunity in the commercial bank and middle market space, as well as our other large corporate clients there. And so, a lot of that's going to be dependent on the market. But we're confident that we're going to be positioning ourselves better and better to take advantage of it. And then we talked about mortgage. Mortgage is a small piece of the -- it's a much smaller piece of the puzzle than it was today. Sorry. Smaller piece today than it was historically. And so -- and that's going to be a pretty challenging market until -- in this rate environment. So, I think we're confident in the investments we're making that will pay off over time, but it may take a little time to start to see some of that come through depending on the market dynamics. Good afternoon. I just have one question. I guess, Charlie, in your opening remarks, you mentioned that the impact on customers from higher rates, I think you implied was not getting worse with the incremental sales. Was that the right takeaway? And if so, and if the Fed were to stop after another hike, do you actually see that the impact your customers may not be as meaningful as feared over the last six to 12 months and implications of that on the credit quality and the credit performance of your book? Would love to hear any perspective you can share. Sure. What I was trying to say in those remarks was the impact on rising rates is continuing to impact customers on a period-over-period basis, and we would expect that to continue, but it's not accelerating. It's much more linear than exponential. And the fact that it's much more linear is actually a very helpful thing because that gives people -- that's just -- that's a more orderly transition to a slower growth economy and gives consumers a chance. It shows that they're adjusting their spending patterns and saving patterns and borrowing patterns to adjust for the reality of higher rates. And on your second question, we would anticipate that we would continue to see deterioration in those metrics continue after the Fed stops raising rates, for a period just because of the amount of time that it takes those things to filter through the economy more broadly. So, hopefully, that was helpful. That's helpful. And just a quick follow-up. I think you mentioned earlier around commercial real estate. Like are you seeing any stress? There some discussion around the ability of these loans to get refied given the move in rates we've seen over the last year. Any steps within the CRE book? And anything just in terms of home state, a lot of negative headlines around San Francisco. Would love to your perspective on that, too. It's Mike. I'll try to take that and Charlie can add if he needs. When you look at the -- and you're really getting at the office, I think, space more than anything there. There's certainly more stress in the office space than there was a quarter or two or three quarters ago. And I think you're seeing that. Now, it hasn't translated into lost content at this point. And so, we're keeping a careful eye on it. And I think it is -- as you look at where you see it most, it is in older, lower-class properties. And over 80% of our portfolio is in Class A space. And so, we feel like the quality of it's pretty good, but we will see some stress as we go through here. So far, it's been pretty idiosyncratic in terms of individual buildings and individual places. But we are very watchful on cities like San Francisco, like Los Angeles, like Washington, D.C., where you're seeing lease rates overall be much lower than other cities across the country. And so, certainly, those are markets that we're keeping a pretty close eye on and making sure we're being proactive with our borrowers to make sure we're thinking way ahead of any maturities or extensions, options that need to get put in place to help manage through it. Hi. Good afternoon. Just one more clarification question, if I may, on net interest income. You know, Mike, your underlying assumptions to your NII outlook in terms of low to mid-single-digit loan growth, moderate declines in deposit balances in the first half and stabilizing, it doesn't feel very different from what consensus had been assuming to get to 51.5 billion for '23, which is clearly higher than what's implied by your outlook. So, I'm wondering if I could reask Ken's question, what deposit betas, what terminal deposit betas, what range of expectations are you baking into that 49.5 billion forecast? And did you make a significant amount of conservatism as you think about your NII outlook? And I'm asking that question because one of your peer CEOs said their 74 billion outlook was not conservative. So, I think that given the outlook versus consensus expectations, I did have to reask that question here. Can I just ask to start before Mike actually goes to the facts? Again, I think one of the things that you're hearing from all of us that were all very consistent on, which I know you appreciate, but I just want to say it anyway, is we don't know what the rate path is going to look like from here over the next 11.5 months, which is exactly what you're asking and exactly what the competitive environment is going to be month by month versus all of the people we compete with. So, you're looking at -- we don't know what the alternative is going to be in nonbank deposits, and we don't know what the alternatives are going to be in bank deposits, but we're trying to make those predictions. So, I think when we go through all of this, we're all just trying to, in our own way, make sure that there's clarity that we're -- and I'll speak to myself now. We're trying to give you what we think is achievable. And in our case, based upon the rate curve that we've laid out in the document, and it might or might not turn out that way. We're also assuming, and I talked about this at a conference in December that we are going to continue to raise rates in which we pay our consumers because we're thinking about this not in terms of maximizing short-term NII, but thinking about it in terms of the value of the relationship and making sure that we pay properly for that, so that we're continuing to recognize how expensive it is to get a new relationship and how profitable it can be to keep an existing relationship. And so if your views are different toward the end of the year as to what the rent scenario could be, that's fine. Specifically, what we've tried to do, as we've gotten closer to the periods with which we see is give you some clarity as Mike did on what we're -- the first quarter is a little clearer to us. But beyond that, is pretty difficult, and we're not going to go through every last beta that we're assuming in terms of what those forecasts are. Yes. The only thing I'd add to it is as you -- as the Fed does -- when the Fed does ultimately peak in terms of rising rates, you will see a lag on pricing as that will continue -- pricing will continue to increase over a quarter or two quarters, three quarters. Really, it all depends on the competitive environment. So, you're going to have some lag there. But I'm sure all of us have our own points of view and assumptions underneath those models. But what we're trying to give you, as Charlie said, is a case that we think is achievable through the year. And as I said earlier on the call, I think if we're -- if we've -- depending on how it plays out over the first and second quarter, we could have some opportunity in the second half. But I think it's unclear exactly how that will play out. I did want to just unpack a couple of things around the correspondent exit and also some follow-up questions as it relates to the mortgage business in general there. I think you mentioned that it's not substantial impact. Maybe you could help us understand revenues, expenses, EPS. I made my own assumptions, but I got a lot of questions from people on what managements say. So, I would like to understand that piece of it. And then could you help us understand how you're thinking about the mortgage business once you exit correspondent, is there any originate and sell servicing retained left in any panel? Or are you staying with this correspondent exit -- your exit that you'll be moving entirely to portfolioing for yourself, and the MSR will wind down over time? Just give us some color around that. It would be appreciated. Thanks. Yes. So, maybe I'll start on the second, and then Mike will circle around to the first. So, we are not assuming that we will balance sheet every loan that we underwrite in the future. Again, what we're just -- what we're trying to do in the path that we've laid forward is just to make very clear that we're not interested in running and having a business which is focused on a stand-alone mortgage product. We very much appreciate the importance of mortgage to the consumer base. And we're going to continue to stay in the business. But we're going to view it as part of the importance in the broader relationship. So, that means we'll be originating both, conforming and nonconforming mortgages. And we'll continue to make the decision as to what goes on our balance sheet as we have done in the past. The fact that we'll be originating a lot less will certainly mean that over time, the MSR and the overall servicing book will come down very naturally based upon that, over a fairly long period of time. But we'll also look for intelligent and economic ways to reduce the complexity and the size of our servicing book between now and then. And if those present themselves, we'll certainly be interested in doing that. And I know Mike will talk a little bit about this, but I think one of the things we were just trying to say when we think about the size of the impact of exiting the correspondent business immediately is given the fact that mortgage volumes are so low, and revenues are so low. The revenue impact of exiting the correspondent business in the short term is not meaningful. It's a very small number of people. So, that's not all that meaningful in the short term. The real benefit comes over time as we reduce the size of the servicing business, which, as we've tried to make the point is, it's not just reducing expenses, but it's not profitable for us today in a whole bunch of these segments where we continue to have the servicing. And so, it becomes a positive over time. And it's just -- but that is not a short-term benefit for us but certainly a medium- to longer-term one. Yes. And the only thing I'd add is all you lose initially, Betsy, is the gain on sale on the origination. The servicing is still here. And that in any given quarter over the last couple of years is low tens of millions of dollars. So, it's a really small impact. Because one of the follow-ups I got was it, does it impact the scale? Obviously, it reduces the flow over existing plants. So, does that matter to how you price your reach? No, it's not even close. I mean, the amount that we're originating today relative to the scale we have in the business is -- it's immaterial. And we'll -- and even as we downsize the portfolio on the servicing side, the whole point -- our servicing portfolio can be substantially, substantially lower, and we'll still have scale to be able to originate the product and we would say in a more profitable way than we're doing it today. Thanks. Thanks for taking my questions. A question for you. With the CFPB settlement, there was a comment by the head of CFPB about growth initiatives slowing your progress. So, Charlie, as a question to you is what are you planning to do in regards to that comment in terms of the growth initiatives? Are you trying to slow anything? Any color on that? Yes. I addressed it in my remarks, which is we've been very, very clear. And I think if you look back on every earnings call, let alone any time I speak publicly, we're very consistent in making sure that everyone understands both, internally and externally, that our No. 1 priority is getting that work done. That is how we're running the company. We have very clear processes internally to make sure that, that happens. And we're very confident that's the case. And the things that we are doing to grow the business, we think, are actually helpful to actually making it a more controlled place. And we're going to continue to go forward the same way we've been going forward, being very conscious of making sure things don't get in the way. Thanks. A completely different question. On -- in the past, you've given some color on deposits and among different tiers of customers. Any color, any update on where those stand currently and your outlook on that? It's still very much the same, which is kind of intuitive that those who went in with lower balances are the ones who are living more paycheck to paycheck. And they are seeing more stress than those that have not had that. But I would say that it's the rate of change, it's still the same across most of the affluent spectrum. So, the trends are still very consistent. Thank you. Good afternoon. Charlie, kind of to -- excuse me -- flip this question from your answers to the servicing and the residential mortgage business, are there any lines of businesses that -- I know you can't go out and make an acquisition, of course, but any lines of businesses you're looking to grow and enhance and beef up maybe through hiring groups of people to do that, you know, strategic increase? Listen, I think when we look at all of the -- I mean, I've said this in the past, when we look at each of these businesses that we have, and that's going to be a consumer bank, it's consumer lending, wealth, commercial and the corporate investment bank. With the exception of the Home Lending business and that the rest of the consumer lending businesses that lend, it's all going to be based upon returns and what we're seeing in terms of market competitiveness. All of these businesses have the opportunity to continue to grow share. And when we think about the things that we're doing to invest, we are targeting investment banking ads in both coverage and products. We're focused in Commercial Banking, the build-out of both the corporate investment offerings for that customer base, both the corporate investment bank and the commercial bank of opportunities to continue to improve what we do from the treasury services perspective. And so, we see growth opportunities there. I've talked about the opportunities in our wonderful wealth management business to bring on some more investment teams as we've reoriented that business. And when we wind up looking on the consumer lending side, you've seen growth in the Credit Card side of the business, which we would expect to continue. And our consumer bank is -- we very carefully evolve from fixing the problems that we've had, taking advantage of the franchise. So, when we talk about -- and we have this page in the deck, Page 19 in the investor -- in the earnings presentation, we do see multiple places for us to be able to increase the rate of growth by just organically, which sometimes involves adding people. Sometimes it's building technology. Sometimes it's just improved execution. And there are other things like affluent and whatnot that I haven't mentioned, but they're a bunch, and they're pretty broad. Great. And then just as a quick follow-up. Mike, you guys mentioned that there was a private equity or equity write-down in the quarter. Can you share with us how big that was? And then just -- I know over the years, you guys have done very well in this area. But -- and then second, how big is the portfolio? What's the remaining there? Sure. It was about $1 billion write-down, 750 million after noncontrolling interests. And so, that's on the first page of the release, if you want to refer back. It was primarily driven by some write-downs in enterprise software companies. And in particular, it was really one investment that drove most of it. And I would just point out, we had a -- that investment is still a very good investment. The company is a good investment, and we're still holding it well above where we -- where the invested amount is. But like all of -- all enterprise software companies, it's the company -- it's just -- it's the rate of growth over the next year or so has come down substantially, but it's still a very high-quality company. And then just more broadly, on the venture business, we've done -- the team has done a great job over a very long period of time, and we still think it's a very good business. Okay. Thank you, all. And we appreciate the time, and we'll talk to you next quarter. Take care, everyone. Bye, bye.
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We're delighted to have Marianne Lake with us as our next presenter. She is the Co-CEO of the Consumer & Community Banking businesses at JPMorgan. She's a member of the Operating Committee. She leads three industry-leading businesses: Card Services, Home Lending and Auto Finance. She's been with the firm for over 20 years. And the last time she was at this conference, it was 2017, and she was CFO. So, Marianne, welcome back. Thank you. It's great to be back. When Richard said was the last time you were here in 2017, I was like no, no, it's got to be like â19. So, the last five years, super quick. So, why don't we start off with just a broad discussion about the macroeconomic environment? I know there's a lot of moving pieces here, and I know a lot can change. Can you talk about two things? First is, what's your view of the current state of the economy? What are your expectations as we head into next year around inflation, interest rates and monetary policy? And how do you see it playing out from here over the next 12 months? Okay. So, look, as we sit here today, the US economy is still strong. I'm sure we will talk more about it. My sort of center of gravity being in Consumer Banking and Lending, consumers and small businesses are still generally in good shape. And so, everything today is pretty good. I do think as we look forward, we are generally, at least -- we're supportive of moderating the pace of rate hikes looking forward, more in restricted territory, no longer need a shock and normal approach to monetary policy. Inflation expectations, I feel like theyâve stabilized, maybe even rolled over. And so, our economists, looking forward, have obviously a 50-basis point price hike in December and another 50 basis points between February and March. And clearly, there's an appreciable risk that the Fed will go higher. At this point, we don't think that there's necessarily going to be a need to do that. Could happen. We are seeing signs that inflation will moderate through 2023 and â24, but remaining meaningfully above target, but still show, we think, clear and convincing signs of moderation. And then, I think the labor market is still super tight, no matter how you measure it, obviously. But it does feel like in the tail end of 2022, things improved slightly. And so, it feels a bit like we've got the peak of wage inflation that we might have thought that true coming into 2022. And there was a lot of wage action in 2022. But it does feel like we're past the peak of wage inflation. It feels like the sort of frenzy on hiring and thereâre like super-elevated attrition rate for us, and generally, have abated a bit. And so, we look for that to soften into 2023. We could clearly be wrong. With that, updating our outlook for unemployment, as unemployment moving higher in 2023, peaking in 2024, at or slightly above 5%, which in the context of any kind of stress test, sort of in the context of history is like really quite modest. So, a shallow and short-lived recession at the end of next year, again, with all of the caveats around that. What does it mean for us without being flippant in any way? It will be what it will be. We don't manage the company based upon short-term macro expectations. We understand that there are a range of potential outcomes. We look at all of those, including the sort of tail risks. There will be impacts. We can talk more about them. We have worsened our central case very slightly on macro variables, including unemployment. That comes with impacts most notably on reserves, less so losses in the near term. And if rates hit a terminal rate of 5%, a lot less or more, and slightly higher through 2023 and 2024, which we think will be likely the case, that we could earn some more NII as that happens. But reprice is a wildcard and QT is a wildcard. I think we're pretty sanguine at this moment. So, obviously, there are ways we could be wrong, and we'll update you as we know more. Just as a very quick follow-up. Has your view of the economy for the next few years changed in any way over the last three months? I would say that we feel like a modest recession is more in our near term, so the probability of a recession has gone up. We're actually looking for that right now. We think it could be like a lower case âvâ, mild and short. And I think if you -- we'll talk, I'm sure, about credit and risk and tightening, but unemployment at 5% is not super elevated in the context of how we think about running our businesses. We know we run them through cycles. So, maybe you can talk about what you're seeing in your platform in terms of consumer spending patterns. How has that changed in the fourth quarter, either compared to last year or compared to the third quarter? And then, it would be really interesting to hear if you've seen anything different in terms of trend by consumer segment. Okay. So, consumers, small businesses, obviously, sentiment reflects recessionary fears not yet fully reflected in the data. So, if you start looking at consumer spend and you know this, this has been pretty well telegraphed by us and others, nominal spend is up strongly since the pandemic. It's up year-on-year. That's across sectors. It's across risk profiles and income levels. It's across geographies, so on a nominal basis spend continues to be strong. Spend trends are moderating through 2022, so we're ending the year above 2021, but at a much more normal level. And that more speaks to the base effects of 2021, which was going in the reverse direction. If I'm thinking about areas where we're watching, subsequent to the third quarter, we started to see retail spend a little softer. Now base effects matter. The quarter -- third quarter last year was very strong. So, I don't think there's anything flashing amber or red right now, but it felt a little softer. The holiday period will be a watch item. So far so good on the holiday period. It could break either way, but I would say solid. And then, in terms of areas where I still think that potentially there is room to grow, I think travel. We still feel like travel momentum is, like, in the run rate, and so we're looking for that to continue into 2023. Cash balances, credit, I mean, the words we've used continue to be true, slow normalization, they're continuing to normalize, continuing to normalize somewhat slowly. Obviously, normalization is deterioration on an absolute basis, but it's not accelerating and we're not back to pre-pandemic levels. But that normalization is stack ranking exactly how you would expect, so higher risk, lower income consumers normalizing faster. And then, if you look at small business space, it's pretty similar story. Small businesses have been very durable. They were able to pass on a lot of costs for a long time. More recently, so over the last few months, the smaller end of small businesses, particularly the consumer-facing ones, have had more margin pressure, but still at reasonably healthy margins. And there, too, cash is normalizing. Credit performance remains strong. And there, too, normalizing faster on the smaller end of small business. So, pretty much how we expected, with everything on a normalization path to 2023. We can talk about where we think those things will end up. But it's true in consumer and it's true in small business that normalization is faster at the lower end of the spectrum. So, I know on the third quarter earnings call, Jamie said that excess cash in consumer accounts could deplete by middle of next year. Can you just expand on that? Do you still think that's something that could happen? And what are you seeing on the consumer balance sheet in the fourth quarter? Has anything stood out to you or surprised you? Yeah. So, right, just in the fourth quarter, nothing has specifically stood out, and we haven't seen a step change or a material change in that sort of pace of change, letâs say that. There are a couple of different ways you can look at liquidity in consumers' accounts. And so, I think if you just look at the absolute level of deposits, by absolute deposits today versus pandemic, it is absolutely true that they are elevated and remain significantly elevated. But lots of things have changed since the pandemic. And inflation has had an impact both on inflows and outflows to consumers. So, one of the ways that we like to look at excess liquidity in consumers accounts is to take a stable cohort of customers that were our customers at the time the pandemic hit, and to take a look at how much cash they have on hand today, so how many days' worth of operating expense can they pay today, acknowledging that their operating expenses today are higher than they were. So, we call that the cash buffer. We measure it in days, and basically it says how much cash does the average consumer have today to pay their bills in comparison to how much cash did they have relative to the outflows before the pandemic. So, if you look at the lower income spectrum, less than $50,000, they're about halfway back. They are down year-over-year. They are normalizing faster. They are not yet at pre-pandemic levels. And so, that's good news. Even with inflationary pressures, there still is excess liquidity when you look at how capable people are at paying their bills. If you just flow that forward and you don't -- all other things are equal, that's when we would see the middle of next year being important. If you flow forward those rates of change, then they would be back to effectively pre-pandemic levels of capacity to pay bills, call it, the middle of next year. And so, we're expecting that to be the case. They are a large portion of our deposit base. So, while the overall picture is slightly different and a bit longer, it's pretty instructive base. That's what we're looking for. And we're looking at all of our metrics normalizing through 2023. And what that tells you is that you should start to see things change because that's all other things being equal. Clearly, depending on the macro environment, it could be faster or slower. But also, we would expect consumers to start to change behaviors in more noticeable ways, to start pulling back on spending, to start re-leveraging maybe a little faster, the credit metrics to start normalizing a little faster. So, that kind of second quarter of next year, I think, is going to be pretty instructive. We could be wrong about the exact pace, but that's what we see happening. So, let's talk a little bit about credit. It's very much top of mind. Obviously, being a focus all year, but credit conditions remained pretty benign at least through the third quarter. So, maybe you can talk a little bit about what you have seen in the fourth quarter. Are you seeing anything stand out to you? Maybe talk about what you are tracking most closely? And then, maybe talk about what your expectations are for credit normalization next year? So, I mean, I said it before, delinquency levels, loss rates remain relatively low in comparison to pre-pandemic levels. We told you we were expecting Card loss rate for this year to be 1.5%. We still are. But we know that we expected them to be a bit higher than that coming into the year, so normalization has been slower so far this year than we thought. As I think about things -- I should say that you will all have a view. I do not think that there is a fundamental change in how people think about managing or using credit, which means that when I think about normalized performance, I am thinking about reverting back to kind of normal pre-pandemic levels, my view. So, things that we're looking at, obviously, we look at payment rates in Card. And payment rates are still very elevated. They've come off the peak a bit, but they're still very elevated. We look at how many people are making min pays. That's usually a leading indicator, when people start migrating to making min pays, haven't really seen much movement in that space yet. We look every day at delinquency trends. In particular, we look at entry to delinquency, so into that first bucket. If you look at entry to delinquency, we're at about 80% of pre-pandemic levels. We were 50% at the trough, but we're a little over halfway back and continuing to normalize. There, too, by the way, if we project that forward, we see that sort of entry to delinquency normalizing middle of next year. And just knowing how things roll through buckets that means that, if we're right, losses will normalize closer to the first quarter of 2024. So, nothing has changed in the fourth quarter, the continuation of what we saw. I told you what we're expecting to happen in terms of unemployment next year. It will have a minimal impact on losses next year. It will take time for that to roll through, peaking at or above 5% in 2024. So, for 2023, we're still going to be on a normalization path for the full year. Right now, today, with all the caveats around it, we would say Card losses would come in around 2.6%. I say that a little bit more specifically and a little bit more prematurely than when weâd normally give you guidance for next year because that also happens to be what you guys have in your models, and so I think it's a good place to start. So, health warning on it is the following. We've been wrong about the pace of normalization so far. If things normalize more slowly, it will be better. If it normalizes faster, it will be worse. So, there's a plus or minus around that, and we'll have to watch that and see. Where I think a slightly worsening central case for macro variables does have an impact in the near term is on reserve levels. So, obviously, our central case features in our reserve models and methodology. And so, in the fourth quarter, we were already going to be building reserves as we're growing Card loans strongly and growth more broadly. We will be incrementally adding to our reserves, reflecting those slightly updated macro variables. And as we sit here today based upon assumptions of the third quarter, and you all know what goes into modeling CECL outcomes, we would expect for Consumer that our reserve builds would be about $1 billion, plus or minus, and for the Firm about $1.5 billion, plus or minus. So, based on third quarter assumptions, that incorporates both growth and the update to our central case around macro variables. I should just put that in -- I know Jamie made a comment, I think, in third quarter earnings that if we saw unemployment get to 6%, you could be talking about reserve builds of the order of magnitude of $5 billion or $6 billion. So, two things. The first is, this is a small first step. We don't know that that's where things are going to go. That's not our central case expectation. And for reserve levels to get to that level, it's not just the peak that matters, it probably matters a lot, but you need to see things worsen a bit more sharply and there to be a higher level of uncertainty. But the point that he was making, that even if we see unemployment at those levels, even if it happens more quickly than we're expecting, the kind of reserves that we would need to build are, in the context of our capital and our earnings, relatively manageable, is still true. So, this is a modest down payment on whatever the end result will be. Okay. That was a very comprehensive answer. So, thank you. But let me ask you a follow-up in terms of underwriting standards. And I know that you are a very consistent underwriter over the cycle. But are there areas in the Consumer business that you have tightened underwriting standards over the last three or six months in any meaningful way? And are there lending categories where you think it is worse or unattractive at the moment, just given where spreads are relative to your perception of the risk? Right. So, kind of start with a very big picture and the very big picture out there is not a lot tightening yet. Why is that? Because we underwrite through cycles. We know that there are cycles. We incorporate an expectation that there will be stress in how we think about onboarding new relationships. We didn't widen our buy box when we saw the outperformance over the last two years. Back to my point that we think normalized performance would look like pre-pandemic performance, thatâs where we've been underwriting, all those things, we don't want to pull back just on small changes to expectations of the environment. We want to be able to serve our clients through the cycle. So, thatâs all true. Obviously, if you get like super detailed and granular, of course, we are tightening. And I'll just give you a few examples. In Home Lending, we saw home price appreciation nationally above 40% over the last few years. We're expecting it to come off the peak this year, to go down nationally by about 5%. You'll have your own view. Clearly, there were markets that had more significant appreciation that may come off a little more. We're, obviously, looking, therefore, at LTVs in certain of the hottest markets around the country, still pretty marginal, but we are obviously doing that. Auto has seen more normalization a bit faster. Our policy has actually been a little bit faster, still pretty marginal, but in retail indirect used cars, LTVs again being something that we're tightening slightly at. The area where it's honestly tweaking is Card. And I should start by saying we're always tightening and we're always also expanding, we're always trying to swap in goods and swap out bads based upon improved modeling and data and expectations. At the margin of our most marginal new customer acquisition cells, we are paying more attention to low tenure on bureaus, we're paying more attention to thin files, we're also paying more attention to customers who don't have a Chase relationship, super tweaking at the margin of customer acquisition. And so, we'll always be doing that. I think there'll be more tightening ahead of us. But, again, I just think we have to look at a 5% unemployment number as not being a bad outcome, relatively speaking, and certainly not one that we don't contemplate happening over the course of relationships with consumers when we onboard them. Yeah. So, before we talk about strategy, maybe we can just talk about the current quarter just from a update perspective. So, could you -- and I appreciate you're no longer CFO, but flash back to 2017, but maybe you can talk a little bit about whether anything has changed either in terms of guidance on NII. I think you talked a little bit about credit, but I don't know if there's anything else you want to talk about there, but also around the trading environment in terms of Investment Banking, and Equity and Fixed Income trading. In terms of NII and expense for the fourth quarter, I would say things have panned out pretty much in line with the guidance on each, if a little better, right? So, Jeremy gave you guidance for NII for the fourth quarter. You have still your expense guidance. The fourth quarter is coming in line with our expectations, a little better on each. So, I'm not going to do 2023, I'll leave that. You've only got a few weeks to wait for Jeremy. Youâve had the health warning about reprice next year is going to be a prominent feature in terms of whether you should or could annualize the fourth quarter NII. So, you should take that health warning that, I think Jeremy gave in the third quarter, and we would continue to see that's an area you should be somewhat cautious. Oh, right. Letâs start with fees. So, pipeline fees relatively robust. Catalysts to convert haven't materially sort of resolved themselves, so volatility, macro uncertainty, et cetera. The overall wallet, as you know, is down about 60% year-on-year and weâll be down in line, if not a little better than that [indiscernible]. And then in Markets, I think the performance of Markets thus far this quarter is good, good particularly in Fixed Income, specifically in macro. The last three weeks of the quarter are always hard to predict, so I will give you quarter-to-date year-on-year guidance, which is up about 10%. So, quarter-to-date year-on-year up about 10%. Next three weeks, your guess as good as mine, somebody else's guess is better than mine. Okay, total Markets. Got it, okay. So, maybe we can go on and talk a little bit about deposits and deposit betas. Obviously, a critical component to your overall asset sensitivity and something that's getting a lot of focus at this conference. So, maybe you can talk a little bit about deposit flows this quarter, how they've tracked? What you've seen in terms of deposit betas? And, if you can talk across Consumer, Corporate, then that would be helpful. Also, perhaps talk a little about what your expectations are for both deposit flows and betas as we head into next year, with Fed funds up 4% and QT ongoing. So, so far in 2022, I think our deposit levels and deposit betas have generally tracked in line with our expectations. I'm not telling you something you don't know when I say in retail -- and thatâs for mortgages and Consumer, I'm not telling you anything you don't know when I say that in retail, it's not just a function of product level pricing, but very, very importantly, a function of migration as thereâs money in motion, people seeking higher yields. So, the starting point matters a lot in any cycle. The starting point in this cycle is one where there's significant excess liquidity in the system, in bank balance sheet, also one where we're coming off a decade of low rates and near zero rates in many cases. And so that matters a bunch. The second thing that matters, and I think it's specific to us but may not be unique to us, is mix matters. And so, the Business Banking deposit is a bigger part of our deposit base today than it has been in previous cycles. And Business Banking deposits, they behave like operating deposits, they are operating deposits. And so, they have a little bit less price sensitivity. So, just a bit of context. That said, this cycle is already different. Rates are higher. They've moved faster. The expectations are higher, and we do expect that repricing betas will continue to react. We've had a decade of discussions of all factors that feature into repricing higher or lower. Technology, people can move money easier, but they also love the convenience yield of living their life in one app. Liquidity, excess liquidity means competition is lower, but bank level specific liquidity might mean competition is higher, and smaller banks may see that manifest more quickly. Macro factors matter. So, we've had all of those debates. Reprice lags are real. We're experiencing them. The industry is experiencing them. They will continue in 2023. The NII benefit is real, but it is somewhat transitional because we are continuing to exact our model that both migration and reprice will happen. So, when we think about our strategy then, what do we care about? We don't care about protecting outflows at all costs. That's not what matters to us. We want primary bank relationships. We want to both grow them and defend them. We want to compete on value and not price. And we want to capture money in motion. We think we have the right product to do it, right? So, we are seeing migration into CDs. It's just we're seeing it from a pretty small base, so it's having a not particularly big impact on average rates paid yet, but we are seeing it, it will continue. We do think we're competitive on CDs. And then we look at flows. We look at inflows and outflows on a growth basis, every day, every week, every month. We're capturing a healthy share of those into our Wealth Management complex. We've been investing heavily in that. So, we're happy with that. And that's what we look at and we adjust our tactics going forward. We haven't changed our view on deposit flows overall, which is, we continue to see that through the cycle our overall deposits should be flat to slightly down because we are going to see some outflows that we think are natural, that donât meet that set of framework criteria we used, and we continue to add new relationships and we continue to deepen existing ones. And they don't completely offset, but they are an offset. So, our deposit levels are expected to be through the cycle kind of modestly down. They're up year-on-year, but down quarter-on-quarter modestly at the beginning of that and we haven't changed our expectation. Just very briefly, the competitive environment to compete for consumer deposits, has that changed materially over the last three to six months? I mean, it's changing all of the time, right? With rates rising at the level they're at, we're pricing our CDs nationally at 3%. That was not true three months ago. I'm trying to think that -- yeah, that was not true three months ago. We started that, and yes, everything is moving. But I don't think it is irrational. I don't see -- yes, online banks pay more. We know why. Smaller banks have a different pricing methodology. We know the value that we're providing to our customers. Liquidity matters, nothing yet is changing, obviously, and every day, and we look at it every day and we look at it every week, and -- but nothing that I think is super unexpected. Got it. So, let's look on loan demand, and again, maybe you can talk about loan demand. So, if you can talk about loan demand, both in terms of what you've seen so far this quarter, but then again, talk a little bit about how you think that's going to play out over the course of next year? Do you think there'll be more of a bifurcation through Consumer and Corporate loan demand as we head into 2023? Right. So, I'll start with the area of strength for us in Consumer, which is Card and you've seen the industry seeing strong growth in total outstandings. We're not an exception. Obviously, strong spend growing over pandemic levels, all a part of that. We've seen our total outstandings grow and our revolving balances grow about 20% year-on-year. In fact, if you look at revolving balances now, on an absolute basis, theyâre at pre-pandemic levels. So, if that were your benchmark for they're back, then they're back. If you actually look, however, at customers -- like a stable cohort of customers and are they back to pre-pandemic levels, on a per customer basis, they're still down about 13%. Now, they were down 20%, and so they're nearly halfway back. But that will be a tailwind for Card growth in 2023. So, we still have not seen, on a per customer basis, all the re-leveraging, let alone the kind of growth we would have seen had there not been a pandemic. So, I think Card growth looking into 2023 will still be strong overall. It will moderate through the year and I would say double-digit growth for credit card outstandings, but with strong growth in revolve, which is obviously pretty important looking into next year. But the story on secured lending is totally different for reasons that are obvious. Obviously, the macro environment has had an impact, a pretty significant impact to the size of the market this year, itâs about $2.2 trillion for Mortgage, it'll be less than that next year, refi is like pretty much gone. And then, we specifically, as you know and pretty publicly said, are also very actively managing our balance sheet and risk-weighted assets and theyâre having an impact. So, demand on a much, much lower market with rates much higher, is pretty low at or trending to historical lows. Home buyer sentiment is low. So, our average balances in Mortgage should be flattish through 2023. And in Auto, flat to slightly down, because higher rates, itâs rising, and inventories are still a little constrained. But I'll deal with Small Business rather than Corporate more broadly. In Small Business, we talked about cash balances are still elevated. Small businesses are focused on managing expenses. That's what's top of mind, borrowing is not top of mind right now. And so, while there is still reasonably healthy demand for [indiscernible] credit, like all traditional lending and utilization is low, remains low, and we expect it to stay quite low in 2023, which means that our Business Banking loans will be lower year-over-year a bit. So, let's talk about your strategic and investment priorities for the Consumer business over the next few years. And I think at the Investor Day, you said that you're going to invest $7.5 billion in the business this year, and an additional $4 billion in Card marketing. How should we think about the trajectory of that investment spend? How should we think about expense growth more broadly for the Consumer business, given the inflationary environment that we're in? And how should we think about the return on those investments? Okay. So, we showed you what we thought we would spend in investments in 2022 Investor Day. That is still our outlook, maybe a little bit inside of $7.5 billion, but in the context of the law of big numbers, that's still a pretty good number. We showed you what we're spending it on, right? We're spending on things that are very important to the long-term strategic growth and profitability of the franchise. That's how we're spending our money. We are spending about $3 billion -- a little bit less than $3 billion in tech and product. That has stepped up a lot over the last several years, both a combination of an increased investment in modernization. We're seeing some benefit from that already, but that's a part of it. But also in -- as a focus on not just modernization, but on utilities and platforms and products and customer experience and how we deliver product. We are investing more heavily in product and design. And so, we saw bigger changes in that in the years running up to 2022. We do see also hiring. We do still have a healthy backlog of strong business cases. We are still therefore expecting the amount we spend on tech and product to go up, but at a much, much lower rate in 2023. And as I say, we have strong business cases. We want to get this work done. And that's pretty much the story across all of the categories. Branches, the strategy is working. We've added 500 over the last five years, number one retail deposit share, 60 basis points of share year-over-year, record branch customer satisfaction. We're now number one in the top three markets in the U.S. We feel great about the investments we've made. 20% of the network is still young. That's a huge amount of deposit growth opportunity. But we still have more opportunity in these exciting high growth markets like Boston and Philadelphia and D.C., where we are underpenetrated and branch share matters. But we will continue to be expanding in expansion markets, yes optimizing, but net expanding. Marketing, I think I did to death at Investor Day, I hope. All I will say is that we have been acquiring customers strongly this year, and that we're excited about the performance. It's even a little better than we showed you at Investor Day. And so, as we grow that business, we would expect quality growth there. Our investments in Commerce are largely behind us, but itâs still a business that we intend to grow, and Wealth Management too. All of that is to say that we feel great about the investments we're making. They will be higher year-on-year in 2023. They will be higher at a much more moderated pace because weâve caught up on some of the modernization and other things that we wanted to get done, and itâs all in the guidance Jeremy gave you for 2023. So, this is not new news. This is not something that you didn't already have largely in your expectations. And I think it's all a bunch of investments that you would feel great about. And how do you measure the performance? I know that everybody would want us to show the business case, but we measure the performance by are we able to generate industry-leading profitability, returns, market share, market share gains in this year, while we still continue to invest significantly in long-term growth and profitability, so that we can spend in the future. And I think if you look over the last several years and if you look forward, you'll feel good about that too. So, we've got a few minutes left. So, let me ask about the branch strategy as well. I think you gave some interesting numbers on the Investor Day. I think you said the average branch serves 25% more households than in 2017, and another 20% deposit market share is something that Jamie talks about. So, do you think the⦠But do you think the current platform is sufficient to get you to 20%? And are there products or geographies that youâre particularly excited about, when you think about the long-term growth of the business? So, I gave you some thoughts a bit earlier about how we think about the markets we're expanding in. We're expanding in high-growth markets, where we are currently punching below our weight. And so, we will continue to identify our presence in those markets. We are in all lower 48 states, so we have that done. Now, we need to get more share in some of those markets. That's not to say we won't be consolidating or de-densifying elsewhere, that's true. It is definitely true that branch share is strongly correlated to deposit share. And it is also true that in markets where we have more branches, our digital channels performed better, and they performed better across products. So, we are focused on all of investing in our digital channels, investing in products and services. Yes, investing in growth in the network, because it matters not just for the deposit base, but it matters across products. Do we have the network to 20%? So, if you look at our ratio of deposit share versus branch share, it's a little less than 2:1. If you use that as a measure, itâs an indication youâd want 10% market share in branches to deliver 20%. While we definitely have that in some of our more mature markets, we definitely don't in others. So, again, another way of saying, we continue to be committed to densifying in key growth markets. There will be some offsets, but it's a long game over the next several years, we'll continue on that journey. Okay. So, just a final question. Can we just talk about the regulatory landscape, again, briefly in terms of what you're focused on? Obviously, a lot of focus on capital requirements, how those could evolve, but there's also new leadership at the Fed, at the CFPB and the SEC. I mean, what's top of mind when you think about regulation over the next couple of years? Yeah. And I'm not going to be able to give you any particularly new insights. But when we think about our advocacy for regulation, we think customer first, we think system second, we think competition third, and we don't think hostile or adversarial, we think robust and all of those things. And so, you know our view. We've been pretty public about the things that we think could or should be changed. But hope is not a strategy and so we are optimizing the business and the company under the current rules of engagement and you've seen us make significant progress doing that. It feels regrettable that to do it, it has impacts on important parts of the business at the worst moments in time. So, for me, Consumer lending is an area, when you are trying to build capital, you shrink what you can. And Consumer lending is an area we've been very focused on thinking about balance sheet and RWA rotation, which is a shame, but we know we're optimizing to the current rules of engagement. We're supportive of the overall cohesive review of the regulatory framework and really believe that it's an opportunity for there to be many things recalibrated and tested, many moving pieces, not just RWA. And so, I'm hopeful that there is a future to the incremental capital in the system for us. I have no added insight. We have a good relationship with our regulators. It's challenging and robust, as it absolutely should be. Okay. With that, we're out of time. But, Marianne, thank you very much for joining us. And hope to see you again in less than five years.
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EarningCall_1663
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Great. Welcome, everyone. I am Batya Levi with the UBS Telecom Team. Our next speaker is Chris Stansbury, CFO of Lumen. Thank you so much for joining us. Thanks. A lot of changes at Lumen this past year, new management, new capital allocation. I wanted to start off with maybe as we head into the next year, what the strategic focus of the company would be and your main priorities? Sure. Well, we announced a new CEO and she joined about a month ago, Kate Johnson. And Kate and the management team are hard at work on a number of things right now. But I would say the big thing is just clarifying exactly where we are going, particularly in the enterprise space, where I think in a lot of legacy telecom companies, there is technologies and services that linger and they hang around for a while and there is also the places we need to go. So there is a lot of work being done right now to clarify that. And I think that ultimately will drive the decisions we make around things that we will stop doing, things that we need to start doing or get better. And then within that, what do we make, what do we buy? What do we sell? So there is a lot of work going into that. We should have a lot of that baked by the time we provide guidance in February. And then by mid-year next year, I expect we will do an Investor Day and provide even more clarity around that in terms of where we head over the next few years. And you already started to provide more disclosure in terms of your customer mix, your product mix, what the focus is and thatâs providing more visibility to the investment community. How should we think about like some of the areas that you would like us to track and to show that there is improvement in the underlying trends? Yes. Itâs a really good question, because one of the challenges that I think we have and frankly, a lot of legacy providers have is there is this cash-rich declining business thatâs at the end of its lifecycle. And the fastest way we could get to growth would be for those businesses to go away. And that would be the wrong decision to accelerate that, because there is a lot of cash to be generated in which we can reinvest in our growth portfolio. So I think the key focus for me is to get a growth bucket, which within the enterprise space is the biggest of our, we call it grow, nurture and harvest, really to get that bucket growing faster. And I think if investors can see that happening, then they will see a pathway to total growth. But really getting grow to grow faster is the primary focus. Okay. And in terms of the customer mix, should we expect you to realign some of the customer segmentation as well? So, you will see some changes in how we disclose. So with the sale of the EMEA business, which hopefully we get to by the end of the year, the international segment pretty much goes away. So I think end state will likely be large enterprise, public sector, mid-market and wholesale. So you will see that delineation. But I think from an opportunity standpoint, if you look at where Lumen performs really well today, it is in that public sector, large enterprise space. And I think there is more that we can do there. We can leverage that strength. But the real opportunity is in mid-markets and we are showing signs of improvement, but I think continued investment in our digital interface with customers, the services that we are providing, so that they can do more self-service. Those will be the kinds of things that you will see us continue to focus on. Okay, great. I did want to start with the largest segment enterprise, but itâs a little blur right now, because it has the public sector in it. If you think about just a large enterprise, can you talk a little bit about the trends you are seeing if there is any macro pressure? We had AT&T and Verizon also presenting at the conference. And they do talk about that trends are similar. The enterprises are not making quick decisions. They wouldnât really call out that itâs getting it any worse, but itâs not getting much better either. Where are you? Yes. And I think we would say the same thing. I mean, if you look at the solutions that we are selling, I mean, first of all, they are very complex. So you think about a post-COVID world where there is on-prem, off-prem, the need for efficient network utilization, a security that goes around that, et cetera, et cetera. That complexity is good, right? There is margin in that. But the decision process, this is a question that people are taking a little longer, thatâs the bad news. The good news is they are not descoping things. This is important infrastructure. And when those decisions get made, they stick to them. Itâs just the decision cycles are a little longer. I would say, itâs not a number we disclosed at this time, but Iâd say that backlog and the funnel remains strong. So, itâs not where we are seeing a future problem thatâs starting to manifest now. Itâs continuing to remain strong. Yes, we put some words around that. There was a contract that went away and then a one-time event last year in results that is a -- itâs something that doesnât happen every year. And so when you normalize for that, that thatâs in the ballpark. So again, not terrific, thatâs where we want to see growth and that will be driven by that growth portfolio. But I would say that from a competitive standpoint, we are performing better and we think we can continue to do that and improve from there. Okay. A lot of cost currents in the enterprise side, I guess there is the shift to maybe from legacy products into more hybrid products. Where do you think we are in that shift? I think itâs early. I mean if you -- there are certain aspects you think about communications, obviously, voice is well down that path. But if you think about broader compute environments, I mean the next growth area unquestionably is edge. There is a lot of companies talking about the growth and need for edge compute as you get to more smart solutions, whether thatâs smart retail, smart factory floor, where data latency is a real issue. You canât have that. And so thatâs something that I think is still early innings. And there is a lot of opportunity for growth there and we are well positioned for that with our edge compute infrastructure in place. But I think the shape will continue to evolve and I think thatâs the new world of tech. Itâs not one solution that you sell over and over again to the same customers. If you think about each of the wins that we have had in public sector, which we can publicly talk about in large enterprise we can, but they are similar. Customer by customer, the needs are different. And I think thatâs the key. So depending on how many locations, how many people working in office, how many people working remotely, whether data latency is an issue for a piece or for all of that all of that content, that ultimately drives the solution and thatâs what we excel at. Great. Thatâs definitely a topic post pandemic where enterprises are looking to retune their real estate, how many branch offices they need, the hybrid working environment. Do you say like the read-through for us seems -- oh, thatâs not great for enterprise, right? They donât need as much as connectivity as they needed to. How do you view that change? Yes. Iâd say itâs the opposite, because, again, complexity means margin. And so if you think about the business that we are in, if you -- the United States Postal Service, for example, they have got multiple locations. And there is a need for on-prem compute, but there is also a big need for remote connectivity and security around all of those locations. And you could be selling a VPN for part of the solution in SD-WAN and another part of the solution. But making all that work in a very orchestrated manner is not easy. And so I just think itâs different. And I think that difference drives complexity, which ultimately is a good thing. Okay. How do you view the -- maybe the competitive environment in large enterprise, because there are the legacy providers, which have been mostly the connectivity providers. But now you are competing more and more with the tech companies on more complicated solutions. How do you see your ability to compete with some of those? Thatâs really where the future is. If you strip it all back, the underlying nature of connectivity, I think ultimately is being commoditized and we see that. And so doing more of the same thing isnât going to be enough. We are going to have to continue to expand that service layer, frankly, in the space that we either own today or should own. So itâs not about going far afield, but there is a lot of connectivity as it relates to security or edge compute as an example, and I mentioned earlier, that needs the network and vice-versa. And thatâs the space we should own. And I think thatâs where youâre going to continue to see us focus. So we will be providing more clarity on that as we get into the new year with Kateâs vision and focus. But I think itâs safe to say what you are going to hear from Lumen is itâs going to be a very customer-focused, a company thatâs focused on customer problems. And ultimately, those problems are solved on the backbone of connectivity and what is a very strong network, but really being enabled through services. Right. So -- and I just say you have been making some progress in that in the last few years. But as you go to an enterprise, how do you ensure that they donât think of you as just the connectivity pipe and you can participate in that layer of applications? Thatâs a great question. I think when you think about the success we have had in public sector, which is very visible. I think itâs because weâve got a dedicated team of people that are focused on public sector and understand that customerâs problem set. That kind of focus is what we are going to have to have as we look at different verticals and we come to market with solutions. So I think youâll continue to see us to ramp those kind of capabilities. I think youâll see us do everything we can to shift resources within Lumen to focus more on that selling effort and educating our sales force to sell to those specific customer problems as we go forward. So I think we are well set up to do that. But to your point on the ultimate ability to deliver a solution, it also depends on product. And I think part of what we are working on right now and what will come as we get into the new year is, how do we solve that? Are there things that exist inside of the company today that we can invest more in? Are there things that we feel we should be doing that we either have to make or buy. And I am sure partner network will be part of that conversation as well. So thatâs really where Kate Excel to Microsoft and thatâs the work thatâs going on right now inside of Lumen. And do you think that, that could be sort of the main priority and start with that from the get-go, or is it going to need some investments, some planning before you can really move into that? I would say itâs both. I mean there are certain things that we can do right away and we are doing where we have capabilities, and we know that those are winning capabilities that weâll continue to expand. But there will be other things that we have to sort through. That said, I donât think we are going to be slow about how we approach that. We are going to be quick. We are going to test things and we are going to move from there. So this is about, I would say, a cultural shift inside Lumen. Itâs very non-telecom, I would say, in terms of the way weâre thinking about it. Itâs definitely with more of a tech angle and being aggressive and making sure that we know we can scale businesses as we invest in those. Got it. Can we talk a little bit about the pricing environment in enterprise? Itâs very difficult to gauge the trends because there isnât a lot of KPIs that we can track. This is more kind of like talking to CIOs out there. But the thought is that legacy networks always come down. There is double-digit pricing pressure almost every year. UBS would tell us that our telecom build is never going up, so is going down. Whatâs your -- and how -- like maybe different product sets that you look at, what are some of the pricing dynamics? Sure. So again, back to the disclosures weâve done around grow, nurture Harvest. And just to ground everyone, Iâll give you examples in each of those. So if you think about Harvest, I think legacy voice, think about nurture, VPN and Ethernet. And if you think about grow, think, IP waves, edge compute, SD-WAN, those kinds of things. If you just run the businesses for the sake of connectivity, youâre going to experience the commoditization of those businesses. And thatâs not attractive. Now in the case of legacy voice, there is a real pricing opportunity in many cases that I donât think weâve been as aggressive about as we could be. And you saw some of that start to correct itself in Q3, where our declines in Harvest revenue were improved versus previous quarters. And some of that was because of rerate activity. So visibility as you get to end of life and there is less price elasticity to do some of that. But the way to deal with the commoditization as things move from grow where there is less pressure into that nurture bucket is really around the service layer that I talked about. I think itâs a fact of life. I donât think itâs -- weâre certainly not here to say, yes, we can send the tides and everything is going to be fine. It really comes with bringing customers the solutions that they need to their problems, and thatâs where the margin is. When you look at those three buckets, are you also aligning the resources for them separately? Or is it sort of one account that actually provides all three buckets of services to the same enterprise. Itâs very much a change in focus. So I would say -- and this is before the activities that have really begun since Kate arrived. But when I came to Lumen, there was so much pressure understandably to grow that product managers individually were feeling the need to grow. So you may have had a product that was number four or five in its category, and those product managers were fighting for CapEx marketing dollars, all the things that they felt they needed to drive growth. And when we came up with the lifecycle approach and got things in the right bucket, it dramatically changed that behavior. So we do have, for example, in the case of harvest when we broke that out, a dedicated leader who has been decades in the business knows it well. And his focus is really twofold. Itâs on making sure that weâre priced appropriately and itâs making sure that we are managing cost aggressively so that we can maximize the remaining NPV associated with those products before they eventually expire. So itâs been a big shift for the company, and itâs definitely benefiting us today. Got it. In terms of -- we talked a little bit about the competitors, which are not just your typical legacy network providers now more tech. How do you view wireless getting into enterprise as a competitor? I think wireless has a role to play, and thatâs not to be questioned. That said, itâs not a replacement for what we do. Jeff Storey used to say, and it was a great line, as Iâll quote on it, which is data needs to find its way to fiber as fast it can. And so you think about what underlies all the 5G networks today, itâs fiber, right, in the ground. So wireless can be part of a solution. It may be part of a non-campus last few hundred feet piece of the solution. And we have relationships -- obviously, we talk about relationship with T-Mobile, where we can enable that. But itâs really not replacing the core of what we do at all. And I donât see that as a threat going forward. You wouldnât completely replace it, but is it eating away at the edges of the growth of the branch that you could have? Not really. Because again, if you think about that campus environment that I just talked about, itâs fiber connecting the campus to the rest of the network. And again, the security and the services and whether itâs VPN or SD-WAN or whatnot, if there is execute around that, thatâs where weâre focused. So that a little bit of 5G at the end, not as much of an impact. Got it. Again, maybe just to go over it. Now that LatAm is sold and EMEA is pending, there is very little left. And I think whatâs left is really the domestic enterprise customers having that international connectivity needs. So as you put it all under enterprise, should we think about any changes on how you would manage the international connectivity needs? Yes. Not really. I mean, frankly, some of the historical ways that we divided things up didnât make sense to me. Itâs one of the things that I passed when I arrived because I was trying to understand that business. And so if you think about the global accounts that are in that IGAM bucket, they are really large enterprise customers that have international operations. And our decisions on not being in the LatAm market, not being in EMEA are less about capabilities that we can sell to our customers. And itâs more about focus. And quite frankly, making sure that those markets could get to scale so that those networks are as good as they can be. So said another way, if you think about LatAm and you think about EMEA, in the new world, they are going to be at a different level of scale than they were with Lumen, theyâll get more investment. Theyâll make the right choices to ultimately strengthen that offering to customers. We can sell those assets to our customers. They can sell our assets to their customers. And itâs just, I think, the way of the world. There is no one global network. So it doesnât really change the motion itâs probably, again, back to complexity, thatâs our friend. It makes it more complicated for customers because they are now in that example, dealing with three different entities. To the extent that we can make that easy for them and solve that problem for them, there is value in that. And thatâs really what our focus will be. Got it. So public sector, weâre going to get some underlying trends in there, but press releases would suggest that youâre taking share. And some of it is maybe extending your own contracts and getting new business in with the existing players but also taking share from, I think, the incumbents. How should we think about when that will start to show up in the numbers. And -- is this a segment -- I guess there is a little bit of uncertainty in terms of decision-making. But how should we think about trends going forward there? Yes. Again, we play very well there. Weâve got a dedicated team. they are very focused on public sector needs, and I think thatâs why weâre winning. And even though weâre dealing with government, weâre actually getting a lot of requests for these complex solutions that are cutting edge, where they are looking for edge compute and SD-WAN, but dealing with multiple locations. So itâs interesting because the DoD doesnât make a decision based on price. Itâs got to be bulletproof. Itâs got to be secure. Itâs got to have redundancy. And our ability to bring that solution to them is why weâre winning. How quickly it gets turned on is the challenge. And there is a lot of push from Kate, from myself on the ops team to get that done as quickly as possible. What I can say is that there is another government contract we announced earlier in the year. I wonât pick on which one it is. Weâre where our ability to execute and get things turned on quickly has actually benefited us, and weâre actually getting more as a result of that. So the answer is you will start to see it show up as we move forward in the next few quarters. But itâs still, in many of these cases going to take 12 to 24 months to do the full conversion just given the numbers of locations. I think itâs really two, if we were to keep it at a high level. One is our ability to bring the right solution to their problems, that deals with this complexity, multiple locations, on-rem/off-prem security compute. And the other is our ability to operationally manage that transition very effectively. And do you think the incumbents who are losing it, is it because they cannot offer these? Or is it pay attention? Or they... I think itâs really get underneath it. They donât have the capabilities that we have today. I think many will argue they do, but we do have a differentiated portfolio. And I donât -- our competitors donât break out products into the same life cycle products we do. But I feel pretty strongly that our growth portfolio is probably the strongest growth portfolio of our major competition, so... Okay. May markets, I think -- it had been under pressure, but weâre starting to see a little bit of stability. Can you talk about maybe how competitive environment is there? And how can you continue to improve trends? Yes. Thatâs a real opportunity for us. Again, as I said, we play well in kind of large enterprise, public sector. The gap for us is we tend to be -- and this is part of the cultural change that weâre driving. The gap is that weâre very engineering and product focused. And I think for the most part, that has boded well for us in places like public sector, where they are very well engineered solutions to complex problems. If you try to transition that same solution to the same problem in mid-market, you end up with a big miss because the actual customer problem, if you really get underneath it is different. And so we have done some good work around bringing product to market that is more of a digital enablement approach for the mid-market customer, but there is a lot more work to do there. So there is I think tremendous upside. I think we can also use partners selling networks to help us sell that better. So the bad news is weâre not starting in a great place. The good news is, to your point, it has stabilized somewhat, and I think there is a lot of upside there. Itâs a good question. There is certainly more competitive players, but again, itâs an interesting dynamic because you almost get a little bit of the Amazon effect when people are self-selecting and they are pointing, clicking and buying. Itâs -- there is a level of pricing that youâve got to stay within, but itâs also ease of use. And if youâre solving my problem and youâre making it easier to -- for me to do business with you, then thatâs a good thing. Okay. Letâs go to our Quantum Fiber business. So I guess this year you had a lot of different things that you were juggling and the build was a little bit slower than expected. Letâs go over why that was the case? So there is full transparency. There is the external factors with tough labor markets and permitting, but there is also some internal stuff as well. And when I came in I wanted to make sure that the investments that we were making were in the right markets. We obviously, when we go into a market, we want to cover it well, but we want to make sure that long-term, we are going to earn a return on that. And so we hit pause to double down. I wanted to make sure that there was financial rigor around that. And as a result, we did make some adjustments in terms of what to do and what not to do. And so that slowed us somewhat. I would say the good news is, I think it put us on a better path as we go forward. The bad news is it slows us down. From here, I think it will take us probably two quarters, three quarters to get to scale. And scale is really, really important in this build because when you have scale, itâs easier to navigate permitting delays because if I have a commitment for labor and I am slow to get a permit in one market, I can shift that labor to a different market. If I am not at scale, I donât have another market to shift that labor too, which makes it tougher for me to make a labor commit upfront. So, thatâs really where we are right now is building that scale. And that scale is also important for us to do I think, effective marketing. So, one of the things that is very encouraging about the Quantum product is very strong NPI scores from customers. And we havenât done a lot of marketing. So, as -- and we are getting very good penetration. So, as we go forward and the scale comes in our ability to invest in marketing growth, I think you will continue to see improvement there. So, there are a lot of different parties building fiber right now. And some of your peers suggest that the heavy lifting has been done in terms of the planning period. They know exactly which markets they are going to go and maybe labor has been secured. Most of the equipment has been secured. Where are you in terms of in that stage? When the plan starts, do you know -- like do you have sort of -- will you share with -- this is the plan, this is the pacing and this is how many homes we are going to reach. Yes. We will give more color around that as we go forward. I would say that the planning -- again, we had a bit of a shift because I hit pause for a few months, but we now know exactly where we are going and what we are doing, and how we are going to go about that. So, we will give more color as we go forward. But I think there is no more debate as to what are the right areas to focus on. Itâs now going and executing. And the majority of the 12 million or so locations will get the fiber build over the next few years. Is thatâ¦? Right. And just given the macro backdrop right now, are you seeing higher costs or some delays that maybe you hadnât really seen a year ago? There is no question costs are a little bit higher, but itâs interesting because when you really look at the sensitivity in terms of the economic return. There is three important variables as we all know, right. Itâs the cost to enable. Itâs the penetration rate and itâs the ARPU. And the only thing you know day one is the cost to enable, right. Our penetration target is 40%. We have disclosed that the 2020 vintage at 18 months was a 27%. And itâs now over 30%. We will give more color on that when we close the year. So, I feel very good about our ability to get to the penetration rate, again, with no marketing dollars really to speak of, a lot of door hanger kind of activity behind that. So, our ability to, I think get to and potentially exceed that penetration rate, there is probably more tailwinds than headwinds. And then ultimately, the ARPU can come into play once we get a little further down the path as well. So, economically, when we look at the sensitivity, the slightly higher costs that we are paying right now are really inconsequential in terms of the returns over the life of the project. And as you start building, will the approach be cherry-picking where it makes more economic sense or focusing on the cluster. So, as you build, you can open up for marketing and move that... Itâs really clustered. I mean we did have a micro-targeting approach. Initially, we have talked about that, but it is dense urban markets and we want to cluster the market. And ultimately, that gives us the ability to drive scale in operations and in marketing. Okay. And the cost to connect, I guess some of the industry figures we hear is like about $1,000 to pass a home. Is your footprint -- I am sure if thatâs an average of a wide range. But is that in the ballpark as you canâ¦? Thatâs in the ballpark. Yes. And again, there is a huge variation to that. We are depending on whether itâs off of a pole or a subterranean. And obviously, when you go subterranean and you are in tougher environments, then it comes down to the density of those markets and everything else. The economics can work well above $1,000, depending on what the density is, the penetration rate looks like, et cetera. We did -- we pulled some data last night which is interesting and about 65% to 70% of whatâs getting turned on by consumers today is gig product. So, they tend to be leaning more towards the larger product versus the smaller product, which is very good. Right. And how do you manage the DSL base as you start to deploy the fiber? Is it -- like would you like to put them in sort of like a nurture bucket so that you can upgrade them when the fiber is ready? Well, I will give you a good news and a bad news story. The bad news is that our -- I think about our copper penetration, itâs at about 10% today, but thatâs also the good news because we are not really cannibalizing ourselves. There is very little loss there. So, itâs -- I would say the real issue is that there hadnât been investment in this space for so many years that cable took it on to flash out of Lumen and others. And so now itâs our opportunity to go take share back. So, itâs really a share opportunity for us. Got it. And today, you made some announcements that you are going to double the intercity fiber miles to 12 million. Frankly, I was surprised because I thought you dominated that already. So, where is that new investment coming from? No, itâs interesting because I know there is noise out there, and we have heard others saying we have a 90% share. We donât believe we are anywhere close to that. If thatâs what they believe we can be at, then I feel great. But I think we are probably closer to a third today of that market. But the real point is that we have made significant investments over the last few years, where over 24,000 route miles, we have actually put in about 6 million fiber miles. Thatâs about 250 fiber miles per route mile, I think if you do the math. And the cable that we are replacing is 10-years-old. So, we have done everything we can to future-proof the underlying network today. And we will continue that going forward. Thatâs all been part of our CapEx budgeting and will be. There is no real incremental to go do the remaining 6 million miles. But itâs the most efficient fiber network that exists in the country. And thatâs what enterprise is looking for. They donât want hold fiber that needs multiple powering stations and everything else. They want the reliability that current gen fiber brings, and thatâs what we put in the ground. Okay. So, you started to give a little bit of a glimpse of the â23 outlook and CapEx was in there to $3 billion to $3.2 billion. Can we talk about what that includes? Maybe if you can break it into buckets. I believe this initiative was already contemplated in that. Yes. It was. So -- and again, we tried to give some color. There are so many changes in the underlying algorithm because of the divestitures that we want to bring as much clarity as possible. And again, we will firm those numbers up when we give guidance. But the $3 billion to $3.2 billion is about what we said for this year. But this year, about 10% of that number included LatAm and the 20 state ILAC sales. So, in effect, itâs freed up about 10% of the capacity for us to invest in further digitization and whatnot. But big picture, if we say $1,000 per enablement, maybe a little higher you are going to get to the math thatâs roughly $1 billion for Quantum. We have said that there is a $0.5 billion for maintenance. And then the rest is really enterprise focused. And a lot of that is what we call success-based. So, itâs a lot harder to determine where that goes at the beginning of the year because you donât know if you are going to win the contract with DoD, when thatâs going to take -- get signed, when the work is going to start, and there is CapEx associated with that. So, I would like to say that there was a fine art to forecasting that, but itâs a tough thing to forecast. So, as you approach new investment decisions, there is two growth buckets, one enterprise, one fiber, how do you decide to allocate CapEx? Is this the budget that you work on, or if you see growth opportunity, you can put more...? I would love to have the problem. I frankly told the Quantum Fiber team that I would love for them to give me the headache that they could double the amount of Quantum they could get in the ground, so we could get to the end of this journey faster because thatâs a problem thatâs solvable, right. We can talk about it. We can talk about how we pay for it, and we go from there. So, right now, itâs not about having to make tough choices between growing here or growing there. We do have capacity, obviously, with the decision that we made around the dividend. And so right now, the number one focus is growth. Letâs make sure we are investing in smart areas and doing the right thing, like the hitting pause on Quantum to make sure that we were building the right markets. But then from there we go. So, the real focus today is making sure that we understand where the gaps are, where we need to invest and then building that into our guidance for next year. So, thatâs what we are working on. Okay. So, as we go through the asset sales, you gave a little bit of puts and takes in terms of how we should think about cash flow going forward. We have been kind of like waiting for that stability for some time. And I think sort of like the pieces are in place to get into that motion. But can you high level talk about sort of like how should we think about when Lumen could start to see some stability and growth? Yes. Again, I want to be careful not to give guidance, but I would say very big picture. I think the big decisions on divestitures are largely behind us. I think there could be some product choices that we make. And I am not even sure that we would sell those businesses versus just take a different approach to managing them where we are harvesting cash from those as we go forward. So, that has to be determined. But I think the big structural changes with the proposed announcement for EMEA are pretty much sums up. There are a few other little things out there, but the big stuff, I think is behind us at that point. Okay. And maybe just to go over a couple of minutes left, your priorities for capital allocation in the near-term, like in the mid-term, letâs call it, and longer term, your starting point leverage is 3.7, 3.8. When do you think that you would like to start to see that going to your target level? And part of that is going to be also coming from some growth potentially, just like overall how you think about it? Yes, lots of moving pieces. I would say the number one priority unquestionably, I donât want to make that as clear as I can, is growth. And so the first dollar of capital available to us will be focused on growth. Once thatâs been satisfied, we have got to manage leverage and the buyback opportunity really in a dynamic way because leverage is important. We donât want to risk debt ratings because that ultimately has a negative impact on equity holders as well. So, four is the limit. We donât want to go above four. And so you will see us manage that in a very dynamic way where is the stock, whatâs the opportunity, where is leverage and making sure that we do that in a very balanced harmonic way.
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EarningCall_1664
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Good morning, and welcome to our third quarter earnings conference call. On the call today are Signetâs CEO, Gina Drosos; and Chief Financial and Strategy Officer, Joan Hilson. During todayâs presentation, we will make certain forward-looking statements. Any statements that are not historical facts are subject to a number of risks and uncertainties, and actual results may differ materially. We urge you to read the risk factors, cautionary language and other disclosure in our annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. Except as required by law, we undertake no obligation to revise or publicly update forward-looking statements in light of new information or future events. During the call, we will discuss certain non-GAAP financial measures. For further discussion of the non-GAAP financial measures as well as reconciliations of the non-GAAP measures to the most directly comparable GAAP measures, investors should review the news release we posted on our website at www.signetjewelers.com/investors. Thank you, Vinny, and thanks to all of you for joining us today. I want to begin by thanking the entire Signet team for a standout quarter in a challenging retail environment. Their passion for rising to every challenge and opportunity is inspiring. Iâm particularly pleased that our Signet team was recognized this quarter by Fortune as one of the top 20 best workplaces in retail. This is a great reflection of the purpose, pride, and excellence, our team members bring to our customers every day. Iâm proud to lead this exceptional team. Thereâs one core message that I want you to take away from todayâs call. Signet is uniquely positioned to deliver consistent market share growth and value creation. Given our number one and growing leadership position in jewelry, an industry that tends to grow steadily from year to year and is more resilient to economic cycles than other parts of retail. Weâve established our strong position in this attractive industry over the past five years by making significant strategic pivots that are now creating a virtuous flywheel effect with compounding advantages that are accelerating positive momentum and grow. First, weâve created a differentiated portfolio of banners that appeals to a broad, diverse and growing mix of customers. Second, weâve established a connected commerce presence that is resetting customer expectations for the experience they want to have when shopping for buying and owning fine jewelry. Third, weâve built a flexible operating model that gives us multiple levers to pull so we can deliver our commitments even when faced with challenging economic or market conditions. And fourth, we are executing a disciplined capital allocation strategy that is delivering meaningful value creation. Itâs focused first on expanding market share growing the top line and consistently delivering double-digit annual operating margin. Since the beginning of our transformation in fiscal 2019, weâve invested nearly $700 million in capital and over $900 million in acquisitions, far beyond any company in the industry. On the strength of these investments, weâve accelerated growth and returned more than $1.3 billion to shareholders through share repurchases and dividends. We saw the benefits of this flywheel effect again in the third quarter. We beat expectations and are now raising full year guidance inclusive of Blue Nile. Revenue was nearly $1.6 billion, up 2.9% versus a year ago and up 33% compared to prepandemic levels. We generated non-GAAP operating income of $58 million, a strong result in a quarter that saw onetime COVID and supply chain induced benefits last year, but consistently lost money prior. In fact, Q3 fiscal â20 suffered operating losses of nearly $30 million. And we delivered non-GAAP operating margin ahead of expectations for the quarter. This improvement was largely driven by the positive impact of services, the health of our inventory and strategic assortment choices, including tiering up, value engineering and balanced pricing. We achieved this despite Blue Nile losses, which we anticipated and more than covered without impacting our core businesses or distracting us from disciplined execution. Now even in a challenging environment, weâre heading into holiday with multiple points of strength. First, weâre well stocked with significant newness and great value at all price points. And most importantly, we are not overstocked like much of retail. In fact, our inventory was down 2% in the quarter, excluding acquisitions, and with clearance at the lowest levels in recent history is healthier than itâs been since our transformation began roughly 5 years ago. Weâve tiered up our assortment and nearly 30% of our assortment is new for holiday. Since Q3 fiscal â20, our inventory is down 17%, excluding acquisitions, with sell-down and clearance penetration down 13 points. In addition to being well stocked, weâre well staffed. A key driver of our staffing strength is retention. At Kay, for example, staff turnover is 17% lower than it was last year. This ensures we have more experienced consultants on the floor, an important factor because consultants with at least 2 years of experience in our stores sell 2x more than consultants whoâve been with us for 6 months or less. And weâre able to optimize labor costs by adjusting staffing plans dynamically in response to changing retail traffic. Using our proprietary store level data, we can flex to optimize coverage by hour when and where we need it, without being under or overstaffed. As a result, our sales per labor hour are up more than 70% versus fiscal â20. Weâre still facing macroeconomic headwinds and consumersâ behaviors can be somewhat volatile, but weâre compared to this. Our flexible operating model is designed to sustain our financial commitments even in the face of these challenges. We are ready for strong holiday execution. Now Iâd like to provide perspective on where weâre headed longer term, and why Signet is so well positioned to deliver consistent market share growth and value creation year-over-year. My confidence in our long-term growth is grounded in both the attractiveness of the jewelry industry itself and in Signetâs strong leadership position within the industry. Jewelry is different from the rest of retail. For example, cyclical industries like apparel, are more sensitive to economic volatility. Carry inventory was a relatively low residual value and sell products that consumers see as more discretionary. Conversely, customers place to higher value on jewelry. They see jewel repurchases as less discretionary because theyâre tied to special occasions and people in their lives, and jewelry retains its value or appreciates over time. In addition, jewelry doesnât go out of style from season to season. This makes jewelry more resilient and as a result, more attractive than many other retail industries. Itâs an industry well designed for sustainable long-term growth. And Signet has an advantageous position in this attractive industry. Jewelry rewards the flywheel effect I described, which is a point of difference for Signet. Inventory is a good example. Over the past 5 years, we have transformed the way we plan, manage and optimize inventory. We operate today with a disciplined, tightly integrated approach. First, we leverage our vendor relationships and purchasing scale to ensure quality and availability while managing cash and protecting margins. Second, we consumer test our assortments with the most advanced AI and data analytics capability in the industry. We believe our proprietary product concept testing capability is improving our new product success rate, enabling us to bring bigger ideas to market with greater confidence in speed. Third, we provide unrivaled inventory depth and transparency to both customers and our jewelry consultants. Customers can work with our virtual and in-store consultants to find, see and purchase individual pieces across our multi-banner ecosystem. And finally, we provide a whole range of flexible fulfillment options, including buy online pick up in store, ship to store, curbside pickup, same-day delivery and now more than 25,000 secure consumer access clients. After launching the program just 2 years ago, customers are opting for a flexible fulfillment option in over 38% of online orders. These capabilities not only benefit our customers but also minimize stranded inventory across our fleet. Taken together, this holistic approach to inventory design, management and delivery is a significant competitive advantage. And it has driven significant inventory productivity gains with our core turns of 1.5x now nearly twice with a world we began our transformation. Iâd like to turn now to progress we have made in the quarter on our four where to play focus areas. Letâs start with winning in big businesses. A good illustration is how we are growing market share and winning in bridal. Itâs the most important segment in fine jewelry, not only because of its high relative value, but also because bridal is the point of market entry for jewelry lifetime value. Itâs the emotional and financial moment when long-term relationships are established between coâples and with their jewelry consultants. 35% of new customers during Q3 made their first purchase of Signet through bridal. And over the past three years, roughly a third of bridal engagement customers have returned for subsequent non-engagement purchases, winning bands, fashion jewelry, statement pieces and gifts. This is a more than 40% higher repurchase rate versus non-bridal customers, and average transaction value of their second purchase has increased, up 23% compared to three years ago. We have also continued to widen our customer funnel with Diamond Direct and Blue Nile, to very strategic acquisitions that focus in bridal and have brought younger more affluent and more diverse customers to our business. The good news is that, overtime bridal is not cyclical. Engagements, weddings and anniversaries happen consistently year in and year out. COVID is presenting what is a first meaningful lift in engagement ring purchases in the past four decades. Calendar year 2021 represented a 40 year peak in engagements, which is being somewhat offset in 2022 and 2023, both expected to be down low double-digits. We anticipated this blip in consumer dynamics and positioned ourselves to increase our share of bridal and lean into fashion and gifting. As engagements return to more normalized levels, we will be especially well-positioned given that maximizing lifetime value is an ongoing priority for us and a playbook that we are running across our entire business. Accelerating services is our second strategic focus area. As we said, we see services as a $1 billion business over time, and weâre continuing to make steady progress toward that goal. The success of our loyalty program, Vault Rewards is a good example. We already have 1 million Vault Rewards members in just the first year of the program. Our program is especially powerful, but if weâre the only jewelry retailer that can offer this type of holistic loyalty approach across multiple banners and versus other specialty retail, we provide high value, given the very nature of what we sell, particularly for the engagement and bridal experience. Jared was the first to roll this out in the first half of fiscal â23, and now has more than 30% of sales coming from its loyalty members. â and sales followed with rollouts during the third quarter and are already seeing more than 25% of sales coming from loyalty members. In addition, loyalty members are spending 40% more per repeat purchase than non-royalty customers on average, and they are making second purchases 25% faster. In repair, we simplified our offerings with bundles that combine typical repair services. This improves both the customer and the employee experience by simplifying the offer and the operation. Earlier this year, bundles represented about 15% of our repair business. Today, 65% of paid repairs are part of a bundle. This is encouraging because bundles drive margin through AUR, which was up 18% versus a year ago. With this success, we have further opportunity for growth. Our research indicates that only 40% of people who shop in malls even know that our banners do repairs. We see upside potential and have doubled our marketing spend on services versus a year ago, which is helping drive growth and customer awareness. Our third, where to play strategy is to expand accessible luxury and value. Accessible luxury continues to grow in importance. This top end of our market now represents approximately 30% of our business up nearly 10 percentage points versus the pre pandemic period. The shift toward higher price products is being driven by a combination of factors, our database ability to attract higher income customers, the appeal of our high value assortment and ability to trade customers up the value chain, and our price architecture. Weâve also added Diamonds Direct and Blue Nile, both of which have a strong presence in accessible luxury contributing to the increase these factors are working. Weâre seeing spending at higher price points in all our categories, engagement, anniversary, and wedding bands and fashion. Overall, North America average transaction value increased 8% compared to last year and is up 27% versus pre pandemic. Weâre equally committed to serve customers at the value end of the market. This is the cohort that is most impacted by economic pressures, and we want to ensure we are providing them with superior value as part of our portfolio strategy. To do this, we continue to innovate within our assortment to cut costs customers donât see or care about, and to provide a breadth of financing options for every budget. Leading in digital is our fourth strategy. We are now delivering a digital data driven connected commerce experience that is unrivaled in jewelry. One of the biggest differences in Signet today versus five years ago is the mix of customers we serve. Weâve added 22.5 million new customers since fiscal â19. As a result, our customer base is significantly stronger today than it was five years ago. Itâs younger, more multicultural, more affluent, more digitally savvy, and more demanding in terms of total customer experience. No other jewelry company is as well positioned as Signet to meet these expectations. In recognition of this shift, we are continuing to enhance our digital capabilities and offerings. We introduce two-way SMS just over a year ago, for example, and it now represents 14% of our digital support contacts year-to-date. In Q3 alone, 23% of all contacts were through our SMS channel. This matters after texting with a jewelry expert. Conversion is more than 15x higher than a typical e-commerce purchase. Interestingly, 60% of these purchases are made online and 40% are made in store. We also know that net promoter scores are typically 15 points higher when a customer shops with one of our virtual consultants. Weâve enabled social selling by equipping our jewelry consultants to curate personalized digital style guides and use them as a way to reach out to customers with client â support driving both digital sales and store traffic. Customers can browse and buy directly from the file guides that connect directly via chat, SMS, or social platforms. We also know that virtual appointments booked online have more than doubled since last year, and sales attributed to virtual JCs have grown 150%. Customers who engage in a virtual appointment convert 12x more than those who donât, and AOV is nearly 3x more. Weâre also adding enhancements specifically focused on mobile conversion because 87% of our website traffic is now coming from mobile devices. We see digital as much more than a standalone e-commerce capability. The power of digital is the ability it gives us to create a seamless connected commerce capability that no one in jewelry can match. The final point I want to underscore is the strength of our financial position, which enables so much of the progress weâre making. Disciplined cost management and our flexible operating model allow us to invest strategically in our core business and in acquisitions to expand market share, maintain appropriate levels of leverage, and return cash to shareholders through repurchases and dividends with a goal of becoming a dividend growth company. So to recap, jewelry is an attractive industry and we are in an advantageous position within this industry. Itâs analogous to being the best house in a great neighborhood, and given our compounding advantages, weâre growing share and investing in growth well ahead of the industry, which positions us for sustainable value creation. As important as our financial health is, itâs only part of our story. As I said at the outset, the most important part of our success and of my confidence in our future is our culture of innovation and agility, powered by rigorous executional discipline. Our team continues to rise to every challenge and to go after every opportunity to serve our customers, grow our business, and lead our industry. We have built many advantages that set us apart in the jewelry industry and in retail. But none is as important as the caliber of our people and the culture in which they are thriving. Thanks, Gina, and good morning, everyone. Our key message is that Signet is uniquely positioned among retailers to deliver consistent returns. Weâre doing this by growing market share, expanding margins and optimizing our balance sheet, all of which lead to long-term value creation. We are committed to delivering double-digit annual operating margin, which weâre able to do with our flexible operating structure even when the top line environment is challenging. Beyond, we are continuing to take advantage of our balance sheet strength to consistently invest in our growth while returning cash to shareholders. Before turning to the quarter, Iâd like to share some additional perspective on our recent acquisition of Blue Nile. This acquisition is a great example of our ability to be agile as market share growth opportunities emerge. Our balance sheet strength and our ability to generate cash enables us to step in at the right time for the right assets at the right price. Weâve now been working with the Blue Nile team for just over 90 days. We see significant opportunities to maximize value by bringing together Blue Nile and James Allen, our 2 digitally native banners. This combination is driving prior synergies that we anticipated at the time of acquisition. We also see top line and margin opportunity by leveraging assortment, price architecture, data analytics and the integration of our merchandising capability. Importantly, Blue Nile enables us to grow our share in bridal with a slightly higher price mix and a demographic that is different and additive to the top of our customer funnel. With all of this in mind, we are reaffirming our full year non-GAAP operating margin of 10.8%. Even with the dilutive impact of Blue Nile, which is offset by a greater line of sight into the efficiencies we see in our core business. Now turning to the quarter. We exceeded the high end of our revenue guidance, excluding Blue Nile, despite a more than $20 million drag on the top line from the sharp decline of the pound and the Canadian dollar. On the bottom line, we exceeded the high end of guidance even with the impact of Blue Nile, which operated at a loss during the quarter. We delivered profitability during a historically challenging quarter and despite a negative high single-digit comp. In the 2 years prior to the pandemic, we had losses in Q3. Weâve reset that trend. Our results are a meaningful shift from pre-pandemic levels and reflects the impact of our always-on marketing, rigorous cost discipline and even earlier preparation for holiday. For the quarter, we delivered total sales of $1.6 billion, up 2.9% year-over-year. On a constant currency basis, we were up 4.2%. Same-store sales were down 7.6%, which was attributable to consumer behavior shifts and macroeconomic pressure. Roughly half of the comp decline was attributable to lower price points, including Banter, which was down roughly 30%. We saw our strongest performance at higher price points. Our average transaction value in North America was up 8% in Q3, which reflects our mix shift to higher price points as we broaden our reach into accessible luxury with more targeted customer acquisitions, tiered on assortment and price architecture. We also raised prices selectively as needed in response to inflationary pressures and weâll be closely with our vendors to ensure we can deliver the best pricing and value in the industry. Our fleet reflects our transitioning to higher price points as well. Sales for the quarter were up 33% compared to Q3 of FY â20 with roughly 450 fewer stores, which translates into a 45% increase in sales per square foot versus the pre-pandemic period. This is a result of a much stronger footprint weâve established over the past few years. We have decreased our exposure to C malls by almost 20 points, and weâve increased the off-mall stores to almost 40% of our fleet. Turning now to services. North America revenue in Q3 increased roughly 8% on a year-over-year basis and nearly 16% versus FY â20. This growth was driven by increased awareness of our services offering and the success of service bundle. As we continue to improve attachments on warranty and repair, we are seeing both meaningful margin contribution and an increase in return visits. Even better services margin is over 20% higher than merchandise margin. Non-GAAP gross margin in Q3 was 35.2% of sales, down 220 basis points on a year-over-year basis. This reflects the expected impact of Diamondâs Direct and Blue Nile, both of which carry a lower relative margin due to the higher bio mix. Merchandise margin in our organic banners improved versus last year. This is a direct result of our disciplined inventory management, flexible fulfillment capabilities and higher-margin services partially offset by the deleverage of store fixed costs. Non-GAAP SG&A in Q3 was roughly $500 million or 31.4% of sales, deleveraged 80 basis points compared to last year but 215 basis points better than Q3 FY â20. This was primarily driven by strategic investments in IT and digital, and our flexible opârating model enabled us to partially minimize the impact of a negative high single-digit comp on labor and other variable costs under our control. Non-GAAP operating income was $58 million or 3.7% of sales. We continue to demonstrate the positive impact of the structural changes in our business. Our Q3 non-GAAP operating margin is more than 600 basis points higher than it was during the third quarter of FY â20, and we had an operating loss of 2.5%. Now letâs turn to the balance sheet. We ended the quarter with approximately $330 million in cash and equivalents on hand. Since the end of Q2, we returned cash to shareholders through December 2, up $52 million in share repurchases or nearly 1 million shares, along with common dividend of $18 million, and we completed the cash purchase of Blue Nile. Further, our leverage ratio on a trailing 12-month basis currently stand at approximately 2x EBITDA, well below our previously stated goal of below 2.75x and down 50% from Q3 of FY â20. Our capital investments are also an important differentiator. As an example, since we began our transformation, we have spent more than $300 million in strategic, digital and technology investments, a significant part of the $700 million of capital that weâve invested in total. We have also invested in standard differentiation through the continued expansion of foundry and the freshness of our fleet. Looking forward, we expect capital investments this year of up to $250 million, down from our previous expectations, reflecting the impact of external supply chain constraints. We continue to buy back shares and have $570 million remaining in our authorization as of December 2. This reflects our belief that Signetâs stock is significantly undervalued. The resilience of the jewelry industry and the disciplined execution of our strategies give us confidence that the market will soon recognize our unique ability in the jewelry industry to generate consistent shareholder returns. Iâll close with our financial guidance for fiscal â23, which reflects current business trends and the inclusion of Blue Nile. Black Friday weekend was encouraging and met our expectations with our biggest Cyber Monday in our history. We are seeing shifts in consumer purchasing talents that indicate many consumers are waiting until later in the season to complete their shopping. We anticipate the strength in our assortment units will persist. Customers will continue to purchase at higher price points, and our holiday readiness will enable us to be there for customers with the product fulfillment options and value they expect. At the same time, we know that economic pressures and concerns will continue to exist. Foreign currency is expected to remain a headwind and our digitally native brands are likely to continue seeing the consumer shift back to store through holiday. Weâre approaching Q4 with a healthy balance of confidence and conservatism. Confidence driven by our overperformance in Q3, the inclusion of Blue Nile, our readiness for holiday and the strength of our operating model, and in an appropriate level of conservatism that reflects consumer and macroeconomic variables beyond our control. Keeping this in mind and reflecting current business trends, we are raising fourth quarter revenue guidance in the range of $2.59 billion to $2.66 billion, partially offset by the expected headwind related to the sharp decline of the British pound and Canadian dollar. We expect non-GAAP operating income guidance for the quarter in the range of $363 million to $404 million. Our guidance does not include a worsening of macroeconomic factors. Compared to last year, Q4 guidance includes merchandise margin expansion, reflecting strength in our assortment architecture and inventory health. In addition, we continue to leverage efficient labor and advertising model, along with the flexibility to support further Q4 promotion. We are raising fiscal â23 diluted EPS guidance to $11.40 to $12 per share, including the Q3 beat and the impact of share repurchases through December 2. Quarter after quarter, I continue to be inspired not only by our teamâs dedication to customers but also by their strong sense of accountability to shareholders. They are both agile and discipline, which shows us time and again in our results that matter of the environment weâre in. I guess I wanted to ask if you provide a little bit more context on how do you get to the fourth quarter sales guidance. Maybe you could break it down, like what does that imply for same-store sales growth and then like roughly the contribution from Blue Nile and Diamonds Direct. And also maybe on the fourth quarter gross margin, I recall last year, there was an impact on an inventory adjustment on the 4Q â21. So I just was wondering if you could provide like what was that impact that we should keep in mind for â as we model the 4Q gross margin? Mauricio, let me give just some big-picture context and then Joan will jump in on some of the more specific details that you just asked about. I think first, letâs start with the Q3 beat. It was broad-based. On the top line, we beat both on the core and on our pure-play banner, inclusive of James Allen and Blue Nile. And what I think is important is that this punctuates that Signet is not a COVID story. Weâre successfully executing on a multiyear turnaround of this company, which also led to outperformance on the bottom line in the sense that our core outperformed sufficiently to more than cover the anticipated Blue Nile losses. On the guidance, weâre â I think, appropriately encouraged by the trends that we saw Black Friday weekend. Our omni traffic was up strong double digits. We saw strong AOV margin in line with expectations, but probably the most encouraging sign with Cyber Monday where we had record visits to our sites, low double digits. And purchases in the strong single digits. So I think customers are beginning to shop. We think this holiday will come in later than usual customers that every income tier are looking for value. And so theyâre waiting a bit later to shop, but itâs encouraging to see so much online traffic because we know that we see that first before we see purchases happening online and in-store because people in the jewelry category tend to browse first before they buy. So I think thatâs the positive side. Obviously, weâre still very mindful of the macroeconomic environment that weâre in, customers, especially in the value tier are the most challenged. And so our expectations are that we continue to drive purchase at higher price points in the accessible luxury tier more so than value. And then to respond to the guidance question, Mauricio, our top line guidance for sales implies a 1 to 2 points change in the comp for our core businesses, and that largely relates to the impact of foreign currency exchange and to Ginaâs point, the impact on the lower price point performance in our business. And then basically, as we think about the gross margin for Q4, remember, we had some inventory charges. So thereâs a few puts and takes. We had inventory charges related to onetime accounting adjustments that were not anniversary-ing this year as well as the positive impact of our services business as well as other benefits that weâre seeing come through are related to our inventory and the cleanliness of our inventory in terms of scrap and other inventory-related charges. So really a good margin story. On top of that, I would say, our merchandise margin mix itself is improving, and itâs really structured around the higher price point assortment, value engineering our products to support our lower value price point customers and really just the overall health of the inventory. The impact of clearance sales is far less negative than it had been in the past. And to Ginaâs point, over the Black Friday weekend, even while promotions were occurring within our business, we had a margin performance that met our expectations. So weâre very pleased with the overall view. Can you provide some further details on Blue Nile, maybe what you're projecting for sales over the next several years. And then also, is it loss-making in the fourth quarter? Was that folded into the 4Q operating income guidance? So with respect to Blue Nile and the guidance, we folded our view of Blue Nile -- we incurred a loss in the third quarter. We folded in its view for our view of that for the fourth quarter, which, in fact, is a slight loss and as well as when we think about Blue Nile, we think of it in a combination of the range. So it's a combination of our digitally native banners. And as we are addressing synergies, we're seeing greater synergies than we had at the funded acquisition. We see opportunity at the top line as we reset assortments, integrating our merchandise capabilities. We see opportunity in margin expansion, merch margin expansion as well as the back off of synergies through SG&A. So all of that thinking is included within our guidance for the year. And as we progress through this year, we'll come back to you on our view for -- in the later years. But we see it all as positive. And then just 1 follow-up, Joan, would you be able to quantify the inventory reserve that you'll be going up against in the fourth quarter this year? We haven't quantified that, Lorraine. It was a reasonably large reserve that we don't need to [anniversary] (ph) this year, all about -- given the health of our business. And I'd just remind you that we're also -- the implied guidance is a negative comp on the top line when you're thinking about this cost leverage. Question and congratulations on a great quarter. I wanted to dig into the commentary you provided about your long-term outlook, talking about engagement in bridal. If Bridal is about 40% of your sales mix, you're expecting some softness post COVID, should we start to look at maybe mid- to high single-digit sales declines related to that segment in 2023 calendar year? Is that the right way to kind of look at that category? Yes. I think what I was trying to provide was some perspective on on the stability actually of bridal over time, it's a very consistent part of the jewelry business. I mean, year in, year out, you have engagements, weddings, anniversaries. And if you look back pre-COVID, it was very, very steady. So about 2% growth of engagements and lettings year in, year out. COVID has caused a bit of a blip in the sense that last year, we saw an uptick in engagements. This current year that we're in, we've seen a downtick in engagement, but it's the peak ever or peak in the last 4 years anyway of weddings. So we shifted, we saw that coming, and we've shifted and we've really been working to own the wedding. So 2 wedding band purchases, bearings for the bridesmaid, wash for the groom, gifts for the mother of the bride, [indiscernible] thing as an offset to slight downtick that we see in engagement. Next year, we expect to see a slight downtick again in engagement, but then it normalizes all actually grows to get back to normal the year after, and we think normalizes ongoing after that. So it's really the first meaningful, I would call it a temporary blip that we've seen in how engagement and weddings have been working. But the great news is that with our consumer insight work, we predicted that and came around that so that we're really working on lifetime value. Our loyalty program and I gave a lot of stats in the call, has been a fantastic addition in that context because we're seeing most people come into the loyalty business through engagement, we're contacting previous engagement customers to bring them into the loyalty program, and then we're working lifetime value with them. So I think the fact is that there will be less engagement next year, Signet would expect to grow share the engagement category and we expect also to grow our fashion and gifting business as we surround the wedding. Okay. So a little bit of offset to maybe some slight tick down in the segment related to just the timing of the impact of COVID. Is that the message I want to take away? Yes. It's really just a demographic fact. But what we do is leverage all the different aspects of our business to understand those and then offset that as we put together our business plans for the year ahead. Look, I understand you're not going to be guiding here, but maybe can you just give us some color on the puts and takes of gross margin, operating margin into next year, how to think about Blue Nile and Diamond Direct, how their impact on the business from a gross margin and an operating margin perspective. . So Blue Nile carries a profile similar to Diamonds Direct and James Allen because it's largely -- it's predominantly in the bridal business, which carries a relatively lower margin well. So as you think about Blue Nile and it's merchandise content, that will affect its merchandise margin rate. When we think about integrating that with James Allen, we believe that we can continue to expand the operating margin as we influence the assortment architecture of Blue Nile. So the other point that I really make is that as we continue to grow our services business, which can attach to all of our businesses, all of our banners, that also carries a higher gross margin profile. I mentioned in my prepared remarks that it's 20% higher than other merchandise margin categories. So that's a positive. The other -- we have sourcing opportunities that we continue to explore. And while we give us room to be positioned to be flexible with our promotional strategy into Q4 and as well as into next year. So that's really the gross margin story. As we think about Blue Nile go forward, we've said in the past that it would be accretive as early as Q3 of next year. And as we look at it, we're really viewing the combined banner with James Allen. So if you look in our 10-Q, you'll see digitally native banners. What we're really presenting to you is that this is a combined entity that really drives 2 commercial banners that play off of each other, attracting different customers with Blue Nile being slightly higher and slightly younger and more affluent, which really opens up the top of the funnel, but brings with a different margin profile. So overall, really positive about Blue Nile, its impact on our business, our ability to manage its performance within the guidance that we've provided for this year. And as I said earlier, we will come back to you on our fourth quarter call with respect to looking into next year. Two questions. One, I think you mentioned encouraging results of a Black Friday weekend met expectations. But you also said that you were seeing signs that the consumer was waiting for later in the season to complete their shopping. So just kind of curious how to square those 2 things. And then curious if you could talk a little bit more about transactions versus ticket and in which categories you're seeing higher AURs versus where you might be seeing some pressure. Sure. So I'll take the Black Friday and later in the season. So both of those things are true. We saw encouraging results over Black Friday. As I mentioned, we saw omni traffic up double digits. So a lot of people in stores, but a lot of people online and we saw our online revenue up mid-single digits. So that was great that we see people buying at the time, but a lot of people we see browsing. And they'll be waiting, we think, until later in the season, making sure they get the very best value that they can. We're well positioned for that. We're positioned with, I think, very strong merchandise offers, great newness, non-comps in digital experience, marketing, all of those things to drive closure of those customers. And as we think about the sales equation, Paul, our conversions were relatively flattish. We mentioned we have a higher average transaction value but at a lower traffic, our transactions were down. Those are all the questions we have time for today. So I'll now turn the call back to management for any concluding remarks. Well, thanks, everyone. The point that I want to ensure that Joan and I have made this morning is that Signet is uniquely positioned to deliver consistent market share growth and value creation given our strong and growing leadership in jewelry, an attractive industry that tends to grow steadily from year-to-year and is more resilient to economic cycles than other retail industries. We've established our leadership position by strategically creating a virtual flywheel effect that is building positive momentum and growth that no other company in our industry is achieving. We're raising the year integrating Blue Nile ahead of plan, continuing to deliver annual double-digit operating margin and maintaining the flexibility that comes with a strong, healthy balance sheet. We are ready for holiday and confident we can deliver the long-term growth to which we're committed. Thank you, very much, and happy holidays.
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EarningCall_1665
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Hi. Thank. Thank for joining us. My name [technical difficulty] with UBS. Joining us is Josh. Josh needs no introduction [technical difficulty] CEO of Etsy. [Technical Difficulty] Jessica, Investor relations, has a message. This is question that you would be getting at any meeting is, you talked about October being strong. What the rest of the eCommerce space kind of saying, hey, what October was weak versus 3Q trends. Honestly, I don't have a silver bullet answer to that. I will say that what we saw was October was a slight uptick versus our trends in Q3, which we felt good about. Seems like maybe relative to the industry was more of an outlier. I get asked a lot, why have we held on to so much of our pandemic gains? Frankly, a lot more than even we thought we would have. And I -- the answer is we talk to our customers seems pretty simple. People just really like the Etsy experience more than they thought they would. Millions of people came and hopped on Etsy the first time during the pandemic because they had very few other choices and it just was better than they thought. Search works better than they thought. The quality of the products was better than they thought. Items arrive on time. They're priced really attractively. They come with a handwritten note from the seller that connection with the seller. And then when the item actually arrives and unbox it, people are delighted with the product. So, we keep getting better at all the core blocking and tackling the business. I'm sure we'll dive into a lot of that, but honestly I think most of it is Etsy does something different than what everyone else is trying to do. We've got Amazon that's great at what it does. Everyone else is trying to compete with Amazon on their terms. We're going to try to sell you the exact same product that's for sale on Amazon, $0.02 cheaper, or ship it two minutes faster and we wish to the best of luck. That is a hard road to tow. Etsy genuinely offer a different experience that turns out to be relevant quite a lot of the time and is really compelling. And I think people are more and more becoming aware of that. Great. And a follow up to that question is, so, what's -- the rest of the full kind of looking like, you don't talk about in trends, but can you talk about what the competitive environment is? We've heard from other retailers it's extremely promotional, but if you can talk about the competitive environment and what you are doing that is different? Yeah. We know it's a tough environment right now. And especially when we think about what we're lapping from last year, so at this time last year, if you remember, the only thing everyone was talking about was supply chain issues. Everyone had supply chain issues. Almost everyone. Etsy, we said was not having any supply chain issues. Our supply chain is two hands making. And so, we said all through last year that our sellers are shipping absolutely as normal, and we know we got a real tailwind from that. In fact, the Biden administration was talking about us specifically as a proof point that supply chains are okay, because it was hard to find a lot of other examples out there. So, we're lapping that and yet we gave guidance that we thought was pretty robust for the fourth quarter. We entered the quarter of confidence based in part on the October business -- October trends that you're saying, but also just based on all the other core health metrics that we're seeing. In terms of the competitive environment, it is certainly competitive. There's a lot of promotional activity out there. We have been building tools to allow our sellers to put things on sale, and making those tools better for the past few years. And sellers are sort of steadily availing themselves of that. So, I know there's been some reporting about [technical difficulty] on Etsy. I wouldn't say we're doing anything different. We're just giving our sellers tools to run sales through promotions and they are doing so at a sort of steadily greater rate. The amount of discounting tends to be not as big, or not massive on Etsy, 10% or 20% discounts, not as often 40% and 50% discounts. Those discounts are -- the vast majority of them are funded by sellers, not funded by Etsy. Those are decisions our sellers make as part of the story. You're also seeing us lean in with marketing to the fact that items on Etsy are very affordable. That's a word you hadn't heard us use in the past, but it's true. And so, we're running a TV series right now, TV campaign right now that's talking about how Etsy is special and it's made just for you, but it's also affordable. And I think that message is really resonating. That's interesting that we talked about two hands and so the supply chain isn't a big issue. How does the two hands kind of limit your time? How many hands can you have, and how much can they build? I don't know. What we've said in 2017 when I joined Etsy, the big observation that I had is we're really demand constraints. There's far too much for sale on Etsy relative to the amount of demand. In fact, over 50% of search queries have more than 10,000 relevant items. And the big challenge we had was just getting good stuff fast. It's just overwhelming. There's too much good stuff on Etsy. Fast forward, we had 2.2 million sellers, then -- I forget how many items. Now we have over 5 million sellers in the Etsy core marketplace with over 100 million items. And the problem we have continues to be, we are hugely demand constrained. We have way too much stuff for sale relative to the amount of inventory -- amount of demand. I mean, to give you some dimensionality on that, in on April 2nd, 2020, sales on Etsy doubled literally overnight, woke up in the morning to find that sales had more than doubled and obviously no time for sellers to stock up or do anything differently. And sales that week were -- saw no issues, masks -- some sellers got a backlog of mass sales, but other than masks, our sellers shipped completely as normally. So what that would suggest is in April of 2020, we had way more than twice as much available supply relative to the demand. And the supply on Etsy has grown dramatically since then. So, it's not obvious any time in the medium term that supply will be strain on Etsy. So that brings us to the other side. And you talked about demand and not -- there not being enough demand. I mean, I remember earlier in this year when we used to talk to Etsy Bulls, what they used to tell us is, hey, on eBay, people are spending, $450 to $550 per year on average per buyer. On Etsy, you are stagnating at around the $135 level and you were at $100 prior to the pandemic. So what drives that $135 up to $250? How do you get there? Well, first stagnating is an interesting word. You're right. We went from to -- like what a $100 to like $140, $135. And imagine a world where everyone else is locked down. You can't shop offline. And most places online are out of stock or having huge delays. So, in a world where you had very few other options, you saw GMS per active buyer grow by about 35% on Etsy. It would stand to reason that when the whole rest of the world reopens and people have a million other options where they can shop, that number would go down maybe substantially. And in fact, we've seen it be quite sticky. So I'm thrilled by the fact that GMS practiced buyer has retained almost all of its growth in spite of people having a million other options. But there continues to be -- I agree with the premise of your question, which is there's a ton of opportunity for us to continue to grow GMS per active buyer, and it is significantly less than on many other platforms. For example, as you point out, eBay, four times more than us, or five times more than us. So, there's a frequency and [technical difficulty] opportunity. Stating with frequency, we have what we call habitual buyers. They're about 9% of buyers on Etsy, and they represent about 46% of spend, those buyers by an average of 13 times per year, 13 purchase days per year. And most buyers, buy much less than that. Not because we aren't relevant for them, but because they don't think of us. Consideration is the biggest opportunity for Etsy. We have 15 different categories that have at least a million buyers out there. That means there's 15 categories where we can satisfy a million people's needs a year. We can satisfy a lot more people's needs in those categories. They just don't think of us. I mean, obviously, right now, with the holiday season coming, Etsy and holiday gifts is great, but what about Etsy for your Halloween? How many people in here went to Etsy to buy your Halloween? How many people dressed up for Halloween and how many of them bought your costumes on Etsy? I promise you Etsy had better costumes than you would've been cooler at the party had you shopped on Etsy. But my guess is between zero and one of you did. How many of you decorated your Thanksgiving table with Etsy? I promise the table would've been cooler and felt more special if you had. How many of you did your back-to-school shopping on Etsy? I promise your kid would've showed up with a cooler backpack that would've felt more special at a really fair price and on and on and on. Any week we talk about, I can tell you why Etsy's got something for you that's better than your alternatives. You just didn't think of us. So that consideration gap is a huge opportunity. Why are those habitual buyers chopping so differently than everyone else? Mostly we're top of mind. Another issue, another opportunity. What's different about habitual buyers? They know how to get the best out of Etsy quickly. They know the right words to put into our search engine to get to the good stuff fast. They can get in and out. When you talk to buyers that are less savvy about Etsy, oh, there's a thousand to the seller issue. Quite the opposite. Nothing for sale. They say there's a thousand things. And it's overwhelming. So, how do we help them get to the good stuff fast? We're doing a lot to make sure recommendations better there. One fun feature by the way. If you want your Etsy app in the search bar, you'll see a little camera. We just launched this feature where you can take a photo of anything and we'll show you what on Etsy we have that's like that. I really encourage you to try it. Just around your house and in your daily life, you'll be shocked at how many of the things you enjoy in life. There's a version of that for sale on Etsy. That's a great version, and it's to sale at an affordable price. So get you to the good stuff fast, to make it easier for non-expert to do that. And the third piece is trust. Our habitual buyers know that it's going to arrive on time and it's going to be a great product and they're going to have a great experience. Less experienced buyers are skeptical about that. And I get it, you're buying from an unbranded percent and it's unbranded item. We launched Etsy Purchase Protection in the third quarter. We said if it gets lost at now or it's not as described, Etsy will refund up to $250, no questions asked. And we told you that that program is going to cost about $25 million. If you think about Etsy, $13 billion-ish of GMS and that program only costs $25 million. What that tells you is things very rarely go wrong. Our sellers do a great job. And so, it's about helping the new buyers get confidence in that, that we think can drive a lot of freedom. Interesting. You talked about Halloween, you talked about holiday. You've talked about every day in as in the past. And when we look at most of the inventory that is listed on Etsy, it's almost entirely consumer disparate. Now consumer spending has been opened down until now in the US, at least, as it has in maybe Europe. As you get into the next year and maybe the consumer spend kind of breaks down at that point in time, how do you tackle the recession with the platform that is complete consumer discretion? So, in a world where people want to buy a few things, having them buy things that have more meaning at a fair price, we think can really resonate. I think people are becoming a lot more aware of the supply chain they're part of. Friend shoring is something we're suddenly all aware, not all, but many of us are suddenly more aware of where things coming from? What are the values of the company on buying from? What does that say about me, and how do I feel about that? And again and again, in those conversations, Etsy sellers stand out. People would rather support Etsy sellers in those moments. I think the lipstick effect is important. And the time when I can't afford the bigger luxuries, maybe I'll -- I can't afford a small indulgence, and Etsy is great for small indulgences. And you're seeing us now talk about affordability in a way that we had -- we know it matters to buyers. Our sellers do a great job making things that are made just for you, but they also sell them at affordable prices. I think for a long time, we've looked at the benefits of scale, producing things in units of 10,000. But I think we're increasingly seeing that as you produce things in units of 10,000, you've now got to put it on a boat, get it to a port, get it on a train to get it to a warehouse to put it on a van to get it to your doorstep. And actually someone who just makes it and ships it directly to you and make something that means something that works. And by the way, doesn't have three layers of markup between it with six different logistics points along the way. And so actually, you can deliver great value in small scale in a way that means something. And I think that patterns to people. So it's interesting. Etsy is only 15 years old. We haven't been around at scale through a recession to tell you, here's how we perform in recession. We're going to find out together. There are reasons to be concerned about consumer discretionary for sure. But there's a lot of reason actually to be optimistic as well about Etsy and I continue to be optimistic. Great. Before we go to the next one, you can definitely ask your questions, and I will get the pop up on the iPad over here. So, if you have any questions, please do across me. So, you talked a bit about the product cadence in terms of search and recommendations about this picture search that you have. How are you thinking of marketing as you get into 2023? So, we've made a lot of progress on brand awareness, unaided and aided awareness in the US and the U.K. is now much, much higher than it was before. Aided awareness in the US is now around 90%. And if you just walk the street ask your friends and neighbors, where do you shop online, more and more of them are going to say Etsy. And if you ask them, what do you think of Etsy, they're going to say, oh, I love Etsy." But if you ask people where do you go to shop for home furnishing. Where do you go to shop for jewelry? Where do you go to shop for art? Where do you go to shop for gifts? Etsy is not in the top 10 of any of those except gifts. Home furnishings is our largest category by far, billions of dollars of home furnishings sold on Etsy. And yet when you ask people, where do you go to shop for home furnishings, we're not even in the top 10. In fact, by our own internal research, Hobby Lobby came in 10 with 6% of people. I didn't even know Hobby Lobby sold home furnishings, but more people did name Hobby Lobby than Etsy. This is our opportunity. People generically think warm and fuzzy things about Etsy. But in the moment of truth, I need to go by this thing. We are not top of mind. So, attaching Etsy to specific logistics is a big opportunity, and you're seeing us at this TV campaign we're running in Q4, you're starting to see us much more specifically lean into very specific purchase occasions, and that's going to be a theme in 2023 and beyond. Interesting. One of the other things that the media has at least reported in terms of category based buying -- a category based selling for you guys. How are you approaching the category based kind of approach to kind of sell stuff to people? Yeah. It's a great question. So, everything we've done at Etsy to date has been horizontal. It's a one size fits all. So, we just -- we launched a search update that works to make search better everywhere. We launched a UI update that makes the UI better everywhere. Most of our marketing has been about Etsy and Etsy is better sort of generically. We are looking at leaning it more into vertical experiences. So, if we're going to talk about home furnishings in our TV campaigns, which we plan to and really say Etsy is a place you should really think about first, start your sort on Etsy for home furnishings. What's the landing expense look like if you come to the home page and do home furnishings. Right now the taxonomy looks year, frankly. When you're searching for home furnishings, you're used to searching by living room versus kitchen, right, or Mid-century modern versus BoHo. Etsy is not organized that way because it's a lot of machine learning, figuring out what's going to drive the most convergent in moment. So, you'll see us clean up a lot of those experiences and really lean into some more verticalized experiences starting in 2023. How do we really make, for example, home furnishings feel like a more organized and better experience, particularly for newer and less savvy buyers who aren't as good at the sort of Etsy has that are more experienced buyers are going at. It's interesting you talked about Etsy ads, a bit ago, you also talked about knowing the Etsy lingo. It's almost as if you have -- let's say, the analogy would be you have a physical store that is sitting 5 miles outside the downtown area. And so, people that live in that local area know that, that is there and can shop, but people that live in the downtown are not able to do it, because it's too far away. How do you get closer to the consumer? Well, fortunately, we are virtual. So, everyone is just a mouse click away. But maybe in their brains were the store next door for habitual buyers and we're a shop in three states over for people who are less familiar and the pandemic caused everyone to need to travel that three states over. And in doing that, Etsy became much more mainstream. And -- so where before the pandemic -- maybe a few of your friends that maybe have received as a little more crafting shopped on Etsy, you weren't as familiar with it, you weren't sure what to make of it. Now, it's quite common. You're having dinner with some friends and it's just point natural to say, hey, I got this on Etsy, right? So, we're all encountering Etsy, a lot more in our daily life, and we're gaining a lot of trust because more and more people we know and people like us are using Etsy and it's becoming very mainstream. Our opportunity now is to build on that trust and to cement much more concrete and specific purchase occasions by getting back to that. But I do think we seem to have had a lasting benefit around just brand familiarity, brand trusted being more for kind of people like me. I mean, in 1999, friends and I launched Evite and when we launched Evite in 1999, it was really a techy thing to do to get an invitation by email and not everyone had email was this weird techy thing. A few people in the room may be as old as me, and will kind of remember those days. And so Evite was really nail like connector type people. And it took years for that to become a mainstream experience where we take it for granted that we're going to get invited to events through an online me. I feel like the Etsy's prospect chasm in the course of the pandemic. And so now it's become much more familiar and much more trusted. And I think that's working hard to make sure we take full advantage of that in this moment. Great. And then, while we are on the subject of marketing, new buyers, that has remained extremely robust even after you lapped 1Q 2021. Where are the new buyers coming from? And is the cohort of new buyers for 2022 kind of different from the previous cohorts that you've had? Great question. So, we -- there's no question we had a massive pull forward of buyers during the pandemic. There's been a big question of what's that going to mean in terms of our go forward growth rates. I'm delighted to say last quarter we acquired 50% more new buyers than we did during the same quarter pre-pandemic. So somehow, about 5 million people lasted through the whole of the pandemic without ever shopping on Etsy only to wake up last quarter and decide now is the time because of Etsy, right? And so, is still the case that a very, very large number of people in the US and U.K. have number shops on Etsy because when we talk about new buyer, by the way, we mean truly new to Etsy. If you shop at Etsy a decade ago, and you come back and shop on Etsy again today, we don't counter is new. We counter as reactivated to lap. You're lapsed [technical difficulty] Etsy. So, these are truly new to Etsy as far as we know. And -- we're seeing that the cohorts look quite similar to pre-pandemic. There are some -- they're slightly more male and they're slightly less [technical difficulty]. We are penetrating deeper segments of the population than we were before. But Etsy was never particularly awful. So, these are changes on the margins, not massive changes. We have had a very strong female view, and we're realizing now that some of that is probably a self-perpetuating cycle like inside of Etsy, we exclusively use female when talking about our customers, buyers and sellers because historically, they've been over like 85% to 90% women, both sides. But we just haven't thought about male buyers. And we started looking at the data and say, well, we do have millions of mail buyers, and we have great verticications for them. So, now you're starting to see us market in the NFL, and we're seeing that work. And so simply talking -- speaking to different communities has been important for us. As I said -- well, I don't know if I said 30% of women in the US shop that in Etsy in the last 365 days, that means 70% didn't. And if we're good enough to serve 30% of the population, you think we have a lot to offer for the next 70%. 10% of men, only 10% of men in the US shop on it on Etsy in the last 365 days. We have a lot to offer to that other 90%. And that's before we talk about the rest of Western Europe. We've made great progress in the US and the U.K. In the U.K., Etsy is now a top five eCommerce site. We're seeing great strength in Germany. Germany -- our German business is three times bigger than it was pre-pandemic off a smaller base, but three times bigger. We're now a top 10 eCommerce site in Germany, not yet top five. And our growth is quite robust in Germany, especially relative to war on their near border. All of the challenges that the German market is facing, we're quite pleased at how well we're doing there. And so, there's a lot of the world left to address, and we're excited to go after that and invest for that. Interesting you bring up Germany. I mean, Europe has been particularly weak recently, at least as far as retail sales is concerned, and more so in Germany. So, what are the buyers in Germany really buying? The home furnishings is popular in Germany. The category mix in Germany is not that different than the US. We -- starting from a lower base, we have more opportunity to grow there. Germany is a wonderful eCommerce market. Payments works well. The postal service works well. It's a high trust society. And Etsy offers something truly different. And I just think the German consumer base is just now sort of starting to wake up to the fact that you can buy a lot of really great things on Etsy and that's a really good prices. And the affordability thing, we'll come back to again, they are made just for you. They're designed just for your space. You have a relationship with the seller. You're supporting a small business, and hard times you care even more about where your money goes and who you're supporting with that money. I think we're all even more aware of that. And it's at a price you can afford. Interesting. Again, sticking with the marketing team. One of the new things that you've started talking about is demand generation in India. And India, of course, is a big market. Yet in India, you have a plethora of handcraft sellers, practically every other market, every other pavement has sellers that are coming from one village or the other. How do you approach that kind of a market, which already has enough. Yeah. So, first, I'd say that marketplaces, it's been my experience that Western Europe and North America make a common market with a relatively free flow of goods, and we see that lots of cross-border trade that works quite well. That breaks down when you go to South America, when you go to Asia, much less common to see a really good two-way market. So, we began investing in India because what we saw is we do have exporters. We have artists in India who sell things on the Etsy marketplace. And we saw that when people buy things from Indian sellers, the lifetime value of the buyer goes up disproportionately. And in hindsight, maybe not a surprise, India has a wonderful history of craft and artisanship. They make great products. They do it [technical difficulty] and they sell it at a good price. And lots of other people appreciate that. So, we started to invest in bringing Indian sellers onto the marketplace several years ago with an eye towards export. And we've done that with care because you want to know that you're talking about a real seller who makes things in a good way and not factory that got [technical difficulty] practices. We care a lot about that. So, we've had feet on the street or ability to bill it to learn the Indian market and get invested in the Indian market, and we've seen great gains. We did start to hear signs of demand from the Indian market where people in India also appreciate craftsmanship and artisanship and going to your local offline marketplace, more and more people are coming online. And so, in the past year, we've invested in having our payments system support the rupee, now starting to have domestic payments, which is its own lift, as you may be aware of in the Indian market, getting Indian shipping providers on and sort of putting the infrastructure in place to start to allow for domestic trade in India. We want to invest in India for the long run, and that means sustainably invest, not go and spend hundreds of millions of dollars in a year or two and think we're going to suddenly build a huge business. I've seen that fall over under the weight of it. So, how do we invest in a thoughtful plan for and sustainable way for the long-term in that market so we can build the business more organically. And we're excited to do that. We have a wonderful team, by the way, in India, such talented people and I'm really excited to see where that market can go. Great. One of the questions we get from investors, and this is away from marketing and more to numbers is, how high can your take rates go, given you don't do fulfillment? So, how should we think of like take rates maybe in the medium term and then longer term? I think the gating factor on take rates, first, how much value are we offering? We are always thoughtful about the fact that our take rate needs to go hand-in-hand with value delivered to our sellers. We've got to earn it. So, we did a take rate increase in the beginning of this year. And we told our sellers were going to reinvest this back in you and your growth, and we did. We invested in marketing. We invested in better product, better customer support. The result is -- I think that's a meaningful part of why their growth has stayed stable in such a difficult macro environment as we were able to invest more in marketing. We're able to give even better service. Our product investment, we've been able to scale our team. So, they are seeing value from that. And as a result, you've seen our seller metrics stay great sticky. You're seeing a great buyer growth, which is ultimately what our sellers care about. So, tying our pricing to our value is always the bedrock. The other thing we've got to be thoughtful about ultimately is our sellers' gross margin. Are they able to run a business in a way that makes sense for them, where the return on time as well as the return on money is really valuable? And so, we're always thoughtful about that. You'll notice when you look at our take rate that some of it are mandatory fees, but a lot of it are opt-in services, things like Etsy ads that our sellers opt into and that's driven a lot of our take rate expansion in the last few years as these value-added services or sellers opt-in to as fast as GMS has grown and it's grown very fast. Etsy ads has grown even faster. And I continue to think there's a great runway for growth in these value-added services. Yeah. In fact, advertising, that is that -- retail media has been really hot over the past a year and a half, two years. And so how much -- so when you think of like growth in retail media dollars coming in from your sellers, is the opportunity more in terms of like adding more sellers to the base that is advertising? Or is the opportunity more in like increasing the spend per seller? So, on the Etsy ads product, most of the sellers that are established enough on the Etsy marketplace to be advertising have opted into the Etsy ads program. So, adding more sellers is probably not where the gains are going to come. Most of the gains are better algorithm to match the right ads of the right buyer. And that's where a lot of the gains have been, and that's where I think a lot of the gains are going to continue to come from. There's so much science around that. It's very similar to the search problem. We've got 10,000 relevant ads, and we have room to show eight, which are the eight out of these 10,000 and just getting better at personalization, getting better at relevance, all of these things are driving better [technical difficulty] for our sellers, which allows everyone to win. By the way, it's also a better buyer experience. So, better algorithms is a lot of it. There is an opportunity to have our sellers raise their budget. So, on average, we have a lot more budget in Etsy ads than we can spend. But it's not evenly distributed. So, there are some sellers who are giving us $10 a day of budget, and we can only spend one for them. But there are plenty of sellers that are giving us $1 a day of budget, and we could spend 10 at a good [technical difficulty]. So, giving confidence to the sellers who should be raising their budgets, why they should be reaching their budget is a meaningful opportunity for us. Great. And while we are talking numbers, this is a question from the audience. As we lap reopening headwinds, how do we think about normalized top line growth over the medium term? So, we gave long-term or medium term guidance back in 2018. We haven't reiterated that guidance and we're not going to give long-term guidance in this meeting. But I do think we've all been wondering how much of the reopening tailwinds that we've faced will stay. And in this most recent earnings call, we showed that we've now had five months of stability on a year-over-year basis. That gives me increasing confidence that the reopening headwinds maybe we fully experienced those. And it's sort of increasing confidence that maybe this is a new normal. I will remind people, as you think about our growth that, that means that as we move through Q2 of next year, is when we will have put the tough comps from the pandemic in the past. And I'm sick of talking about tough comps, you're sick of hearing about tough comps. And I think we're not that far from a point where we can stop talking about pandemic comps. So that's really encouraging. What's going to happen with the macro, lots of talk of recession and whatnot, who knows? So, we're not planning giving long-term guidance right now. What I would say is that I do believe that we are at the early stages of unpacking the opportunity for Etsy. Most people who should be shopping on Etsy store, are not shopping on Etsy, most people who shop on Etsy, they are not stopping nearly as often as they should be shopping on Etsy. And I think we offer something truly different than what's out there. It's relevant very, very often and it's better very, very often. And we've been saying for a long time, and I think we're starting to finally see it. The world is consolidating around fewer and fewer places to shop. So all the talk of -- everyone's going to have their own website, we're going to have millions of websites out there, millions of eCommerce places, it doesn't make any sense to me that there's going to be 1 million places to buy things online or 100,000 or 10,000 places to buy things online. Why? Because we can't remember that many brands. So, most of them are going to have to go to Google and if you're downstream of Google or Facebook, all the rents go to them, right? The brands that are going to last are the ones that are important enough, often enough, different enough for you to actually remember them and come to them organically. There can only be a handful of those. Amazon almost certainly is going to be one. Maybe there's room for a few Amazon look alike, but there's got to be an alternative to Amazon, right? I'm not saying you're not going to shop on Amazon. You're just going to want not Amazon, a lot of the time. And if we're the first place you speak as the first alternative to Amazon, that is a huge opportunity for Etsy. Interesting. One of the things that came out at least over the last couple of quarters is, when we look at the absolute number of your habitual buyers and the repeat buyers, that number has also been declining. And the thing is, one would expect that these are the guys that can talk Etsy lingo. They understand exactly what to search for and how to search for. Why is that number kind of declining? It ticks down a tiny bit. I mean, not by millions by hundreds of thousands, I don't remember. It's a small amount. I guess, I would say that we're coming through a period where people had very, very few alternatives and had to avail themselves of Etsy because they had very few alternatives. In light of the fact that in a short amount of time, it feels like whole world reopened and something people have every alternative again. The fact that virtually all of those people are staying with us and staying habitual with us. The vast majority of them are, I think, is great cause for optimism. Great. And then one thing, again, that we keep getting questions on is [technical difficulty]. What's happening there? So what is the -- how are you measuring the turnaround there? What is the time line that we can kind of hold you to in terms of maybe be in a better state kind of thing? Yeah. So, just to remind folks, we bought Depop because we think, first, it's the choice for Gen Z in re-commerce. And we think re-commerce is an important space, and we think Gen Z is an incredibly important demographic. Their business model is just like Etsy and that it's very capital light. It's purely peer-to-peer marketplace and we like peer-to-peer marketplace. And a lot of the dynamics managing that market look a lot like Etsy. We took a very significant writedown last quarter. That's not something we take lightly. We love the business. We bought it, I think, at the wrong time, and we paid too higher price. It has experienced much more significant reopening headwinds than we did. The reopening headwinds Depop has faced or much more like most of eCommerce has faced. Etsy has, I think, held its games better than most. That hasn't been as true of Depop. And teenagers who were locked in their apartment bought out of line and when you let them create some of them want to go back to the mall in the near term. That's not that surprising. But over the medium term, we continue to think re-commerce is an important trend. It's going to be much bigger in Gen Z is going to offer a lot of the spend of people. So, we think that's important. So, we continue to really like Depop and really like the space. We put in a new CEO, a new Chief Product Officer and a new Head of Engineering. Those are all folks who are long time Etsy alums who have been core part of the turnaround you've seen at Etsy. And the same kind of product discipline we brought at Etsy around focusing on the fewest things that are going to unlock the most growth, that mentality, that urgency, they're bringing. How do we optimize marketing spend or the return on last marginal dollar with like fanatic discipline, we're bringing that to the marketplace. So, I think, there's a lot of best practices. From Etsy, we've injected some great and senior talent there. And we want to see that business growing and growing faster than Etsy and doing it and sort of the better. Great. One last one. And you -- on the last call, you talked about getting back to growth next year. And yes, you have easy comps, and you are, of course, tired of talking about lapping COVID. So, what gets you optimistic about 2023? So, an easier comp [technical difficulty]. I am optimistic about 2023 in spite of all the macro. When I look at how we've been performing year-to-date, there's lots of reasons to be concerned about how Etsy with discretionary spend, reopening and all the other things. I think our performance year-to-date has been pretty strong. And I look at how we're doing in Germany, where that's a market that's facing a lot of challenges and yet doing quite well there, all things considered. So what brings me to optimism is that I think we genuinely do something different and I think it's something you're going to -- people are going to want more and more. I think people are becoming -- people are more conscious about where they spend, what they buy, what value they're getting for money, what relationships they have in life, all this conversation about friends showing, I think that stuff matters. And I think Etsy is on the right side. By the way, we've always cared a lot about our environmental footprint. And I think that's going to matter more and more. We've always cared about diversity and inclusion in our marketplace, and we've been put up some very public targets and we report a lot on that. I think that's going to matter more and more. So, when I think we're on the right side of a lot of issues with over the medium term, I think, are going to serve us well.
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EarningCall_1666
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Good morning and welcome to Wileyâs Q2 Fiscal 2023 Earnings Call. As a reminder this conference is being recorded. At this time, I would like to introduce Wileyâs Vice President of Investor Relations, Brian Campbell. Please go ahead. Thank you, and hello everyone. With me are Brian Napack, Wileyâs President and CEO; and Christina Van Tassell, Executive Vice President and CFO. A few reminders to start. The call is being recorded and may include forward-looking statements. You shouldnât rely on these statements as actual results may differ materially and are subject to factors discussed in our SEC filings. The company does not undertake any obligations to update or revise forward-looking statements to reflect subsequent events or circumstances. Also, Wiley provides non-GAAP measures as a supplement to evaluate underlying operating profitability and performance trends. These measures do not have standardized meanings prescribed by U.S. GAAP and therefore, may not be comparable to similar measures used by other companies, nor should they be viewed as alternatives to measures under GAAP. Unless otherwise noted, we will refer to non-GAAP metrics on the call, and variances are on a year-over-year basis and will exclude the impact of currency. After the call, a copy of the presentation and a transcript and a playback of the webcast will be available on our Investor Relations web page at investors.wiley.com. Iâll now turn the call over to Brian Napack. Good morning everyone. Thanks for joining us. As I often do I will start by pointing to Wileyâs mission which is to unlock human potential and do so by powering scientific research and career connected education. This is far more than just a statement, it is our purpose, our culture, and our differentiator. Through many cycles and periods of disruption, the Wiley brand has helped us to win and retain customers, authors, and partners. And together with them we have promoted science, growth, and social progress for more than 200 years. The Wiley team accomplished a lot in the second quarter. This is both despite and in response to a challenging economic environment. We have seen a confluence of headwinds, these include decade high inflation, low consumer confidence, a tight job market, rising interest rates, FX volatility, and ongoing geopolitical disruption. These pressures have caused a pullback in consumer spending that is effective about consumer facing and enrollment dependent businesses. And this has impacted our revenue performance for the quarter and our growth expectations for the year. Christina will speak to that later in the call. Despite all this, our core growth engines of research publishing, research solutions, and corporate talent development remains strong and they are performing well. Research has a solid growth trajectory, consistent margins, and a recession tolerant profile. It continues to be supported by ever increasing R&D spending worldwide that drives up publishing volume and the demand for Wiley's research content and solutions. Since 2000, global R&D has more than tripled to $2.4 trillion. This spending growth has persisted through multiple recessions. Corporate talent development is now a major growth driver for Wiley, driven by the success of our unique education services that help corporations to fill their big talent gaps rapidly and reliably. That said, earnings were down this quarter due to revenue challenges in academic and professional learning, along with ongoing investment in our core growth areas, most notably research. To mitigate these revenue challenges, we've accelerated our cost reduction program, including implementing targeted workforce actions, the general hiring freeze, real estate consolidation, and disciplined expense management. Our important work to simplify and optimize Wiley is moving forward steadily. As part of this, we continue to streamline our structure to better align with our customers and their needs and this is helping us to drive greater impact, synergy, and efficiency. You will recall that last quarter we reorganized our research segment into publishing and solutions to great effect. Now we are reorganizing education lines of business into two new customer centric segments to achieve similar goals, namely to align tightly with Wiley's two primary target markets in education, universities and employers. I'll talk about this a bit more later in the presentation. Let's look at our Q2 performance. As always, all variances exclude currency impacts. Wileyâs revenue for the quarter grew 1%, but it was down slightly on an organic basis. Growth and open research, research solutions, corporate talent development, and corporate training offset declines in APL's publishing lines and in university services. Adjusted EBITDA declined by 4%, which is in line with our expectations for the quarter. The decline is attributed to the soft APL revenue performance combined with our planned investments to scale both research publishing and research solutions. Our adjusted EBITDA margin of 24% came in slightly ahead of prior year. Christina will take you through our segment performance in more detail. Adjusted EPS declined 13% due to the adjusted EBITDA performance and to $5 million of additional interest expense compared to prior year, a result of the current rate environment. As you know, we hold ourselves accountable for achieving our commitments. In research, we said we would do four things in fiscal 2023. One, publish more to meet global demand and drive revenue. Two, establish more transformational agreements. Three, scale our research solutions. And four, streamline our workflows to increase both revenue and profitability. I'm pleased to say that we're making good progress on all fronts. And publishing more we grew article submissions this quarter by 6%, although publishing output rose only 1% due to variances in publication timing. Open research continues to be a strong driver of growth for us, with OA article output up by double digits. We continue to make good progress in the market on transformational agreements, recently renewing our landmark countrywide agreement in Germany. This multiyear renewal is significant and that it validates our model and our long-term customer centered approach. The new deal gives research authors in Germany even more publishing options, with an additional 240 journals integrated into the new contract. To date, Wiley has signed over 40 agreements representing over 2000 institutions spanning 23 countries. The deal pipeline remains very strong, particularly in the U.S. and Europe. In the U.S., these important agreements will allow our customers now to comply with the new White House guidance on federally funded research. As a reminder, the U.S. Office of Science and Technology policy or the OSTP, issued guidance in August calling for all new federally funded research to be open and freely available starting in 2026. As you know, this direction is fully aligned with our strategy and supported by our strong momentum in open research. In research solutions, we continue to see strong momentum. We signed 18 new research solutions partners in the quarter, including Project Hope, a renowned global health and humanitarian relief organization. We also executed several product launches, including the Career Center for the American College of Emergency Physicians. As expected, cross sell and upsell opportunities are accelerating within our network of 900 society and corporate partners. We expanded nine partnerships with additional services, including our multifaceted partnership with the AAAS, the world's largest scientific society. We now provide them with editorial services, distribute their journal content through our platform, and manage their important job board, which is appropriately called Science Careers. Wiley now powers the recruitment sites of four of the world's most significant scientific organizations. Two of them are also primary publishing competitors, demonstrating the power of Wiley's ecosystem approach. I recently attended the Frankfurt Book Fair, the most important industry event for the research publishing community. While there, I met with lots of prospective customers and industry stakeholders. Got to say that the buzz around Wiley and our solution strategy is incredible. After the event, one prominent industry pundit summed it up perfectly writing this, âWiley is taking a bold stance with this new division, investing in the collaborative solutions that will help the industry successfully navigate the transformations necessary in open research. It is likely to be a good move for Wiley, helping to extend its customer base, diversify revenue streams, grow revenue through facilitating upselling, and sustain its partnerships across the publishing supply chain. Wiley will enjoy access to volumes of data about publishing and research trends, which could open up new product or business opportunities, as well as greater strategic advantage.â That pretty much says it all. Finally, we continue to drive increasing automation, intelligence, and efficiency across the research publishing process and our investment is paying off. For example, the intelligence systems we are implementing are allowing the proportion of submitted articles kept in the Wiley universe to continue to rise. Year-to-date, 66% of rejected authors were offered another Wiley Journal option, up from 52% the prior year period, and 33% in fiscal 2021. These efforts will pay off with incremental revenue growth and strong margin contribution over time. So Q2 was another solid quarter of execution in research. Now let's turn to our commitments and career connected education. At the beginning of the year, we said we were going to expand our corporate and university client base, drive growth in our differentiated courseware offerings, and gain operating efficiency. On growing the customer base, we're making good progress. Wiley signed another six large corporate clients and talent development during the quarter. These included multinationals in technology, healthcare, financial services, and consumer staples. The client pipeline remained strong and we are seeing double-digit growth in employee placement. Of course, we are monitoring the labor market very closely given the current economic uncertainty, but so far demand for our talent development remains robust across both existing and new clients. It's important to note that there remain over 300,000 open tech jobs in the U.S., even higher than it was before the pandemic. Wiley also continues to be the go-to partner in university services. We signed four new partnerships this quarter: Cal State San Marcos, the University of the Sunshine Coast in Australia, Bay Path University in Massachusetts, and Bernau University in Georgia. Within our existing partner base, we added nine new degree programs for a total of 56 new programs year-to-date. These new programs are underlying drivers of our future growth. So while enrollment remains a cyclical headwind, we continue to see consistent institutional demand for Wiley's value-added services. Let me say a few words about enrollment and its drivers. Despite the softening economy, we're still seeing a very strong labor market. Consequently, many would be students are being drawn directly into jobs instead of preparing for their careers with education. We expect this to unwind as the economy slows, but there is historically a 12 to 18-month lag between the start of a recession and the material uptick in university enrollment. In any case, our focus now of course, is on helping our university partners to compete in this challenging moment while also preparing them to win as the cycle turns back in their favor. Wiley, of course, continues to deliver differentiated courses and courseware for learners. Our STEM-focused courseware called zyBooks saw a growth of 27% this quarter. This is a great example of how we win despite market challenges. We delivered great products in high potential disciplines. During the quarter, we launched our first courseware solution in data science, a rapidly growing career-connected subject. We also won an important adoption with the Virginia Community College and we expanded our institutional relationships with three of the largest online universities in the United States. Finally, on the efficiency front. We're actively reorganizing and rightsizing the APL publishing lines to reflect market realities and improve their profile. Among other things, we are reducing overhead, focusing our development efforts, outsourcing lower value editorial activities, and modernizing our go-to-market approaches. And in talent development, which is in rapid growth phase, we are driving towards meaningful profit contribution by automating and reengineering our processes as we scale the business. So overall in education, we continue to execute on our fiscal 2023 commitments despite the economic and market headwinds. We continue to drive real-world impact at Wiley through our core business activities in research and education while making progress on our commitment to the UN sustainable development goals. We remain focused on three of the UN SDGs, quality education, reducing inequities, and climate action. In Career Connected Education, we are actively expanding access to high-quality education and gainful employment and thus, we are working to reduce inequities. In fact, 60% of our IT placement candidates globally now come from underrepresented population. This is well ahead of our target. And as a leading scientific publisher, we published, for example, over 100 journals related specifically to climate science. Wiley is committed to being carbon net zero by 2040, aligning to the critical climate goal of preventing the global temperature from increasing beyond 1.5 degrees. This critical goal is in line with both the science-based targets initiative and the Paris agreement. In addition, Wiley continues to be recognized for our ESG progress and risk profile, achieving strong scores from Sustainalytics, S&P, ISS and MSCI. Hats off to all of our Wiley colleagues for their dedication to and support for our ongoing impact journey. I'll now pass the call over to Cristina to take you through our segment results, cost measures, and outlook. Thank you, Brian, and hello, everyone. Although we're navigating through a challenging economic environment, our core research remains strong with healthy profit margins in a recession tolerant industry. We remain bullish on our opportunities there to expand and scale our publishing and solutions offerings. In our academic line, we're tackling our cost structure to align with current market realities, which are both cyclical and secular in nature. Talent development continues to grow nicely as we extend into new industry verticals and new regions. We're investing there to grow our client base while driving towards meaningful profit contributions in the future. In research, as Brian noted, we continue to drive strong momentum as we invest to publish more high-quality research and do it more efficiently. We've also set our sights on scaling solutions offerings such as content platforms, OA publishing, and other revenue-generating services to help support the industry transition to open research. The team spent considerable time out in the market in Q2 and the feedback from both current and potential customers is that they're focused on the changing economic and policy landscape and they need help in the OA transition. The recent OSTP guidance only confirms our solution strategy here, and we believe we are well situated to seize that opportunity. Research revenue for the quarter was up 3% or 2% organically. Research publishing revenue rose 2%, driven by continued growth in Open Access with OA article output of 34% over prior year. Research Solutions revenue was up 11%, driven by recent acquisitions and modest organic growth from platform services and career centers. As Brian noted, we continue to make terrific progress in adding new solutions partners, including 18 logos this quarter as well as upselling existing ones. To give you a sense of the upsell opportunity, only around 15% of our current solution partners subscribed to more than one service and roughly only 5% subscribed to more than three. Given the expanding pipeline of publishers, societies and corporations, we recently increased this investment case in the space. A quick note on research integrity. In Q2, we attracted a small number of articles due to an investigation into viewer activity in selected OA journals. We are constantly scrutinizing our publishing process to ensure the quality of our content. Our industry continues to work very closely together to ensure the peer review process, which underpins the knowledge in the industry. Adjusted EBITDA in research declined 4%, primarily due to investments to expand our editorial capabilities to manage increasing publishing volumes and to scale our solutions offerings to meet partner demand. Our adjusted EBITDA margin was 36% for the quarter, on par with prior year. Year-to-date, revenue was up 3% and adjusted EBITDA was down 7%. We expect improvement in the second half on both revenue and profit driven by open research and solutions growth as well as lower expenses. Now on to APL. The current economic environment is particularly challenging for higher Ed course material and professional books, given the pullback in consumer discretionary spending and cyclical enrollment headwinds. Note that U.S. enrollment this fall was down 1% after being down nearly 5% in the spring and 3% last fall. APL revenue for the quarter was down 10%, driven by a 10% decline in Ed Publishing and an 11% decline in professional learning. Ed Publishing saw double-digit print declines offsetting growth in digital content and courseware. In addition to inventory reductions across our channels, we also saw soft consumer demand. On a more positive note, as Brian noted, zyBooks Digital Courseware continues to grow nicely and we see strong institutional demand. During the quarter, we expanded our zyBooks partnerships with Southern New Hampshire University, Western Governors University, and Arizona State Online. In our Professional Learning lines, declines in Professional Publishing offset continued double-digit growth in Corporate Training. In our Professional Publishing lines, which includes books for business, finance, and tech professionals, we are seeing both inventory reductions and slowdown in consumer demand. The bright spot here is our virtual and in-person corporate training services, which continued to see strong growth as companies invest in leadership and team development. Adjusted EBITDA on APL was down 12% this quarter, mainly due to the revenue declines in our publishing lines, offsetting expense savings. Our adjusted EBITDA margin is 33% for the quarter, which is consistent with prior year. Year-to-date, revenue was down 6% and adjusted EBITDA was down 18%. As a reminder, we are adjusting our cost structure to align with market conditions with the restructuring savings to materialize in the later part of the year. Now for Education Services, which saw overall revenue growth of 17% or 13% organically. This is driven by talent development revenue growth of 61%. As Brian mentioned, we added six new multinational corporate clients this quarter. We're rapidly growing our tech employee placements, up over 60% compared to prior year, and we continue to expand into new regions with strong placement growth in Eastern Europe and India. University Services revenue declined 1% or 6% organically, driven by ongoing cyclical enrollment headwinds and lower revenue share in our long-term renewals. As we discussed last quarter, we continue to work with our strategic partners to ensure long-term, mutually beneficial relationships. For some, this means a narrow service bundle at a reduced share of revenue to Wiley. While this will weigh a bit on our revenue performance over the intermediate term, it builds healthy relationships, and we're optimizing our offerings and cost structures to ensure a healthy return. Some institutions will continue to refer an upfront fee-for-service model, which will allow us to remain flexible in our business model to ensure good commercial outcomes. Adjusted EBITDA was up 69% driven by the revenue flow through in talent development and the timing of expenses in University Services. Some of it related to Hurricane Ida and some of it from year-over-year swings in marketing and advertising costs. Our adjusted EBITDA margin is 17% for the quarter compared to 12% in the prior year period. Year-to-date, Ed services revenue was up 14%, while adjusted EBITDA was down 14%, mainly due to revenue performance in University Services and investment to expand client relationships and talent development. Historically speaking, Wiley has held up well through difficult economic periods because of the nature of our businesses. First, scientific research is vital to economic progress, and therefore, spending on it continues through the cycles. Second, while we're currently working through unusual enrollment challenges, the education sector tends to be countercyclical with people going back to school in times of market contraction. Nonetheless, the current environment calls for us to not only be prudent but to act decisively and drive cost savings and efficiency gains while investing in our core growth areas. We recorded a $14 million restructuring charge in Q2 stemming from a targeted workforce reduction and real estate optimization on top of the $22 million we recorded in Q1. We anticipate these actions to generate targeted run rate savings of approximately $50 million. $29 million of savings is expected this fiscal year and is reflected in our 2023 outlook. The vast majority of these savings materialize in the back half of the year. We've implemented a hiring and travel freeze to mitigate first half revenue performance, and we're making steady progress in our broader simplification and optimization efforts. We continue to consolidate our office footprint with a 32% office space reduction since spring of 2020. This is up from 28% at the end of last quarter and 18% at the end of last year. We are also in the process of closing our technology development and APL content management center in Russia. It has been one of several Wiley tech centers around the world, and we have comprehensive migration plans underway. I'll update you on this and other Q3 savings initiatives when we get to March. Our process of simplification and optimization is a major focus that will yield increasing benefits in the quarters and years to come. We will keep you posted on our plans and progress as we move forward. Free cash flow year-to-date was a use of $126 million on par with prior year with lower cash earnings offset by lower incentive compensation payments for our fiscal 2022 performance. As a reminder, our cash flow is normally a use for the first half of the year due to the timing of collections for general subscriptions. CAPEX was $50 million for the half, essentially in line with prior year, and there were no acquisitions of note. We remain opportunistic on the acquisition front as we look to add scale and capabilities in research and corporate talent developments. At the end of October, we had $118 million in cash on hand and undrawn revolving credit available of $464 million. Also note, we recently amended our revolving credit agreement to extend more than $1.3 billion in credit capacity through November 2027 with approximately $200 million in existing credit commitments to remain through the current maturity date of May 2024. Our current credit facility size remains at $1.5 billion. Net debt-to-EBITDA ratio was 2.1 at the end of October compared to 2.0 in the prior year. Finally, we allocated $56 million year-to-date to dividends and share repurchases on par with prior year. Our current dividend yield is around 3% and we acquired 382,000 shares at an average cost of $45.84 per share. Total spend on repurchases was around $17 million, in line with prior year. In summary, our strong balance sheet, consistency of annual cash flows, and ample liquidity gives us the flexibility to continue to invest in our core and return cash to shareholders. Let's review our full year outlook. Due to the market-related headwinds in education, we are reducing our revenue guidance at constant currency from mid-single-digit growth to low single-digit growth. Revenue growth continues to be driven by solid performance in Research and Corporate Talent development. We are reaffirming adjusted EBITDA at constant currency in the range of $425 million to $450 million, given second half restructuring savings and other cost measures. Adjusted EPS at constant currency is now trending to the lower end of the range of $3.70 to $4.05, mainly due to rising interest expense. As I mentioned at the start of the year, adjusted EPS guidance reflects higher interest expense, higher tax expense, and lower pension income. These three items were expected to account for $0.35 of additional adverse impact this year. This impact is now anticipated to be $0.44 due to the rising interest expense. As a reminder, our adjusted effective tax rate is expected to rise this year from 20% between 22% and 23%. This is primarily due to a less favorable mix of earnings by country and an increase in the UK statutory rate. In terms of lower pension income, note that our pensions have been frozen since 2015 and are above 90% funded. We are reaffirming free cash flow in the range of $210 million to $235 million. Positive cash earnings and lower incentive payouts for fiscal year 2022 performance are expected to be offset by higher cash taxes and interest. Our CAPEX outlook is now around $110 million to $120 million, modestly lower than anticipated. Capital investment is primarily focused on platform and product development and research and corporate talent development. In summary, we are navigating difficult market conditions in our academic lines, but our core growth areas are solid. We are aggressively managing our cost structure to mitigate the revenue challenges and taking tangible steps to reduce complexity. With that, I'll pass it back to Brian. Thanks, Christina. Before I sum up, let me say a few more words about our segment realignment. The changes we are making in Q3 focus on our education group. The research segment will remain unchanged. Research Publishing and Research Solutions are already focused customer-centric lines of business that complement one another and that together are a strong market leader, delivering new pathways for profitable growth. In Education, Wiley targets two primary customer groups, universities and corporate customers. Organizing our segments around these groups will naturally result in a simpler, more customer-centric and more efficient Wiley. Our new academic segment will consist of two lines: Academic Publishing and University Services. Academic Publishing will incorporate both Education Publishing and Professional Publishing. Together, the Academic segment team will focus on delivering outcomes for learners in university and other institutional settings, leveraging Wiley's full suite of content platforms and services. This alignment will enable both revenue and cost synergies over time. Our new talent segment will include Wiley's Talent Development and Corporate Training Products and Services. The new talent team will be fully focused on meeting the critical talent needs of employers by delivering all of Wiley's training, sourcing, and upskilling solutions. This customer-centric alignment will allow us to achieve more revenue and cost synergies as we optimize both our offerings and our go-to-market efforts for the corporate customer. We will begin reporting on these new segments in Q3. So, let me quickly summarize the key takeaways for the quarter. Despite the difficult economic environment, we continue to execute well on our commitments. Our results have been weighed down by consumer spending and enrollment challenges in education. But our core growth areas of Research Publishing, Research Solutions, and Corporate Talent Development remains strong. We are actively tackling our cost structure to adapt to cyclical headwinds and to drive long-term margin improvement. We believe that a simpler Wiley is a better Wiley, and we are consistently taking action to achieve greater focus and alignment with fewer moving parts. This quarter, we are reorganizing education around our customers to drive better alignment, synergy, and efficiency. Wiley's consistently strong balance sheet and cash flow continue to enable us to reinvest while rewarding long-term shareholders with dividends and share repurchases. One final but important point. We've decided to move our Investor Day, which had been planned for April to October, specifically to October 12th. We had hoped to have it sooner, but we're shifting it for two important reasons. First, we are now hard at work driving towards a simpler and more impactful Wiley, and we want to be able to share our full plans with you. We will be better able to do this in October. In the meantime, we will continue to update you on the progress we are making along the way. In addition, the ongoing market uncertainty, particularly affecting our academic lines has clouded our ability to commit to long-range targets, which we plan to do when we see you in October. In the meantime, we will continue to update you on the progress we are making along the way. In closing, as always, I want to recognize the global Wiley team for continuing to execute at a very high level through this challenging period. Every day, they bring their full selves to work and make a real difference. And for that, I'm extremely grateful. So as 2022 comes to a close, I wish all of them and all of you a very happy holiday season and a healthy and prosperous 2023. I'll now open the call to any questions. Hi, good morning. It's Pete Lukas for Dan. Just starting with what's causing the clients to slow spending on professional learning. Is it the general macro concerns that you mentioned or are there other factors out there and if so, what visibility do you have in terms of how long that may last? And on the flip side, what do you see as the main drivers for the strong corporate training that you've seen? Yes, great question. Great to have you on the phone, Pete. So in professional learning, we are seeing some softness but not related to a slowdown, particularly in corporate spending. What we're seeing is slowdown in consumer channels. And that slowdown in consumer channels is largely of cyclical nature. The underlying demand for our professional learning products remains quite strong. In fact, we're seeing excellent growth out of our corporate training in -- for team leadership and certainly our Corporate Talent development, which we'll talk about later. What's driving demand in professional learning and some of the softness is effectively an industry restocking that's happening at our key retailers, key online retailers where they have adjusted their inventory policies and practices and in the near term have rightsized basically their inventory according to what they believe demand is. And so therefore, that is what we would call a cyclical or a temporary thing and that should come back. There is, however, and it's important to note an underlying headwind that is economic that is driving our -- that is driving softness in consumer demand. And that consumer demand relates to professional buying a book. It relates to a person spending money on their own personal development. It's -- but we're not seeing the demand yet from the -- any demand softness at this point due to the economic pullback in professional development funded by corporations. And that's leading to a very solid performance in our corporate training business, where businesses, which are growing very, very nicely and in talent development, specifically, as you can see, we're seeing a tremendous investment that companies are making in the acquisition, the development, and the retention of their talent. Notably, one of the things that we've seen in this cycle different than prior cycles is a reallocation of funds in corporations towards digital education and talent development in the most key areas that companies need to succeed. Companies are still obliged to pursue their strategic plans and they're investing to do so. What we're seeing is less demand across the industry or sector for in-person training, but we are primarily in digital training at this point in time. And so we're seeing pretty good performance there, as you can tell from our numbers. Very helpful, thank you. And in terms of the faster-than-expected decline in print materials, would you say that's mainly due to enrollment or has usage taken another leg down? Yes. So no, by all accounts, usage and attachment of curriculum materials professionally published are the same as they've always been. What's happening now is different than in prior periods where we had concern about the evolution of this segment in the long run. What we're seeing is very similar to the answer that I just gave you on professional learning, which is that during this period, we've seen significant economic changes, and that has caused two primary factors, the largest being this inventory adjustment that we see at our retail channels, that accounts for the bulk of it. And the second is this idea of consumer spending. Just because I call it consumer doesn't mean it doesn't affect students. Students are looking for ways to save money like everybody else. And so we have seen -- certainly, we've seen enrollment softness. We see that across a number of our businesses that does affect the underlying demand for the units of our products, both in our publishing lines and also in our services line. But really, what we're seeing right now is primarily a factor of these two cyclical factors that I keep talking about, with regard to inventory and underlying consumer demand. But not shift in the underlying nature of the sectors that we're in, or their long-term outlook. Great, thanks. And then just jump into research. Prior to Open Access becoming a larger percentage of your research revenue, you would provide updates on what percentage of your following year's journal subscriptions were under contract. Is that still a relevant metric for you and if so, how is it trending related to years past? Yes. No, we're not providing that guidance now. And it is -- I will say that we continue to see very, very strong demand, most importantly, for our transformation of OA agreements. These are the agreements by which we help the market transition from the traditional models to the more mixed and open models that we're going to see in the future. We're at a point in the year, which is where we haven't seen much of that activity just because this is the way that annual timing and patterns work out. We will see -- we have a very strong pipeline of transformational agreements and our more traditional subscription agreements will continue to chug along as normal, and we expect that to pick up seasonally as we move through the balance of the fiscal year. So yes, things are trending as we would expect them to from a pipeline perspective and from a transition perspective. And that, of course, supports our long-term Open Access strategy, our long-term aggressive forward-leaning strategy towards embracing the new models in the marketplace. That's a little less relevant these days to talk about traditional subscription deals. Great, thanks. And last one for me, just on a more big picture. Can you give an update on capital allocation priorities, outside of internal investments, is M&A still the priority or is it more focused on debt reduction and perhaps opportunistic share repurchases? Yes, I'll start the question -- answering the question, Pete, and then I'll hand it over to Christina. So our capital allocation is driven by our belief in the long-term opportunities that we have as a company. And we divide it obviously into multiple categories. We've been very consistent about that. The first category is the investment in the future of this business, both through organic investments, which you've seen and through inorganic investments such as M&A. And I will say our M&A strategy here is consistent. We are being cautious, of course, we're being patient, and we're being focused. So our strategy drives our capital allocation and our capital allocation is thus tightly aligned to our investment priorities in our growth areas. Those being research publishing, research solutions, and corporate talent development. And everything flows from that. So Christina, perhaps you can say a few more words. Sure, thanks. Hi Pete, we are continuing to remain balanced on capital allocation to Brian's point. And just a note there that historically, our steady cash flow has allowed us to be very balanced and has rewarded us in difficult times, and this is no exception. So we're continuing to look at this. We are still keeping margin towards our priorities. You specifically mentioned debt, that is moving up our priority list given the market environment and our interest expense outlook, and we will look at that as we go forward. But I'm not uncomfortable with our leverage right now, which is at a good place. And finally, on dividends and share repurchases, you also mentioned, this is a reminder there, we allocate about half of our free cash flow to dividends and share repurchases, and that's in line with last year. And so we have a long streak of raising our dividend annually. We're paying a nice yield and share repurchases have also been steady. And we'll continue to look at that, but we're going to continue and stay the course there. Thanks for the question. Alright. Well, I want to thank everyone for joining us today. I want to wish everyone a very, very happy, healthy holidays and a prosperous New Year, and we will look forward to seeing you and sharing our Q2 results in March. Thanks very much.
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EarningCall_1667
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Good morning, everyone, and thank you for participating in today's conference call to discuss Kirkland's financial results for the Third Quarter ended October 29, 2022. Joining us today are Kirkland's President and CEO, Steve "Woody" Woodward; EVP and CFO, Mike Madden; and the company's External Director of Investor Relations, Cody Cree. Following their remarks, we'll open with the call for your questions. Before we go further, I would like to turn the call over to Mr. Cree as he reads the company's safe harbor statement within the meaning of the Private Securities Litigation Reform Act of 1995 that provides important cautions regarding forward-looking statements. Cody, please go ahead. Thanks, Jason. Except for historical information discussed during this conference call, the statements made by company management are forward-looking and made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks and uncertainties, which may cause Kirkland's actual results and future periods to differ materially from forecasted results. Those risks and uncertainties are more fully described in Kirkland's filings with the Securities and Exchange Commission. I'd like to remind everyone this call will be available for replay through December 9, 2022. A webcast replay will also be available via the link provided in today's press release, as well as on the company's website at kirklands.com. Now I'd like to turn the call over to Kirkland's Home President and CEO, Woody Woodward. Woody, over to you. Thank you, Cody, and good morning, everyone. We continue to operate our business in one of the more dynamic and unpredictable macro environments I've ever experienced in my career. From a global pandemic to geopolitical unrest to inflationary and recessionary pressures, the challenges we faced over the past few years have been tough. That being said, I'm proud of how resilient our organization has become at adapting to these challenges. As we head into 2023, I firmly believe we're on track for a more stable year that will allow us to advance our transformation efforts. Before I address our strategic priorities for 2023, I'd like to discuss our third quarter. While volatility within the consumer environment made it difficult to predict sales patterns heading into the quarter, our financial results were generally in line with our internal expectations. Importantly, we also remained well on track to achieve the year -- our year-end inventory number and liquidity targets we set for ourselves. Consumer spending habits were volatile throughout the quarter. Early on, we saw an improvement in our trends throughout the month of August, which resulted in sales comp decline of only 2%. As we started the month of September, the momentum continued with our Labor Day Sale, backed by a strong promotional offering spurring customer demand. Unfortunately, business softened for the balance of September and into early October, as customers proved very price conscious and less interested in Harvest Decor than years past. This resulted in total comp sales being down around 7% for Q3. However, we began seeing improvements for the end of October, as our customer base shifted to holiday shopping. I'll dive further into what we currently are experiencing later in the call. During the quarter, we focused on weathering a difficult consumer spending environment by leaning on our improved messaging around pricing and online promotions to capture more of our discount oriented customer base. Our furniture and textile categories continued to perform well. While most other categories delivered performances in line with our internal projection. I'm encouraged to see that our furniture assortment is connecting with our customers and delivering fairly consistent results as we utilize a high low price, retail pricing strategy to generate more demand from our value oriented customers and we are gaining awareness for our high value merchandise items from customers that historically would have looked elsewhere. Our AUR continues to grow, supported by larger ticket items and more products within the better invest categories compared to the prior-year. The macro environment -- macroeconomic environment continues to hamper our trafficking conversion rates for both our stores and e-commerce due to the -- though the compression in conversion rates was relatively minimal by the end of the quarter. Our store conversion declined around 1% by e-commerce declined around 3% both year-over-year comparisons. While conversion rates are down, it could have been much worse. This leads me to believe that customers are still connected to our assortments even in the midst of a challenging environment. After launching our in-home delivery service last quarter, we are seeing relatively healthy adoption from our customers. While we don't expect this to be a significant growth driver for the near-term, we're pleased with our customer response so far, and expect in-home delivery to gradually become a more meaningful revenue stream in the future. We will continue to develop our back-end operations to ensure that our program remains scalable and easy to use for customers across our omni channel platform. As we move into the fourth quarter, we're encouraged by the improvement in trend we have observed thus far in the holiday season. This momentum continued over Black Friday weekend, as we experienced increased demand in response to our promotion. And our results were in line with internal forecasts. The sell through we experienced thus far has allowed us to strengthen our balance sheet, which I'll discuss in a minute. While the consumer is being -- is beginning to shift away from holiday decor spending at this point of season, we're focused on capturing remaining holiday sales through a wide assortment of merchandise that can be used for gifting, and final decorating touches. With a clear promotional strategy in place, we will continue to look at our pricing strategy to ensure we are capturing our historically discount-oriented customer base to drive further holiday spending as we close up season. Turning to our liquidity, I firmly believe we are on track to restoring and maintaining a healthier balance sheet. I'll let Mike go into further detail shortly, but I'd like to highlight that we've already paid down $30 million of our borrowings so far in the fourth quarter, and expect to achieve a year-end target of net borrowing in the $10 million or less range. We also continue to successfully work through our peak inventory position from August. In fact, we believe that we will be below our initial inventory, year-end inventory target, and now we expect to end the year with inventory in the $70 million to $80 million range. As we continue to convert existing inventory into cash, our margins will remain relatively depressed due to the high costs in which we procure that inventory. However, supply chain tensions are starting to ease and we expect to begin meaningfully recapturing margin in the New Year. Coupled with the disciplined cost structure we've implemented, our profitability has room to grow in 2023. We have identified several initiatives in the coming quarters that we believe will get us back on track with our transformation strategy. After executing towards our critical objectives to manage inventory to appropriate levels and decrease our borrowing base, we can begin to focus more on other objectives, such as stabilizing store costs, growing e-commerce sales, and targeting high ROI projects and enable sales growth and improve. Our projects include using our Customer Data Platform or CDP to carefully manage price points and create targeted promotions, increasing the effectiveness of our marketing program, improving ROI on existing advertising spend. The reorganizing of our distribution channel to ensure optimum inventory distribution to stores and our e-commerce channel. Throughout this past year, we targeted our historical, our historically price sensitive customer base through tailored promotions and we look to continue to capture their demand by rebalancing our furnitures growth with diverse opening price points across multiple categories. While we are committed to adding more high value items, we're going to be thoughtful and curating items at price points that appeal to a broad base. The CDP will be an integral part to finding this right -- the right price points for the right customers, as well as providing the data necessary for developing targeted promotions. We'll also evaluate our marketing strategy to ensure that we maintain the highest ROI for marketing dollar spend. As we acquire new traffic, we plan to invest in our stores increased coverage during peak selling hours, and in turn drive increased conversion rates. Our stores have undergone dramatic changes throughout the past years, including refreshed arrangements, and a shift towards an engaged selling culture by our team members. We will continue our transformation and support our stores with additional investments in the coming quarters. With the development of our omnichannel platform, it is important that we optimize our inventory distribution capabilities to provide added flexibility to our customers. We have identified technology investments to our existing point-of-sale and order management system that will enhance inventory availability across the system. We believe these investments will make our DC and delivery channels better optimized, improving margins, inventory turn, and leading to more efficient working capital use. Our e-commerce platform will also undergo operational enhancements to drive growth and support a better user experience. We look forward to sharing more with you on the upcoming months. As we begin ordering new inventory for '23, we will be maintaining a leaner inventory flow and delivering margin improvements throughout inbound freight cost reduction, and targeted initial market increases. While we're uncertain of the sales landscape for next year, we're diversifying our opening price points to ensure that we can operate successfully in a shifting market environment. Overall, I would like to reiterate, sticking with our managed inventories will probably level, improve our liquidity position and set the table for stabilization in '23. We're firmly committed to our shareholders in creating best-in-class companies that can unlock the immense potential and value we believe it has. Before I turn the call over to our new CFO Mike Madden, I'd like to officially welcome him back to Kirkland's Home. Mike's substantial executive experience, and previous long tenure with this organization has helped him transition quickly into our operation and make an instant impact as we navigate through the current macroeconomic landscape. Mike's deep understanding of our business model makes him a superb fit to lead our financial operations and support the execution of our long-term growth strategy. And I'm grateful to have him back on our team. With that, I'll now turn the call over to Mike, who will provide detailed commentary on our performance vertical and our outlook. I'll be back for the Q&A to answer any questions you might have. Mike, the floor is yours. Thanks, Woody. Good morning, everybody. I'm pleased to be back at Kirkland's, where I've spent a large part of my career and I'm looking forward to contributing to a successful recovery of the business. While we do have a lot of work to do, I believe in the long-term opportunity that's before us to make Kirkland's Home a dominant specialty home furnishings retailer. As Woody outlined, our third quarter performance was focused on working within a difficult sales environment combined with margin pressures from elevated inventory levels, and higher freight and supply chain costs. I'll go over the details of the P&L in a minute. But I want to start with a summary of our current financial position. Since our last update, our primary focus has been on improving our liquidity position by converting excess inventory into cash, reducing the borrowings under our revolving credit facility and returning our accounts payable to normal levels. Despite the challenges we faced in the third quarter, we made considerable progress in each of these areas. As expected, our revolver borrowings peaked at $60 million during the third quarter, and we've reduced our borrowings by $30 million thus far in the fourth quarter, leaving $30 million currently outstanding. Our inventory position at the end of Q3 which is traditionally our peak period was $126.3 million and that's down from $141.7 million at the end of Q2, as we emphasize clearing excess inventory and reducing our receipt plan for the balance of the year. This is likewise influencing our accounts payable which dropped from $61.6 million at the end of Q2 to $47.2 million at the end of Q3. For the balance of fiscal 2022, we will continue to prioritize improving our liquidity position heading into 2023 by converting inventory into cash, creating top line momentum through targeted promotional activity. As Woody mentioned, we expect our net borrowings outstanding at the end of the year to be $10 million or less, and our inventory balance to be in the range of $70 million to $80 million. Moving to our third quarter results, net sales were $131 million compared to $143.6 million in the year-ago quarter, which includes a 3.5% decline in store count, and a comparable sales decline of 7%. The comparable sales result was driven by year-over-year decline in store and online traffic and conversion partially offset by an increase in average ticket. E-commerce was 27% of the total sales in the quarter, which was similar to the prior-year. Breaking down sales within the quarter, we had a total comp decrease of 3% in August, a decrease of 10% in September, and a 6% decrease in October. Comp trends improved in the latter part of October and into the early part of Q4. Gross profit margin declined 970 basis points to 25% of sales compared to 34.7% in the prior-year quarter, I'll break out this decline into five components. First, merchandise margin declined 480 basis points to 52.9% versus 57.7% in the prior-year quarter. Heavier discounting associated with our efforts to reduce inventory levels and higher inbound freight rates led to this decrease. Inbound freight rates spiked in late 2021 and early 2022 and much of the product that's sold through in Q3 carry the impact of higher freight rates and cost of goods. Second, central distribution costs increased 290 basis points to 7.2% of sales from 4.3% in the prior-year quarter. This increase was largely due to operational inefficiencies in our distribution centers, resulting from elevated inventory levels and uneven product flows. These costs spiked during the first and second quarters of this year and were capitalized as the underlying inventory was held prior to sale and are now being recognized in the P&L as inventory sells through. This is an important call out because this timing is atypical. The third quarter is usually a period of rising inventory levels and supply chain costs, with costs build up being recognized in the P&L during the fourth quarter. This year, with inventories peaking much earlier and heavier than normal and order flows curtailed for the back half of the year, inventory levels declined sequentially from Q2 to Q3. However, the inventory that sold through in Q3 had the higher distribution costs from earlier in the year attached, which negatively impacted our operating results. Third, store occupancy costs increased 130 basis points to 10.8% of sales from 9.5% in the prior-year quarter, due to deleverage from a lower sales pace. Fourth, outbound freight costs, including both store and e-commerce shipping expenses, increased 110 basis points to 8% of sales from 6.9% in the prior-year quarter. The increase was primarily at the store level and due to additional routes deployed to move more products on elevated inventory level. Additionally, shipping rates and fuel costs were higher than in the prior-year. E-commerce shipping costs were up slightly versus the prior-year reflecting the launch of our in-home delivery service. And lastly, depreciation included in cost of sales decreased 40 basis points to 1.9% of sales from 2.3% in the prior-year quarter. Total operating expenses were $39.4 million or 30.1% of sales, compared to $40.8 million or 28.4% of sales in the prior-year quarter. A reduction in advertising expense of over $3 million drove the overall decline. This was offset somewhat by increases in insurance and corporate salaries due to the collection of a property insurance claim and favorable accrual adjustments in the prior-year. The increase as a percentage of sales was primarily due to the lower sales pace. Adjusted EBITDA excluding impairment and other minor non-operating expenses was negative $1.7 million, compared to $14.8 million in the prior-year quarter. Our normalized tax rate in the third quarter was 24% compared to 25% in the prior-year quarter. Adjusted loss per share, which excludes non-cash impairment, normalizes the tax rate, and excludes other minor non-operating adjustments was $0.38 compared to an adjusted earnings per share of $0.51 in the prior-year. GAAP loss per share, including these items was $0.58 compared to earnings per share of $0.51 in the prior-year quarter. While we are not providing specific guidance for the fourth quarter, we do want to provide some color around our expectations for sales and margin performance as well as our outlook for liquidity and other key balance sheet components. Sales thus far in Q4 have improved from Q3 trends for the fiscal month of November, which ended this past Saturday. Comparable sales were approximately flat. This is something we anticipated as we were in a better in-stock position on our holiday seasonal category this year, and as Woody mentioned the assortment has performed well. While we're optimistic about the sales results we experienced in November, we're being cautious in our expectations. And within our internal forecasts, we're not extrapolating the sequential improvement we experienced in November for the remainder of the quarter given the persistent consumer volatility. From a margin perspective, heavier promotional activity will continue for the remainder of the year as we reduce inventories and reposition the assortment for 2023. We expect to again show sequential improvement in our gross profit margin during Q4. But we will still be below last year due to an anticipated merchandise margin decline in the range of 300 to 400 basis points due to the increase in promotional activity. We also expect that we will experience some additional overhang from the spike in freight and distribution center costs earlier in the year as inventory continues to sell down. We expect some deleverage on the fixed components of our gross profit margin, but the impact should be less than what we've experienced year-to-date. While we're seeing inbound freight rates decline, we won't see a significant benefit in our financials until the first part of 2023 as most of the inventory, we will sell for the remainder of this year shipped at higher freight rates. However, with inventory levels and freight costs declining, our overall margin profile for 2023 is setting up to be much improved. From a liquidity perspective, as I mentioned earlier, we anticipate paying down our revolver to a net borrowing position of $10 million or less by the end of the year, with inventory levels in the range of $70 million to $80 million. Finally, as to capital allocation. Our first priority is to reestablish a level of liquidity that allows us to operate the business flexibly and to confidently pursue our long-term goals while maintaining downside protection in an unpredictable environment. Second, we want to invest cash flow back into the business and high return projects that advance our long-term goals to be a Premier Home Furnishings retailer. Share repurchases and dividends have been important components of our capital allocation strategy in the past, and we would expect to use them again in the future once our near-term goals have been achieved. Looking ahead to 2023, we do not expect the inventories to fluctuate greatly during the first half of the year. And we expect a more traditional seasonal inventory build-up ahead of next holiday shopping season. Leaner inventories will further improve our overall working capital position and combined with continued expense control should lead to reduced utilization of the credit facility as compared to fiscal 2022. Thank you all for joining us today. And once again, I'm very glad and thank Kirkland's Home for my warm welcome back. I look forward to assisting this outstanding organization as we embark on the next chapter of our journey. Operator, we're now ready to take questions. Thank you, sir. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Anthony Lebiedzinski from Sidoti & Company. Please go ahead. Good morning, Woody and Mike and welcome back Mike to Kirkland's. I guess first, as you look to stabilize comp sales and increase e-commerce sales, what are the main demand levers that you expect to use? I know you've been sort of driving a lot of promotions now. But how should we think about that near-term and longer term as you look to turn around the business. So just curious to get your thoughts on that first? Yes, one thing is making sure that we have a solid promotional strategy. I think we've been a little bit schizophrenic in past years about our discounting process. So what we did was we went through and we made sure that we made sure that our IMU was slightly increased and that we would be able to bake in the right promotional levels for driving both e-commerce and store business. The other thing was just also working diligently on the store experience, the cultural experience of coming into a Kirkland's store, which has been changing since we've been a retailer that sold items to a retailer that's now selling full room home furnishings, we've been focused on that. And then e-commerce has been a really intense part of our focus on making sure that we have the right platform, the customer experience, using our new CDP to be able to detail out, how do we make sure that we're sending the right emails to the right customer base, and not having to be promotional across the base, and really taking advantage of the fact that, we've got lots of new customers coming into the organization, and we want to treat them a little differently than what we've done in the past with some of our core customers that have expected a highly promotional environment. Okay, thanks for that. And then, in terms of your operating expenses, I mean, they were down looks like 3.5% in the quarter. How should we think about that as far as, I know you're obviously looking to certainly have firm cost controls, but just there's still inflationary pressures out there. So just overall, what are the different puts and takes as you look to manage your operating expenses effectively? Yes, Anthony, we continue to maintain that strict cost control posture. If you look at what the big influencers are there in general, I mean, we can talk about third quarter in particular, but in general marketing expense, we're kind of holding that flat as we think ahead, we want to reposition some of that spend to higher return opportunities. But that's how I would think about it going forward. Woody just mentioned one other big area where we're really looking at closely and that's store payroll, we would like to layer in a little bit more there. But we're going to test into that really, and understand what layering in a little bit more in the way of hours and coverage does for us. But that is an area to Woody's point just now that we think we can benefit from with an enhanced focus at the store level on really servicing the customer. So that is one area that I think about it now as we're going to manage it very tightly as we have been, but we want to invest there, as we see things that really worked for us. Got it, okay. And then in terms of your store base, so you closed one store, you opened one store, Mike now that you've been with the company for a few months back, what are your thoughts as far as just additional store closings and perhaps maybe even some store openings? Yes, so yes, it's an important area that we're focused on. Just to start out, just to give you a little bit of what's in front of us, we will close about 10 stores at the end of this year, right the beginning of next just with natural lease expirations. Some of those are not strong performers. So we will see that going into next year. But overall, I would say we want to maintain the store base kind of where it is right now around, give or take 350 stores, most of them have worked their way into better rent situations over the last few years, as we achieved a lot of reductions post COVID, we've been able to maintain most of that, it's getting a little bit more difficult to do that. But our view on the store base right now is let's maintain, let's get the overall business to a level of recovery that we can benefit from that, we've got a customer base out there that not only goes to these 350 stores that they shop us online, and that has a halo effect on our overall revenue profile. So we're careful about that. We think the stores are crucial to our overall delivery and want -- at this moment really want to maintain that 350 around about 350 and that would include being targeted and maybe layering in a few new stores just in the right positioning across the spread that we have. Got it, okay. So thanks for that. And my last question, so as you look forward to next year, as you're looking to, I know obviously near-term, you're focusing on reducing your inventories. But when you look forward to the next year's holiday season, will we see more merchandise done on the directly source basis. I know that's an area where you guys had talked about previously. So just wondering how you're thinking about that? Yes, thanks, Anthony. First of all, yes, we are continuing our direct sourcing opportunities, I think we cut back a little bit this year, just because of the over inventory and the unstability in the market. But yes, that's been really good for us over the years, it helps us with having more exclusive products. It helps with improving our design, it helps with packaging, so we have less damages. So we're very satisfied and happy with the work that's been done in our direct sourcing area. And I think over the next couple of years, what you'll see is that we did learn a few things this year. One is that when the economy gets a little tough, we need to make sure that we're highly, they were covered in the opening price point item. And what we decided to do for Spring 2023, was even pull those items together to make it really easy for a customer that's just looking for a fun thing from Kirkland, maybe something under $20, to be able to find it easily. What we found was that, we had some of those items, but they were mixed in throughout the store. So we've not only additionally purchased some of those items, but we've pulled them together in a way that's really easy for the customer that's just wanting to buy something fun for their house or fun for themselves, to encourage. And then we're continuing to really evaluate every single department, you'll see us really looking towards the customer to help us decide what categories to drive forward with, what categories to pull back on a little bit. But generally, as our goal has been stated over and over again, now when we want to become a recognized home furnishings retailer, you've got to carry some of the basic items, we did probably moved furniture artificially a little bit quicker than we'll have that maybe that will happen this year, where we'll let the customer demand and dictate that, we also to reduce our better in stocks while reducing inventory. We're also looking at some skew reduction in some categories that have just grown this few days to large. And so a lot of detail work around all of that has gone into the assortments for 2023. And how to work on assortment that is substantially less than previous years, but still flowing in had the customer be able to get products, no matter where they are, whether they're in our warehouse, whether they're at the store or whether they're directly from vendor. Thanks. Nice progress on the inventory management. I wanted to just first start with the quarter-to-date trends. So, progress there on a flat comp in November, I think if we go back to last year, November was actually maybe your easiest comp of Q4, I think it was down 9.5%. December, I think maybe improved to like down 3% to 4%. And then maybe January was softer again, maybe down high single-digits. But I wanted to see if you could just clarify, in terms of the comparisons that you're looking at this year, that would be helpful context. Yes, the comparisons if, boy, talk about volatility. One thing that happened in December last year, was that we were out of some what people considered perfect gifts from Kirkland. As we had mentioned, I think on previous calls, we were out of or we didn't have the right number of throws and some other things that people wouldn't typically come to Kirkland's for Christmas divide. So we're in pretty good stock shape there. So we anticipate better response in December, but we know, it's still a cautious environment. So we're trying to maintain some cautiousness. The December number was when we were up against some real volatility last year, we got our Spring assortments that should be setting hopefully the week after Christmas, where that's mostly coming into the DC right now. So I'm hoping that we can see some improvement in January. But December, being a five week month is still the month that we're really focused on. We will make sure that we are appropriately discounting to be able to hit the $70 million to $80 million in inventory and to get it close to no debt as possible as Mike had mentioned. But these are all moving parts. And I think what happens when we get into these very unstable development is that we have to be really on the business daily, closely watching, how did we do yesterday? And what are we going to do tomorrow to make sure that we're kind of right in line with what the customers are expecting. I would say that's probably fair, just given as Woody just mentioned, there are things going both ways, right. So we're going to be better stock position on things like throws and giftable items this year versus last year. But we did benefit somewhat this year from having the Christmas and holiday assortments in for most -- for the month of November, whereas last year, it was later. So, we're up against that later hitting now, but then have a benefit maybe offsetting that with the throws being in stock. Okay, and then wanted to also just ask about like holiday hours and typically have a little more staffing, little more payroll in Q4 was down in Q3 on a year-over-year basis. Wanted to just get a sense for how we should be thinking about that on your OpEx side in Q4? Yes, this has been a good year for us last year, we were really having a hard time staffing up for seasonal hires. This year, we did a much better job of making sure that just those extra people in the stores branch out during our holiday hours. We were not as extreme as we did, maybe after we would stay up until like 10 or 11 o'clock at night. So we moderated that a little bit while extending some holiday hours. I'll let Mike answer the OpEx part of that, but generally we feel good about our staff. And there's a whole new energy, we didn't cover too much in the call with the store effort to really deliver a better customer experience and better customer service. And I feel that there's just a whole energy in our stores right now that's really good. And so they've been a really good partner with us in terms of the additional training that we're doing, and the additional service levels that we're offering to our customers, Mike? Yes, from an OpEx standpoint, Jeremy, I'm looking at this kind of year-over-year Q4, I don't think that that's going to drive it very much. I mean, our hours are pretty similar to what they were last year. And when I mentioned earlier in the call in response to one of Anthony's questions about investing in stores that's primarily at the 2023 look ahead as and we plan to test even before we get to layering in any more OpEx there. Got it. Okay. And then just coming back to some of the puts and takes here on gross margins. So obviously, you noted, still a promotional environment out there, both in your stores and at competitors. You have freight, which sounds like it's improving, but still a drag year-over-year. Can you just quantify expectations around great drag, again from what it was in Q3, what do you expect it to be into in Q4? And then as we look ahead to start 2023 based on where your inventory levels are, and the timing of when those float in and are expected to sell through, any color you could share on that Mike would be great. Yes, so I mentioned in Q3, I'll start there, our merchandise margin was down 480 basis points. And just directionally the way I would think about that is about half and half, half of it's probably being more aggressive on the promotional front as compared to last year. And then the other half being pressure from inbound freight rates. That again, as a reminder, we incur that, when those goods are shipped from overseas is when we incur that cost, but it hangs up on the balance sheet until the goods sell through. So these goods sold through in Q3 and into Q4 for the most part have much higher rates attached to them. And so the P&L is impacted by that in Q3 and Q4. As we get closer to the end of the year, that pressure on the freight end of it starts to wane a little bit and the way I would think about it on the freight because real time today, we've got much lower inbound freight rates. So as we get that inventory received in in the system and start selling it early next year, you'll start to benefit from that. And it's a little early to project maybe what impact that will have going into next year. It could be, if you kind of take from peak, kind of this time last year with the freight rates word to now, I mean, it could be 200 to 300 basis points of improvement. But as you know, and as everybody's watched those rates can move around quickly. So we're mindful of that. But we are in a period now where we're back to kind of the normal inbound rates. I don't know if I got all your question there. But if there's anything left, let me know. Well think, yes, let me just put it in slightly different context. So yes, I think your landed margins last year were in the kind of 57% to 58% range. And they've obviously been down substantially. This year, I think something more like let's call it 53% around there, so I'm just trying to get a sense for the sound like we're going to get back to maybe 57, or 58 like you had in 2021. But it does sound like your expectations are for more in the mid-50s range for 2023. Is that fair? I think you're on the right track, I think actually, we could potentially have more benefit come our way depends on what the top line is, I mentioned freight that's kind of in place. But one other thing to keep in mind is, we've been spending most of the back half of this year, kind of prepping our assortment next year with higher initial markups, designed to capture more promotional activity, that will margin out at a higher margin. So with inventory levels coming down, with freight rates coming down, with supply chain just costs in the system coming down, along with an assortment that's going to be more positioned to handle the type of promotional messaging that we're engaged in. I think the ups -- we could get back to where we were relatively quickly. But again all of that under the heading of caution that says there's a lot going on in the environment, the consumer is a little bit hard to predict. And the top line sales have a lot to do with where that margins out. So I think structurally, as I mentioned in the comments, the profile of our margins going in the next year is much improved. However you look at it, so it's a matter of can we take full advantage of it with some sales momentum. Great, understood. Last one real quick for me in terms of your OpEx expectations, as you look to next year, just kind of simply, you're going to close, I think you said close to 10 locations at the end of this year. In terms of OpEx spend for 2023, would you expect that to be up or down at this point, I mean the visibility you have? Again, I mean we have a couple of, I mentioned the store payroll, and that's an area we're really looking at, that's we're only going to really layer that in, if we see it leveraging and has an effect on driving sales. So from a dollar standpoint, that could be higher, but it will only be higher if it comes with a nice sales lift. But just stepping back big picture, knowing that we're not quite ready to really unveil 2023, I would think about OpEx is kind of steady state, dropping with the store count, keeping our marketing spend about where it is but more effective. And again, trying some things in terms of driving store payroll to support our overall sales effort. Yes, thanks. Good morning guys. Woody, would you comment a little bit about when you look at the product assortment that you have, what are customers resonating to at the moment? What areas of the offering do you think that when you look at that lever for promotions, what is the highest sensitive area competitively and just sort of a deep dive into what consumers are buying these days? Yes, you know, that's a good question. Because we've been experiencing some relief partially and happiness in our furniture assortments have been working, although we might have been a tad over skewed in that area. So that's part of the inventory driving down for next year, we were very pleased with that. We've been very pleased with our textile acceptance, pillows, throws, anything in the tabletop textile area has been very successful. Our floral business and our fragrance business has been fairly consistent. We ran a promotion last week on a jar candle and sold 150,000 candles in a couple of days. So we're having good response. I don't think that we're getting the credit that we deserve right now. I think our stores possibly look better than they've ever looked. The customers that are walking in are very impressed. They are buying, I wish that we could get more new customers in but we are experiencing some relief in some better customer new customer flow into the stores. There are a couple areas that are still challenging, wall decor has been a challenge for us this whole year as customers are just not interested in putting up those metal wood wall hanging things that we sold so well at Kirkland's for so many years. And so and so we're trying to really reduce a few reduction and kind of bringing our assortment and wall decor up to the new level of not just being one note with floral. But generally and then I do think that we had a little miss at some of our opening price points. And the merchants have done a great job for next year. saying did we dislocate some customers who just wanted to come in and buy a $20 to $30 thing, maybe. So we've got that covered, it's flowing, and it'll be in for the Spring assortment. And I think that could be a good item for us to show that we're an easy place to find value. But generally, I think that our goal to become a legitimate home furnishings retailer in the value space is progressing fine. And that is one of our long range goals is to make sure that as we move into the specialty store pyramid, away from the Big Box pyramid that we've been kind of like, compared with over the years, we've got to do a great job of making sure that our stores look great and our assortment is really reflective of home furnishings, the same kind of things you might see at higher end retailers, but in our store can be offered at a little bit better price point with lower cost structure. Can you talk a little bit about maybe the 10 stores, any 10 stores, you're going to close where kind of I mean were those, can you quantify maybe what losses you were seeing as those stores combined? Yes, it's not, it's not why we think about it as kind of overall breakeven type for walls. So not a big loss of profitability. And so therefore, not a big impact going into next year, and they're really associated with kind of an annual review of short-term leases and leases they are about to expire. And so we were able to retain most of what we wanted to retain there, so I would, I think it's pretty negligible. At this time, this concludes our question-and-answer session. I would now like to turn the call back over to Mr. Woodward for any closing remarks. Well, first of all, we'd like to thank everyone for listening on today's call and we look forward to speaking with you, when we report our fourth quarter and 2022 fiscal year results. And again, thank you for joining us. Have happy holidays. Ladies and gentlemen, this does concludes today's teleconference. You may disconnect your line at this time. Thank you for your participation.
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EarningCall_1668
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At this time, for opening remarks and introductions, I would like to turn the call over to Ji Yoo, Head of Investor Relations of Broadcom Inc. Joining me on todayâs call are Hock Tan, President and CEO; Kirsten Spears, Chief Financial Officer; and Charlie Kawwas, President, Semiconductor Solutions Group. Broadcom distributed a press release and financial tables after the market closed, describing our financial performance for the fourth quarter and fiscal year 2022. If you did not receive a copy, you may obtain the information from the Investors section of Broadcomâs website at broadcom.com. This conference call is being webcast live and an audio replay of the call can be accessed for one year through the Investors section of Broadcomâs website. During the prepared comments, Hock and Kirsten will be providing details of our fourth quarter and fiscal year 2022 results, guidance for our first quarter as well as commentary regarding the business environment. Weâll take questions after the end of our prepared comments. Please refer to our press release today and our recent filings with the SEC for information on the specific risk factors that could cause our actual results to differ materially from the forward-looking statements made on this call. In addition to U.S. GAAP reporting, Broadcom reports certain financial measures on a non-GAAP basis. A reconciliation between GAAP and non-GAAP measures is included in the tables attached to todayâs press release. Comments made during todayâs call will primarily refer to our non-GAAP results. Before I provide color on our Q4 results, let me put in perspective what we achieved in fiscal year â22. For the year, Iâm pleased to report that consolidated revenue hit a record of $33.2 billion, growing 21% year-on-year, yet another year of double-digit organic growth. This growth was driven by our strong partnerships with customers and increased R&D investments, which enable accelerated adoption of our next-generation technologies. With our robust business model, we grew our fiscal 2022 operating profit by 28% year-on-year and our free cash flow per share by 25% year-upon-year. Now to discuss details of our fiscal Q4. In our fiscal Q4 â22, consolidated net revenue was a record $8.9 billion, up 21% year-on-year. Semiconductor solutions revenue increased 26% year-on-year to $7.1 billion, and infrastructure software revenue grew 4% year-on-year to $1.8 billion. In Q4, our semiconductor business continued to perform well across hyperscale, service providers and enterprise. On top of this, wireless grew sequentially as we ramp up the new platform and our North American customer. In reporting these results, Iâd like to emphasize, we demonstrate our continued discipline in shipping our strong backlog only as and when needed by our end customers. So, in contrast to weak consumer electronics spending today and despite concerns of a global recession, we believe overall infrastructure spending remains strong, and we continue to experience sustained demand in most of our end markets, and this is what we continue to see in Q1. So, let me expand on this. Starting with networking. Networking revenue was a record $2.5 billion and was up 30% year-on-year, representing 35% of our semiconductor revenue. We see strong growth from deployment of Tomahawk 4 for data center switching at hyperscale customers. And we see upgrades of edge and core routing networks with our next-generation Jericho portfolio at cloud and service providers. And at multiple cloud customers, we continue to lead in delivering custom solutions for compute offload accelerators and actually surpassed the $2 billion amount in revenues in fiscal â22. Looking into Q1, we do expect networking revenue to be strong and grow about 20% year-over-year. Next, our storage connectivity revenue was a record $1.2 billion or 17% of semiconductor revenue and up 50% year-on-year. As we have mentioned in previous earnings call, we are benefiting here from substantial content increases as both, cloud and enterprise customers adopt our next-generation MegaRAID and storage adapters. This trend will continue in Q1, and we expect server storage connectivity revenue to grow above 50% year-on-year. Moving on to broadband. Revenue of $1 billion grew 20% year-on-year and represented 15% of semiconductor revenue. Our broadband business is benefiting from ongoing multiyear deployments by North American and European service providers of 10-gigabit PON and DOCSIS 3.1 with embedded Wi-Fi 6 and 6E. In Q1, we expect the secular drivers behind broadband to continue and our business to be strong at about 30% year-on-year growth. Moving on to wireless. Q4 revenue of $2.1 billion represented 29% of semiconductor revenue with the 13% year-on-year increase coming largely from higher content. And in Q1, we expect wireless revenue to be sequentially flat and up low single digits year-on-year. Finally, Q4 industrial resale of $234 million grew 1% year-over-year as softness in China mostly offset the strength in North American and European automotive. In Q1, we forecast industrial resales to continue the trend of low single-digit percent growth year-on-year. And so in summary, Q4 semiconductor solutions revenue was up 26% year-on-year. And in Q1, we expect semiconductor revenue growth to sustain at approximately 20% year-on-year. Moving on to software. In Q4, infrastructure software revenue of $1.8 billion grew 4% year-on-year and represented 21% of total revenue. Core software revenue grew 5% year-on-year. In spite of adverse ForEx impact in dollar terms, consolidated renewal rates averaged 117% of expiring contracts. And in our strategic accounts, we averaged 128%. Within our strategic accounts, annualized bookings of $357 million included $101 million of cross-selling of our portfolio of products to these customers. Over 90% of the renewal value represented recurring subscriptions and maintenance. Over the last 12 months, consolidated renewal rates averaged 120% over expiring contracts. And in our strategic accounts, we averaged 135%. Because of this, our ARR, which is annual recurring revenue, the indicator of forward revenue, at the end of Q4 was $5.4 billion, which was up 4% from a year ago. And in Q1, we expect our infrastructure software segment revenue to be flat year-on-year, reflecting core software revenue growth of mid-single-digit percent year-over-year, offset by a year-on-year decline in the Brocade enterprise and business. In summary, weâre guiding consolidated Q1 revenue of $8.9 billion, up 16% year-on-year. While we are fully booked for fiscal 2023, in this environment, we are not providing you guidance for the year. Before Kirsten tells you more about our financial performance for the quarter, let me provide a brief update on our pending acquisition of VMware. We are making progress with our various regulatory filings around the world, as we very much expect having received merger clearance in Brazil, Canada and South Africa. We anticipate that time line for the review process would be more extended in other key regions, especially given the size of this transaction. Having said that, weâre still confident that this transaction will close and be completed in our fiscal 2023. The combination of Broadcom and VMware is about enabling enterprises to accelerate innovation and expand choice by addressing their most complex technology challenges in this multi-cloud era. And we are confident that regulators will see this when they conclude their review. Revenue was $8.9 billion for the quarter, up 21% from a year ago. Gross margins were 75% of revenue in the quarter and up 10 basis points year-on-year. Operating expenses were $1.2 billion, up 3% year-on-year, driven by investment in R&D. Operating income for the quarter was $5.5 billion and was up 25% from a year ago. Operating margin was 62% of revenue, up approximately 240 basis points year-on-year. Adjusted EBITDA was $5.7 billion or 64% of revenue. This figure excludes $129 million of depreciation. Now, a review of the P&L for our two reportable segments. Revenue for our semiconductor solutions segment was $7.1 billion and represented 79% of total revenue in the quarter. This was up 26% year-on-year. Gross margins for our semiconductor solutions segment were approximately 71%, up 70 basis points year-on-year driven by product mix and adoption of next-generation products across our extensive product portfolio. Operating expenses were $825 million in Q4, up 4% year-on-year. R&D was $731 million in the quarter, up 4% year-on-year. Q4 semiconductor operating margins were 59%. So, while semiconductor revenue was up 26%, operating profit grew 33% year-on-year. Moving to the P&L for infrastructure software segment. Revenue for infrastructure software was $1.8 billion, up 4% year-on-year and represented 21% of revenue. Gross margins for infrastructure software were 91% in the quarter and operating expenses were $348 million in the quarter, down 1% year-over-year. Infrastructure software operating margin was 72% in Q4, and operating profit grew 6%. Moving to cash flow. Free cash flow in the quarter was $4.5 billion, representing 50% of revenue. We spent $122 million on capital expenditures. Days sales outstanding were 30 days in the fourth quarter compared to 29 days in the third quarter. We ended the fourth quarter with inventory of $1.9 billion, up 5% from the end of the prior quarter because we expect the mix of revenue in Q1 to have a higher cost of materials. We ended the fourth quarter with $12.4 billion of cash and $39.5 billion of gross debt, of which $440 million is short term. Based on current business trends and conditions, our guidance for the first quarter of fiscal 2023 is for consolidated revenues of $8.9 billion and adjusted EBITDA of approximately 63% of projected revenue. In forecasting such operating profitability, we would like to point out that because of product mix changes, our non-GAAP gross margin could be down roughly 100 basis points from Q4 and R&D spending could be up sequentially as we step up hiring of engineers for multiple critical projects. Let me recap our financial performance for fiscal year 2022. Our revenue hit a record $33.2 billion, growing 21% year-on-year. Semiconductor solutions revenue was $25.8 billion, up 27% year-over-year. Infrastructure software revenue was $7.4 billion, up 4% year-on-year. Gross margin for the year was 76%, up 110 basis points from a year ago. Our operating expenses were $4.8 billion, up 6% year-on-year. Fiscal â22 operating income was $20.3 billion, up 28% year-over-year and represented 61% of net revenue. Adjusted EBITDA was $21 billion, up 27% year-over-year and represented 63% of net revenue. This figure excludes $529 million of depreciation. We spent $424 million on capital expenditures. And free cash flow grew 22% year-on-year to $16.3 billion or 49% of fiscal â22 revenue. Turning to capital allocation. For fiscal â22, we spent $15.5 billion, consisting of $7 billion in the form of cash dividends and $8.5 billion in repurchases and eliminations. We ended the year with $13 billion of authorized share repurchase programs remaining and expect to resume our repurchase of common stock as soon as we can under SEC rules. Excluding the potential impact of any share repurchases, in Q1, we expect the non-GAAP diluted share count to be $435 million. Aligned with our ability to generate increased cash flows in the preceding year, we are announcing an increase in our quarterly common stock cash dividend in Q1 fiscal 2023 to $4.60 per share, an increase of 12% from the prior quarter. We intend to maintain this target quarterly dividend throughout fiscal â23, subject to quarterly Board approval. This implies our fiscal 2023 annual common stock dividend to be a record $18.40 per share. I would like to highlight that this represents the 12th consecutive increase in annual dividends since we initiated dividends in fiscal 2011. You talked about infrastructure holding up well across most segments. I guess, I was hoping you could speak more to why infrastructure to date has been so immune from the weakness weâve seen elsewhere in semis. Specifically, can you speak to trends youâre seeing perhaps in hyperscale versus enterprise? Any differences there? And also, can you speak to how you see these trends throughout all of fiscal â23? Thanks so much. All right. Great question. What we see now, last quarter and this current quarter as we progress is hyperscale spending continues strong; enterprise consumption continues strong; and broadband deployment across North America, Europe and even parts of Asia continues their multiyear trend of growth simply because out of COVID-19, there was a lot of invest -- there was a lot of plans to invest, and these are multiyear. So, exactly as I said, all these areas currently continue to be very much on track as weâve seen it. Now, keep in mind, as I said in previous earnings call and Iâd just reemphasize here today, again, itâs -- I just want to assure you, we donât believe we are shipping beyond true demand. We continue to scrub -- to basically judge orders, the backlog we have, and we also take pains to only ship to customers who can consume it pretty much within the same quarter before we do it. And so, as far as we can tell, based on what we see as a willingness of our customers to accept and consume the products we ship, thatâs what we see right now. Asking me for the rest of â23, no, I tend to be more careful in being able to answer that. I donât know the answer to that is my opinion. I do not know whether the strength in acquisition and consumption of our products will continue to sustain for the rest of â23. What we do see is over the next several months, we see those orders still in place. We see customers willing to take the products. We have -- talking to multiple, multiple CIOs among largest enterprise customers we have out there. We have not seen them talk about a reduction in their IT spending. Weâve seen many said it will grow and others saying it will at least remain flat. So, I guess, Iâm cautiously positive about trends looking forward. Thank you. One moment for our next question. That will come from the line of Ross Seymore with Deutsche Bank. Please go ahead. Hock, I want to follow on C.J.âs and maybe ask similar question but in a slightly different way. Last quarter, you talked about actively scrubbing your backlog. And clearly, thatâs helped to avoid some of the inventory pitfalls that some of your peers have seen. But have you noticed since last quarterâs call a change in either the rate of your backlog growth? I think it was up about 7% sequentially last quarter, the composition of your backlog or how actively and aggressively you need to scrub it? Any sort of changes in those forward-looking metrics that would alter your view on kind of the sustainability of demand, the duration of it, et cetera? It comes down very simply to we continue to scrub our backlog in a manner this quarter, last quarter, no differently than we did it six months or a year ago. We havenât changed our focus on ensuring that we do not ship products to the wrong people who just put it on the shelves. That is still very much, very, very intact in our view. Our backlog continues to be way up there, and youâre right, makes us change. As you can see, one quarter, it would be broadband growing 20% year-on-year and networking growing 30% year-on-year, and the following quarter is broadband growing 30% year-on-year and networking growing 20%. And it impacts not just from hyperscale bearing their purchases in -- for one of a better word, seasonal manner; itâs also the particular end markets it goes to. So thereâs a mix of backlog and products we ship in any particular quarter will vary, and they all change. But it doesnât change the fact that we have still a very, very strong backlog. And what weâre shipping, which is most important in the current quarter, we believe, is what we are reflecting as end demand for our products. So Hock, I guess just to ask the question explicitly. Last quarter, I think you said your semiconductor backlog was $31 billion and your lead times were still 50 weeks, give or take. What are those numbers now? Like, where is backlog and where are lead times? Right. Weâre fully booked for the year. So, if I give you the backlog number, Iâm effectively guiding you to the year. So, weâve chosen not to provide that data at this time. Our forecast for the year, if you want to call it, forecast base -- our backlog, itâs not our forecast. Weâll continue -- for the year, weâll continue to grow. Other than that, Iâm not telling you what it is. We donât guide. Thank you. One moment for our next question. That will come from the line of Harlan Sur with JP Morgan. Please go ahead. Hock, your server storage connectivity business has been extremely strong, right, up 50% plus in fiscal â22. And more importantly, that business continues to sustain based on the January quarter outlook. We typically tend to think about HDD controllers and preamps, but your business is much more diverse than this. So, can you just, first of all, walk us through like what percentage is MegaRAID, PCIe or what I call overall storage connectivity versus your storage controller business, which is primarily HDD controller and preamps? And maybe whatâs driving the near-term growth in the storage franchise when many of your storage competitors and customers are seeing major weakness in this segment? Well, thatâs an interesting question. Itâs -- our server storage connectivity -- and youâre right, which includes nearline hard drives, which includes some, what we call, on-prem server storage connectivity, host bus adapters included is broad. And I donât have the numbers on my mind exactly what it is. Just broad-based, particularly from the MegaRAID business, as I said, a big part of the growth, the big dollar -- the big percentage growth, as I indicated before, is due to the fact that the new generation of products are all subsystems, our boards. Weâre not just shipping chips. So, that counts for a big part of the growth. Notwithstanding, unit [ph] growth is up, but not as much as the 50% we announced, obviously. A big part of 50% is content growth as we ship subsystems and boards versus chips. But even then unit growth is up, and itâs across the board, and itâs not everything that grows. But enough said that overall, it grows. Hock, you keep on scrubbing demand and youâre shipping to what you think is consumption. So I guess I take it to believe that thereâs still a gap between what youâre shipping and what customers want in any given quarter, I guess we could call that delinquencies, some others call that delinquencies. Obviously, you havenât changed your approach, but I would imagine that this delinquency or this gap between what youâre shipping in a quarter and what your customers want, thatâs probably declining. So I guess the question is, can you quantify the gap? And is the gap getting smaller? Thanks. Thatâs an interesting question. And we donât really try to quantify the gap. And a big part of it is -- I donât want to get you guys overly excited, but customer -- you know backlog is -- sometimes itâs very often categorized or characterized under CRD or customer request dates. Our customer requests date in this particular quarter, for instance, our last particular -- last quarter was much, much higher than what we actually shipped, and it was the same way six months ago. Has it got better from six months ago? I can only guess, and in this forum is the last thing I want to do. But thereâs still a big amount of CRDâs backlog in excess of what we actually ship up. Thank you. One moment for our next question. That will come from the line of Vivek Arya with Bank of America. Thank you. I actually have two very quick clarifications. First, Hock, have you seen the impact or you expect to see any impact of China lockdowns in your wireless business in Q2? I know thereâs nothing -- doesnât seem to be anything in Q1. I was just wondering if thereâs something we should be prepared for in Q2. And then on the gross margin, I thought I heard gross margin goes down sequentially in your semiconductor business in Q1. Is that really all mix-related, or is there a like-to-like impact that we should keep in mind? Okay. Letâs take your first question first and then go to a more interesting second question, which is interesting, because it connects a few dots here. On the first one, as you know, our wireless is one single customer, and the COVID shutdown and all that does slow down inter-quarter shipments. But nothing -- we donât see -- Q2 is too far away for me to really give you any sense and our accuracy of what is like, but thatâs obviously movements between Q4 and Q1 as our numbers does kind of reflect. But -- which is why year-on-year is a pretty good measure. As you see there, Q4 year-on-year was just 13% -- and I shouldnât say just -- was 13%, and Q1 was actually still 1% up, but thereâs obviously some movements in between, but -- and Iâm sure that has something to do with COVID logistics -- impact on logistics chain of our largest customer, but I canât really tell in the bigger picture. Now switching and certainly on Q2, Iâm not positioned to give you any indication. We donât have visibility. Now turning to the second part of your question on gross margin, itâs all product mix. And itâs all product mix because there are some -- depending on the particular products we ship, as Iâve said many times before, the margin, product margin, gross margin does vary, simply because itâs the nature of the market conditions, the ecosystem that we have in each of those markets, those niche markets we participate in. But broadly, to give you a sense, perhaps that gives you more color, networking tends to have some of the highest margins collectively of our products and much higher than broadband; and of course, wireless has the lowest. And when you look at Q4 to Q1, the mix shifts away from networking somewhat and more to broadband, and wireless still remains a big chunk of it, even though it hasnât receded as a percent. So, thatâs why we see that impact on gross margin sequentially. Nothing more than just the mix of products we ship and the natural gross margin on those products vary one from the other. And you can actually see it with the way our inventory grew, too. As we -- as Kirsten reported, our inventory ending Q4 grew about 5% from that ending Q3, the quarter before. And obviously, the Q4 inventory is positioned to ship in Q1, and you see that increase even as our guidance on revenue remains pretty flat. Great. You talked about being booked for the whole year next year. How much visibility do you think that gives you really? And I guess, whatâs your philosophy going to be if customers with non-cancelable backlog come to you and try to make an adjustment in a potentially weaker economic period next year? Letâs start with the first part. I mean, when weâre booked, weâre really booked. I mean we got paper that says they have committed orders for us to ship. And as you know, our orders are non-cancelable orders. Customers know that. We have the paper. And when we say we are fully booked, it means we have the backlog sitting there. Now, the second question you asked is a more interesting question. What if we all hit a massive recession, depression or recession, late next year, in the next 6 months, 9 months, and customers -- and things really collapse around years, what would we do? My answer is I donât know, which is partly why weâre not giving you annual guidance. We will react as and when circumstances require us to do. But at this point, we have the orders. Great. Thanks for taking my question, and congrats on the good results and outlook. The -- it seems that the capital allocation policy in terms of the outlook -- maybe the policy didnât change, but at least the tactics did. The payout ratio relative to free cash flow, youâre setting that a little bit lower than the 50%, and youâre resuming the buyback. And Iâm hoping you can just discuss why these decisions were made. Does it reflect an indication or a changing view about the timing of the VMware close, or is it related to concerns around macro or anything else? Thank you. Well, I would say that we are -- policy-wise, weâve always said we would pay out approximately 50% of the preceding yearâs free cash flows. And in this economic environment that weâre all seeing, we believe that a 12% increase year-over-year is a robust dividend. And so yes, weâre quite happy with that. And donât forget, weâre going to start buyback once the rules allow us to do that. And so, thatâs another return of cash to shareholders, and we fully intend to get that going as soon as we could. And one moment for our next question. And that will come from the line of Matt Ramsay with Cowen. Please go ahead. Hock, I think in some of the prepared script that you guys disclosed that youâre now sort of in the compute offload ASIC franchise, the fiscal year was $2 billion. And I think thatâs maybe a third higher than it was last year. It looks like some of the -- you guys did an event on that business earlier in the year, and things really jumped up in fiscal â18 and then kind of leveled off a bit in terms of revenue. And this is a pretty big, I guess, acceleration in that compute offload business. Maybe you could talk a little bit about the trends there. And are you seeing a broadening of the customer base or maybe higher volumes per tape-out as you go down the node stack? Iâd just be interested in seeing some of the trends there. It seems like hyperscale really wants custom silicon at this point. Thanks. Yes, youâre right in that regard that we have multiple programs from the hyperscalers on custom or semi-custom silicon, or largely collectively we call as offload compute. And they all have -- do their own. So, thatâs -- in one way thatâs very positive and very opportunistic for our technologies to be deployed. On an ongoing basis, the tricky thing in all this is more will come on, the rate of ramp is harder for us to predict. These are very lumpy programs, fairly large and lumpy, which is why we can get to $2 billion and a raise -- an increase of like, as you correctly say, a third from a year ago. But itâs lumpy. And the trend is very hard for me to chart out unless you ask for it over the next five years. And even then, if you look it five years, it becomes a question now, would these hyperscalers revert to merchant silicon versus continuing to use custom ASICs, and that poses another issue for me to figure it out. But if you ask for me over the next year or two, where it will go, Iâd be honest and say Iâm not positioned to give you really a good forecast. Hock, I wanted to go back to the prior comment you had made, and I want to make sure Iâm clear on it. I think possibly within the context of lead times, you talked about customers, I think it was giving you forecast that were notably longer. I just want to understand a little bit of the context behind that comment earlier. Any kind of -- appreciating that youâre not giving backlog, any kind of context around that lead time discussion would be helpful. We havenât in any major substantive way changed our lead times by any means, as Iâve said before, and we kind of go along on that practice mode. And we have forecast, but weâre really not talking about forecast either as it relates to the previous comment. I think I was referring to backlog and paper that we use. And as I said before, even on those papers, we have with customer request dates for shipments, we scrub that date and then scrub each of those demands before we ship it out in the current quarter or the preceding quarter, depending on what it is. But we donât -- we have forecast. But obviously, weâre not giving you any indication of our forecast at this point simply because we are still grinding our way through the backlog. Hock, I was hoping you could talk a little bit about your business in China, not so much from a ship to perspective from -- end consumption perspective. I know you donât have perfect visibility into being whatâs consumed at the end customer level. But if you can kind of talk about what youâre seeing in terms of trends across enterprise, cloud and service providers, that would be helpful. How significant of a headwind was China in fiscal â22? And what are your expectations going forward? And what are you hearing from your end customers? Thank you. Well, to answer your question directly is China has slowed down in terms of consumption of products across industrial, across even infrastructure. It has slowed down, and we see that. Theyâre still not totally collapsed, but they have slowed down compared to what they were taking a year ago. But thatâs -- and we see that particularly in our industrial business, which as we -- I indicated in my prepared remarks, strength in Europe, strength in North America especially in automotive, but weakness in China, which is a big part of our industrial business slowed it down. But beyond that, in the IT side, yes, we have seen a slowdown. But keep in mind, China represents just less than 10% of our total revenues today. So, while it obviously has some level of offsetting effect, itâs not sufficiently launch to have that much impact on our overall growth trend for the entire company. I think itâs too early at this point for me to make a call. Itâs -- thereâs a sense of some reopening. But if I make a call, good chance I could be wrong in a monthâs time when things might shut down again. Congrats on bucking the trend on semis here, Hock. So, my question, it was kind of addressed on the last one, but I wanted to talk about the divergence, particularly between storage and maybe China enterprise networking. You had -- thereâs a lot -- your other competitor in, call it, core hard disk drive, talked about a downturn in demand, in storage, a large inventory build, and something similar happening in China networking as well, and you guys have seemingly such a big divergence there. And I was wondering if perhaps you had an explanation for some of that and why the difference. The only explanation to an earlier question was our portfolio in service storage is pretty broad-based. Now, with a couple of areas that are very large areas like RAID, MegaRAID, particularly pretty much, but they are more than MegaRAID we have. Youâre correct. Itâs pretty broad-based. And there are some puts and takes, obviously. But overall, we see what we tell you. Hock, Iâd like to talk a little bit about your wireless business, which is more retail-focused and probably will be the first one to see any recessionary pressures if you him them. I know you guide this really solid. First, give us some idea of your firm order book. I know you get a projection when the model year starts on what the total number would be for the year, but you donât get a firm order for that for some time. So just kind of what is -- what would you -- how would you characterize firm order book for that or orders per se? Is it a 30-day, 60-day? So help anticipate if you see a change when would that be. And then maybe if you could touch on how we should think about overall content at your largest customer in the next year or so because thereâs obviously increased competition in some of your core areas, and I was wondering if youâre looking to shift more of your focus there into some of the mixed signal custom stuff and maybe wait for some of the RF. Thanks. Okay. Interesting question. Let me try and address that. First, I assume you imply when you say orders or forecast on shipments, we only guide Q1, so I can only give you Q1. And itâs all -- we have been all on paper, orders. These are real orders, non-cancelable. So, weâre giving you numbers that we intend to ship that we think the customer needs as far as we can scrub. And we have it. These are committed orders. These are not forecasts at all, especially when you talk about Q1, which ends, by the way, end of January. We have orders beyond end of January as it is. So, these are very committed orders. And in that -- by that same token, pretty committed revenue forecast. Just to make it clear. Youâre right -- and by the way, we have pretty good visibility for -- from that particular customer, too. Now beyond that, to the second part of your question, yes, weâre very pleased with content increase that we have experienced, not every year necessarily, as you know. But over a period of years, we always see this content increase. And weâre still very, very well positioned in our product line -- in those few product lines that are, I call it, almost franchise in our North American customers. And this is Wi-Fi, Bluetooth, this is RF front end, and this is touchscreen controllers, high performance, mixed single. And thatâs -- we can only -- and thatâs all we focus on because these are areas where we are the best, we believe we have the best technology and delivering value to our customers. Thereâs no reason to find something else where youâre not the best and hope to gain share from someone else. I could apply the same to my competitors in their thinking. But you donât see the competitive landscape shifting and making things more difficult for you in that, especially in the RF section in the next coming year or so, you think your franchises or your franchises and you... Hock, you mentioned youâre fully booked for 2023. Youâve had a lot of questions on that one. So, I apologize in advance for squeezing in one last one. And I was wondering, if you look at the year as you see it books today, if you could tell us in this like booking dynamics, where do you see for the full year 2023 the most growth and the least growth? I know you canât give us like numbers, and you donât want to guide. I completely accepted that. But if you could give us like a kind of idea of where things keep growing very fast, where things are slowing down in your order dynamics over the full year. Infrastructure is still holding up very well, as we have said in this call so far. We see -- we continue to see infrastructure. And infrastructure, by looking at it, comes from hyperscale, in building their data centers and components to their data centers; in service providers, like telcos, where we see our strength in broadband access, gateways and broadband. And I know people are finding hard to imagine, weâre seeing it even in enterprise, where we do not -- where -- thatâs why I made a comment earlier, we do not see across a cross-section of large enterprises, reduction in the IT spending for 2023. We have not seen -- we have not come across too many enterprise customers, and Iâm talking real end-use customers, end-user enterprise customers who are seeing their IT budget drop below â22. For most that we have asked, itâs either flat or even up as they all continue to have the compelling need to keep modernizing their platform and workloads and digitizing their business model. And I think that is the only -- that was the only explanation given to me why there was no such clear reduction even as we all hear every day the likelihood, possibility of a global recession. Thank you. As there are no further questions in the queue at this time, I would now like to turn the call back over to Ji Yoo for any closing remarks. Thank you, Sherri. Broadcom currently plans to report its earnings for the first quarter of fiscal â23 after close of market on Thursday, March 2, 2023. A public webcast of Broadcomâs earnings conference call will follow at 2 p.m. Pacific.
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Good morning. On behalf of Morgan Stanley, I will begin the call with the following disclaimer. This call is being recorded. During today's presentation, we will refer to our earnings release and financial supplement, copies of which are available at morganstanley.com. Today's presentation may include forward-looking statements that are subject to risks and uncertainties that may cause actual results to differ materially. Please refer to our notices regarding forward-looking statements and non-GAAP measures that appear in the earnings release and strategic update. Within the strategic update, certain reported information has been adjusted as noted. These adjustments were made to provide a transparent and comparative view of our operating performance against our strategic objectives. The reconciliations of these non-GAAP adjusted operating performance metrics are included in the notes to the presentation or the earnings release. This presentation may not be duplicated or reproduced without our consent. Thank you, operator. Good morning, everyone. Thanks for joining us. The macro backdrop of the last year presented challenges we haven't seen for some time. The combined impact of persistent inflation and rapid central bank tightening pressured asset levels and led to very little strategic activity and capital raising. Despite volatility throughout the year, Morgan Stanley demonstrated resilience and delivered on an ROTCE of 16%, including integration-related expenses from our deals. The firm did what it was supposed to do with our more stable Wealth and Investment Management businesses offsetting declines in Institutional Securities. This is hard evidence of the transformation we've made to become increasingly durable and a stark contrast to the 8% ROTCE we had in the last notable challenging environment of 2015. When markets rebound, we will capitalize on growth once again across the full firm and from an even stronger position. Before turning to Sharon to discuss the details of the fourth quarter and the full year, I'll walk you through now how we plan to achieve these goals in our annual strategic update appropriately titled delivering growth through the next decade. Briefly first, I'd like to acknowledge the many contributions Jon Pruzan made as CFO and COO. As you know, he's retiring from Morgan Stanley at the end of this month, and we wish him the absolute best. Please now turn to the deck into Slide 3. What informs our confidence in growth strategy is that we know who we are. We've been clear about that for over a decade. Our clarity of purpose has been a key driver of our success to date, and the next decade will be no different. On Slide 4, you can see we've been consistent since the financial crisis. We have a client-centric franchise with a common objective to facilitate capital flows between those who have it and those who need it. We're committed to our clients and to the markets we're in, clearly illustrated by the leading competitive positions we have. In each of our businesses, we have a significant competitive moat, which will enable us to maintain and further enhance our strength. Slide 5 highlights the strategic decisions we've made over the past decade that are focused on aligning markets -- ourselves to the markets where we perform best. And these are core businesses with scale in major markets that are on the whole more balance sheet-light and benefit from more durable fee-based revenues. We continue to invest in these areas to drive future growth. We have proven track record in our ability to acquire and integrate the businesses that are aligned with this strategy, namely within Wealth and Investment Management. Importantly, we've also taken action to get out of businesses that are not core to this flow of capital. While we may facilitate activities across varied markets, we do not own businesses that are built around unsecured consumer credit payments, physical handling of commodities and the like. Instead, we focus on markets we best, and our ability is there to support our clients in those markets. Please turn to Slide 6. This illustrates the ongoing growth and shift of our business mix. As we continue to grow our client assets, we expect Wealth and Investment Management will become an increasingly larger portion of the firm's pretax profit. The stability of the firm will be further enhanced by this growth, all the while coupled with a preeminent institutional franchise. Fair to say our business model was tested this year, as you can see on Slide 7. 2022 was a paradigm shift. But first the common acts continuation of the first pandemic in 100 years, the first war in Europe over 70 years and the highest inflation in 40 years. Despite lower asset values and an anemic underwriting calendar, the firm performed well. We generated, as I said before, a 16% ROTCE and the most excess risk-based capital of our peers and attracted over $300 billion of net new assets, all while integrating two major acquisitions. So, now moving to the opportunities to maximize growth in the next decade, let's start with Wealth Management. On Slide 8, you can see we have leadership positions across channels, reflecting our combination of best-in-class advice and best-in-class technology. And we have the ability to meet any client wherever they are in their wealth accumulation journey. This allows us to grow with our clients along the way and provides the opportunity for clients to migrate across channels. The growth of our business is reflected in our higher average daily revenues, something I've been tracking for well over a decade. 2022, every trading day saw revenues in excess of $80 million, and over 1/3 of those exceeded $100 million a day. Contrast that with only three years ago, where 95% of trading revenues were each below $80 million, and none exceeded $100 million. It is through the journey as illustrated on Slide 7, Wealth Management has gone through a powerful transformation, as you all know, including with the most significant recent acquisitions in E*TRADE and Solium, which have expanded our client base with two new channels. Today, we have 18 million relationships. We focus on deepening those relationships far up the right product at the right time and consolidating assets under our platform. From here, we're building on the scale and the tools to reach -- and the reach that will propel future growth. Net interest income has certainly been part of the profitability expansion to date, and you can see the driving forces highlighted on Slide 10. We have invested in expanding our bank offerings, allowing us to offer attractive products to our clients on both sides of their balance sheet to meet their needs. We've nearly doubled our lending balances over the last three years, and we expect to continue to grow attractive high-quality loans. On the other side, our deposit franchise has grown significantly since 2019 and will continue to support future NII through various cycles. Approximately 90% of our deposits are sourced from our Wealth Management client base. And in the current rising rate environment, our cost of deposits is more efficient than that we experienced in the last rate hiking cycle. Sharon will discuss this important topic and our outlook around NII further in a few minutes. Let's turn to Slide 11. This now talks about NNA growth, net new assets. Over the last three years, our platform generated nearly $1 trillion of net new assets showing a clear step change from prior periods and marking Morgan Stanley as a leader across our peer group as an asset accumulator. Given the scale and reach of our businesses, we expect to deliver this pace of asset accumulation going forward. Obviously, there will be up and down individual years. But over a three-year period, we expect to drive approximately $1 trillion in net new assets. Most importantly, as you can see on the right-hand side of this page, no single source is accounting for greater than 25% of this net new money. Some people think it's just a result of recruiting. It is absolutely not. It's a combination of several things, which the team has described as filling the funnel of net new money. You can see on Slide 12, which shows our growth in client assets, we have experienced that through our workplace channel. We estimate now that relationships wealth held away has expanded by about 4x in the last three years. Our ability to serve clients across the entire wealth spectrum, we're well positioned to consolidate a portion of these assets. Further, the workplace channel continues to bring new relationships to the platform. We've executed on key steps to deepen those. We've already reached our goal to roll out companion accounts to 90% of workplace participants and to achieve 30% retention of stock plan assets. We look forward to even higher retention. The results of our client-driven strategy are illustrated on Slide 13. The workplace channel has driven the majority of our growth in client relationships and stands at 12 million relationships to date. While it can take several years to deepen those, we've already seen success in some parts of the offering that of our stock plan administrative services. Over the last three years, we've had approximately $350 billion of after-tax vested inflows. Vesting assets gives us more opportunity to deliver an integrated client experience, and that's allowed us to showcase the power of advice. To date, we've already seen advisor-led flows of approximately $150 billion that originated from a workplace relationship. Portion of those assets are the stock plan investor balances, but a larger portion are from assets that were previously held away. In short, we will -- as we deliver our full suite of capabilities, our strategy to attract clients to advice is working. Investment Management has also delivered strong fee-based growth over the course of its own transformation, as you can see on Slide 14, which encapsulates the business together with Eaton Vance. This business has more than doubled its durable asset management and related fees since 2014. And importantly, this significantly larger revenue base is more diversified. Increased diversification from fixed income, customization and alternatives continues to support results in more volatile equity markets. We remain very aligned to key growth areas. Our alternative investment capital is at $210 billion with strong growth in private credit, real assets, including infrastructure, our multi-strategy hedge fund platform and special situations. And customization by our market-leading parametric business continues to be a significant growth engine. Shifting to Institutional Securities on Slide 15, we have a global and balanced franchise. And our integrated investment bank has and continues to focus on meeting clients where they are active. This has served us well as our strength is evident across various market environments. We remain a leader in equity in Investment Banking and have steadily rebuilt our fixed income franchise focused on our strongest capabilities. On Slide 16, you can see our institutional business remains a top three global leader in the industry, as demonstrated by a wallet share position. We have demonstrated our ability to defend share and gain it in relatively more capital-light businesses. At the same time, we've shown prudent several resources as illustrated clearly by the disciplined RWA usage, which actually dropped from '21 to '22 and our consistent G-SIB surcharge of 3%. Let's move to our capital strategy on Slide 17. We have 200 basis points of excess capital above our regulatory requirement. This is intentional. Our capital strategy has focused on bringing the risk down in our businesses, and we've seen a steady decline in our SCB excluding the dividend add-on reflective of our more durable business mix. Our capital position gives us enormous flexibility, and we're comfortable with our decision to be prudently positioned. On Slide 18, you can see our excess capital position enables us to continue to invest in our business for future growth and deliver robust returns to shareholders. Our business transformation, especially the durable earnings from Wealth and Investment Management, enable us to double that dividend -- enabled us to double our dividend in 2021 and further increase it by 11% in 2022. At the same time, we've reduced our shares outstanding from the much higher levels driven by the impact of our recent acquisitions. Taken together, we delivered a 9% capital return to our shareholders last year. We remain committed to ongoing shareholder return, adjusting always for whatever the business performance is and the regulatory requirements demand. Shifting to how we see the future state on Slide 19. Starting with the expected path to $10 trillion in client assets across Wealth and Investment Management, we've demonstrated our ability to generate over the last three years positive net new assets of approximately $300 million a year. Combining that with reasonable average market assumptions give us the confidence this will lead to $10 trillion in client assets in reasonable years ahead. Now let's consider this within the broader firm picture, and bear with me for a minute. In 2022, the firm delivered $14 billion of pretax profit. In this future scenario of $10 trillion of assets, which I believe will happen, generating approximately 50 basis points of revenue which is about what we're doing currently at a 30% pretax margin, which is within 2% of what we're doing currently. If you put that math together, it should create of itself over $14 billion of pretax income. As you can see, that exceeds that of the full firm today just from the wealth and asset management businesses. So if you pull it all together, just to wrap it up, Slide 20 reiterates our confidence in our performance goals. They have not changed on account of what's going on in the markets in the last 12 months. These are the metrics we need to support our longer-term objectives. Of note, we've added a new goal that I spoke to earlier that we've talked about in the last six months to generate $1 trillion in net new assets approximately every three years. Again, I'm sure there will be volatility quarter by quarter, year by year. But as we've demonstrated through the funnel of sources, we expect an outcome over three years of approximately $1 trillion. That's about by the way up to 5% to 7% of beginning period assets within wealth and asset management. As we approach 2023, we do so with quiet confidence, recognizing we have a line of sight with the durability of our Wealth and Investment Management businesses and our market share leading positions across much of Institutional Securities. As always, our objectives are subject to major moves in the economic, political or regulatory environment. However, with a constructive outlook and a proven track record we've delivered thus far, we fully expect to achieve our goals over time. I will now turn the call over to Sharon, who will discuss the fourth quarter and annual results and we'd be delighted to take your questions. Thank you, and good morning. In a complex year, the firm delivered solid results. Full year revenues were $53.7 billion, and PBT was $14.1 billion. The fourth quarter contributed to $12.7 billion in revenues and PBT of $2.8 billion. The strategic investments we have made over the last decade have paid off. Wealth Management had a record year and Fixed Income had its strongest performance in over a decade. While the firm was broadly impacted by increased volatility and economic uncertainty, the business model performed very well in a challenging environment as it was designed to do. The full year results included $470 million of integration-related expenses of which $120 million were incurred in the fourth quarter. Excluding these impacts, EPS was $6.36 and $1.31 for the full year and for the quarter respectively. The full year ROTCE was 15.3% and 15.7% excluding the costs associated with integration. In the quarter, severance expenses of $133 million related to a December employee action and a net discrete tax benefit -- or net discrete tax benefits of $89 million largely offset each other through net income. The full year efficiency ratio was 73.2%. Excluding integration-related expenses, our full year efficiency ratio was 72.4%. Total expenses were approximately flat to the prior year. Lower compensation expenses principally related to movements in DCP and on lower revenues were offset by higher non-compensation expenses primarily driven by investments in technology as well as increased marketing and business development spend. As a reminder, this year also included a $200 million charge related to a legal matter regarding the firm's record-keeping requirement in the second quarter. As the environment evolved over the course of 2022, we actively managed our expense base. Cognizant of the ongoing macro uncertainty, we continue to review efficiency opportunities. We are in the final stages of completing our integration of both E*TRADE and Eaton Vance. And this will be the last quarter we present measures that exclude integration-related expenses from reported results. However, particularly as it relates to the integration of E*TRADE, the final back-office integration remains scheduled to conclude in 2023. We expect to incur approximately $325 million of additional integration-related expenses this year. These expenses will largely be spread evenly across quarters with approximately 2/3 related to E*TRADE and 1/3 related to Eaton Vance. Now to the businesses. Institutional Securities full year revenues of $24.4 billion declined 18% from the record prior year. In the fourth quarter, revenues were $4.8 billion. Overall, quarterly client engagement across fixed income and equities tapered from the higher levels seen in the first nine months of the year, reflective of seasonality and the macroeconomic environment. Weaker Investment Banking results persisted, reflecting the challenging banking backdrop. Investment banking revenues were $5.2 billion for the full year, down 49% from the record prior year. Advisory delivered its second best result, supported in part by the completion of previously announced strategic transactions. Underwriting was more challenged, in line with the broader market. Full year global equity volumes dropped to levels unseen in the last 20 years. Debt volumes contracted following the first quarter. And while the market was receptive to higher quality issuance, activity was limited to constructive market periods. Fourth quarter revenues of $1.3 billion decreased 49% from the prior year. Lower completed M&A and underwriting market volumes weighed on results. As we have highlighted in prior quarters, client dialogue and engagement remains high as clients seek advice to navigate the difficult environment. Greater economic clarity should lead to increased confidence to undertake strategic transactions. And looking ahead, we expect issuers to take advantage of these windows of opportunity. Equity full year trading -- excuse me, equity full year revenues were $10.8 billion, representing another strong year of over $10 billion and making us a global leader in this business. Revenues declined 6% from the record prior year primarily driven by lower market activities. Revenues were $2.2 billion in the quarter, reflecting lower asset levels and volumes. Prime brokerage revenues were lower than the prior year as average client balances declined from record levels driven by lower equity markets and deleveraging. Cash results declined on lower client activity across regions. Derivative results increased slightly as the business navigated the market volatility well. Last year's fourth quarter also benefited from a mark-to-market gain on an investment versus a markdown this quarter. Fixed income revenues of $9 billion for the full year were the highest in over a decade. The divergence between the Fed's guidance on financial tightening and conditions and the market expectations engaged clients and drove revenues in macro while volatile energy markets benefited commodities. Quarterly revenues were $1.4 billion. Macro performance benefited from higher client engagement as inflation expectations moderated, and clients repositioned in rates and foreign exchange. Strength in micro was supported by active secondary markets as expectations for inflation tempered and credit spreads tightened, driving an increase in client activity. Results in commodities were down significantly and primarily reflected lower revenues in the power and gas businesses. Other revenues included $356 million of mark-to-market losses on corporate loans held for sale and loan hedges. These losses were substantially offset by net interest income and fees of $287 million. Turning to Wealth Management. For the full year, Wealth Management produced record revenues of $24.4 billion and a record pretax profit of $6.6 billion, resulting in a PBT margin of 27%. Excluding integration-related expenses of $357 million, the PBT margin was 28.4%. Full year results reflect mark-to-market impacts of our deferred cash-based compensation plans referred to as DCP. This negatively impacts our full year revenues by $858 million with a corresponding decrease of $530 million in compensation expenses. As we have explained historically, there is typically a timing difference between the mark-to-market gains and losses on the economic hedges and the deferred recognition of the compensation expense over the vesting period. The revenue and the expense impact of DCP is now included in our financial supplement. Fourth quarter revenues were a record of $6.6 billion and the PBT margin was 27.8%. Including integration-related expenses of $94 million, the PBT margin was 29.2%. Total client assets were $4.2 trillion. Fee-based flows were $20 billion in the quarter, and asset management revenues were $3.3 billion. Net new assets of $311 billion in the year represent a 6.2% annual growth rate of beginning period assets. Fourth quarter net new assets were $52 billion with contributions across channels. Transactional revenues in the fourth quarter were $931 million. Including the impact of DCP, transactional revenues declined 15% from the prior year. The decline was driven by lower levels of overall retail engagement and fewer new issuance opportunities, partially offset by increased transactions related to fixed income products. Bank lending balances grew by 17% in the year or 13% -- or $17 billion in the year or 13% and stand at $146 billion. The pace of lending growth slowed for the second consecutive quarter and was largely unchanged sequentially. While mortgages and tailored loans continue to grow slowly, this was offset by pay downs in securities-based lending due to the higher interest rate environment. Total deposits rose 6% sequentially to $351 billion driven by continued demand for our savings offering among our Wealth Management clients. We have seen success with our strategy to provide advisers with expanded tools needed to offer their clients choice in varied market environment. Further, the pace of sweep outflows also moderated in the quarter. As a result, we have a favorable deposit mix, largely sourced from our Wealth Management client base with attractive pricing and options to meet our clients' needs. Net interest income was $2.1 billion in the quarter. The 52% increase from the prior year was driven by the benefits of the increased rate environment, an efficient deposit mix and strong lending growth over the last 12 months. Looking ahead, we do not believe that NII is peaked. We entered the year with an attractive deposit base with higher intrinsic value. While we expect the growth of NII to moderate from the pace of the last two quarters, we anticipate continued expansion in the first quarter of approximately 5% sequentially, assuming the forward curve is realized. Investment Management reported full year revenues of $5.4 billion, declining 14% from the prior year. The challenging market backdrop led to lower accrued carried interest in several of our private funds. Also -- and also impacted our AUM, which declined to $1.3 trillion. Fourth quarter revenues were $1.5 billion. Long-term net outflows of $6 billion in the quarter were driven by equities and fixed income, reflecting the challenging public market backdrop, partially offset by demand for alternatives and solutions, particularly parametric customized portfolios as well as our special situation strategies and private credit. Fourth quarter asset management and related fees were $1.4 billion, declining on the back of lower average AUM, partially offset by higher liquidity revenues. As a reminder, performance fees are recognized on an annual basis, largely in the fourth quarter, which drove the increase versus the third quarter. Quarterly performance-based income and other revenues were $90 million. We saw broad-based gains in our private alternatives portfolio, though lower than the prior year. The diversification we gain from having fixed income, parametric customization and alternatives positions us well to perform through the cycle. We continue to invest in this business and leverage our premier global distribution capabilities to support future growth to meet continued global client demand. Turning to the balance sheet. Total spot assets were $1.2 trillion. Standardized RWAs declined by $9 billion sequentially to $449 billion, reflective of our prudent management of resources. Our standardized CET1 ratio was 15.3%, up 50 basis points from the prior quarter. Solid earnings, lower RWAs and gains in OCIs partially offset by capital actions contributed to our strong CET1 ratio. We continue to execute our buyback program, and we repurchased approximately $1.7 billion of common stock in the quarter. The full year tax rate was 20.7% driven by the resolution of certain historic tax matters and the realization of certain tax benefits. We expect our 2023 tax rate to be approximately 23%, which will exhibit some quarterly volatility. The firm's results demonstrate the ability of our business model to perform in an evolving environment. While there are, of course, uncertainties as we look ahead into 2023, we remain the growth opportunities in the year ahead. Our combined $5.5 trillion of assets across Wealth and Investment Management provides us balance. Importantly, our scale positions us well to capture the asset opportunity when the markets recover. Finally, while still very early in the year, we are encouraged by the levels of client engagement we've seen so far. I appreciate all the slides, too. Okay. Two big picture questions, I guess. One, James, with the 200 basis points of excess CET1 requirements, the big buffer served you well. You've got a lot of buybacks, but also it's dilutive to returns. And I'm just curious how you balance that of keeping that buffer or is that buffer more temporary weighting on Basel III end game final results? Or is that something you want -- you plan on sitting at? I'm just curious on your big picture resting spot for that excess capital. Sure. Glenn, it's a great question, and it's sort of pivotal to the whole strategic positioning of the firm because right now, I think capital strategy is critical. There are a few things going on. Firstly, we have been able to reduce our peak to trough in CCAR because of the change in mix in our business. Secondly, because of the market environment we've reduced RWAs, just we've taken maybe a more prudent lean in. And obviously, we can reverse that at any point in time, which heats up CET1. Thirdly, we have the Basel III finally looks like it's coming to fruition at some point in the first half of the year, although I don't expect that banks will be required to implement whatever the new capital rules are until the beginning of 2025. So while there's a pretty long time frame, a year is a long time in this business, let alone 1.5 years, I still think that it's prudent to kind of have some capital sitting there and just -- I'd rather be in a position where we have excess capital when particularly in an environment where we don't see obvious places we've put it to work. Now that said, we did our best. We bought back I think it was $8 billion and $10 billion last year. We doubled the dividend the year before. We increased the dividend 11% last year. Obviously, we're -- I mean, it's fair to assume that we're going to continue moving on capital distributions. But I like a number of 15%. We actually -- we triggered a little higher than that this quarter. We could easily drop down to 14.5%. That wouldn't bother me at all, but that will be driven by the environment and business opportunities. So, great position to be in coming into a change in the regulatory outlook potentially, and we can always act aggressively, and we've proven we will do that when we have more clarity. I appreciate that. One other big picture is so Wealth Management is growing great. Everybody is happy. I think historically and even now, you've been considered very equity-centric from whether it be wealth and asset management or your dominant equities platform. So curious if you're thinking about it's possible with these higher rates, lots of clients shift to a more defensive stance. There's good income out there to be earned without much risk or too much risk. If we see a more material shift towards fixed income appetite in general, do you think that in any way disadvantages Morgan Stanley as a firm and overall profitability? I mean, listen, our share of fixed income is 10%; banking, 15; equities, 20. So obviously, the fixed income call grows. By the way, I share a few years ago, it was 6%. So the team under its head in Sam Kellie-Smith has done a phenomenal job. But if the pool grows faster in fixed income, just arithmetically, you're not going to do as well as if the pool grew faster in equities. That doesn't bother me a whole lot. I mean, we've never tried to be the FX EM shop. We've never had the global rates trading, FX trading macro businesses that some of the correspondent-driven commercial banks have had, the HSBCs and Citis. And that's a business model just different. We don't have as big transaction services, so we're not going to have as much FX. That said, what the team have done in macro under Jakob and the credit in Jay Hallik in commodities is really impressive. So I'm totally fine with that. And we clearly have the product. It's not like we don't sell muni bonds to our clients, and we don't have fixed income underwriting, et cetera. We have the product. It's just arithmetically, given our share relative to the others, we wouldn't grow as fast. By the way, I was happy to see I think equities was back at number one this quarter, core franchise. And we're really well positioned, Glenn. I'm not bothered by that at all. I guess maybe first question, just Sharon, following up on the efficiency ratio about 72% for 2022. As we think about the journey from 72% to something sub-70% kind of in line with your strategic target, a sense of what it means. Is it this time? And are the businesses growing, which are more efficient and that changes the mix? Or could we see that up 70% even over the next couple of years? Would love to hear it in terms of both from a timing standpoint and what needs to happen at the firm to get to a sustainably below 70% efficiency ratio. Sure. So if you think about, we were -- we've been below 70%, right? So if you look back to the last couple of years, and there are periods of time where we are below, there's obviously two pieces to it, both the expense side and the revenue side. I think that as we continue to gain scale across the businesses, each of those dollars that we put to work will be more and more efficient. As I highlighted, where we've been investing a lot of those dollars is on the technology side. I noted that in my prepared remarks, and we have seen that both from the cyber resiliency side and also just as we think about the broader integrations of all of the platforms that we've acquired over the last couple of years. So as I think through it and I think about the timing, obviously, a different revenue environment will certainly help. And there's tremendous operating leverage, particularly as you think about the Institutional Securities business, which will help to drive that. Now if you go through each of the businesses, each of those businesses also exhibit operating leverage, right? If you have a constructive market environment, we've seen very strong margins also from the Investment Management business. We're on our way to achieve the 30% margin target as you relate to the Wealth Management business. So I'd say it's a balance of both, both the revenue environment and how that turns around and then just continued discipline in making sure that we have the right investments as we think about our expense base going forward. So we've been extremely prudent and disciplined as we think about the base over the last especially nine months that we've seen with this type of environment. Got it. And I guess just a separate question around market activity obviously highly uncertain how investment banking activity shakes out. But if the Fed were to power and the central banks have done with the majority of the rate hikes, is that enough to drive a rebound in M&A, ECM, DCM? Or do we need a lot more in terms of just confidence returning to the market before we see IB activity picking up? Like what are you hearing for the clients? Sure. Why don't I start and if James has anything to add? I basically say that from -- if we think about the Investment Banking pipeline, the pipeline itself isn't what's changed. What's changed is that movement from the pipeline to realize. And when we think about what will cause that, that policy pivot, a peak in inflation, something that allows the CEOs that are actually having those conversations in boardrooms to have more confidence both with their own economic outlook and -- or excuse me, our own company outlook, the economic outlook that hinges on and then also just price clarity valuation certainty. Those are the things that as you think through it, we would expect to see move from the pipeline stage into the realized and announced stage. So the macro environment that you laid out where there is more clarity on the economy and then also a reduction in volatility should help that move forward. Yes, I would say I think Sharon stayed right. And I am highly confident that when the Fed pauses, deal activity and underwriting activity will go up. I would bet the year on that, in fact. CEO's job is to drive growth in their businesses, and they do that two ways, organic and inorganic. And I've been doing this a long time, and I've done both. And the only tricky part about inorganic once you've got your strategy set is timing. And sometimes, you've got to ignore timing, but if the market is really volatile, it behooves CEOs, particularly those relatively early in their careers to be a little cautious, and that's what we're seeing. That will change. And just like to wish Jon Pruzan best of luck, looking forward to watching his next chapter play out. So Sharon, would love to double click on your expectations for NII. I hear you that it's sort of based on the forward curve playing out, and encouraging certainly to hear it's not peaked. But could you maybe give a little bit more color around expectations beyond forward curve? What do you assume for deposit dynamics? Do you think that the decline in sweep balances will continue to decline? What's underlying that? Thanks. Sure. So, let's take a step back and just say, why did we outperform in the fourth quarter, Brennan? And if you think about that, we obviously -- when we look at the liability side, we outperformed there, and we performed on the asset side. So if we unpack a little bit of the liability side, I take it into two pieces. As you highlighted, it's obviously about the deposit mix and also about pricing. So what we've seen in the deposit mix is that we have seen a moderation in the pace of outflows of those CDPs. Obviously, what -- where we will go from here, we'll need that to play out. But that is something that we take out into account when we think about the first quarter guidance. The second point is, obviously, on the actual liability pricing, we did see an outperformance of that pricing. And when we exit the first quarter, we take that in -- exit, excuse me, the fourth quarter and take that into the first quarter, that's a benefit as well. So, the Fed hiking 125 basis points over the fourth quarter and then being able to have disciplined pricing over the fourth quarter will serve us well in the first. Okay. Thanks for that. And then certainly different question. Wealth Management, if we look at the client asset trends, they were barely up quarter-over-quarter. Basically, total client assets in wealth were up about the equivalent of the net new assets and can clearly see that self-directed and workplace were a little weak, probably because their exposure -- more exposure to the Qs and the more growthy stocks. Was -- but I would think, given what we saw in the markets that there'd be a bit more of a tailwind to client assets. Was there anything unusual that was happening there? No. Actually and what you highlighted is broadly correct in terms of where you see the broader exposure, the underlying exposure of those different channels. So, it's just a function of the assets that you actually see as well as the mix of the underlying assets based on the channel. So wanted to dig in a little bit further, Sharon, as it relates to Brennan's question on NII. The two pieces I want to understand a little bit better is, one, what are you assuming for SBL growth in the coming year or even loan growth broadly across the wealth complex? And secondly, you saw really nice deposit growth in the fourth quarter. I wanted to understand how much of that is a function of tax loss harvesting that you expect to be redeployed? Or do you think any of that deposit growth is actually going to prove to be a bit stickier? Sure. I'm just going to take them -- I'll take them in order. The first is, as you asked about loan growth. The NII guidance in the first quarter is not dependent on the loan growth projections. Obviously, the loan growth itself will be a function of the environment. As I said, from an SBL perspective, we have seen some pay downs and it will be dependent on market conditions. Now, the second quarter -- the second question that you asked me around the deposits and the deposit growth, obviously, there are -- there could be a portion of it that does come from, as you mentioned, different inputs that you might see, be that interest, et cetera, in the end of the fourth quarter. But broadly speaking, what we've seen with the deposit base is that we have many channels, i.e. savings, for example, where we can begin to get those deposits and attract new deposits to the institution and to the bank from other sources, external assets held away that come in. And also, as you think about every piece of NNA that comes in over time, the $1 trillion that James mentioned, there's generally a portion of that, that's actually held from a cash perspective. And so that, I think, also needs to be taken account when thinking about the build as you go forward from the deposit, a longer-term deposit perspective. That's great. And just for my follow-up, as it relates to the trading outlook, I thought you guys did a really nice job of articulating some of the potential sources or drivers of inflection in Investment Banking activity. Admittedly, we've experienced a couple of years of pretty gangbusters trading and market activity. I was hoping to get your perspective on how you're thinking about the outlook for the trading businesses. If you're willing to go so far as to suggest what normalization might look like across both FICC and equities would be really helpful. Sure. I would look at it more holistically from an institutional perspective. And so when I think about what does it mean? We entered -- I remember doing an investor conference in February of last year. And we talked a lot about what is normal and is 2019 normal. And our answer then was we would expect to actually normalize somewhere between 2019 and 2020 from an industry wallet perspective. In fact, it looks as though the industry wallet has just been right around that range within those two bonds. And when we look ahead, we would expect to remain above that 2019 level, and we'll have to see what the upside is. But a lot of that growth in Sales & Trading has come from the divergent central bank policies and has also come from the fact that you have higher yields, right? So when you think about investing in the fixed income product, and you go into that going forward, that could create different dynamics than we would have seen over the earlier 2010 through 2019 or '17 outlook for Sales & Trading. I wanted to follow up on the wealth business and the rollout of the companion accounts and the 90% that you've headed. Can you talk about the behavior change or what has happened subsequent to clients receiving those companion accounts and try to get a sense of what that could mean on a longer-term basis in terms of increased activity and asset flows? Absolutely, as James highlighted in his prepared remarks, the intention is to generally be in a position where we're able to offer the right type of advice and content and wealth advice over the course of time when we go into the workplace. And so when we think about the retention of assets or we think about the companion account rollout, eventually, what that's really doing is to make sure that we've provided content. We look at content, as I've said before, as a passport into the employees. And you think about that as financial wellness. Something that Jed highlighted in his presentation in the spring is, generally speaking, will you see $1 of vested assets that come into the institution through the stock plan business, we actually see approximately $9 compared to that $1 that come from assets held away. That's the consolidation of assets once you have this advice-based channel and the advice-based relationship. And so, what we're trying to do is build on that. We have an FA referral process. We continue to use technology to help match the right individuals with the right FAs. We have better relationship management within E*TRADE and making sure that larger accounts are also connected appropriately to the right teams. These are all ways to build the right advice for the right clients to provide them choice and give them a reason to bring assets held away into the institution. Got it. Okay. And then just as a follow-up, you talked about the longer-term efficiency potential. But I guess the thing about fourth quarter, there was some severance looking at non-comp expense as you think about next year. I just want to understand how we should think about the base level of expenses and potential changes and/or where you're looking to be more efficient into this year? I mean, we're always, as I said in my prepared remarks, looking at efficiency opportunities where there might exist. We just, as you highlight through the severance, we just had a December employee action. So, we obviously walk in with a different level of comfort as we kind of think about the expense base going forward. But as we've done with our own resources from a capital perspective, we'll remain nimble and prudent, and look forward if and as the economic environment changes. I think just on the efficiency ratio, it's worth pointing out and Sharon mentioned this earlier, if you actually average the last two years, '21, '22, you end up right at 70%. '21 was about 67, '22 at 73. Part of it is revenue driven. We took the efficiency that will take some expenses out in the coming year. We also want to feed the beast. I mean, we're growing parts of this firm. We're trying to -- we don't -- we're not of the view that we're heading into a dark period, whatever negativity in the world is out there. That's not our house views. So we want to make sure we're positioned for growth. This thing will turn. M&A underwriting will come back. I'm positive of it. So, we want to be well positioned for it, but we're going to manage to that number of around 70% as best as we can. I have a bigger picture. James, you gave us some very good detail about the expectations for growth in the Wealth Management and the new assets, $1 trillion every three years. When you're looking at your three channels, the advisor-led workplace and self-directed, where do you see the most growth? And which one has the best margin that can get you to that 30% goal? Well, the advisor is the biggest, obviously, by far. We have 15,000, 16,000 advisers, phenomenal business. The direct channel is from the acquisition of E*TRADE combined with our Morgan Stanley Direct, great business. Obviously, it's a little more market sensitive, a little more active, particularly on the option side during bullish market environments. And the workplace is sort of the sleeper. I've said previously, I think, two years ago, I thought in a decade, we'd look back at this firm and say that the workplace was the most significant strategic change to happen over the last decade. I truly believe that the workplace employee, the retirement space is sort of the next frontier, and we're right in the middle of that. So as to margins, they're probably margin accretive in reverse order. In other words, workplace first, the direct second and the adviser third, that's simply a function of advisers. We have adviser payout, and God bless them for the jobs that they do, and we're very happy to pay them. So I think it's a combination, Gerard, of all three of them. We will hit the 30% margin. I mean, we're almost there now in a more challenging environment. So that zero anxiety about whether it's this year or next year, it's coming, and all of them will contribute. Very good. I appreciate that. And Sharon, you talked about the marks that you took in the corporate loan portfolio in the quarter, just over $350 million, I think you said. Can you share with us how big is that portfolio? And where did the marks come from? Were they bridge loans? Or what drove those marks? So you have different disclosures as it relates to various loans and lending that we gave. As we think about that line, it's inclusive of losses across the loan portfolio. And it was also worth highlighting there that we also mentioned the interest that you received on the loans that we hold as well as the fees associated with those loans. James, last quarter, I asked you when will you be ready for plan B if the pipeline doesn't seem like it's going to be converted, and you said you're at plan A minus, so just kind of looking for an update there. And in terms of the headwinds, if I hear you correctly, it sounds like the pipeline is still good but down quarter-over-quarter because some of those deals have converted. And also, you said it's still not back yet. And as it relates to the Twitter financing, you were the lead bank. Can you disclose any write-down that you had on Twitter or simply the leveraged loan category? So that's the headwind. On the other hand, I guess, there's been some reports that you've reduced headcount. So if you could just give us more color on that, especially Twitter? Okay. Let me try and unpack that a little bit. I'm not going to talk about Twitter. We don't talk about single names as you would expect. You did see the line -- the other ISG line. You can assume that whatever marks we took on any single name are reflected in that. And I think the way I think about this is we run a portfolio business. We obviously have single credits at any point in time that disappoint relative to others. But it's the total package, and the total package, if you look at it actually turned out to be very fine given the environment we're in. So on the plan B, I don't know if the rip we did -- we took about 1,800 heads in early December, would equate to a plan B. It certainly felt like it. We've reduced -- we took a severance charge, Mike, which affected some of the efficiency ratio for this year, but we'll improve it for next year. And that was the rightsizing. We were frankly a little overdue. We hadn't done anything for a couple of years. We've had a lot of growth, and we'll continue monitoring that. Obviously, with the way bonus pools work, we reflected the performance of the firm in the bonus pool. So we're not very different from the rest of the world in that regard. And that obviously resets comp a little bit. So, I feel good about where the whole package is. I'm actually, as I said earlier alluded to I'm a little more confident about the long -- medium-term outlook for the market. I'm not talking about the first quarter or two, although Sharon said the first quarter has actually started well. But the medium-term outlook for the markets, I see the Fed has moved from 75 to 50, likely to go to 25. The next stop on the train line is zero and then to mention they start cutting. Not sure they're going to cut this year, but I think there'll be zero increases this year for sure. So that's the inflection point. And there's a lot of money sitting around waiting to be put to work. And that's our job is to be the flow of capital between those who have it, and those who need it. So I'm pretty confident actually about the outlook. So we're -- we've done our plan B, I guess. We're not anticipating a plan C. And we're going to watch and wait for a little while, but I feel pretty good about it. I was wondering if you could talk a bit more about the flows within Investment Management, both the long-term and liquidity and how you're thinking about the outlook there specifically in the long term? Sure, absolutely. The long term, obviously, what we saw over the course of this year was some movements in equities. That was the most notable. That obviously had to do with some of the higher growth specific -- the specific funds that we have there. But I think you have to really think about those long terms from a long-term basis, right? So you're just focusing on this year, but there were many, many years of very strong flows into that business. What's important is actually the diversification that we had because of Eaton Vance, where we have other products that we're able to offset some of the long -- some of the outflows in, say, the equity product, for example. So parametric is one where we continue to see inflows throughout even the course of this year. We're really focused on the secular growth trends, sustainability, alternatives and customization more broadly. Those are the things that we think as we move forward, we'll be positive for those line items. There are no further questions at this time. Ladies and gentlemen, this concludes today's conference call. Thank you, everyone, for participating. You may now disconnect.
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EarningCall_1670
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Hello and thank you for standing by. Welcome to the Stitch Fix First Quarter Fiscal 2023 Earnings Conference Call. [Operator Instructions] It is now my pleasure to introduce Hayden Blair. Good afternoon and thank you for joining us today to discuss the results for Stitch Fixâs first quarter of fiscal year 2023. Joining me on the call today are Elizabeth Spaulding, CEO of Stitch Fix and Dan Jedda, CFO. We have posted complete first quarter 2023 financial results in a press release on the quarterly results section of our website, investors.stitchfix.com. A link to the webcast of todayâs conference call can also be found on our site. We would like to remind everyone that we will be making forward-looking statements on this call, which involve risks and uncertainties. Actual results could differ materially from those contemplated by our forward-looking statements. Reported results should not be considered as an indication of future performance. Please review our filings with the SEC for a discussion of the factors that could cause the results to differ. In particular, our press release issued and filed today as well as the Risk Factors sections of our annual report on Form 10-K for our fiscal year 2022 previously filed with the SEC and the quarterly report on Form 10-Q for our first quarter of fiscal year 2023, which we expect to be filed tomorrow. Also note that the forward-looking statements on this call are based on information available to us as of todayâs date. We disclaim any obligation to update any forward-looking statements, except as required by law. During this call, we will discuss certain non-GAAP financial measures. Reconciliations to the most directly comparable GAAP financial measures are provided in the press release on our Investor Relations website. These non-GAAP measures are not intended to be a substitute for our GAAP results. Finally, this call in its entirety is being webcast on our Investor Relations website and a replay of this call will be available on the website shortly. Thanks, Hayden. As we stated on last quarterâs call, following a transformative year with the rollout of Freestyle, we began fiscal year 2023 with a clear focus on growing our client base and achieving profitability. As the macroeconomic environment continues to be uncertain, we are now further balancing the need to optimize our cost structure against achieving the long-term growth objectives of the business. We are confident in this approach and are determined to use this moment as a catalyst to create a leaner, more nimble and profitable Stitch Fix, while continuing to enhance the experience for our clients. In fiscal Q1, the retail industry experienced a meaningful pull forward of the holiday promotional environment, which continues to be more pronounced than expected due to weak consumer sentiment and excess inventories. We believe this resulted in lower client spending and also had a large impact on our net active clients, which declined 11% year-over-year. Overall, Q1 net revenue declined 22% year-over-year to $455.6 million, which was at the low-end of the range provided on the Q4 call. Despite this, we continue to deliver on operational efficiencies and cost control, which enabled us to beat our provided outlook on adjusted EBITDA and negative $7.4 million for the first quarter. Dan will provide more details on the quarter in his section. Today, I will discuss our plan for the balance of 2023 in a few key areas. First, our focus on profitability and how we plan to further simplify our cost structure to create a more efficient operating model; second, how we continue to strengthen our client experience with an emphasis on our biggest differentiators of discovery, fit and human relationships; and lastly, how we are evolving our marketing strategy to reach our focus on engaging and reactivating the audiences that already know us. First, on our focus on profitability and a leaner operating model. On the last call, we said that we recognized returning to positive adjusted EBITDA and free cash flow with the utmost important. This remains our central focus and the continued uncertain macro environment underscores the value of a leaner profitable business model that will allow us to adapt quickly in the future. As such, we are increasing our FY â23 cost reduction targets that we announced two quarters ago to $135 million from the $40 million to $60 million previously discussed. While much of the new reductions will come from advertising, which I will discuss more later on, we are also targeting more fixed and variable productivity in a number of areas. We recognize we need to operate the business more efficiently and focus on the areas most critical to move us forward in the current environment. We believe we can execute these initiatives while simultaneously enhancing our client experience and without compromising the long-term growth potential, our highly differentiated business model presents. To reinforce, our biggest focus is on achieving profitability. That said we do want to give you an understanding of what we are working on in the background that is foundational to further enhancing our client experience. Our clients choose Stitch Fix to find items they would not have otherwise found for themselves for the tremendous convenience our styling service provides and for the personalization we deliver in client style and fit. We are the leaders in providing personalized styling support through our fixed model which together with Freestyleâs on-demand styling features like shop your looks and trending for you drive higher conversion and lower return rates relative to traditional e-commerce retail. Knowing this, there are two specific areas of opportunity we are focused on enhancing to grow and retain our net active client base, making it easier to enter our ecosystem and ensuring our clients feel consistently heard and served in a personalized way to keep them coming back again and again. In terms of entering our ecosystem, we made progress in the first quarter, testing a new outreach strategy to a large number of signed-up prospects who have not yet purchased from us, which increased conversion by 30% over last quarter. We are also working on faster sign-up processes and more personalized search-based landing pages to continue to make it easier for clients to get started with Stitch Fix. In terms of feeling heard and served in a personalized way to keep clients coming back again and again, we see clear opportunities to improve client retention at critical moments with fixed preview and fixed checkout. For example, we know that when clients keep at least one item and are looking forward to their next fix, they are likely to have multiple future fixes. The inverse is also true. If a client buys zero items in their first fix, they are 3x is likely to cancel their auto shift than clients who bought one item. Given the criticality of these moments, investing multiple new ways for richer interaction and listening. Both the four clients receive their fix as well as when they share feedback if we havenât hit the mark. One test underway includes stylist experts contacting first-time clients who purchased zero items to get to know our clients better and to proactively suggest replacement items from Freestyle for the client so that we can get it right. We expect this higher level of personal touch and communication will be meaningful in improving client happiness and ultimately improve retention. And lastly, we are evolving our marketing strategy to increase our focus on engaging and reactivating the audiences that already know us, while continuing to lean into new acquisition channels. This is a critical step towards increasing profitability as we will reduce marketing spend in the back half of the year. As a business, we have relied on digital performance-based channels and lower funnel spending on client prospects. While these channels did and still prove to be successful, they are now less efficient than they once were. In addition, we have a pool of over 10 million consumers that have already interacted with us, but have not recently or ever made a purchase that we can more directly target to bring back into our ecosystem. Recent testing showed the cost per acquisition for reengagement of this pool is significantly less than prospective clients who have never interacted with us. Our experience has continued to evolve and we want to reach those clients who already know us and help them rediscover their love for Stitch Fix. In addition, we are continuing to expand our under-penetrated marketing channels, such as affiliates, influencers and SEO SEM, which will take time to develop into meaningful contributors, but will be important over time for new customer acquisitions. In summary, we remain confident in our unique and differentiated business model and the long-term opportunity ahead of us and we are adapting to meet the moment in these uncertain times. By focusing on these things within our control, we will continue to set ourselves up to achieve adjusted EBITDA and free cash flow positivity in the near-term while maximizing our long-term potential. Thank you, Elizabeth and hello to everyone on the call. Q1 net revenue declined 22% year-over-year to $455.6 million, which came in at the low end of our guidance due to lower net active clients and a pull forward of holiday-related promotions across the industry. The deep discounting the industry has experienced well in advance of the normal holiday season, particularly impacted October Freestyle revenue. Adjusted EBITDA for the quarter came in at negative $7.4 million, which was above our outlook largely due to effective cost controls as we continue to drive towards our goal of positive adjusted EBITDA and free cash flow. Net active clients in the quarter declined 11% year-over-year to $3.7 million. While this was an improvement from the sequential loss from Q3 to Q4 of last year, net active clients were lower than what we expected at the onset of the quarter. While we are seeing an increase in new active customers, we continue to see a high number of customers delaying spending partially due to the macro environment. Revenue per active client was approximately flat year-over-year at $525. However, our analysis does show that clients are spending less across a broad set of cohorts and we expect this to continue given the economic backdrop and the deep discounting we are seeing in the retail industry. Q1 gross margin came in as expected at 42.1%, down 490 basis points year-over-year, driven primarily by higher product costs, higher clearance and unfavorable transportation costs year-over-year. Sequentially, gross margin was up 210 basis points from Q4 due mostly to improved inventory reserves. We continue to believe gross margin will be approximately 42% throughout the rest of FY â23. Advertising was 9% of revenue in the quarter. For the remainder of the year, we expect advertising as a percent of revenue to be lower than our historic rate due to the marketing shift Elizabeth discussed. We will be laser-focused on spending advertising dollars where we see near-term positive ROI and we will continue to build out new marketing channels. For the remainder of this year, we expect advertising to be approximately 5% to 6% of revenue, but we will continue to evaluate our advertising spend to ensure we are managing to the right return on investment. Net inventory grew 20% year-over-year due to higher receipt volume. We did expect this higher inventory given our long lead times from order placement to receipt of inventory. We aggressively adjusted our bond in Q4 of last year and we expect inventory to come down sequentially in Q2 and continue to decline in the second half of the year. Free cash flow for the quarter was negative $16 million and we ended the quarter with $209 million in cash, cash equivalents and highly rated securities. Now on to our outlook. The challenging economic environment increases uncertainty around the trajectory of net actives and therefore, revenue as we look forward. We know that high rates of inflation are impacting consumer purchases and high levels of inventory are impacting pricing with deeper discounting across the retail industry. Additionally, we are reducing our advertising spend amidst a very promotional holiday season. In these times, we are less certain how the revenue story plays out for the rest of the year. And so our goal continues to be managing our overall costs while continuing to focus on improving our client experience, with the goal of becoming adjusted EBITDA and free cash flow positive in the near-term. In light of this backdrop, we anticipate revenues to be between $410 million and $420 million for Q2 as we continue to see pressure on net active clients and expect the holiday promotional environment to continue throughout the end of the quarter. We expect adjusted EBITDA for the quarter to be between negative $5 million and positive $5 million, primarily reflecting our ongoing cost structure efforts and a reduced level of advertising spend. Given our current visibility around our marketing and retention efforts and balancing the uncertainty in this challenging backdrop, we are lowering our full year FY â23 revenue guide to be between $1.6 billion and $1.7 billion. This assumes no material change in the current competitive landscape and macro environment from where we see it today. Despite this, we are raising our outlook on adjusted EBITDA for the year to be between negative $10 million and positive $10 million reflecting our reduced advertising levels and ongoing cost management initiatives. Before we turn it over to Q&A, I want to remind everyone that even at current levels, our unit and order economics continue to be strong, with contribution profit, excluding advertising in the range of 25% to 30%. We know there is further opportunity to improve both fixed and variable costs and therefore, we see an opportunity to increase our contribution margin in addition to improving fixed leverage. In the meantime, we will continue to focus on the things we can control, deepening our differentiation improving our client experience and rightsizing our overall cost structure, all with a focus on near-term positive adjusted EBITDA and free cash flow. During this sets us up to be in a strong position, producing healthy and profitable leverage as the economy improves and for a return to growth. Great. Thank you very much. Hi guys. So just a couple of questions for me. One, on the last earnings call, you guys talked a little bit about some of the new product enhancements, personalization features, efforts that you guys were doing to drive engagement and improve the user experience. You also had a brand campaign that was launched, if I remember correctly, in mid-September. Can you just speak to the one, the efforts you are making, where are you there? Second, how the campaign did relative to your own expectations? And then broadly speaking, how are you kind of positioned for the rest of the year from kind of an inventory standpoint? Where would you like inventory to be at the end of Q2? Thank you. Hey, thanks, Youssef. I can take the first part of that and then Iâll let Dan speak to our inventory position. On the customer experience, I think I alluded to some of this on the call, but we are pleased with the progress that we are making on clients entering our user experience. That was an area that we have been focused on over the last several quarters and we are significantly off our lows in new client conversion, which gives us confidence that we are doing the right things to create an even more seamless entry into new to Stitch Fix customers and thatâs starting to pay dividends. We did things like improved our dynamic landing pages depending on where clients were coming from, including some improvements to the style quiz and we have begun to experiment with what we are really featuring and talking about in terms of how it works in the Stitch Fix experience and sort of the unique differentiators of our styling experience. And we are leaning into further improvements on that as we enter Q2 with things like delaying our e-mail capture, one-time login, just areas that we are very aware of, that create friction. So pleased with the progress that we are making and continuing to focus on doing more there. More broadly, within the user experience I also had mentioned these kind of critical moments of truth within fixed preview as well as within the checkout experience. And so we have made a number of improvements on how we are surfacing inventory to our clients. I mentioned fixed preview, that one were a little bit â that as we launched and rolled that out over time increased our overall AOV and retention as we rolled that out a year or two ago. We now see kind of the next wave of improvements of client listening and learning, and weâre eager to dive in there. We like what weâre seeing in these very early tests, but weâve yet to scale them and more to come over the coming quarters. And then kind of related to the â those landing pages and how weâre educating consumers, thatâs a good bridge into your question on the brand campaign, that was the first time we had done a campaign that was consistent across the UK and the U.S. and really focused on an always on messaging around how it works and really educating consumers on the unique differentiators. And so the consumer qualitative feedback that weâve received from that is strong. We like what weâre hearing in terms of consumer appreciation of the value proposition. We also saw some improvements in organic traffic conversion that we think could be attributed to the relevance of that campaign. Itâs something that we imagine kind of being layered within how our influencers are talking about Stitch Fix, how we talk at â within TV and OTT. So itâs something that we anticipate we will build on in the future and is part of really conveying our unique value proposition. I will let Dan touch on the inventory position question. On inventory, as we mentioned in the prior call, we did expect us to increase inventory, and we did expect this quarter, the $220 million to be the peak. And we are seeing that decrease throughout November and even through the first week of December. So the trajectory is right where we expected. We will be lower in Q2. Weâre going to continue to be lower in Q3 and Q4 sequentially because we have rightsized our buying for the second half of the year. So that inventory will go down, and I suspect it will be negative on a year-on-year basis in the back half of the year. Thanks, everyone. I hope youâre doing well, and have a nice Thanksgiving. I was hoping you could give any color on gross versus net adds maybe a client this quarter. And then if I heard it correctly, and apologies if I didnât, and I was hoping you could elaborate a little bit on the comment about consumers having choice where to shop impacting the net adds. I guess that sounds a little bit more typical for traditional retail. So I guess you guys had been maybe insulated given the loyal fixed shoppers. So are you seeing a pivot in the existing base or the customer approach to your company? And if the active client positioning is now competing against traditional retailers, does that change how you focus on running and forecasting the business? Again, if I mistake or misheard, I apologize. Thanks, guys. Yes. Thanks, Simeon. I can start, and Dan, feel free to chime in as well. So on the gross versus net adds, I think Dan touched on that, where we did see an increase in clients in our gross add quarter-on-quarter, so Q1 versus Q4. That said, we also saw an increase in clients who havenât shopped with us in 12 months plus, and that is something I think we attribute in part to the macro environment and just to pull back that overall, I think the category is seeing in retail spending. We believe that a lot of the efforts that weâre focused on in terms of retaining clients longer, improving the experience, reactivating clients, some of what I talked about on the marketing front, all will be important in terms of driving improvements over time. The competition with traditional retail, I think what we were referring to there is quarter-on-quarter, we did see increases in things like our AOV, and our average unit retails. That said, we did see softness in Freestyle relative to what we would have anticipated. And we could see, as we compared it to a lot of the pull forward in the promotional calendars of other players in the space that we were impacted by some of those promotional offers that happened August, September, just far earlier than we typically would have seen. And then I think Dan mentioned the cohort to cohort spending. Our consumers are telling us that in this macro environment that they are just being more judicious with their spending. And so while our keep rates and our average order values are holding steady, we are seeing some stretching out of frequency and stretching out of those freestyle purchases. So we still believe we are very unique in our core value proposition. We compete on things like Discovery and fit in human relationships. That said, I think Freestyle in particular, is probably more impacted by really, really promotional environment, which we saw in particular in that August, September, October time frame. Got it. Thanks, thatâs very helpful. And then just, Elizabeth, maybe just a follow-up on that comment you made about the quarter-over-quarter ASP. How was the year-over-year ASP this quarter? Yes. I think quarter-over-quarter, we saw a few percentage points increase on AOV and similarly on an ASP basis, in part I think ASP was over 10% up quarter-on-quarter. Part of that is seasonal. We do see it leaning into outerwear and goods that are slightly higher priced. But overall, I mean, we saw health, I would say, in general, within our AOVs and average unit retail, I think itâs more maybe a frequency of spending that we saw more of a pullback. Good afternoon. Thanks for taking my question. With respect to the shift in marketing strategy, is this a temporary shift in the current macro? Or what are the proof points that you want to see in the transformation to give you confidence to more aggressively go after the TAM of consumers who havenât engaged with the platform before? Yes. Thanks, Mark. I it is in part a response to the environment but also a really strong belief that really happy clients and reactivating clients are some of our best channels for marketing and believing there is opportunity to further expand those. In addition to the areas of TAM expansion into some of these new marketing channels that weâve just historically been underpenetrated. One thing I think we were very deliberate about and I think Dan mentioned this in his remarks, as did I, is just being very focused on near-term positive ROI. And so I think what we really work through is just being more deliberate and really raising the bar of our payback thresholds, which weâre always very disciplined. We just essentially made the decision given the ambition of free cash flow positivity, EBITDA positivity and just what weâre seeing in the macro backdrop to be even more disciplined in terms of those payback periods. We are also using it as an opportunity to go even faster at really doubling down on opportunities to reactivate clients that have loved us in the past. That pool and that opportunity has obviously grown over time as we become a more mature business. And so Dan mentioned the 5% to 6%. Thatâs our best view for the full year. But we will learn over the next few quarters. And based on the paybacks weâre seeing, we may opt to spend more as we go forward. But itâs not a permanent shift. Itâs more letâs learn into this and be even more disciplined on paybacks in the near-term. Thank you. And then a follow-up on Freestyle, does it make sense that the heavily promotional backdrop would impact engagement there? What are you doing or what can you do to kind of manage your competitive position in such a dynamic price environment? Yes. Itâs a great question. I mean I think weâre very focused on, first of all, just continuing to invest in our biggest differentiators, things like outfitting, things like focusing on new arrivals that are most relevant to each of our clients. Part of what weâre hearing from consumers is making more value out of the wardrobe that they already have. And we know that our output-based feed showing new arrivals in the context of outfits is highly converting. One example recently is, we do a new outputs e-mail every week. We added dynamic content thatâs one-to-one for each consumer that shows them how to wear items through our new arrivals that bespoke to each client, and we saw a 30% increase in conversion rate on those e-mails. So part of our strategy, I think, is just being more relevant and differentiated on the things that make us special and relevant week to week and moment. I think the other is we never really had any sort of limited time offer, clearance valves, pre-free style. So over the course of this year, we have been experimenting with episodic events that we feel like meet the moment within the promotional calendar, roughly, I would say, around once a quarter. But our goal is not to become a promotional retailer, but to really deliver value on these differentiators of discovery fit human relationship and really focus there first and foremost, while also recognizing Freestyle creates an opportunity to map more fully to the retail calendar and be relevant with what consumers are seeing. Hey, good evening, guys. Thanks for taking the question. I guess, first, itâs a bigger picture question and making sure weâre framing this correctly. Are you effectively saying that until the environment becomes less promotional that youâre going to kind of trade off net adds or profitability? And are we fair to assume that until that changes that net adds will remain negative, and then as a follow-up, as you think about the promotional environment staying particularly prolonged, I know that youâre obviously not in the percent off game or coupon game, but are there other ways you can drive a stronger price value relationship if thatâs what the consumer ends up pivoting towards? Thank you. Yes. Thank you, Ed. On the first point, in terms of where weâre focused, I think both Dan and I emphasize that, that first and foremost, this return to free cash flow positivity and EBITDA profitability is our main focus. So we are very much emphasizing that. And I would say, given the current macro environment and then this deliberate and intentional decision to pull back on marketing spend for the focus of being very near-term ROI positive. Weâre not predicting a return to inflecting that sequential net active client base this year. That said, all of the things that weâre working on that I talked about in the background, both the client experience to improve retention. Adapting our focus on marketing to do more with the clients that already know us we believe really sets us up for healthy client growth in the future, particularly as the economy improves. So I would say weâre very focused on profitability together with the most critical places of our customer experience. And then on the promo environment, we have always had our buy five discount within the fixed offering, which we know delivers value to clients. We have our Style Pass offering for customers that have kept over 10 items where we offer them essentially unlimited fixes. Those are places that we see as a jumping off point. for the expansion of our loyalty program over time. Nothing to announce there yet, but that is on our road map to deliver value to our customers really across what we now know is such a compelling ecosystem between fix and Freestyle and to some extent, an untapped opportunity to really bring all of those elements together in a more systematic program. So we definitely see something there down the road, nothing specific to announce just yet in terms of timing. Hey, thanks for taking my questions. So first one on the revenue guidance for the year. So Q1 fell within your range, albeit towards the lower end, so did you see trends slow materially towards the end of Q1 and so far in Q2 have you subsequently adjusted each quarter of the year down further since then? Just how should we think about the change in the pace of which it took shape in terms of the revenue guidance for the year? Yes, Iâll take that one. We did see, as we mentioned, some impact of the deep discounting in the retail industry, which impacted our October sales which is the last month of the quarter. And on a go-forward basis, how weâre looking at the revenue guide is a function of what we saw in the holiday period and the deep discounting and expecting the macro environment to continue as is, but also taking into account some of the marketing initiatives that weâve talked earlier in the call. So the way I would think about that guide going forward is itâs more of a similar change on a year-on-year basis for the rest of the quarters as it is just given that the guide that we gave of the negative the $1.6 billion to $1.7 billion for full year revenue. Got it. And then my follow-up, just bigger picture, if we step back, do you think your inventory position is holding back revenue growth and client growth in some ways? Is there some type of larger inventory issue at play for Stitch Fix? And do you need sort of a reset or a refresh in order to again connect with your core customer base? I mean I can start, and Dan, feel free to chime in. I mean, I think we feel like over the course of the last year plus, we introduced a really healthy mix of national brands together with our strong exclusive and Stitch Fix only brands, which is the latter make up the majority of our inventory. We onboarded north of 80 brands in FY â22. We have been able to grow our different product categories with Freestyle in particular, like footwear and outerwear and dresses. And we have a refreshed rebuy approach to our exclusive brands that makes us reasonably adaptable that we will keep leaning into. So I think we actually have a lot of the right product. Now of course, for true category expansion, getting into the layers of growth we see possible as we really go after expanding our TAM. That, I think, is setting ourselves up as we work towards this fiscal year on some of the client experience, some of the other work that weâre focused on in the background are things like a unified data platform, which I think Iâve mentioned some of this on prior calls that our infrastructure was built very rapidly to scale our fixed business into multiple lines of business like womenâs, menâs, kids in the UK. It didnât have the foresight to know weâd launched Freestyle or the fourth site to say letâs get into a lot of different product categories. So we are essentially slowing down a bit to speed up in the future by preparing our infrastructure so that we can add on more of these new categories as we get into fiscal year â24. But that all said, we feel like we have the right assortment for our consumer. Weâre very focused on a combination of what we call our super mom within womenâs as well as leaning into a fashionista, and we know weâve actually grown the penetration of that fashion used to client over the last 12 months. This is Jesse Sobelson on for Ike. I was just curious with the Freestyle offering being a little bit challenged with the promotional environment today, do you guys ever plan on evolving the offering to be maybe more in line with general retail business practices and the general retail landscape with the calendar promotions and such? Thank you. A lot of traditional retailers typically exhibit promotions on a typical calendar such as deeper discounts during the holiday period or summer sales depending on whether it is for selling, whereas I kind of understand Freestyle to be a little bit more full priced. So I was curious if there was any interest in potentially adapting the offering to be more in line with the cadence of some other apparel distributors in the industry? Okay, got it. Yes. So I mentioned this a little bit earlier. I guess a few things I would offer. First, in terms of some of our highest converting areas within Freestyle, I think weâve shared this in the past between 40% to 50% of our conversions happen in outfit-based shopping, which is a big differentiator. Weâre helping clients see what items could go with something that they have already purchased as well as output-based shopping based on what we think is trending for them as well as in any of our product detail pages being able to see items in the context of algorithmically generated outfits as well as outputs that have been curated by our stylists. So, those characteristics, one thing thatâs interesting as we have done episodic, limited time offers now that we can flex that muscle similar to traditional retail is that we see a halo effect to full-price items during those same time periods as people come into the site experience. So I think we absolutely will continue to experiment and likely lean forward. We had our first Black Friday, Cyber Monday event, which we saw good lift in terms of what we were able to offer our clients in that window. But I think we really want to strike a good balance of being relevant in those seasonal time periods, but ultimately do what we do best, which is differentiated based on style discovery fit. And as I mentioned to one of the prior questions I got on the notion of loyalty, weâve always had the Style Pass but we see down the road, no time line yet to share here being able to offer just rewards back to our clients the same way they are rewarded if they buy five items in a fix. So I think rather than trying to just replicate the retail calendar, we would like to be really focused on whatâs unique to us. Hi, everybody. Thanks for taking my question. Is it safe to assume that the cut to the revenue guidance is predominantly because of more conservative assumptions, a lot Freestyle [Technical Difficulty] when the business inflects if you start growing again, it would be predominantly driven by a recovery in the Freestyle business? Thanks. Hey, Tom, you cut out a little here. I think Iâll let Dan answer but just to play back, I think your question was, is the reduced guide largely driven by Freestyle. Was that the question? Or can you just clarify? Yes. I can take that. It wasnât driven entirely by Freestyle. We talked a little bit about the reduction in advertise, talked a lot about the reduction in advertising. Certainly, thatâs some of the reduction in revenue that we guided to. We also â part of that is just the net actives and where we are today. And so while I do think Freestyle will â as the economy improves, freestyle improvement that will help with growth certainly fix is critical and important to our business as well. And Elizabeth talked earlier about a variety of areas that we are focusing on to drive re-engagement, engagement in clients who have filled out their style profile, but never purchase with us, et cetera. So, that is also going to be the catalyst to grow going forward. And of course, the macro environment, as we talked about, will be a catalyst when that does improve as well. Hi. Thanks. Thanks for taking my question. A few, if I could. One is on the inventory side. So, I go back to Q3 â22 earnings call, where you talked about the supply chain and the improvements that you have made. And I am literally reading from the transcript. One of the big benefits of our business we can make adjustments pretty rapidly, especially given the nature of how many goods we are actually in control of directly? And I compare that to what you said earlier in this call today is the inventory was higher because of long lead time. So, can you help us understand exactly whatâs happening with the inventory? Are you in control of the supply chain? Are you not can you rapidly flex up and down? That will be the first. So, let me just explain. First of all, from order placement to receipt of inventory for a lot of our products, especially, of course, our exclusive brand product, which is made to order is about a six-month lead time. So, there are other areas, specifically within national brands and other areas that we can flex up or down in, but we have a fairly sizable exclusive product. And those are pretty long lead times. Actually, they are probably even longer than six months. So, what I was referring to in why our inventory was â is higher now is because we had placed those orders when we had a different demand trajectory six months to nine months ago. We have since adjusted, which is why we expect inventory to go down in Q2 and then continue to go down throughout the rest of the fiscal year. That said, where there are pockets of opportunity, we absolutely can chase into that demand depending on where it is, and we do that fairly well. But we do have these slightly longer lead times for exclusive and our â well, our exclusive product. Got it. Thanks. Second one would be, you have guided to 5% to 6% of some advertising cost of like 5% to 6%. That is significantly below anything that you did pre-COVID. And you were extremely disciplined even then. But what that means is, this quarter, your advertising spend was down 19% year-over-year when sales were down 22% year-over-year. For the rest of the year, you are guiding to sales being down 20% in each of the following quarters, but the advertising spread will be down about 50% in each of the quarters. So, what gives us the confidence that sales should not be even lower than the guide right now? Yes. Kunal. I can start on that, and Dan feel free to add on. I mean first of all, I think we have always been very disciplined about how we manage our marketing spend and I think we both touched on that to some extent. On the call, we are opting to be even more rigorous in the time period of payback than we typically are just in the spirit of the macro backdrop, this uncertain time and really ensuring that we have very near-term ROI on our marketing spend. A certain portion of our revenue, to be clear, comes from subsequent sales of existing clients that we are marketing to through channels like CRM and engaging them to come back in. But itâs not as much as the result of our paid spend. So, our growth rate is in part due by new customer acquisitions, but itâs also in part based on the installed base of our customers that are on auto ship and subsequent sales. So, I donât think you should expect to see a perfectly one-to-one correlation with that downshift in marketing spend relative to our revenue rate. I would say overall in terms of is that a permanent shift or not, I think we got that question earlier. We are going to measure as we always do, day-to-day, week-to-week and make adjustments accordingly. And some of the new areas that we have been leaning into that are underpenetrated for Stitch Fix, SEO, SEM, influencer affiliate as we start to see goodness there, we will begin to scale those. So, of course, that number may change over time. But I would say net-net, the delta between those two rates is that part of the growth rate as an installed base and part of the growth rate is new customer acquisition. Got it. Thanks. And one last one, if I could. And this is with regard to the comment around keep rates and we are flat, but we see stretching frequencies. So, is that â can you give us a sense of like how the frequency is stretching? And could that stretch into once every 6 months or once every 12 months in order to further push the fixes into maybe next year kind of thing? Yes. I can start on that. Our clients arenât all university â universally like every three months. We have a mix of cohorts, some of which you get fixes every six weeks, some of which are every three months, some of which are biannual. Itâs more that â and then a certain amount of our clients are what we call manual. They are episodically ordering fixes and they tend to occur at a certain frequency. I would say a few things are probably driving that stretching out. One is a little bit of stretching across all of those cohorts. So, itâs not like everyone is going from three to six. Somebody might have been six weeks and maybe they are skipping a shipment and then going back to that six-week cadence. It also â as we have slowed down the new ad cohorts, they tend to have some of the higher frequencies. And so some of the stretching is also a result of the mix shift of our client base in terms of the cohort age. But I think our goal is really overall on just continuing to be meeting the moment for our clients, helping their dollars go further with things like what I was describing with outfits being incredibly effective at how we are listening. And frankly, just having the right assortment. One thing we have seen is that we have sort of a sweet spot of where we have seen very strong velocity with price points under $100 blazer sort of contemporary apparel and womenâs at the $150 price point. So, just really making sure we are meeting them with what they are looking for, regardless if they are extending a little bit or at the same frequency that they have been with us over time. Great. Thanks. Just first on the increase in the cost reduction target to 1.35. Do you expect to realize all of that in â23 since most of that is advertising. And then within that, how much is really advertising and durable versus just more kind of near-term pulling back given the current environment? Yes. Thanks Trevor. I can start, but I definitely would love Dan to chime in here. As we said in prior quarters, we had that $40 million to $60 million, we shared that we were tracking to that and likely to go beyond it. Now, this increase to 1.35, a meaningful chunk of that is, in fact, advertising dollars together with fixed and variable productivity. In terms of when we will see it realized. Dan, do you want to just share more on that? Yes. That will be realized in our fiscal year. Thatâs how we â thatâs why we are quoting it the way we do because a lot of it is advertising. And when you model out that 5% to 6% of revenue, you will see that. And then of course, the remainder is a combination of fixed and variable efficiencies and leverage, which on the â to answer your second part, on a go-forward basis, as we mentioned on the advertising, that will be â we will look at that very closely. We will look at the ROI on that. We will spend into where we have near-term positive ROI and we are not â we are going to pull back where we donât. And so we will manage that very closely for the rest of the year and, of course, into our fiscal â24. And then the â on the variable and fixed, obviously, that is indefinite and wonât continue going forward as we see those efficiencies and take advantage of them. Good afternoon everyone. As you are talking about the customers delaying spending, is there any particular cohorts that you are seeing it from more or less? And then can you talk about product trends in terms of what you saw and in terms of pricing, both on Freestyle and what you are seeing requested and fixes? And lastly, with the advertising spend moving from 9% this year to 5% to 6%, what made 5% to 6% the right number? And what are you looking for to see if you need to increase advertising given what the revenue impact may be? Thank you. Yes. I will start with that, and I will ask Elizabeth can take the second part of that question. When we look at â itâs a good question on the cohorts, and we looked at this in many different ways across our cohorts. And we â I mentioned in my prepared remarks, we did see a broad spending reduction across all our cohorts. So, clearly, the macro environment is impacting spend, whether itâs a client who has in 50-plus fixes or a client in their first 15 fixes and regardless of tenure, we looked at it every which way. And while we had seen increasing spend quarter-on-quarter in these cohorts, for many quarters back, and even a couple of quarters back, we saw an increase. We clearly saw the spending go down across the broad set of cohorts in this latest fiscal quarter. And we do expect that to continue just given the high inflationary environment, the competitive landscape and the overall macroeconomic factors. And Dana, I can touch on the trends question and the marketing question. So, maybe I will start with some of what we saw in the quarter and some of the trends we are seeing and then we are about to release our style forecast, our annual sale forecast will come out next week, so I can give a preview of some of what we are hearing there from our 3.7 million clients, from our stylists, from consumer surveys and industry data, which are sort of our â some of our predictions for the coming calendar year. But in terms of what we saw this quarter, I would say in particular, for womenâs back to work, clients shifting into workwear over more of that casual end use that we saw a year ago. So, structured blazers was an area where we saw particular growth, a real sweet spot in the sub-$100 blazer price point. Those were up north of 120% year-on-year. We also saw a shift to address your outerwear with a variety of kind of workwear styles and silhouettes. We also saw strength within booties and heels against last year, up over 25% year-on-year. So, clearly, a female consumer who is going out again, night out and workwear styles that can transition into the evening. We also saw with men some similar, I would say trends in terms of going back to work, very strong velocity within our Workwear segment and with outerwear seeing strength in things like shirt jackets. And then kids have stayed more casual, I would say, with graphics and cozy attire. Within our forecast, some of the things that we are seeing now and coming forward is a real focus on getting back to holiday parties and holiday trends, brighter and bolder colors is something we are expecting in the future. And then a tendency towards wide leg bottoms, which started several seasons ago, but we are beginning to really see that shift occur in a more meaningful way. And then on the marketing spend, the 5% to 6%, I would say it was kind of a combination assessment of really being very focused on our free cash flow and EBITDA ambition for the year and really holding ourselves to this very strong threshold of the timeframe of payback, together with the belief that there is opportunity for us to be doing more in areas that I mentioned on the prepared remarks, like reactivation of clients who have not shopped with us as recently and being more productive going after those segments as well as that group of clients we often call our signed up prospects. And so together, that was our estimate of what we could do to still create momentum with clients but be able to really be more efficient in the back half of the year. Thanks. I think most of my questions have been answered. So, I will just ask one. Just on free cash flow and the ability to sustain positive free cash flow going forward, outside of the macro recovery, what would be the key factors that will cause that to happen or not to happen? Like what are the variables that you can most control outside of macro that will allow you to sustain positive free cash flow over the next several years? Thank you. Yes. I can take that. I mentioned towards the end of the prepared remarks, just our overall contribution margin which is very healthy at 25% to 30% ex marketing. And so really, it is that inflection on revenue, of course, getting â growing again at some point. We do feel like our order and unit economics are very strong. We are rightsizing our cost structure. We do have a lot of opportunity for variable productivity all of these work streams are in process and part of the cost savings initiative $135 million that we stated on the call. So, we feel good about the second half in terms of â and obviously, our EBITDA guide, our adjusted EBITDA guide shows that, that we feel good about the second half. And going forward, we do think there is leverage on top of that. So, itâs a combination of continuing on these areas that we â that we have embarked upon to streamline our cost structure. And of course, we will â we need to get the revenue growing again at some point, whether thatâs through category expansion and/or all the initiatives that we are working on right now, inclusive of the new marketing, the new advertising models that we have talked about. Mark, I would just â I think that really sums it up in terms of where we see that long-term return to free cash flow. I guess a couple of other things I would add on that gross margin side of things, the majority of our goods are exclusive brands, Stitch Fix only, and those have very meaningful gross margin kind of delta between those and national brands, and thatâs just continuing to be a strength for us. There is a several hundred basis point difference where just continuing to make sure that we are investing in the right brands, the right price points that we are building exclusively for our clients. And then I think that marketing piece that we are making the shift on we really do believe that we can get stronger over time with a combination of these newer channels were less penetrated in, but also doing more with keeping our clients happier longer, better conversion, better retention, better reactivation that should drive more productivity in the P&L as well. Hi. Thank you. My question is around inventory. So, Elizabeth, you talked about national brands being slightly lower margin. I am curious if you are seeing more interest from vendors, particularly national brands as they try to clear their own inventories this quarter and probably going into next quarter as well? And is there an opportunity there in terms of gross margin from a better buying environment that you may be seeing right now? And then a follow-up also on inventory, you mentioned the six months lead time as your typical lead time. So, I guess I would assume that the goods that you have now are spring/summer â23 goods, how do you think about the risk of sell-through for that product, especially if you see macro continuing to be weak into the next quarter or two quarters? Thanks. Yes. I can take that question. No, we are not seeing that, and itâs not something we have considered in terms of national brands â of course, we have been selective on bringing in the right national brands that we think our customers are going to love that, do well within fix or within Freestyle. But we havenât seen anything changed beyond that in terms of being approached for national brands top load inventory. And really, with our focus on exclusive brands and our Stitch Fix only brands, which is not only higher margin, but itâs what our clients love. We just feel there is an opportunity to continue to invest in those areas. With respect to the question on inventory, we talked a little bit about summer spring in Q4, we took some inventory reserves to account for that. We feel that we are in a very good spot in terms of what we have reserved for. And we have also â as Elizabeth mentioned, we also have different avenues to focus on overstock inventory, mainly limited time offers and/or clearance events, whether they are at the end of the season, which we often do to help us clear out some of the inventory â excess inventory that we do have. So, while we do have a high inventory, we watch it pretty closely. I am not concerned about the health of the inventory at this point. Again, we looked at this in our Q4 and took the appropriate level of reserves and have since clearanced a lot of that inventory out, very focused on fall/winter right now, which we are just getting â going into that season. And so we are watching how that does. And again, as we expect inventory to come down sequentially over the next three quarters, we feel we are in a good spot going forward. Hi. Thank you for taking my question. Just â and primarily, since itâs already answered, but on the Freestyle penetration, I believe you have talked about that being pretty consistent around 30% for women. Is that still the case today? Hey Lamont, thanks for the question. Yes. I think overall, we look at it across our base. But yes, itâs kind of in that 25% range, and it stayed pretty steady, I would say, in terms of new client adoption and then holding steady there. We do have things on the horizon that we will be launching in the back half of the year like SMS, encouraging were app demos. Those things, we believe we still believe there is opportunity for that to get higher but it stayed pretty stable, I would say, over the last several quarters. Thank you. And that does conclude todayâs conference call. Ladies and gentlemen, thank you for participating. And you may now disconnect.
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EarningCall_1671
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Good morning, ladies and gentlemen, and welcome to today's Eco Wave Power Third Quarter, 2022 Earnings Conference Call. All participants have been placed on a listen-only mode. It is now my pleasure to turn the floor over to your host, Jeff Stanlis with FNK IR. Jeff, the floor is yours. Thank you, Tom. And welcome everyone to Eco Wave Power's third quarter 2022 earnings conference call. Hosting the call today is Inna Braverman, Eco Wave Power's Co-Founder and Chief Executive Officer. Before I turn the call over to Inna, I would like to remind everyone that matters discussed on this conference call will constitute forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements generally relate to the company's plans, objectives and expectations for future operations and are based on management's current estimates, projections and future results or trends. Actual results may differ materially from those projected as a result of certain risks and uncertainties. For a discussion of such risks and uncertainties, please see risk factors as described in Eco Wave Power's registration statements on Form F1 that have been filed with the SEC and which are available on the SECâs website at www.sec.gov. So I'm very excited to provide our quarterly update and then to update our key initiatives continue to accelerate and we're moving quickly to significant operational milestone. We are well on path towards achieving the goals that we have set for this year. In particular, we are moving steadily towards the commercialization of our pioneering wave energy technology by expanding our presence in the United States, Europe and Israel, which are our core market. The first core market for Eco Wave Power is Israel, since this is the company's based and our country of origin and our most advanced project in Israel is the EWP-EDF One project in Jaffa Port in Israel, which is been executed in collaboration and co-investments from the Israeli Energy Ministry and EDF Renewables IL, which is a subsidiary of Electricity at the French and the French National Electrical Company. The EWP-EDF One project is currently in final stages of grid connection and is soon expected to become fully operational. As previously discussed in the previous call, the Israeli Electrical Authority has set a Feed-in Tariff for the electricity produced by our wave energy pilot as part of our technology's recognition as pioneering technology by the Israeli Energy Ministry. And on the 28th of November, a few days ago, the Director of Engineering Supervision of Low and High Voltage from the Israeli Electric Authority visited our project to discuss the final electrical inspection necessary for Eco Wave Power to receive the approval of sending electricity from the waves to the Israeli national grid. Once the power station is officially connected to the grid, this will be the first time in the history of Israel that electricity from sea waves will be sent to Israel's national electrical grid. We expect that our success at the EWP-EDF One project will enable us to gradually position wave energy as a viable renewable energy source. Two additional targeted markets for Eco Wave Power are Europe and the United States. Europe is a key market because of its high wave energy generation potential. According to recent studies, wave energy is expected to generate 188 gigawatts of power, which are 10% of all Europe electricity needs by the year 2015. In addition, Europe has the most advanced regulations, grants, and other favorable conditions for wave energy technologies as part of its overall blue economy agenda. Our progress in the European market includes progress with our planned projects in Portugal and Spain. In Portugal, we have previously obtained the licenses for operation and grid connection of the first 1 megawatt in the city of Porto from an organization called DGEG and we have since retained Efiki Partners to produce a social-economic report for this first 1 megawatt, which will enable the company to receive the final required license for the project, which is expected to be granted by the site owner APDL once the report is completed to the satisfaction of all parties. So basically in order for us to be able to move from planning to extra construction of the Portuguese project, we're missing only one license called the TURH license. In Port Adriano in Spain, we have commenced an in-depth feasibility study once the study is fully completed, assuming favorable results, the parties will enter discussions regarding the licensing requirements and financial terms of the plan 2 megawatts. In the interim, the port has been awarded the prestigious Innovation Award by the Port Authority of the Balearic Islands. The prize recognizes the best idea linked to technological progress that have been projected or implemented in any port of the Balearic Islands during this year. We are extremely pleased to receive such recognition and share the port's authority's excitement to make this project a reality. We are also announcing today that we have recently signed a feasibility study agreement for a potential 1 megawatt project in Morocco to be finalized in the next few months. The project is expected to move forward upon favorable results from the feasibility study for the selected site. All of these opportunities came after Gibraltar adopted legislation and enabled implementation of our wave energy technology. I strongly believe that the regulatory action by Gibraltar served as a catalyst for neighboring jurisdictions to follow suit. Portugal, Spain and Morocco are all countries that neighbor Gibraltar and have all entered different agreements with Eco Wave Power for the promotion of our pioneering technology in their respective countries. In Portugal and Spain, we have entered concession agreements, whereas in Morocco we have recently entered the feasibility study agreement, which is the first step towards first 1 mega installation. This makes me extremely optimistic as it reinforces my belief that once regulation and legislation is set in one territory, other territories will follow, action in one country drove nearby countries to take action as well. Now turning to opportunities in the U.S. market, according to the U.S. Energy Information Administration wave energy of the American coast can generate the equivalent of about 66% of all the United States energy needs in 2020. However, right now only 20% of all the U.S. energy is generated from renewable energy sources. So if the United States government is serious about going towards net zero emissions by the year 2050 then it definitely needs to add innovative renewable energy sources, like wave energy into the United States renewable energy mix. In terms of our operational goals in the United States, we're moving forward on both coasts. First, we are progressing toward the deployment of our very first demonstration project in the U.S., which will be done as part of a collaboration agreement that we have signed with AltaSea at the port of Los Angeles. The first floater and the energy conversion unit has now arrived to the port of LA fully assembled and is currently being set up as a static display by Eco Wave Powerâs engineering team, which are currently on site in LA. After a pretty fine time in which the conversion unit will serve for educational purposes to all relevant parties, our goal will be to produce seven additional floaters in California to be installed on a dedicated real-conditions site within the port of Los Angeles serving as the first Eco Wave Power implementation in the United States. Simultaneously, we are working to advance initiatives in New Jersey. We are working closely with Assemblyman Karabinchak, who has developed ambitious legislation initiative dedicated to adding wave energy into Governor Murphy's Energy Master Plan for New Jersey. In June this year, Assemblyman Karabinchak introduced Bill A4483, which calls for the Utility Board to create a commercialization and deployment plan and to offer financial incentive to companies and port owners for executing wave energy power stations. And in September, 2022, the bill passed the assembly committee and is now headed to the New Jersey Senate for the next step of the legislation approval. Our expectation is that this progress on each coast will lead to similar legislation and actual project implementation in other states within the U.S. We are also progressing with different R&D grants that have been secured in the past as well as receiving new grants. This includes the grant from Innovate U.K. in collaboration with the University of Queen Marry in London, The Green Deal grant secured by the ILIAD consortium, Eco Wave Powerâs participation in a grant for the production of an in-depth feasibility study for a 1 megawatt project in Halki island in Greece, which is meant to be the first step towards the construction of an actual 1 megawatt project in the island, a grant where Eco Wave Power participates for the planning of a project in Heraklion Port in Greece, and a new grant by ERDF the European Regional Development Fund called Ports Towards Energy Self Sufficiency by PORTOS that was approved for a research project in Porto in Portugal, led by the University of Porto on the 24th of November, 2022. I believe that the progress that we're experiencing clearly shows that world governments continue to embrace clean energy as key to our economic vitality. Our progress in Europe and in the U.S. combined with new policies that have been adopted and new grants obtained for wave energy research and implementation reinforces the rising commitment for the commercialization of wave energy. We believe that as our technology becomes more widely adopted, it will lead to wave energy commercialization and the acceptance of wave energy as a significant part of the world's renewable energy mix. I've been highlighting the importance of wave energy sector at high profile events around the world, including recently the WIRED Impact Conference in London and it seems that each engagement creates more believers and supporters towards wave energy commercialization. I truly believe that our hard work during this year of 2022 is expected to translate to growth in the year 2023. 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.
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Hello, everyone and welcome to the Silvergate Capital Corporate Business Update Call. My name is Emily and I'll be coordinating your call today [Operator Instructions]. Good morning, and thank you for joining us today to discuss Silvergate's business update and select preliminary and unaudited fourth quarter 2022 financial metrics. These metrics are subject to change in connection with conducting and completing normal closing procedures and an audit for the year ended December 31, 2022. With me here today are Chief Executive Officer, Alan Lane; Chief Financial Officer, Tony Martino; and President, Ben Reynolds. Alan will kick off the call with a few prepared remarks, and then we will dive into your questions. As a reminder, a telephonic replay of this call will be available through 11:59 PM Eastern Time on January 19, 2023. Access to the replay is also available on the investor relations 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 thank you, everyone, for joining today. Our main goal for this call is to answer your questions. But before we do, I wanted to take a moment to provide a few brief comments. As you know, the digital asset industry has undergone a transformational shift with the potential for further evolution still to come. Significant over leverage in the industry has led to several high-profile bankruptcies and sparked a crisis of confidence across the entire digital asset ecosystem. As a result, many industry participants have shifted to a risk-off position across digital asset trading platforms. Our first priority has been supporting our customers through this challenging period. The Silvergate Exchange Network, or SEN, continues to operate 24 hours a day, 7 days a week, and serves as critical market infrastructure for the digital asset industry. We have seen average daily volume on the SEN of $1.3 billion during the fourth quarter of 2022, which compares to average daily volume of $1.2 billion in the third quarter of 2022. Meanwhile, SEN Leverage, our bitcoin collateralized lending product has continued to perform as expected, with zero losses and no forced liquidations to date. In light of recent industry dynamics, including customers moving to a risk-off position across digital asset trading platforms, total deposits from digital asset customers declined to $3.8 billion at December 31, 2022, compared to $11.9 billion at September 30, 2022. We saw a high of $11.9 billion and a low of $3.5 billion during the fourth quarter. As of December 31, 2022, approximately $150 million of Silvergate's deposits were from customers that have filed for bankruptcy. Importantly, deposits with Silvergate have been and continue to be safely held. As of December 31, 2022 Silvergate held total cash and cash equivalents of approximately $4.6 billion, which is in excess of deposits from digital asset customers. Overall our business is designed to accommodate deposit inflows and outflows under a range of market conditions. And because we maintain a cash position in excess of our digital asset-related deposits, our customers know they can access 100% of their deposits. In response to the rapid changes in the digital asset industry during the fourth quarter, we took commensurate steps to ensure that we were maintaining cash liquidity in order to satisfy potential deposit outflows. As customers began to withdraw deposits during the quarter, we utilized wholesale funding to satisfy outflows. Subsequently, in order to accommodate sustained lower deposit levels and maintain our highly liquid balance sheet, Silvergate sold debt securities for cash proceeds. We sold $5.2 billion of debt securities during the fourth quarter of 2022, resulting in a loss on the sale of securities and related derivatives of $718 million. This sale included available-for-sale securities as well as certain securities that were previously identified as held-to-maturity. At December 31, 2022, the company held $5.6 billion of total debt securities at fair value, all of which are U.S. government or agency-backed and available for sale, and which include unrealized losses of approximately $0.3 billion. The company anticipates selling a portion of these securities in early 2023 to reduce wholesale borrowings, which will result in recognition of a fourth quarter impairment charge related to the unrealized loss on those securities expected to be sold. As we always have, we will continue to evaluate our balance sheet and liquidity management needs, which will depend on deposit flows and customer behavior. Now I would like to take a moment to outline our go-forward strategy. As we prepare for a sustained period of lower deposit levels, we are taking several decisive actions to ensure our business is resilient, including recalibrating our expense base and evaluating our product portfolio and customer relationships going forward. First, we have made the difficult decision to reduce our workforce by approximately 200 people or 40%. Throughout 2022, we increased employee headcount at a rapid rate in an effort to keep up with our growing business and to serve our customers effectively. It has since become clear that we need to manage expenses in order to account for the economic realities facing our business and the industry today. We estimate aggregate costs associated with the reduction in force of approximately $8 million and expect the majority of these charges to be incurred in the first quarter of 2023. This is a difficult moment and I'd like to extend my sincere gratitude to those impacted for their contributions to Silvergate. We are committed to providing severance and job assistance resources for all those affected by the reduction in force. Second, we are focusing our strategy to provide the most value-added solutions for our core digital asset customers. Over the coming weeks, we will be streamlining our product portfolio to reduce complexity while ensuring our institutional clients have the tools they need to continue operating efficiently. In line with this approach, we exited our mortgage warehouse lending product in the fourth quarter of 2022, incurring a restructuring charge of approximately $4 million, primarily related to severance and employee benefits. Finally after performing an impairment analysis of our intangible assets, we took an impairment charge of $196 million in the fourth quarter of 2022 related to developed technology assets purchased from the Diem Group. Given the significant changes in the digital asset industry landscape, this charge reflects our belief that our launch of a blockchain-based payment solution is no longer eminent. We remain committed to seeking opportunities to realize value for these technology assets. Before we open the line for questions, I want to emphasize that Silvergate's mission has not changed. We continue to believe in the digital asset industry and remain focused on providing value-added services for our core institutional customers. While the decisions we have had to make are difficult, we are confident that these changes will enable us to continue serving our core customers in a responsible and profitable manner. Given the current level of industry uncertainty, 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. As we have said many times before, we purpose-built this business to support our customers, not only during periods of growth, but also in times of volatility. Despite significant challenges in the broader industry, we stand ready to support our digital asset customers. We look forward to sharing more during our earnings call on January 17. Thank you. [Operator Instructions] The first question today comes from the line of Michael Perito with KBW. Michael please go ahead. Good morning. Thanks for taking my question. So I have a lot, but I guess I'll to try to keep to two here. Number one is just can you give us a little bit more color on the security sales and the corresponding impact to kind of where book value goes? I know you guys aren't releasing full financials, but it seems very relevant just kind of given where the stock is to try and have an idea here. I mean it seems like you're suggesting you sold some HTM securities portfolio -- securities rather. Is it fair to assume that, that entire portfolio will have to be marked? And just some parameters there, I think, would be a helpful starting point. Sure, Mike. I appreciate the question, and I'll go ahead and start and then turn it over to Tony for any additional detail. But you are correct. We did make the decision late in the fourth quarter that we no longer have the ability and the intent to hold the securities that were previously categorized as held-to-maturity. And that was fairly obvious given the fact that we were selling a significant portion of our securities portfolio. And as I mentioned in my prepared comments, we will likely sell additional securities here early in 2023 to further pay down wholesale borrowings. And so just to make sure nobody is double-counting here, you could go back and look at the mark on the available sale portfolio at September 30, and then also look at the mark on the HTM portfolio, which was disclosed in our 10-Q. And you could assume that all of that now has either been realized through that $700 plus million of loss and/or is included in the remaining roughly $300 million of mark on the portfolio. Yes. Thanks, Alan, and thanks for the question, Mike. And yes, Alan covered off the result. As we indicated in the Q3 10-K there was a $426 million mark-to-market unrealized on the held-to-maturity. But as we've disclosed, the portfolio at fair value as of year-end is $5.6 billion and it includes all the securities that we've got left in the portfolio, and they're all mark-to-market through AFS. So your assumption, Mike was correct. Thanks for the question. Got it. And then for my follow-up, just I think, I know you guys don't provide deposit guidance and -- but the environment here is obviously pretty challenging. I guess the short version of the question is one, why are customers pulling funds? Is it simply that they are not investing in crypto assets anymore, and hence moving those monies to treasuries and other things, and there's no point in holding money on the sand if they're not investing in crypto? And then two, as you think about where deposits go from here, I mean, is there still a commitment to the space as much as you guys are committed to it? Do you expect these customers to eventually start trading again once the FTX fallout kind of is closer to completion? Or how are you guys viewing that kind of outlook for the industry and your business on the deposit side relative to the $3.8 billion period on level? Yeah, Mike I'm going to just make a couple of high-level comments and then turn it over to Ben, because I think he's got some good market color, having spoken with a lot of our customers over the last quarter. But the first thing that I do want to say is I'd like to zoom out a little bit and encourage everybody to zoom out a little bit. And you asked the question there towards the end about -- you framed it as the FTX fallout. Let's zoom out and look at what happened throughout 2022, because what you really saw was a significant over-leveraging that began to unwind in the first half of the year. And everybody on this call is probably well aware of the Terra Luna collapse, the subsequent collapse of Three Arrows Capital, the bankruptcies of in the second and third quarter of Celsius and Voyager, and then more recently in the fourth quarter, Block5. So this was a much more widespread kind of deleveraging of the ecosystem that obviously culminated with the collapse of FTX. But when you put all of that in context, then, yes, what we have seen is a lot of institutional players. There's just been this crisis of confidence and in that kind of a situation, many of the institutional players have been pulling money off of these trading platforms. I would also say that we saw that happen throughout most of the fourth quarter. But obviously, at year-end, we were up a little bit off of the low in terms of deposits. The low point was $3.5 billion. We settled in at year-end at $3.8 billion. I'm not suggesting that we've hit the bottom. I'm not suggesting that we're bouncing and now we're going up. As you correctly indicated, we don't provide guidance. And now everybody probably understands why we don't provide guidance, because this is a really volatile industry and it is impossible to predict. And because it's impossible to predict, that is why we structured our balance sheet the way we did so that we could, in fact, withstand essentially a 70% drawdown on our deposits and still be here today to talk with you, and to also be able to confidently say that we actually, in addition to the 70% drawdown, we are holding cash in excess of all remaining deposits in this digital asset space. So that we are here to serve our customers 24 hours a day, 7 days a week. And as I mentioned, the SEN continues to operate uninterrupted. But with that, Ben, do you want to provide some additional market color in response to Mike's question? Yes, thanks, Alan. So as Alan characterized, there was a crisis of confidence and a lack of trust in the industry that happened in the fourth quarter. And so we had clients that were proprietary traders, market makers that had been doing business with each other for sometimes six to eight years, that just stop doing business with each other and pulled their -- essentially pulled all their deposits. We had some clients that moved -- these are crypto-native firms that moved almost completely into U.S. treasuries. So that was sort of the dynamic that happened in the fourth quarter. As we were talking with our clients and asking them, hey, when might you shift to a risk-on position? They really couldn't tell us. That said, we didn't have any clients that said that they were exiting the space altogether. Perhaps there will be some that do, but we didn't receive that feedback. And our clients were generally supportive of Silvergate despite the fact that they pulled their deposits, and just really given the overall circumstances decided to take that action, but seemed to be committed to the space and willing to come back when market conditions are right. Thank you for that first question. We will now move on to our next question from Steven Alexopoulos from JPMorgan. Steven, your line is open. Hey, good morning, everyone. I wanted to start on the expense side. So given the reduction in headcount can you quantify the expected cost saves? And do you expect to be profitable beyond the fourth quarter? Yes, Steve, it's a fair question, and it's a little bit too early for us. As you know, we typically don't provide guidance. We will absolutely, when we release first quarter earnings, we'll be able to have -- excuse me, fourth quarter earnings, we'll be able to have a little bit more detail, if you will, on what we think the expense base will look like going forward. As to whether or not we'll be profitable in the first quarter, as I mentioned in my prepared remarks, we are likely going to continue to sell securities here in the first quarter. Some of that will actually already be reflected in fourth quarter via an impairment charge. We're still working on those numbers. But then we also will be taking the restructuring charge for the severance, et cetera, here in the first quarter. So we take a long-term view here. And so the goal is to get as many of these restructuring charges and adjustments to the business completed here in the first quarter, so that we can be profitable prospectively. But at this point, we're not able to comment on whether the first quarter will actually be profitable. Okay, yes, Alan I was really getting at -- excluding the onetime charges, if you're recalibrating expenses to get to that point where you're at least breakeven moving forward, it sounds like you're saying yes to that. Yes. I mean, again Steve, the way I would just kind of qualify that is we are recalibrating our expense base. And then also as we've mentioned, taking a look at the products that we're offering, et cetera, to make sure that all of the products that we offer are profitable. But obviously a big wildcard in all of this is where are deposits, right? It's part of the reason we've had to essentially cut as deep as we have on the expense side is a reflection of looking at where deposits kind of settled out in the fourth quarter and assuming that a range of plus or minus range around that level is where we stayed. That's how we've kind of tried to recalibrate our expense base. The other thing that I would point out is that it wasn't too long ago that we, as a company, were at this very spot in terms of deposit levels and employee count, right? It was literally two years ago, the fourth quarter of 2020, when we were operating the bank as under a $5 billion bank, we crossed over the $5 billion threshold in total assets right at year-end 2020 and we had roughly the same headcount that we do now after this reduction in force that we just implemented. So there is absolutely precedent for looking at Silvergate through the lens of where were we two years ago and were we profitable then, et cetera. So without providing forward guidance, I think you can look to the past as a proxy. Hey, guys. Good morning. Thanks for hosting this call to get some of this information out. Just wondering on the customer side, clearly there's less demand in the industry and maybe you're onboarding less customers, but any change to that onboarding kind of profile of customers that you're looking at or may not bring on to the SEN now versus before this? I have a quick follow-up. Yeah, hi, Joe. Good morning. So as you know, we serve the institutional side of the business, and we've definitely seen a slowdown in institutions coming into the space. So most of the institutions that are clients of ours are raising money from limited partners. Obviously, given everything that's been going on in the industry, raising money at this time is challenging. So we have seen a bit of a slowdown there. That said, we've always been focused on adding quality clients that we believe are profitable for the platform. And so that mission hasn't changed. And we do think that -- we are continuing to have discussions with folks, and I would guess, probably characterize it overall as a slowdown. Okay, thanks for that. And then on the Diem assets that you're kind of writing down or taking an impairment charge on, I mean, clearly, if there's less, I guess, operating ability right now to kind of expand the business and investment spend there. Is it -- do you see it -- or do you see that as an operating constraint now or a balance sheet constraint more in not moving that forward at this point? Or is it an industry-level thing where you believe that maybe the kind of just the overall environment, regulatory environment, et cetera, just doesn't lend itself to moving any of that forward right now? Thanks. Yes, Joe, that's a really good question, I'm glad you asked it. Because I think what we should do is separate kind of the accounting treatment of an intangible asset from what our hope is going forward. And I would stress hope because obviously, in the current operating environment, it's going to be really challenging to bring a tokenized dollar, what others have referred to as a stable coin or tokenized deposit or a tokenized dollar. It's going to be tough to bring that to market anytime soon. And that is really what has driven our decision to take the impairment charge, essentially, writing down that intangible asset. And as some on the call may be aware, the accounting rules are pretty specific here on the valuing an intangible asset. And when we look at it through the lens of can we actually essentially validate the carrying value of the asset. Well, how do you do that? Will you do that by protecting some future revenue that would be generated by activity that would be supported by that asset? And with no visibility in sight here, certainly, the way we phrased it is certainly not imminent, which is contrary to how we were feeling as recently as the end of the third quarter of last year, right? And so at this point in time, the prudent thing to do is to take the valuation allowance against the asset. But it doesn't change our view that a tokenized dollar on a blockchain will still have value to the market. And we believe, especially given our recent performance -- and I fully want to fully acknowledge the losses that we've incurred, fully acknowledge the reduction in force and the changes that we're making to our business, but if you do go back and look at this through the lens of the fact that we were able to satisfy 100% deposit withdrawals, a 70% drawdown and we still have cash on hand, and you kind of look at it through that lens and then you look at, well, how does the stable client operate, I think Silvergate has demonstrated that we can in fact be a responsible operator in this space, which would include the launch of a tokenized dollar in the future. We just don't believe that to be imminent at this point. Hey, good morning, guys. Are you guys anticipating any DTA impairments at this point? And I appreciated the securities loss discussion from earlier and we can certainly apply those marks to tangible book value to get some sense of where that is. But it'd be great if you guys had some kind of a rough estimate for where you see tangible book value per share at the end of 4Q as well. Thanks. Yes. I'll turn it over to Tony in just a second, Dave. I appreciate the question. But we aren't, at this point, able to really kind of disclose where tangible book value is because of the fact that we haven't closed the books completely and we haven't gone through our year-end audit process, which is currently ongoing. Having said that, the reason we're having this call this morning is because we wanted to share with all of you the facts for what we actually could disclose, what are the things that we know here at year-end, what we know where deposits ended up. We know the actions we took to sell the securities to support the deposit withdrawals. And we know the absolute losses that were taken on those sales of securities. But when you start getting into some of the other accounting treatments and things, that all needs to go through the normal close process. But specifically on the DTA, I don't know Tony, if you want to provide any additional color on that. Yes, sure. And it's a good question, Dave. And certainly, as Alan said, we've disclosed the losses that we've taken on the securities and the impairment charge, and there are certainly pretax losses. And given the magnitude, there is a valuation allowance that needs to be looked at for tax purposes. And so we'll get into further detail on that when we do our earnings call a week from Tuesday. Hi, thanks for taking my questions. I wanted to ask about legal and regulatory risk. So there has been some class action lawsuits. Can you frame your expectation of the legal liability to Silvergate related to FTX and Alameda? Yes, David, I'm surprised it took this long to get to that question. But what I would say is -- and unfortunately, as you know, we probably can't say much. But I first want to restate that as a federally regulated bank, we take our compliance and risk management responsibilities very seriously. There's a lot of fuzz [ph] out there, a lot of misinformation, but we are a regulated financial institution operating in this space for nine years and so we obviously take our responsibilities very seriously. As to litigation, we don't comment on pending lawsuits at all. We're certainly aware of the lawsuits and we intend to defend against them vigorously. Understood, makes sense. And then shifting over to on the regulatory risk. What has the posture of regulators been with you and Silvergate? Could there be a potential change to Silvergate's CAMELS rating? Yes. As I'm sure you're aware, no bank can disclose their CAMELS ratings. And so I'm not going to speculate on the CAMELS rating part of the question. But as to the regulatory posture, I'm sure you're aware of the joint statement that was issued this past week by the Federal Reserve, the OCC and the FDIC. And obviously, we are a Fed member bank. We've been a Fed member bank the entire -- during the duration of our operating in this space. And as we've characterized many times in the past, we engaged with our regulators very early in this initiative in 2014 when this space was bitcoin only. And we have been engaged with them continuously for the last nine years, not only with the Federal Reserve, but obviously, the FDIC insures our deposits and so they often tag along with regulatory examinations. We are state chartered in California. So we have the California DFPI as our chartering regulator. So we have regular ongoing interaction, regular examinations, targeted reviews of specific areas of -- as the regulators would deem heightened risk, whether that be capital liquidity, regulatory compliance, BSA, et cetera. And so there's certainly a lot of attention on this space right now, but we've been operating with the full transparency in this space with our regulators for the entire duration of this initiative. Hi, good morning. Yeah, I guess any thought to changing the revenue structure around SEN in light of this, or in terms of like charging a fee for it? Or do you still feel that using that to purely accumulate deposits is the best use for that platform? Yes. Jared, it's a fair question, and I'll kick it to Ben in just a second. Because we have mentioned in our prepared remarks and I've mentioned it here now in the Q&A section here, that we are going to be looking at all of our products. But I do want to just point out that the "gathering" of deposits is not really the way we've looked at this business for quite some time. I've talked about -- I've compared and contrasted the Silvergate strategy versus other banks that have come into the space more recently. And without at all being disparaging when looking at those other banks, what I've observed is that many banks that were attracted to this space over the last couple of years essentially were starting where we started back in 2014. When we first started this initiative, it was bitcoin only. And what we saw was that there were very few banks that understood the space that were willing to bank participants in this ecosystem. And so we saw it as an opportunity to gather deposits to fund our other asset strategies, right? So that's where we started in 2014. For the last five years or so, that has not been our strategy, as we've essentially exited other -- some of the other legacy community -- or commercial banking businesses, which -- there's nothing wrong with those businesses. But as you know, it is very hard to differentiate yourself when you're offering the same loan and deposit products that everybody else is offering. So then you end up having to compete on price -- or excuse me, on service because you can't compete on price. Well, let me not get distracted there with that. But the point I'm trying to make, Jared, is that we do not look at this business as, oh, let's gather deposits to go fund our asset strategies. That is why we carry cash and securities to cover these deposits. And as to other pricing strategies, let me ask Ben to comment. Thanks, Alan. Yeah, so as we take a step back and look at the SEN, it really does provide critical market infrastructure to the digital asset industry which trades 24/7. And even despite lower deposits, we saw incredible usage of the SEN in the month of December, and for the quarter, actually finished with SEN volumes above third quarter SEN volumes, which I think speaks to the usage of it. Obviously usage of the SEN decreased a little bit in December as deposits decreased, but it is a critical market infrastructure for our clients and something that we will continue to support and develop on. So with that, because it is critical market infrastructure, we do think that clients will pay for it. But we're still in the process of evaluating sort of what that pricing structure looks like, and really the whole portfolio of services that our clients are looking at. Okay. And I guess maybe just as a corollary to that, would you consider looking to combine with a bigger company to help get some more diversification or limit some of the stress periods of time like this put on the business? Or do you feel that being a mono line, what we call it, a crypto-only focused institution is still the most efficient structure to take? Yes. I'll jump back in and take that one. We certainly will always consider ways to maximize shareholder value, while also providing service to our customers. And I've been in this business, have been in commercial banking for 40 years and so have bought and sold many banks during my career. This business initiative is obviously unique and the very opportunity -- the circumstances that created the opportunity for us to get into the business and differentiate ourselves in the way we have has also translated into the fact that there are very few larger institutions that have been willing to look at this space. But you are touching on something, Jared, which is important because my experience in the banks that I've sold in the past is that when a potential acquirer is looking at a target, very often, they're looking for kind of one or two specific things, whether it's a core deposit franchise, a specific geography, a specific line of business that, that acquirer is essentially looking for. And that is one of the reasons we decided to let's just focus on being the best we can at providing services to the digital asset industry because we don't think this is going away. It's going through period of significant stress, but we don't think it's going away. And at some point in the future, it is quite likely that a larger institution that wants to get into the space will want to take a look at Silvergate because we've been operating responsibly in the space for over nine years. Hey, guys. Good morning. Thank you for taking my question. First, I want to just say congratulations. I don't think that there are that many banks that could face say like a 70% decline in deposits and come out of it with no operational liquidity issues. So I do think that that's acknowledgment. That being said, I'm wondering if you could kind of talk around the securities portfolio that remains on the balance sheet. Is there anything you can tell us about the yield profile of that? There's been a lot of questions about tangible book value. I won't belabor that anymore. But as we think about calibrating the earnings stream going forward, maybe you can hit on what the yield profile looks like of the securities that are on the balance sheet? And similarly, if you could talk about the yield profile of the funding that you've raised during the fourth quarter. Thank you. Yes, that's probably a question best answered by Tony. But unfortunately, we're not going to be able to provide you with a lot of detail right now. Well, we certainly will provide more when we release our earnings. And then all of that detail, as you know, will be in the 10-K. The one thing that I would point you to in our earnings release is -- or excuse me, in the release this morning is the fact that the remaining securities are all government or agency-backed. And if you were to go back and look at what the makeup of the portfolio was at the end of the third quarter, you would have seen that there were quite a few munis in there as well. And so you can kind of deduce that we sold more of the longer-duration securities that would have been fixed rate. And if you just step back and think about -- and by the way, I also want to thank you for the acknowledgment on the fact that we survived this deposit, essentially run. That's what other people have been calling it. But essentially, Will, we had a playbook that we hoped we would never have to execute, right, which is what do you do if you have sustained deposit withdrawals. Well, initially, you want to make sure you have a securities portfolio that is high grade, high quality, high credit quality that is pledgeable so that you can borrow against it. So as I said in the prepared remarks, that's what we did first. Not knowing whether the deposit withdrawals were going to be temporary, we borrowed against our securities portfolio. That's what it was there for. It was all pledgeable, high quality, and so we borrowed against it. But then to your point, when you're borrowing, you're borrowing at current rates, right? So if the securities portfolio was yielding a lower level at the end of the third quarter because it had been put in place and some of it was longer duration put in place in the past, then you could just connect the dots, right? We were borrowing at a higher level all in because the Fed had been raising rates so rapidly during 2022. Once we get to the point where it's like, okay, well, this is going to be lower for longer and we're still in a rising rate environment, we need to protect capital, both now and in the future. How do we make sure we're protecting the future capital? Well, it's by selling the longest duration right now so that we can preserve the earnings power and the mark-to-market on the capital going forward with the remaining portfolio. Yes, no, that is very helpful. I appreciate that. And obviously, I'm sure things have not been fully finalized on the security sales in the first quarter, but I think you gave some help for detail there about how you thought about the sequence of events post the deposit decline. Could you talk about any kind of guidepost or guide rails around how you're thinking about the appropriate level of securities on the balance sheet going forward? I mean is it your intention to match one-for-one deposit to cash, and we should be thinking about significant reductions in the securities portfolio? Or I guess, maybe you can speak to kind of the mix of securities versus cash once the balance sheet restructuring is kind of fully finished. Yes. Unfortunately, Will, we're kind of getting into guidance there. What our goal is for today, is to tell you exactly where we are, what we've done to get here. And then as I said in my prepared remarks we'll continue to evaluate our balance sheet and liquidity management needs, but it's going to depend on deposit flows and customer behavior. And so I think you can look at what we've done so far, look at where we are now, but it's anybody's guess as to what happens in the future as it relates to our customer behavior. It's our hope that we've kind of reached a level with deposits that are going to be sustainable. As Ben mentioned, we haven't had any customers come to us and say, hey, we're closing our account, and we're leaving this ecosystem. But our customers have taken a huge pause, and we're going to have to digest that, and we will make the appropriate actions going forward. Hey, good morning. I just wanted to follow up maybe on the prior line of questioning around what balance sheet should look like going into next year? Just given the drawdown in deposits, can you talk about how you're thinking about the SEN Leverage business? Do you expect to shrink that business over time? And also do you have the option to cancel some of those $800 million or so of undrawn commitments that are there on your book right now? On the SEN Leverage book, one, were we going to continue to offer the product? And two, do we have the ability to cancel? So again, we're not providing specific guidance on specific products right now. We have said that we're going to look at our entire product portfolio with a view of are the products that we offer profitable and is there a good product market fit. What I can tell you is that, that product continues to perform exactly as designed through all the periods of ups and downs in the price of bitcoin. We have control of the collateral through our custodial partners and we have the ability to liquidate 24 hours a day, 7 days a week if our customers do not maintain the appropriate margin. We have not yet had to ever do a forced liquidation and the product portfolio continues to perform as agreed. And as we've also reported the fact that our commitments are slightly in excess of $1 billion. We've been pretty -- we've been hovering around that $300 million range in terms of outstandings for the last couple of quarters. And I think that's reflective of the fact that there's just not a lot of activity and the related conviction in the bitcoin space at the moment. Got it. And separately, I appreciate all the comments around compliance and AML and KYC. And as you said, there's a lot of misinformation out there. So I was hoping you can provide a general overview on the steps you take on the AML/KYC side before you onboard a customer? And if you can, any color on how much visibility you would have as a bank to transactions related to FTX and Alameda from both? Now this question has been really well covered in the past. We obviously take our -- what am I trying to say here? Sorry, I got distracted. We -- KYC requirements, which includes the initial onboarding. It then also includes monitoring transactions on an ongoing basis. And so a lot of -- as you said, the misinformation out there is candidly very frustrating. We follow the Bank Secrecy Act, the USA Patriot Act for every account that we open and we conduct ongoing monitoring. But to your point, to part of your question, we can only see what we can see in terms of what is coming in and out of Silvergate. We don't have visibility into what's going on with other banks. Yes, thank you. Good morning. Signature Bank during the fourth quarter said that they would be pulling back from the digital asset business, reducing the amount of deposits that they had intentionally. How much overlap is there from digital asset clients using the SEN on the one hand and using Signet from Signature on the other hand? And do you anticipate that you're going to see some movement as a result of that announcement? Yes, Mark, it's a good question. And I think I'll ask Ben to comment. The only thing I'll say as an overriding statement is that it's certainly, we're not privy to Signature's business in general other than what they say publicly. But we are aware that many of our clients use both the SEN and Signet, and that's not surprising given the fact that there are very few banks that operate in this space and that most of our clients don't want to have a single service provider, because then that provides a single point of failure for their business. But Ben, do you want to comment on -- any more on Mark's question? Yes. I think the point that Alan made is exactly right in that this is an under -- it's an underbanked industry. And I know that our clients are always concerned about losing their banking relationships or having limited banking relationships. And despite what's been going on in the fourth quarter, our clients have been very supportive and proactive actually in reaching out to us and providing their conviction towards Silvergate and their understanding of the need for banks to be in the space. And so we don't -- I think the short answer is we don't really see anything changing there. We think that customers will continue to use Silvergate and the SEN as well as our competitors because they understand how critical banking relationships are to their overall business. So I don't think we see really any change there coming. Thank you. And I know that the question regarding the wholesale funding was asked, but in terms of the interest rates associated with the advances from the Federal Home Loan Bank and the brokered CDs, how should we think about the interest rates that are associated with those? How are you thinking about those balances over the course of 2023? Of course, as you mentioned, you're going to be selling some securities as a means of reducing the wholesale balances, how should we think about that? Yes. Tony, do you want to jump in since I've kind of already addressed the question, but maybe you can take it from a slightly different angle. Yes. No, I think, Mark, as Alan had said previously, the funding -- the wholesale funding is more recent, and therefore would track more in line with current rates. And it's relatively short in terms of duration. So from that perspective, it's early in the year to -- as Alan has said previously -- to kind of walk forward several quarters. But as we look out at this point in time, we're signaling in our press release today that there's a portion of the securities that we fully mark to market that we intend to sell in the short term. So I think the way Alan had categorized it previously, if you -- just to kind of go back as to what we've said, we had a portfolio of very high quality, fully pledgeable securities, relatively short duration. And directionally, it's now of even shorter duration. And as we said, the securities that are left are all U.S. government or agency securities. And therefore, you can presume we've sold the municipal bonds that were fixed rate. So the matching between the securities and the funding is more in line, given what's transpired in the fourth quarter. And that's probably all the color I can give today, and we'll provide more details with earnings in 1.5 weeks from now. Thank you. Long call, so just one quick question relative to Diem. Just to make sure I understand, are there still people on the project? Is this still something you are moving forward with internally? That's it for me. Thanks guys. Yes, George, appreciate the question. There are still people on the project as we sit here today. We will obviously have to continue to evaluate, as we do with the rest of our business, the expenses that we're incurring for the products that we're offering as well as the products that we contemplate offering. And so as it stands today it's largely an accounting issue that we're dealing with, but we're also very mindful of the fact that there are significant headwinds to launching something in the near future. And so we'll have to continue to look at the expenses that we're incurring for that hopeful outcome in the future. And I think with that, I suggest Emily will -- you already mentioned that, that was the last question. So I just want to once again, thank everybody for joining us today on such short notice, and we look forward to sharing more when we report our fourth quarter results in a couple of weeks. Thank you, everybody.
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EarningCall_1673
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Hello. And welcome to the Ashtead Interimâs Analyst Call. Please note this call is being recorded. You will be in a listen-only mode throughout the call and have the opportunity to ask questions at the end. [Operator Instructions] Good morning, everyone. And thank you for joining our Half Year Results Call. I am here with Michael Pratt and Will Shaw in our London office. Todayâs update will detail our strong performance in the period, review our outlook for the balance of the year, detail the latest end market forecast and cover, of course, the execution of our strategic growth plan Sunbelt 3.0 which from a timing standpoint we are actually at the halfway mark. Before getting into the slides, Iâd like to speak to our Sunbelt team members throughout the business to thank them for their engagement. We recently completed our latest engagement survey, which garnered an extraordinary response from over 18,000 of our colleagues throughout the organization. The response rate alone is impressive, however, more or so is the cultural feedback around topics such as safety, family, belonging and customer focus. Another example of engagement is the success of our 10th Annual Safety Week held across the U.S., Canada and the U.K. This year was the week of October 3rd. And as I witnessed firsthand in many branch locations and through the countless post via our internal engagement app, our people are not just present, they were engaged, whether itâs events like Safety Week or working together as a team to respond to natural disasters like Hurricane Ian or servicing any one of our thousands of customers every day. I am ever grateful for the way that you all show up. So thank you, keep living positively and safely out there, and stay focused on people, people, people, customer, customer, customer. With that, letâs move on to highlights on slide three. Conditions are strong and the business is performing very well, delivering another period of strong revenue and earnings growth in end markets, which I would characterize as ongoing high demand. And when combined with a clear and more improved outlook, ongoing market dynamics supporting structural advancements and our position of financial strength. These conditions are as favorable for our business as I have ever witnessed. In the half, Group rental revenues increased 26%, while the U.S. improved 28% on top of strong growth a year ago. These revenue gains are the principal drivers of course of PBT and EPS growth, which was 28% and 32%, respectively. During the half, we continued to advance our Sunbelt 3.0 plan. Doing so, by executing on all our capital allocation priorities, beginning with nearly $1.7 billion in CapEx, a notable increase in pace from Q1, which fueled our existing locations and greenfield additions with new rental fleet and delivery vehicles. We expanded our North American footprint by 72 locations, 34 through greenfield openings and 38 via bolt-on acquisition. Further invested $609 million in bolt-on acquisitions in the half and returned $206 million to shareholders through buybacks and we announced today our interim dividend of $0.15 per share, which is a 20% increase on last yearâs interim. Despite these levels of growth, capital investment, acquisition and returns to shareholders, we remain near the bottom of our net debt-to-EBITDA leverage range at 1.6 times. These activities demonstrate our confidence in the ongoing health of our end markets and the fundamental strength in our cash generating growth model. With this performance and outlook, we now expect full year results to be ahead of our previous expectations. Letâs move onto the outlook on slide four. Recognizing the performance and momentum in the business, we increased our full year rental revenue guidance versus last year as follows, we now anticipate the U.S. to be in the 20% to 23% growth range, Canada increases to growth of 22% to 25% and the U.K. improves to a flat outlook. Gross CapEx is unchanged, maintaining the range of $3.3 billion, $3.6 billion, of which $2.7 billion to $3 billion will be in new rental fleet. Also unchanged is free cash flow of circa $300 million. Thanks, Brendan, and good morning. The Groupâs results for the six months is shown on slide six. We had a strong quarter and have six months with good momentum across the business. This momentum drove strong growth in the U.S. and Canada, while U.K. rental revenue grew slightly despite all the Department of Health testing sites being demobilized in the first quarter. As a result, Group rental revenue increased 26% on a constant currency basis. This growth was delivered with strong margins, and EBITDA margin of 47% and an operating profit margin of 29%. As a result, adjusted pre-tax profit increased 28% to $1.243 million and adjusted earnings per share were $2.12 for the six months. Turning now to the businesses. Slide seven shows the performance in the U.S. Rental and related revenue for the six months was 28% higher than last year at $3.8 billion. This has been driven by a combination of volume and rate improvement in what continues to be a favorable demand and supply environment. The strong activity and favorable rate environment have enabled us to pass through the inflation we are seeing in our cost base, both in general, as well as in the direct costs related to ancillary revenues such as fuel, transportation and erection and dismantling, which are growing at a higher rate than pure rental. These ancillary revenues generated lower margin than the pure rental business and represent a greater proportion of revenue this year. In addition, we continue to open greenfield adding 31 in the period and complemented our footprint through bolt-on acquisitions, adding 32 locations in the U.S. Inherently, in the early phase of that development, greenfields and bolt-ons are lower margin than our more mature stores. As we discussed at Q1, these factors are dragged on drop-through, which we expect to improve as we move through the year and margins. This progression can be seen in the second quarter with drop-through of 49% contributing to drop-through of 46% for the six months EBITDA margin of 49%. This drove a 32% increase in operating profit to $1.283 million at 32% margin, while ROI was 27%. Turning now to Canada on slide eight. Rental and related revenue was 22% higher than a year ago at $341 million. The original Canadian business goes from strength-to-strength as it takes advantage of its increasing scale and breadth of product offering as we expand our Specialty businesses and look to build out our clusters in that market. The level of bolt-on activity, particularly the MacFarlands and Flagro acquisitions, which had a higher proportion of lower margin sales revenues in our business has been a drag on margins. This impact will reduce in the future as we reduce the level of outside sales of these businesses. Our Lighting, Grip and Lens business continues to improve following some market disruption earlier this year, with the threat of strike action in the Vancouver market, which resulted in productions being delayed or transferred elsewhere, but again it was a drag on margins. As a result, Canada delivered an EBITDA margin of 44% and generated an operating profit of $92 million, thatâs a 24% margin, while ROI is 19%. Turning now to slide nine. U.K. rental and related revenue was 7% higher than a year ago at £293 million. This growth is despite the significant reduction in work for the Department of Health, as we completed the demobilization of the testing sites during the first quarter. As a result, the Department of Health accounts for only 8% of total revenue for the period compared with 32% a year ago. The core business continues to perform well with rental revenue 26% higher than a year ago. However, the inflationary environment combined with the scale and the -- of the logistical challenge in completing the testing side demobilization over three months and the significant increase in demand over the summer, particularly in the returning events market contributed to some operational inefficiencies, which impacted margins adversely. The principal driver of the decrease in operating costs is the reduction in the work for the Department of Health offset by the additional cost referred to earlier. These factors resulted in an EBITDA margin of 30% and operating profit margin of 13%. As a result, U.K. operating profit was $48 million for the six months and ROI was 12%. Slide 10 sets out the Groupâs cash flows for the six months and the last 12 months. I will not dwell on this slide for long but it does illustrate the significant change we have seen in the business over the last 10 years. Despite increased replacement expenditure and significant growth capital expenditure in the first half, this has all been funded from the cash flow of the business, while still generating free cash flow of $144 -- $154 million. Slide 11 updates our debt and leverage position at the end of October. Our overall debt level increased in the six months as we allocated capital in accordance with our policy. Spending $619 million on acquisitions and returning $293 million to shareholders through our final dividend for 2022 and $207 million through buybacks. As a result, leverage was 1.6 times excluding the impact of IFRS 16 towards the lower end of our target range. Our expectation continues to be that we will operate within our target leverage range of 1.5 times to 2 times net debt to EBITDA, but most likely in the lower half of that range, as we continue to deploy capital in accordance with our capital allocation policy. Turning now to slide 12. One of the actionable components of Sunbelt 3.0 is dynamic capital allocation, an integral part of this is a strong balance sheet, which gives us a competitive advantage and positions us well as we take advantage of the structural growth opportunities available in our markets. In August, we accessed the debt markets in order to strengthen our balance sheet position further and ensure we have appropriate financial flexibility to take advantage of these opportunities. We issued $750 million of 10-year investment-grade debt of 5.5%. those issue. Following the notes issue, our debt facilities are committed for an average of six years at a weighted average cost of 4%. Thank you, Michael. We will now move on to some operational and end market detail beginning with slide 14. Our strong U.S. growth continued through the second quarter delivering half year growth of 22% in General Tool, Specialty continued its remarkable performance growing 34% in the half on top of last yearâs 23% in the same period. The strength of this performance continues to be broad, extending through every single geographic region and Specialty business line. Consistent with what I have been saying in conjunction with recent results, the current supply and demand equation is as favorable as we have ever experienced. This effect continues to contribute to market share gains and record levels of time utilization throughout the business. This ongoing reality which is now sustained for several quarters makes incredibly clear the step change in structural change we are witnessing, meaning, first that rental penetration is deepening before our very eyes, and secondly, those benefiting from this increased rental penetration R&D the larger more experienced, more capable rental companies who can position themselves to be there for this increasing customer base, and therefore, realizing a larger share of what is without question a larger market. With the ongoing backdrop and demonstrably improved discipline within the rental industry, it is warranted and logical that we are increasing rental rates and certain other aspects of what we charge to provide our service. These trends continue as our sequential and year-on year rate improvement remains very good, something we believe will carry-forward as we enter next year. Letâs take a closer look at our Specialty business performance on slide 15. The year-on-year rental revenue movement illustrated herein demonstrates the ongoing and compounding growth across all Specialty business lines. Total U.S. Specialty as you see, rental revenues increased 34% in the half. As history has taught us, inflection points in the cycle create flash points or swift step changes in rental penetration. In this instance, three things are different than points previously, particularly when it comes to Specialty and they are; one, there is now a reliable alternative to ownership in these Specialty business lines; two, todayâs undeniable and ongoing market dynamics of supply constraints, inflation and labor scarcity; and three, these three dynamics have not been transient, and therefore, we are not in an inflection point, rather we are in an inflection period. Together, these form as enablers and tailwinds to structural change and have contributed to our great growth in Specialty over the last few years and will continue to do so into the future. Further, as you will see, I am pleased to announce the recent acquisition of Modu-Loc, Canadaâs leading temporary fencing provider. This creates our 11th Specialty business line in North America, which we see not only as a great addition to our Canadian offering but a platform to expand into the U.S. with this new Specialty business line. Finally, this level of activity in our Specialty business serves as a proxy for the strength of our non-construction end market which generates a significant portion of our Specialty revenues and is an important part of our General Tool business as well. As a reminder, letâs move onto a non-construction overview on slide 16. Our Specialty and General Tool businesses services a large and broad range of non-construction end markets. When we describe the vast scale and diverse landscape of this component of our end markets, it seems some struggle to understand the relationship between equipment rental and construction. However, I do think itâs becoming clear so we are going to keep at it. We commonly refer to an incredibly large component of this non-construction end market as MRO, which is the very maintenance, repair and operations of the geographic markets that we serve, such as facility maintenance, which we covered before but worth seeing again, clearly, defined as a market in which hundreds of billions of dollars are spent annually running and maintaining facilities. As we have described before from cleaning to painting to decorating to planting to temporarily powering and to cooling to repairing and so on of the many, many types of facilities that make up the 100 billion square feet of commercial space under roof in the U.S. alone. The rental of our broad range of Specialty and General Tool products will increase. As I pointed out when covering the Specialty slide, this is very much a structural growth arena in the very early stages with a long runway for growth. Now that we have touched on Specialty and non-construction markets, letâs turn to slide 17 and detail the construction landscape. For a variety of reasons, and more importantly, tangible evidence, the non-residential and non-building components of the construction end markets are proving to be incredibly strong in the present and increasingly so in the forecast. To characterize them as resilient would at this juncture be an understatement. I am going to spend a bit of time on this and the next two slides as I think itâs worth a fuller understanding and appreciation. Starting on the top left with the Dodge construction starts chart. You will see at first glance the strength of recent starts and the forecasted growth through 2026. If you look a bit closer, beginning with the downturn in 2020, 2021, thatâs the first period highlighted with that dotted line you will see on the slide. You will recall that was a non-residential slowdown, as residential construction to most everyoneâs surprised turned out to be a boon during that period and thus was softening to the overall fall. Same chart, now just a couple of years down the line, the second period highlighted, noticed the swift uptick in starts in the very recent period. This is not a residential uptick as experienced in 2020, 2021, rather this is the actual happening not forecast but actual of what we have been saying would happen. Specifically, as the early wave of new project starts derived from a combination of private investment and legislative led federal project funding and incentives. Moving to the bottom left-hand chart, you will see the Dodge Momentum Index is now at its highest ever level. To be clear, this measure indicates projects in planning, not projects that have started. So what should your takeaway from these charts be; one, a whole pile of new projects has just begun; and two, a supportive waivers in planning that more than validates, in our view and Dodgeâs, these starts and put in-place forecast. So moving now to the top right. These figures in dollars are in put in-place values. In other words, spreading the cost of the project over the duration as opposed to all in one period as is the case with starts. As you look at these forecast for the heart of our construction end markets, specifically, non-residential and non-building, the strength over the last several quarters and recent spike in starts I have just covered translates into consistent growth and put in-place for the next several years. As seen here, growing from roughly $900 billion in 2022 to nearly $1.2 trillion in 2026. Many have commonly held opinion that as goes residential goes non-residential, that is just not the case today. It is increasingly clear, there is far less a correlation between residential and non-residential construction in this era of mega projects and larger than ever before seen federally funded initiatives both of which we will come onto. This backdrop should set up nicely the next couple of slides beginning with 18. You will recall in June, we introduced the detail surrounding what we internally refer to as mega projects. Projects with a value of over $400 million ranging from data centers to healthcare to airports to liquid natural gas plants to electric vehicles, et cetera, et cetera. A key point we attempted to get across was the abundance of these projects and how much of the overall non-res and non-building construction market starts they made-up. As listed here, these projects have made up roughly 30% of recent years construction starts values, a number much larger than in fact more than double what it was in the pre GFC era. And look at the trends, there are currently 200 projects in this genre with an average project costs of $1.2 billion that are ongoing. In planning and pre-bid phases, there are 300 with an average value of $1.9 billion, with estimated start dates by December of 2023. Projects of this scale and sophistication are ideal for resident, on-site solutions, meaning, we often have dedicated storage and working space on the actual project site housing a very large and broad offering of our products and associated services. These services ranging from on-site maintenance repair technicians, telematics equipped product producing efficiency gaining benefits to our on-site and remote teams, and of course, to our customers, providing benefits such as reduce carbon emissions, and of course, our mantra of availability reliability needs, all of which are essential for the success of these mega projects. Solutions like I have just outlined require a rental company with the scale, experience, technology, expertise, breadth of product, and of course, financial capacity. I hope you understand this is a material contributor to structural change in our industry which we are a certain benefactor of. Turning now to slide 19. Organized here are three major legislative acts that are just beginning to drive increased demand and overall market you have by now realized is already very active. Beginning with perhaps the act has been covered and understood the most, specifically Infrastructure Investment and Jobs Act. The headline figure of $1.2 trillion may be best understood by compartmentalizing, $650 billion as a renewing of sort of ordinary run rate federal investments in roads, bridges, rail, utility, et cetera. The key to this act is not only reassuring the baseline investment but itâs delivery of an incremental $550 billion in new project spending throughout the U.S., with over 10,000 programs and projects identified ranging from $100,000 in project cost to $3 billion thus far. Despite the fact that this act was actually signed in law back in November of 2021, very little has yet to translate into actual project starts. However, this is now beginning and will go into full effect with starts largely commencing between 2023 and 2025. You will notice that $129 billion of incremental $550 billion has been allocated from the federal government to states through October, which will begin seeing actual shovels in the ground so to speak in early 2023. So this is just less than 25% of the overall incremental funds to be allocated indicating the substantial and long-tail inherent and federal infrastructure funding like what we see here. Next is the CHIPS and Science Act. A bipartisan bill swiftly passed through Congress and signed into law by the President in just August of this year. Putting the motion a revitalization of domestic semiconductor manufacturing, whereas for decades U.S. actually experienced a decline from 40% of the worldâs semiconductor production to less than 20%. The overall Act will invest $250 billion to progress American semiconductor research, development and manufacturing. The Act is designed to support directly or through tax credits nearly $140 billion in new semiconductor manufacturing projects, a number of projects have already begun even before passage of the Act, indicating what one could comfortably conclude as the beginning of a new era of mega projects coming to fruition. As you will see in some of the detail on the slide, these are more than a step above the run of the mill mega project, individual semiconductor buildings are underway with more already announced to begin in 2023 with price tags as large as $10 billion per project. As you can imagine, these projects will take three plus years to complete. They will consume an enormous amount of rental fleet and require very much of what I have described earlier in terms of rental company capabilities. We will be talking about semiconductors for years to come. Similar, if you will to the way that we have been talking about data centers for well over a decade now. And finally, the Inflation Reduction Act also signed into law just this August, $370 billion of this bill will fund directly or by way of tax credits, a broad basket of energy production and manufacturing, ranging from solar field construction, which will triple the current U.S. capacity by 2030 to battery factories to wind farms, to EV production and so on. So what we have here is a trifecta of government investment equaling nearly $2 trillion in investment that will indeed create thousands and thousands of projects, which Sunbelt is poised to take great advantage of. Letâs now turn to our business units outside of the U.S., we will begin with Sunbelt Canada on slide 20. Our business in Canada continues to expand and perform well as our brand increases and customers recognize the growing breadth of products and services offered. The growth is coming from existing General Tool and Specialty businesses complemented by well-paced additions of greenfield openings and bolt-on acquisitions. Consistent with our last update, the conditions are not just similar to U.S. in terms of activity, demand and the supply environment, and thus we are experiencing equally strong performance from a utilization and rate standpoint. We are well underway executing on our Sunbelt 3.0 plans in Canada and our runway for growth remains long. Turning to Sunbelt U.K. on slide 21. I am pleased to be in a position to report our U.K. business is now fully made up for the loss rental revenue associated with the Department of Health testing phase, that was a substantial part of our revenues throughout last year. This is no small accomplishment, signaling a combination of market share gains and a reassuring level of end market activity, particularly in infrastructure and industrial projects, as well as increasing progress in areas for us such as solid maintenance, being brought about by our unique cross-selling capabilities across our unmatched product and services portfolio. Live events have been an ongoing contributor in this post-pandemic period, which of course, was virtually nil through 2020 and 2021. The team was incredibly proud to provide our products and services surrounding the Queenâs funeral. Something that I am sure those involved will remember for years to come. The consistent area of focus to improve our U.K. business has been on advancing rental rate and the associated fees we charge to provide service to our customers. Although progress has been made, the focus in this area has been significantly heightened in recent weeks, as we work to rightfully increase rates in a more meaningful manner late this calendar year and into 2023. This is something the U.K. rental industry seriously falls behind in, and our position will be steadfast in making a demonstrable change in the face of notable inflation our business and indeed our industry has absorbed. This is not the last that you will hear about our rate focus and I look forward to reporting further on material success in the periods to come. Turning now to slide 22. With Octoberâs conclusion came the halfway point in our three-year strategic growth plan Sunbelt 3.0. And as we have done with every set of results since the launch, I am pleased to give you a midpoint glance at our progress. For time sake, I will cover just a couple and what more tangible than our expansion. In just six quarters, we have added to the footprint of our business 195 locations in North America, 122 by way of greenfield openings, complemented by 73 locations from the bolt-on acquisitions. This combines for a nice mix of Specialty and General Tool locations, further advancing our clustered market progress. We actually achieved cluster status in an additional 13 of the top 100 U.S. markets, giving us 44 of our full 3.0 program target of 49. This is great progress, particularly when you look to years down the road, as these new locations to the Sunbelt Rentals platform mature into larger contributors in terms of revenue and profits, and importantly, create more outlets to deliver the service to our customers Sunbelt is so well-known for. Also worthy of a call out is the inaugural issuance of our annual standalone sustainability report that we put out earlier this month. One could summarize by saying we are well-ahead of our plan that Sunbelt 3.0 pace. Turning now to slide 23. As demonstrated in the results today, our business has enjoyed a successful period of growth and execution against our plan. This has been accomplished despite a number of uniquely challenging dynamics happening simultaneously in the markets we are operating. We first introduced this slide to our Q3 results last year in an attempt to highlight the primary macroeconomic concerns, and more specifically, our view on duration and the effects on our business. Understanding the dynamics of supply constraints, inflation and skilled trade scarcity, as it relates to our end markets and our business is really important. This version is specifically updated today with our views on anticipated duration. Taking this in, we now know that these three monumental factors proved to be not transitory. Although, we do join the increasingly popular opinion that inflation should moderate in the quarters to come, at the very least given the lapping comparators, our view on supply constraints and skilled trade scarcity is far more of the same. We believe as it relates to our industry. We have several quarters ahead of tough access to supply of new rental assets and the associated parts for many in our industry. Itâs also vitally important that we believe this constraint to be a material preventive factor of our industry over fleeting. Lastly, we are seeing no signs of excess availability in the precious commodity of skilled trade workers. The important thing in understanding the tailwind effect these have had in the recent past, will have in the near-term and we believe amounting to a real advancing steps in structural change, one that will be in the near- and long-term favorably impact the larger more capable companies in our industry. We will update you on any change in views particularly in terms of duration in the quarters to come. Moving now to our fleet plans on slide 24. Our CapEx guidance is unchanged from our Q1 update. As I have just covered the supply constraint environment is still present. However, we are working well with our primary equipment manufacturers in the landings throughout the half have been strong, picking up pace through the second quarter and into November. So with the component parts unchanged, we guide to $3.3 billion to $3.6 billion for the Group in the full year. Letâs conclude on slide 25. Itâs been a very good half year of growth and ongoing momentum. Itâs been a period that has added a significant amount of clarity to the strength, our end markets are very likely to yield in 2023, 2024 and beyond. Some of this clarity came in the form of the recent passing of the CHIPS and Science and Inflation Reduction Acts, adding to what was already a plentiful level of end market activity, flush with day-to-day MRO, small- to mid-sized projects and the very present and growing mega project landscape. The trifecta of market dynamics being supply constraints, inflation and skilled trade scarcity remain very real. The ongoing presence of these come with operational challenges, however, are outweighed by the secular benefits to our business resulting in the increased pace of rental penetration and considerable market share gain for businesses in our industry who again possess the scale, experience, equipment purchasing, influence and financial strength. Rest assured that our business is positioned to win in this reality. This update should demonstrate once again the strength of our financial performance and the execution of Sunbelt 3.0 well ahead of our planned pace. So for these reasons and coming from a position of ongoing strength improved trading and positive outlook. We look to the future with confidence in executing our well-known and understood strategic growth plan, which will strengthen our business for the years to come. Hello. Good afternoon. Good morning. Thank you for taking my question. I have couple of questions. In terms of one is the mega project and in terms of structural shift we are seeing in the industry, just want to understand. Just given the mega of what we are seeing, whatâs really driving the M&A pipeline from the sellerâs point of view. Thatâs the first question in terms of whatâs really driving that. And the second in terms of the mixed fleet, I noticed that there is a decrease of mixed fleet basically from 40 months to 38 months and given the supply constraints, this quarter is driving the mixed fleet, is it because of this is -- if you can give some sense of the older fleet versus new fleet in terms of age dynamics? And the final question in terms of the free cash flow guidance, I donât -- is it CapEx guidance unchanged and given the increase in revenue growth, maybe just whatâs driving the free cash flow guidance unchanged? Thank you so much. Sure. Rahul, I think, I understood your first question, but if I am slightly off just let me know. But I -- my -- think I understood it as whatâs the driving factor between Sunbelt Rentals being the benefactor of winning those projects. I understood it less to be whatâs driving the very presence. If it was the latter, the driving the very presence of it is the things we have been talking about. Things when it comes to this trend of onshoring or reshoring when it comes to U.S. manufacturing, the advent of things like electric vehicles, batteries, the increased importance around liquid natural gas, just big, big, funding the big projects further now complemented by the Infrastructure Act, the CHIPS Act and the Inflation Reduction, so I covered that just in case. Whatâs driving the very selling, if you will, of Sunbelt Rentals winning our sort of unfair share of these projects. It is just simply what it takes to do it, not least of which is just the fleet, and obviously, you see the CapEx guidance that we have given, getting this level of fleet in this constrained market is no easy task and simply what we seeing is, we are seeing winners and we are seeing losers and ourselves and a couple of others out there are the real winners in that. We are just simply occupying a larger ration of what manufacturers can produce. And then the other bits and pieces are, of course, besides just availability is the experience. We have teams that are seasonally experienced, operating and delivering on-site capabilities on these mega projects. Itâs the things that you have to have their table stakes in that environment. Telematics reporting when it comes to telematics and that broad, broad range of fleet. So I hope I have answered that one, but I will allow you to come back if you need. In terms of fleet mix, you kind of answered it in your question, itâs a combination of these increased landings at pace that we have recognized, but also disposals of some of our oldest fleet thatâs out there and I will yield to Michael here for free cash flow. Yeah. On the free cash flow, what we are seeing is a slight increase in working capital and the easiest way to characterize that is, some of our debtors or the receivables are paying a little bit more slowly. Thatâs a little bit more slowly than last year and the last two years have been somewhat exceptional and that our receivables book was as clean and as young as itâs ever been, which is the worst, given it was a COVID time, but thatâs the way to. So absent the last two years, I have been sitting here and saying our receivables are consistent with as or was good as they have ever been, thatâs not quite true. So what we are saying is a slight uptick in working capital from last year, which sort of mitigates the improvement that you are seeing from the performance of the business. I guess also the other thing just to bear in mind with free cash flows, yes, itâs roundabout $300 million. But we are at the moment landing the best part of $300 million of rental fleet per month. So thatâs only going to arrive a little bit early or a little bit late and that number can be somewhat different from $300 million, $100 million, $200 million difference. So there are a lot of moving parts, but the main one is just a slight increase in working capital, but nothing that we wonât the -- we havenât experienced before. Hi. Good morning. Thank you for taking my questions. I have a couple as well. So, firstly, just coming back on these mega projects. So you have been very clear about how the larger players like Sunbelt will continue to take share versus the smaller players. But I am just wondering, given some of the size of these projects and you mentioned some of these are taking up to three years, how confident are you that rental will be the preferred option, given the size of it and if itâs a three-year project, thereâs more -- perhaps more of an argument to only equipment or is it a case of those supply chain constraints will continue and actually even if you want to own it you can get hold of it. Iâd love to get your thoughts on that. And then secondly on -- as you said, you have added close to 200 locations, 18 months in two or three year plan. So should we infer that you will add few in next year or is it more likely that you will come in ahead of target or ahead of schedule with regards to adding those locations? And then, lastly, you have mentioned 11th Specialty vertical in financing, in the past you have very helpfully given color on rental penetration and potential market share for some of your Specialty verticals, so Iâd love to hear a bit more about how big that market is, what the penetration is like and what the scope is to consolidate? Thank you. Thank you, Annelies. Let me take a stab, first of all, to be clear on the mega projects, itâs not really some that could take up to three years, most are going to take three-plus years in terms of the construction. Itâs a really good point you make and is what I will used to add clarity to the step change in rental penetration. In fact, the matter is given the quantum of fleet that will be requisite in the construction of these sites. What we are seeing through very, very recent and active dialog with customers is, their propensity is to go even further rental. And one of the reasons will be just the sheer quantum of capital that they would even be far less experienced or exercised in dealing with. And secondly, if you actually look at dealer stock levels, whether that be your traditional yellow iron or types like ground engaging trenchers that sort of thing, pile drivers, light towers that if you were an owner you would be going through the dealer distributor route, dealer distributor stock levels are at their lowest point in history, literally lower than what they were in 2009 when it was rather intentional. So this supply constraint. I think one of the very important points we made during the call and this picks up on your question here, the very supply constraints is actually a governing or limiting factor or preventive factor from our industry over fleeting which is very important and I donât think many get. They look at the CapEx levels of ours and see our top two publicly listed peers and they worry the industry is over fleeting, itâs quite the opposite. If you actually look at manufacturer production detail, manufacturers are still in most cases when it comes to servicing our industry, like, if you take for instance, aerial work platform and telehandlers, which makes up 40% to 50% of the original equipment cost of many of the fleets that are out there in the rental industry, we know that 2018 was their peak production in terms of manufacturing delivery into North America. So for scissor lifts, booms or analysts as they are called and telehandlers, we are still producing significantly below. So 2019, it fell off which was in the intention of the rental companies at the time. 2020, it fell off of a cliff. 2021, it halfway recovered, 2022 is still below the peak of 2018. So what the production levels today is only just about enough to satisfy replacement from seven years, eight years ago. So I know thatâs not directly answering, but that part anyway is additive to your question, but there will be more rental for those reasons and not ownership on these mega projects. Your point about, yeah, we have done nearly 200 locations, you will remember our full three-year plan for greenfields was 298, we said it would be augmented and added to by way of bolt-on acquisitions, no. Our full year greenfield add this year was going to be about 90 locations and we will be in the 100 or so range for next year. So we are going to satisfy both that whole greenfield program, but a bit more than that given the activity which has been great in that the bolt-on domain. And in terms of 11 Specialty with temporary fencing, I promise you this, when we get to rolling out our next plan and we give that great update, which would have been Slide 44 in our Capital Markets deck that would have given all the nitty gritty detail of these specialties, we will revisit that then. But I can tell you this about temporary fencing, here you have got this great business in Canada with just less than 20 locations. We have identified already 100 locations that we would target geographies in the U.S. This is a few $100 million rental revenue business for us in the not too distant future. So itâs not something that we would do thatâs going to be this little tiny Specialty, itâs a really nice business that also has great features from a cross-selling standpoint. I hope that answered your questions, Annelies. Good morning, gentlemen. Thank you for the very detailed presentation. A couple on my side and I guess related to slide 23, which -- yeah, I will follow-up on Annelies question. But firstly, on the supply of new equipment, steel prices have come down a lot, so I am assuming this inventory should be reflected in the pricing of some of these new equipment or what you buy for replacement. How should we think about that, could that have an influence on your CapEx spending going forward? And secondly, when I look at this slide 23, if everything comes to fruition, as you think it will, it should drive some meaningful wage inflation, right? So if demand is good, thereâs still inflation in the system, thereâs not enough people on the ground. How do you or what sort of wage inflation are you seeing coming for later in the year? Thank you. Great. Thanks, Arnaud. The first one I should bring you along with myself and some of our colleagues of Brad, Brad covered it all more specifically who is in those negotiations with our OEMs. Look, you are right about steel, I would not, all of a sudden, as well as some of the other commodity pricing. I would not, all of a sudden, wave the flag and say that our purchasing prices will be going down. What I think you will see or what we are seeing is some of the surcharges that would have been out there go away. OEMs largely have gone through a period of rebasing what they charge for producing their products, just as we have gone through a period of rebasing what we charge for rental and the associated services. And certainly, the key to understand for us, it cuts so much when it comes down to dollar utilization. If things cost a bit more and our dollar utilization is at parity or better, thatâs a great capital allocation channel which we will continue to pursue. However, when you think about what this is going to future, I do think we have taken the most meaningful pieces of the inflation of our rental assets and that will begin to wane a bit. But the key, key thing is this, we obviously with our spending size, we get the best pricing thatâs available in the marketplace and that delta between ourselves and others has not changed. Whatâs really important when it comes to our ability to bring products to our customers at great overall value is making sure that our delta has the advantage and that has not changed at all. When it comes to wage inflation, look, itâs obvious, we are in an inflationary environment particularly when it comes to skilled trade. We have made and we have telegraphed and we have shared very well the steps we have made back in October of 2020 then June of 2021 and then May of the current year, given the fact that this is a call that I began by thanking our team about. I am not going to get into the details of what we would expect wage inflation to be specifically next year, we will address that early in the New Year in conjunction with our Q3 results. But, yeah, this is an environment where we would see wages ticking up. Time will tell us to whether we made the turn in the size of the step change. I hope thatâs covered both your points or questions. It seems we have lost the operator for a brief moment. Please standby, first ask you to rejoin. Thank you very much. It seems to be an issue connecting to the operator for a moment, Brendan, if you would like to give any further remarks and we give her a moment to just rejoin and allow the remaining people ask a question that would be really great. Thank you. Why donât we just give a -- we will give it one minute here. If everyone can hang on and if we canât get the operator back momentarily. I suppose everyone thatâs in queue for question is how to reach us. If anyone who is waiting in the queue to ask a question, if they want to email me the question, I can then read them out and Brendan can answer them. Yeah. Sorry itâs Will here. I have got a question from James Rose at Barclays. Itâs remind us the percentage project spend that goes into rental same from -- is it the same for mega projects? Second question, is there a Specialty cross-sell into mega projects seeing this is -- are you seeing this in customer requests and the mega project margin profile, are these consistent with 50% drop-through rates? I will begin with the last. Yes. Especially when you are on-site you get big benefits of scale there. One thing we commonly refer to, as you know, deliver once use many and if you think about some of those ancillary charges having smaller margins, you make up that benefit. So these are very profitable projects. Percentage of flow-through, if you will, in rental dollars and projects, itâs a wide range. And generally speaking, we would use that 5% for your smaller commercial construction and down to as little as kind of 1.5% or so for a mega project, by this I mean sort of a project like one of these semiconductors, you might be in that 1.5% or so range. So it really just depends on the project, a datacenter is going to be more in the middle of those two points. So, unfortunately, thereâs no just specific all-encompassing the answer but thatâs what you have. But to put in perspective, if you think about fleet required for one of these semiconductors, you are talking about $100 million in rental fleet and thatâs going to be General Tool, as well as to move-in your second question, Specialty. So, yes, you are going to see quite a bit of ask for Specialty whether it would be the latest, Specialty we have just added, a perimeter fencing and temporary fencing or the load banking is going to be significant in virtually all of these power generation, of course, but so much so more so these days is taking diesel power and augmenting that with battery storage. So, yes, very powerful cross-selling attributes with mega projects with Specialty. Okay. So this is from Dominic Edridge at Deutsche Bank. What percentage market growth wood Chips, IRA add to rental market growth. Does the 3% industry forecast include this? Second question, is there a fundamental difference in the fleet used or just amount of fleet used in infrastructure projects versus say other projects? And third question on U.K. rate improvement, does this require a rebasing of rates or just yield management, are you seeing support for rate increases in the market in spite of a softer U.K. market? Yeah. So in terms of the industry forecast that one and you are referring to of course slide 17, there where we show the IHS Global Insight and they are -- they tend to be a bit behind and they tend to focus more on the closer years and the further years. I would say, the answer is, there is a small amount of CHIPS and Science and Inflation Reduction that has been entered into those figures. I would fully expect those to go up and I will remind you that our cadence has been in the 2.5 or so times of what the industry ends up being in any given year. So if you are 2.5 times to 3 times the outer years of three, there are worse outcomes, but thatâs just the beginning and they will move forward, I am sure. Fundamental difference in fleet, when it comes to infrastructure. No, not really, much, much of it is very core. So whether itâ be light towers, of course, they are going to migrate from diesel light towers to solar or hybrid light towers, you are going to have much of the ordinary ground engaging skid loaders, mini excavators, trench compactors. There will be a notable step change in some of the larger ground engaging 45,000 pound class and above excavators, I am probably getting too detailed here, which is something that we have been adding, but itâs not something that we donât know, we are quite good at it actually when it comes to some of the infrastructure projects we are working in today and some of the mega projects that we are working in today. So very, very much in our wheelhouse. When it comes to the U.K., this is not yield management, this is rebasing. I donât know any better way to explain it but the U.K. industry when it comes to rental has just been sort of this incestuous environment of everyone chasing everyone to the bottom. And we are plain and simply making that change. We have had very good dialog with customers thus far. They fully understand it. I mean, if you think about our customers in the infrastructure or commercial side of the business or construction side of the business, every single other supplier has increased what they charge to supply them what they charge and here rental is just lagging behind. It takes leaders in the industry number one, but number two or a tied at number one, if you will, it takes a product portfolio and a level of service that warrant your increase and our team between Andy Reid, Phil Parker, the MDs Dave Harris, our strategic sellers who are with these customers day-in and day-out. What they have done is built a much better business over the last few years and we are now poised, we are in a position to actually charge what we should. And again, I think, you will see results like what we have seen in the U.S. in the next 12 months. And just a couple from me. Letâs just dig back into the mega projects again. Two parts there. One, what sort of visibility do you actually have on work contracted for 2023, is it a bit earlier or are these big projects looking to get locked-in quite early? And then on a typical large project, particularly the ones I guess maybe a broken ground already, what sort of market share does Ashtead have from rental equipment, is it in line or maybe slightly higher than that gets the 12% share you have in the broader market? And then just moving on the drop-through, I think, you talked obviously about improvements through the year, full year target, I think, was around 50%-ish, you did a decent number in 2Q, are you expecting a further decent step-up in the second half? And then my very final question, just on interest cost guidance, which looks like itâs obviously creeping up a little bit, what are the assumptions you have got behind the interest cost line for the full year now and around the second half number? Thank you. Yeah. Thanks, Allen. I will take the first and Michael will take those last two. Visibility is remarkably clear when you look at projects that have all the intention, ambition and really the mandate from the payer here, whether that be a semiconductor company itself for or liquid natural gas company that has brought on these contractors to do it, they have expectations when it comes to starts. The difference is today, in a way, as the rental industry, we have spoiled customers. In the past, if you had a project that was beginning in March and you engage with the likes of us or one of our peers for a larger -- a rather large order of letâs just say $10 million, $20 million, $30 million in original equipment cost, we spoiled you, because we could come through with that. Today, itâs a bit different, maybe not so much on the 10, 15 sort of genre, but when you get into $50 million, $75 million plus $100 million, itâs very different. These customers and the suppliers like ourselves have to engage very early, because really what you are doing is, yes, of course, you work down the line and you begin with replacement needs and then you have anticipated growth levels and we in turn work with our OEMs for increased deliveries. In essence, as I have said today, itâs increased rations. So the customers now know better than ever before. They need to work with who their supplier of choice would be or suppliers in some cases of choice will be and they realize that they have to be working several quarters out. I mean, just as a, for instance, week before Thanksgiving, I was in two cities and sort of 24 hours meeting with two customers. Two customers alone have a need of about $1 billion in rental fleet. Not too terribly many SKUs. These are the key SKUs, things like telehandlers, light towers, skid loaders, generators that sort of thing, $1 billion worth of need and these would be suppliers in the alternative energy space and actually a semiconductor and liquid natural gas space. So it gives you the ideas to the quantum that we are talking about. And in terms of average project share on these mega projects, in many cases like data centers have been in the past, you may have a pure lionâs share, like, you may have 70%, 80% share with the rest going to a few others here and there. But when it comes to your typical, if you will, run of the mill, couple of 100 million project, itâs going to be more, itâs going to be a bit more than the overall market share, but not extraordinarily more or so, because those tend to be less the on-site provider. So I hope that helps on the first and Michael will take the next two. Yeah. On drop-through, as we have said, we expect it to improve as you -- as we went through the year and so we would expect to have good drop-through in Q3 and Q4 with a view that we will be aiming towards that 50% for the whole year. I wouldnât expect -- the step change we have from Q1 to Q2, I wouldnât be expecting to have the same step change for Q3 and then through Q4, but we would expect to see a degree of improvement. There always be a degree of lumpiness in it but we would expect it to continue to progress. From an interest rate perspective, obviously, most of our debt is in dollars, so we are expecting rates there to move towards by the end of our financial year. We are sort of more in sort of upper 4%, 5% area for that viable interest rate, which compared with last time around at Q1 we thought it was going to be, payers would have said it was closer to 4%. Yeah. Thanks very much. Good morning, team. Just a couple of devilâs advocates questions from me please. I mean, a lot of talk here on supply environment and the mega project side, just looking at how potentially reliable some of Dodge data is, we have obviously had a pretty weak print from the ABI in October. So how would you guys reconcile that with the DMI, particularly the DMI print, which is still pointing to all time highs? And then the second question, again, just to sort of squaring the circle around that very optimistic residential put in-place forecasts from Dodge. How that squares with the latest National Association of House Builder data points, which particularly from a West Coast point, itâs been pretty significant year-on-year price declines. Again, just how should investors be thinking about those very mixed signals that we are getting on the demand side of the equation? Thanks very much. Yeah. Thanks, Karl. I am actually glad you asked both of those questions. So, one, letâs go to slide 17 and letâs break up -- letâs take it into two pieces here forecast and actual. So if you look at the top left of slide 17 that second circle indicating the kind of now time of the solid line. Remember, the solid line is no longer speculation and no longer forecast. Those have begun and when projects like this begin, there are always black swan events out there, but they finish and 99% of the time big, big projects which begin finish. And certainly, when we have talked about the funding apparatus that we have gone through, i.e., legislative activities et cetera. So that is indeed finished. When you look to the top right here, remember that figure you will see there footnoted and I know this is getting quite granular, that would be the update from September for Dodge. Wouldnât you know it sometime around tomorrow or later this week we will get the updated translation from the starts on the top left to put in place on the top right where we will then update them. So itâs just in terms of our timing where they havenât come fully through. You asked a great question about ABI and I think ABI is not surprising at all. When you think about the amount that has cleared the deck. So when you think about the amount that has gone from being in that indexing of planning and preparation in terms of literally what architecture going through and that which has come through. Furthermore, when you look at the momentum. Those projects are already in the -- in some cases bidding phases and those sort of post pre-planning but still planning, so a lot of that architecture work is complete for those projects. So itâs not surprising to me at all. I would sit here on this call and say Dodge Momentum Index is soon to start going down a bit, which is what traditionally happens when you go from in planning to start you see that translate from one going up and one going down. Whatâs unique about this printing is, both the starts went up and the momentum went up, which means we are about to see even more stores. All of that I think validates that point on the top right of what ultimately comes through. Your point on residential is a very important one, because as I have just said, the residential figures that you see on the top right of slide 17. So, for instance in 2022, the $836 billion. Thatâs still from the September figures. If you go to appendix slide 30, this is an important one, hereâs what the update will have. So this, as you will see on slide 30, is represented in units. So I remind everyone from sort of single housing. And as I would have said in my script, letâs face it, with the capital markets we are concerned with, when it comes to Ashtead, primarily was this, residential construction is going to slow, therefore, so will non-residential, why do they feel that way? Well, thatâs in the tail and tips since World War II, thatâs why. But what we are seeing is thatâs not happening this time. Furthermore, if you just look at what happened. So I would draw your attention to right third of those lines in this bar chart and look at 2021, we peaked in the U.S. at base 184 million single-family, the green component of that bar, 1.1 in essence than single-family home starts. That fell in 2022 this year as interest rates climbed and whatâs happened here is the forecast. That forecast for 2023, which is now 891, that number was actually about 1.2 million. So thatâs how much we have seen that forecast come down. Now what I bet the ranch on whether or not 891 is right, Iâd say, it probably would be -- Iâd be pleased if it was 891, but maybe itâs something more like 825, 800. But the point is in that, look at pre-pandemic, basically what we are saying is single-family housing construction is going to be about what it was in 2018 and 2019 pre-pandemic levels. If you remember, we were quite busy in 2018 and 2019. So what we are seeing is because of the very fast period fact that the U.S. doesnât have enough homes, thereâs still single-family home production and sometimes itâs better to be lucky than good, look at multifamily, because of this multifamily is going to actually grow into the forecast, but either way itâs understanding those dynamics. I think people are expecting far worse, this I think is much more what itâs going to be like. So, Karl, does that answer those questions. Yeah. Good morning. Two left for me please. I wanted to circle back Brendan to your point on visibility and the tightness of supply and demand and length of projects. And I wonder if you have been able to more broadly alter in terms of trade, i.e., extending contractual terms not just on the mega projects, but elsewhere, given the nearly unprecedented supply/demand balance that you have seen. So are the industry terms of trade altering in any degree? And then, secondly, and when you think about the cross-selling and on the businesses that you have bought, are you able to quantify in any way or help us understand how you measure sort of the cross-selling sort of contribution to organic growth in acquired units? Yeah. Let me start with the second one and the short answer would be yes we could quantify, not so much on this call. Thatâs a good capital markets point to take. But as our colleague who you would have met by way of virtually a during our last Capital Markets Day, Kirk Henkel, often points out. The common denominator to the businesses that we buy, with our approach of bolt-on, just look at the bolt-ons that we have done through October with $610 million or so. I mean, thatâs an average of $25 million of bolt-on. These are not humongous deals, instead these are nice little businesses and we like what they do and we like precisely where they are, itâs our ingredient. But the reason why I say this is Kurt always reminds all of us, the common denominator in these businesses they lack the capital to grow the way that they otherwise would be able to. So what we do when we come in, besides having it integrated, in almost every case on the day we closed from a system standpoint is that we invest further to give their customers which they have had a broader range of products and that just happens and therein lies the cross-selling opportunities, if you will, or realities that come following those bolt-ons. So I hope you will accept that as an answer to your second question there. When it comes to visibility, the tightness, et cetera and how that relates to contractual terms. I mean, keep in mind, thereâs only some portion of our business that is on terms other than just whatâs on the back of a rental agreement and itâs going to be basically one-third of our overall business that are these strategic customers that have something more than a pricing in the market for 30 days or something like that. So in these contractual terms, you have a whole host of things. But most importantly, you change overtime as you get bigger and bigger and more important to the delivery of their project, the very spirit of engaging in negotiations, you are just taking more seriously. Therefore, the red lines you may have in your contract are more noted and easier to get what you are looking for, all looking for a win-win with our customers. But things come to mind like Michael talked earlier about, our receivables in the time, so we get more significant when it comes to the actual agreement in terms of what those contractual terms are and then the obvious things such as rental rates. But another big one and that one would be, I keep saying, what we charge for the other services such as delivery, and of course, one of the things we have highlighted on these calls is delivery cost recovery. And if you think about just the progress we are making on that, if we just look at it from a year-to-date standpoint, we are actually at 90% delivery cost recovery through October. You will remember we would have said that was our goal not even our budget as we turn the year and thatâs at 90% for the year versus 79% a year ago and actually October itself was 94%. So all of these things are coming through in some of these agreements, if you will, given the unique circumstance that we find ourselves in from a visibility and supply chain standpoint. And itâs not so much from a change in terms of trade, but what you do find is people are hanging onto fleet for longer in the current constrained environment, whereby if they were going to return it and re-rent in a week or twoâs time, they actually hang onto it because they want to make sure they have got access to it. Yeah. There could be some -- also that is true. But furthermore, itâs less top up and itâs the top up fleet that is easier sent back and sort of exchanged et cetera. But it just shows this dynamic change that we are going through, as I have said, under our very own eyes of structural advancement. So hope that answers your questions, Neil. Hi, guys. Just one left from me as well in terms of the CapEx guidance being unchanged into, obviously, a very, very strong market. Itâs not really a question, just the timings of the supply chain is being able to land in the second half of the year. It doesnât seem like the bolt-ons are -- have been particularly about buying the fleet itself rather than just the locations and the synergies and the investment is able to go into them. So just any thoughts around that? And then, secondly, on the M&A itself, how has the market been facing multiples at this point into an improving environment where supply chains are in short supply of kit so to speak? Yeah. Thanks, Steve. First of all, from a CapEx standpoint, we wanted -- look, our plan is what our plan is in terms of that $3.3 billion to $3.6 billion that we have seen. Frankly, if we were able to say today that we could land an extra few $100 million in kind of February, March, April, then indeed we would say that. But our focus today, we really wanted to get across was this increased clarity and what our end markets are going to be in 2023 and 2024 incredibly clearly. As we usually do, we will give our first look at CapEx guidance in March. I wouldnât be shocked if we do find from our primary OEM suppliers that some of our next fiscal year, Q1 year might be available, we might land some of that a bit earlier in say March, April. So Iâd be understanding of that. But itâs not easy to get extra rations these days as I have been saying. M&A, I would just say more of the same, nice, nice pipeline, great little businesses. To your point, we are not buying businesses just to get rental fleet, we are buying businesses because we like who they are, what they are, where they are in the main. There have been one or two bolt-ons where I do think some of the -- some of you are on the deal was, hey, we pick-up some fleet and some highly utilized categories. But in the main, these are businesses that I have said before, we have to put that much more CapEx into which we look forward to. Thank you. And as there are no further questions, I would now like to hand the call back over to you Mr. Horgan for any additional or closing remarks. Great. Well, thanks for joining the call today. Apologies about that little bit of a delay. I guess whenever you have got any sort of technology even telephone involved that can happen. But appreciate your time and we look forward to speaking in our next update come Q3. Thank you.
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EarningCall_1674
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Thank you for standing by. Welcome to the Accenture's First Quarter Fiscal 2023 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Managing Director, Head of Investor Relations, Katie O'Conor. Please go ahead. Thank you, operator, and thanks, everyone, for joining us today on our first quarter fiscal 2023 earnings announcement. As the operator just mentioned, I'm Katie O'Conor, Managing Director, Head of Investor Relations. On today's call, you'll hear from Julie Sweet, our Chair and Chief Executive Officer; and KC McClure, our Chief Financial Officer. We hope you've had an opportunity to review the news release we issued a short time ago. Let me quickly outline the agenda for today's call. Julie will begin with an overview of our results. KC will take you through the financial details, including the income statement and balance sheet, along with some key operational metrics for the first quarter. Julie will then provide a brief update on our market positioning, before KC provides our business outlook for the second quarter and full fiscal year 2023. We will then take your questions before Julie provides a wrap-up at the end of the call. Some of the matters we'll discuss on this call, including our business outlook, are forward-looking and, as such, are subject to known and unknown risks and uncertainties, including, but not limited to, those factors set forth in today's news release and discussed in our annual report on Form 10-K and quarterly reports on Form 10-Q and other SEC filings. These risks and uncertainties could cause actual results to differ materially from those expressed in this call. During our call today, we will reference certain non-GAAP financial measures, which we believe provide useful information for investors. We include reconciliations of non-GAAP financial measures where appropriate to GAAP in our news release or in the Investor Relations section of our website at accenture.com. As always, Accenture assumes no obligation to update the information presented on this conference call. Thank you to everyone joining us today and especially to our people around the world for their extraordinary work and commitment to our clients, which resulted in delivering another strong quarter of financial results and the broader 360-degree value we continue to create for all our stakeholders, our clients, our people, our shareholders, our partners and our communities. Let me share a few highlights of this 360-degree value and our continued disciplined execution. We delivered strong bookings of $16.2 billion, with 24 clients with quarterly new bookings over $100 million, demonstrating our clientsâ continued commitment to transformation and our ability to understand and anticipate our clients' needs, whether for growth, cost optimization or resilience and our ability to deliver compressed transformations. We delivered revenues of $15.7 billion, representing 15% revenue growth in local currency, with double-digit growth in each market. We estimate that we are growing more than 2x the market, while delivering margin expansion of 20 basis points. We continue to invest in our people, with 10.4 million training hours this quarter, representing an average of 15 hours per person, providing learning opportunities and upscaling to enable us to pivot as our clients' needs evolve. We earned the number one position on the Refinitiv Diversity and Inclusion Index for the third time in the past five years and a top score on the Workplace Pride Global Benchmark, recognizing Accenture as the leader in our industry. We believe our unwavering commitment to diversity and inclusion is both the right thing to do and an essential element of our business strategy and strong financial performance. We have reached 97% renewable electricity, closing in on our goal of 100% by the end of 2023. Our own progress in sustainability is important to our ability to lead in helping our clients harness this key force of change and in attracting top talent. Finally, I want to congratulate our more than 1,200 new promotes to Managing Director, 119 new appointments to Senior Managing Director and the more than 90,000 people we promoted around the world in Q1 overall, reflecting our commitment to providing vibrant career paths. Thank you, Julie. Happy holidays to all of you, and thanks for taking the time to join us on today's call. We were pleased with our overall results in the first quarter, where we continue to drive growth across markets, services and industries to extend our leadership position in the market. We ran our business with rigor and discipline and expanded operating margin while investing at scale, and we continue to deliver on our shareholder value proposition to both our financial results and by creating 360-degree value for all our stakeholders. Let me begin by summarizing a few key highlights across our three financial imperatives from the quarter. Revenues grew 15% in local currency, reflecting a foreign exchange headwind of about 9.5% compared to the 8.5% provided in our business outlook last quarter. Adjusted for the actual foreign exchange impact in the quarter, we were approximately $150 million above our guided range with double-digit growth across all of our markets and industry groups, with 10 of the 13 industries growing double digits and three high single digits. We continue to take market share with growth estimated to be more than 2x the market, which refers to our basket of publicly traded companies. Operating margin was 16.5% for the quarter, an increase of 20 basis points. We continue to drive margin expansion while making significant investments in our people and our business, including acquisitions. We delivered very strong EPS of $3.08, up 11%, while absorbing a substantial FX headwind. Finally, we delivered free cash flow of $397 million and returned $2.1 billion to shareholders through repurchases and dividends. We also invested $686 million in acquisitions. With those high-level comments, let me turn to some of the details, starting with new bookings. New bookings were $16.2 billion for the quarter with a book-to-bill of one and growth of 6% in local currency. Consulting bookings were $8.1 billion, with a book-to-bill of one. Managed Services bookings, which we formally refer to as Outsourcing, were $8.1 billion with a book-to-bill of 1.1. In addition, we continue to see improved pricing on our new bookings, which refer to contract profitability or margin on the work that we sell. Turning now to revenues. Revenues for the quarter were $15.7 billion, a 5% increase in U.S. dollars and 15% in local currency. Consulting revenues for the quarter were $8.4 billion, up 1% in U.S. dollars and 10% in local currency. Managed Services revenues were $7.3 billion, up 11% in U.S. dollars and 20% local currency. Taking a closer look at our service dimensions, Technology services grew strong double digits, Operations grew double digits and, as expected, Strategy & Consulting grew low single digits. Turning to our geographic markets. In North America, revenue growth was 11% in local currency, driven by double-digit growth in Public Service, consumer Retail and Travel Services, Industrial and Health. In Europe, revenues grew 17% in local currency, led by double-digit growth in Industrial, Banking & Capital Markets and high single-digit growth in Consumer Goods, Retail & Travel Services. Looking closer to the countries, Europe was driven by double-digit growth in Germany, the United Kingdom, Italy and France. In Growth Markets, we delivered 19% revenue growth in local currency, driven by double-digit growth in Banking & Capital Markets, Public Service, and Chemicals & Natural Resources. From a country perspective, gross markets was led by double-digit growth in Japan. Moving down the income statement. Gross margin for the quarter was 32.9%, consistent with the same period last year. Sales and marketing expense for the quarter was 9.8% compared with 9.7% for the first quarter last year. General and administrative expense was 6.6% compared to 6.9% for the same quarter last year. Operating income was $2.6 billion in the first quarter, reflecting a 16.5% operating margin, up 20 basis points compared with Q1 last year. Our effective tax rate for the quarter was 23.3% compared with an effective tax rate of 24.4% for the first quarter last year. Diluted earnings per share were $3.08 compared with diluted EPS of $2.78 in the first quarter last year. Days service outstanding were 48 days compared to 43 days last quarter and 42 days in the first quarter of last year. Free cash flow for the quarter was $397 million, resulting from cash generated by operating activities of $495 million net of property and equipment additions of $99 million. Our cash balance at November 30 was $5.9 billion compared with $7.9 billion at August 31. With regards to our ongoing objective to return cash to shareholders, in the first quarter, we repurchased or redeemed 5.2 million shares for $1.4 billion at an average price of $272.3 per share. At November 30, we had approximately $4.9 billion of share repurchase authority remaining. Also in November, we paid a quarterly cash dividend of $1.12 per share for a total of $706 million. This represents a 15% increase over last year. And our Board of Directors declared a quarterly cash dividend of $1.12 per share to be paid on February 15, a 15% increase over last year. Finally, turning to the 360-degree value we are creating for all our stakeholders. We are extremely proud to be recognized as one of the seven company all stars on the Wall Street Journal Management Top 250 List for Excellence in customer satisfaction, employee engagement and development, innovation, social responsibility and financial strength, and we also received the top score for social responsibility overall. In summary, we were pleased with our results in the first quarter, and we're off to a strong start for the year. And now let me turn it back to Julie. Thanks, KC. We remain laser-focused on staying close to our clients, advising them how to navigate the macro, providing the right solutions to enable compressed transformations and adjusting to their changing needs. Let me give some further color on what we're seeing in the market and how we see the demand environment shaping up. Over the last quarter, as we can all read, the economic estimates for 2023 continue to decline. While the latest industry estimates for 2023's technology spending continue to show robust growth of 5% or so, we will see how the market evolves as clients finalize 2023 budgets. So what does today's market mean for our clients? We believe that the current macro is making it even clearer to clients that they need to change more, not less, and that two of the five key forces of change that we have identified for the next decade: the need for total enterprise reinvention enabled by tech data and AI; and the ability to access, create and unlock the potential of talent, are critical to succeed in the near, medium and long term. We see this continuing across industries and markets with two common themes. First, all strategies continue to lead to technology, particularly cloud, data, AI and security. And second, companies remain focused on executing compressed transformation to achieve lower costs, stronger growth, more agility and greater resilience faster. What does this mean for Accenture? Our strategy positions us for continued industry leadership because we have a unique set of strengths that our clients need to navigate today and succeed tomorrow. We are able to do so because of our deep strategy and consulting expertise across industries, allowing us to be a trusted adviser during different economic cycles as we bring the expertise, coupled with the real-life practical experience they need. Our ability to help clients achieve total enterprise reinvention through our depth across the enterprise, from the frontline to core operations to corporate functions, as well as our ability to advise our clients shape and deliver value-led transformations, and through our breadth of services, from strategy and consulting to our strategic managed services, which help clients digitize faster, access talent and lower costs. And our global footprint allows us to act at scale and with speed. Together, this positions us as the compressed transformation partner of choice, as you can see, and yet another strong quarter of clients who selected us for work of more than $100 million this quarter. I am pleased to see how quickly we are pivoting to meet the evolving needs of our clients. We have seen a higher level of sales and pipeline coming from cost-focused initiatives, often also including growth or capability enhancements. We are leveraging our breadth of services, deep-client and ecosystem relationships and industry and functional expertise to help our clients and Accenture shift to the highest value opportunities. Our track record of delivery at speed and scale over many years with clients -- remember, 99 of our top 100 clients have been with us for over 10 years, this gives our clients confidence that by partnering with us, they will deliver on their commitments. Investments in our assets and solutions such as myWizard and SynOps, which underlie both strategy and consulting, technology and operations managed services, as well as our delivery of compressed transformation, enables us to differentiate with our insights and services. Our ability to invest in acquisitions helps us to expand our relevance across the enterprise from building a digital core with Sentia and Albert, to optimizing upper duration to achieve agility, efficiency and resilience with Pilatus, to accelerating their growth agendas with RAMP, and our substantial investment in the skills of our people allows us to pivot to new areas of demand to be an attractive destination for top talent. Now let's turn to the quarter. To bring to life this demand environment across the five key forces of change for our clients: total enterprise reinvention, talent, sustainability, the metaverse and the ongoing tech revolution, which in turn drag our growth. First, total enterprise reinvention, we continue to help our clients achieve a new performance frontier by building their digital core, optimizing operations and accelerating growth, leveraging cloud, data and AI and new ways of working. We are helping Roche, a Swiss multinational health care company specializing in pharmaceuticals and diagnostics, with a total enterprise reinvention, building a digital infrastructure to match changing business needs. Using data integration, we have changed the way tumor boards are organized and conducted, empowering counter teams to be more efficient and effective in determining next steps for cancer care. And we have built a digital ecosystem that will create innovative products and solutions to drive diabetes care. Now as part of one of the largest ERP modernizations in the world, we are working together to deploy a digital backbone that will unify and harmonize nearly 700 business processes for more than 100,000 end users. The integrated platform will simplify the system landscape and connect activities across the value chain from R&D and manufacturing to patient treatment. Cloud, a $26 billion business in FY '22 grew 48%, with even stronger growth in Cloud First and continues to grow very strong double digits. In fact, we believe that the cloud continuum will become the new operative system for the future enterprise. Migrating to the cloud to drive efficiencies is just the first step. As we anticipated with our Cloud First strategy and investments, we are seeing our clients make significant investments to modernize, improve and innovate in the cloud, leveraging data and AI to drive new business value. For example, Accenture Federal Services is partnering with the Centers for Disease Control and Prevention, a U.S. federal agency under the Department of Health and Human Services, to accelerate its migration to the cloud across the enterprise and modernize its IT portfolio. Through this work, we will also help to achieve CDC's mission to protect people from health, safety and security threats by supporting the development of integrated, real-time public health data and surveillance systems. As our clients build their digital core, security continues to be more important than ever, as reflected in our very strong double-digit growth in Q1. We are expanding our cybersecurity footprint for a large health care network in Brazil to elevate their cybersecurity posture to a new hot level of preparedness. We are growing the organization's security profile with a cyber as a service solution that will enhance the cyber readiness of their infrastructure and operations. This new project not only consolidates the work that up to four different providers typically do, it also is the largest cybersecurity contract ever signed in Brazil by any provider. High demand for our strategic Managed Services, reflecting $7.3 billion in revenue and 20% growth in the quarter, demonstrates the importance of these services to our client strategies as it enables clients to move faster, leveraging our digital platform's expertise and talent. Our Managed Services are differentiated by our ability to bring in our deep expertise from across the enterprise, including Song, which grew double digits in the first quarter. For example, we're expanding our partnership with Allianz, an Italian and main bank of Allianz Group, to continue the bank's digital transformation with a new platform in the cloud, a modern IT architecture and a new operating model. Our Song team is helping to create a new customer mobile app to improve customer experience. And our end-to-end managed services capabilities, tailored to the financial services industry, will help the bank grow and scale its position in the market, ensure regulatory compliance and lower total cost of ownership. We continue to see strong demand for our industry edge capabilities, digitizing engineering and manufacturing, which we see as the next digital frontier with continued very strong double-digit growth in Q1. We are helping Celanese, a global chemical and specialty materials company on their digital transformation journey that will increase their manufacturing production resiliency, productivity and predictability of plant operations. We're teaming with ecosystem partners to design and implement a scalable digital twin platform at one of their largest manufacturing facilities, which plans to increase revenues through increased plant output, reduce costs through improved productivity, product quality and equipment reliability and improve overall safety in the workplace. We also are supporting an enterprise cloud transformation to provide a scalable platform for future enterprise growth and innovation. Next, talent. Our clients continue to look to us to access, create and unlocked talent as a critical element of their transformation. We're helping a global chemical manufacturer with an end-to-end IT transformation as part of their multiyear digital journey. The Company faces increasing IT costs, aging assets and tools and overreliance on contractors. We're implementing a full Managed Services model that will help modernize its IT, and this digital transformation includes a talent transformation. Together, we will upskill their people and data cloud and AI through our Accenture Academy so that everyone grows together, helping the Company leapfrog its competitors with innovative industry-leading solutions. Now, sustainability. We continue to prioritize embedding sustainability into our clients' digital transformation and on providing a direct sustainability service. For example, we are expanding our partnership with the European Multinational Aerospace Corporation to help improve their environmental and social impact across the enterprise. In recent years, we have worked together to digitize the Company's supply chain and manufacturing operations using a digital twin to improve productivity and reduce waste. Now we are working together to advance their sustainability agenda. We're supporting their aviation decarbonization road map, from accelerating the use of sustainable aviation fuel to helping design low-emissions aircraft. We are finding new ways to help make the supply chain more transparent and ethical, helping the Company replace hazardous materials from the product life cycle with safer, greener alternatives. And we are outlining a strategy to help them meet its net zero targets and internally foster a culture that is focused on sustainability. Finally, the metaverse and the ongoing tech revolution. While still in the early innings, we believe the metaverse will not only change how people work, but it will also profoundly change every part of every business, from how we interact with customers, what products and services they offer, how they are made and distributed, how you engage with your people from employee onboarding to personal productivity. We're partnering with NTT DOCOMO, a Japanese mobile operator to speed up the adoption of Web3, a new blockchain-based version of the Internet that promises a digital economy with greater social impact. We will develop and grow a secure technology platform for Web3, which will enable new products, services and community building. Training will ensure that Web3 engineers and business leaders collaborate with organizations effectively and securely on the platform. NTT DoCoMo's work on societal issues will now expand with the use of Web3, helping companies and governments transform social infrastructures and provide solutions that would improve people's lives. We continue to invest ahead of our clients' teams to the future, with a keen focus on innovation and the ongoing tech revolution. Thanks, Julie. Turning now to our business outlook. For the second quarter of fiscal '23, we expect revenues to be in the range of $15.2 billion to $15.75 billion. This assumes the impact of FX will be about negative 5% compared to the second quarter of fiscal '22 and reflects an estimated 6% to 10% growth in local currency. For the full fiscal year '23, based upon how the rates have been trending over the last few weeks, we now expect the impact of FX on our results in U.S. dollars will be approximately negative 5% compared to fiscal '22. For the full fiscal '23, we continue to expect our revenue to be in the range of 8% to 11% growth in local currency over fiscal '22, which continue to assume an inorganic contribution of about 2.5%. For operating margin, we continue to expect fiscal '23 to be 15.3% to 15.5%, a 10 to 30 basis point expansion over fiscal '22 results. I mentioned last quarter, we may see more variability in quarters as we go throughout fiscal year '23, and that's playing out as we expected, with contraction in the second quarter expected and potentially overall for H1. We continue to expect our annual effective tax rate to be in the range of 23% to 25%. This compares to an effective tax rate of 24% in fiscal '22. For earnings per share, based on the change to FX, we now expect our full year diluted EPS for fiscal '23 to be in the range of $11.20 to $11.52 or 5% to 8% growth over fiscal '22 results. Full fiscal '23, we continue to expect operating cash flow to be in the range of $8.5 billion to $9 billion, property and equipment additions to be approximately $800 million and free cash flow to be in the range of $7.7 billion to $8.2 billion. Our free cash flow guidance continues to reflect a strong free cash flow to net income ratio of 1.1%. Finally, we continue to expect to return at least $7.1 billion through dividends and share repurchases as we remain committed to returning a substantial portion of our cash to our shareholders. Thanks, KC. I would ask that you each keep one to question and a follow-up to allow us to as many participants as possible to ask a question. Operator, would you provide instructions for those on the call? Happy holidays. Really good results, strong results here. The one area that was a little softer was the Strategy & Consulting area, and I think you guys called that out as expected. Just thinking about Strategy & Consulting that you knew it was going to be a little bit softer, and it's becoming a little bit softer. Is that just more the move towards the cost agenda versus growth and just thinking about what we can expect there going forward? Hi, Bryan, thanks for the question. As you mentioned, our Strategy & Consulting results for Q1, they did come in as expected. But let's talk about what we're seeing go forward. And we do see a slight decline in Strategy & Consulting for Q2 before we're going to reconnect with growth in H2. And why is that for Q2? It's really a couple of things. We do see that we are going to have some impact from less revenue from smaller deals that which Julie will talk a little bit about here. And second, we do continue to see our S&C practitioners focus on high impact transformational deals, and they're going to bleed into revenue a little bit later in the year. There's a really important to our clients, but the revenue conversions at a slower pace. Yes. Bryan, maybe -- I want to maybe say -- to make sort of two points. So first of all, specifically on S&C, I think it's important to understand we really have a tale of two worlds. So our S&C work is growing high single-digit to low double-digit when it's tied to areas around cloud, enterprise and industry platforms, talent, cost reduction, everything tied to building to the core. So underneath our results, like that's growing great. The other world, right, is S&C that's tied to things like ad spend, creative marketing strategy and campaigns and other sort of front-office initiatives are contracting, right? And that's, of course, the strength of Accenture, is that we've got a very broad range of services even within the Strategy & Consulting as well as a broad range of industries. And so while the -- at the top line, you saw it 3% this quarter, there'll be a slight decline next quarter, underneath that, you've got a lot of strength in everything that's really driving our results. And I think that's really important to just understand. But then, I want to take a step back and just maybe comment on the demand environment. KC just mentioned kind of the impact in S&C and smaller deals. So first of all, like we're obviously super pleased with Q1, right? Great growth, and we're really happy with how we're seeing the year start. Now at the same time, what do we see over the last 90 days, what we saw what everybody saw, right, which was the macros continue to have uncertainty and you've got GDP estimates declining over the past 90 days. And on the one hand, our clients clearly are remaining ambitious, right, they're committed to revamping their business. And you see that in the 24 clients with quarterly new bookings over $100 million, right, which is an increase over this time last year. At the same time, they're more and more focused on cost and resilience. And many are having to make pretty hard choices, right, because the macro affects the industries differently. So you've got some industries, retail consumer goods, that are much more challenged than say, energy. But at the same time, and we talked about starting to see this last quarter, kind of regardless of industry, as the macro uncertainty has increased, right, they're being a little bit more cautious. So we're seeing some delays in decision-making. We see changes in the pace of spending, and we're seeing some pausing of the smaller deals. And all of this impacts the smaller deals more than the bigger deals because we're continuing to see that big transformation focus. So that impacts our revenue and profit build over the year, which is part of what we're seeing in S&C in the second quarter with the decline. And then, I just want to remind everyone that this is exactly the environment that you see the strength of Accenture. It is because we are so broadly diverse. I mean you saw it in the examples in my script, all around the world, all around industries. But who else could be in Asia doing border security, in the U.S., working with the state of Missouri on a talent and tech implementation; in Europe, working with a European grocer doing IT modernization, cost reduction and customer experience? Just moving around the world, you're back into Asia, working with a telecom operator, digitizing their platform, creating a new customer experience. And so, you just continue to see that our strategy that we've had for decades to be across industries, a global footprint and depth and breadth of services. I mean Managed Services is on fire because we could digitize faster, get that compressed transformation, help them access the talent and lower cost. Okay. Just to â and good morning. I just add to the Bryan's last question here, just as on the visibility side, especially in consulting relative to Managed Services. And given, Julie, what you just said there, any change in your thinking on mix of growth across Consulting versus Managed Services, asking for both, I guess, bookings as well as revenue here? Yes. I'll take â Hey, Tien-Tsin. I'll take the -- in terms of the outlook for how we see growth going by our various â by our two types of work. So for the full year, at the top end of our range, we see Consulting high single digits, and we see Managed Services continue to grow double digits. And as it relates to outlook and bookings, what we're seeing is that we do have a strong pipeline and we actually see continued strong pricing in that pipeline. And we do see that we will have a solid bookings quarter in Q2, and that includes Consulting. It's likely -- it will likely be lower though than the record bookings in Consulting that we had last quarter, and we expect to continue to see really strong bookings in Managed Services. Gotcha. Okay. Perfect. Then a quick follow, if you don't mind. I heard the pricing favorable utilization looks like it's steady attrition nicely, better or lower, 13%, I think I saw on the sheet there. So just same question on visibility with respect to cost and margin, if you're flexing or changing anything here, I know the range overall is the same, but it feels like you've got a good line of sight in terms of your costs. I just wanted to confirm that. Yes. Sure. So I'll talk a little bit about on the attrition point, and then we can get into kind of what we're seeing overall in our cost and our visibility in that regard. So attrition was down to 13%, and I think all of you know, but there's a structural pattern of attrition that typically comes down from Q4 to Q1. This year came down at a tick more, and we're really pleased with that. And that means we have to hire fewer replacement people, it means less recruiting costs, and you saw that in our improvement in G&A this quarter, and it's less ramp up for new hires. And so Tien-Tsin, in terms of visibility of what we see, I mean, we expect to continue to hire for the specific skills that we need. With upskilling, we may not need to hire as many people as we go throughout the year. But we have a very deep -- and we have a very deep competency in our supply and demand balancing and we're always focused on. And in terms of profit, let me talk a little bit about what we're seeing in operating margin. So operating margin, we're pleased with the 20 basis point expansion that we have in Q1 and really pleased to be confirming our 10 to 30 basis points expansion for the year. And as I said last quarter, we'd be pleased to land anywhere within the 10 to 30 basis point range. But let me give you a little bit more color about what we're seeing in Q2 and then just the visibility, as you ask, about the rest of the year. So I mentioned last quarter, we may see more variability in the quarters as we get through fiscal '23. And as I mentioned in the script, that is exactly playing out. Now, there's a few reasons for that. So in Q2 overall, the first thing, and I think all of you know, it's a structurally lower profit quarter just to begin with, in part because of the holidays. As well as for us, it's when most of our compensation increases kick in. So while we've planned for those comp increases, it does take some time to work through our P&L. And then in addition, in Q2, the impact of the changes of smaller deal volumes that Julie described, it's going to impact Q2 revenue. And that -- when you take everything into consideration, that's why we expect the Q2 operating margin decline in Q2 and potentially for the first half of the year. And so with that, then the math shows that most of our margin expansion will be in the back half of the year. And how -- why is it that we see that? We have a strong pipeline, as I mentioned. We have continued strong pricing improvements in our pipeline. And as always, we have some simple, but important levers on how we run our business. We are going to in addition to pricing, focused on cost efficiencies and delivery efficiencies within how we run our contracts. We're going to manage supply and demand, as we always do, with even more rigor and discipline. And we're going to continue to work on digitizing and cost-effective running the operations of Accenture. I wanted to ask, Julie, a bit about the progress on compressed transformations. I think you started using that phrase about two years ago sort of in the earlier days of the pandemic. And now as you're working with clients looking out into 2023, can you just give some color on sort of like how far they are along in the compressed transformation? Is this -- do we -- are we still only in the third or fourth inning? Or a lot of your clients sort of in full rollout mode and we've got a couple of years left? Just trying to get a sense for sort of that big push we've seen, how far through the process are we? How much of this sort of sustained growth can we expect going forward? Thanks, Lisa. It's a great question. And there's a couple of ways that you look at it. So what we saw particularly in the early days was that leaders before the pandemic kind of we're doubling down and becoming more ambitious. And from that time, you've got more and more companies then looking to see their competitors and sort of being pushed to themselves being more ambitious. And so, I think I shared last quarter that we got some recent research that said something like 68% of CFOs we surveyed are working in companies that have three or more transformation programs in progress in parallel. That being said, it's still very much the early days because we're so early in building the digital core that's enabling these transformations. So while we've had a big acceleration on the migration to the cloud, it's still kind of early innings, 35% or so. And most of the companies report, that although the -- when they get to the cloud they haven't actually been able to access the services and get the value yet, and that's why you're continuing just to see this drive in our cloud business, particularly Cloud First, because we continue to do all the migration work. And then those we've migrated are now coming to us and say, "Hey, look, we sign these big consumption contracts. We're trying to figure out how to transform our business and we don't know how to." So you basically got people who have moved fast, have lots more to do, and that's this concept of total enterprise reinvention. And then you have many companies that are just starting to really take on these more ambitious programs. So, we see this as a decade of transformation. Okay. Good. Then a quick one on M&A. I think you highlighted, KC, about close to $700 million in this past quarter in M&A. Can you guys just give a little more color on what you're seeing in the environment? Have you seen some of the private valuations come in? And are you seeing sort of an uptick in activity in that space? Yes. I mean great companies never come at cheap prices, is what I would say. So -- and we really try to focus on buying highly valued companies. So we really aren't seeing that. The broader environment, yes, but where we're focusing, we're not really seeing any big differences. And we think that's the right answer, right, we want to buy great companies. And I guess my question, I've noticed your -- the strategic priorities continue to grow significantly. And they grew at the same pace, at least the qualitative like numbers you wrote were at the same pace as last quarter. Is that -- I mean, is that like very close to, I guess, the same growth? Like did it decelerate at all? Or is that actually very similar? And what percent of revenues are those? Just I'm kind of thinking through the rest of the business must have decelerated a little more of that. Yes. So, overall -- let me say first, Happy Holidays. It's good to talk to you. In terms of overall, our strategic priorities, as you mentioned, and you're right, you would expect in a quarter where we grew 15%, we did have higher growth overall in terms of what we have in our strategic priorities. They would -- in total, they did grow at a faster pace than the rest of Accenture at 15%, which is the intent overall of our strategic priority. And so -- which does account for the majority of our revenue. Yes. Look, as you go forward, we talked a little bit about earlier, you've got parts of our business like some of the customer focus ad spending and marketing that's -- where clients are more challenged to be able to prioritize those areas, you also see some changing in industry. So, we're all reading about comms, media and tech, right? So, we are going to see -- we expect kind of a slowdown in spending from those clients as they reposition and think about sort of their -- what the changes they need to make, and we're helping them do that. So again, the diversity of our business really helps us balance. You do have, at any given time in an environment like this, areas that -- where the clients are having to make different choices and we're trying to pivot to help them and be really relevant to their current needs. And that's why it was so important to see the -- we've been talking about this for a couple of quarters, the importance of cost and to see that really coming through in our sales and pipeline, just demonstrates how our breadth of services allows us to pivot to the needs of our clients. Yes. Got you. And just one quick follow-up. You mentioned in Consulting, I think Tien-Tsin asked, you mentioned in Consulting, I think, bookings being down. Was that sequentially or year-over-year? And is that on a constant currency basis? Yes. So just first of all, bookings overall in terms -- let's just talk about bookings overall, Dave. They were up in local currency by 6%. But when you take the FX headwind, they were down overall in U.S. dollars. And what I mentioned was -- we expect a strong bookings quarter in Q2. The question that Tien-Tsin had was about the Consulting bookings expectation for Q2, and we expect a strong bookings in Q2. I just want to remind you that that's where we -- that was also the quarter though, last year, where we had our record Consulting bookings last year of about $11 billion. And so I just wanted to set the expectation that will be strong, it may not surpass the $11 billion that we did last quarter, last year in Q2. Great. Just wanted to follow up on the D&A question, and I completely get the point around valuations and wanting to look at the best companies. But are there any specific capabilities we should think about that you would be targeting especially as you're seeing clients evolve a bit their needs in the current environment? So a few things, right? So first of all, since the pandemic began, we've been very focused on building scale in markets around cloud, data and AI because that's so critical to building the digital core. So last quarter, we bought something in the Nordics, for example, that was all about getting scale. We bought something in France around mainframes because that's a very specific skillset that is relevant to moving some industries like financial services off of these core systems. And so we'd expect to continue to invest there. And we did this quarter, for example, with eLogic and with Sensis, these were acquisitions that we did this quarter, all in sort of the cloud and cloud platform technology space. Data and AI solutions will continue to be important. And again, we try to focus both on scale and getting scale in market. So we made a really exciting acquisition in Japan this quarter around data and AI solutions because we see that such a big market for us and we see a lot of interest, and it was just a great company. So, if you think about what clients are focused on building their digital core, that's going to continue to be a focus. The next digital frontier, so supply chain, digitizing supply chain and manufacturing, so we made a couple of acquisitions there this quarter, MacGregor, Stellantis. And so really, we keep very close to our strategy, which is tied to clients. They want reinvention across the enterprise, so continuing to build areas like in the digital frontier, making sure we've got scale and all of the capabilities needed across the digital core will continue to be a focus. That's great. And then just as a quick follow-up, and it's kind of related to accounting or some of the accounting metrics that are moving in. Looking at DSOs, you guys almost always have industry-leading DSOs. But for you specifically, it looks like it's a little bit higher than last year. Can you talk us through puts and takes and what's moving that around? And should we expect to see improvement from here? Or is this something, just from a monitoring working capital, that this is the kind of level we should expect going forward? Yes. Thanks for the question. And you're right, we do have industry-leading DSO, and we continue to have industry-leading DSOs. So let's talk about what we're seeing this quarter. So we had 48 days this quarter. And I think as you know, we do have a structural uptick every year from Q4 to Q1. And this is about a day of higher uptick than we would traditionally have, but it's nothing that we're concerned about. And we do feel really good about our DSO coming down by the end of the year. As I mentioned in our free cash flow guidance at the beginning of the year, we did allow for a couple of days uptick in DSO, and that's what we still expect. And maybe I'll talk a little bit about the free cash flow. So when you take a look at that in free cash flow and our expectations, overall for free cash flow for the year, you heard me reiterate the free cash flow guidance for the year. So that allows for us to have a few days uptick in DSO. And so, we're still really -- feel that the $1.1 billion is a really very strong free cash flow guidance, and it takes into account and increased DSO for the year. I wanted to follow up on the growth outlook and a little bit of the client behavior. So I'm curious if you've seen any actual change in backlog or prior book sales being deferred or potentially coming out there? So I hear you on the macro uncertainty, and I'm curious if their incidence of clients actually taking work out versus more so dragging on new bookings? Yes. So, I -- we haven't seen any real change. What you're talking about is what's happening with the work that we've already sold, we're not seeing any real change in anything that's already in our book of business in terms of what's happening with the macro. And Julie, I don't know if there's anything else you want to add? Yes -- no. And really I think what's important is that regardless of industry or country, the focus still is on transformation, right? There is nobody saying, "I'm going to change less," right? Unfortunately, the companies are having -- sometimes are having a harder time, right, doing what they'd like to do because they're under pressure. And again, that's where our relationships really matter because we're the trusted partner, right? And if you got to know that whatever you are going to spend money on, it's going to have to deliver value, it's a flight to quality, right? And so, we've seen that since the early days of the pandemic, and it continues in this environment. And remember, that the idea of total enterprise reinvention is things are connected. Like I gave the example of the European grocer, right? One company that can transform IT, do an ad strategy, provide personalized customer experience and lower overall cost, right, that is not easy to do, and it requires industry expertise and expertise in many parts of the enterprise. And that's really where our resilience comes from. And by the way, also our ability to pivot, right, to pivot, and that particular one started as a cost play, and we were able to show the client how not only could they reduce cost, but they could actually drive more growth by connecting these things and understanding the intersections. And that's what we're focused on, right? We always start with what do our clients need. And right now, they need to be more efficient, they need to do more with less, they need to optimize what they have and we're investing. And I will tell you that one of the things that's so critical are assets and solutions. Because I was just doing or earlier this week, and I always ask the client what do you think about what you've seen, and they're like, it's amazing like you have this myWizard platform, it's got data, it's got AI, it's stuff that we can even begin to build, and you not only have it built but it's been used in thousands of clients. So that's the kind of place where our ability to invest, not just now, but over the last decade, really matters to clients. And compared to anybody out there, right, the amount of money that we're putting in acquisitions and solutions is really tremendous in driving value for our clients. Okay. That's good to hear. Follow-up, just geographic and vertical growth performance was quite broad-based here. Did you expect that to continue through the balance of the year? And I was particularly surprised on Europe and Growth Markets actually outperforming North America, is that going to persist or do you see that changing? By the way, my CEO of Europe and my CEO of Growth Markets like that out to their friends in North America as well. So, a little good-natured competition there, but KC, why don't you... Yes. And so in terms of what we expect to see for the year, we do expect to see Europe and Growth Markets for the full year be in the double-digit range. And we do expect that North America, which is -- as the CEO of North America says, "I have a much, much bigger business," will grow at a mid- to high single-digit range for the year. And Julie, I don't know if there's anything else that you want to add on... Yes, on North America, I mean, they had unbelievable growth last year on a huge book of business. So growing anywhere in the high single digit to double digit again this year is quite impressive. I mean their growth was 26% last year. So, we are very pleased with kind of the growth we see ahead. Let me say a good quarter in a tough environment and also Happy Holidays. Let me -- I'll ask both the questions together. The first one is I see the sequential hiring growth, and obviously, many other tech companies cutting back. And I'm wondering if your positive hiring is partly a function of the rapid decline in attrition, so you might not have put the brakes on hiring yet? So, what should we expect for hiring? And could you comment on wage inflation? Yes, sure. Hi, Ashwin, nice to speak with you. So just in terms of what we expect for hiring, first of all, as you know, our ability to manage supply and demand is a core competency of ours, and we're always focused on it. And so, we did hire about -- we added about 17,000 people this quarter, as you mentioned. And we will continue to hire for the specific skills that we need. I think I made reference to that earlier, which means we may not need to hire as many people as we go throughout the year, but we'll balance that as we go through. And on wage inflation, I'll just go back to what we said when we set guidance, we did see wage inflation continuing. We do have comp increases that are kicking in that we've planned for, of course, and included in our pricing. But they are higher than they've been, and that's a statement across all industries, all geographies. And of course, that we're no different in that regard. Understood. And then on bookings, obviously, a good quarter overall. And you've referenced the underlying sort of Consulting versus Managed Services a couple of times. I want to kind of take that forward and ask the revenue conversion question because, obviously, Consulting, one might think of shorter cycle and it gets into revenue faster; Managed Services, longer ramps and things like that. Is that a fair observation still just looking at what you signed? And how might that affect sort of the calendar 2023 layout, if you will? Yes. I think here's the way I would look at it. In terms of when you look at Managed Services and Consulting, as a broad statement, you have more the benefit of Managed Services is that you have already sold a fair amount of work, right? So while they are longer deals and they made the deals that you sell in that quarter may turn into revenue a little shorter than they would in A consulting sale, for example, which is typically a shorter duration, you have more work already sold as you go into a quarter. So there's a terrific benefit to that, which is why we like this diversity, right? We have that as well as in Consulting. They do -- the length and shape of them really do vary. And when you look at it overall, Ashwin, if you go back, and I know you followed us for a long time, and just look at our mix, of Managed Services to Consulting, it doesn't really change the bookings, really don't change much as you go throughout our history, in terms of the percent -- the proportion of each. Yes. I mean this year, the bigger shift that we called out is just the smaller deal volume that's tied more to the macro and the sort of the shift on to these mega transformation deals, some of which are Consulting, some of which are Managed Services, they just bleed through revenue differently. So, that's more of the impact this year that we see right now. Okay. Well, thank you very much, and happy holidays. Good. So in closing, I want to thank all of our shareholders for your continued trust and support and all of our people for what you do every day. And I'd like to wish everyone a happy and healthy holiday season. Thank you. That does conclude your conference for today. Thank you for your participation and for using AT&T teleconference. You may now disconnect.
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EarningCall_1675
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All right. So why don't we get started here. I'm Aaron Rakers. I'm the hardware analyst here at Wells Fargo. I'm pleased to host a discussion with Andy Rhodes, the General Manager of the peripherals business with the HPQ. So Andy, first of all, thanks for joining us. Maybe to start just the conversation, give us a quick overview of kind of your background, your responsibilities. And then we'll dive right into some questions. Yes, we'll use this one, and then we'll jump in. So yes, great to be here, thanks. And just a quick background on myself. I've been at HP around four years. Prior to this role, I was running all of the commercial PC business for HP. Actually, it's my second rotation into the company. I was with HP from '97 to 2000 in the U.K., doing sort of actually PCs back then, spent 18 years out of the company at a competitor and then came back to HP really to drive innovation. I think HP itself is just such a strong company that values innovation, and it's a great place to work because you can go drive that. So the last six months, I've been doing peripherals and then also responsible for the acquisition of Poly that we closed recently, and we're in the immediate throws of integrating that company as well. And that's perfect. So we'll definitely get into the Poly acquisition and the integration. But maybe to start, obviously, a lot of discussion, I'm sure, with investors that you've had around just the demand environment. PC demand obviously continues to come under some pressure. Talk about maybe what HP has been seeing in terms of the peripheral side of the business as well as the hybrid workforce solutions growth in a fairly weak PC demand environment. Yes. So we still see the demand for peripherals relatively strong. And it's a broad term as well. And so if you think about what we provide now as a portfolio in HP, it's everything people need around the PC, whether you're working from home, remote, which is a display, a keyboard, a mouse, a dock, lighting, or as you sort of we get back into this notion of hybrid, and I say this to many, many customers, and we have a lot of debate right now, hybrid is not remote, hybrid is hybrid. It means that you're working in multiple different environments. You're working at home. You're working on the go again like we are now traveling and you're working back in the office. And so there is still relatively good demand because people are going in these states. And I'll give you one example. Let's talk about audio and headsets. If you're at home, you might have a very, very different solution than if you're on the road. So at home, I use a Poly deck headset of Voyager. On the road, though, I use ear buds, and then when you're in the office, you might use a third solution, that's number one. Secondly, what we're seeing is a lot of debate and discussion about back to office. And as I said, hybrid is not remote, and so people are coming back into offices. And one of the primary reasons that they come and they don't return is that the technology in the office is not as good as it is now at home. We spent three years developing our at-home setups. And so we see good demand still around the office solutions. There's 90 million rooms in the world of only rooms or spaces that people should come to collaborate together. Only around 10% of them have any technology in them today. And it's one of the biggest inhibitors. You go back into the office, you want a conference room to work. You want to be seen and heard. You want to be able to communicate with people that are remote and a lot of that has not been refreshed over the last three years. And so huge upside potential there for us. And do you think as the PC market goes through kind of the post-COVID dynamics that customers come back and say, now I'm going to subsequently make that upgrade to the work solutions piece of the equation, like we've done the PC upgrade. Is there kind of a lag effect at all in terms of how we think about the pull-through of some of the peripherals business? What's interesting on the peripherals, a couple of data points. One is there's a 5x refresh rate versus a PC on IO as an example, keyboards, mice, headsets. And that's holding pretty steady. So number one, people are refreshing these devices much, much quicker than they are. Secondly is this isn't just about IT spending and IT buying. What we've seen is a real shift in buying behavior over the last three or four years and many individuals are now buying these peripherals themselves, whether they get a stipend from their IT department or their company or do they just decide to buy themselves because they know that productivity -- their own personal productivity is highly related to the tech that they have, especially around the PC. Now we haven't seen a huge amount of shift on PC, bring your own device and things like that. But in the peripheral space, there are these two models, which is one of the reasons, by the way, that we're bullish about some of the synergies on Poly, is the Poly didn't have the breadth and depth of penetration in the e-tail/retail space that we do at HP, and we can bring now the Poly products into our channels in e-tail and retail. So that buying behavior shift is also what we're seeing is, even if IT aren't buying these, we're seeing a good demand still with end users themselves going through an e-tail or retail and buying full work the peripheral set. And just to kind of go back to what the company has been said -- has said in the past, which is, I think you're talking about very large TAMs, right? You're talking about, I think it was a $110 billion TAM by 2024 in the peripheral's piece. And I think with the Workforce Solutions group with Poly another $120 billion TAM. I think the growth was like 8% CAGR. Are those still kind of how you think about the size of the market opportunity that you're addressing now with the broad portfolio? Yes. Yes. That hasn't changed even with the economic environment that we've seen. And those are obviously over multiple years. And so we still see that CAGR as is, and it comes down to a number of things, as I said. Number one, refresh rates are still holding pretty steady. And also, they're relatively lower AUPs, and so people are still prepared to spend that kind of money because it's lower. And they really see it as linked with their own personal productivity, and that's a key driver. So that's -- that definitely is working in our favor. Second is inside of that TAM of $110 billion is the conference room itself. And as I said that if you want people to go back to the office, and this is a boardroom debate right now, how do we get people back into offices? How do we get them working on things together? I mean, remote is great, but when you have new and difficult problems, putting people inside of rooms is absolutely critical. And as I said, those rooms are just not built out yet in any meaningful way. So we're still very, very bullish about the growth of room solutions, which is a much, much video requirements are much, much higher. You need in the future, multi-cameras in that room to get the same experience. No one wants to see the back of someone's head if you're remote. And so having multiple cameras in the room, that the market is shifting to much more PC-based solutions in those rooms. We have actually replaced our solution with -- from Dell and Lenovo PCs to HP PCs in our room solutions. So that part of the market, yes, we see it still very, very much the same as we did before and the growth in high single digits over the next couple of years. That's perfect. How do we think about or how do we appreciate HP share in kind of the two categories, peripherals and workforce solutions? Well, I think if you think about keyboard, mouse, bags, docks, hubs and then personal video, we still have a relatively low share in a high-growing market. So there's a huge amount of upside for us. And we believe that the channels that we have, it's the same channels that buy the PC. So it's very, very complementary still, and it's a good business to be in, and we are underpenetrated there, which allows us to have all of this upside, and that hasn't changed over the last six months in terms of the opportunity that we see. And so kind of with that mindset, I mean, how do we think about kind of the expansion of the portfolio from HP from this perspective in terms of peripherals, is there other areas of white space for you to go after? How do we think about the road map within the peripheral strategy, if you will, inclusive of the Poly acquisition? Yes. So I mean, with the poly acquisition, what we get now at scale, whether it's in the product portfolio or the go-to-market is three major areas. The first major area is room solutions. And as I said, that those room solutions are absolutely going to grow because if you go into a room today, it's very monolithic. It's front-of-room camera. It's not how people want to operate. So we see the growth there around multiple cameras, really driving experiences, things like face framing, focusing on the speaker, but also seeing multiple different people in the room almost being able to direct that experience from afar. So there's just huge upside in the number of rooms that need to be penetrated, but then also upside in what customers want to put in those rooms to gain a better experience. So it's not simply just a dumb camera anymore that's projecting what is in the room. It's really using AI and software technology to provide that amazing experience. So that's number one. I think then in commercial headsets, we have relatively high share, but as I said, this is crossover into customer buying behavior shifting and then consumers themselves buying for hybrid work environments, and that's where I think our strength in e-tail, retail really benefits us, and you'll start to see us drive that over the next year. And a much more considerate, taking Poly into brick-and-mortar, retailers where we are relatively strong on the PC and in our other peripherals of keyboard and mice. Poly also has IP phones. Interestingly enough, that market, as people come back to the office, people are refreshing phones. And then again, a keyboard and mice and bags and everything was surrounding the PC, our share is relatively low in a stand-alone business. So we have just a huge amount of upside there. I mean we're very, very low single digits on share right now. So there's a huge amount of upside. And customers want to buy from us. They want to buy from one company. It helps them in terms of buying behavior, it helps them in terms of support all of that. So lots of the customers that I speak to, and I speak to tens of them a week right now. None of them have told me that this is a bad idea. They all think it's a great idea because they can consolidate their buying now into HP and they know that we can drive a much more integrated road map and get these experiences that they want right. I walk into a conference room with an HP PC, it knows that, that room solution is there and it can almost form part of the mesh network almost in these conference rooms. And so you've got great audio, you've got great video on your laptop, you can incorporate that into the meetings that you have. So I think with that said, kind of just getting into some of the details around the Poly acquisition. I think HP when you made the acquisition, I think the outline was like a 15% revenue compounded rate of growth. I think you talked about HP achieving $500 million of, I believe, revenue synergies by fiscal '25. Can you just unpack that? Or are those still kind of the targets we're thinking about as far as this acquisition and maybe double-click on some of those revenue synergies. You alluded to a little bit go-to-market, but anything else that we should think about? Sure. Yes. So the answer is yes, we're still on track for that. I mean, it's early days. We've just started the integration, but all the signs are very encouraging. I think on the revenue synergy side, just at the higher level, we see a number of areas. One is, we have very complementary channels, and we're seeing growth of video solutions, especially into the SMB and the S market through the long tail of IT channel partners that we have a very, very good penetration in. So expanding Poly products into those channels is one of those big revenue synergies. Second is Poly is very strong in what's called the AV channel, and we can bring more of our other products. We had personal webcams in the HP portfolio. We can bring that into the AV channel. So we still see good traction there and encouraging signs. The third is obviously in accounts. Poly was strong where maybe HP wasn't and vice versa, especially where HP had big penetration, but Poly wasn't. We have very, very robust programs in our go-to-market to capture those synergies and those accounts. And then we've got assets like hp.com and really sort of taking this attached motion where if people are buying a PC, they want to buy all the other things at the same time. And so hp.com is a good indicator of that. So you'll start to see Poly products really be pushed through that channel on hp.com. And then one other synergy on the revenue side that we have is really around, as I said, replacing some of the Dell and Lenovo PCs that were in the Poly solutions with HP. On the rest of the P&L, HP sells a PC a second. And so leveraging the supply chain even more in terms of ODM consolidation in terms of logistics rates, in terms of driving some of our commodity costs. We're seeing good signs there. And then lastly, on the cost side of the business, we're still on track to get the savings we had through consolidation of certain corporate functions. Yes. And I think with that being said, I mean, the target was to drive, I believe it was 600 basis points of operating margin. I'm guessing the base of that was the 10% to 12% rate. Is that the way to think about the leverage here on the operating margin side? So I guess one of the questions I tend to get, and we kind of touched on it at the beginning, is that with the PC weakness or basically, the -- if you will, demand normalization post COVID, why do I not think that the portfolio of Poly saw some of that demand insertion and normalization is something that we should be thinking about as we look forward now. My view is, as we sort of see weakness in other areas, people are still trying to drive for productivity of every worker that they have. And if you look at the portfolio we have, that's exactly what it's all about. It's about driving productivity. And so even as companies look to cut costs, they want to drive up productivity. So this is an area we're still seeing a lot of spending on. And I talk about this back to office is just a great example. Even in a reduced real estate environment, customers want to change the optics of that real estate, the way it's used and the office is going to be a place that people come back to work together. And what's inhibiting that right now is the technology in those conference rooms in those spaces. And so we are still seeing spending happening in those environments. And that's why we still remain committed to those synergies that we had at the acquisition. Yes. Perfect. And maybe just to kind of think about the context of the hybrid work environment. How do we think about the dollars spent on the peripheral's pieces and the Workforce Solution's pieces relative to the spend that you typically see from a -- on a PC side. Do you guys think about how that ratio has changed? Or is there anything you might share there? Well, as I said, I mean, let's say, the commercial market as an example. Even as IT spending comes down on that core -- on some of the core, like a PC and maybe a display, they're still spending on the peripherals of IO, of headsets, of audio. This notion have been seen and heard in remote environments is important not just to corporations, but to people themselves. And so two things are happening. One is we're seeing corporate spending still be very robust in those areas and in the environments where corporate spending is declining, individuals are going out and spending their own money on those elements. And again, that's the -- and they're not doing it through the corporate IT department, they're going to Amazon. They're going to Best Buy, they going to Belongia, they going to Finnek, they're going to Harvey Norman around the world and spending some of their own money on those areas. And as I talked about, that's one of the great synergies that we had in the Poly deal is, Poly was not in those areas in any significant way, and we are at HP. We have great connections on the PC and some of our other peripherals that we're leveraging to go do that. So we still see spending on the peripheral space been robust. And it might be a little bit of a shift away from corporate IT spending onto personal spending as well, but that's definitely happening. Yes. And then the final thing I just want to touch on, again, kind of double-clicking on the 600 basis points of synergies that you've laid out, obviously, an important piece because it would obviously be accretive to the overall, the PSG segment within HP. The couple of key synergies and how we think about the cadence of that 600 basis points, what's the key things we should be thinking about there from an operating margin perspective? I mean I think revenue growth is still a key one. So we're in this, we said it from day 1. This is about growth. This is about growth. And actually, our sales -- our general sales force is responding incredibly well to that. The corporate culture between the two companies, which you know in acquisitions is absolutely critical. I can tell you, I'm really, really happy with the way that the sales forces are engaging. They speak the same language, they understand each other. We're seeing very, very quick sort of account by account strategies being formed in the field. So the big, big key here is growth, and we continue to go drive that every day. And then it's not saying that we're not going to see the rest of the benefits through the OGM line on all the things I outlined earlier around logistics costs and using the buying power that HP has, but we are ultra-focused on growth, and we're ultra-focused on those revenue synergies. That's perfect. The other quick question I had here, and I apologize I'm going a little bit back and forth is that, can you help us unpack a little bit of the mix of the Poly business? I think one of the areas was obviously the video capabilities in the office side. I think HP outlined an expectation of seeing that market triple over the next several years. What -- unpack Poly, what percentage of Poly would do you put in this -- in some of those segments? Sure. I mean we're not going to break it down, but I'll give you a rough idea. It's probably roughly 30% room solutions, 30% headsets and then 30% IP phones and then services that surround all of those. We see the significant growth in room solutions. And so room solutions is the key because the two reasons. One, it's where the growth is going to be over the next couple of years? And second is, it's the one that is most ripe for radically changing the experience for this hybrid work environment. Second area that we're focused on moving forward is many of our customers want to buy it as a service. And that dovetails into you talked about Workforce Solutions. Dave Shull, who is the CEO of Poly has stayed on HP, which is fantastic, and he's leading that workforce solutions business. And so bundling this all together providing superior value for our customers by offering it as a service is going to be another big area that we're going to focus on in terms of providing that offer and then seeing that grow. Perfect. Andy, I think we've -- you've answered a lot of the questions I had. Is there anything that we didn't touch on that I think would be worth maybe highlighting here? No, I think you covered it very, very well, and we're excited about the business. I think acquisitions are always relatively hard. I think two things. One is, as I said, culturally, the fit is amazing and had a very, very fast start. Secondly, haven't yet met a customer that doesn't think this is a great idea or a channel partner. And thirdly, as I said, even as spending is reduced in certain areas, this is one that customers want to continue to go spend on because it's absolutely tied to productivity. And as you go through these environments, that's what you want, you want to have much more productive workers.
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EarningCall_1676
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Hi, everyone. Welcome to our keynote day two of our Global Retail and Consumer Conference. I'm Simeon Gutman, Morgan Stanley's hardline, broadline and food retail analyst. It is our distinct pleasure to welcome Walmart's President and CEO, Doug McMillon to our stage. Thank you for your participation in this event. You want to clap, feel free. Walmart has been a regular participant at this. Doug helped keynote one of our virtual sessions a couple of years ago. We're thrilled to have him in person. I'm going to read a quick disclosure. Iâm going to turn it over to Doug for a few opening remarks. And then we'll get into a discussion. For important disclosures, please see the Morgan Stanley research disclosure Web site at www.morganstanley.com/research disclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Can you guys hear me? Thanks for your attention. Appreciate you being here. I'll be brief to kick things off. I'm excited about where we are. I'm excited about our future. Iâm working with a great team. I think they've navigated this year well, considering everything that happened and we're setting ourselves up for a stronger future. And when I think about winning with the customer and member, I think the improvements that we're making in-store with pickup, with delivery, whether that's from a store or e-commerce around the world in the 24 markets that we operate in, is making progress. I've got some confidence in the top line growth of the company looking forward and in our long-term algorithm. Same is true for the bottom line. Why do I feel that way about the bottom line? And I think it's kind of three things, first one is just opportunities to manage the business better in all the kinds of ways that we do in retail. Maybe more strategically, there's a productivity opportunity with automation particularly in our supply chain and how that will affect store operations in particular. And then thirdly, the business model is changing. And the thread that you move through as you build a first party e-commerce business and then a marketplace and then fulfillment services and then ad income and then other forms of data monetization creates an opportunity to have higher margins and change the margin mix of the business so that we're more resilient and more profitable at the same time. And that work is underway. We're making some progress as it relates to that. Hopefully, you've noticed that in our results as we've shared them. So I look ahead at next year and beyond and I acknowledge the amount of uncertainty there is from an environmental point of view. But when I think about what we can control and where we're at, Iâm excited and optimistic. Thanks. So it was about nine or so years ago I was at the first meeting where you took over as CEO and the strategy takes a long time to evolve. And you can't really pivot as quick as you'd like with some structural things. Walmart seems like it's made all the right steps. Not all the right but many correct; fortified grocery, you're investing in membership, you're getting new customers from different income brackets, marketplace fulfillment. I want to talk about the evolution of this omni-channel strategy. It feels like the business is winning. The last 10 years was about adapting to this omni-channel. It feels like the investments are in place. And you could argue we're getting towards a payback period and that big have gotten bigger and some of the winners have been set out. So curious how you think about the evolution of that strategy and if we're at a different phase now within the strategy in retail? I think we are. If you go back to that kind of 2014-2015 period, we were really focused on U.S. supercenters. We were operating in more markets. And if you get to the center of the center and what's most important, if the U.S. supercenters are not performing well, Walmart doesn't have a good business. And you know all the investments we made there in terms of remodels, inventory improvement, wages, and the supercenters were in a better place than they were. Then very quickly on the heels of that, need to build a much bigger e-commerce business. The customer wants e-commerce. We were behind. We did the things we did to accelerate that. And last year, as we've shared, we had a $73 billion e-commerce business globally in terms of revenue. But that all kind of felt like silos or channels. And what happened along the way is we realized that the magic is in the way that you put them together and truly creating omni-channel to save people time not just money. Yes, a broader assortment. Yes, a variety of experiences that include pickup and delivery. But also things like the digital experience-related to tire should enable the in-store or in-club experience with tires to be better, or the deli counter or the way we interact with pharmacy as a customer or a member. And so it does feel like that for some period of time now, the channels went away. It's been more seamless and that required us to change how we work inside the company. We finished off organizational structure changes to make that easier for our teams to execute. And now I think we are truly an omni-channel retailer. Yes, it feels like the next phase could be maybe the big -- maybe keep getting bigger. The pandemic validated this omni-channel platform. And it feels like you have a proper offense and defense to battle the e-commerce threat that once was. I want to talk about the consumer, diagnose the consumer, not a short-term euphemism question. But diagnosing more about trade down, what we've seen throughout the year. There's been some fits and starts maybe around gas prices. But what do you see from the consumer? What's happened the last year? Yes. I didn't forecast inflation to be in the U.S. what it has been. If you'd asked me 16, 18 months ago, we were looking at mid single digit inflation. Certainly didn't see what has ended up happening in dry grocery and consumables happen. As it accelerated through January, February, it moved quickly and it was steeper in terms of trajectory than we expected. And that had an impact on what people buy. So if you were, kind of, let's say, typical U.S. household and you've been through two years of a pandemic, some of you have worked from home more and some people have more discretionary income because of government stimulus, you spent more money on home goods, you spent more money on the backyard, et cetera. You then get to this period of January, February of this year, and I'm talking about the U.S. consumer, and you've got gas prices headed up and you've got food and consumables taking more of your spend. And so we started seeing in around March this behavioral change, particularly with people with household incomes below 50,000 where they started really prioritizing. So their dollars went to food and consumables, it went to gasoline. The discretionary purchases, they'd kind of been making those. They didn't have to invest in home decor, for example. They didn't have to buy a new sweater. And so general merchandize sales started really dropping off. And that pressure played through to higher income levels as the months went by. So you can see behavioral change now at basically all income levels in the country as people are more price sensitive. And so they're more selective on discretionary purchases. They'll buy the things that they need. The kids will be taken care of. Pets get taken care of. Their partner gets taken care of. And then they put themselves last. And you can kind of see that in the ranking of how they make choices. And so I think that means that this Christmas, if you look at a top line point of view, will look better because of inflated dollars than it actually is. If you look at units and kind of the quality of the breadth of what sells at retail, as a retailer, we won't feel great about the quality of this Christmas. And it will come later, Christmas is a day later and sales after Christmas will be strong. And we'll be working all the way through the quarter, the end of January 31, to get inventories where we want and manage as we go through that. We've done this many times before. We've seen this before and we'll work through it. But it's not ideal. We use government data to try to assess reversion, especially of these durable goods where there was some overconsumption to try to understand units. You probably have the best data set of everyone. Curious throughout '22, does it appear that the rate of deceleration in durable goods is it stabilizing, is it getting worse, or is it actually getting better? Stable to a little worse is the way I would characterize that and very fluid. And you can look at the data and you can see flat panel televisions in Walmart's still selling really well. So you can find some conflicting data points. People will have Christmas. They will buy items. But some of those flat panel televisions are under $500 now. I think we had one at $238 that was a huge television for Black Friday related events. So they're price sensitive and selective. And is the price elasticity there like it would be normally if you took the price of a durable good down, does the consumer respond or because we've over consumed or over purchased that over the last couple of years, a home item, we're hesitant to buy it? Makes sense. Okay. Last quarter we talked about higher income consumers. I think we talked about it for a few, but I think there was an exclamation point on it. Walmart Plus feels or seems to be the gateway to this higher income consumer. Maybe it's just the marketplace. Maybe it's broadly. So first, can we just talk about Walmart Plus as this gateway to getting new customers? Is that a fair assumption? I don't think it is. I think if you want to look at how income levels shop at Walmart, the way to think about it at first would be everybody buys food and consumables or almost everybody buys food and consumables from Walmart. But they might not buy their apparel from Walmart or their home categories from Walmart typically. The market share growth that we've seen with higher income levels that have driven our growth the last few quarters have been people making over 100 buying food and consumables. And so our challenge is to have market shares that look more consistent across the whole assortment. We sell a lot of units of bicycles. We sell a lot of units of televisions, but we don't sell as much in home and apparel and some hardlines categories as we could. So the way for us to attract and retain higher income customers and members is first to have a great assortment of great prices in those discretionary categories so they don't need to go somewhere else and have more brands and grow the marketplace assortment as we've done. Then secondarily, having a digital relationship which starts to head towards Walmart Plus is really important. And we've shared before, if people buy in store and online with Walmart.com, they generally spend twice as much and they shop in store more often. That data has held over time. And so that digital relationship, which could be for a pickup order, it could be for a delivery order, whether that's from a store or an e-commerce fulfillment center, that's really important to us. And then you get to Walmart Plus and we do like the behavior we see when someone becomes a Walmart Plus member. So Walmart Plus is important. But it's not a simplistic shortcut for the investment community to think about valuing Walmart. Walmart can grow sales and profit regardless of how many Walmart Plus members we have. So a couple of follow ups in that. So what would you attribute then this higher income consumer who's coming to Walmart with more velocity or frequency? They're just looking for value. And they're looking across categories more than they were before. And to your point about kind of past cycles and the degree to which we held on to customers, what's different now is we've got this bigger e-commerce business, 370 million items on the U.S. marketplace, we've got an app, we've got pickup, we've got delivery, we've got Walmart Plus. We added Paramount Plus to it. So there are other things in place that were not in place in the last cycle that we hope will help us retain more customers. And you said you like the behavior of the Walmart Plus customer. Are they entering the flywheel as you'd expect, they're purchasing either consumable or discretionary, the frequency? And then I'll get to retention in a second. The primary reason why someone would want to become a Walmart Plus member is for free delivery. And our food and consumables customer value proposition is attractive. It's high quality at a Walmart price. And now you can get it delivered for free in an unlimited fashion. Our challenge is to take that frequently purchased set of items in that relationship and have it extend into more discretionary items and build the basket out over time. Yes, I think we launched it in September of '21, if I remember correctly, when we were out of stock related to the pandemic. It was perfect timing. Right. So we've seen a chance for retention, and I'll make it a bigger question. You don't disclose the membership numbers. But you've progressively added features to the program. Based on what you've added and the uptick you would have expected, is the membership number trending at or better or worse than what you would have thought? Yes. I think the way to think about this is we want to engineer an offer to customers that cause them to want to be members that is going to appeal broadly. And so it was helpful to add a fuel discount, it's helpful to have scan and go, Paramount Plus has proven to be helpful and will add more things over time but in a strategic and choiceful way, not just throwing spaghetti at the wall. Okay. So 2022 thus far from an earnings perspective, it's somewhat been defined by the inventory snafu. If you look at the core business, and I'm not sure there's a whole commentary, but it's probably not playing out that different other than the inventory snafu. So first, how are you approaching purchasing? Are you looking at it any different either to avoid the pothole, we talked about the ditch earlier, or do you just go back to being more aggressive to take market share? We are doing our best to sync an item and a category at a time and not overreact to a situation such as to go from one ditch to the other, which means that you've got to have calculated bets related to what you think Christmas next year for important goods is going to look like. If you're a merchant for our company and you're responsible for categories that are fast turn and consumable, you don't have as much of a challenge. You've got a shorter lead time, you can adjust, a lot of that's replenishable. That's not as complicated. The more complicated stuff is long lead time, merchandise and more discretionary merchandise. For the U.S. business, two thirds of what we sell is either grown or made here. The other third comes from China, India, Mexico, Canada. So those things that are longest lead time, we are generally taking a more conservative view. But asking our merchants to make item and category decisions not some general decision to be less aggressive because we do have opportunities to grow sales and we have had out of stocks. If you look at our Sam's Club business, our inventory in Sam's is up higher than our inventory in Walmart U.S. because Sam's has a lot more members, they're driving double digit comps for almost three years in a row, and they need to keep playing offense. So everything needs to be a little more targeted, a little more specific. Don't paint with a broad brush. That's the way our merchant leaders are approaching it. And this inventory issue, it feels like it hit Walmart relatively early relative to retail. And you made the decision how to deal with it. Some of it marked down, some of it moved out. It seems like the problemâs compounded to some degree with the rest of the industry. And now there's a lot of merchandise entering into the off price channels. Do you feel -- do you see that being an impediment? Not trying to be a loaded question with a sales outlook, but the environment could get a little muddy because there's so much excess inventory that's still sitting out there. Do you see that or not see that? That's plausible. I think in our case, we finished last quarter up 13% in inventory. A lot of that 13% is just driven by inflation. So inventory is in a pretty good place. And what we want to do is be positioned for flexibility. And I think we're in pretty good shape as it relates to that, whether it's hardlines or apparel. And connected to that, the promotional backdrop preholiday, did that potential excess or over inventory position affected or has it been relatively stable throughout the year? So during the course of the year, did the backdrop become more promotional up until the fourth quarter, reflecting more inventories in the channel? The way I would describe it is there was more clearance in the market. And so for us showing was now value, handling our clearance aisles well, managing our apparel racks well from a presentation point of view, those were the keys. And yes, the market had more clearance in it than what it would normally have. Fair enough. Price; inflation, deflation, disinflation, I can ask a lot of different questions about it but what -- I don't know if we can talk about expectation, but based on what you're seeing from suppliers and how the business is progressing, I guess what can we talk about regarding price? Yes, let's break it into categories. If you start with fresh food, the pricing on proteins, dairy, et cetera, is very volatile. It's moving around quite a bit. Chicken right now is up, beef is down, fruit and veg is in pretty good shape from a price perspective with disinflation or moderate inflation. So we'll manage that, like we always do. Dry grocery and consumables has mid double digit inflation that feels stubborn to us. And then general merchandise is coming down. Our cost of goods inflation for general merchandise across hardlines and apparel is still there. We still have an inflated price, but it's single digit and the trend line is coming down. GM is reacting to demand. But dry grocery and consumables where farmer input costs, supplier wages, their own input costs have driven prices up, that feels to us like it's going to be here for a while. And we're trying to figure out with our suppliers what could we do that's different that would help mitigate some of those costs? Is there any waste in the system, transportation point of view? Can we get better at forecasting? What are we doing with packaging? How do we help the American family as much as possible on dry grocery and consumables so that we can bend this curve back? And unfortunately, some of those suppliers are still pointing us towards more inflation next year on top of the mid double digits this year, and we don't like that for any reason. We don't like it for families. We don't like it as it relates to mix and what that can mean for us. So we're pretty incented to try and make that turn happen faster than it might normally. And we've got good insight into commodity costs through private brands and others things. We know we can kind of penny out a P&L on an item and have a productive discussion with a supplier about what they're doing and try to encourage them to focus on market share and growth and the longer term with us. In the meanwhile we will allocate space to private brands and tertiary brands to the degree that we need to, to help make this work for families. Some of the price pressure is because of the input cost of labor, which is more structural. Is that still a valid case to be made? And wouldn't that argue that more of what we've seen in terms of price will likely get kept? We are always trying to keep prices down. And so yes, we held -- we managed mix pretty well. We got a lot of variables to play with. We've got the product mix variables that we've always had and now we have some advertising income and some membership income and some other data monetization income. And we're building a fulfillment services business. So if you think of retail as a big mix game, we had a broad set of variables to manage and we're now broadening that even more, which is helpful and that's happening around the world in the various markets where we operate. And we did do some things like, for the Thanksgiving meal in the U.S., hold our prices at last year's prices for a broad set of items that people could shop to avoid inflation for their Thanksgiving meal. And I think the team is still looking for more places to be able to do that to help those that need help the most. At this point though, does it seem like the business has now been repriced for the inflation we've seen, or there's still some catch up or could have been over -- Price gaps, one last one on price, I think the message has been your price gaps have largely held, which a lot of retailers have actually made that assertion which something has to give. The checks look like your price gaps have largely held. So your posture on price. And I have a second question on it later on where weâll talk about grocery, but just your current posture on price. Again, on the Walmart U.S. business specifically, but this would be true more broadly as well, we have a sense for where our price gaps need to be to drive the growth that we're trying to drive. And we've managed that pre-pandemic through the pandemic and now. And it's moved around a little bit. Things have normalized more to pre-pandemic levels and we're comfortable with that. It happens to be the next question about grocery. So there could be some disruption given potential M&A in that space. I wanted to see if you'd entertain some game theory thinking about how -- Right. Maybe we could go with the pros of leaning in on price. But the environment is going to consolidate. So in theory, if it does, you have stronger competitors. Anyway, you don't -- it doesn't sound like youâd change your thought on price? We have had and will have a strong set of competition. Weâre not worried about that. We can count on it. Done deal. So marketplace combined with Walmart Plus combined with physical offering, it seems like you're better equipped than ever to deal with digital threat. We kind of talked about this. Do you feel like you've reached a critical scale now across your network in terms of investments? There's more in front of us to do with the supply chain in particular, and we're very excited about automation. And I think it's going to really help our store associates and help us with productivity. And specifically what we're seeing is after a number of years of work, there are opportunities to use automated storage and retrieval systems in ambient distribution centers, food distribution centers, e-commerce fulfillment centers, and eventually market fulfillment centers next to stores. And they're all four basically the same thing. We're working with four different parties to do it. But it's all basically carts with wheels, putting away items or cases in dense steel, almost like data in the cloud that does not have a human in the middle of it, a forklift in the middle of it, or an empty aisle like you see in an old fashioned distribution center. The items go in and they come out the other side either as a customized e-commerce order for a customer or as a pallet that has been mixed that is specific for a department and a store. So if you and I were in a Walmart store today in the U.S., we would receive the grocery product on pallets and it's easier to work that freight. But if we were working the general merchandise receiving area and we opened a trailer, there would be brown boxes floor to ceiling on the floor. And we would touch every one of those boxes, put it on the roller, push it into the back room, put it away somewhere in the back room and then eventually somebody comes and picks that order, puts it on the sales floor. In the future, those orders will come in palletized, arranged by layer for that department in that store. So we'll take the pallet jack, put it under the pallet, pull it to the sales floor, stock from the pallet. And if anything's left that doesn't fit, it'll go to the back room. It's a different process, eliminating a lot of the hours that we invest in today in the backroom of our stores. That capital will take multiple years to put in place. In addition to the robotics aspect of what I've just described, there's work underway related to the data that we've got for our supply chain and the algorithms that we use to optimize it. You can imagine that in the past, we went from an ambient network for discount stores to an ambient network plus a food distribution capability. Then we layered on e-commerce fulfillment centers. Each one of those had different operating systems and operated to a degree in a silo. What we've been changing, and it made progress towards changing, is syncing all those together in a way that you can inventory, optimize like you couldn't before. So if you can understand demand, get even better at forecasting with today's forecasting tools, and then have a supply chain that's got data algorithms and robotics in it, you can take costs out of the system that we've not ever been able to take out before. So that's a multiyear investment journey. We'll share more information about that in the future. But it's something that we're really excited about. That has to happen in conjunction with the business model changing. So the thread that you mentioned that runs from let's build an e-commerce business, part of that marketplace, we can get paid to operate a marketplace and people want to buy fulfillment services. In fact, a lot of people want to buy fulfillment services and they want to have sales, so they're willing to buy an ad. The thread that runs from omni-channel to all of those things I just mentioned is a very strong thread that is being pulled through as we speak. And so that business model remixing happens in parallel with the automation of the supply chain and ends up with a different business model, which weâre excited about. I want to ask two follow ups to that, first about the general infrastructure and second about grocery. You build these mega DCs. This is about seven or so years ago. I think it was six mega DCs at the time, maybe five. You picked up three more from Jet. It now feels like maybe remixing these new -- you're building another set of DCs too that are bigger that can accommodate longer tail that can do everything from dry good to grocery and correct me if I'm wrong, is that right? And is the core infrastructure around becoming an endless aisle marketplace with all of the goods within the network, is that what's becoming the reality now? Yes, think about it this way. Think about our existing buildings, not new buildings, being outfitted with automated storage and retrieval systems. Step one. As we do that, we get more throughput through those buildings and we avoid the necessity of building more buildings in the future. And as we do that, thereâs space freed up. Because they're more dense, you now have in some of these million square foot boxes excess space that you can do a variety of things in, including sortation for e-commerce, non-conveyables, other things you can do with that space, again, avoiding the need for future buildings. That's true for the ambient DC network. The grocery DC network is also existing buildings with automation. Then there is e-commerce fulfillment centers. And you're right, we had a set of buildings. We added Jet buildings to it. Those buildings in most cases, if not all cases, will also be receiving automated storage and retrieval systems in the existing buildings, which helps with throughput. And we're building a few new ones where we need them. I was in a new one in Chicago the week before Thanksgiving and it's remarkable. There's not a lot of human engagement with that product. There's still some which eventually we'll work through to an even greater degree. But it is really slick and also more accurate. And so you get more productivity through those investments. Each one of these I should say individually has its own IRR, our own set of metrics, each one of those investments is vetted individually. And then you get the benefit of the collective system that I've been trying to describe as a big additional benefit. What have you learned around these capabilities coupled with grocery automation distribution? It feels like you're on the four of the technology, the debate between macro-micro fulfillment. You're pioneering. I think it's Store 100, the self driving trucks moving out to the spokes. So do we have a model yet and a profit model that's tied to all these technologies that you feel good about? Not good, but you understand what it looks like? Yes, we can fill the pieces. I think the challenge that we've got is getting them together in one place fast enough so that we can measure all of the other unintended or things that weren't in the model, because you got to prove them all out. The Store 100 market fulfillment center that you're referring to is one of several. There's some other places where we're opening those. And we believe that having onsite market fulfillment centers with these big parking lots we've got, and in some cases some of the buildings weâre trimming back a little bit, the 200,000, 220,000 square foot boxes can be 185,000 and still be as productive from a sales point of view, that gives us space to use cost that we've invested in the past to put MFCs in place and use the last mile advantage that we have of being so close to people. Yes. I know we don't talk individually about e-commerce profit, and this is a sideways question to it. We used to discuss the lever of higher mix of general merchandise being one of the biggest levers to that margin. Is the cost of fulfillment as powerful? Is that -- now it wasn't going anywhere but it is now because we're using the stores more and then we're building this network? Just tap into the interplay between those factors and driving cost down. Good question. The way that I would describe it is first, the mix of sales by product category is a key driver. You want to contribution profit that includes apparel and home and those kinds of things. Another way to think about mix of sales is first party, third party. You want a big enough marketplace business to make that mix work. And then as you work down the income statement and you get to wages, one of the biggest costs that we have in our e-commerce business is for store level wage investments to pick orders. We assign store picking for e-commerce to the e-commerce P&L. So as we raise store wages or we use more hours to pick orders because sales are going up, that penalizes the e-commerce P&L and we manage it that way as a habit. So if and as the market fulfillment centers take labor hours out of that system, because we've automated using MFCs, and the other automation coming in the back door is better, you end up not needing as many hours at store level to pick orders, which further relieves the P&L. And then if you keep working down the way I think about it is the other income associated with fulfillment services and advertising and membership start to kick in. And that's when you have a more attractive income statement than even our original income statement that we had as a company, which was buying and selling merchandise, having associates and managing a narrow margin, all of that core P&L is still in place. But we've kind of -- sometimes I visualize it as three P&Ls. There's the original retail P&L. They're the new things we're building. They have GMV, marketplace, advertising, membership, all the things I mentioned. And in the beginning that P&L loses money because you're building it out. And then eventually, it's better than the first P&L. You put them together, you get a third one. And that's our new business model. And that's what we're trying to build. We were going to go next to alternative profit, but I want to -- I think it's worth repeating what you just said is that you had an EBIT margin of this business or an EBITDA that reflected a brick and mortar business. You've been mixing it with an e-commerce one, which naturally has had some dilution. And both the improvement in that e-commerce site or omni-channel coupled with the alternative profit pools youâre saying gets you to a better place than when we started this whole journey eventually? That's well said. I think in the midst of all that, we had a Sam's Club business that was growing and performing well. And then the international portfolio got changed. Sometimes I get questions from this community asking, don't you need to do less, donât you need to focus? And I'm like, yes, we exited Brazil, the UK, Japan, Argentina, that's happening. And so if you look at our business or portfolio, we're actually in a different set of businesses than we were a few years ago. And we kind of subtracted and then we added back a tremendous growth opportunity in India with financial services and an e-commerce marketplace business, which as we said when we bought it would put pressure on earnings for a while. And it has, but every time we raised money for those businesses, the valuations gone up and it looks like a really good business not only from an investment point of view, but just from an operational point of view. We see synergies in financial services to some degree in healthcare as well as in all this omni-channel core retail discussion that are causing us to work more like a global company and in some ways more like a tech company, building tech products that can be leveraged across markets more so than we've done in the past. And I think that will be even more true in the future. Moving to alternative profit, you mentioned a few. We've had to write notes because there's so many of them. Maybe I'll let you choose, but I was going to throw it out advertising, healthcare, fulfillment services, Spark, but maybe to talk -- I was going to ask you to prioritize, but they kind of have done but can we talk about it, and maybe the trajectories within each of those businesses and how they're progressing? Yes. I think of marketplace first, and that's because it will matter a lot to customers and members to have that breadth of assortment. And there are fees associated with that from marketplace sellers that matter. And it's very connected to fulfillment services obviously and then advertising. Our advertising growth globally is not just with the product suppliers we have that are first party in nature but also marketplace sellers. So when you can sell an ad to either group, that's a bigger business. So that's important. So I think that's the sequence I would go on to be marketplace, advertising, fulfillment services, other forms of data monetization. I wouldn't have healthcare and financial services in that same continuum. I think those are part of our flywheel and they connect up together, but I think of them in a different way. And when you run the business now, you have these other profit contributors that you didn't have before. Do they fall into the P&L, meaning its house money now and we can reinvest in other parts, or they flow on their own lines and you run the business as distinct? A degree of both. So we obviously have budgets and plans for each component. But we are thoughtful about where we set those objectives. And that came up in several of the small group meetings this morning. What's your prioritization? Is your prioritization to maximize ad income or is your prioritization to serve customers well from a retail point of view? And those are actually two different things and our prioritization is to be where America shops. We will prioritize retail and ad income will grow, but we don't want it to somehow damage or pollute the experience of shopping with us on our app or in store. Great. Eight minutes, we're going to quickly pivot to Sam's, a little international and mix in some Flipkart. On Sam's, this is an investment conference so I'll cut to the chase, which is it's a very valuable asset that may not be getting the proper value externally. Can you fix that? We need some of your help. But does that -- is that something that it could be -- is there any monetization of this asset over time, or is this -- If we didn't own it, we would want to buy it, right? And it's an awesome business and we love it and it's multinational, like it's a great business in Mexico. Sam's Club is a terrific business in China. It's our strongest brand in China, stronger than Walmart. And the Sam's Clubs that we open there have all done really well and we'd like to have a bunch more. So you could look at Sam's as kind of a global brand, not just a U.S. brand. It's a great place for people to learn. We've, in some cases, recruited talent out of there. I used to work at Sam's. John Furner used to work at Sam's. We try not to turn over Sam's merchants too fast, but it's a great place for people to grow and develop and it's just a really awesome business. Fair enough. We'll go to international. A lot of the portfolio has been cold or pruned under your leadership, either by the key markets in place. And then I want to talk about a couple of the key markets. Yes. The key markets would include Mexico, Canada, India, China. Walmex is a fantastic business, multi-country, high growth rates, profitable. They're further down the line in some instances with customer centricity and member centricity, just really a big fan of our Walmex business. Canada has always been a terrific business. And I think we've got a good opportunity there. We're still down the list of the top retailers in Canada. And then India is amazing. I was there in July I think it was and the momentum that we've got in both PhonePe and Flipkart is tremendous, strong teams. I think a bright future there. And there's synergy flowing back into some other markets in terms of what they can bring to the company. It's not like we run these in silos entirely. And then China, as I mentioned, the Sam's Club business is terrific. The Walmart supercenters have been performing better. Our team has done a great job navigating the environment in China with zero COVID as a policy, and just really proud of them. And what's your patience or tolerance on these highly populated markets, India for one? You have some high growth, great business in PhonePe. And then Flipkart seems to be continuing to perform well and there's tremendous opportunity. I guess what's the tradeoff between waiting to do something external, like monetization versus sticking in that business several more years absorbing full losses or whatever the P&L looks like? We don't know officially. How do you think about it? Timing matters. The teams that are leading those businesses are really capable. They've been with the business for a long time. And they want a path towards long-term large cap sustainable business. So they think about things like profitability. What we've said is we want to get the timing right. And that's one of the reasons why people like me go to the market to listen and to hear them as they think about timing for different structures. And as we've said, we're thinking about different structures. And at the right time, we'll make that happen. Geopolitics, really both India and China, how does that change how much time you spend thinking about these things? Does it take a lot of time thinking through the next several years or youâre so long-term focused on these markets, you kind of put it aside it? We definitely think about it. And yes, we're long-term oriented. But in both instances, job one is to in any country that you're operating in, including this one, demonstrate to all the stakeholders, including government, that you're a good actor, that you're doing good work. So when I'm meeting with leaders and government in a foreign market, we talk about what we're doing to serve customers and members and help them save money and live better. We're talking about the work we're doing on sustainability. We talk about our compliance programs. We talk about how we treat suppliers. And people want us to be there because of those things. And therefore they support us appropriately to have a level playing field. And that's all we ask for. Okay. Just quickly on China individually. You've been in that market for I don't know the number of years, but probably -- Yes. Does the business continue to make progress? I know Sam's is extremely successful there. Walmart concept maybe not as successful, but not as successful as Sam's. Can you talk about that market? I can. 420-ish units I think, 100,000 associates that work there. The Sam's Clubs have an incredible track record. Just everyone we open has been high volume and highly sought after our biggest challenge opening more is just citing them from a real estate point of view, which can be a challenge because they get unique needs in terms of how you build them out. The supercenters have been performing better, and theyâve become hybrid. So we do a lot of business. I don't know if we've shared it, so I won't say the number but we have a very high percentage total in China, both in Walmart and Sam's in terms of the digital portion of the business. There's a lot of delivery happening out of those units and weâre profitable. And optimistic about what that could mean over a longer time horizon. Final question. I sent this quote to you a few times. We can do both. That was your quote referring to both investing for the future and delivering operating leverage at the same time. Little bit of a slip. There's some fair excuse for what happened in this current year. Can you talk about that algorithm, that philosophy? I think we might be overdue as an investment community to hear some updated thoughts. So here's your forum. Yes, I think we kind of owe some more transparency next year in particular as it relates to how we think about the longer term, but I'm still very excited about that algorithm. I think four and more than four is achievable in our plan. And the way that we are changing the mix of the business helps give me more competence on the bottom line. So nothing's really changed there. This year, it's disappointing that we ended up with inventory in the wrong categories. I think our team did a nice job identifying it and moving quickly to fix it. And now we're on trying to get back to long range plan that we've had our eyes on the last few years. Thanks. I appreciate it. Thanks for sharing your thoughts around the holiday. Thanks for being at this conference. Good luck. Congratulations on everything.
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Good evening, and thank you for standing by, and welcome to the AeroVironment Fiscal Year '23 Second Quarter Conference Call. At this time, all participants are in a listen-only mode. After the speakersâ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that todayâs conference is being recorded. Thanks, and good afternoon, ladies and gentlemen. Welcome to AeroVironment's fiscal year 2023 second quarter earnings call. This is Jonah Teeter-Balin, Senior Director of Corporate Development and Investor Relations for AeroVironment. Before we begin, please note that certain information presented on this call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements and may contain words such as believe, anticipate, expect, estimate, intend, project, plan or words or phrases with similar meaning. Forward-looking statements are based on current expectations, forecasts and assumptions, which involve risks and uncertainties, including, but not limited to, economic, competitive, governmental and technological factors outside of our control that may cause our business strategy or actual results to differ materially from the forward-looking statements. For further information on these risks, we encourage you to review the risk factors discussed in AeroVironment's periodic reports on Form 10-K and other filings with the SEC, along with the associated earnings release and safe harbor statement contained therein. This afternoon, we also filed a slide presentations with our earnings release and posted the presentations to the Investors section of our website at avinc.com in the Events and Presentations section. The content of this conference call contains time-sensitive information that is accurate only as of today, December 6, 2022. The company undertakes no obligation to make any revision to any forward-looking statements contained in our remarks today or to update them to reflect this events or circumstances occurring after this conference call. Joining me today from AeroVironment are Chairman, President and Chief Executive Officer, Mr. Wahid Nawabi; and Senior Vice President and Chief Financial Officer, Mr. Kevin McDonnell. Thank you, Jonah. Welcome to our fiscal year 2023 second quarter earnings conference call. I'll start by summarizing our performance and recent achievements, after which Kevin will review our financial results in greater detail. I will then provide a summary of our expectations for the remainder of fiscal year 2023 before Kevin, Jonah and I take your questions. Let me first emphasize a few key messages, which are included on Slide number three of our earnings presentation. First, second quarter and first half results were largely in line or slightly better than our expectations, while we continue to experience solid demand across nearly all our product lines. Second, solid first half performance, coupled with growing order volume gives us confidence to increase our revenue guidance for fiscal year 2023. We're also slightly reducing our profitability outlook for fiscal year 2023 due to increased R&D investments to capture additional growth opportunities and accelerated Medium UAS or MUAS asset depreciation related to a shift in U.S. DOD funding priorities. And third, we experienced funded backlog of $293 million at the end of the second quarter and record funded backlog of $388 million through November. With this record backlog, revenue visibility and increasing order flow, we are well positioned for profitable double-digit top line growth in fiscal year '23 and beyond. Now let me summarize our financial results for the second quarter. We delivered second quarter revenue of $111.6 million compared to $122.0 million last year, a decline of approximately 9% year-over-year. This decrease was primarily due to lower SUAS sales, although, we posted higher revenue within our Tactical Missile Systems or TMS product line related to increasing international demand for our Switchblade loitering munitions. Gross profit for the quarter was $25.9 million compared to $42.5 million in the prior year period. Our gross margin decreased to 23% from 35% last year, primarily as a result of unfavorable product mix and accelerated depreciation charges related to the anticipated reduction in MUAS service revenue due to changing U.S. DOD budget priorities. We expect gross margins to increase during the remainder of the fiscal year 2023 and anticipate a return to historical levels in fiscal year 2024. We reported adjusted EBITDA of $6.8 million compared to $21.9 million in the second quarter last year. Finally, non-GAAP EPS was $0.00 per diluted share as compared to $0.78 per diluted share for the second quarter of fiscal year 2022. The decrease in adjusted EBITDA and non-GAAP EPS were primarily driven by lower revenues, unfavorable product mix and higher R&D investments. Non-GAAP EPS decrease was also due to accelerated depreciation of MUAS assets as I explained earlier. Looking ahead, recent contract awards and increasing demand for our portfolio of intelligent multi-domain robotic solutions gives us confidence that we are positioned for strong long-term performance and value creation. While the budget for the government's fiscal year 2023 has yet to be finalized, we maintain broad bipartisan support for our innovative solutions across the U.S. DOD and our allies. In addition, we remain diligent in managing the ongoing global supply chain constraints, inflationary pressures in a tight labor market. While the entire industry is dealing with these issues, we believe AeroVironment has taken the right actions to minimize their impact. So far this year, our company wide continuous improvement initiatives have delivered significant cost savings, while positioning us for growth and scale. The flexibility of our manufacturing operations has enabled us to meet the planned and unplanned needs of our customers. We continue to work directly with the office of the U.S. Secretary of Defense and key suppliers when possible to expedite customer shipments and are optimistic about improving industry fundamentals in the quarters to come. Based on this recent progress, we now feel confident that we will have sufficient supply and labor to meet this year's financial objectives. Now I would like to switch gears and provide an update on current developments within each of our product lines. Let me begin with our Small UAS or SUAS product line, where we recently received the largest Foreign Military Sales or FMS award in our company's history. This contract award has a maximum ceiling value of $176 million with an initial funding of $86 million and includes deliveries of Puma LE, Puma 3 AE systems, spare parts packages and associated training and logistics support. Shipments are set to begin later this quarter and will continue for six months to 12 months thereafter. Let me emphasize, our Puma systems have proven to be very critical to Ukraine forces, and its ongoing conflict with Russia, particularly when combined with our highly effective Switchblade loitering munitions to scout enemy targets and provide battle damage assessments. This award is an amazing testimony to our entire Puma Small UAS platform. That said, and as indicated earlier, while such a significant order strengthens our outlook in reaching our goals, it was largely anticipated. We have carefully planned for this contract award and the requirements to execute it. These shipments also incorporate our latest anti-jamming software enhancements to enable successful operation in a highly contested battle space. In addition to this large FMS award, we announced in September that AeroVironment had received two additional firm fixed price FMS awards totaling nearly $21 million for Puma 3 AE Small UAS initial spares packages, training and support for two allied nations. There is an urgent need for such systems and we are proud to continue helping the people of Ukraine and our allies abroad. Now I would like to highlight some of our SUAS team's recent new product introductions. In September, we announced the introduction of our next-generation VAPOR unmanned helicopter, the VAPOR MX 55. VAPOR MX 55 is a more rugged, reliable and capable platform and includes a completely redesigned modular autonomy framework, enabling 25% increased endurance and 20% expanded payload capacity. Also in September, we announced the introduction of the Puma VNS, a visual-based navigation system for Puma 2 AE and Puma 3 AE. Puma VNS enables operators to navigate in highly contested GPS-denied environments using onboard computer vision algorithms and visual terrain information. Customers will also be provided with navigation capabilities, features and functionality through future software and hardware updates. This solution provides unprecedented advantages in a contested battlefield environment. This is yet another example of how our investments in R&D and especially in artificial intelligence and computer vision further enhances our solutions capabilities to -- for our customers. And finally, we introduced a new Raven Gimbal called Mantis i23 D. The solution will be offered as an upgrade to Raven's existing large global installed base of customers who will benefit from this new state-of-the-art sensor suite. It is also important to note that we have already secured initial customer orders from many of these innovative solutions already. As anticipated, we're seeing improving demand for our Small UAS product line, while we continue to prudently invest in product advancements and features positioning us for continued future growth. This year will certainly prove to be one of the best ever for our Small UAS product line and we are confident we will build on this strong foundation for years to come. Moving to our Tactical Missile Systems or TMS product line, we are experiencing solid demand and nearly doubled revenue this quarter versus fiscal year 2022. Our TMS product line performance this quarter largely reflects shipments of the Switchblade 300 and 600 to the U.S. Army in support of the Ukraine Security Assistance Initiative or USAI and to backfill depleted U.S. DOD stockpiles. Given Switchblade's strong applicability to current conflicts, we expect order activity to remain heightened for the foreseeable future. And we are now pursuing multiple opportunities with a wide range of domestic and international customers. Domestically, we are working with the U.S. DOD to backfill and expand existing Switchblade inventories. Overseas, we're seeking additional contracts to supply Ukraine, while pursuing orders with new international customers that U.S. DOD recently approved for sale. We continue to receive positive feedback that AeroVironment solutions are highly effective and best-in-class. Our family of loitering munitions continues to expand through multiple strategic partnerships such as with Northrop Grumman. This Switchblade variant called Jackal is a turbojet-powered loitering munition with a range of more than 100 kilometers, supporting multiple warheads and payloads and can be launched from ground or air. This Long Range Precision Munition or LRPM is meant to provide flexible, durable strike options for the U.S. Army's next-generation helicopters. The program is under a three year to five year development cycle and could result in significant new awards for AeroVironment over the long term. We're making solid progress on this new variant of Switchblade and have recently received initial funding to demonstrate this new disruptive capability. Going forward, we anticipate healthy bipartisan support for our solutions as funding priorities are laid out for the government's fiscal year 2023. In addition, with the approval of Switchblade 300 and 600 sales to over 20 allies, there is ample opportunity for continued double-digit growth across our TMS product line for the foreseeable future. Just like with our SUAS product line, there is the potential for much larger orders going forward, and we're proud of developing such innovative solutions that help defend our country and our allies worldwide. I will now switch gears and discuss our Medium UAS or MUAS product line. As announced last quarter, we were awarded Increment 1 of the U.S. Army's Future Tactical UAS or FTUAS program, which was greatly anticipated and is now fully underway. We continue to train U.S. Army personnel in Germany, while activities are ongoing at Redstone Arsenal in Huntsville, Alabama, with flight testing expected to start in 30 days to 60 days. We're pleased to be deepening our partnership with the U.S. Army, and we're working hard to prove our advanced capabilities on this next-generation program. For government fiscal year 2023, the U.S. Army's proposed funding for FTUAS is approximately $100 million. We expect the next phase of FTUAS or Increment 2 to be awarded in the next six months. While FTUAS is an exciting $1 billion potential program of record, our current fiscal year is now expected to be flat in terms of MUAS growth. Ukraine has been the near-term priority for the U.S. DOD spending and programs outside of Ukraine that typically utilize the JUMP 20 aircraft are not seeing as much activity. As a result of this, we have recorded some accelerated depreciation expenses, which are now reflected in our revised financial outlook for the fiscal year. In addition, we have completed the integration of our most recent acquisition, Planck Aerosystems into our MUAS organization. Regarding our Unmanned Ground Vehicles or UGV product line, we have secured a contract to provide ground robots to Ukraine with deliveries this calendar year. Overall, UGV proposal for activity remains solid, and we expect additional positive developments in the months to come. Within our HAPS product line, as announced last quarter, we're successfully executing against our current contract with SoftBank for the next-generation Sunglider. Both AeroVironment and SoftBank remain fully committed to the vision of developing and commercializing stratospheric-based telecommunication services. At the same time, we're engaged with the U.S. DOD in multiple fronts, which could lead to a new incremental contract in the coming quarters. There is an emerging and growing need for stratospheric ultra-long endurance persistent ISR capability for defense applications against near peer adversaries. HAPS solutions are ideal for these applications and the performance capabilities of our Sunglider UAV stand well ahead of competitors. Overall, we remain on track for HAPS revenue to be between $30 million to $35 million this fiscal year. And finally, I will share some exciting developments at MacCready Works Advanced Solutions. Aside from the well-known contributions we're making for NASA, with the Ingenuity Unmanned Mars Helicopter, MacCready Works continues to experience growth and customer-funded R&D. These efforts are focused in the areas of artificial intelligence, machine learning and contested environment logistics. Recently, we received contracts from the U.S. Navy. to continue R&D, testing and evaluation of certain advanced image and video analytics capabilities in biometrics target recognition. We've also completed several field experiments with customers to explore AI and machine learning based solutions for GPS-denied environments operations. At the same time, we remain actively engaged with NASA's Jet Propulsion Laboratory's or JPL on the next important Mars mission, now in the preliminary design phase. In summary, AeroVironment remains on track for another year of profitable double-digit top line organic growth and improved underlying results. I am especially proud of how effectively and efficiently our team has executed so far, despite ongoing supply chain constraints. We are well prepared to deliver on the second half of our current fiscal year while positioning AeroVironment for even more growth beyond fiscal year 2023. With that, I would like to now turn the call over to Kevin McDonnell for a review of second quarter financials. Kevin? Thank you, Wahid. Today, I will be reviewing the highlights of our second quarter performance. During which I will occasionally refer to both our press release and earnings presentation available on our website. Let me start by saying that the second quarter results were in line with expectations and with the strength of our order bookings, backlog and subsequent large FMS order, we are positioned for a very strong second half of the year. As a result, I will try to provide increased visibility to the second half during my remarks. Revenue for the second quarter of fiscal 2023 was $111.6 million, a decrease of 9% compared to the second quarter of fiscal 2022 revenue of $122 million. Slide 5 of the earnings presentation provides a breakdown of revenue by segment for the quarter. Our largest segment during the quarter was Tactical Missile Systems or TMS, which contributed $31.1 million of revenue compared to $18.4 million during Q2 of last year. This increase was driven by a higher level of TMS manufacturing activity in the quarter, which was recognized based upon revenue overtime accounting. Our small UAS business finished the quarter with $26.7 million revenue, down from last year's $54.7 million. The lower revenue in the quarter result of order timing and we expect a very strong second half of the year for SUAS, given the large FMS order received after the end of the quarter. We also continue to see growing demand for upgrades and add-on products for both U.S. and international customers. The Medium UAS segment finished the quarter with revenue of $27.3 million, a 3% increase compared to the second quarter FY '22. We expect increased product sales of the MUAS JUMP 20 in the second half of the year, however, we do anticipate a reduction in COCO sites service revenue as overall MEUAS program is reducing the number of sites operated. Our half segment contributed $9.1 million in Q2, a decrease from $10.3 million in the prior year second quarter. Revenue from the other segment increased year-over-year to $17.5 million versus $12 million in last year's second quarter. Most of the growth in other came from our MacCready Works business, which has seen strong demand for both classified and unclassified DOD customers, as well as Jet Propulsion Labs. Turning to gross margins. Slide 5 of the earnings presentation shows the mix of product versus service revenue. For Q2, we saw a product mix of 56% compared to 58% in the second quarter of last year. We anticipate a shift back to the 70% product and 30% service mix during the second half of the year based upon expected significantly higher SUAS product sales and the shift to Medium UAS business to increase product sales. Slide 6 of the earnings presentation shows the trend of adjusted product and service gross margins, while Slide 12 reconciles the GAAP gross margins to adjusted gross margins, which excludes intangible amortization expense and other non-cash purchase accounting items. For the second quarter, GAAP gross margins decreased from 35% to 23% year-over-year and overall adjusted gross margins decreased from 39% to 27%. The decline in both GAAP and adjusted gross margins as a result of lower overall revenue reduced small UAS product mix and accelerated depreciation of Medium UAS COCO assets impacting service gross margins. However, we still expect adjusted gross margins for the year to be in line with fiscal 2022 as indicated previously. I'll now provide some additional detail adjusted gross margins during the quarter. Adjusted product gross margin for the quarter were 38% versus 48% in the second quarter of last fiscal year, primarily due to lower SUAS product mix. In terms of adjusted service gross margins, the second quarter was at 12% versus 27% during the same quarter last year, primarily as a result of lower MUAS margins following the accelerated depreciation charges of $4.5 million due to the anticipated site reductions mentioned earlier. We also expect additional accelerated depreciation of approximately $2.5 million in Q3. I want to reiterate, we expect annual gross margins to be in line with FY '22 and additional depreciation expense will be more than offset by higher product sales as a percentage of total revenue in the second half of the year, driven by higher small UAS product sales. Further, we expect product gross margin in the second half of the year to be in the low to mid-40% range. Now turning to GAAP earnings. We had a net loss for the second quarter of $6.7 million compared to a net income of $2.5 million in last year's second quarter. The $9.2 million year-over-year decrease in net income was due to $16.6 million in lower gross margin due to lower sales volume, unfavorable product mix and MUAS accelerated depreciation. In addition, R&D investments increased $2.3 million in the second quarter of fiscal 2023 versus the same period last year. Interest expense was $0.9 million higher over last year and equity investment losses were $1.6 million higher versus last year. These items were partially offset by a decrease in SG&A expense of $1.2 million and a $10 million reduction in other expense. As a reminder, in last year's second quarter, we recognized a $10 million litigation settlement charge that was recorded as other expense. In terms of adjusted EBITDA, Slide 13 of our earnings presentation shows the reconciliation of the GAAP net loss to the adjusted EBITDA. The adjusted EBITDA for the second quarter of fiscal 2023 was $6.8 million, a decrease of $14.1 million, primarily due to the $13.8 million lower adjusted gross margins from decreased revenue and unfavorable product mix. Given the strong revenue and gross margin outlook for the second half of the year, we expect that our adjusted EBITDA in the second half of the year to be significantly higher than the first half and the same period last year. As a consequence, we are narrowing our adjusted EBITDA outlook to the upper end of our previous guidance range. Slide 10 shows the reconciliation of GAAP and adjusted or non-GAAP diluted EPS, the company posted adjusted earnings per share -- diluted share of $0.00 for the second quarter of fiscal 2023 versus $0.78 per diluted share for the second quarter of fiscal 2022. Turning to the balance sheet. Total cash and investments at the end of the quarter was $123.9 million, which is essentially the same as last quarter. We had a good working capital quarter as the combination of accounts receivables and unbilled receivables decreased during the quarter, partially offset by increasing inventories. We expect inventories to continue to increase as we ramp up to meet demand. I'd also like to note that we paid down $20 million of our long term debt during the quarter. We continue to have a strong balance sheet, with over $120 million in cash and investments and approximately $100 million available under our working capital facility. I'd like to conclude with some highlights of our backlog metrics. Slide 8 of the earnings presentation provides a summary of our current fiscal 2023 visibility. As Wahid mentioned, our funded backlog at the end of the second quarter of fiscal 2023 was $293 million. However, November, we were awarded a large FMS contract with an initial value of $86 million, resulting in a November ending backlog of $388 million. Our visibility as of today to the midpoint of the revised guidance range is 92%. We also expect orders to continue to be strong for the remainder of 2023. Thanks, Kevin. As I noted earlier, we now have greater line of sight on our fiscal year 2023 financial performance, given the overall robust demand environment and recent contract awards, especially our record FMS order for Puma systems. As such, we are now raising our revenue guidance for this fiscal year. Our new outlook for fiscal year 2023 is shown on Slide number 7 and is as follows: we anticipate revenue of between $505 million and $525 million, which is higher than our prior guidance; net income of $8 million to $17 million, or $0.33 to $0.65 per diluted share; non-GAAP adjusted EBITDA of between $84 million and $92 million; and non-GAAP earnings per diluted share, excluding acquisition-related costs, amortization of intangible assets and other one-time expenses of between $1.26 and $1.58. While we are raising revenue guidance and narrow guidance for adjusted EBITDA, we have reduced some earnings metrics given greater than expected depreciation of MUAS assets and higher R&D investments necessary to capture future business opportunities. However, we believe adjusted gross margins will increase sequentially going forward, driven by favorable product mix and higher volumes. We expect to deliver adjusted EBITDA between 17% and 18% of revenue and R&D investments between 11% to 12% of revenue for the full fiscal year. We continue to anticipate roughly 60% of full year revenue will be recognized in the second half of this fiscal year. Of that second half total, approximately 60% of it will occur in Q4 as we deliver on orders now in the production stage. In summary, with 92% visibility to the midpoint of our revised revenue guidance range, we are confident in our ability to achieve not only these objectives in fiscal year 2023, but also position AeroVironment for another year of strong profitable growth in fiscal year 2024 and beyond. Before turning the call over for questions, let me once again summarize the key points from today's call. First, we're performing according to our plan with second quarter and first half results largely in line or slightly ahead of expectations. Second, we have confidently raised revenue guidance for this fiscal year even as we continue managing through several challenges, including supply chain constraints and inflationary cost pressures, while making the investments necessary to capitalize on future growth opportunities. And third, we are positioned for strong organic double-digit growth this year as evidenced by our solid visibility, record backlog and continued growth across nearly all our product lines. We expect margins and backlog to increase throughout the second half of this fiscal year, laying the foundation for strong profitable double-digit organic growth in fiscal year 2024 and beyond. I would again like to thank our employees for their hard work and dedication to our success. They and our loyal shareholders have made AeroVironment what it is today, a global leader in intelligent multi-domain robotic solutions, which help to protect our country and our allies around the world. Yeah. Wahid, I guess, just to comment on the backlog, maybe you could just give us an expectation of kind of how you see things progressing here from here with TMS? Obviously, it sounds like a lot of the Small UAS is really ramping up based on the order. But maybe if you could just walk us through kind of some of the demand signals that you're seeing on TMS just given the growing list of countries there? Sure. So, Peter, we're very excited about the prospects of growth this year as well as next year. Yes, for this quarter, at this time, our Small UAS have booked some very significant international FMS orders and domestic orders that have really propelled it. But we expect similar demand and growth in our Tactical Missile Systems business, if not greater. It's purely based on the timing of the quarter and our customers' ability to execute the contracts. The U.S. DOD is really, really backed up in terms of resources to be able to execute on these contracts. The Ukraine conflict is obviously priority number one for a lot of the customers of ours and folks that we deal with, but we expect strong order growth in the next second -- two quarters for not only our Small UAS but absolutely also for our TMS business. Similarly, we expect some strong growth in our other product lines such as our MacCready Works, which really is constrained primarily not by contracts but by resources, the top talent that we need to execute to work. So overall, I see very, very positive signs in terms of our prospects for growth in the future. And I expect the order activity to continue to be in this momentum that we are today, and it will even pick up towards the latter part of this second half of this fiscal year. Okay. Great. And just as a follow-up, just thinking about like the bottom line, adjusted EPS, so you're still expecting quite a big range to come in, in the second half of the remaining two quarters of the year. That range still with only two quarters is still pretty wide. Is that just the mix driven or are there any other puts and takes we should be thinking about within that EPS range? Thanks. Great, Peter. Glad you asked that question because really, the range has to do with the timing of these orders, the mix obviously is the number one driver there. Given the different product lines that we have, the profitability profile of each and every single one of these contracts vary. And depending on which contract is able to come in first and what takes priority versus the other, it really makes a big difference on the profitability. Overall, though, we expect profitability significantly increase in the second half, especially in the fourth quarter. And we also expect our gross margin to pick up and since volume is going to be up, all of that ends up being a better profitable outcome for the second half of the year for us as we have forecasted. So a nice outlook in the quarter here. Your Puma delivery outlook over the next couple of quarters would seem to imply that CPU and GPU supply chain is improving. Is this because of softer consumer demand, you're able to get your hands on some of these CPUs and GPUs now? So Austin, the supply chain picture is really a mixed bag. If you look at the entire spectrum of parts, CPUs, GPUs, composites, et cetera. I believe that our team has done a fantastic job navigating through those challenges last couple of years as well as this year. For this year, we have very strong visibility on our booking in backlog as you saw from the numbers. And we have pretty much addressed vast, vast majority of the supply chain risks related to the execution and delivery of products within the second half of the year. By no means is the supply chain constraints overall completely done and gone, it's actually improving, but it's improving slowly. And we don't see risk on our fiscal year '23 forecast as much, although there's always some uncertainty. But beyond that, it's still a day-to-day, week-to-week challenge of addressing them. The other thing that has really helped us is, we really plan our supply chain many quarters out in upfront. And since we actually have been building up inventory and buying material at risk and building product, it allows us to execute on these orders and respond to the U.S. government in Ukraine conflict very, very quickly. These orders that we received, we were expecting these orders before the timing of which was not really very firm. We have built ahead of that, many of the modules, and we were able to ship some of that -- majority of that this fiscal year. So it is a great testament to our team's ability to execute and also plan for the growth that we expected this year and the years after this. Okay. That's super encouraging. DOD, I don't know if you've seen the news that they're running out of HIMARS rockets and now they're trying to stick small diameter bombs onto artillery rockets to send to Ukraine. Can you do the same with Switchblade 600's warhead just given the Javelin production delays and supply chain issues? Could you put a different explosive on there and still make to work? So the short answer is yes, but there's a big but on that response. We are definitely the number one supply chain constraint for Switchblade remains the warhead for Switchblade, both 300 and 600. We have tackled all the other supply chain issues, and we're getting those two from two major primes, primarily General Dynamics and Northrop Grumman. And both of them have constraints in terms of the capacity of producing that warhead. We are actively not only working how we can secure more warheads for Switchblade 300 and 600 but also to put in new warheads as you indicated on your comment. Now the challenge with substituting the warhead is that it has to go through a safety confirmation test and approval by the U.S. Army. And that process is not only nontrivial but it also takes time because they're backed up in a lot of other requests and activities related to this. Nonetheless, we're focused on multiple fronts. We feel very confident about our forecast for this fiscal year. We're really working on issues beyond this fiscal year because we believe that the demand for our Switchblade is going to continue to grow. We're going to have one of the best years for our Small UAS and TMS this fiscal year, and I am confident that we're going to be positioned extremely well for the next year as well. The order activity and demand is pretty robust both domestically and internationally, and I expect that to continue and those to transition into orders and leave us this fiscal year with a pretty healthy strong backlog going into next year. Thank you. One moment please. Our next question comes from the line of Pete Skibitski of Alembic. Your line is open. Yeah. So sorry, if you addressed this already, I got on the call a little bit late guys. But on the $86 million Small UAS contract with the, I guess, $176 million ceiling, the FMS contract. What's the time frame for both of those portions, the $86 million portion and the larger portion? And then also, is that the one country or multiple countries? So Pete, that order is the -- historically, the largest FMS order we've ever recorded in the history of our company. It's an exciting big order for our Pumas. It includes Puma LEs and Puma AE systems and spares and logistics. $86 million of that contract is funded today. The total ceiling value of that contract is approximately $176 million. Because it's a contract that involves delivering hardware and logistics support and training, the tail of that will continue for another six months to 12 months even. But majority of the hardware will be delivered between the second half of this fiscal year starting this quarter and the beginning of next fiscal year. The -- in response to how many countries, that is specific to one country, one country, and it just shows the power of our systems and the value that our customers place on our systems as part of their battle rhythms in their conflicts. As you know, Switchblade has received a lot of notoriety and success in Ukraine and also have sort of attention, but Pumas are equally as effective and vital to the Ukrainian forces and their conflict against Russia. And we believe that it's going to continue to be the case for not only Ukraine, but many of our other allies around the region and around the world. And then just last one for me. On the Medium -- on the MUAS segment, the steep loss there this quarter on gross margin and operating margin. I was just wondering, was there some strategic reason there for that loss? Was there a surge in R&D or some unusual mix or -- I'm just wondering -- because revenue was good this quarter in MUAS, but the loss was the largest since you acquired the firm. So I was just wondering what's going on there? Sure, Pete. So let me shed some light onto that. This is a one-time really accounting thing that took place and the math is pretty straightforward. We operate all these sites as a COCO, contractor-owned, contractor-operated sites for the U.S. SOCOM. Because of the attention to Ukraine and the conflict with Russia, many of the other activities around the world is getting less attention and less focus. So if the sites in the other parts of the world are reduced or the OPTEMPO is shrunk, then by accounting GAAP rule -- accounting rules, by definition, it means the inventories that we carry as the assets -- I'm sorry, the capital assets that we carry to operate those sites get accelerated in terms of its depreciation on our books. That charge is directly a result of that. We still feel very solid and confident about our MUAS business in the long run. As I said in my remarks, we won Increment 0 and Increment 1 contract for FTUAS. We're performing well against that contract. We've already started training the U.S. Army forces on those. We have shipped the product to them, and we're looking forward to Increment 2 awards, which there is close to $100 million in the U.S. DOD budget for government fiscal year '24. So long term, we feel very strong about our MUAS business and its process for growth, both domestic and internationally. That was a onetime depreciation -- accelerated depreciation that resulted as a result of the slight reduction in... Right. It was $4.5 million in case you missed it in our comments of accelerated depreciation in the quarter. And even with that, we still believe we're going to hit our gross margin targets for the year. Yeah. Thank you very much. Just a couple of follow-ups real quick. In terms of operating expenses, can you give us a little bit of guidance for third quarter and fourth quarter, how they look versus second quarter in terms of R&D and SG&A, maybe give us directionally flat, up, down from the second quarter levels? We don't normally give that level of guidance, but as Wahid indicated, I think we're at 11% to 12% R&D for the year. And generally, we usually try to level load our -- in R&D throughout the year because of capacity of headcount and resources. So you don't usually see a major increase or decrease on a quarterly basis in our R&D spend, Brian, in general. I mean it's the same situation. Your SG&A expenses aren't going to bump way up with revenue in the next couple of quarters. We're going to get a lot of leverage with that increase in revenue. They will continue to increase primarily because there are some commissions and things like that, and we are expanding our sales force activities. And the BNP (ph) business proposal activity has been high and will continue to be high, but those are very positive signs, Brian, because it means that there's a demand for our solutions, and we're competing for projects and our win rate generally is quite high. Thank you. I'm showing no further questions at this time. And let's turn the call back over to Jonah Teeter-Balin for any closing remarks. Thank you once again for joining today's conference call and for your interest in AeroVironment. An archived version of this call, all SEC filings and relevant news can be found on our website at avinc.com. We wish you a good evening and look forward to speaking with you again following next quarter's results.
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Hello, everyone. Pleasure to have Biogen management join us right after Merck and thereâs a lot to talk about, but let me turn it over to you, Mike, to kick things off. Excellent. Thank you very much, Umer, and thank you for having us today and thank you to everyone for joining us. Priya and I are very happy to be with you. Before we begin, I do want to just point out that we, Priya and I will be making some forward-looking statements and those are based on current expectations and beliefs. Actual results could differ and I would encourage you to refer to our risk factors in our SEC filings. Here at Biogen, we're very focused on executing and delivering the best results that we can. We last reported in October, and at that time, we raised our guidance on both the top line and the bottom line for the second time this year. Our guidance back in October was on the top line 10 billion to 10.15 billion and our EPS, adjusted EPS guidance was $16.50 to $17.15. We've had a number of important developments since that time. Most importantly, we've announced that Chris Viehbacher has joined Biogen as our new CEO. We are thrilled to have Chris. He's got extensive, just experienced both in the industry and large, you know, running large international businesses at both GSK and Sanofi, and then a lot of experience working with entrepreneurial biotech companies as well. So, Chris is now completing his third week at Biogen, and I know he looks forward to meeting many of you in the months to come. We also are very pleased to have announced some very positive top line results along with Eisai on the Clarity Ad Clinical Trial for lecanumab. You may have seen that lecanumab met its primary endpoint and all of the key secondary endpoints with high statistical significance. And you may have also seen that Eisai presented additional data on lecanumab earlier this week at the CTEC Conference, and we have a filing that is going through review with the FDA. Today, for accelerated approval with the PDUFA of January 6, we're also â and we're obviously very excited to be working with Eisai on this very exciting project where we share economics 50-50. We're also working very closely with Sage on a collaboration which includes products Zuranolone, and we are expecting to launch a single regulatory filing for both MDD and PPD sometime before the end of this year. So, as we look ahead, we're very excited about both of those collaborations. Those are our two large near-term opportunities to bring ourselves back to growth, which is our number one objective. We also have tofersen, which is an investigative drug for SOD1 ALS with a PDUFA date in April. And we will remain very focused on execution as we always have. We continue to have a very strong balance sheet with over $5 billion of cash and a modest amount of debt. We've got 30 programs in the clinic, 12 of which are in Phase three were filed, which gives us a deep pipeline and we believe good opportunities to again bring us back to growth, which is our number one objective. So, thank you again for having us. The last thing I want to say is, encourage all of you that are interested on December 6, we will be hosting a joint presentation along with Sage where we'll talk about Zuranolone and some of the commercialization efforts that are underway named [at that] [ph] drug is approved, and you can find information on how to join that on our website. So, thank you for the opportunity to speak upfront. Umer and Mike. And again, thank you for having Priya and I today. Outstanding. So, maybe and since lecanumab was fresh out of lecanumab data presentation, maybe let me just â it'll be fair to just spend a brief second on it. Any feedback that you guys heard out of the [indiscernible]. I mean, I think the [data's data] [ph], and we all know it, but any feedback in particular that stood out to you guys in some â how â was it different or similar in any ways with the aducanumab data experienced from a couple of years ago to which was completely different obviously? I can get started on that. So, I think overall, you know, we're very pleased with the data set. I think it's a very robust data set with the primary endpoint and all secondary endpoints having been met. A lot of sensitivity analysis have been done and were presented at CTAD in addition to subgroup analysis and we're really pleased across the board with all of this. So, I think overall, it's really a high quality data set that can provide the strength of evidence, I believe, that NCD laid out that they would be looking for. And in addition, I think that there is the potential for generalizability to the Medicare population, because the Clarity Ad did include patients with comorbidities, you know underserved populations, about 25% and we believe that this is really very encouraging and we're optimistic about it. Got it. So, that's actually a nice segue into the question that really matters, which is on NCD side. I guess, what is the strategy from your perspective right now? Do you want to let the existing NCD update itself? Do you want to start a new lecanumab specific NCD? How are you guys thinking about that? Yes. I can start. So, I think that the way the current NCD is written, there were a couple of important points. One was that there was a hard line drawn between accelerated approval and full approval. And in-line with that, we are really going forward for the accelerated approval. As you know, our PDUFA for date is January 6 and soon thereafter, we are in a position to file Eisai will file for full approval. So that's number one. I think the second point here is the strength of evidence, which I already spoke to in my earlier comment, which is going to be important. So while the NCD is for a class, NCD did point that the data for every antibody will matter. And so, that's really I think where we think we have a robust dataset. And then the third piece was generalizability to the Medicare population. So, I think all of these factors we are very optimistic about. How the process will fold out with the CMS? I think that would be hard to speculate the way it's currently written, but there are two areas. One is, if there is strength of evidence. It's possible that it could get reimbursed in a setting of prospective comparative studies. There are not too many details on that, but it would again depend. It hops back to the strength of evidence, which we believe we have. And then the second is that there could be a reconsideration. And then the third piece here is that, you know, CMS did say that they would act with speed if the data, you know, were important then there was strength of evidence and rigor. So, we believe that these are all very important factors. What I can say is that Eisai has already initiated dialogue, and they believe these dialogue is very constructive with the Clarity data in hand along with a peer-reviewed publication in the New England Journal of Medicine, I think it puts us in a very good position to have these dialogs. So, beyond that, I think it's going to be hard to speculate, but we think we have everything we need. Got it. And so that's very interesting. And your point around CMS saying they could act with speed, I mean, this is some of the buzz coming out of DC as well that this may not necessarily be a full nine plus one type of review, do you guys think this could happen in a much more rapid three or four month turnaround or just hard to say? I think it's hard to say. Historically, it's been, kind of a 9 to 12 months process, but, you know, CMS did indicate that if the evidence was strong, that they would look to act more quickly. So, we don't control that hard to say. Obviously, you know, we're hopeful to get to a good answer on reimbursement. And Mike, did you guys, like, or Eisai start that already or why not? Because theoretically, it could have been started a couple months ago. Yeah. I mean Eisai serves as the lead of lecanumab development and regulatory submissions on a global basis. So, I can't comment specifically on interactions that could be occurring between Eisai and CMS, but what I can say is that, you know, we have a high degree of confidence that they'll, you know, handle it in a way that's, you know, very well throughout. And obviously, there are, you know, there are lessons learned through the ADUHELM experience that we share very openly with each other we can be informed by. Makes sense. Which actually is a good sort of segue into, among the lessons learned from ADUHELM, one of the big ones that stands out to investors is on pricing side. And I feel like, is there lessons from that? Granted the dataset was different, but the question that always comes up from investors is, was ADUHELM just too high? And the granted entity is not focused on pricing, but if we price lecanumab much lower, might open up the market more. Like, how are you guys thinking through pushes and pulls, granted that's not your decision to make? Yeah. So, that's correct. Lecanumab Eisai will determine the pricing. I think as it relates to ADUHELM, you know, it's hard to speculate exactly what CMS considered in all the different pieces. I personally believe at the end of the day, a lot of it was about the data and just, you know, the data set and a lot of the controversy around that and there was, you know, the [utility] [ph] and then there was, you know, the whole advisory committee situation and so forth. And so the dataset that was in front of them and kind of the controversy around that that they just couldn't get over. So, my sense was that was the biggest factor, but, you know, we're just not in a position to know for sure how much pricing played in is really hard. Got it. Got it. Have you â Mike, have you guys had discussions or given feedback to Eisai on pricing? Because one of the feedbacks that came out of their side was, initially they had this health economics estimates of 10,000 to 38,000, and then since the data came out, they're saying it could be higher. While some investors were kind of encouraging them to go down more towards [indiscernible] pricing just to open it up, but I'm curious if any of those conversations have happened? Yeah. That's not really something that I can comment on, unfortunately, Umer. And as I said before, the pricing will be determined by, you know, ultimately be determined by Eisai. Got it. Do you guys expect to be involved in marketing? So, we have a, you know, a long standing and ongoing collaboration, and we have co-commercialization and co-promotion rights. They have final decision-making authority. So, and we have things like joint steering committees that we develop, you know, strategies together. And as I said, you know, we've been have a long standing relationship, and we have deep respect for each other. So, we'll work on those things together, but ultimately, they will have final decision making rights similar to what we had on ADUHELM. Should we expect some sort of an update on that side by JPMorgan because I got to believe even from a CFO perspective, you're trying to figure out resource allocations and all that appropriately depending on whether you will be or won't be marketing? Yeah. I mean, that's something that we're thinking about, and, you know, is all under development. I would say that, you know, another checkpoint, which would be after JPMorgan would be, when we report the fourth quarter. It's likely that we would provide guidance for 2023 at that point in time. And as we provide guidance for 2023, certainly as we think about our important potential product launches and on things like Zuranolone, and lecanumab, if appropriate, we would try to provide some insights on how that was going to impact our estimates for 2023. Got it. Okay. Got it. Makes sense. That makes a lot of sense. And maybe just my last one, Mike please step in as well on any anything else you want to touch upon on Alzheimer's, but one more that I just want to touch upon is, the status of the relationship, and I know there's always been questions you guys have clarified on last earnings call. So I think I asked about it as well, but is it a functional relationship? Let's just ask that way. I think that, look, I mean, we have worked together for many, many years. It's a long standing and ongoing collaboration. I can tell you that that we and Eisai share the same goal and vision, which is to serve people living with early AD and their families by bringing lecanumab to the market as soon as possible. I mean, I think that's the best way that I can answer the question. We've got a very, very deep commitment to getting this right. And we've been working together for years and we have a deep mutual respect. I think that's probably the best way that [I can get] [ph]. Hopefully that⦠I have a commercial question for Mike and then a technical question for Priya. So, Mike, a lot of this has been coming up from investors regarding the infusion capacity. So, some rough math was done whereby if we assume pricing parity to ADUHELM. And then we kind of just calculate a rough number of infusions required to get at a certain number. I mean, my question is, does the U.S. have enough infusion capacity to [indiscernible] a meaningful sales from the drug? Well, over time, you know, our hope would be â the answer would be absolutely yes, but, you know, there is some build out that would have to happen for infusion centers. And we saw that with ADUHELM. This is, you know, this is kind of a pioneering. There would be some, because [indiscernible] that will have an infusion center that they can tap into and others that that may not, and we'll need to find an affiliation or something new that has to be built-out. So, I think as you look at the aggregate infrastructure build-out that has to happen for lecanumab, you know, infusion center, readiness and build-out is all part of that. Priya, I don't know if you want to comment further. That's exactly right. I mean, I think there was a RAN Report a few years that commented on the fact that, you know, the availability effect, infusion centers, specialty centers, and specialists could be bottlenecks. But this is something that we're working on very deliberately and thoughtfully. And I think systematically we also have experience with aducanumab, as Mike mentioned, and we are sharing everything that we know with our â with Eisai as they lead this effort. So, I think that do they have it? Does the U.S. have it today? I think that would be, maybe hard, but the other thing is that we would expect a ramp up of patients as well because they need to all get confirmed with amyloid and things like that. So, I think there's more work to be done. Can I can I just clarify, Priya and Mike, because I feel like there's a sliding scale here, and there might be a tendency among investors to confuse this broader topic. So, we say over time, yes, there will be an infusion capacity. I think what you're referring is to be able to serve a big part of the market. And we know, for example, Namenda Aricept is like, 1.5 million or so, folks on it. Whereas some of the investor estimates, especially even for [indiscernible] on lecanumab are 10% of that, so 150,000 patients or so. And near term folks what folks are really just asking is, when to the extent you launch 30,000 to 50,000 patients worth of infusion capacity does that exist? So that would be let's say, 50,000 times 12, 600,000 times twice a month. That's over a million infusions. Does that type of capacity already exist or not so much? Yeah, I mean, it's a hard question to answer because it depends in part on where the patients geographically. You have some areas that are concentrated or not. So, the short answer, yes, depending on, you know, if there's concentration of patients in the right areas, and potentially some gaps, if they're not. So, a lot of it depends on, kind of the geographic footprint and how it [indiscernible]. Yeah. One more question for Priya. Regarding the [plaque lowering data] [ph], you guys showed good data and you used â in terms of the lower limit of detection, you used a level of below [30 centiloids] [ph] to kind of establish that. And one thing I noticed, I mean, you know, a lot of other investors noticed that when, you know, take the [indiscernible] [plaque lowering data] [ph], they established a lower limit of detection as low 24.1 centiloids, I think. So. why did they use 24.1 versus why did you guys use less than 30? Yeah. I was going to say that this is why itâs going to be a difficult question to answer. We believe that the limits are quite fair in terms of amyloid positivity that Eisai used, and I think that the most important thing is that with a baseline of about 79, there was a big reduction and that's what's important. The other thing I think that's going to be important here is what is the implication of maintaining that. So, I think that's the other unanswered question that Eisai is also evaluating in the Phase 2 open label extension where they're assessing what's the frequency of dosing that's needed both with the four-weekly or the 12-weekly dosing. So, I think overall, I don't know that that's going to be that relevant. I think it's going to be a matter of amyloid reduction demonstration of clinical benefit. Got it. Okay. Makes sense. Maybe sort of transitioning a little beyond, I want to spend a couple of minutes on the bigger picture P&L, if I may. Mike, if that's okay. First is, sort of with Chris on board, how are you guys thinking about the P&L as it stands today and P&L as think about it going out. And I realize there's some pushes and pulls whether you need to market or not, whether Alzheimer's is a big number or mid-sized number, etcetera. But how are you thinking about that? It's something we're thinking about a lot, and it's a really good question. I would say, you know, a few things. When you look at our cost base, we've done a lot to take cost out. We had an OpEx base of $5.2 billion in 2021, which included a pretty fully built-out ADUHELM infrastructure in the U.S. and now that's been removed and we will deliver on the billion dollars of run rate cost reductions that we committed to. We will reinvest some of those savings, and that's something that's under review, but primarily the â any investment that we would make would be to support product launches. And at the end of the day, as I mentioned in my opening commentary, our number one, objective is to return the company to growth on both the top line and the bottom line. So, there are a couple of scenarios, you know, one of which is if lecanumab and ADUHELM, excuse me, if lecanumab and Zuranolone are successful and we're able to get both of those drugs approved and have successful launches, you know, we'll obviously have to put money behind that to support. And in some cases, you know, you'll have to see spend in front of revenue. And so that will, you know, potentially pressure the P&L a bit in front of longer-term growth, and that's something that we will evaluate very, very carefully. And then in the hopefully unlikely event that either or both of those drugs are unsuccessful, then I think you would have to, you know, probably put a little more pressure on some of your business development efforts. And we've got a lot of cash on hand and a modest amount of debt and more borrowing capacity that we could utilize there, as well as looking at your cost base and having to, you know, do some further work there to, kind of, you know, right size it to a new normal. So, at this point in time, I would say that, we've done a lot with the cost base to rationalize it to some extent, but we're really, really focused right now and hopefully getting to the finish line in the near-term along with a science age on lecanumab and Zuranolone, and spending the funds necessary for commercial launches to make sure that we could get successfully off the ground on both if we were able to get to approval. Got it. Okay. Makes sense. And is there any consideration on some sort of an EPS number you have to be at, regardless of where some of these opportunities go in outer years and I realize I'm not necessarily looking for some, sort of guidance? Sure. No. I would say that, you know, I'll go back to what I said before, which is, we do understand that our number one objective is to grow on both the top line and the bottom line. And so that would mean growing EPS. I would say that that path back to growth is probably faster if we're able to achieve success along with Eisai and Sage. And if not, then, you know, we'll have to find a different path to achieve that objective and maybe it takes a little bit longer and maybe there's â it's a little more of a mix of incremental revenue and cost reductions versus just more revenue, but we will, you know, our job is to find a path back. So, I can't give you a target number. But what I can say is it's a return to [Multiple Speakers] Correct. And when you say pass back, you do have some of the â okay. Got it. Makes sense. Okay. And if I may also, BD-wise, is there a certain number in mind? So, the way I would answer that is, you know, we've got over $5 billion of cash and, you know, a modest amount of leverage, call it like two turns on a gross basis on a net basis, we're basically close to a net zero in terms of net debt relative to EBITDA. So, if you were to hypothetically, you know, have gross debt at say 3x, which is probably still within investment grade. Along with the cash on hand, you've got, you know, $8.5 billion of capacity. I don't necessarily see us utilizing all that in one transaction, but there are a number of things that we could do with the balance sheet, and we've got quite a bit of capacity to bring in incremental programs in addition to the 30 that we already have underway. Well, you know, you never want to rule out anything for the right transaction, but I don't know, it would be one where, you know, you'd be making a transformational bet and you'd have to make sure that we're comfortable with it. Makes sense. Mike, just before we move on to some R&D topics, there's a couple investor questions that came in live. So, one of the questions is, someone pushing back saying Eisai has out to the contract, is that true or not? Okay. So, that was one. And then the other one was, give me one second. Sorry. I'm just â I think I've just misplaced it. You know what? Oh, here we go. You know what, I'll find it. If I find it, we'll come back to it. Okay. Let's keep moving. Let's turn to some R&D topics. The BTK inhibitor, can you perhaps speak to that on what would be realistic from Biogen perspective in terms of commercial potential knowing that it's slightly behind versus some of the other competitors, although they've had a little bit stumbles to? And how important is it from a more de-risk pipeline perspective? I can speak to, sort of what we're looking for from a scientific perspective. And I will say that, obviously BTK inhibition is thought to be really important from a mechanistic perspective. And the fact that we have access to both central and peripheral BTK inhibitors is important for us as we consider how we make progress in MS, which is obviously a very important area, very important disease that we've been focusing on. So, from that perspective, BIB135, which is in our collaboration with Enercare that we announced about a year ago, it remains in Phase 2 in our RMS, and we'll readout in Phase 2 , and that will then decide how we take it forward. But from a molecule perspective, it has high selectivity, it has good CNS penetration, and we believe that eventually the data, you know, both from an efficacy and safety perspective will be important for us as we think about it in the context of PDK inhibitors and also in context of our own pipeline. So, I think that that's going to be really the key point, how does it read-out in Phase 2? And we also have access, I don't know if you know, but we have BIB91, which is a peripheral BTK inhibitor. So, we continue to advance that and that will potentially enter Phase 2 at some point next year. I think that it's going to be hard to really speculate on that, and it depends on what kind of indication we're going for. So, if you have a bigger plan in terms of progressive MS or just RRMS, I think all those factors will be important on what constitutes the pivotal program, if that makes sense. Okay. Got it. Okay. Makes sense. And then perhaps the BDCA2 in lupus, I know that's a high profile Phase 3 readout set that's coming up, could you remind us any lessons from the AstraZeneca program that could be incorporated here? Yeah, sure. So, I think that we are very excited about BIB059. It's an anti-BDCA tool. We believe that it can be really important not only in SLE, but also in cutaneous [lupocidizumatosis] [ph], which remains a high unmet need. We think that the package that we have currently is really the two [topaz studies] [ph] in SLE and one-stop Phase 2b study [indiscernible] in CLE. So, we believe that this is going to be really important. In terms of lessons learned, you know, the topaz studies have SRI, the responder index as the primary endpoint. This is the endpoint that we saw activity from the LILAC Phase 2 study that we published recently this past summer two publications in the New England Journal of Medicine both on Part A, which was SLE; and Part B, which was CLE. So, we think that, you know, several lessons learned in terms of baseline characteristics of the patients, as well as other medications that they might be on and the primary endpoint, which is SRI-4. So, we think that all of those have definitely enhanced our understanding and our development of the clinical development program and also of the topaz studies themselves. So, we look forward to, kind of continue to enroll. It's a global study, and we remain very excited about the mechanism of action. Makes sense, makes sense. Maybe the SOD1, there's buzz that FDA has a lot of inclination towards a biomarker based approval there, but if a scenario like that plays out, is there real commercial appetite if it's just biomarker supporting the approval? So, maybe I can talk about the data. So, tofersen, which is the SOD1 ASO, you know, as you know, SOD1 is a genetic type of ALS, about 2% of the population. And I think what's really, really important here is, we ran the [ballast study] [ph], which was a Phase 3 study, but it completed at six months and it did not meet the primary endpoint, which was ALSFRS-R, but what's really important is we saw a huge movement on neurofilament. And I think two criteria that we utilized, one was, of course, the duration of the study, but the second was how we distributed, sort of thought about the patient population. We divided it up based on the mutations, as well as on their ALSFRS-R slope, decline, prior to randomization. And now we believe that both these factors are actually not that important because there's a lot of inter-mutation variability and what's really important is the duration of the person that the patients receive. We saw this with the 12-month data that we presented earlier this year in the summer [ENCALS] [ph] and then has been also published in the New England Journal of Medicine. And I think what we see is that it's actually not just a biomarker impact. And that biomarker, by the way is really important based on all the literature that we've seen on neurofilament and the importance of neurofilament reduction for ALS, specifically SOD1 ALS. So, I think that's very critical, but we also saw hints of movement on clinical benefit. Respiratory function, muscle strength, pulmonary function, and at the 12-month time point, we really see significant impact. And if you step back and think of the biological pathway here and the biology in totality. It makes sense that by the time you see the neurofilament reduction, it takes some time for that to translate into a clinical benefit. So, we've been accepted by the FDA on an accelerated approval pathway. It's a very small population. We remain in discussion with FDA about what a confirmatory data package could look like. And I'll just remind us that we have an open label extension that's ongoing. We also have almost more than a 120 patients in the Expanded Access Program that's global. And in addition, we have the ATLAS study that aims to, kind of assess the impact of tofersen in a 12-month period based on a baseline of NFL and conversion to a clinical phenotype. So, we've got a lot of access to ongoing data readouts and data generation, which we believe will continue to be important. Turning to the â and, you know, from everything we've seen and talking to the key opinion leaders, we believe that this is very important data. We believe that the neurofilament is really important and that physicians are really excited about what tofersen could do for their patients with SOD1 ALS. So, turning to the commercial opportunity, I'm going to turn to Mike, but that's from scientific perspective. We are very excited about this. Yeah. No, I think you've I think you've covered it very, very well. So, are you looking for some commentary on the commercial opportunity for ALS there? No. No. I think Priya covered it pretty well. And then, I guess, maybe just beyond in the pipeline, Priya, what are some of the things that you feel like there should be more questions on, but you just don't get very many? I feel I get so much of a focus on lecanumab that even the BTK or the BDCA is not much of a focus. So, what are the things that you're always excited to talk about and what's high on your mind and where you're spending your time? Yes. Thank you. That's a great question and a great time for me to comment on that. So, obviously, lecanumab and Zuranolone, they're very important. Our teams are very much focused collaborating with both our partners in this case for filings and more. And that's important. Beyond that, we have 30 clinical development programs, 12 of them are in Phase 3. We just talked about our SLE program. In addition, we've got bid 122, which is very exciting, you know. And before I leave, SLE, we have our [indiscernible] program, as well as BIB059 addressing different pathways, and then I'll move to BIB122, which is important because this is addressing LRRK2 mutations, as well as idiopathic Parkinson's. Obviously, this is a very high unmet need, and we believe this is a very important target, genetically validated, in the LRRK2 mutation population for sure, but also in idiopathic Parkinson's, we have data from autopsies and such which lead us to believe that lysosomal dysfunction, specifically the LRRK2 mutations can really result in a very high kinase activity, which then results in, you know, inability to, kind of be great proteins and accumulation of proteins, including proteins like alpha synuclein, which we all know are hallmarks for PD. So, this remains very important. We have already enrolled our patients in the LIGHTHOUSE and LUMA study, and I think it's a very innovative clinical development program with our collaborators, Denali. So that's important. I'll go then to stroke with, we have two programs, BIB131, which is acute ischemic stroke, and we also have BIB093 in Phase 3 for large [indiscernible]. So, we think we are addressing a very high overarching population of stroke, which again remains a high unmet need and not much innovation beyond TPA, which was, you know, almost two decades ago here. So that's important. And then moving beyond that, Alzheimer's remains a very important area of focus. And I want to say, I'm very proud of the fact that, you know, we've been focusing on it for more than 15 years. It wasn't just about lecanumab or aducanumab. We've got a lot of depth in our scientific expertise here and also in our programs. And for today, I would love to comment on BIB080, which is our antisense oligonucleotide about to enter Phase 2, and this is a very exciting program. It's an anti-tau ASO. Obviously, through our collaboration with Ionis, we believe our partnerships have been very instrumental in sort of us breaking the science together with our partners. And BIB080, we're very excited about BIB080 in the Phase 1b. So, time and dose dependent reduction in tau, and we think this is going to be really, really important because we do believe that the future of Alzheimer's would go beyond addressing it with beta amyloid reducing therapies, and it could be potentially combinations and more. So, behind that, we also have BIB113, which is an O-GlcNAcase inhibitor in Phase 1. We've already dosed our patient in Phase 1. And then we are looking at a lot of targets and we have a lot of collaborations. The â I think the privilege here at Biogen and in terms of leadership of the pipeline is that we have access to many modalities, and we are looking across the board at significant diseases of high unmet need, but we're really going with the science first. So, I think that, you know, many exciting programs, I might I might be able to talk for another hour, but I don't want to take up all your [time on it] [ph]. No. No. That's great. That's very helpful. Maybe just last minute, and Mike, please jump into if anything outstanding on your end. An investor question that came through, which I was looking for earlier and here's an investor question. If you are not allowed to co-commercialize by Eisai, the economics do not change, but at that point, you take a harder look at the cost structure and cut more SG&A to maximize profitability of the royalty stream? So, the economics on lecanumab are shared 50-50. So, it doesn't matter whether it's a dollar spent by Biogen or a dollar spent by Eisai, it shared equally. So that would that would have no impact. and it's a 50-50 on everything. Yes, just kind of want to drill down on the [indiscernible] assets. I know, I'm feeling that these stroke is something that's largely underappreciated. I guess number one, how big could this opportunity be? And for the IV glibenclamide, the CHARM study, I feel like that study has been kind of ongoing for a while. I think it kind of stalled due to COVID. Is that study very prone to bouts of [COVID wave] [ph] in terms ofâ¦? Yes. Thank you, Mike. So it's a great question. I do believe that that part of the pipeline is kind of underappreciated. And â but you're right, that the CHARM study has had some setbacks due to COVID. What I can tell you is that the teams are very focused on it. It's been a very important area of attention for me and the teams broadly. And we have brought everything to bear in terms of, you know, how can we listen to sites, you know, manage the protocol, address the COVID impact, and look at operational aspects of execution. So, this continues to be an important area. I think we are on the right track, and I'm optimistic that we will be able to close the [study and complete it.] [ph]. I know we're out of time, so I just want to be very respectful as well. Thank you guys again. Mike, unless we miss anything on your end, we're going to go ahead and wrap it up here. That's great. Thank you very much, Umer and Mike, for having us. It was our pleasure, and thanks to everyone for sitting in with us today. Thank you.
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EarningCall_1679
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Greetings and welcome to the REX American Resources Fiscal 2022 Third Quarter Conference Call. During the presentation, all participants will be in a listen-only mode. Afterward, we will conduct a question-and-answer session. [Operator Instructions] Good morning and thank you for joining REX American Resources fiscal 2022 third quarter conference call. We'll get to our presentation and comments momentarily as well as your question-and-answer session. But first, I'll review the Safe Harbor disclosure. In addition to historical facts or statements of current conditions, today's conference call contains forward-looking statements that involve risks and uncertainties within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements reflect the company's current expectations and beliefs but are not guarantees of future performance. As such actual results may vary materially from expectations. The risks and uncertainties associated with the forward-looking statements are described in today's news announcement and the company's filings with the Securities and Exchange Commission including the company's reports on Form 10-K and 10-Q. REX American Resources assumes no obligation to publicly update or revise any forward-looking statements. I have joining me on the call today, Stuart Rose, Executive Chairman of the Board, and Zafar Rizvi Chief Executive Officer. I'll review our financial performance and then turn the call over to Stuart for his comments. Sales for the third quarter increased by 8.5% as we experienced higher pricing for ethanol, distiller grains and corn oil. Ethanol sales for the quarter were based upon 66.3 million gallons this year versus 69 million gallons last year. We reported a gross profit of $11.3 million this year versus a gross profit of $25.2 million in the prior year. For the current year quarter improved selling prices were offset by higher corn and natural gas pricing. Ethanol pricing improved by 8%, dried distiller grain and corn oil pricing both improved by 25% for this year's quarter over the prior year third quarter. Corn cost increased by 17% and natural gas pricing increased by 56% for this year -- this quarter, compared to the prior year as inflationary pressures and the impact on commodity pricing from Ukraine, Russia conflict continued. Corn pricing was also impacted by higher corn basis based upon reduced availability of corn as we approach the harvest season. Gross profit comparison between years benefited slightly from fewer ethanol contracts sold net of freight in the current year, which leads to higher sales. SG&A increased for the third quarter to $7.9 million from $6.3 million in the prior year. The increase is primarily due to an increase in the number of ethanol contracts that require the freight to be paid by us compared to the prior year, which we classify as SG&A cost. We had income of $661,000 from our unconsolidated equity investment in this year's third quarter versus an income of $349,000 in the prior year. The company's interest and other income in the current year increased dramatically to $2 million versus $35,000 the previous year, primarily reflecting increased yields in our cash. The discontinued operations reflected in the prior year's numbers are from the refined coal business as we ended those operations on November 18 of 2021, there was no impact in the current year. We reported a tax provision from continuing operations of $1.2 million for this year versus the provision of $4.3 million in the prior year, primarily reflecting the lower level of income in the current year. These factors led to net income attributable to REX shareholders from continuing operations of $3.2 million for this year's third quarter versus $13.3 million in the prior year. Total net income per share from continuing and discontinued operations attributable to REX shareholders was $0.18 for this year's third quarter versus $0.85 in the prior year. I would again like to point out all outstanding shares for all periods have been retroactively adjusted to reflect the three for one stock split, which was effective on August 5, 2022. Thank you, Doug. Going forward, currently -- in the current quarter, we remain profitable, but crush spreads are still challenging, which our CEO Zafar Rizvi will discuss in his segment. We've made significant progress in carbon capture, which again will be discussed by Zafar Rizvi in his segment. In terms of our cash, we have approximately $290 million in cash, very little or no debt. We continue to look for investments in ethanol companies although nothing is imminent. We're also making major investments in carbon capture, which will be discussed later in the call. We also now can earn meaningful interest on our cash and with $290 million we expect our interest income to go up during the current quarter and during the following quarters. We buy back stock on dips. We bought back approximately 250,000 shares in the quarter. We have Board authorization for another 875,000 shares. Thanks, Stuart. Good morning, everyone. As I mentioned in our previous quarterly calls, challenging logistic problems caused by issues with the railroad and availability of corn were slowdown in our production. The availability of corn in the South Dakota due to a drought last year and again this year resulted in a decrease in corn yield, which led to an increase in the price of corn greater than the ethanol price. On top of that, the high price of natural gas is also negatively affecting the profit margin in the ethanol industry, as Doug mentioned earlier. The USDA November corn report shows the corn yield dropped 26% in Nebraska and 10% in South Dakota. Nebraska about 2.9 million bushels were dropped and in South Dakota, 78 million bushels were dropped compared to last year. In the South Dakota, where our Nugen plant is located, and while it -- but -- it increased 13% in Illinois, where our One Earth Energy plant is located. Sorry for that. The USDA also reported corn production increase in Illinois, North Dakota and Minneapolis and production drop in all other corn producing states. The worst affected states are nearly all western states, Nebraska, Kansas, South Dakota, and Texas. The November USDA reports show an expected output of 13.91 billion bushels for 2022, 2023 crop year compared to approximately 15 billion bushels in the â21, â22 crop year, a decrease of 8%. On the bright side, ethanol and DDG export have increased compared to last year through September 2022 and the non-food corn oil price continues to increase and it is expected to increase even more. Ethanol exports of 2022 total 1.12 billion gallons, compared to 873 million gallons for the same period last year, a 27% increase. Despite all these issues and difficulties, as long as we continue to source corn at a reasonable price and railroad efficiency and logistic improves at this very early stage, as Stuart mentioned, we expect that the fourth quarter could be profitable. Let me now share the progress of our carbon sequestration project. These are the bullet points. The first test well at One Earth Energy was successfully drilled in total depth of around 7,100 feet. The 3Ds seismic testing and water movement tests are completed and we are very pleased with the results. Several other tests and modeling work were performed to verify the maximum injection pressure, reservoir quality, rock core analysis, expected movement of the CO2 bloom. The test results show the location is a very good target for carbon sequestration. The design of the compression facility is complete. The contract to build the compression part of the facility has been signed and long lead time equipment has been ordered. The pipeline to injection well operator identification number have been received. The work on pipeline FEED study is expected to be finished by January 2023. The Class 6 permit for three injection well with a capacity to store 90 million tonnes of carbon has been completed and submitted. We continue to complete several other documents required by different government agencies, but most documents that require a lead time are completed or expected to be completed very soon. Once again, this is a highly technical and time consuming project. It required considerable time to make progress, but we are pleased that we have started -- but we started four years ago now has achieved some big milestone. As I also mentioned in our previous call, we are also evaluating several other projects that would increase production efficiency and energy saving as well as reduce water consumption at our plants. We believe the completion of some of these projects will lead to a greater benefit under the Inflation Reduction Act passed by Congress. The Section 45Q cash payment for the carbon sequestration increased to $85 per metric ton from $50 per metric ton. The clean fuel production [indiscernible] 45G, which has led to a reduced carbon intensity score would provide a much better return than 45Q. In summary, we are very pleased to announce once again a profitable quarter in a very, very difficult environment as well as very good progress with our carbon sequestration projects. Hitting these carbon sequestration milestones and achieving a ninth consecutive quarter of positive income cannot be accomplished without the hard work and dedication of our colleagues. We are very appreciative of their efforts on achieving these positive result. Thank you, Zafar. In conclusion, the ethanol business remains steady and [indiscernible] carbon capture business. It's been helped significantly by government legislation along with great progress by Zafar Rizvi and his team. We continue to consider -- we continue to believe that we have the best plants among the best plants in the industry, our locations are good, especially the one that is right in the middle of what we consider the best carbon capture area of the country. But more importantly, we truly believe it's a [indiscernible] we have among the best employees in the industry. Most companies in the industry were not -- many, many companies were not profitable. We had a profitable quarter and we continue to consider our employees to be among the -- we consider that the real reason why we're doing better than most is we consider our employees to be the best and that I think separates us in ethanol and I think, you'll see and we hope that it will continue and will separate us in carbon capture. Good morning all and really nice execution again this quarter. Maybe I'll start out, you're clearly making good progress on the CCS side. If I think about that project moving forward along with the clean fuel credit and the IRA that starts I think in 2025, maybe -- could you just help us think about how those two items might play together as we get into some of the out years, assuming CCS progresses and what that means for the business? Yes. Jordan, the 45Z and 45Q. 45Q is a direct payment up to $85 per ton and 45Z is a tax credit, which you receive if you reduce the carbon intensity, which is the line right now if most ethanol plants had approximately 70 CI score what we call it carbon intensity plant. And then there is a line, which is a 50 if you reduce anything below the 50, you get some per gallon basis tax credit on each gallon you produce. So, there is a far more like to look at it carbon. We are not -- just want to make sure, we are not tax experts, but this is what I understand. So, when you do the carbon sequestration, you reduce approximately 30 points to CI score. And then there is about 18 points is for the land use. That also reduced because we are -- our land use what happened, we further reduced that 18 point. So if you started 170 and then you reduced by almost 48 points and then you can reduce your further CI score. If you are able to achieve zero, which is not that easy, but there is also have to be made a lot of changes in the process and other things, which has to be accomplished. As I mentioned, we were working on a lot of these things previously for the last couple of years to reduce our CI score. So, we are already working on that thing we -- for example, if we are able to achieve zero, but I'm not saying that we will be or we will not be, then it's almost equal to a dollar a gallon of your ethanol production. So, if we are producing 150 million gallons and we reduced CI score to zero, we can have almost per gallon basis, a dollar a gallon that may be in one location, can be as much as $150 million. But we are not expert, but that's what we understand at this time. And I'm certainly no tax expert either, but that's a great explanation. Maybe just the clarify, did you -- on the land use side of that, did you mentioned that you're working on something to get that 18 point reduction or is that [Multiple Speakers]. When we have accomplished the carbon sequestration, if we take the carbon all and put it in the ground, under that formula, we get approximately 30 point for the carbon sequestration we did and 18 point, which is now ethanol has been used. They use always that when they compare their our CI score, they always add 18 point for the land use. For that land use will be automatically will also get the reduction with carbon sequestration. So that's where it adds up. That's what I understand. None of these numbers Zafar saying include what we potentially the higher selling price of zero carbon or low carbon ethanol, which, it's another parts -- we don't want anyone to put that in our numbers, but that's a real possibility also. Exactly. As I've learned generally there is a 70 -- normally 70 to 72 generally ethanol plants has CI score, which they call it. So if you take it 30 point reduction for the carbon sequestration and 18 point reduction for the land, that's a 48. So, 70 minus 48. So, you can see that it's going to come approximately 22. So the line started with the 50 that you have to have minimum 50 and then go down. So, that's where the comparison is done. So, it is there a far more lot, which we understand that will be used. Got it. That's helpful. Next, there been some headlines on Rovio's coming out in the next day or whatever. Just curious, your thoughts if we assume mandates for ethanol roughly held flat over the next three years or so? I think, we are hearing it's approximately still going to be staying at 15 billion for ethanol, which they may increase the overall 21 billion, but we understand that it's probably going to stay at 15 billion for the ethanol, but we're not sure up until it's released. One thing that would be important and we don't know -- so far the Biden administration held firm is no waivers. They have the ability to keep waivers wherever they feel like giving them and they happened in the administration, they have in the past and Biden, it's been pretty good, very little or no waivers. So, if there's no waiver, so it's actually a decent increase. Yes. And hopefully, this export continue to increase as I said, this year we can see that we are way ahead compared to last year and if export continues to increase, that will also help us. Got it. That's helpful. Lastly, jumping around a bit here, but just to go back to CCS. Zafar, maybe can you go over it in your prepared remarks, but just so we have separated out, can you just talk to kind of the next steps as we move into early next year? I know, you mentioned that you've -- most of the long, long-term items, you've been working on and the detailed plans but maybe just break out what we should be looking for as you move into 1Q, 2Q? Yes, Jordan. As I have mentioned year on there was a lot of still work to do, because there is a lot of government agencies' permits we are still in process applying. Those permits doesnât take that long compared to Class 6 permit that would take from six months to 18 months, but other permits, which is required by Illinois, required by the federal government and other things. So we are working on those progress, and then we are -- we cannot start injection well start even digging the injection well up that time we received EPA permit. So we are in the process of looking at to starting the bid already to be prepared for as soon as we receive a permit from EPA. We should be prepared to start injection well. So there's going to be a lot of work will be happening next year, but our goal is hopefully. But certainly, as Doug said forward-looking statement that we complete this project by the end of 2024. But this could take longer, but that's what we are trying to achieve. I think at this stage, probably that's what we're thinking because we do not have enough capacity for our ethanol facility, but we know there is a lot of demand for the well going to be in -- for in the future. And so we just wanted to make sure, is they're going to be too extra well. we'll be available. We don't have to start digging them right away as we -- there will be started as needed basis but we will have already a permit for the EPA to achieve though. So that if we wanted to start it, we can start it anytime. I think the main concern, which we have is, as you can see the recently going on that there is a strike and you can hear it from the strike and all around that during that 2019, 2021 and railroad laid off a lot of people and certainly these drivers and all those things demand increase, but there is not enough manpower. We see sometimes that power is already there-- are the power made it to the plants to pull but there is no driver and they're supposed to pull it on fair Monday, they're not, they're up to Saturday, Sunday, as these things delayed further to pick up those railcars. Are there other containers that are not available sometimes and that delays car our-- there is limited storage, although we have increased a lot of our storage compared to other ethanol facilities, but there is a per point reach, which you have your tanks are completely full, then you have to slow down the project are storages are full you can't really overflow the ethanol from the tanks and then you have to slow down and wait for that to the railcars to come back before you loaded again. So that certainly caused the problem production that certainly is the caused the problem of shipment and unfortunately that's the consistent continue problem at this stage. Okay, thanks. As you head into winter can you comment on how an increase in the price of natural gas will affect profitability? Yes, I think it does really we are already analyzing it journey we try to make sure that we have at least enough get natural gas before we got into that plan, but you can see it's Nymax is trading today it's a $6.93 and last, last month this was $6.35 and last year it was $5.42. So there $1.50 change and that's change since that happened and it's consistently continuously, we see the natural gas is although there is enough natural gas in this country. I think basically reaction is due to the European situation or Ukraine war again since that happened at the time natural gas prices start going up and that makes really major impact if we look at it actually in calendar year it was about $2.08 average and 2021 it was $3.84 average. And now for this calendar year so far, is a $6.64 average. So this, and we don't know what happened in 2023, but that certainly is affecting the bottom line as Doug mentioned is a 56% increase. So that takes away your 56% of the portion of the profit. Thanks for taking the question and you provided some useful perspective on natural gas, let me zoom in on corn. When we look at the futures curve, it basically points to $5, $6 a bushel practically forever and we went through a decade pre COVID with $3, $4 is $6 corn an your view going to be the new normal now on a permanent basis? I think it seems to me that at this stage, at least the area where we have seen what country probably going to continue to trade that level, but the major problem is that area is where you have drought, which I had mentioned earlier in my prepared marks, those areas like South Dakota, Nebraska and Kansas and Texas. Texas is already deficit corn area, but these area is certainly due to the drought the basis, are very high. You can find somewhere basis are $50, $60 or $80 even though we have seen a $1.20 basis for the corn basis. And if the corn is going to leave some area like say North Dakota this year has a bumper crops last year they didn't have that great. I mean Annapolis has a great crops this that area and Illinois has great corps. So when you are shipping these corn from one area to other area by rail, the rail cost about some we are depending on the destination. But if you look at if you send it from North Dakota to Texas it's about $1.60, just to ship per bushel. And on top of that they're going to be $0.60, $0.70 or maybe $0.80 on a basis. So if you are delivering $1.60 plus paying $0.80 basis so $2.40 to deliver a corn in those Texas or in Nebraska in other area, which is further away, would be very difficult for some of these ethanol facility to continue to produce at that corn level price. Okay, let me turn to our regulatory topic. It seems like it's forever, we've been talking about E15 on a year-round basis and I know there is a new bill from Senator Fisher in Nebraska to put a legislative authorization on that without going through the EPA waivers, you it's a pay that bill has a good chance of passing. What do you think? I believe this time looks to be, is the good surpassing because the most all the players are agreed seems like agreed, I should say, seems like they agreed that E15 will not be bad idea. So if that path I think that will be great help, because if the pumps continue to supply 12 months in a year, then people will convert that because I have seen some several pumps in actually in Illinois, Nebraska and other area. What, they call it E88, they are selling, and you can see the price difference almost $0.15 to $0.20 sometime difference than regular price. So people are using that. So I think if these pumps can produce regular sell basis 12 months. I think this will catch up more and more in depth. That will be very certainly will increase another 5% ethanol demand. Okay and then lastly, you mentioned exports and obviously kind of vary from quarter to quarter, but your general impression on the export window to China where do things stand on that? I think if you look at it really, we didn't see much export to join China this year mostly. I think we can see that mostly it was Canada was the highest we produce Canada, South Korea, Netherlands, India, and UK, and I think India is certainly moving also rapidly to meet their own demand locally in India and they are pushing very hard and suddenly better deal was not a major player this year so far, but we have seen certainly Canada and South Korea and Netherland step up and but we have not seen any major shipment to China this year. Okay. Like to thank everyone for listening and we'll look forward to talking to you at the end of next quarter. Thank you very much. That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line. Have a great day, everyone.
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Hi there. This is Liisa Bayko, Biotech Analyst at Evercore ISI. Welcome to HealthCONx Day 2. I'm very pleased to be hosting a nice, juicy 45-minute session with Vertex. And we've got Stuart Arbuckle, which I think is just like the great person to be talking to today, because we do have a lot of commercial questions, and you are the COO. And so, you know all about operations and commercialization, and we have a lot of questions there. So, I don't - I think just to frame it up, maybe just give us a quick snapshot of Vertex to frame the conversation for anyone who may be kind of needing a bit of a refresher that's on the line. All right. Certainly, Liisa. Well, firstly, thank you to you and to Evercore ISI for inviting us. Really pleased to be here. Hello to everybody who is on the webcast. Just a reference, we will be making forward-looking statements on our call. Obviously, there are inherent risks and uncertainties, and I would refer you to our SEC filings to read more about those. But yes, let me give you a quick update, Liisa, on where we think we are. We do think we are at a really important strategic inflection point for Vertex as a company, and I'll explain why I think that, and what we see as some of the really exciting things ahead of us in the future. I'm going to start with our corporate strategy and our research strategy, because I think those are incredibly important to understand, to understand why we think we're at this really important inflection point. So, our corporate strategy is invest in scientific innovation, to discover and develop transformative medicines for people with serious diseases that can be served through specialty markets. And every word in that corporate strategy statement is important. Invest in scientific innovation, we invest well over 70% of our operating expenses in R&D because we believe that is the best way of driving value for patients and for our shareholders. We only invest in things where we think we are going to make a transformative medicine. We're not interested in me toos or incremental improvements. We're only interested in really serious diseases. And specialty markets is important because we want to make sure that we can commercialize those medicines through a specialty sales and marketing infrastructure again so that we keep our SG&A as low as possible to invest the vast majority of our OpEx into R&D. So, that's our corporate strategy. Underpinning that is our research strategy. And our research strategy has a number of important components. The first one is, we only go after diseases where we truly understand the human biology. And in addition to that, we only go after diseases where we have a validated target. Now, could be validated genetically. It could be validated pharmacologically. But the reason why we only want to go after validated targets is, we want to address the challenge which have been inherent in our industry for decades and decades now, which is R&D productivity is typically not very high. For every 20 molecules you might put into a first in human studies, only one ever makes it to the market as an approved medicine. Those are really terrible odds. Most people's answer to those odds is kind of the shots on goal hypothesis. We think that's one solution. We just don't think it's the best solution to go after. What we are trying to do is radically increase our chances of success, and we think we can do that by going after validated targets. The last part of the research strategy is being modality agnostic. We are going to choose the right tool for the job. So, whilst we were born, if I can put it that way, as a small molecule company, if you look at our pipeline now, we have CRISPR-Cas9 gene editing. We have cell therapies. We have cells plus devices. We clearly still have a big focus on small molecules, but we're going to go after the right tool to hit that validated target, because we believe that's the best way of discovering and developing a transformative medicine. So, now, let me talk about where we are because that's going to tell you whether that strategy is working, and we fully believe that that strategy is working. Obviously, we're well known for our success in cystic fibrosis, with our latest medicine TRIKAFTA. We've had terrific, terrific success getting reimbursement and access for patients around the world. We shared on our latest earnings call our revenues for the quarter, $2.3 billion. We've raised our guidance for the full year to $8.8 million to $8.9 billion as we continue to add new patients around the world. There is still substantial growth left in our CF franchise. That's either through get securing new reimbursement agreements in the increasingly small number of countries where we don't yet have reimbursement. It's executing on launches, and it's continuing to develop our medicines down to younger and younger age groups. And then the additional thing is, we're continuing to raise the bar. We have a new triple combination in Phase 3, which I'm sure we'll talk about, which we are very excited about. And then in addition, there's about 5,000 patients who either produce no protein or the protein is not responsive to our CFTR modulators. And that's where our approach with mRNA comes in for those 5,000 or so patients. And we're on track to submit our IND this year. Outside of that, the pipeline has really delivered. We have seen proof concept in five diseases outside of cystic fibrosis, including sickle cell, beta thalassemia, pain, Type 1 diabetes and AMKD. We have multiple late-stage clinical development programs ongoing. Our next commercial opportunities are on the very near-term horizon. As we've disclosed, we are planning to file for Exa-cel by the end of this year for the EU and for the UK, and begin our rolling submission here in the US for Exa-cel. And therefore, we would expect the approval probably to come towards the back end of next year. And then our pain program, VX-548, we are in Phase 3 development in acute pain. And we see that as a very, very significant opportunity as well. So, the pipeline has really, really matured, I would say over the last year, 12 to 24 months. And that's why we think we are at such an important strategic inflection point. And then the last thing I would tell you is, we all know this is a very capital-intensive industry. We are in a very strong financial position, with the ability to invest both in internal and in external innovation. We have a very significant cash balance, which gives us all the flexibility that we need to invest in all the great things we've got going on internally, but also continue to look externally. So, that's the five- or seven-minute summary on where I think we are, Liisa, but we - overall, we think we are at a really, really important inflection point for the company, and it's an exciting time. The number one question I personally probably get because of the reason that you cited at the beginning, having responsibility for commercial, is about our future growth prospects in CF. Obviously, we've seen terrific, terrific growth in CF over the - literally over the last decade since we launched KALYDECO back in January, 2012. And as we've continued to discover and develop better and better medicines, we've continued to see our revenue grow at really, really prodigious levels as we've been able to get access for more patients around the world. So, the biggest question I typically get is, what does the future look like? And we think the future looks really good for our CF business. There continue to be patients, as I mentioned in my opening remarks, who aren't yet on a CFTR modulator. They're either in countries where we're early in the launch, for countries where we've recently secured reimbursements, places like France and Italy and Australia and places like that, or they're in a relatively small number of countries in Europe, for instance, where we don't yet have reimbursement. And then, we're also continuing to work down the age ranges for all of our medicines for ORKAMBI one to two, for TRIKAFTA for two- to five-year-olds. We are planning to submit global regulatory filings by the end of this year. So, continuing to get down into younger and younger age groups. And then, as I mentioned, there are 5,000 or so patients who don't produce a protein which is responsive to our CFTR modulators. And for them, we're working with our partner Moderna on an mRNA program, which I said we will be - we're on track for the IND for that program for the end of this year. And that's an incredibly exciting program. This would be the first time those patients might have something which addresses the underlying cause of their CF, as opposed to just the sort of symptomatic therapies that they're currently on today, which is the same situation the rest of the CF population was in 10 years ago before KALYDECO was approved. Your CF business stands alone in terms of like ownership of the category and the size of the market. I mean, I've pointed this out to people multiple times. I've been doing this for a long time. I've never seen this before where you can really own a category, get almost all the patients, and you have virtually no competition. It's incredible. I do get a lot of questions on kind of like valuation based on forward growth as you kind of near the peak, because right, you talk, you're close to $9 billion the end of this year. I think a lot of people in my seat think of it as kind of maybe an $11 billion business in total. Like where do you see kind of like the peak in terms of the size of the CF franchise? Let's not talk about the mRNA platform right now, but just the oral. Yes. I mean, I would say that we're not in the practice of giving long term guidance, Liisa, but as I said, we do think there is substantial growth still to come from a number of areas. TRIKAFTA is an amazing medicine. We still have some work to do there, as I said, both in terms of launches, new reimbursements, and getting down, importantly, into lower and lower age groups. The second area of growth that I think is underappreciated, and it really talks to the kind of durability of our franchise, it really talks to, I think, why we have had such a strong leadership position, is that we have continued to serially innovate in cystic fibrosis. KALYDECO was a great medicine, but it only served 3.5% of the population when we first got it approved. ORKAMBI was an incredible breakthrough when it first came along, had the potential to treat patients with up to sort of 50% of genotypes, but we knew we could do better, and that's where SYMDEKO came along. But we knew we could do even better in terms of efficacy and get into more genotypes. That's where TRIKAFTA KAFTRIO came along. But we're not done yet. And our real goal is to try and get the vast majority of patients to carrier levels of chloride transport, and to get into those patients as early as possible in life, because our belief is that if we can do that and restore their chloride transport to carrier levels, essentially the same as their parents, we may be able to prevent CF developing in people as we know it today. That's the kind of the ultimate goal. It's been our goal for the - all the time that I've been here at Vertex. And whilst TRIKAFTA is an amazing medicine, we believe we can do even better. And why do we believe that? We believe that from our in vitro assays, which have proven incredibly predictive of what is going to happen in our hands in people with cystic fibrosis and the vanzacaftor/tezacaftor/deutivacaftor combination in vitro shows superior impact on chloride transport than even TRIKAFTA did. We then did our Phase 2 studies with that same triple combination, and we saw greater impacts on sweat chloride and really profound impacts on FEV1 as well with that combination. Now, obviously, that Phase 2 program was not comparing it with TRIKAFTA, but in that study, if you kind of accept cross-story comparisons, that was the greatest levels of sweat chloride reduction we had ever seen. And so, that's why we are so excited about taking that program into Phase 3. As I say, it's in Phase 3 now. We fully expect that the two Phase 3 studies will complete enrollment this year. It is a 52-week treatment period just to set expectations on when we might see data from that program. So, it's a 52-week treatment period, but we are excited about the potential for that triple combination to provide even greater benefit to patients with CF. So, we still think we've got a long way to go in CF and even accepting the mRNA program as an additional kind of growth driver. We think there's lots we've got yet still to do to serve the CF population around the world. Yes, we've been keeping our on the competition and we don't need to get into it, because who knows about AbbVie, but there's a company, Fiona, that I've also been tracking and they're going after this kind of target, I guess that they say has been really hard to get to an MD-2 or something along those lines. Can you talk about kind of your thoughts on maybe kind of partnering with someone on the outside or bringing something in or is it something you even need to do, and what do you think about this particular target that Fiona's working on? Yes. So, as you know, it's not our practice to talk about specific competitors, but let me provide a few comments for context. The first one is around business development. And as you know, from a capital allocation point of view, we've essentially had the same priorities for a number of years. And one of those has been that we continue to look at everything that people are doing in cystic fibrosis to see if they've got things that we believe could be additive to what we are doing internally. And I think it's fair to say that we have seen the list of things that look potentially attractive to us that could be better than what we are doing internally through our own labs, has kind of decreased over time. That doesn't mean to say that we are complacent. That doesn't mean to say we're not looking at everything that people are doing in cystic fibrosis. We're certainly not lacking in humility. We've been out-innovated before by ignoring what's going on in the outside world, and we're not going to let that happen to us again. But we are very confident in the work that we are doing in cystic fibrosis. I think the best thing that we can do is continue to raise the bar on ourselves, continue to out-innovate ourselves, and as I said, reach higher and higher so that we're providing incredible levels of clinical benefit to patients. I think that's the best thing that we can do. As I say, it's not that we're ignoring anything that's going on outside. We look at absolutely everything that could be incremental to what we are doing, but we're very confident in the hand that we've got right now. The mRNA program, I did want to talk about that briefly. Others have tried mRNA for CF and it hasn't worked out very well. What gives you confidence? I know when I was talking to Michael Partridge, and miss that guy, but when I was talking to him in the past, he was like look, like we're really committed to CF patients and we're not going to bring something forward unless we really feel like it's going to work. And so, you obviously feel that way because you - weâre expecting IND relatively soon. What is different about your mRNA program than others that have gone before you and tried this unsuccessfully? Yes. So, I think there's - it's important to remember, there's kind of two concepts that you really need to get right for these kind of genetic therapies, including our own program with Moderna. The first one is the construct. Is the construct that you've got able to achieve the impact that you would want it to have? And we have known for some time using our own in vitro assays and essentially the same assays that we have used for our CFTR modulators, that with the mRNA for full-length CFTR protein, we can get high levels of CFTR protein expression in human bronchial epithelial cells in our internal assays. So, we've known that the construct can work for a while. The real challenge has been, and you see this with all genetic therapies and gene therapies, has really been delivery And you need to get delivery to the cells of interest. And I would say, it's really on that dimension that working with our partners at Moderna, we've really made great strides over the last 12 to 18 months. So, now, we've seen not just in in vitro studies, but in our - in some of our animal studies in non-human primates, that we can deliver using the liquid nanoparticle technology, where we can deliver to the cells of interest and get high levels of delivery to those cells and protein expression. So, it's really the combination of those two things. It's been less about the construct, whether mRNA itself could potentially work. It's been more about solving the delivery challenge. We think we've made great progress there. That's why we're looking forward to the IND hopefully the IND being approved, and then being able to move into the clinic and see whether we can deliver kind of clinical benefit to patients who - obviously today, there really is nothing that can treat the underlying cause of their disease, but it's really that second, it's really been delivery that has been the area that weâve made the most advances in. I would say about liquid nanoparticles is there is precedent for dosing with liquid nanoparticles to the lung and repeat delivery. And so, that's the other thing obviously as part of your IND enabling studies. Obviously, there's a lot of work you have to do on the kind of toxicology side. Obviously, that's something which has been helpful that there's precedent for LMPs for repeat delivery. Let's start talking about the pipeline and turn to that. So, Exa-cel is kind of top of the list, right? You've begun to describe your commercial strategy. So, we can get into that, but let's start with the regulatory timelines. Can we count on a prior review? I've been getting actually a lot of questions on when we expect approval. I conservatively that end of the year, maybe into early 2024, is kind of what I was thinking. I just wonder if there might - I don't know, are you going to get a priority review, do you think? Is that kind of a really realistic, tangible thing? It seems like it would be eligible for it. At the same time, this is, I think a very novel technology. You struggled with FDA in kind of agreeing on what you need for submission, all that kind of stuff. So, I just wonder if there might be some additional discussion that's required. Yes. So, I mean, we can only really comment on the things that we control, and I can't really comment on things that we don't control. So, what have we said that we are going to do? We've said that we are going to complete our submissions in Europe and in the UK by the end of this year, and we're on track to do that and begin the rolling submission for our BLA here in the US, and that we anticipate that that will complete by the end of Q1 of next year. As to exactly what the regulatory timing will be, unfortunately, Liisa, that's not kind of in our control. It will depend on things like what designations we get, how they choose to look at the application, how quickly they choose to move, et cetera, et cetera. None of that is in our control. I would anticipate it's going to be approved towards the back end, all going well towards the back end of 2023, but as I say, that is not in our control. And therefore, we can really only comment on what is in our control, which is making sure we get the submissions in as per the timeline that we've outlined. You've described, is it 23 centers, you said that the centers of sort of excellence kind of thing that you'll be sort of targeting in your initial phase out of the rollout and have those to be accredited centers? Is that what you said? Yes. So, we have said that we anticipate going through kind of authorized treatment centers. Clearly, the centers that can perform this procedure are transplant centers. So, we'll be working with those transplant centers. The diseases are relatively concentrated, both actually in Europe and in the US. It's concentrated in about 25 States. 90% or so of the patients who might be eligible are in about 25 States in the US, and over 75% are in four countries in Europe. What we've said is that we anticipate kind of getting to a study state of about 50 or so centers here in the US, and about 25 or so in Europe. And we think that network would be able to serve the vast majority of patients in both the four major countries that have a prevalent population in Europe and here in the US. Obviously, we're already working with those centers now to see who might be interested in kind of being part of that network. So far, the response has been really positive, which is great, but it's 75 between the US and the EU. Correct. Yes. And just to put that in perspective for people, we currently serve cystic fibrosis patients through about 275 CF treatment centers in the US. So, just to give you some sort of context. It is a relatively concentrated network of treatment centers that we imagine kind of bringing on board. Thatâs the ⦠What's the - like I've always - and I've talked to you about this before, Stuart, but one thing that kind of I've always been thinking about is the capacity, and maybe that's a good problem to have, but as you think about these 25 centers in the US, what's the capacity that you think you can get to with these centers? No worries. So, yes, I mean, I think the capacity is one of those discussions that we are having right now with those transplant centers, because clearly these transplant centers are doing a lot of other things in turn, including malignant hematology as well. They are doing some haplo and other transplants like that. So, that's one of the conversations that we are having with those centers right now. But clearly, capacity is going to be a consideration in terms of the uptake of these types of technologies, as indeed is going to be physicians and patients wanting to embark on what is not a short treatment journey. So, certainly, there are logistical, if I can call it that, issues, and it's really those logistical and administrative issues that we are currently working through with the treatment centers in this period between us filing and subsequently getting approval. Look, I imagine this is going to be a relatively expensive therapy, and you're targeting a population that I would say as a whole maybe has more trouble with access to healthcare than maybe other demographic groups. What can you do to ensure access? This has been on my mind as well, and it actually applies to the - in a different way, but to the AMKD program as well. And I think like - I think there's never been a better time to try to address some of these difficult topics, but at the same time, what tangibly can you do to ensure ask is what are you working on? Yes, I would totally agree with you, Liisa. I don't think there has been a better time for the payer and policymaker community to kind of step up and address some of the issues that this population and others, but this population has faced over the years in terms of their interactions with the medical establishment. So, we are working at all levels, federal level. We're working at the State level with policymakers. A relatively large percentage of this population is Medicaid. And therefore, what individual States choose to do is incredibly important. So, as I say, we are working at both the federal and the State level. We are also working with commercial payers. A lot of this is going to be about helping them understand the very, very significant unmet need, the very, very significant emotional, clinical, and financial burden that this disease puts on both patients, caregivers, and the overall healthcare system. And therefore, there is a real clinical, but also moral imperative to address these two diseases and to provide access as close to day one, if I can call day one the day of approval, as possible. That's what we're focused on. The other insight that we are gathering from those interactions with payers is that we are going to have to be working with them to define what is the appropriate payment models. That is one of the big issues for these kinds of potentially one-time curative therapies is, what does the payment model look like for these types of things? It's been fascinating in our discussions with payers, not just here in the US, but also in Europe, but it's clear that one size fits all is not going to work. We are going to have to have a variety of different payment models available. We're going to have to be creative. We're going to have to be flexible. I think our experience in cystic fibrosis is going to stand us in good stead there. I think we've done a great job in being flexible and creative with our reimbursement agreements around CF. Our portfolio agreements are, I think, still truly unique in the industry. And I think that same sort of creativity, innovativeness, ability to work very closely with the payer community is going to be really important to solving the access challenges that this population has experienced in the past. So, you're a first mover in this whole area of ex vivo treatment for the sickle cell and beta thal population, but there's a bunch of people coming behind you, right? And they kind of all want to be in the same category. What - how do you think about kind of, I guess, offensively and defensively positioning yourself, given the kind of wave of competitors are coming behind you? And are there any advantages to being kind of first? Yes. I mean, I think the first thing that's going to be important is, what is the level of clinical benefit, and what is the benefit risk profile of the technology that you are bringing forward? And we feel really good about the data that we've seen and disclosed to date on Exa-cel. We feel really good about the approach we are taking with our CRISPR-Cas9 based approach, and the very precise editing that that delivers. So, I do think as always, with the uptake of any medicine, you really need to evaluate two things. What's the level of unmet need? Clearly super high in these two populations, and then what's the level of clinical benefit and the benefit risk profile that you're able to bring to bear? Again, we think this is a truly transformative medicine. In terms of, what are we looking forward to in the future, it really is similar to what we've done in CF, which is continued innovation to try and improve on the technologies that we've got. We've disclosed previously that we're working on better conditioning regimens, because clearly one of the challenges with this kind of procedure, with the Busulfan-based conditioning regimen is that actually the vast majority of the adverse effects that you see are inherently due to the conditioning regimen, not due to the CRISPR-Cas9 gene editing and that process. And so, clearly if you can improve that, that would make the procedure ⦠Yes, weâre continuing to make good progress. We really don't have much to disclose right now, but we are continuing to make good progress on that. And we'll obviously keep you and others updated, but that's clearly very important. And then in addition, which I think to some extent gets a little bit forgotten here, we originally struck our agreement with CRISPR way back in 2015, it's because we were already working on sickle cell disease as a disease and looking for other approaches to increase fetal hemoglobin. And so, we continue to do that as well. So, without specifically commenting on what's going on externally, I think you can hopefully feel reassured that the lessons that we've learned from both our own experiences in HCV, and what's happened to others in the industry is that we're in the innovation business. If you're in the innovation business and you stop innovating, there's a good chance you're going to get made obsolete. So, we are not going to let that happen. We are going to continue to serially innovate in sickle cell disease and beta thalassemia, as we have in CF, as we expect to do in all of the disease areas that we're working in. Okay. What would innovation in sickle cell beta thal look like? Would that be something different than an ex vivo approach or continuing? Yes. So, there are other approaches that you could take. For instance, if you could develop an oral-based therapy that had the same impact in terms of rating in vivo globin, then clearly that would be something which would not just be something which could potentially be attractive in places like the US and the EU, which have the infrastructure to be able to look at something like Exa-cel, but we know there are many, many more patients in other parts of the world for whom a technology like that could be really life changing and could fit into their healthcare infrastructure much more so than essentially what is a bone marrow transplant. So, there's lots of areas where we could potentially innovate. Interesting. And then just final question on this, like how big of a product do you think Exa-cel can be? Can you give us some ballparks? I think investors are a little like, ho hum. I think they're a little bit not sure how big of a market this can be. I mean, on paper it looks like it could be a big market, but we just talked about all the kind of headwinds that you'll be facing, right? So, can you give us a sense of how you guys are viewing it? Yes, definitely not ho hum, I can tell you that. So, let's just talk about the potentially eligible treatment population to start with. We estimate it's about 32,000 patients who would be potentially candidates for Exa-cel based on the current Busulfan-based conditioning regimen. And how do we get to that 32,000 liter? That's essentially patients who are at the more severe end of the spectrum, the sorts of patients who are, have been enrolled in our clinical trials. They're the sort of patients who are having multiple red blood cell transfusions a year, experiencing multiple VOCs a year. Of that 32,000, about 25,000 of those have sickle cell. The vast majority of those are here in the US. So, we're not talking about hundreds of patients here. We are talking about tens of thousands of patients. So, we do think this is a multi-billion-dollar opportunity. What I think you've described or asked about is really, what does the uptake rate look like for something like this? And I would definitely say, we are not expecting it to be CF-like. As you know, our CF uptake is virtually vertical. There's a lot of different reasons for that. We are not expecting the uptake rate to be like that in this particular population. As I've said, this is a significant commitment the physician and particularly the patient is making to a lengthy procedure. They have to evaluate the benefit risk. Then obviously, it's something which requires scheduling, which needs to fit into a patient's life, needs to fit into the treatment centerâs schedule. This is not something which is going to be, as I say, CF-like in terms of its uptake. But in terms of where do we see it getting to overall, we do think, given the very high unmet need, the benefit risk profile we're seeing with Exa-cel, we do think this is a multi-billion-dollar opportunity. I know we're getting close to time, but I just wanted to touch on a couple more programs very briefly. The AMKD program reminds me a little of Exa-cel in terms of you're kind of targeting this patient population maybe that has access to healthcare issues, but it is an oral therapy, so that's a good thing. There are 100,000 patients you've talked about that kind of meet the description of patients that would be eligible for this kind of a treatment, meaning they have the genetic variant and they have proteinuria, right? But can you talk about like how many of those are identified of the 100,000 and how will you work to get more people identified? It's a great question. So, you're absolutely right. About 100,000 people is our estimate for patients in the US and in the EU, pardon me, or in Europe, I should say, who fit that definition that you described. In contrast to, let's take CF, where the vast patient majority of patients are diagnosed, identified, regularly visiting a physician, this is the polar opposite, both in terms of the number of patients who even know that they have kidney disease, and even less obviously who have been genotyped and know that they are homozygous for the APOL1 mutation. Now, that isn't particularly surprising, I think, this mutation and it's linked to rapidly progressing kidney disease, has only been learned for the last 10 years or so. There is no available therapy right now for which knowing the genotype would really help you. And so, you can understand why the number of patients who've been tested for APOL1 is relatively small or is very, very small. So, for sure, there is a significant market development, if I can call it that, need to both have those patients diagnosed with kidney disease, and have them tested for APOL1. So, clearly, that's going to be a challenge that we need to address. We are at the beginning of addressing those challenges. Certainly, our clinical trial is driving awareness of both the disease and APOL1. We have an ongoing genotyping study which is looking to genotype patients of African-American ancestry for APOL1. And if they are found to be homozygous, then they have the option to consider enrolling in our clinical trial. We recently launched at ASN a program with Alonzo Mourning, who is probably, certainly here in the US, one of the most famous people with kidney disease in the whole of the US. He had FSGS. He's now a very, very committed disease and healthcare advocate. We've partnered with him, and we're partnering with others in the kidney community to raise awareness of the disease. So, for sure, it is something that we need to work on. We've already begun that work. Interesting. Okay, pain. Just wanted to quickly ask about pain and then we'll wrap it up. There's so much to dive into in your pipeline, but I'm just going to focus on the main drivers. So, sometimes I get questions from people like, pain, isn't that really deviating from their kind of core strategy? Could you maybe explain why you think - how pain kind of fits into your strategy? Yes, yes, absolutely. So, I think in many ways, you need to go back to our corporate strategy and our research strategy, and we think pain fits it beautifully. Why do I say that? Pain is certainly a very serious unmet need around the world. There have not been new pain therapies developed in decades, certainly not new classes of pain therapy. Reformulations and stuff like that aside, no new pain classes and certainly not ones that treat the underlying cause of pain. So, our VX-548, which is a NaV1.8 inhibitor, we understand the human biology of pain. We understand NaV1.8 receptors and 1.7 receptors are causely linked to the creation of the pain signal and the transmission of the pain signal. That's been known for many, many years. What we've done here at Vertex is the team in San Diego has really, and in our other research sites, cracked the chemistry of how you actually interdict that target. And as you know, we had VX-150, which proved the concept that inhibition of NaV1.8 could have a profound impact on pain across multiple different pain states. It just was not the right molecule to take forward to commercialization. We feel really good about VX-548. It's demonstrated that it works in acute pain, and we've advanced that into the Phase 3 program, which has already begun. So, super exciting. The other question is, well, isn't pain - pain isn't a specialty. You said your strategy was to focus on specialty markets. So, let me just break down the pain market for you. The way we think about the pain market, there is acute pain. Obviously, that's short-term pain, multiple different kind of etiologies or causes. There is neuropathic pain, which is obviously a type of chronic pain where nerve involvement is the cause of that pain. And then there's the broader chronic inflammatory, lower back pain, osteoarthritis, and knee pain. That third segment is clearly a very, very large number of people, but is largely served through primary care. And so, that will not be an area of focus for us right now. We are focused on acute pain and neuropathic pain. With 548, we're in Phase 3 for acute pain. We're starting our Phase 2 program in neuropathic pain with VX-548 this year. So, why do we say acute pain is a specialty market? Let me just dimensionalize the market. For acute pain, there are about 1.5 billion with a B, treatment days of pain meds prescribed for acute pain in the US alone. And despite 90 plus percent of those prescriptions being generic, the market today is valued at $4 billion. That's the market today at generic pricing. So, we think if we could bring forward a novel, effective pain med without the adverse effects of some of the other pain medicines used in acute pain, and that's priced at a branded price, we think VX-548 in acute pain alone is a multibillion-dollar opportunity. So, then the real question is, is it specialty? Of those 1.5 billion treatment days, the vast majority of that, two-thirds of that, is actually instigated in the hospital setting. It's either used for acute pain when somebody is in the hospital, potentially post-surgery, or it's prescribed at discharge for follow up pain treatment. That's two-thirds of the business. We can get to fully two-thirds by focusing on the hospital segment, and even within the hospital segment, it's concentrated. We believe we can get to that with the specialty sales and marketing infrastructure. Now, it may not be the 16 representatives we have in CF, Liisa, but it is not going to be thousands and thousands of representatives. It will be a specialty sales and marketing infrastructure. That's acute pain. Neuropathic pain represents a very, very - also a very, very significant multi-billion-dollar opportunity as well. The market dynamics there are slightly different. The standards of care are different. But in terms of the size of the current market, it's also very, very substantial. And again, that is almost all genericized. If we bring forward again, a truly effective medicine, which doesn't have the adverse effects and side effects of some of the existing standards of care, we think both of those are very, very significant commercial opportunities. The vast majority of neuropathic pain is dealt with by neurologists. Again, a specialty segment that we can serve with a specialty sales and marketing infrastructure. So, we feel pain fits our corporate and research strategy to a tee. It's certainly a very significant opportunity. But then again, so is Type 1 diabetes where there's two and a half million patients ⦠.. that we could serve. So, we have many, many multi-billion-dollar opportunities outside of our work in CF. Again, that kind goes back to my opening comments. We've been working on this strategy for a number of years, Liisa. It is playing out, I think, right before our eyes. That's why I think we are at this very, very important inflection point for the company as we continue to execute in CF, bring forward this really, really exciting pipeline, much of which is in late stage, all of which has multi-billion-dollar potential. It's just a really exciting time. Yes. So, we'll be saying more about that at JPMorgan. As is our habit, Liisa, we kind of present kind of our scorecard, if you like, of the things that we can anticipate. So, I won't do that. What I'll tell you is, we have a lot of good news, I think, between now and the end of the year. And what do I mean by that? As I said, we are planning to complete our filings for Europe and the UK for Exa-cel and begin our rolling submission in the US for Exa-cel. Our IND for our mRNA program, that's going to be incredibly exciting. We're planning to submit our IND for our Cells Plus Device program in Type 1 diabetes. So, this is the same cells that we've shown data on with VX-880 encapsulated in our proprietary delivery device. That's an incredibly exciting program, which unfortunately, we haven't had time to talk about. Plus, we're going to be filing, for instance, for TRIKAFTA in two- to five-year-olds. As I said, our work in CF is not done, and we anticipate completing enrollment in the vanzacaftor triple combination program. So, I won't talk about everything we're anticipating for 2023, but even in 2022, we think we've got a lot of work to do between now and the end of the year. Okay. Well, listen, it's been great to catch up with you, Stuart. Really appreciate the time today. I know it went over, but gosh, I didn't even touch upon some of the other things like DMD program, which maybe we'll find out about next year. We'll hold our breath for the beginning of January. Anyway, okay, thank you very much for the time. Thank you, everyone, for bearing with us as we dove into everything, and have a good rest of your day. Thanks.
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EarningCall_1681
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Greetings, and welcome to the Wejo's Third Quarter Business Update 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 turn the call over to Wejo's Senior Vice President and Investor Relations, Tahmin Clarke. Please go ahead. Thank you, Darrell. Good morning, everyone, and thank you for joining Wejo's business update call to discuss our third quarter 2022 operational and financial results. With me on the call today are Richard Barlow, our Founder and CEO; and John Maxwell, our CFO. Remarks made today on this call about future expectations, events, strategies, objectives, trends or projected financial results, and other similar items are forward-looking. Forward-looking statements are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not guarantees of future performance and as such should be taken in the context of the risks and uncertainties that are outlined in the SEC filings of Wejo, including our recently filed quarterly report on Form 10-Q, as well as other documents filed with the SEC. Forward-looking statements speak only as of the date made and the Company undertakes no obligation to update such statements in the future. In addition, during this call, we will be discussing certain financial metrics that do not conform to Generally Accepted Accounting Principles in the U.S. better known as GAAP. For a reconciliation of these financial metrics to GAAP, please refer to our quarterly report on Form 10-Q filed with the SEC. Thank you, Tahmin, and thank you for joining us on Wejo's third quarter 2022 business update. Cementing Wejo's status as a global market leader in the Smart Mobility solutions for connected, electric and autonomous vehicles has always been one of my primary goals. We are starting to deliver on that goal given the very strong operation momentum that we generated this quarter. Despite the challenging economic conditions, restrictive access to capital and tight labor markets, Wejo has successfully delivered on our plan to date. We have made significant investments in our technology platform and product portfolio, successfully managed resource challenges and created a [cultured value with our values] innovation. Additionally, we are strengthening our strategic partners, including our development plans with Palantir to accelerate our marketplace development. These investments are paying off with strong customer engagement in U.S. Traffic Management market base and early positive signs of significant new opportunities in end-to-end insurance, audience and media measurement, and automated company software-as-a-service offerings. Our strong [indiscernible] our business performance are clear indication that we are heading in the right direction. We delivered revenue of $2.6 million in the quarter, which is up 632% over the prior-year period and its more revenue than we generated in all 2021. We generated strong levels of Total Contract Value, TCV and Annual Recurring Revenue. We engaged with record number of customers, which was driven by our expanding product portfolio and increasing vehicles on platform. All of this is testament to the focus the entire Wejo team has had on delivering the plan and building a track record of consistent execution. Not only we are currently executing on our plan, but we've also created a tangible roadmap of what future success looks like in the form of strong customer pipeline and new products and marketplaces that we anticipate adding in the near future. To date, our booked contracts in Q4 support more than half of the revenues to ensure we achieve our full-year 2022 revenue guidance of $10 million plus net revenue. We expect that our strong pipeline will generate balance to the revenue and need to attain that goal. We expect that based on current operating performance and the strength of our future pipeline, we will be well positioned to accelerate both our revenue profitability in 2023. Critical to revenue acceleration is our customer base and all times customers recognized the value of our products and solutions and how transformative they are for their operations. Our customer base is broadening, nearly doubling since this time last year and we are translating that success into several sizable opportunities in both private and public sector. Let me highlight a few of these examples for you. Expanded the companyâs relationship with Ford to offer end-to-end insurance solutions in the United States. Wejoâs offering will include data and insights to help insurers understand driver behavior in better assessing their risk profile, minimize fraud and reduce risks for safer journeys. Also, as we previously announced, a major SaaS deal with a large North American OEM will be signing a longer term expansion of SaaS relationship in the fourth quarter. This is the start of a very large revenue opportunity for Wejo in providing services to the automotive industry. These include platform-as-a-service, PaaS, which is the licensing of Wejo's entire platform and software-as-a-service, which is the licensing of specific Wejo platforms. During the other parts of the fourth quarter, we have been awarded new contracts from three state Departments of Transportations, including Texas, Virginia and Georgia. We also have our first customer for Real Time Traffic Intelligence or RTTI we call it, as part of the award with the State of Texas. This deal is important as we firmly believe are the Departments of Transport and numerous other public and private sector organizations will see immense value gain in Real Time Traffic Intelligence. We see RTTIs significant revenue stream to the business in the future, especially given that there are 47 other U.S. states, which like Texas and another two previously mentioned are focused on safety and sustainability. In addition, there are counter-cities and municipalities that will be interested in our platform after they see firsthand how these states will benefit from Wejoâs insights and capabilities. We also believe there will be very tangible opportunities to leverage the Jobs and infrastructure bill in the future. The U.S. government expects to award over $7 billion in grants, including money focused on increase the number of electric vehicle charging stations, EV to help accelerate adoption. We believe this will enhance opportunities to serve customers in the federal and state and DOT space. We expect the web effect from multiple DOTs will create opportunities to demonstrate the breadth of solutions that run our platform, including the EVOS. The insights that we best derive from our EVOS solution can help any state, city or municipality determine where an EV charging station should be located as well as merged how and when EV Infrastructure should be used. Finally, on customer relationships, we signed a co-development agreement with Sompo to deliver Smart Mobility solutions, including enhancing safety and sustainability to the Japanese and South Asian markets. We set out at the start of the year to broaden our customer base and deliver products that accelerates our revenue profitability. We are doing that. This is substantiated, that attraction we are seeing in our financial performance and KPIs. Speaking of financial performance, that's a good opportunity to bring our CFO, John Maxwell into this discussion. Over to you, John. Thank you, Richard. I'm very excited about our Q3 performance and the fact that we are beginning to experience the benefits of the strong foundation we have put into place. As Richard mentioned, we have attained record levels of performance including net revenue, ARR and total customers. The KPIs show that we are continuing to deliver on what we said we would do and our success is now starting to manifest in our revenue. We are building a strong track record of execution and we are also well positioned for future growth given the strong pipeline that we have. Our customer base grew more than 80% over the same period last year continuing a strong trend. As we look at our customer base, what excites me the most is not just the growth in the customer base, but the increasing variety of customers that leverage Wejo's platform and products ranging from small businesses to large enterprises and universities to government agencies. The broadening of our customer base fits with Wejo's vision, that over time the company will not only rely on large enterprises, but we will also support thousands of smaller customers from all realms of business and public sector line. Total contract value similar to customer activity was up 71% over last year. Our TCV continues to demonstrate a strong book of business the company is building for the long-term, our growing pipeline will bolster that number even further as we continue to engage with new customers and their eyes are open to the value proposition that we offer. Gross bookings were down year-over-year on a sequential basis or on a year-over-year basis when compared to Q3 of 2021, but on a nine-month year-to-date bookings, we were up 75% when compared to the same period last year. The third quarter has some seasonality around summer vacation that affected the timing of a few deals between Q3 and Q4, we expect that Q4 will be our strongest booking quarter to date based on the current activity and expected deal closings in the next few weeks. ARR was at record levels during the period, up 64% as subscription-based contracts increased as a percentage of our total product mix. ARR also increased sequentially up $1 million to $7.2 million highlighting the impact of our service offerings us having on our customers who are opting for longer contracts. Our average contract point has increased now to 24 months versus 20 months a year-ago. With all of these factors, net revenue for the quarter was $2.6 million, representing a 600% plus increase when compared to the same period in the prior year. Today, we are reaffirming our guidance for $10 million of net revenue for the full-year 2022. Our revenue performance to date of $4.6 million leaves a little over $5 million of additional revenue in the fourth quarter. Based on where we are today, we need a few deals to complete to exceed $10 million and they are in process. As Richard mentioned, we have signed several large state DOTs and in one instance there are a few steps in the process on their end that are needed in order to complete delivery and that is expected to occur in the next few days and that's about $500,000 to $600,000 of revenue tied to that. We also are in the final stages of our first major automotive cloud solutions deal, being signed and working through the final technical points before that deal is signed. Assuming those points are resolved, we have just under $1 million at 2022 revenue that will be recognized after signature. Finally, we have an R&D platform that is in late stage discussions with about $600,000 to $700,000 of revenue tied to it and depends upon completion of that contract. All of these deals are likely to occur in 2022 and therefore we maintain our guidance. We are very excited about all of these opportunities and what they mean to the building of Wejo's business. Whether we are talking about a multimillion dollar deal with state DOTs, which is the first for us, or our first major cloud solutions deal with the global automotive company or a platform R&D deal for the Japanese insurance market. They all demonstrate how Wejo's business is reaching an inflection point and beginning to accelerate growth at multiple levels. We expect this to continue as our business progresses forward. Irrespective of the timing, these deals will be impactful on our financial performance and bolster our gross bookings in total contract value. The remainder of our financials and other key metrics, that we want to talk about this year are adjusted EBITDA loss of $22 million and a 16% increase in live vehicles on platform. Adjusted EBITDA loss was impacted by cost reduction initiatives that we put in place and also the weakening of the pound versus the dollar, which also impacted our expenses. We expect that adjusted EBITDA also as a proxy for cash burn will step down as we move further towards a burn rate of $5 million to $6 million in this quarter as we exit 2022. We will continue to focus on efficiency and our cost base as we exit 2022 and enter 2023 to further improve our cash burn rate, while continuing to drive strong revenue growth. Given that traction, we believe that we will hit our adjusted EBITDA loss target and be in the range of $85 million to $95 million for the year. With respect to vehicles on platform, we are likely to come in less than our guidance of $27 million to $32 million by year-end 2022. We are onboarding new vehicles closer to the time. We expect them to generate revenue, this saves data, cloud and people cost and ultimately enhances our ability to become a profitable company in the long-term. We ended the third quarter with $14.7 million of cash on hand after incorporating the cash raised from the PIPE transaction we executed in July. On Monday, we filed an 8-K announcing a binding term sheet with a strategic partner with respect to the sale of a $10 million of convertible notes and warrants. Completion of the offering is subject to due diligence and negotiation of the definitive agreements, which we expect will occur in a week or so. We also are in dialogue with several other potential investors that are participating in the convertible offering to try to raise an additional $5 million to $10 million and we will update you as that occurs. We also have our equity financing facilities that we expect to use to raise capital and we will continue to utilize plug capital strategies like the PIPE we completed in July and the convertible notes offering that we are working on currently and we are continuing to pursue long-term capital strategies that will complete our financing picture and provide liquidity that positively positions the company until cash flow breakeven. We will update the market as these strategies being pursued become certain and disclosable. Thank you, John. To broaden our revenue profile, we need to find ways to design new products and services that expand our current revenue use cases and positions to deliver to continue to deliver on the power of innovation. Our prime example [indiscernible] is our revolutionary AVOS platform, which is focused on accelerating the EV future. To become an integral part within the AV ecosystem, we are building AVOS to one day offer a full suite of service that need to our data platform to generate insights and analytics that can solidify that path forward. These AV solutions while innovative and toughens new market segments, build in basic capabilities that we have in our portfolio today and with investment of time resources we can monetize in the near future. In the traffic marketplace, we are aggressively positioning RTTI, Real Time Traffic Intelligence as our [indiscernible] all our consumers, customers. Why? Because we are the only company in the mobility space that can deliver real time traffic insight to have a level of granularity RTTI can provide, but RTTI is not just an application that can used in traffic. As the company continues to expand its offering into end-to-end insurance, audience and media measurement markets, RTTI will play a pivotal role in assessing risk profiles and measuring efficiency â the efficacy of media on driving behavior. As we come to close this business update, I just want to reiterate some key elements that demonstrate the progress of the business we continue to build. Operationally, we are continuing to deliver on the goals we set out for the year. We are broadening our customer base, signing new customer deals and expanding partnerships with the likes of Ford and the Texas, Georgia, and Virginia DOTs. We signed a co-development agreement with Sompo and we've enhanced the partnership with Palantir to accelerate development of product verticals for our marketplace. And as John mentioned, we have advanced the financial progress significantly by reaffirming our financial guidance for the year, increasing our revenue for over [630%] in the quarter and reporting backward levels of ARR. We are also continuing to focus on the efficiencies of our cost space as we exit 2022 and enter 2023 to further improve our cash burn rate or continue to drive strong revenue growth. In terms of capital, as John highlighted on Monday, we filed an 8-K announcing a binding term sheet with a strategic partner with respect to sale of $10 million of convertible notes and warrants. We are also in dialogue with several of the potential investors that are participating in the [indiscernible] to try to raise an additional $5 million to $10 million and will update as needed. Most of our equity facilities are expected to raise capital. We will update the market, these strategies being pursued become more certain and disclosable. Thank you. We'll now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Jeff Meuler with Baird. Please proceed with your questions. Yes. Thank you. I would just love any more perspective on kind of the long-term capital raising strategies and on the equity facilities. I think there's been a pretty minimal drawdown and I think there is some restrictions on how much you can impact share count, which is impacted in turn by the stock price. So just wondering how viable those still are as a funding mechanism at the current stock price. But I know you tried to give us a lot already, but just in terms of getting past this, like $10 million to $15 million per turn, given the current burn rate, would love any perspective on other funding plans longer term or any other steps of contemplating to reduce the burn rate further into 2023? Sure. Let me provide some color and Richard can add as well. With respect to the long-term capital strategy, if we're going to look at whether it is a strategic partnership that would enable us to fund in a more robust way or it could be an acquisition of a company that has a significant cash position, it could be really anything that would enable us to significantly strengthen our balance sheet and also strengthen our business. The capital markets are in tough shape and so we tend to take a more creative approach, once we've found that solution, which we're in dialogue actually on several of them. But once we've found the solution that we think works, we will update the market and hopefully that'll be soon, but I can't promise timing, but we'll do it as soon as we can. With respect to the equity facilities, you're exactly right. The reason that we're doing â we did the PIPE in the summer and the reason that we are doing the convertible deal now is really to make sure that we've got capital that supports us beyond those equity facilities. Those equity facilities are limited. They're limited by the volume that our stock trades at and they're also limited by the price of our stock. So we have to find other means to fund, which we've been able to successfully do to date. And then with respect to cash burn, we're continuing to really focus on where prioritization, we've talked about that, but we've deprioritized some things that are not as critical to near-term revenue. We have focused on efficiency doing what we need to do. We are now focused on where can we automate and where can we get more automation needed working with our partners in terms of how we deliver to customers or even internally where we do. So we will continue to reduce our burn through those types of measures, through working with our vendors to right-size our relationship, whatever it happens to be that we need to do. And then the other factor of course is revenue. Our revenue is really inflecting well. We have a very strong pipeline and as revenue grows, that will also obviously reduce our cash burn. John was saying the strategic, are not only helping us with capital, but they're also helping us in terms of bringing more support to the business, whether, for example, John mentioned automation is a great example of how we're working with Palantir. So we're continuing to scale the business in terms of revenue whilst maintaining or reducing our cost space and our strategics are making capital available to us at a fair market rate. So we have visibility to how we scale revenues next year without significant scale costs, which fundamentally improves our profitability, improves our margin as a business. Got it. And then great to see the progress on building the access to data for the insurance use case. Can you talk a bit more about the pipeline from a monetization perspective? I just don't know how far out that is on the horizon. In the past you've made references to a potential large insurer in the U.S. that you're in conversations with. I don't think that's come to fruition, just curious on monetizing the insurance use cases? So as you noted, we made announcement yesterday where we now represent Ford in both Europe and the U.S. for their insurance marketplace. We are not yet giving 2023 guidance, but we now have our first European and U.S.-based wide insurance offering from an OEM and we expect that make a cyclical contribution to our revenues next year. Meanwhile having strategic support from Sompo puts us in a very firm place to be aligned with the partner in APAC and Japan and further field later on. That helps us scale our products without taking an unnecessary or expensive product deployment, which may â will not drive the revenues in the short-term. So we're navigating through support from Sompo, the great support now from Ford on European and U.S. base is somewhere we're excited about what insurance can do this next year, but we're not yet giving 2023 guidance. Right. And then on gross bookings, just what's the cause of the change in the estimate of prior period bookings and how material is that? Just trying to understand I guess the quality of the gross bookings metric and the potential for other revisions to prior periods. There is no revision to prior periods as much as there was. The way of timing, the gross bookings metric is important to us to help you understand how we're booking business. So you take the million dollars that we booked in Q3, that's a low quarter for us actually. We had several million dollars of deals that were actually signed in early October that were originally slated and we thought they would come in, in September, they didn't. And so you're always going to have timing and I even though as we talk about revenue as we come into the end of the year, we expect to get to $10 million plus, but there's always timing factors that could cause something to slip into the next quarter. We're focused really on building our business, and the building of the business is very strong. That shows up in gross bookings. It's showing up in our revenue, it's showing up in our ARR and we think that will continue as we go. So there's not really any factor that would cause that other than⦠Okay. And then you got into some contract specifics on like the full-year guidance. So you have about a little over $2.5 million of revenue already booked from things that you subsequently sold and then a little over that that you need to still sell and recognize this revenue, I guess in the final month of the quarter. Is that correct? I guess just given that some of your contracts result in revenue being recognized over longer periods of time, not always in period, just trying to understand just line of sight or confidence and potentially getting to that number. It sounds like there's a decent risk that maybe it slips. Well, I want to build out for you a clear way, what we're working towards, just to be as transparent as we can possibly be. And if I take the SaaS relationship as an example, most of the revenue associated with that contract will be recognized in future periods. There's a lot of setup type work that we've already done actually that once we get the technical points resolved then we will sign the deal and then that revenue would actually get recognized in the period that we sign the deal. So that's a significant amount of revenue. It's there, it's waiting to be done, it's just now working through the details. If I take the state DOT, that's also a multimillion dollar contract and there's about, roughly $500,000 of revenue in the period that we've contracted for, we're waiting on, but their process won't take delivery until certain signatures are received, and it's a multi-party organization basically. So we work through that with them and we're ready to go when they sign, but we don't control when they sign, and they complete their own internal paperwork. And those are the kinds of things that we are working for. So we're positioned to deliver the revenue, assuming the pieces that I described are completed. And all I was laying it out for you was, look, we are in a position to get to in excess of $10 million, but it does depend on those things completing, I just wanted to be transparent. Okay. And then on the, DOTs and I guess Texas buying RTTI in particular, what would the past be for like future expansion of say the Texas relationship? And then as you think about RTTI, it seems to make a lot of sense for a lot of other state DOTs, so just where are you in those conversations? So Jeff, without giving away too much, the idea of RTTI then supporting our [AVOS] proposition where we're seeing live charging of vehicles, where we can advise utilities companies on demands on the grid, we see that amalgamation of products being really powerful for DOTs. And indeed that's the feedback we're getting. So our contracts with DOTs are now starting to go into the million dollar range of value in terms of TCV, and we see significant scale from going there by being the only source of real time data. But real time data's not just real time location data, it's real time active understanding of charging demand from vehicles, for example, as one example or another real time example is identifying crashes or in terms of audience and media measurement, knowing how people are responding to news broadcasts on radio or other devices in the car. So we're seeing an amalgamation of marketing we're doing from having this unique real time data output from tens of millions of vehicles. Got it. And then just in part of John's answer to my first question, he referenced, one option would be acquiring a company with a sizeable cash position. Could you talk through, what else kind of aligns with your acquisition criteria and if you'd acquire another company in the space, just how duplicative our expense structures that we could get some sort of sense of how material expense synergies could be or how complimentary is the data? Is there risk of any cannibalization, et cetera? I mean, from what we've learned from feedback from the industries and marketplace we are operating such as mapping, we are the only source of real time high quality location data. And in terms of how we see that being applied in terms of an M&A model, as you recall in our original S-1 filing, we intended â subjects access to capital to build deals flow, in fact, we've done that on one of our tests, which we set the time on S-1 would be to provide a better quality data asset at a lower cost, which then provides a higher margin. There are businesses, there are number of business that would fit that, that make, where we'd fundamentally have a net benefit, net revenue and net margining benefit from replacing a poor data quality asset with the data asset we have. And as we build our own synthetic data lake, we see that also being a massive contributing to other businesses where we can fundamentally produce the data acquisition costs. Thank you. And we do have someone else in the queue here. Our next question comes from the line of Ryan Koontz with Needham & Company. Please proceed with your questions. Hi, thanks for the opportunity here and thanks for color on the update on the company. I want to get more color you could share around go-to-market with regards to your kind of updated near-term view on different market verticals around the traffic insurance and fleet, et cetera. Like, are you still, what's the balance of kind of direct versus indirect and can you find ways to plug into other vendors, other established vendors solutions to kind of minimize your investment levels required on go-to-market? Thanks. So Ryan, as you know, partnerships important to us and we set out in our Q2 business update that we'd be investing in partnerships. We publicly talk about a partnership with Microsoft. We're building partnerships with other corporates and blue chips as well. So direct sales, we feel is still important to us in terms of winning the larger contracts with especially the DOTs where we have a unique product offering that's difficult to market through partnerships. But we're very mindful that and especially going to next year, the partnerships will with the right quality products, be a very powerful inbound source in new sales inquiries. So we're very much minded on not duplicating what partnerships can do in terms of our own cost base. Got it. Okay, helpful. Thanks. And on the cloud cost, it sounds like you're trying to onboard vehicles now closer to revenue generation. How should we think about kind of optimization of cloud costs here going forward? And is that a concern for you that we should consider also in terms of keeping the burn rate down? I mean our strategic partners and our own partners to being very supportive about how we prioritize the onboarding of vehicles. We're not varying our guidance for onboarding vehicles. And we have a robust pipeline, but at the same point as you noticed, we're now at a point where we're processing 18 billion data points a day and more, we're aiming for 27 plus million vehicle life on platform. We have critical masks in a lot of places in the U.S. and we expect to start seeing the same in other parts of the world as well. So we are being very selective now about how we onboard and when we onboard and the business case needs to support onboarding. So we're not reducing our margins by having vehicles being processed on platforms which don't make an immediate revenue contribution or near immediate revenue contribution. It's very much where part of our focus and the support we've had from our partners is helping us get that methodology refined. Thank you. There are no further questions at this time. I would like to hand the call back over to management for any closing comments. Thank you all for attending today. We've had a great number of attendees considering our last minute notes to make this business update. We will continue to inform the market. We are very much focused to deliver ahead of guidance this year and to continue to monitor our costs and to maximize the margin, the opportunity for you all as stakeholders in Wejo. Thank you for your time.
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EarningCall_1682
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Good morning. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the J. Jill Third Quarter 2022 Earnings Conference Call. On today's call are Claire Spofford, President and Chief Executive Officer; and Mark Webb, Executive Vice President, Chief Financial Officer and Chief Operating Officer. 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] Before we begin, I need to remind you that certain comments made during these remarks may constitute forward-looking statements and are 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 such statements. Those risks and uncertainties are described in the press release and J.Jill's SEC filings. The forward-looking statements made on this recording are as of December 6, 2022 and J.Jill does not undertake any obligation to update these forward-looking statements. Finally, J.Jill may refer to certain adjusted or non-GAAP financial measures during these remarks. A reconciliation schedule showing the GAAP versus non-GAAP financial measures is available in the press release issued December 6, 2022. If you do not have a copy of today's press release, you may obtain one by visiting the Investor Relations page of the website at jjill.com. Thank you, operator, and hello, everyone. Thank you for your interest in J. Jill. For today's call, I'll review highlights of our third quarter performance and provide an update on our strategy, before turning the call over to Mark to review our financial performance and outlook in more detail. Our disciplined approach to executing our strategy helps support our better than expected third quarter performance as we navigated a volatile consumer backdrop and absorbed planned strategic investments. We delivered adjusted EBITDA of $27.5 million, up modestly from a very strong Q3 last year on expanded margins of 69.9% and sales down 1% versus the prior year. While we did begin to see some hesitancy from customers as inflation and macroeconomic concerns increased, she continued to find pieces she liked and remained willing to pay full price for unique and special items, which we flowed regularly throughout the quarter. She continued to respond very well to our unique pieces and especially our assortment of dresses, leading to a third consecutive quarter where dresses were a standout category. Our Wearever sub brand benefited from her gravitating toward restocking her wardrobe with versatile and beautiful pieces for work, travel and occasion. Also of interest, we continue to see real strength in our best customer segment with both shopping rate and spend per customer up, driven by increased average order value. With that said, we continue to stay close to her to keep a pulse on how the inflationary environment is impacting her purchase intent on an ongoing basis. And to ensure we continue to deliver the products and experiences she wants and expects. Now I'd like to provide an update on the Welcome Everybody and inclusive sizing initiative, which we launched on August 4. Welcome Everybody and inclusive sizing marked a significant enterprise wide initiative to modernize the J. Jill brand and value proposition to be more relevant for our core customer and to welcome the next cohort of customers to the brand. And I'm pleased to report that the campaign successfully engaged with both existing and new customers. We checked in with our customer following the launch to ensure they were responding positively to the campaign and to learn how we could continue to improve their experience. They told us they recognize that representation is important in fashion, believe the same price for all sizes is a fair approach and that inclusive sizing either personally impact them or their friends and family. I want to thank the team for the expertly led rollout and continued execution of the initiative. This is an ongoing strategic initiative and the team's disciplined approach to inventory management, ability to create a fully inclusive shopping experience and relentless focus on the customer enabled us to carry out a successful launch this quarter. In addition to the Welcome Everybody and inclusive sizing initiative, we continue to leverage our customer research and testing new and different opportunities within our assortment, where we see potential for growth over time. One such example is a recent test of a small capsule collection called Pure Jill Elements that we are piloting in seven stores and online. This collection features special artisanal pieces designed for the customer who is a fabric enthusiast and who values unique details that can command a higher price point. Early reads from this pilot have already provided helpful insights into opportunities where we can potentially stretch our value proposition over time. The small capsule outfit did a great job of interesting prospects between 35 and 55 years old and was the subject of the top performing social and digital communication efforts to that audience. We will continue to use an ongoing test and learn approach as we continue to leverage data and insights to support our strategic growth initiatives. I look forward to sharing more on the learnings as we continue to focus on modernizing the J. Jill brand, explore opportunities within our sub brands and make progress against our other strategic initiatives. Before I close, I want to acknowledge all of our team for their continued dedication to J. Jill and for delivering our customers the products and experience they love and expect from our brands. Our teams have continued to execute against our initiatives and our results year to date are a testament to their hard work as we continue to build a strong foundational platform for the long term profitable growth of the company. Now, looking to the remainder of the year. While we continue to take a conservative outlook based on today's macro headwind, we remain excited about continuing to delight our customers with beautiful styles, luxurious fabrications as she shops for the holiday and winter season. Thank you, Claire, and good morning, everyone. The third quarter again demonstrated the merits of our disciplined approach to managing the business with a profit focused business model. The third quarter represented a difficult comparison to last year, as we lapped the significantly lower full price promotional performance in Q3 last year. Despite this difficult comparison, we maintained a low level of promotional activity and were pleased to deliver gross margins and adjusted EBITDA above prior year. Now for an overview of our financial results. Total company sales for the quarter were $150 million, down 1% versus Q3 2021. Total company comp sales were down 1.2%. Store sales for Q3 were down about 2.2% versus Q3 2021 on 5% fewer stores as higher average unit retails partially offset lower traffic from fewer stores. Direct sales as a percentage of total sales were 46% in the quarter, direct sales were up 0.4% compared to third quarter last year. Looking at the rest of the P&L, reflecting our continued focus on driving profitability, gross profit was $105 million, up $500,000 compared to Q3 2021. Q3 gross margin was 69.9%, up 100 basis points over Q3 2021, driven by moderating freight costs. We also benefited from the impact of strategic price increases, which offset product cost inflation. SG&A expenses were $85 million compared to $86 million last year as increases in selling costs from store operating hours and shipping and strategic investments in marketing were offset by savings in occupancy costs and management incentive. SG&A was essentially flat as a percentage of sales compared to the prior year. Adjusted EBITDA was $27.5 million or 18.3% of sales for the third quarter of 2022, compared to $27 million or 17.8% of sales in Q3 2021. Please refer to today's press release for a reconciliation of adjusted EBITDA. Turning to cash flow, results continue to demonstrate the strong cash generation of the business. Cash flow from operations was $31 million in the third quarter and $67 million year to date. End of third quarter cash was just over $90 million. As will be noted in the 10-Q expected to be filed later today, we received an $8 million payment from the IRS late in the third quarter that was subsequently identified as an error. Following quarter end, that payment was repaid to the IRS. Separately in November, we received the expected remaining $9.2 million tax refund from the IRS associated with our fiscal 2020 tax filing. As noted in our press release today, we continue to explore options to refinance our remaining outstanding term loan credit facilities and stand ready to execute when the market is supportive. We ended the quarter with inventory up 5.7% compared to the end of third quarter 2021. This increase is driven by the timing of holiday floorset receipts, which we shipped and received earlier than last year to ensure on time delivery of this important floorset. As we enter the fourth quarter, we are cautious on the consumer and stand ready to take promotional pricing action as necessary over the holiday period to ensure a clean end of year inventory position. Capital expenditures in the quarter were approximately $3 million and were primarily related to the POS project, as well as repairs and investments in the store environment. Capital spend will continue to ramp in the fourth quarter as we progress with the POS project and new store investments. With regard to store count, we did not close or open any stores in the quarter ending with 247 stores. With respect to our future outlook for fiscal 2022, for the fourth quarter of fiscal 2022, we are projecting sales to be flat to down 3% versus Q4 2021, and adjusted EBITDA to be between $9 million and $11 million. Included in this outlook is an expectation that gross margins will be about flat to last year as any necessary pricing actions will be offset by the benefit from lower year over year freight costs. The resulting expectation for full year 2022 is, annual sales will grow between 4% and 5%; gross margins will be up about 100 basis points versus prior year; and adjusted EBITDA will be between $103 million and $105 million compared to $92 million last year. Regarding store count, we will close net four stores in the fourth quarter of fiscal 2022, including the opening of one new store late in the fourth quarter, ending the year with 243 stores. And finally, we now expect capital expenditures of about $13 million for the year. Good morning, everyone, and congratulations on the nice progress. Can you expand just on the top line what you saw as you went through the quarter, given that you had mentioned the slowing down in the second half of the second quarter, anything that you saw during Black Friday? And when you think about your buckets of product categories, Claire, anything to note in terms of acceptance, given the Welcome Everybody campaign? And then Mark, the moderating freight expenses, what magnitude of moderating freight are you thinking about as we move through 2023? And I think the CapEx reduction, is that delays in any stores or anything to note of [indiscernible] $2 million a little bit lower than it had been, what we should be looking for? Thank you. Sure. Thanks, Dana. We did see sort of an up and down cadence over the quarter. And we did see some resistance in terms of certain basic categories. As you know, we stay close to the customer and we have a tracker that we put in the field to really get an understanding of how she's feeling, her consumer confidence, her purchase intent and how she's feeling kind of about the macro environment as well as how she's feeling about our brand and our products. And we did see an increase in sort of her hesitancy and her awareness and some caution around the macroeconomic environment. That said, we continued to see very little price resistance for products that were truly unique and special. I mentioned in my remarks about the strength of dresses. We had a small capsule collection called Pure Jill Elements, which is actually slightly higher price points, products with a lot of make in them, beautiful fabrics, artisanal details. We had a nice response to that and very little price resistance. So it really was a combination. And as I said, some ups and downs over the quarter. With regard to Black Friday, obviously, this quarter we are sticking to our strategies and our intent. And while we are certainly paying a lot of attention to what's happening in the macro environment and the competitive environment from a promotional cadence and level standpoint, we are -- we continue to try to minimize our promotions in full recognition of the fact that Q4 is just a little bit of a different animal, but we anniversaried the same promo level over that weekend as we did last year. And that's -- the product piece is really what I said, the special piece is the unique pieces and newness standout categories like dresses, Wearever was strong in the quarter as well. Those are really the big callouts. Great. And Dana, I'll take maybe the second question first related to CapEx. Yes, you're right. It's a couple of delays in store -- new store openings that did move into the first quarter of next year, so pushed out. And then I would just call it a couple of other delays. The supply chain for our particular part of the industry is much improved, and I'll talk about freight in a second. But with respect to procuring some technology assets, etcetera, there is -- a slight delay is still there. So nothing other than mostly shifting expense or capital related to projects that are underway. With respect to freight, we mentioned that there was about 100 bps of benefit in the Q3 margin related to freight costs moderating. And that really is two factors right now. Remember, last year when things started to get complicated in the freight world, in the supply chain world we made the decision to air goods in and we're no longer really airing at elevated levels. And then, we also were seeing ocean rates increase fairly dramatically late last year, which carried over into this year. We are seeing those ocean rates moderate, but we're not back to pre-levels yet. I think there's still room to go as we roll forward with ocean rates continuing to come down and we will continue to use airfreight as we sort of normally like to use it, which is more strategically for getting goods in a little bit of chase, etcetera, versus just securing goods on time. The on time deliveries, the reliability of the shipping lanes has improved dramatically. The rates are coming down. That should now turn to a tailwind. And we indicated it would in Q4 and then a little bit into the first half of next year as well. Hey, thanks for taking the questions and nice quarter. Just kind of diving in further to the store comps, can you break out how we should think about price versus traffic mix? So Daniel, with respect to what's driving the revenue pricing. We've taken strategic price increases. We've spoken a little bit about it the last several quarters. Those strategic price increases are sort of in the system now. We also are still experiencing raw material first cost inflation in our goods. And we indicated on the third quarter that those strategic price increases essentially offset the inflationary pressures in our first cost. Our primary driver of inflation is cotton and we're a heavy user of premium cotton or pima cotton and that is a crop that we're watching and hopeful will start to come back down from its peak levels in the coming quarters. The other factor we've had year to date, it's worth noting that our business model really has been to become much more focused on the full price promotional line and that has been contributing on a year over year basis AUR or positive increases in AUR above and beyond the ticket price increases. And Q3, we mentioned on the call that it was the most difficult comparison and that's because last year was really the first quarter Q3 that we obtained a really low healthy level of full price promos where we want to be. So that year over year gain kind of went away, but now we're a ticket, full price mix, etcetera, as we continue to move forward that will continue to drive the AUR. Got it. That's helpful. And then just looking at the cash balance quarter over quarter, can you maybe talk about some of the puts and takes outside of the margin benefits as you saw year over year? Were there any kind of abnormalities in working capital? And maybe how you think about uses for cash? And maybe do you think that there's -- potential you could use that for further delevering to help effectuate the refinancing? I think on the second front, we would say, yes, as one of the potential uses for cash is addressing the balance sheet, as well as fueling growth initiatives, etcetera. With respect to the quarter, I would say it's primarily gross margin driven. We did call out and it's a little bit complicated, but we did call out that there was right at the end of the quarter we've been awaiting a tax refund from our 2020 filings and we did receive a significant portion of what we expected late in the quarter. We subsequently identified that that was an error, which we then repaid and then received immediately -- almost simultaneously received the actual refund, which is slightly more, it's about $1 million more than we had sitting in cash at the end of the quarter. In those the balance sheet that you see that you'll have the cash that reflected that payment again, then you'd have a receivable that was for the entire amount, the $9.2 million amount. And then you'd have a payable that reflected the payable obligation to repay that $8 million up in cash. So it's more noisy than it needs to be, at the end of the day net $1 million better, but just timing cusp through the quarter, which is why we called it out in my script. Got it. That's helpful. And then last question for me here. Looking at the fourth quarter guidance on the top line flat to down 3%, you said gross margin is expected to be flat year over year. Still looks like there's pretty significant kind of EBITDA margin compression, given kind of the outperformance in third quarter, can you maybe talk about the puts and takes into the 4Q margin guide? And how you think about maybe some one time kind of investments in G&A that could be leading to that compression, if that makes sense? Thank you. Sure. Yes, there's a couple of things going on in SG&A. We've been alluding to them along the way. Kind of ramp into the fourth quarter, we have holiday operating hours for stores, which does add pressure to SG&A in the fourth quarter relative to where we've been. We also have our strategic investments in marketing that we continue to make. And those really are in our view intended to address current business, but also to build the file and support future growth. So those continue. What we mentioned on the Q4 guide behind the margin and the sales is that, we are taking a cautious view of the consumer just given the macro uncertainty and noise, inflation, etcetera and indicated that the gross margin will be flat, even though tailwinds are expected from freight. And those tailwinds in the fourth quarter we've indicated will offset any additional promotional activity that arises as a result of the holiday promotional time period.
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EarningCall_1683
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Greetings and welcome to the Frequency Electronics Second Quarter Fiscal 2023 Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. Any statements made by the company during this conference call regarding the future constitute forward-looking statements pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements inherently involve uncertainties that could cause actual results to differ materially from the forward-looking statements. Factors that would cause or contribute to such differences are included in the companyâs press releases and are further detailed in the companyâs periodic report filings with the Securities and Exchange Commission. By making these forward-looking statements, the company undertakes no obligation to update these statements for revisions or changes after the date of this conference call. Hi. Good afternoon, everyone. Although the results for the second quarter are not where we would want them to be, there are significant indicators that were on the road to recovery. Revenue quarter-over-quarter has increased. Our backlog of approximately $56 million at quarter end is higher than it has been any time in the last 8 years as is the book-to-bill ratio of 2.8. In addition, we have booked $4.4 million of new business already in the third quarter. At the annual meeting, we discussed the satellite industry move to develop systems, which utilize a large number of low cost delights which are by design replaced much more regularly every 3 to 5 years rather than the 15-year lifetime required of todayâs large satellites. One of our key customers, large government-like prime contractor has communicated that they experienced 15% growth in satellite business over the past year, anticipate sustained growth of 10% to 15% annually over the coming years, and as a result, is interested in engaging FEI and development of advanced technology appropriate for what they refer to as proliferated low earth orbit satellite systems often referred to as large systems of small satellites. We are experiencing similar overtures of other satellite prime contractors, all of which bodes well for our future space business prospects. All that being said we still struggle with supply chain issues, persistent inflation, but in both cases, signs of easing are beginning to appear. Continued effort is required to navigate the changing economic and geopolitical environment, but we are confident that we are progressing in a positive direction and look forward to a dramatic improvement in results. The company is committed to moving towards sustained profitability and cash generation in the near future. We remain debt free and our strong balance sheet allows us to pay the special dividend discussed in a separate press release today, while still maintaining the ability to invest for future growth opportunities. Thank you, Tom and good afternoon. Before I give you the financial report for the second quarter of fiscal â23, I just wanted to give you a brief explanation relating to the delay in filing the 10-Q as well as the restated fiscal â22 10-K. During the preparation of the current 10-Q for the period ending October 31, â22, we realized there was a formula error in the calculation that split contract assets and contract liabilities from a net presentation to a gross presentation. The net number is correct. However, our formula didnât split the assets and liabilities of related contracts being calculated as one project for revenue purposes. For example, if there were three related contracts that made up one complete project, two with a contract asset of $1.5 million each and one with a contract liability of $1 million, our formula would have recorded a contract asset of $2 million instead of a contract asset of $3 million and a contract liability of $1 million. As we put together footnote C in the 10-Q to show the effect of the formula change going back in time, it was determined that it was an immaterial error and that it would be only footnoted to show the effect going back. It was also determined that when the fiscal year Form 10-K for the period ended April 30, â22 was filed with our stated fiscal year â21 contract assets and contract liabilities shown gross as opposed to net as was shown in the fiscal year â21 annual report on Form 10-K, the footnote was deficient in that it did not disclose to the reader that the fiscal year â21 contract assets and contract liabilities will change from net to gross. As a result, we had to amend the fiscal year â22 annual report on Form 10-K to advise the public not to rely upon the financial statements as well as the controls on financial reporting. It is a GAAP requirement to disclose the change that were made with regards to the fiscal year â21 presentation changes in the annual report on Form 10-K for the period ending April 30, â22. But management wanted to clarify the situation, despite the emission to disclose the reader of the financial statements that the contract assets and contract liabilities were changed from net to gross presentation, management feels that the financial statements were accurate and could be relied upon, other than the formula mentioned above, all of the information, a reader of the financial statements needed was in the financials and was completely accurate. The only thing causing this restatement and delay in filing was the correction of a footnote to make the reader aware that the contract assets and contract liabilities, which changed on the face of the FY â21 balance sheet from net to gross. However, it was shown gross in the supporting footnotes. I should also mention that this change does not affect the P&L, working capital or any other calculation that would have helped in evaluating the financial statements as presented is because of these reasons that management of the company feels that the financials were accurate and could be relied upon. I believe I have said enough about this subject. However, if you want more details, feel free to contact me after the call. And now, I will go into the financials for the second quarter of fiscal â23. For the 6 months ending October 31, â22, consolidated revenue was $17.2 million compared to $25.9 million for the same period of the prior fiscal year. The components of revenue were as follows. Revenue from commercial and U.S. government satellite programs was approximately $7.8 million or 46% compared to $13.3 million or 52% in the same period of the prior fiscal year. Revenues on satellite payload contracts are recognized primarily under the percentage of completion method and are recorded only in the FEI-New York segment. Revenues from non-space U.S. government and DOD customers, which are recorded in both the FEI-New York and FEI-Zyfer segments were $8 million compared to $10.6 million in the same period of the prior fiscal year and accounted for approximately 47% of consolidated revenue compared to 41% for the prior fiscal year. Other commercial and industrial revenues were $1.4 million compared to $2 million in the prior fiscal year. Consolidated revenues increased quarter-over-quarter by approximately $750,000 or 9.1%. Intersegment revenues are eliminated in consolidation. For the 6 months ending October 31, â22, gross margin and gross margin rate decreased as compared to the same period in fiscal year â22. The decrease in gross margin and gross margin rate was due to increased engineering costs on development phase programs and experienced particularly complex technical challenges that have since been resolved. Minor technical challenges that have been or will be resolved reasonably quickly and the negative cost impacts of some programs due to supply chain delays. Gross margin was also affected by under-absorption of costs due to decrease in sales during the 6-month period ending October 31, â22. For the 6 months ending October 31, â22 and â21, SG&A expenses were approximately 23% and 26% respectively of consolidated revenue. The decrease in SG&A expense for the 6 month ending October 31, â22 as compared to the prior year was largely due to decrease in professional fees as well as one-time reductions to stock option expense related to forfeitures and deferred compensation expense. The company continues to monitor expenses looking for additional cost -effective reductions going forward. R&D expense for the 6 months ending October 31, â22 decreased to $1.7 million from $2.7 million for the 6 months ending October 31, â21, a decrease of $1 million and was approximately 10% and 11% respectively of consolidated revenue. The R&D decreases for the first half of the fiscal year â23 are related to focus on projects currently in production phase. The company plans to continue to invest in R&D in the future to keep its products at the state-of-the-art. For the 6 months ending October 31, â22, the company recorded an operating loss of $5.4 million compared to an operating loss of $1.4 million in the prior year. Operating losses resulted largely from decrease in revenue, coupled with the additional costs mentioned previously regarding gross margin. Operating loss improved quarter-over-quarter by approximately $120,000 or 26.5%. Other income consisted primarily investment income derived from the companyâs holdings of marketable securities, Earnings on these securities made based on fluctuating interest rates, dividend payout levels and the timing of purchase sales redemptions or maturities of securities. This yields a pre-tax loss of approximately $5.4 million compared to $1.1 million pre-tax loss for the prior fiscal year. For the 6 months ending October 31, â22, the company recorded a tax provision of $2,200 compared to $2,300 for the same period of the prior fiscal year. Consolidated net loss for the 6 months ending October 31, â22 was $5.4 million or $0.58 per share compared to $1.1 million net loss or $0.12 per share in the prior fiscal year. Our fully funded backlog at the end of October â22 was approximately $56 million compared to approximately $40 million for the previous fiscal year end April 30, â22. The companyâs balance sheet continues to reflect a strong working capital position of approximately $28 million at October 31, â22 and a current ratio of approximately 3.9:1. Additionally, the company is debt free. The company believes that its liquidity is adequate to meet the operating investing needs for the next 12 months and the foreseeable future. Thank you. [Operator Instructions] Okay. And the first question is coming from Brett Reiss from Janney Montgomery. Your line is live. Great, great. First question is on the dollar a share special dividend. Could you just give me a sense of how the Board decided to do that versus maybe looking on bolt-on accretive acquisitions or retaining the money for organic growth initiatives and I suppose our share buyback since the stock is already pretty illiquid, thatâs why that was ruled out. Could you give us some color on that? Well, I think you kind of hit the nail on the head with respect to share buyback. I think the general conclusion of the Board was that this was an appropriate way to essentially provide the same benefit as a share buyback or shareholders, but in a more effective fashion. Okay. It was very encouraging to see the backlog move up so dramatically. Could you â Tom, could you give us some sense on the timing on working through the backlog? Is it a certain percentage each quarter? Is it more back-end loaded? Could you give us some color on that? Well, itâs â yes, itâs not like the backlog is represented by one or two contracts. So I think itâs hard to make a general statement in that regard. I think in general, I think the backlog is converted to revenue for a period of roughly 2 years. But there going to be some cases where itâs significantly longer than that somewhere is a little bit shorter. Okay. And what is the composition of the backlog? Is it mainly with your expertise with the quartz clocks, is it the atomic clocks? Or is it another area of your business that gave rise to this increase in the backlog? Well, I think there are really three things. there is quartz oscillators, atomic clocks and microwave systems and I actually donât have a quantitative breakout available at this time. But those are the primary things. I think itâs reasonably well balanced between those three areas. Okay. And a couple of quarters ago, the company was devoting a lot of R&D to reduce the size, weight, power needs and cost on your clock offerings. Have â could you describe the progress youâve been able to make in that area? Well, I think weâve made considerable progress, but itâs something that we still work on. In fact, we â I just notice made note of the fact that we got a little over $4 million of new business in the third quarter and a significant chunk of that is a contract, which we will utilize the results of some of that R&D to develop smaller devices. And so I think thatâs pretty encouraging. But there is very much an ongoing effort. We do see this as the direction of the industry at this point, moving to smaller, lower-cost systems and we have every intention of being a strong competitor in that environment. Last question for me, and Iâll drop back in queue. Is your employee head count, where you want it to be based on what you see your level of business over the next few quarters are going to be? Yes, I think weâre pretty close to where we need to be. I certainly donât anticipate any further reductions at this point in time. Hi, thank you. And first, thank you for the dividend. And my first question has to do with your supply chain problems. Youâve had this difficulty getting parts, and that continued in the second quarter. My question is, can you see an end of that? Can you see getting back to normal in that regard at some point and foresee... Yes, I think we can. What we continue to see, we place orders and we get extremely long lead times on electronic parts that ordinarily would have lead times of a couple of weeks, maybe a month, we now are quoted to lead times of more than a year. In some cases, weâve had lead times of 80 weeks. But what weâre starting to see is that we get promised deliveries 80 weeks out in the future. And then we actually received the parts in 10 weeks or 15 weeks. And weâve seen that in a number of cases. And so I think what I start to see is that people are being very conservative in making promises, but things are turning around and they are able to do much better those original conservative estimates. And thatâs really encouraging. But nonetheless, we have to plan based on the promises made by our suppliers. And so â and then we donât see these kind of improvements to deliveries in all cases. So itâs kind of a mixed bag, but I think it is indicative of the direction that things are going. Okay. Thatâs great. And the additional costs that come as a result of difficulty in getting parts or taking more time to engineer products. Do you ever get compensated for that, that is in your ultimate development or production programs do your customers give you some wiggle room and help you pay for that? Well, we â thatâs something that weâre actively pursuing at this point in time with some of our customers. In one particular case, we have gotten some benefit in that regard. But in general, that hasnât happened. But I think that is something that we are going to be pursuing over the next year or so because, yes, itâs â weâve have suffered tremendously in this regard. Okay. And you said on one of the two calls that you led Tom that you were hoping to get back to breakeven by the end of this fiscal year. And Iâm wondering if you still think thatâs likely. Well, I wouldnât say as likely that this fiscal year will be break-even. But I think the last quarter and going forward after that we do anticipate being break-even or perhaps a little bit better. Good afternoon. Thanks for taking my questions. Tom, the presentation you made at the annual meeting, is that on the website? Okay, thank you. Yes, we really interested in listening to it. So Tom, what kind of time period do you think youâd need to make your own personal imprint on leadership at the company? I mean, youâve been at the home for a relatively short while. You have a wealth of experience with the company. And I assume youâre attempting to reposition the company into stronger growth markets, so I am wondering how you feel about this? Well, I think in some ways, Iâm leaving an imprint already, there not very visible in the financial results at this point. But there are a lot of things going on, a lot of changes that have been made. And so I think itâs kind of a mixed answer. There are some things that are evident already, and there are some things that are going to take a couple of years. We have weâre pursuing new products and things. And those are things that arenât going to develop instantaneously. There are some things weâre working on, and we think weâre going to have some prototype products in the 2025 time frame to 2026 time frame. So I guess, really a summary answer is there is implants happening continuously between the present and a couple of years out. Yes. I mean the burgeoning small satellite business is really coming to the fore. I assume Iâm not saying youâre asleep, but in the past, youâve certainly not been trying to participate, so I assume that this is a really important shift that youâre trying to take the company or direction. Yes. It is in some sense. But I will say we donât believe that the large satellites are going to completely disappear anytime soon. And so we donât want to abandon that business. In fact, there are signs of growth in that business also looking to the near future. But yes, we do feel that the small satellite business is where the future will go. But I think the thing â and Iâve said this before, the question is what does small satellite really mean? And there are satellites, the size of a basketball and even smaller that have been launched recently. And then our people that call satellites that are 100x bigger than that which are also considered small satellites. And so thatâs really the challenge for us is to find where the sweet spot is and where things really end up. I think there are an awful lot of these small satellites, many of which get launched up in the space and never operate even for a minute or two. In fact, as part of the ARTEMIS launch, there were some satellites launched at the same time that never functioned properly. So there is evidence that you canât just make things cheaper and cheaper and smaller and smaller and get away with it. There are challenges in space, there is radiation there are all kind of environmental things that need to be taken into account. So thatâs what weâre really trying to do is make sure that we steer towards the sweet spot in the future. And I think we have some pretty good ideas of where that will be. Makes sense. So looking at the revenue model, do you have a guesstimate as to what kind of volume we have to generate to reach break-even considering gross margins? We have a model. We â I donât want to really forecast the future yet. But based on what we see, what we have in-house and our backlog and everything else, we believe, based on product mix and everything else going like Tom said in the second â the fourth quarter, we should be heading in that direction now. Thank you. The $56 million in backlog was some of that classified because there wasnât many news releases recently about contracts? Alright. Thatâs fine. And then right now technically up to $60 million in backlog, because that $4.4 billion came in after October 31st? Letâs see, went down a drop. I think you did. Did you move more people to â from California to New York? We have actually just completed qualification testing of an engineering model. And in fact, we have also completed as part of that, we needed to do a 140-day stability test, and we have successfully completed that also. We have also delivered an engineering model, which is slated to fly on one of the GPS III satellites. They gave an extra slot on the satellite for extra atomic clock and our clock will be flying in that slot. I donât remember the exact schedule for that satellite at this point in time. But we have heard word that everything is good. And I believe that the satellite is all bundled up and ready to go. Itâs just a question of when it will actually launch. Thatâs correct. Yes, that there is a goal for everybody on the program this is seen as an important step in everybody having confidence in our clock as a primary clock on the satellites. And so, there is an effort to get this inserted as early as possible. Yes, it will take a few years to â I think there are 22 GPS IIIF satellites. But I donât believe if all of them have been released at this point in time. Alright. And one more question. I think you mentioned last quarter some of the companies were buying more parts upfront or something to that effect. Are they continuing to do that? Yes. Well, itâs a challenge because we donât want to just build up a huge inventory of parts. On the other hand, it makes sense given the long lead times to judiciously build up some inventory of parts that we commonly use. So, we are definitely pursuing that. Yes. I think this, you commented like if they can give you the right part, it would take like a year to get the new part of something. I think thatâs what you mentioned last time. We are definitely finishing up the development on a couple of programs. And we anticipate that the overruns are over or nearly over those, so yes. Thatâs right. I am glad to hear that. And I think you said this is the something like in first time in 8 years that you had this kind of backlog in the release. Hi. Thanks. Follow-up on the inventory question. Well, it was pretty clear that the supply chain issues and other issues contributed to that. What do you see as you are â but itâs still a very large number, was $20 million in inventories. So, the trends are pretty poor. On an ongoing basis without any supply chain uncertainties, what do you think your inventory turn should be, because you have a lot of cash obviously tied up in that? We look and manage inventory. The problem is sometimes we use it later on as we get repeat programs. So, you canât â you have minimum buys and various other things that affect the growth of the inventory. So, yes, it stays a little bit higher, but the end result is a lot of it gets reused on the next generation of things and things of that nature. Okay. Could you update us a little bit on Zyfer? Whatâs happening out there as far as their outlook for business? I think their outlook is quite good at this point. We have recently received a large contract. And we have a couple more in the pipeline that look very promising. So, I think we have gone through a challenging period with Zyfer, but I think things look really pretty good right now. Yes. Well, I think the Zyfer, they manufacture hardware that takes advantage, that utilizes GPS receivers. And so there are GPS receivers that are able to utilize the encrypted messages, military messages. And so there is some classified activity that goes on related to that. But itâs not that Zyfer is working on overall classified programs. Okay. And one final question. One, I think the moves you have made is to become interim have been very favorable. Could you update us on what the status is of a non-interim either you or someone else CEO? Well, I donât know that, thatâs really for me to say. I think that â itâs my understanding that the Board is not actively looking for a replacement for me. But I donât have any intentions of going anywhere or doing anything different at this point in time. So, I think that I have every intention of being here certainly for the next 3 years to 5 years. Yes. Thank you very much. Hey and thanks for taking the call. The question that I have really relates to our Board and the dividend that we are giving. While I certainly appreciate it, I have some questions as relating to how our Board is performing and that no one on this call seems to really being concerned. Our backlog is $56 million, up from $40 million. Additionally, we shipped $88 million over the six months. All of the press releases that go through the Boardâs approval and so on, I havenât seen any telling an industry and a public at large that the corporation is in fact, having increased bookings. We took this $88 million contract and that one and so on and so forth to promote our corporation as it relates to a stock price and the value of our corporation. Thatâs a Board responsibility, which to me and maybe others, they have certainly failed. The next thing that concerns me and it only occurs an hour ago is a release of $1 a share dividend. While I certainly appreciate it, the corporation is losing tons of money. And it includes Board members that probably own 20% or 25% or control 20% or 25% of the companyâs stock. Look at the rewards they are getting for a corporation thatâs lost half its value in the last couple of years. I am really upset of the performance of an overseeing Board that determines a temporary CEO or not a temporary CEO or whatever is going on. And no one on this call seems to be concerned that our Board of Directors is rewarding itself in certain instances or the shareholders that they represent. And the corporation is just giving up and losing money, certainly, perhaps for the next balance of this fiscal year and hopefully go turn around next year. And while I am an extremely small shareholder, I guess you can tell why my anger and my conversations today that are more than upset over the performance of individuals that control and run the management, so to speak, of our business. Gentlemen, I only wish you a healthy New Year and next year, fiscal and calendar should be better for all of us. And thank you for accepting my call. Okay. We have no further questions in the queue. I would like to turn the floor back to Tom for any closing remarks. Okay. I would just like to wish everyone a very happy holidays and good health. And yes, thatâs it. Thank you. Thank you ladies and gentlemen. This does conclude todayâs conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.
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â¦probably over 200,000 tons year-on-year; close to 800,000 tons, we believe, by the time the year ends for 2022. And we don't see that slowing. As you look into next year, it will be probably inching closer to 250,000 to 300,000 tons, getting very close to that, if not exceeding probably that 1 million metric ton mark. So it's a pretty rapid growth and accelerating relative to what we thought maybe a few short years ago. There have been some concerns recently about EV demand growth in China perhaps moderating. What are you seeing from that perspective? What about Chinese lifting inventories looking out over the next few months here? So China, as many of you know, is the largest EV market in the world. It's also a market that's probably from a mix of vehicles the most diverse in that it goes from a very high end to very low end. Had a phenomenal year this year. In terms of EV penetration, the view was going into the year was maybe 5 million electric vehicles sold. And we believe it's going to be closer to 6 million by the year-end -- time of the year-end. We are headed now into a period of time of seasonal slowness, going into the holidays, going into the Chinese New Year. And that's compounded by the threat of uncertainty around COVID lockdowns, what those mean. And then you have the global overhang from a recessionary standpoint, what that might mean for China. So if you look at all of those factors combined, I think we're seeing a period of time in the next month -- several months of some slowness in China. But that -- as we look at the fundamentals, that's not a slowdown in EV growth for the year. I mean as we look into next year, we believe EVs could be close to 9 million, 10 million vehicles sold next year. So it's really, as it often has been in China, a year in 2 halves, a slower first half, stronger second. And consequently, what you see with just the rapid build of this year, you're seeing at the battery level some inventory is starting to creep up because demand is just taking that pause we talked about. But the fundamentals are very strong. I mean we're not really concerned. If you look at the China government's policy and posture towards renewable energy and electric vehicles, this is strategic and the consumer has seen widespread adoption there. So we're not concerned for the long-term, maybe a pause in the near-term here. Yes, at the battery level, more than anything. Or between battery and OEM, battery inventories. If you go from lithium down to cathode, inventories are almost, I would not say depleted, but very low at those levels of the supply chain. It's at the battery level we've seen a little bit of building given, again, some seasonal slowdown in demand. Got it. Beyond '23, your forecast, I think, 1.5 million tons in '25 and 3.2 million tons in 2030. What are some of the underlying assumptions behind those metrics? And how much of that is that non-EV demand growth? Yes. So if you look at some of our growth curves and we have some presentations on our website, it is -- just to answer your last question first, it's really all about EV demand growth. Furthermore, we will have a mini Investor Day that we'll do in January, really ahead of the earnings season, just to sort of recalibrate with everyone our views going forward. Because given the year we've had, a lot has changed, so we'll update and look at some of those numbers. But the fundamentals of the assumption, irrespective of how we update that number, are still the same, it's EVs. Non-EV growth is not unimportant and also at the battery level it can be hard to differentiate, particularly between -- if you're down in the chemistry level, you can tell but which battery -- which lithium molecule from a demand standpoint is going into an EV versus, say, a stationary storage application. Those markets are -- we reckon are probably growing at about half or less or 1/3 of the rate of EVs. So again, it really is an EV story as we go through the middle of the decade and beyond. It's dynamic. It is carbonate, as a proportion of demand over the past couple of years, has definitely creeped up as both in China and now outside of China, a portion of the vehicle mix where range is not as important and cost of battery may be more important and/or the availability of other co-metals like nickel and cobalt may be concerning. You're seeing a double-digit sort of percentage of the market being LFP chemistry which is most often served by carbonate. And that's, we reckon, it has been 20%, 25%, it's probably going to be in that range or higher as we go forward. So the dominant chemistry we still believe will be hydroxide, but carbonate is going to have a strong growth curve as well. And from our standpoint, we're well positioned. We have strong positions in both. And as we look out to expand and partner with our customers, we're very careful about trying to understand what their commitments could be to one or the other so that we can build appropriately. Very good. On to supply. Yes, I was reading that BYD was saying they expect the market to loosen in '23 to new supply coming on the market. Can you discuss what your views of our new supply '23, '24, '25? And does the market ever get loose over the next maybe 2, 3, 4 years? Well, it is true that more supply is going to come out in '23. And I would say, thank God, because we are short currently. I don't see that, that supply catching up to the -- by our numbers, we would say '23 is even more in a deficit than we've seen for most of '22. So just to put some numbers on it and these are round numbers but maybe 100,000 tons of supply came on year-on-year to this year by the time the year is done. It might be twice at that level as you go into next year. But demand is going to be closer to 300,000 tons. So we still see -- in growth -- so we still see that deficit there that perhaps by the middle of the decade there's some more balance restored. But as you then go out to the end of the decade, we see a deficit potentially emerging again. So there's -- it's -- there's definitely new supply coming on, it's needed, but it's not going to be able to keep up with demand, in our view. That's the challenge. Right. We look at '25, even '30, as we forecast pretty large deficits in supply over the next 5 to 8 years. How do we -- how does the industry solve that problem? Yes, it's going to be -- you're going to get a lot of views on this today from the people you've gathered because you've gathered a great group of people within the industry. And you'll get different perspectives. But I think if you summarize at the end what you're going to hear is, if we look at the projects that are in the market today and the risks and the know-how it takes to bring those on, there's most certainly deficit as you go, as you said, into the second half of the year. You're also probably going to hear and we're involved in looking at these as well, is that our existing resources that we have can probably be larger. So the workhorse resources in Australia and South America under the right circumstances can be larger. In some cases, that's permitting. In some cases, that's exploration. In other cases, it's technology that's going to be required to know how to get them larger. And then further still, you're probably going to hear that it's going to take new resources with new ways of extracting. These resources will be higher on the cost curve, they will be more complicated to process. It will put more of a burden on know-how and technology. So it's really going to take more know-how broadly within the industry, more investment within the industry with continued investment in the industry and more technology know-how to try to tap some of these areas. The challenge when you look at any lithium cost curve is that, a), it's an upward sloping cost curve because the best resources have already been tapped and those being the high -- rich or high in quality lithium, low on the cost curve. But as you go out, you don't see any -- if you think of cost curve as being the high and with being how much you can contribute to the market, the width of this is very narrow. You're talking about small bites and many, many, many projects being required to get there. So that magnifies the complexity of growing in this industry. And it speaks to, I think, advantages that people who have done this before and/or have positions in these large resources, it speaks to the advantages a company like Albemarle has to try to drive that growth. But it's going to take a lot of others in the industry to rise to the occasion, for sure. On the cost curve, where are we today in the marginal cost production? And how do you see it trending up over the next 5 to 8 years? As I said, to answer the last question first, it's upward sloping. Back in the 2019 period, we would have said it was a mid- to high single digits cost, marginal cash cost. It's probably several times that today when you add in a -- in order to bring these resources on. And then if you add sort of the risk premium or the incentive margin required for someone to take a big bet or take a risk on some of these areas, I think you have to consider that as well on just top of plain old marginal cash cost to bring these resources on. That's why you're seeing prices now where they are and why I think it's -- while it's -- no matter what anybody tells you in this room, it's very hard. No one knows quite where price is going to go. But it's going to remain elevated because, a, because of that cost curve: and, b, because of the supply deficit. Great segue to pricing. I think we've seen Chinese price this year up roughly 90%. What's driven that increase on our first cut? I think what you're seeing is a market that's saying we need more lithium. We're willing to bid up the price to get it if we can. I can't look at that and I don't think -- you can pressure other guests -- I don't think you can look at the price and say, "Well, that correlates to this cash cost plus this incentive margin." It has become disconnected from that because of the shortfall. You could argue that in a more balanced market, certainly, it would be -- it could come down but we don't see that happening for quite some time. And as we just discussed, we see a deficit by the end of the decade. Longer-term, almost all price forecasts call for a normalizing of price over the next maybe 3 to 4 or 5 years. If supply demand is not going to get any looser, why should price drop at all from current levels, not move higher? It's hard to say, David. I don't know anybody knows where price will go. I think if you go back to what I told you a while ago, beyond cash cost being several times higher than they were some 5 -- 3, 4, 5 years ago and beyond the incentive above that which is required to invest in some -- what today seems like speculative and hopefully in the future less speculative resources because of investment in technology, you can see that prices have to -- they will not resemble the past. The peak-trough will not remember the past peak-trough. It will be at a substantially higher level. It's hard to say when prices might come off. You could see short-term blips. We talked about China inventory correction, but the reality is that would be short lived as time goes on. So I'd be hard-pressed to sort of give you why the price will do, what it will do, but it should remain elevated. Got it. In terms of the Chinese spot prices versus maybe the pricing you might realize actually, how should we think about those prices either normalizing and converging over time? Look, price indices, spot prices, the price reporting agencies around the world, it's a very immature, I would say, early stage for them. Spot -- China for a far longer time has had spot prices than any other industry. But if you look at actually the amount of volume and the types of buyers that are buying on that, it's very small and not very representative of the global standing. But it is a way to see the tone what's going on in the industry. If China spot prices remain elevated for a long period of time, you would expect these other industries to converge with that over that same period of time. But although I think we also see is given the thinness of how it is traded, it's very volatile. So it will be more volatile than some of the others as well. Got it. Maybe switching to more Albemarle-specific questions. First, in your contract -- strategy contract structure, can you describe what you've done in the last couple of years in evolving your contracts for lithium? Yes. So if you look at sort of stages of the evolution of Albemarle's strategy and what's going on in the industry, early on, it became trying to provide for a company that now has since invested in 3 new plants and is going to build 3 or 4 new ones. We've built that capital execution capability. We have a ways to go to continue to refine it as does the rest of the industry. But if you look at where we've been in that, early on it was about providing security. So we contracted on fixed prices to give certainty of returns. And what happened in the pandemic and the period of time just before the pandemic is that those -- as prices fell, I would say irrationally because they fell well below marginal cash cost at the time, they didn't work. And effectively then -- they worked to some degree. I mean we were able -- we maintain a higher margin than anybody else in the industry over a period of time but the reality was it was asymmetric benefit we were getting. And it was very hard as we now go into this industry where price is going where there are to agree with anybody about what price should be, because you just asked me and I said I can't tell you. So the reality is the only way that's going to work from a relationship standpoint with the market is to -- is to go to something that's variable or index-based. And so what we've done is taken all the contracts that were legacy of that variety and moved them over to that gradually that index base. We have a small amount that's still fixed that could potentially move over in the not-too-distant future to a variable-based contract. As we sit here today, 2/3 of our battery grade mix is all -- is based on some index. Now there's various different types within that mix. And so it's still, I think, to the outside view are pretty opaque to sort of understand that because there's no one agreement that works for everyone, but we're definitely evolving in that direction. So that we'll be -- a, we'll be able to take advantage of this market and you'll see that and have seen that in our earnings; and b, we can come to a better agreement with our customers. It's more productive and durable as we go forward. I think the mix is -- at least the way the future looks today is it will be increasingly, if not all, index-based or variable-based, yes. Well, we -- I think there'll be an evolution of what we call spot. I mean beyond China, there might be some spot activity in the future outside of China. Our strategy is not to contract our whole business that we would have -- our aim is 20% or maybe as much as 30% of our business is of a spot-based variety. That's for a couple of reasons. One, it allows you to test and take advantage of the market, a, and develop potentially new customers from that spot business; and b, it gives you security. It's again, there's a -- I think we've done within the industry more capital expansion, refined our abilities over time, I'm going on a learning curve that's been pretty significant, have more to go. The projects still don't hit their time lines for us precisely or the industry at large. So I think it's important to have that flexibility of spot to be able to -- if you're not able to deliver because we have customers as soon as the plant comes on, they want the product. They're immediately jumping on qualification of the product, having a bit of flex in the spot markets allows you that risk mitigation in those relationships. Got it. Maybe last minute, your capacity expansion strategy initiatives, how you're thinking about capacity expansion by region and where are we progressing in these various projects right now? That's evolved a lot in the past 12 months, as you might expect. I mean earlier this year, maybe late last year, we would have been saying, where the resources that we have access to and that's where we should build conversion capacity because the market needs more lithium. So in our case, we're very advantaged. We have resources in North -- several in North America. We have 1 operating in South America. One that we're evaluating in Argentina. And we've got several in Australia. So we're well positioned. They're all world-class resources. Some are fairly small, several of them are very small, older resource. But for the most part, they're large, well-established resources. And so we were building capacity or planning to build capacity around where those resources are. You don't necessarily want to move a resource very far, it's not economic. It's -- there's challenges with supply chain and you certainly from -- in a world of CO2, you're generating more CO2 just moving product. Today, that same strategy now works for what's happening in the world. The world has become very, very regionalized. The IRA has played very well to our position, a, in that we have these resources in North America that we're already pursuing, now we have an incentive to go faster because our customers want that faster. B, though, we're in Australia and Chile, they're both free trade partners to the U.S. So those are both IRA-compliant products as well. So the future of our business is one where Europe, North America and Asia and China are separate sort of regions. They'll have their own plants. And then we'll have some certain workhorse plants where for strategic reasons the conversion is near the resource and that resource is in Australia or Chile that provide the world. But it's an increasingly regionalized market. And we're, again, because of our resource base and scale, very advantaged to be able to pursue a strategy that is so broad like that. In our U.S. strategy, you've announced some fairly ambitious plans going forward. Can you describe what they are and update us on the status of those plans. Yes. So they're threefold. One was -- the first thing we've done which was among the easiest, was to just take full advantage of the Silver Peak Resources a, doubling of that capacity. It's 5,000 more tons, so it's not significant. The biggest and most recent and advanced considerably in the past year is Kings Mountain which is -- that resource is as good as Wodgina in Australia from a grade standpoint, maybe even better. It may be not quite as large, although I don't know that we know fully how large it is yet. We're planning on between 50,000 and 75,000 tons for that resource. It is, therefore, puts as the best in North America of its kind. It was decades ago, a resource when lithium-ion batteries knowing what they were but everyone knew at Lithium 6 was for the Manhattan project, that's the history of the development of that asset, now we're restarting it. It's a brownfield expansion. So no mining activity is an easy one from a permitting and social license and working with the communities. But this is a brownfield site once ran. I've actually met many employees. We used to work there from the 1980s. So they're excited about the future. There's a mining town. So that is the centerpiece and the piece upon which we're going to leverage and build this large, for lack of better terms, mega conversion plan. But we're also envisioning as this regionalization strategy unfolds a need for recycling. Recycling is a long-term play but you have to start building the infrastructure and the relationships now. And the refining assets on the backside of a conversion plan are identical and the hydrometallurgical process is identical to what you use for recycle trading. So the idea is you build the asset once. We don't build that the last 10 years, the last 50 years, over time, you can introduce recycled feedstock in the current time that we'll leverage Kings Mountain. Then the last piece is Magnolia. We are already pumping brine. We're extracting bromine from it. And it has lithium in it. And for a decade, it has been reinjected back into the Smackover brine formation. We're not -- the idea is not to reinject it but take advantage of it and track from it. That's going to take an area we spent a lot of time investing in over the past couple of years, coupled almost a decade now and have done a lot of pilot work in which is some form of direct lithium extraction [indiscernible]. It's significant, I would say. First and foremost, it's resources. I mean, I just talked about we have more resources and some of the biggest resources in the world. We're advantaged relative to our competitors. But even if I look out to the end of the decade and talk about maintaining a leadership in this market, we're going to need more resources. So resources either in early stage or at a later stage are our target for M&A. Technologies, processing technologies, including potentially if we have some in-house DLE technology, maybe we continue to look at outside forms of acquiring that. And then finally, other technology that might be product-based for solid-state forms or solid-state chemistry and recycling. And we have the back end of recycling, I mean we'll continue to look at our strategy and sort of say what sort of partnerships or acquisitions are important for us to play in that area as well.
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Greetings and welcome to The Lovesac Third Quarter Fiscal 2023 Earnings Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ms. Rachel Schacter with ICR. Thank you. You may begin. Thank you. Good morning, everyone. With me on the call is Shawn Nelson, Chief Executive Officer; Mary Fox, President and Chief Operating Officer; and Donna Dellomo, Chief Financial Officer. Before we get started, I would like to remind you that some of the information discussed will include forward-looking statements regarding future events and our future financial performance. These include statements about our future expectations, financial projections, and our plans and prospects. Actual results may differ materially from those set forth in such statements. For a discussion of these risks and uncertainties, you should review the company's filings with the SEC, which includes today's press release. You should not rely on our forward-looking statements as predictions of future events. All forward-looking statements that we make on this call are based on assumptions and beliefs as of today, and we undertake no obligation to update them, except as required by applicable law. Our discussion today will include non-GAAP financial measures, including EBITDA and adjusted EBITDA. These non-GAAP measures should be considered in addition to, and not as a substitute for, or in isolation from our GAAP results. A reconciliation of the most directly comparable GAAP financial measures to such non-GAAP financial measure has been provided as supplemental financial information in our press release. Thank you, Rachel. Good morning, everyone. And thank you for joining us today. I will start by reviewing the highlights of our third quarter fiscal 2023 performance and then discuss Lovesac's strong positioning within the industry. Then Mary Fox, our President and COO, will update you on the progress we have made against strategic initiatives this quarter. And finally, Donna Dellomo, our CFO, will review our financial results and a few other items related to our outlook in more detail. Jack Krause, Chief Strategy Officer, is also in the room to participate in the Q&A session. During the third quarter, the industry backdrop remained challenging. Given the significant inflationary pressures that U.S. consumer is facing we observed that the furniture category overall is down off late in the mid-teens percent wise versus last year. Despite this operating environment, we again delivered strong results against tough comparisons from a record set in Q3 last year. And remember, our performance represents a real time pulse on demand Sactionals, Saks, and StealthTech products almost always ship out just days from order placement via FedEx or common carrier, as opposed to long unwinding backlogs that sometimes bolster other home furnishing competitors' sales. With more than two ten physical locations, mostly in shopping malls, we are currently in the midst of our largest quarter from a sales and profitability and cash flow perspective. We are projecting to end this fiscal year with over 75 million in total liquidity, which includes cash, cash equivalents, and availability under our line of credit. We have a strong debt free balance sheet that is fit to whether any further macro disruptions that may arise into next year. Our continued outperformance and market share gains are a testament to our differentiated business model, including our value proposition and patented innovation, design for life platform, foundation of sustainability, inflecting brand awareness, and consumer adoption, with an industry leading in-stock position. We see our in-stock position and our inventory itself as a huge competitive advantage. Our inventory is not seasonal and is designed intentionally to carry little to no fashion risk. It is primarily made up of just a few key evergreen SKUs. Sactionals and all of our newest inventions on the platform are the emphasis of obsolescence. Even StealthTech as a recent add-on was designed to be reverse compatible with all Sactionalsâ pieces ever sold over the past decade or so. Our high in-stock levels have allowed us to gain significant market share and increase customer satisfaction by delivering to the consumer rapidly before, during, and now after the pandemic as well. As we allow our inventory levels to rationalize naturally through the peak of this holiday season happening right now and on into next year, we are seeing working capital become a source of positive cash flow. As I've said before, our addressable opportunity is significant at 46.2 billion for the couch plus home audio TAM, which combined with the fragmentation of the market presents a very attractive and long runway for our growth and share gains as we continue to innovate broadening our opportunity in these categories and new ones to come. Now, let me review the highlights of our third quarter performance. Total net sales were 134.8 million, up 15.5% versus the prior year period. We delivered total comparable sales growth of 8.9% with broad based strength from both new and existing customers. And adjusted EBITDA loss of 8.4 million was better than our expectations for the quarter, driven by the better than planned gross margin declines. We believe that Q3 represented the toughest comparisons we have faced to date or will face for the balance of this fiscal year. We're very proud of these results, especially considering the delta they represent versus the overall furniture category, which is down in the mid-teens of late. Using that as a baseline comparison really emphasizes the resiliency of our business model and our brand, which we have been building very strategically for years now. We are generating real time demand for our superior products even in this challenging macro backdrop. A full 38% of recent customers report not cross-shopping with their Sactionals purchase against any other competitor whatsoever. This is a sign of the growing power of our reputation and of true demand for this brand and this product over and above customers just shopping the marketplace for [indiscernible]. Our results are also evidence of the [depth] [ph] and nimble execution of the entire Lovesac team who are working tirelessly to remain agile in this choppy environment. We are proud of the culture of excellence we are building together. We continue to be very disciplined on the cost side, while still investing across the business in support of our growth initiatives. Coming off four years of nearly 50% growth rates, headcount growth has always lagged. So, with all hiring at Lovesac now, mostly frozen out of an abundance of caution, our cost model needs no drastic rationalization to what is now a sizeable revenue base. Last quarter, I discussed the importance of technology supply chain and our focus on ensuring that we are building a necessary infrastructure to support our multi-year growth runway. Accordingly, we were thrilled to announce the hiring of John Legg as our Chief Supply Chain Officer. John's vast industry knowledge, leadership experience, and vision will play a fundamental role in building best-in-class supply chain operations at Lovesac. He will continue to enhance our world-class supply chain network, which supports our unparalleled customer experience, designed for life products, and circle to consumer philosophy. Mary will give you an update on the broad based progress we are making on our growth initiatives. So, I want to shift gears to what we are focused on as we close out the year and look into next year. Looking ahead, based on current performance quarter to date, we are confident in our positioning for the all-important holiday season. We are seeing notable cost release, especially on the in-bound freight side, and we are starting to see some of that benefit come through in Q4 with most of the benefit expected to be realized next fiscal year. However, the much discussed inflationary pressures across key cost items continue to impact our overall cost base with labor as a notable example. We continue to deploy levers to help offset some of these inflationary pressures, even as we remain very surgical in terms of any price actions. Those levers include adjusting promotional campaigns and managing our merchandising and mix across our channels, which the team has done really well to date as reflected in our results. They also include tight expense management and careful prioritization of spend to ensure we are investing in the most critical areas to solidify our foundation for growth. As we look beyond Q4 and into next year, while we are not ready to provide guidance, I do want to share some context for how we are approaching next year. We expect the macro backdrop to remain challenging. In such an environment, we believe we will continue to significantly outperform our category and generate growth, but at a more modest rate versus this year overall. Even in the recessionary environment, we believe we can continue to deliver sales growth supported by our planned showroom growth, and our highly differentiated products that are bolstered by years of consistent brand advertising, as well as the strides we're making across our initiatives and of course our innovation agenda. I don't want to divulge more on this last point just yet, but we are excited about our future and confident in our ability to compete and expand. The past three to four years of rapid growth that we have delivered has been driven in a large part by rapid increases in dollar spend and planned and focused marketing. In fact, our marketing spend has gone from 9.2 million spent back in 2018 to 71 million total spend projected this fiscal year or a CAGR of about 53%. It is likely the largest focused spend in the subcategory of couches in the marketplace. The long tail benefits of this compounding marketing spend has generated significant awareness for our brand, momentum, and demand for Sactionals and StealthTech ongoing. It will continue to underpin our expected growth. We have demonstrated and expect to continue to improve customer satisfaction and brand affinity through improvements in process and service levels that affect the customer experience even while aggressively taking market share and outperforming the category. We are about to issue our second annual ESG report with more [indiscernible] disclosures and we will relentlessly pursue progress in all key ESG areas. We leverage our design for life philosophy to bring more sustain [hyphenable products] [ph] to market at scale, which can make a huge impact on our carbon footprint. These are products that can actually sustain being built to last a lifetime and designed to evolve with the user. We believe this approach to sustainability is totally unique to Lovesac and will ultimately position us as the leader in this realm. We have already repurposed more than 159 million plastic bottles to date, converting them to our Sactionals and Saks upholstery fabric, which is made from 100% recycled input, and we are now committed to our goal of diverting more than a billion plastic bottles from the waste stream. We are making progress toward our stated goals of achieving zero waste and zero emissions by 2040. We believe we can become a significantly larger multi-billion dollar company over the longer-term, and we see a real incredible path to getting there. In order to realize these ambitions, we will continue to invest in innovation and R&D while scaling our infrastructure cautiously even in this challenged macro environment. Our core business generates strong profitability, which is not fully appearing in our P&L as we are in this investment mode right now. We have a strong debt free balance sheet and a model that we are confident can deliver continued relative outperformance even with a recessionary backdrop. We will stay disciplined on the cost front, controlling what we can control without jeopardizing our ability to capitalize on the growth opportunity we have. Our focus is on generating long-term shareholder value and positioning this business to realize and maximize this open ended growth opportunity, even as we responsibly manage the business with great discipline. Finally, I want to thank the entire Lovesac team for their tireless execution of our strategy and delivery of our goals. Our disruptive model enables us to continue to grow, thrive, and innovate and invest in this business at a time when many other companies are scrambling for cash and even experiencing [de-growth] [ph]. I could not be prouder of this amazing team we have built. And with our continued success, sounds exciting growth opportunities for all who are a part of this #LovesacFamily. Thank you, Shawn, and good morning, everyone. Our quarter three results marked a record third quarter for our company and our demand growth of 22% outpaced our revenue growth, which is in sharp contrast to the category decline that Shawn shared. Our performance was significantly stronger than any of our key competitors' results, which were primarily driven by back order delayed shipments from previous quarters. We are extremely proud of the outstanding performance and using fiscal 2020 as our baseline, our three year comp growth stats is 146%. This demonstrates the significant market share gains we have experienced over the last three years and more. And we estimate that no other brands with a significant market share in the category has kept pace with our growth. Through that same time period, our position in the market has grown from a challenger to being a market share leader in the categories we compete in. The ability to be the market share leader across our categories is testament to our focus on inventing and designing a product platform with products that will best deliver value for our consumer and creating an experience and ecosystem around that platform. Our evergreen inventory position and operational focus has driven our customer satisfaction scores to record levels as our brand experience continues to delight our customers, which in-turn accelerates our flywheel of demand with word-of-mouth being our number one awareness driver. We are uniquely positioned to continue to profitably take share even through the current market dynamics. I will now provide key highlights on our strategic initiatives. Starting with one, products and innovation. We continue to be pleased with the progress with StealthTech, which was a game changer for us and the category from an innovation standpoint. The brand continues to gain share and we believe that brand have the ability to generate hundreds of millions annually for Lovesac and be a market leader. And here are some key highlights: We continue to see attachment rates increase as the year progresses as adoption continues to grow on a sequential basis. Year to date, Sactionals that were sold with StealthTech have an average order value close to $9,000 or nearly 3x the average Sactional average order value. The initial success of the launch and the sequential progress we are seeing provides us reassurance that the launch support and product continue to build relevance and appeal along with a strong lever to grow our customer lifetime value. Also during this quarter, we continue to innovate with unique product collaborations that our customers love, including Disney's very successful recent release of the Hocus Pocus 2 movie and our partnership with Alice + Olivia launched through New York Fashion Week in September, which delivered a billion impressions during the event coverage. Number two, omnichannel experience. In quarter three as part of our continuous improved of the customer omnichannel journey, we re-launched our website configurating experience. The new configurator was designed through a combination of listening to our customers and building the most intuitive path to purchase, infusing more technology by introducing augmented reality. We also improved the omnichannel experience by incorporating some of the best practices from our touch points. Launch to date, we've seen some very compelling results and some highlights are: stronger attachment rates of up to 400 basis points from higher margin products, such as StealthTech and storage fees. And our digital satisfaction scores have increased by 350 basis points versus year to date pre-launch and our conversion has increased over 6% with the new configurator. As the year has progressed, we have accelerated our planned opening pace with touch points as we continue to see a high return on capital with a payback period of around one-year. We believe we can penetrate significantly more markets than our competitors driven by our category leading productivity. Our touch point network will drive a long-term strategic advantage as consumers continue to show their preference to physically experience our product as part of their path to purchase. We are continuing to drive improvements on touchpoint economics as we can build on our brand strength to drive traffic. Traffic in Q3 grew 34% to last year, which significantly outpaced U.S. traffic trend as reported by [SensoMatic] [ph]. This strength coupled with our real estate strategy has allowed us to deliver lower occupancy costs, which bodes well for the already strong four-wall contribution of our touchpoints. As we continue to focus on delivering a best-in-class omnichannel experience, in quarter three, we launched a new cloud-based POS system pilot in partnership with PredictSpring. PredictSpring is a world-class POS [vendor] [ph] that aligns with our objective of leveraging technology to increase transaction efficiency, reduce manual reconciliation, and set the foundation for our continued growth. And learnings will be applied to an extended pilot in early fiscal 2024. In Q3, we leaned into returning to Costco with our physical roadshows and saw some really terrific success. In quarter three, we operated over 60 physical roadshows that have productivity in-line with the pre-COVID levels and we have seen the productivity increase as our teams get used to selling in the Costco environment. Lastly, customer satisfaction performance, we continue to experience tremendous improvements on our CSAT as our focus on digital and post-purchases [are] [ph] priority drivers is really gaining traction. These gains are critical as we know that our number one source of our purchaser awareness comes from word-of-mouth. And as we create a more satisfied customer base, we expect to be able to continue to leverage word-of-mouth. Our third initiative ecosystem, the vision for this is rooted in circle-to-consumer, C2C, and the development of an ecosystem for our customers and products driving optimal value for our customers and for their designs for life product platforms they've invested in. We know this to be true for our biggest brand fans and we have continued to see encouraging signs that our customers are already leaning into generating more value for themselves by evolving their brand platforms to better suit their lives as they change. This dynamic is unique to us in our category and illustrated by our recent customer metrics with over 4 out of 10 transactions in quarter three from repeat customers. Complementary to our strong word-of-mouth, our marketing mix continues to drive best-in-class category growth performance and our brand health metrics continue to strengthen. In quarter three, we continue to see our overall marketing performance trending within our projections and we are still seeing outside demand growth to our marketing spend. Our customer lifetime value and acquisition cost ratio remained strong and our ability to be nimble by closely monitoring programs and shifting spend has allowed us to be efficient and conversion focused. For example, SMS marketing has been performing extremely well as the last click conversion tactic. And we lead the industry in our KPIs for open and conversion rates. This tactic is very strong during key events with last click sales improvements of over 200% to last year. Leveraging the strength of our business model as we are agnostic to where a sale takes place, our digital spend is focused on driving omnichannel sales and we are very successful in converting throughout the funnel and allowing us to drive sales wherever the customer goes. And then our final initiative, making disciplined infrastructure investments, as I shared in quarter three, our customer satisfaction was at the highest level we have measured. And one key contributor of this is our ability to deliver completed orders quickly to our customers, which is enabled by the investments we're making in our infrastructure. In quarter two, I had shared our infrastructure plans and we successfully opened our [indiscernible] in the Dallas Fort Worth area at the end of the quarter ahead of schedule and will be fully at scale by the end of the fourth quarter. This additional DC invest enables us to continue to deliver our growth, as well as benefit from last mile savings as we operate closer to our customers in the south. Our supply chain is advantaged by our focused number of SKUs that are not also exposed to being obsolete due to seasonality. This means we can carry inventory in confidence that we will sell through it and can absorb changes in demand. We have industry leading delivery times to our customers in [mid-days] [ph]. And in quarter three, we're at record in stock levels of 98%. We have been strengthening our supply chain capabilities to deliver strong unit economics, driven by our productivity loop of focused assortment growth and scale efficiencies, as well as optimizing inventory through the planned OMS implementation. I'm thrilled that John Legg, our new Chief Supply Chain Officer, will be leading this work, and we expect to see these benefits starting in fiscal 2024 and beyond. As Donna will share, we have also started to see significant in-bound freight reductions over the last quarter that will mainly flow through to our P&L in fiscal 2024. So in summary, we are very proud of our financial and operational performance during quarter three. As we look to closing out the year, we will continue to focus on our products, omnichannel experience and ecosystem to deliver the best experience and product value for our consumers. By the end of this year, we plan to have doubled our business in just two years. And I want to thank our teams for all their great work to deliver these results. We will continue to invest to drive our growth, as well as leverage our scale for efficiencies and savings. We are proud of our outperformance for the category, which is being driven by our compelling value proposition that our design for life business model offers. We will continue to play offence, staying agile, controlling what we can and delivering a great customer experience. I'll now pass the call over to Donna to review our quarter three results and a few details relating to our fiscal 2023 outlook. Donna? Thank you, Mary, and good morning, everyone. I will begin my remarks with a review of our third quarter results and then provide guidance for the remainder of fiscal 2023. We are pleased with our third quarter results. Net sales increased 18.1 million or 15.5% to 134.8 million in the third quarter of fiscal 2023 with the year-over-year increase driven by growth in the retail and other channels. Showroom net sales increased 13.3 million or 19% to $83 million in the third quarter of fiscal 2023. This increase was due in large part to a comparable net sales increase of 10.4 million or 18.5% to 66.4 million in the third quarter of fiscal 2023, compared to 56.1 million in the prior year period related to higher point of sales transactions, driven by strong promotional campaigns and the addition of 41 new showrooms and 13 new kiosks. As a reminder, point of sale transactions represents orders placed through our showrooms, which does not always reflect a point at which control transfers to the customer and [when] [ph] net sales are recorded. Other net sales, which include pop up shop, shop-in-shop and barter inventory transactions increased 7.1 million or 61.8% to 18.5 million in the third quarter of fiscal 2023 as compared to 11.4 million in the prior year period. The increase was driven largely by continued planned open box returned inventory transactions with Icon, our inventory barter partner, the reintroduction of Costco physical top of shops that were put on hold during fiscal 2021 because of COVID shutdowns and the addition of 17 new Best Buy shop-in-shops. We now operate 22 Best Buy shop-in-shops locations. As a reminder, our inventory transactions with Icon are part of our CTC, DFL, and ESG initiatives. We repurpose returned open box inventory in exchange for media credits, which are being used to support our advertising initiatives to create brand awareness and drive net sales growth. Internet net sales, sales made directly to customers through our e-commerce channel decreased 2.2 million or 6.3% to 33.3 million in the third quarter of fiscal 2023 as compared to 35.5 million in the prior year period as we continue to see some shifts back to in-person shopping. Internet net sales have increased 11% over the prior year nine-month period. By product category, our Sactionals net sales increased 18.9% and our other category net sales, which includes decorative pillows, blankets, and other accessories increased 36.5% over the prior year period. Due to shifts in our SAC promotional activity, SAC net sales decreased 11.6% in the third quarter, but had increased 4% over the prior year nine-month period. The decrease in gross margin rate of 300 basis points over the prior year period was driven by an increase of approximately 160 basis points in total freight costs, which includes in-bound and outbound freight, tariff expenses, and warehousing costs, and 140 basis point decrease in product margin driven by higher planned promotional activity. Our gross margin rate exceeded our guidance, driven primarily by lower in-bound freight costs and realization of the lower [freight benefits] [ph] through the P&L earlier than we have projected, partially offset by a slightly lower product margin rate. We do anticipate in-bound freight rates to stabilize at this level for the remainder of fiscal 2023, but because of the amount of inventory we maintain on-hand to support customer satisfaction of the brand, we will not see the full benefit to the P&L of the drop in these rates as compared to prior year until the associated inventory is sold during late Q4 and continuing through the first half of fiscal 2024. The 40.8% year-over-year increase in SG&A was largely driven by an increase in employment costs due to new hires and variable compensation, an increase in rent expense related to the addition of 54 new touchpoints, and higher percent rent related to the touchpoint net sales increase. Overhead expenses increased due to infrastructure investments such as technology and professional fees and selling related expenses, principally due to credit card fees related to the net sales increase. SG&A expense as a percent of net sales increased by 720 basis points, which was primarily due to planned deleverage unemployment costs, infrastructure investments, rent, selling-related expenses, travel and insurance, partially offset by higher leverage in equity based compensation. The deleverage in certain expenses relate to the continuous investments we are making into the business to support our ongoing growth. Advertising and marketing expenses increased 3.2 million or 20.3% to 19.1 million for the third quarter of fiscal 2023 as compared to 15.8 million in the prior year period. Advertising and marketing expenses were 14.1% of net sales in the third quarter of fiscal 2023 as compared to 13.6% of net sales in the prior year period. The increase in advertising and marketing as a percentage of net sales is primarily due to an increase in media spending to support our third quarter and projected fourth quarter net sales growth. As a reminder, advertising and marketing investments benefit multiple fiscal periods. Depreciation and amortization increased $700,000 from the prior year to 2.5 million, principally related to capital investments for new and remodeled showrooms. The operating loss for the quarter was 11.6 million, compared to operating income of $3 million in the third quarter of last year, driven by the factors just discussed. Net interest expense of $68,000 for the third quarter was slightly higher than the prior year period related to unused line of credit fees that increased due to the increase in our revolving line of credit earlier this year. Before we turn our attention to net loss, net loss per diluted share and adjusted EBITDA, please refer to the terminology and reconciliation between each of our adjusted metrics in their most directly comparable GAAP measurements in our earnings release issued earlier today. Net loss for the quarter was 8.4 million or $0.55 per diluted share, compared to net income of 2.8 million or $0.17 per diluted share in the prior year period. During the third quarter of fiscal 2023, the company recorded a $3.2 million income tax benefit related to the operating loss for the quarter, as compared to a $200,000 income tax provision for the third quarter of fiscal 2022. The effective tax rate increased to 27.8% in the third quarter of fiscal 2023 from the 5.9% in the prior year period. This is due to fiscal 2022 having the benefit of the release of the valuation allowances on the company's net deferred tax assets. The valuation allowance was fully released as of the end of fiscal 2022. We had an adjusted EBITDA loss of 8.3 million in the third quarter of fiscal 2023, as compared to an adjusted EBITDA income of 5.8 million in the prior year period. Adjusted EBITDA for the third quarter was ahead of our expectations, driven by the better than planned gross margin declines discussed earlier. Turning to our balance sheet. Our inventory levels are in-line with our projections. Inventory increased 63% year-over-year and we feel very good about both the quality and the quantity of our inventory. Our evergreen in-stock inventory is a competitive advantage and as it is not comprised of seasonal merchandise, we do not run the risk of being overstocked or having to be promotional to reduce inventory levels. Our inventory levels are in-line with our goals to maintain industry-leading in-stock positions and delivery times. As we move into fiscal 2024, we see the opportunity for inventory levels to moderate as we see in-bound freight [relief] [ph] and our recent technology investments enable us to programmatically allocate inventory more efficiently. We ended the third quarter with 3.8 million in cash and cash equivalents and $36 million in availability on our revolving line of credit with no borrowings. This reflects the timing of our inventory investments and the seasonality of our net sales, profitability, and cash generation. The fourth quarter of our fiscal year will be and has always been the quarter that generates the most significant cash flow from operations for the fiscal year, and as a result, we currently have and we expect to end the fiscal year with total cash, cash equivalents, and availability under our line of credit in excess of $75 million. Please refer to our earnings press release for other details on the third quarter fiscal year 2023 financial performance. Regarding our outlook, we continue to operate in a dynamic environment with wider range of potential outcomes as it relates to the fourth quarter. As a result, our outlook assumes net sales growth over the prior year will range from high single digits to the mid-teens range. While we are tracking to the high-end of this range quarter to date, we still have huge volume holiday weeks ahead of us and believe it is prudent to factor in some variability in our guidance. We expect to continue to see the benefit of lower in-bound freight costs flowing through the P&L with the greatest benefit of these lower costs being most impactful to gross margin in fiscal 2024. In the fourth quarter, gross margin is expected to be up modestly approximately 115 basis points from the prior year period, due to lower in-bound freight expense that is expected to more than offset higher promotional discounting, warehousing costs, and outbound last mile fuel surcharges. We expect adjusted EBITDA margin rate increase approximately 325 basis points year-over-year in the fourth quarter of fiscal 2023. The increase in Q4 over the previous year is due to the gross margin rate increase and expected leverage of total operating expenses with the seasonality higher net sales volumes. So, in conclusion, we are quite pleased with our third quarter fiscal 2023 results. Despite the challenging macro environment, our team continues to execute against our growth strategies and operate the business with discipline. We are confident in our positioning for the all-important fourth quarter of the year, which drives the most significant amount of net sales, profits, and operating cash flow. We will continue to capitalize on the attractive opportunities we see for long-term growth and market share gains. With that, we would now like to turn the call back to the operator who can open it up for questions. Operator? Thank you. [Operator Instructions] Our first question comes from the line of Maria Ripps with Canaccord Genuity. Please proceed with your question. Good morning and thanks for taking my questions. So, you talked about the category being down, and it seems like the Q4 guide is a little bit softer versus your prior outlook. Is there anything you can maybe share about, sort of consumer sentiment today? Are you seeing any customers sort of deferring a purchase decision? And then maybe more broadly, how are you thinking about the impact of higher interest rates and sort of a tight housing market on demand? And then I have a quick follow-up. Good morning, Maria. Thank you for your question. So, I think, obviously, as we see for â as you talked about the category down, that started earlier this year. We've continued to outperform the category. And actually, based on our latest numbers, we're seeing a wider gap to our performance. And as you can see, as you look at, [so Donna shared] [ph], we're tracking at the higher-end of our guidance and have obviously factored in some variability. In terms of what we're seeing for consumer shifts or some changes, I think as everybody has reported, we're seeing more promotions in the category. So, we've responded to that, which is all [planned in] [ph], but they are much more benign to the pre-pandemic levels. Demand is a bit choppier. So, for us, as an example, Black Friday was super strong. And then Saturday and Sunday is okay, and then Cyber Monday was really strong. As we see the, you know shoppers are holding out thinking that there'll be stronger promotions from that side. So, the shape and the timing of fourth quarter, we've planned for, we feel very good based on where we're tracking at the high-end of our guidance. We have record âpipelinesâ. We're just looking at the teams even this morning. It's so strong. And with the strong promotion of [indiscernible], you know the marketing investments that Shawn talked about, we feel very good to deliver, as Donna shared, with our guidance. I think in terms of any other shift within consumers, which is the second part of your question. In general, we're seeing obviously a little bit of a mix shift, but that truly is up against the channel mix shift as a bit of movement back to touch points versus last year, but as you know, last year was really driven in quarter three by some broader post-COVID dynamics. Within the consumer purchasing, the mid-to-large purchase sizes, and obviously, also StealthTech, we see that being very strong. A little bit of shift to financing, but really nothing around sensitivity to discount. On the lower-end, we are seeing some trends with smaller purchases that they are having a high conversion when on promotion. So, very similar, Maria, to obviously what everyone else is seeing, but no other shifts we see. But obviously, the good news is our core consumer is very affluent, and we have a great plan that we will continue to foster through for quarter four. Got it. That's very helpful. And then, Mary, you touched on this a little bit, but maybe can you expand a little bit on the extent of your promotional efforts this holiday season relative to competitors and maybe the broader retail environment, or even prior holiday periods? Yes. I mean, I think for us, as we look at the promotions that we've planned, we have a little bit more frequency and a little bit more depth through the Black Friday and the Cyber Monday, but less deep than we're seeing with other competitors because frankly, our brand strength is so good. And as we think about just the growth that we've had and the brand stickiness, we don't need to extend that. And I think, as Shawn talked about, I think [itâs 38%] [ph] of our most recent customers, they don't even cross shop with anybody. They just want to come to us and they come and build out, obviously, their quotes with us. And then as we think about our marketing investments that Shawn shared, we've got great alignment around the key big weeks through the rest of this year. Very efficient and effective, and I think I shared a couple of with you around SMS as an example, but just others. And the team are very agile and they keep on adjusting, so we actually feel very good about what is planned through the rest of the quarter. Great. So, first off, congrats on the quarter. Second, for my first question, Shawn, you've been very thoughtful and very experienced when it comes to supply chain. And I'm very interested right now in the role of China not just for Lovesac, but for the industry, and I'd love to hear your thoughts on what you're thinking about for the next five years on how China will play a role in your supply chain? How rest of world will play a role? And how much progress do you intend to make on shortening the distance between where your product is made and where your product is consumed? Yes, Tom, thanks for the question. We, as you know, have been very vigilant in trying to diversify our supply chain. It's been a strength of the company. It continues to underpin our success in different ways and manifest itself in different ways as the world evolves. At this moment, China's, you know so, let's rewind three years ago, maybe China was nearly 100% of our â represented 100% of our overseas production and probably 90% of our overall production. And today, that's down somewhere below 30%, and we have redundancy for almost all the products that we make there. So, we make like-for-like Sactionals in Vietnam, in Indonesia, sorry, in â yes, and Malaysia. And our point of view is that the world and the global supply chains continue to become more fructuous, and we want to have more diversity. So, we're pursuing, again, redundant supply chain manufacturing opportunities in North America, in Mexico, actively. And we're focused on the longer-term of being more vertical, even if not owned, and more sustainable, you know manufacturing stuff, using more sustainable inputs, closer to the consumer, delivering over shorter distances, lower carbon footprint with, of course, the caveat that we believe that point of view can be done less expensively and bring our gross margins up over time. I mean, that â we not only believe that, but we have reason to believe that that will be the outcome. So, we view all of these as just a step to that end. All these moves that we're making as a step in that direction. And we think that as much as China has been a great supply chain for â in many realms, we're all watching the same news. We all believe that there can be risk there. And we've seen of late, through COVID, what happens when there are shocks to the supply chain. And so, our focus is on bolstering, creating a strong business with diversity in the supply chain, redundant manufacturing. And I think we've done a good job of that so far, and we hope to be ahead of that curve as that curve continues to present itself in real time. Ultimately, the most difficult piece in this category will be fabric, as you may be familiar with China's supply chain in mills is extremely strong. And thankfully, we've made great headway in Mexico and North America in discovering new sources for fabrics that can give us the redundancy needed to be prepared for anything. And also, of course, to continue to focus on our first product costs, bringing costs down, driving gross margins up, even as we finally begin to recover from all of the supply chain headwinds in the form of the in-bound freight, et cetera, that have weighed on those realms of our business and many others. So, I appreciate the question and the opportunity to discuss. This is something that, again, we're proud to be focused on and hopefully ahead of the curve on. Excellent. And then for my follow-up question, you talked about the opportunity for gross margin improvement next fiscal year on better freight. So, at a high level, how should we think about your planned use of the higher gross profits to the extent that you may engage in more promotional activity or more marketing, or to the extent you let more flow through to the bottom line? Just â can you talk about it at a high level? Good morning. So, yes. So yes, we are planning to see some gross margin expansion out of lower freight rates next year. There's a couple of things that we're looking at, although we're not going to guide to next year where we â there is â a part of it is going to be used to mitigate some of the higher outbound freight costs that everybody is experiencing through the FedEx and the [UPS] [ph] of the world. We are projecting to see some higher warehousing costs just as relative to the increase in labor cost at our [three PL] [ph], so a piece of that will be used to mitigate that. And we will be investing a portion back into the business next year as we continue to say that we still have some foundational infrastructure investments we need. And we do anticipate a portion of that gross margin expansion to flow through to the bottom line, but we're going to navigate that. You know us. We're extremely agile, and we're going to navigate that and allow as much as we think we can flow to the bottom line next year as we navigate through the year. So, we have â there is use of that gross margin expansion, but we will continue to operate the way that we always are and very fiscally responsible and agile, and we believe we have a lot of opportunity next year. This is Andrew [indiscernible] on for Brian Nagel. I just want to start off by congratulating you guys on another great quarter. My first question is in regards to just the sales in the period. On the Q2 call, you discussed the potential [pull-forward] [ph] for about $9.5 million in sales. Can you discuss any other drivers to the Q3 sales slowdown? And then my follow-up question will just be a follow-up to the first question on the outlook for the balance of the year. Can you discuss some of the drivers, the expected slowdowns and any dynamics that may have changed since you laid out prior guidance for low 20% growth for Q4? Thank you. Hi, good morning Andrew, it's Mary. Thank you for your question. I'll take the first part. So, in terms of sales, as you referenced, we have discussed last quarter, there was [about 9.5 million] [ph] of revenue that was pulled forward, some was increased throughput and some was the open-box inventory that we talked about. And then obviously, as I said in my remarks for quarter three, whilst our revenue was up 15.5%, if you factored in for that pull-forward, our revenue really is at 24%. And slightly ahead of, obviously, the strength that we saw in our total demand for the quarter at 22%, which we see as being the strongest growth in revenue, compared to anyone else that has recently reported from that side. So, you see that continuation in performance growth, and then obviously, one of the key benefits for us is our omnichannel model. So, we really are able to respond to where our customers want to go for sales. So, whether it be more in person or whether it be online, we're agnostic to where the sales will be from that side. And then I think, Donna, do you want to talk through on quarter four in terms of the guidance and a bit of that profile? Yes. Sure. So, the guidance that we're providing for Q4 as far as being high single digits, mid-teens range, is that growth is coming out of the comp showroom sales, non-comp showroom sales. We're adding Costco pop-up shops, which we didn't have this time last year. We're adding the Costco roadshow perform at the â that comp show performance is coming through stronger than we've seen in prior periods, and we do have the addition of the additional Best Buy shop-in-shops that we did not have this year. As far as the decrease in the guidance that we provided for the year on our second quarter earnings call, we are experienced, but at a lot lesser impact you see other retailers are. So, again, what Mary said, what Shawn had said, we are very, very happy with the performance of our net sales volume, our associates and â still coming through. Even if you use the midrange of the high-single-digits to mid-teens, that indicates approximately a 26% year-over-year growth rate, which is very, very strong for our category this year. Hi guys. Good morning. Just really quickly on the fourth quarter trends that you mentioned. I think you said, you're tracking toward the higher-end of the fourth quarter guidance on the top line. So, just wanted to confirm that that's what we've seen specifically quarter-to-date in terms of year-over-year growth? And then just any spikes or trends within the Black Friday, Cyber Monday period to call out? Hey, good morning Matt. Thank you for the question. So yes, as we shared, we are tracking at the high-end of the range and have seen really good strength as we think about, for example, Black Friday that youâve asked about, very strong. The weekend was a little bit softer, but still growing, and then Cyber Monday was strong. And actually, what's really been good is the, kind of the days following Cyber Monday have also been really strong. So, I think similar to what you've heard from others, I think comparing to last year is not a great comparison because everybody bought earlier because they were concerned about inventory shortages, so they're just â the whole shape of the quarter was a little bit different, and we're seeing strengthening demand that just keeps on coming. And I think on top of promotional cadence, strength that we have, some softer comparisons in December, for example, and even a bit into January, plus very strong marketing campaigns, we feel good for where we're going to land and obviously continue to lead the category in our performance map. Okay. Very helpful, Mary. And then I guess [takes a] [ph] follow-up, which is, why have a, sort of on the low-end, a mid-single-digit guide for the top line for the quarter, just given that you've tracked towards the mid-teens quarter-to-date and then comparisons seem to get easier as we move through the quarter, just given the cadence that you mentioned, I guess? Just curious like, sort of why, what would drive you guys down towards that lower-end of the guide or does that assume some, sort of significant macro deterioration? What are the assumptions have been in the lower-end of the guide? That would be helpful. It's the conservatism, right. I think everybody knows us to be extremely conservative. But â and that's why we called out that although we are providing that range, we are trending quarter-to-date even through yesterday, absolutely to the higher range. But you never know what could happen macro-wise, right. So, we thought it'd be very prudent to build a range in there, although, again, we're trending to the higher side. And you know us always build some type of conservatism into our modeling, and that's why we elected to provide that range. There's no indicators to us right now that we should be coming in at that lower-end. And again, our performance is extremely strong and it continues to be every single day as we monitor our demand volume. So, again, it's purely baked out of conservatism and some variability as to what macro impacts could happen as we finish up the fourth quarter. That's the only reason we provided that low end of the guidance. Thank you. Our next question comes from the line of Alex Fuhrman with Craig-Hallum Capital Group. Please proceed with your question. Hi guys. Thanks very much for taking my question. I wanted to ask about StealthTech. That was a very impressive number you gave about the initial purchase price being about 3x what you see for a typical first time Sactional purchase. Can you give us a little bit more insight as to how those transactions are stacking up? Are they typically more pieces than you would see bought in initial Sactional purchase or more premium covers? And then just as you're, kind of looking at what you've seen in the last couple of months and the overall category slowing down, I'm curious if you've seen any sort of resistance to StealthTech as well, or if that's been more immune given the high price points? Great. Thank you, Alex, and a good question. You know our passion for StealthTech, and obviously, you heard earlier just the continued momentum. So, I think in terms of your first question around the average order value, and obviously, being so much higher to transactions without StealthTech. We see that both in terms of â consumers just love the experience. I mean, you know. You've been to a showroom. You've sat and experienced and heard of StealthTech. It's amazing. So, the showrooms are doing an incredible job of demoing it, and that's one of the great successes of our business model, and consumers are loving and buying into it. And actually, as I shared, we continue to see StealthTech build month-over-month and are very happy to see the performance. And even, for example, Best Buy, we are significantly advantaged with StealthTech performance there, more than double what we see for the rest of the fleet. So, it just shows us the potential as well from that side. In terms of what else are we seeing in the dynamics of the purchase, we're seeing big setup purchases. Not really seeing any shift in terms of what people are buying around covers. We are seeing a bit of a trend up in terms of the more premium sale. As you know, Lovesoft, which was contrary to where we were early in the year where we saw a bit more of a shift to standard. So, everything really continues to show us with our affluent customer base, they come to Lovesac to buy our product because they love it. Not generally, 4 in 10 are not even cross-shopping because they just buy into the Designed for Life product platform and the ability to flex and change to your life. So, we continue to feel very good about how StealthTech will build, and it's only a year. We should have actually sung happy birthday to it. It's a year for the build, a lot of campaigns success, and we will continue to build, as Shawn always talks about, for many years, in what we see as a market-leading innovation. Thank you. Our final question this morning comes from the line of Lamont Williams with Stifel. Please proceed with your question. Hi, good morning. Just, kind of in general, how are you thinking about the promotional cadence that you're going to basically employ going forward as we've seen the promotional landscape get more intense with inventory levels coming back? How do you anticipate offering promotions? You looked like you picked up a little bit in terms of the level of discount, but how do you, kind of view that going forward at a high level? And secondly, how are you thinking about, kind of the number of distribution openings for next fiscal year? Thank you. Yes, Lamont. I'll take the first question on promo cadence, and then we can talk a bit about your question for next year. So, obviously, as everybody has reported, there has been an uptick in promotions, but obviously, that was up against last year where it was incredibly benign. And even for this year, it is very benign to pre-pandemic levels, so we feel good in terms of what we have seen. And as we have been testing with the [teams agility], sometimes our customers are responding as much to financing as they are to [depths] [ph] of promotions. So, everything that we're seeing is that we won't need to be more aggressive with everything we know today. We've got strong promotional campaigns, but also coupled with the marketing campaigns that we are driving, I talked about SMS as an example, just a great conversion tactic that really enables us to be top of mind for our customers. So, it plans in. We've planned it into our guidance, and obviously feel good to adjust if we need to, but everything we see today, we think that we have the right plan to close out the quarter and have a very strong year. As far as promotional cadence, we're not planning to be any more promotional or have any more promotional activity, any specific promotional activity. And what we're looking at next year, again, we're not providing any type of formal guidance for next year. I can just tell you on the plans that we're building internally, we have a lot of opportunity next year, which will not require us to be any more promotional between the add-on of additional showrooms, the expansion of Best Buy shop-in-shops, the expansion of Costco in-person, pop-up shops, and some other really exciting things we have next â going on next year that I believe Shawn briefly alluded to, but not really in his script earlier today. So, a lot of opportunity next year, which will â we don't plan to have to be any more promotional to still drive some very strong top line growth next year. Thank you. Ladies and gentlemen, this concludes our question-and-answer session. I'll turn the floor back to Mr. Nelson for any final comments. Yes. Just want to say thank you so much to the amazing Lovesac team that has built a company, putting up some of the highest growth in the category for the year as we round out the year in this critical fourth quarter. I appreciate all of the hard work and effort. I appreciate our investors for continuing to support us. And looking forward to a bright New Year as we get through the fourth quarter.
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EarningCall_1686
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We were joking, like our offices right across from each other in New York that we traveled all the way. That's what we do. You have like -- maybe let's start with the kind of brief recap. So you had like a really good strong Q3 results. That was this week, couple of days ago. We, I got a lot of questions, but maybe just to kind of level the playing field here. Just kind of what were the highlights from your end? Yes, so overall, Q3 was a good quarter, really pleased with the results. For those who don't know or need the quick recap, revenue growth of 47%, Atlas, which is 63% of the revenue in the quarter grew 61%. The new business environment continued to be strong for us. We did not see any meaningful delays in sales cycles or deal slippage or some of the things I know others have commented on. We had 500 net new customers added in our direct sales channel, which is a strong and healthy number for us. In terms of that sets the new business environment, which is sort of the biggest factor in the medium and long term. In the short term, the near-term results are much more dictated by how does the existing set of Atlas workloads grow. And we saw a recovery and a nice rebound in the growth rates in Q3. That was terrific to see, it was particularly more pronounced in some of the placing and dicing some of the regions and channels that had seen a little bit slower growth in Q2, and that were more macro affected. So it's nice to see that bounce back. It's a very strong quarter for EA. We can talk about that more, I'm sure, but really strong. So good to see the continued demand and incremental penetration into customers there. And then maybe the last thing, just sort of the headline level that I'd touch in -- touch on is that revenue -- strong revenue performance and really outperformance relative to our guide flowed through to the bottom line and so, roughly $20 million in non-GAAP operating income at a 6% operating margin. So really great to see the progress there. And so all-in-all, really quite pleased with the quarter. Yes. Okay. And then let's kind of unpack that a little bit like the number one -- well, one of the kinds of strong ones was EA. Can you talk a little bit about like the factors there? Yes. So, few things. So EA, Enterprise Advanced, this is self-managed MongoDB. Customers are buying annual licenses. And there's -- so we don't tend to sell a bunch of new customers on EA. They tend to be people who've been using it for maybe a little bit slower to public cloud adoption, but are expanding their MongoDB footprint. No, nothing to call out anyone in particular. But a little bit slower in their public cloud adoption, but expanding their MongoDB usage. So they continue to buy EA, we continue to see strong and healthy businesses there. This quarter was particularly strong 26% year-over-year growth on Enterprise Advanced. And the dynamic there is customers -- the value prop continues to resonate. We're increasingly seeing people look at Enterprise Advanced as an on ramp to the public cloud. So if you take someone in a company or in an industry that isn't as cloud forward, they know they will eventually get there. Right? A number of their software developers, their engineering team wants to start building towards that. And because you can run MongoDB in any environment, on-premises and the cloud and private cloud and hybrid environment, multi cloud. It's a good on ramp to the public cloud. And so they -- in some ways, they look at that as sort of future proofing their businesses. It's not quite the dichotomy, that it might seem just based on the usage, or the deployment model. The other thing that Iâd call out that we benefited from in Q3 was in addition to strong EA overall is, we saw a little more contract activity on multiyear basis than we typically see for EA. We always see some, most of our contracts are one year in nature. But we saw some more multiyear EA contracts, which is particularly relevant given just rev rec under ASC 606 requires us to recognize the term license from that. And so that's why we try and call it out. And that drives us sort of increased variability and reduce comparability, we try and help give everyone enough breadcrumbs to sort of follow the bouncing ball. Yes. And it's funny, I'm asking the question, because like, you remember a couple of weeks ago, like everything that was said, was the negative for Mongo, and Mongo share price? Now we're kind of in the -- thankfully, we're back out of that, like the one question I still got is like, whoa, it was just multiyear, like, how important was that multiyear for the EA performance? Yes, we call it out. To help people understand, and particularly to understand the Q4 guide, so EA outperformed period, even without regard to the multiyear, Atlas outperformed. And I sort of have been describing the multi years, kind of like the cherry on the top, or whatever. But, and the reason why it's important though is, historically people are used to seeing Enterprise Advanced, grow seasonally -- sequentially, sorry about that, grow sequentially from Q3 to Q4. And given how strong and how robust Q3 was, we don't expect that to happen. And so we just wanted to explain to people why, and sort of put that in context, unless they sort of misunderstand or just think that we're being conservative or something. But we want to really people understand the contours of business. And so on that seasonality point on EA, like, if you think about it, like in the olden days, it's like you had a pipeline of new customers. And then Q4, it all came together, and you had these big quarters. But then EA is not about new customers necessarily anymore. So do we have to rethink that EA it's kind of Q4 seasonality and then how much of a kind of just renewal pool kind of play into that as well. Yes. So first, I would say there was no renewable put forwards in Q3. So the performance was genuinely executing on the existing pipeline and the existing renewal base and excellent performance there plus the multiyear cherry on top. The seasonal dynamic in EA is that, renewal base tends to be seasonally highest in Q4, and that hasn't changed. And renewal base, because there's not much new customer activity, sort of the best indicator of our ability to upsell. So all that kind of still remains, the only thing that we're calling out is different because it was so exceptionally strong in Q3, we will not see that sort of sequential growth in revenue. But the overall dynamics are unchanged. Okay, perfect. And then last question and then I am going to move on from EA is, a customer in this environment committing to multiyear seems to me like a very strong signal in terms of commitment, like, why is that happening? And how do you see that? Yes, so I take it a couple different ways. Generally, yes, I agree with that. And to your point, it is customer driven, right? Like, we're reacting to sort of customer desires or whatever. And so, it's customer driven, I think it speaks to the value proposition, it speaks to their confidence in MongoDB as a core platform, a platform to expand on. I mentioned the sort of future proofing aspect and increasing looking at EA as an on ramp to the cloud. I think the last thing I'd say, and this is the middle a bit of a hypothesis. But I think it sort of helps, like, if you're trying to connect the dots, how do you put it all together? Especially when other people are talking about getting challenges and getting people to sign commitments and everything else? I think there's a scenario which the current environment -- yes, maybe I'm reluctant to make commitments, but also for core technology and core technology that's very sticky, and hard to replace. I probably want some price certainty. I kind of probably want to know, so I can lock in my budgets and kind of know what I'm looking forward in the future. And obviously, in our industry, there's a past practice of people taking significant price increases and everything else. Exactly. And so, I think for some, if you're a procurement team or finance team, and you say, hey, there's a core technology, we know we're going to use it like, hey, let's go get that price certainty, right. We are in an inflationary environment, budgets are going to be tight. Let's try and lock that in. Yes. Okay. Perfect. Makes sense. And then, as you mentioned some of the other players, the question I get looks like, what are you -- there you could think about EA as like a potential kind of upgrade to Atlas top. Are we on that journey already? Or is that for you at the moment you just kind of someone wants to move to move, but like, you're not going to kind of do anything? Yes, we don't see a ton of people currently moving, what we more likely would see is, let's imagine you're a historic EA customer, right? You don't -- you probably have many 1000s depending on how large you are, 10s of 1000s of applications internally, but you're running most of them on prem, very few of them are in the cloud. And so you're running MongoDB, you're using Enterprise Advanced. What would be most common as you start to move into the cloud is, you'd be putting new applications on there. And so you'd have existing EA as part of your state, but then you'd have some of your newer applications running on Atlas and you'd be sort of buying both. We see very limited movement today of people running EA into the public cloud. I think over time, we'll see more of that. From our perspective, to your point, it's very much customer driven, right? If I just think about the time that takes, we've already won that workload, right? I'd much rather have the salesperson spend their time getting new workloads within that account, rather than moving it over, again, if we're using Barclays as an example that we are really important to Barclays, obviously, we'd work with them, we do it -- we spend the time, but I'd much rather have the salesperson spend time getting more workloads within Barclays. Even though in the long run, we'll -- And for my fault. Like I remember, we like Serge and I have that kind of running joke. And it's like our big workload is the customer data. And my regulator says like, you can't go into the cloud, I am like why not. And yes, and like let's move forward to Atlas a little bit. The Atlas saw better numbers as well than kind of you talked a little bit of and you call out the quarter before, like, consumption maybe wasn't quite coming in. And it's not people stepping down. It's more people not upgrading to the system. Like, what changed? Yes, so let me just repeat what you said, because I think it's important to make sure that we're sort of level setting understanding. So Atlas, revenue is recognized as consumption. So it's recognized in real time. And in any given short period of time, it's primarily driven by growth of the existing applications that are already on our platform. Because the new ones that come, they're almost always new workloads when they come in relatively small. So in any given quarter, the vast majority of the performance is influenced by applications you already had at start of the quarter. So in Q2, we saw a macro driven slowdown, we expected to see it and we saw it. And it was driven by slower growth in the underlying application -- in the usage of underlying applications and therefore consumption of our platform slowed down, still growing but slowdown. We've seen that get better in Q3, we did not expect that. And in particular, we had two flavors of our performance versus our expectations. The first one is that, areas that were particularly slow growing in Q2, namely mid-market globally and European enterprise, so a bit of a bounce back. But then the second thing that we saw was a more broad-based improvement that we believe is season. And so, as we compare trends, Atlas is a young business, so seasonality is hard to call. But if we look at the two Q3s after COVID, meaning this one and the last one, we noticed similarities in patterns in terms of intra quarter performance. And we believe there's an element of usage growth across our application portfolio as vacation season is over and people go back to work, but not just work, but just interacting with apps in their lives. And we saw better September and October than what we saw in August, and it was similar last year. It certainly is two data points, but our hypothesis is that a seasonality, it played to our advantage, but we take it for what it is and obviously we are happy with the outperformance, but as we think of forecasting the business in Q4 and beyond, we just keep in mind that we think this was a seasonal benefit. Okay. And then the other thing that came up in conversations this quarter a lot was like, oh, it's coin base, it's like Instacart like and that sort of stuff like, how much of a factor is that for you guys like that kind of technology, technology assets? Yes. So we're very well diversified across the board. Some of those customers, we know they are exact customers, we get a lot of questions around. And in Q2, we called out what we call digital natives as a part of our mid-market segment. And just to give you a sense, mid-market is mid-teens of our revenue. And those digital native companies are a minority, but a significant minority of that segments. That gives you sort of the size of the exposure. We did see that segment slowed down more than others in Q2, and we have seen a rebound more than others in Q3. And so, our hypothesis is that, those customers took a bit of a positive, the macro environment adjusted to figure out how they're going to invest to drive their own growth. But there's been a bit more investment there and that shows up in the consumption of our platform. Okay. I like the one question that kind of comes with and it's like, it's macro didn't necessarily get better in Q3 versus Q2 , it kind of got a little bit worse, but your consumption trends got better and okay, I get seasonality, but it also looks like people were investing more. I think the other way, and no I know this is sort of hard to get out to, but I'll give it a shot and make it a little bit interesting. People sort of expect when we say macroeconomic that somehow there's this sort of one-to-one coefficient between our underlying consumption and GDP or something like that. And it's a sort of multivariable equation, right? What we can see is, we can see the underlying activity, right, the reads and writes in the database, right, that drive the consumption and the usage, and that's a reflection of the end user activity and therefore that's the value that our customers are getting, but we don't have some 10-factor model where I can piece out all the different components and what the coefficients are for each of the variables to sort of like, directly map it exactly. He is working on it. But I just so people understand it's not quite that one for one that people might ideally like or would be more easily -- easy to intuit. Okay. Then like, Michael, I need to thank you on the earnings night because you kind of kept me busy all night, with people asking like, okay, so you talked about consumptions in Q3 improving over Q2. And then we all kind of doing our own math in terms of like, well, how much dollar was added, and actually then didn't correlate. So now I kind of like had to try to answer it all night long. So maybe just clarify for everyone. Let me give it a go, I have some practice over the last couple of days. He's really confused. So if you don't mind, I'll phrase it in percentages, because that's how we think about it, that dollar and percentage are the same thing. So the question that we got back from analysts and investors was, well, hold on, you're telling us that consumption got better in Q3 versus Q2. And what I see is Atlas sequentially grew 14% in Q2 over Q1, and only 9% Q3 over Q2, so it's slow down. So what gives? Here the explanation, most of that has to do with the 14, the sequential growth in Q2, and we talked to, about that in the context of our Q2 numbers, but I think it's helpful refresher. So first to remember, it happens to be basic math, but it happens to be true. Q2 has three days more than Q1. And because we recognize revenue in real time, regardless of macro or any other environment, like we get three days extra, that's like 300 plus basis points of growth. So that's 14, it goes down to 10 in change. Okay. And so that's the first part of your bridge. And we've called that up before in terms of sort of seasonal. Well, of course, that was six months ago, not for like six years. The second piece is, the revenue in any -- sequential revenue in any given quarter is a function of consumption growth in the prior quarter, as well as in the existing quarter. So Q2 revenue in that was benefited from strong Q1 consumption, because we said in Q1, we were still seeing expansion along the lines of historical terms. So that means that starting ARR was quite strong, and much of their revenue benefit of ARR growth in the prior quarter actually materializes as revenue in the next quarter. So when you go from 14 to 10, and change after three days, then you have to take a meaningful chunk out of that, because of the historically strong -- in line with history expansion that we saw in Q1. And so that's how like -- we haven't quantified that, but that's like how you actually get too closer to the real number of consumption expansion in Q2, whereas Q3 did not have that dividend, because Q2 consumption was gross. So there was no benefit overflow, at least not to the same extent. And but the consumption in Q3 did rebound. And that's what sets up the 9%. But also, just going back to your question in the guide, most of our raise for q4 is actually Atlas driven. Because that better than expected starting ARR point actually helps our Q4 numbers. And that's part of the reason -- although the beat was mostly EA, the raise is mostly Atlas. One of the ways that I think about it, maybe this is too simplistic, but is when we're talking about the growth trends, we're talking about the trends in ARR, right? And what you're measuring is sort of the lagging, what's happening in revenue, right, which is affected by the seasonality and all these other things. Fewer days, meaning -- In less volatile environments to distinguish them is less important. But in this environment, it is important. And obviously, there's hyper vigilant some relatively short term, so we just want to be as explicit and as transparent as we can. And then the last question on that subject, again, it's more fundamental question is like, so consumption models are different than seat-based models. And I just had Mike Scarpelli, from Snow on here, his consumption was slightly different. And but we just we talked about that. And I wanted to ask the question as I use like, how do you even forecast this? Like what's kind of what are you using? We are coming at it multiple different ways. We're looking at a cohort behavior, we're extrapolating near term trends. We're looking for leading indicators, although we're struggling to find many, and we're still sort of looking at it kind of the traditional way through the sales productivity and sort of the growth of capacity and ability. And we end up triangulate. And the beauty of sort of Atlas is that, it really reduces the friction of acquiring new workloads. And that is additive to our growth rate in the long run. But it does increase this incremental sort of variability in the near term and we're getting better at it, because the base of existing applications growing sort of our portfolio is more diversified. But macro is a factor and it has been particularly factor over the last couple of quarters. Yes, I would just add, it definitely helps to have a larger portfolio, right? Because some of the stuff that might happen at an individual kind of balances out for sure. Two, it is more challenging in a more macro uncertain and kind of fluid environment. And so I think we have to take that into account as well. Okay. And then the shifting gears a little bit. Atlas acts like a database platform. Like the one thing that I walked away with from your customer conference, I think, it was in early June was the conversation I had with SIs and customers about, like, what Atlas is used for is like, oh, shit, that's much bigger than I thought or like proper, sorry. But if that sounds like a fair observation, like in terms of what do you see in terms of like, Atlas adoption, like, what are people using it for? Yes, I would -- it's 100% true. And I think that I would divide sort of the narrative in kind of two pieces. One was backward looking. So we've done a tremendous amount of investment to take an interesting novel database idea and turn it into mission critical database, which the last major step was sort of multi document asset which we had introduced in 2018. And so -- and then from there on out, we further expand the use cases and continue working on it and went from a database to a developer data platform with all these incremental use cases that have two things in common. They are focused on helping the developer and they help solve data problems. But that's what search is, that's what a sync or edge is. That's what in analytics at least the way that we do analytics is, that's what time series is, obviously. And what we're seeing is that we are not only mission critical at the core, but sort of expanding in terms of what we can address. And that's where the incremental R&D dollars continue growing. The thing that's happening and is lagging is customer awareness of that, because we still find that customers have outdated understandings of what we can do. Developers are opinionated, if you try this in 2012 or 2014, you're going to have a different view about where we are versus today, when almost a billion dollars of incremental cumulative R&D was put into the product. But that's an opportunity, it's an opportunity, it's updated understanding to bring people along for the ride, and that will ultimately result in winning more new workloads. And I think that sort of hypothetical, like Barclays example that we were walking through, actually is playing out in real life, right, where you are seeing more enterprise adoption, people who have Enterprise Advanced, but are building new applications, new revenue, generating applications, customer facing applications, mission critical applications, but they're either modernizing existing infrastructure and legacy applications, or they're entering into a new line of business or saying, oh, here's some new capability, mobile whatever it is, and sort of saying, let's start with that clean and fresh, right, without any of the baggage of the legacy systems and adopting Atlas as the best methods to do that. And as part of that, like, talk a little bit about your hyper scalar relationships, like forever our friends at UBS, well, in the early years, try to hunt you down with kind of all sorts of new products, I think that's changed. Like -- so what are you seeing in terms of like the hyperscale than you work with them? Yes. So I think there will always be a competitive dynamic there, across all the players. But I think what we've seen over time is sort of the increasing part of the partnering or cooperation piece was the top and sort of more outweigh. The individual relationships with the three are a little bit different, because they're coming from sort of different positions. Google was pretty early on and part to sort of differentiate themselves from everyone else sort of intentionally picked the best of breed approach. Amazon and Microsoft came up with more. Let's see if we can try and kind of capture more, sell more proprietary products, create imitation products, recognizing the popularity of MongoDB. I think over time, as we've had incredible success, including against their imitation products, and our win rates are exceptionally high. I think they've understood the value of partnering with us, understand the sort of, if you're trying to solve for what solves a customer's needs best, embracing that best of breed solution does work out well. And then they've come to appreciate it now have some years of data around the incremental stickiness and sort of multiplier effect, that MongoDB Atlas brings to their cloud environment, right? So they're competing and we're obviously in a very big market. But the infrastructure, storage and compute markets even bigger, and as they compete with each other we want it being a helpful partner and the kind of differentiator among them. So it's been effective. Like I said, there always be components of competition. But we've been really pleased, I think, getting to the point where we've got integrations with all three consoles where their sellers are compensated on selling MongoDB, where they use MongoDB Atlas burns down their enterprise discount agreements is all really valuable and reduces a lot of that friction, and allows our kind of best-in-class product to stand out. Okay, perfect. And then a last couple of minutes. Let's talk about the profit performance this quarter and your comments for going forward a little bit like the -- so from the outside, I would say like you kind of plan for a slightly lower revenue run rate, you got surprised, the costs were kind of managed to the old guidance, and now you have like outperformance because top line came in better, it's like, is that simple. I think that's an important driver, I wouldn't want to suggest that we haven't also applied incremental scrutiny on expenses and tried to update our frameworks for the current market realities. I think we've talked about this in a bunch of different settings and formats. I know, this is not new to you, but like, we've always been very rigorous and disciplined about how we look at our costs, how we assess channel investments, unit economics, ROI that we're getting on different investments, whether it's sales and marketing, R&D, or whatever it might be. And so we've continued to do that. I think it would be foolish not to acknowledge that the cost of capital has gone up, right. And so definitionally, that means the bar gets higher. And so if your projects clear that bar, right as you're thinking about it, now we take a long-term view. So that doesn't mean that you have to bar some cost of capital to today but you -- I think you could recognize and look out and say like, over time, the cost of capital will be higher. So we continue to run the business for the long term, we continue to invest. We definitely had strong outperformance on the top line in Q3 Atlas, EA, and then -- in the multiyear as well. More of that float to the bottom line, to your point, right. So I think that's sort of a reflection around some of the discipline that we're talking about, but also, as we're looking out over the balance of Q4, and as we're starting and working through our fiscal â24 planning, the challenging and the scrutiny of are we going to get the value out of this? We said we wanted to do these heads, are we still going to get the value of these heads? Are there more important heads? Do we reprioritize? And not just looking at everything on an incremental basis, but trying to really assess things which we've always done. I think the other thing in an environment like this separate from the cost of capital, just to try and give people a more real-life sense of what does this mean right away from the spreadsheets and the models that you build. We try and returning all sorts of different dials and levers all the time and testing and iterating on different things which on ballots have not been highly accretive. But not every single thing works out, right? And so I think in a lower cost of capital environment, I think the inclination is to say, this project should work. It's not working. Let's let it run another couple quarters, right. And I think in a higher cost of capital environment, you sit here and say, you know what, like, I think we just have to accept it. Like, we didn't figure that one out, like that one isn't working the way that we should, right. And we need to stop it or deprioritize it, right. And so, I think that just gives us maybe a little bit of flavor that's useful for some of the thought process. And then the last question for me here, and then I need to let you go, like -- so how do you think about the future? So now we know we are in positive territory like as you said, cost of capital is higher, like, how do you think about the path going forward now? And I don't want guidance, but like it's -- Yes, totally, no. We do think about things sort of long term. But if you take the long term in the rearview mirror for a second, right, since the IPO weâve delivered more than 35 percentage points of margin improvement. This past year it was 100 basis points. We were pleased with that progress this year. And so obviously, we will give guidance in the fiscal â24 call. But that sort of puts things in context for how we feel about how we've been doing. Yes. So mostly think of it as opportunistic M&A, and other things like that. But we've mostly -- we're not a big cash burner. We're not a capital-intensive business. And so I think it just helps put us in a good position to sort of be opportunistic. How do you think about the dilution effects from stock options, et cetera. You kind of working on that to kind of use cash from that. Yes, we think about that, we talked about that. It's part of the annual planning process with the board and the comp committee to think about targets for anti-dilution when you think about employee grants and things like that. So, obviously, that's got heightened focus from everyone and so we're aware of that.
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EarningCall_1687
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Good morning. Welcome to Sage Therapeutics and Biogen's Joint Investor Webcast. Currently, all participants are in a listen-only mode. This call is being webcast live on the Investors and Media section of Sage's and Biogen's websites at sagerx.com and biogen.com, respectively. This call is the property of Sage Therapeutics and Biogen, and recording, reproduction or transmission of this call without the express written consent of Sage Therapeutics and Biogen is strictly prohibited. Please note that this call is being recorded. Good morning. Mike Hencke, Head of Investor Relations at Biogen, and I are pleased to introduce Stage Therapeutics and Biogen's joint webcast focusing on the planned commercialization strategy for zuranolone in major depressive disorder, or MDD, if approved. Before we begin, we encourage everyone to go to the Investors and Media section of our websites at sagerx.com and biogen.com, where you can find the slides we will be presenting during today's webcast. We would like to point out that we will be making forward-looking statements, which are based on our current expectations and beliefs. These statements are subject to certain risks and uncertainties, and our actual results may differ materially. Please consult the risk factors discussed in each company's SEC filings for additional detail. We'll begin the call with opening remarks by Chris Benecchi, Chief Business Officer at Sage. Next, Dr. Maha Radhakrishnan, Group SVP and Chief Medical Officer at Biogen, will lead the discussion with Dr. Greg Mattingly, Associate Clinical Professor at Washington University. Dr. Mattingly joins us today to share a physician perspective on the unmet need in the treatment of MDD. Then, Maha will provide information on the clinical experience to date with zuranolone. In the second half of the call, Alisha Alaimo, President of Biogen's U.S. Organization, and Chris Benecchi will provide more detail on the potential commercial opportunity for zuranolone in MDD and Sage and Biogen's joint plan to execute a fit-for-purpose launch of zuranolone, if approved. Lastly, Chris will make closing remarks before opening up the call to question. During the Q&A session, we will also be joined by Jim Doherty, Chief Development Officer at Sage. Please note that questions can be submitted at any time during today's call through the ask-a-question box located on the left-hand side of the webcast player directly under the speaker headshot. Thank you for taking the time to participate in today's event. This morning, we announced that the NDA for zuranolone in MDD and postpartum depression, or PPD, was submitted to the FDA. On today's call, we look forward to providing an overview of our planned commercialization approach for zuranolone in MDD, if approved. I'd like to note that while today's event is focused on MDD, we are equally as motivated to help people with PPD and we look forward to sharing more on our planned commercialization efforts in the space in the future. I'd like to begin with Sage and Biogen's mission for zuranolone. We are laser-focused on preparing for a potential launch with the ultimate goal of transforming the way depression is treated. We feel a tremendous responsibility to patients to deliver a new treatment option, which is so desperately needed. After hearing from hundreds of patients and healthcare providers, Sage and Biogen deeply understand the unmet needs that exist in the treatment of MDD. These perspectives have motivated us in our efforts to advance zuranolone. While treated chronically for decades, it's increasingly understood that depression is a condition that presents in episodes that can be treated as needed with the goal of returning patients to a state of wellbeing. Our companies stand together in our mission to evolve the treatment landscape in MDD with zuranolone, if approved. With that, turning to the next slide, we would now like to play a brief video featuring several patient advocates providing their perspective on MDD. Turning to the next slide, this is a published visual representation of the complicated path many MDD patients endure to find a therapy that works for them that was developed using U.S. commercial claims data from an analysis of more than 2,100 patients up to one year after their first treatment change. In effect, this is what a patient goes through in their first year of treatment. If you feel like the visual is confusing and you're struggling to find your way through the chart, you're right. This is just a small glimpse into the chaotic and confusing reality that exists for many MDD patients. While we'll only spend a moment looking at this slide, MDD patients could remain in this treatment turmoil for days, weeks, or even years. Depression is one of the leading contributors to disability worldwide with more than 190 million cases of MDD estimated annually. In 2018, depression cost the healthcare system an estimated $326 billion in the U.S. alone. These patients deserve treatment options that offer the potential to simplify that turmoil and society would benefit if the cost of depression were lowered. Slide 9 provides a high-level overview of what we anticipate the treatment paradigm could look like with zuranolone, if approved. We believe that zuranolone will fit into HCPâs existing routine of checking in with patients, while offering the potential to have a much earlier indication if the drug is working. To conclude, zuranolone, if approved, may provide a novel approach to treating MDD. Sage and Biogen are working with urgency to prepare for the potential launch of zuranolone, and I, alongside my colleagues, look forward to bringing this therapy to patients. With that, I will now hand the call over to my colleague, Dr. Maha Radhakrishnan at Biogen, for a discussion with Dr. Greg Mattingly. Maha? Before I review the clinical findings with zuranolone to date, I'm pleased to introduce Dr. Greg Mattingly, who will share his perspective on the unmet needs in the current treatment of MDD. I'm a psychiatrist based out of St. Louis, Missouri, and have been in practice for 30 years now. My partner and I set up a practice in the area of St. Louis that was underserved in mental healthcare 30 years ago, and in that time, we've taken care of children, adolescents and adults struggling with complex mental health disorders. On top of that, about 25 years ago, we started a clinical research company with the goal of addressing the unmet needs in mental health care. Since that founding, I've served as a principal investigator in 400 clinical trials. In addition to my clinical practice, I am a teacher and educator as an Associate Clinical Professor at Washington University, a Principal Investigator at Midwest Research Group, and the President-elect for the American Professional Society for ADHD and Related Disorders, and serve on the Steering Committee for the U.S. Psych Congress. It's also important to note for this discussion that I was an investigator for the studies in the LANDSCAPE clinical program, which are the MDD studies for zuranolone that have recently completed. Thank you. We really appreciate you sharing your background. To kick off our discussion, can you tell us a little bit more about MDD? And how the disorder presents in your patients? Yes. MDD is a common, but serious condition. In fact, in a survey of U.S. adults conducted in 2020, approximately 21 million people reported experiencing at least one major depressive episode in the last 12 months. Unfortunately, we've been losing the battle with depression as health care outcomes have improved with many conditions; disability due to depression has increased over the past decade. More recently, it's important to note that during the COVID-19 pandemic, rates of major depression have only exacerbated. Today, analysis suggests there is a greater than threefold increase in rates of people suffering from depressive symptoms compared with pre-COVID-19 levels. Because of how common major depression is, we all probably know someone who deals with depression. What I typically see in my practice is that major depression often presents them recurrent episodes appearing many times over the course of someone's life. Depression can look different for each patient. Some patients have high levels of anxiety, while some patients are highly withdrawn. Some people are agitated, while many patients struggle with being fatigue and unmotivated. For each of these patients, the need is the same. They are all struggling with depression. These symptoms can have a profound impact on the person suffering from depression and their friends, family and colleagues. Additionally, depression universally affects a person's overall quality of life. And as an example, the STAR-D depression study highlighted that when a mother with depression has not gotten better after a year, it had a profound impact on her family. Her children are also struggling academically, emotionally, struggling to just make a friend. So, patients usually come into my office struggling, suffering, and in crisis, when the symptoms of their current episode are significantly impairing their daily lives. That is when we, as clinicians, have to think about how do we initiate or change the treatment. There are many treatments available for depression today. But despite this, there has been little innovation in terms of the mechanism-of-action in decades. Most treatments approved today are either SSRIs or SNRIs, basically raising the level of monoamines. These have become the standard of care for most clinicians, and despite these medicines being widely available, many patients are still struggling with depression. One of the problems is, first, it takes several weeks or months for many of our standard antidepressants to begin to take effect. I view this as one of the greatest unmet needs in treating depression. Imagine a close family member of yours struggling with an episode of depression and their clinician says their medicine will take weeks to take effect. For many of my patients struggling with depression, weeks can feel like a lifetime. We're talking about weeks of potentially missing school, missing work, and missing social interactions. So, patients with MDD are often debilitated and are seeking relief as soon as possible. Equally important to note is that the longer it takes for patients to achieve a response or remission, the higher is the risk for their overall health to deteriorate, that's further impacting their quality of life. Therefore, it's critical that we treat with urgency with the goal of returning patients to a state of well-being and functioning rapidly. On this point, I'm encouraged to see new innovations coming forward with this goal finally in mind. A second challenge with current antidepressants is that for many patients with depression specific symptoms such as insomnia or anxiety may make treatment even more complicated and increase the risk of relapse. In that case, I frequently augment a patient's treatment with another medication for depression, an anti-anxiety medicine, a sleep aid or an atypical antipsychotic, or sometimes even switch therapies. In each of these cases, the potential side effects of the additional treatments, be it weight gain, sedation or other metabolic issues, must be considered. A third unmet need stems from the current paradigm of chronic treatment for depression. For many of my patients, this feels like a chronic pain model, where our goal is to decrease suffering without a true return to wellness. As physicians, we've been taught to manage major depression chronically, because the currently available antidepressants often require chronic use. However, there is a growing understanding that major depression presents episodically, and we need treatment options to address the episode when symptoms arise. Chronic therapy may also present adherence challenges for patients who are experiencing tolerability issues. My patients are often reluctant to continue a chronic therapy if they are only partially better, or are having side effects they donât like. In some instances, these side effects can be really bothersome and may occur before they've started to notice any improvement in their symptoms. Other potential side effects, such as emotional blunting, insomnia, weight gain, or sexual dysfunction, are not only troublesome, but are frequent reasons my patients will quit a treatment. In fact, one of my most common causes of treatment discontinuation among my patients with depression is unwanted side effects. As a result of these unmet needs, patients often cycle through multiple medications, either due to side effects or insufficient efficacy or efficacy that just takes too long, delaying the time to get to remission. Unfortunately, there can be a lot of trial and error in treating a patient with major depression, which can further delay a patient getting better. Based on the clinical profile seen to-date, if zuranolone is approved to treat MDD, how would you see it fitting in your practice? Obviously, I see a lot of unmet needs in the treatment of depression. There are a lot of patients in my practice who are currently taking one of the standard antidepressants or have taken one in the past, but haven't experienced the treatment response they're hoping for. Instead of feeling less depressed, my patients want to feel well, many are not satisfied with the level or speed of response they've experienced with the antidepressants they've taken or they've had side effect issues that have prevented them from achieving the response they were looking for on a traditional antidepressant. In addition, many patients don't want to be treated chronically. If zuranolone is approved, I can envision trying it in some of those patients either alone or in combination with another antidepressant. As new medications are being tested and become available, they'll be integrated in my practice, moving beyond a chronic treatment model. In terms of fitting into my practice, monitoring a short course of treatment would mean changing my expectations for what I expect to see with an antidepressant medication, watching for improvement, monitoring for relapse, trying to encourage overall wellness will be important goals for treatment. Using the PHQ-9 to measure someone's mental health vital statistics as their symptoms are improving, are there any symptoms being left behind? Are there any signs of relapse or recurrence? I'd envision regular check-ins with my patients. If there are any signs of a relapse or a recurrence, I'd have them come to the office and talk about the next treatment steps. Overall, I'm looking forward to using zuranolone in clinical practice. If it's approved, as I believe, it would be another meaningful tool in my toolbox for treating depression in my patients. Thank you, Dr. Mattingly. We really appreciate you joining us to discuss the unmet needs in MDD. Your thoughts were invaluable in understanding the gaps in the current treatment paradigm and potential opportunity for zuranolone, if approved. I would now like to review the data from the zuranolone clinical development program and why we believe that zuranolone, if approved, could be a meaningful option for patients living with MDD and PPD based on the efficacy, safety, and tolerability profile seen in clinical trials. To begin, zuranolone has been evaluated in two extensive clinical development programs, NEST in PPD and LANDSCAPE in MDD, which now includes more than 3,500 patients. As part of these clinical development programs, zuranolone was evaluated across multiple use cases, including as a monotherapy, add onto existing antidepressant, or co-initiate it with another antidepressant. Importantly, when we look at the results across the LANDSCAPE and NEST programs, we see a consistent improvement in depressive symptoms associated with zuranolone over that of placebo. Specifically, five out of six of these placebo-controlled clinical studies resulted in a statistically significant improvement in depressive symptoms in adults with either MDD or PPD who received zuranolone 30 or 50 milligrams as compared to placebo, when assessed by change from baseline in the HAMD-17 total score at day 15. Furthermore, the CORAL study assessing the efficacy and safety of zuranolone when co-initiated with the new standard of care antidepressant showed that zuranolone treatment resulted in a statistically significant improvement in depressive symptoms as compared to placebo as early as day three when assessed by change from baseline in the HAMD-17 total score. This was both the primary endpoint of the study and the earliest time point measured, underscoring the rapid reduction in depressive symptoms over standard of care associated with zuranolone in this trial. Efficacy as early as day three was also seen across clinical studies of zuranolone in MDD and PPD. Also, in an integrated analysis of four of the completed clinical studies in MDD and PPD, a 14-day treatment course of zuranolone, led to greater improvements over placebo on the SF-36 scale, a validated patient reported outcome instrument that measures functional health and wellbeing. Importantly, patient reported benefits via SF-36 score in the zuranolone cohorts were observed at day 15 and importantly sustained at day 42 in MDD and day 45 in PPD. In addition to the placebo-controlled studies I already discussed, the LANDSCAPE program also includes the SHORELINE study, one of the largest prospective naturalistic studies in MDD to-date. In the 50 milligram SHORELINE cohort, approximately 80% of individuals who responded to the initial course of therapy received only one or two treatment courses in total during their time in the one-year study. It is worth noting that the majority of these participants received only the initial 14-day treatment course. Furthermore, for those that responded, the median time to first repeat treatment in the 50-milligram cohort was 249 days. Of note, across the studies in the LANDSCAPE program, zuranolone showed benefit in patients with MDD, with and without elevated anxiety. As you just heard from Dr. Mattingly, anxiety is a common feature in patients in more than 50% of MDD cases, which historically has made them very difficult to treat. Now, moving on to safety. Across eight completed and ongoing zuranolone clinical trials, a consistent safety and tolerability profile in adults with MDD or PPD has been observed, where most treatment-emergent adverse events were mild to moderate in severity. The most common treatment-emergent adverse events observed to-date have been headache, somnolent, dizziness, nausea, and sedation. Importantly, there've been no signals of suicidal ideation or symptoms of withdrawal. In addition, weight gain and sexual disconnections were not identified as safety concerns associated with zuranolone. Throughout this zuranolone development journey, we have been engaging with a broad set of key medical experts to help shape our clinical program. We have received consistent feedback on what they consider the four main strengths of the zuranolone clinical data. First, a robust clinical development program with approximately 3,500 subjects. Second, rapid onset of action seen in clinical trials with an improvement in depressive symptoms observed as early as day three. Third, improvement in depressive symptoms observed across multiple zuranolone use cases and patient populations in MDD and PPD, including those with elevated anxiety. And fourth, a consistent safety and tolerability profile, which I just described. U.S. key medical experts have also identified areas for further discussion, including sustainability of efficacy and the need for repeat treatment. Weâre also delighted to see the approval and initial use of a combination of bupropion and dextromethorphan as a positive signal that both patients with MDD and clinicians are looking for therapies that work rapidly; in their case, one to two weeks. Overall, physicians have highlighted that a treatment option with the potential to achieve both a rapid and sustained effect could be a meaningful addition for them and their patients in the treatment of MDD. They also are increasingly recognizing the episodic nature of depression that potentially could be treated episodically with treatment-free periods. In summary, the profile observed for zuranolone in clinical trials to-date leads us to believe that, if approved, zuranolone could be a meaningful new option for patients suffering from MDD and PPD. To that end, this morning, we announced the submission of the NDA filing for zuranolone in MDD and PPD to the FDA. Should the filing be granted priority review with no review extensions, this would set up a potential launch of zuranolone in the U.S. in late 2023. We are very excited about the prospect of bringing a novel antidepressant to patients with MDD, who despite the currently available treatments, may still be searching for relief from their depressive symptoms. With that, I would like to turn the call over to Alisha Alaimo, the President of Biogenâs U.S. Organization, who will tell you more about the potential commercial opportunity for zuranolone in MDD. As you heard in the opening video, significant unmet needs remain in the treatment of depression, and there is an urgent need for new innovation. Patients with MDD want to feel relief and to feel like themselves again. They do not want to make the trade-offs between feeling better or experiencing the types of side effects that often lead to treatment discontinuation. And we know MDD is experienced in episodes. So, why are we treating it chronically? Wouldnât it be meaningful if we could help patients with MDD who may be feeling intense isolation, helplessness and a sense of emptiness with a therapy that has the potential to work fast, without many of the side effects often associated with discontinuation of the standard of care, and could be used to treat an episode when it is needed. We want patients to have more options to help them get better quickly. This is exactly why Biogen and Sage are urgently working together. And if approved, we believe zuranolone could change the way depression is perceived and treated. We are driven by a vision of the future to transform the care of depression where each episode that patients experience is rapidly treated and symptoms rapidly improved. We know the depression is deeply prevalent in our society and becoming more prominent in our culture. Nearly every day, we see new statistics reporting an unprecedented increase in MDD, and more and more people from all walks of life are speaking up to destigmatize depression. Itâs estimated that in 2020, 21 million Americans experienced at least one major depressive episode in the last 12 months, and one in six adults will experience MDD at some point in their lifetime, which means there is a strong chance all of us on this call are connected to someone who is struggling with depression. It is hiding in plain sight, and we cannot expect better outcomes with the same approach. Based on our experience and success in highly competitive markets, we know we must begin with a focused approach to ultimately achieve our very bold vision. This means that if zuranolone is approved, we will be intentional in our approach and engage the HCPs who we believe will be the most likely to adopt zuranolone in the treatment of MDD. Our omni-channel and in-person engagements will primarily be focused on specialists, as we know we must earn their confidence before the broader base of PCPs may follow. Which brings me to the types of patients with MDD that we believe will benefit most from zuranolone. As we heard from Dr. Mattingly and supported by STAR-D, the largest and longest prospective clinical trial of MDD ever conducted, generic SSRIs are typically the first product prescribed. However, studies estimate that two-thirds of MDD patients do not achieve remission after first-line therapy. That means that on any given day, there are patients in the process of switching, adding on, or reinitiating therapy. Our strategic focus at launch will be on these patients who still experience residual symptoms of depression, especially early in their treatment. Because we know that longer episodes of depression or a delayed response to treatment can be associated with worse outcomes. There are a few common patient profiles in MDD that weâve identified as our strategic focus at launch, based on our market research and in speaking with hundreds of patients. First, these patients may have achieved partial remission. For example, one woman shared that after attempting multiple treatments while not treatment-resistant, she was still experiencing some residual symptoms. Second, these patients could be experiencing MDD with elevated anxiety, which impacts more than 50% of MDD patients and makes their MDD symptoms especially difficult to treat. Or third, they could be non-adherent. For example, because they do not want to experience the types of difficult side effects that often lead to discontinuation of treatment. Across all of these patient types in MDD, a therapy like zuranolone, if approved, could potentially help patients achieve the response they are seeking. That said, while our efforts will prioritize these patient types, HCPs have shared that other MDD patient types may also benefit from zuranolone, if approved. For example, patients who have breakthrough episodes or young adults in college with MDD who may need a treatment with the potential to be fast acting because they canât afford to lose time waiting six to eight weeks for a therapy to improve their symptoms. As I shared, to help reach these patients, we have carefully identified HCPs based on a clear set of criteria. Those who treat a high volume of patients with MDD write more branded prescriptions and practice advanced therapy, meaning they have experience treating with polypharmacy or adjunctive therapies. Our plan includes prioritizing psychiatrists, nurse practitioners, physician assistance and a targeted set of PCPs, which will also be the focus of our sales force upon a potential launch. Of note, in the last 10 years in the U.S., the number of nurse practitioners who focus on psychiatry has accelerated by over 160%. Many NPs and PAs are now independently managing patients, making treatment decisions and prescribing therapies, and they are critical and rural and underpopulated areas without access to specialist care. We plan to have a tailored approach to engaging with this community. Finally, PCPs. There will be a subset of PCPs we plan to engage at launch, as they meet our criteria because they have similar prescribing patterns in MDD as psychiatrists. We will be prepared to further expand our PCP engagements and scale with success of the launch. Based on our experience, we know that in the last few years, the way HCPs prefer to receive information has dramatically changed. That is why we aim to have an advanced omnichannel approach to reach all of our target HCP with a strong digital strategy. Our advanced omnichannel engine is designed to unite data from our content, media and in-person interactions, including with our sales force to deeply understand customers and create a better experience with the goal of increasing the impact, efficiency and agility of our execution. It is powered by predictive analytics designed to deliver customized and personalized information where and when HCPs want it. We plan to use our omnichannel approach to reach the broader PCP audience. We will be prepared to further expand our PCP engagements with success of the launch. With patients, expectations have also changed for how they would like to receive information and care. In MDD, patients play an important role in their own treatment because they ultimately decide when to engage or reengage with their HCP. So, it is equally important to engage them on our omnichannel approach. We believe, if approved, zuranoloneâs profile has the potential to address many of the unmet needs that patients face today. Our goal is to inform and inspire them to advocate for new treatment options and to help them navigate their treatment journey. We know that to achieve our long-term vision of transforming the care of depression, we must begin with a focused strategy and be prepared to scale with success. For many patients with MDD, the standard of care is not working. We believe a therapy like zuranolone that has the potential to rapidly treat patient episodes with its observed tolerability profile and make a difference in these patientsâ lives, if approved. As we know, we must have market access to ensure therapies get to HCPs and their patients. Throughout this presentation, weâve underscored that our goal, if zuranolone is approved, is to deliver a launch that has the potential to transform the way MDD is thought about and treated. We believe that for zuranolone to truly transform the treatment of depression, it must be accessible. Accessible would mean that when an appropriate patient with MDD is prescribed zuranolone, he or she can get it rapidly and seamlessly. With this goal in mind, our value-centric access strategy is focused on minimizing restrictions like onerous prior authorization or multiple step edits that could delay the prescription immediately from getting filled. For patients with MDD, this would mean if weâre successful, that zuranolone is readily available and that their out-of-pocket cost is affordable. And for payers, this would mean that the budget impact is predictable as they strive to improve patient outcomes. We know that price is an important component of our planned value-centric access strategy. Sage and Biogen plan to provide clarity on pricing at the time of a potential approval. With that said, what I can say now is that weâre thinking strategically about pricing and that we believe our pricing strategy will take the needs of all stakeholders into consideration. Itâs important to understand the payer landscape that zuranolone will enter, if approved in MDD. As you can see from the graph on the left side of the slide, commercial payers account for more than 50% of the current market coverage, with government payers covering the rest. Itâs also important to recognize the current coverage paradigm for branded drugs in MDD. As you can see on the right side of the slide, despite the number of generics in the market, branded products are well covered by all categories of payers. In most cases, patients need to try one or two generic options, but prior authorizations are relatively uncommon outside of the Medicaid space. What that tells us is that the existing MDD treatment landscape, our target patients have access to branded medications when physicians prescribe them. Based on the efficacy and tolerability data we generated with zuranolone in our clinical program, we believe zuranolone could potentially garner favorable coverage with payers and provide a highly desirable treatment option for people living with MDD and the clinicians treating them. Turning to Slide 30. Iâll share more on our plans for a proactive contracting strategy with an aim to establish value-based agreements that we believe could fortify the zuranolone value proposition in MDD. Our goal with this strategy is to minimize friction and drive timely coverage of zuranolone in the treatment of MDD at launch. We want to be as innovative with our access strategy as weâve been with the way weâve designed and developed zuranolone. Our intent is to be customer-centric in design and aim to meet the needs of MDD patients, physicians and payers. To that end, we plan to work closely with our customers to co-design value-based agreement offerings that help meet their needs such as budget predictability, while being mindful of the considerations laid out on this slide. We have already engaged in these conversations with some of the most influential U.S. payers, with the goal of having agreements ready at the time of launch, if zuranolone is approved. It is important to note that not all payers can or want to implement value-based agreements. So, while we believe this is an important component, it will only be one part of a holistic payer value proposition. At this point in our launch preparation, weâve already spoken with all national and most regional payers about their perception of the unmet needs in the MDD marketplace and zuranolone. Weâve had in-depth discussions on the MDD disease state as well as permitted pre-approval information exchange on zuranolone. Our customers have generally been very receptive to the information about the disease state and zuranoloneâs clinical profile. Our engagements have told us that despite generic availability, a major unmet need remains in the treatment of MDD. Payers like other stakeholders would like to see a treatment option for MDD that has the potential to work rapidly. To share some details on their feedback: First, there is a strong desire among many payers to optimize patient adherence to therapy to improve overall outcomes in MDD. Weâve repeatedly heard from payers that there are treatment tolerability issues and comorbidities associated with MDD that add complexity to the management of this patient population. Second, payers are also highly aware of the health equity issues linked to MDD, and see the potential for zuranolone, if approved, to be well adapted for patients who may struggle with consistent access to care. Third, payers have also expressed the need to achieve budget predictability and cost containment for new agents in MDD. They also recognize theyâre both direct and indirect costs associated with MDD if itâs not well managed. General payer sentiment was that zuranolone may offer a treatment option that aligns with their objectives of better managing MDD. These early engagements with payers have reaffirmed our belief in zuranolone as a differentiated therapy with the potential to transform the treatment of depression. To close, our planned commercialization strategy in MDD, if zuranolone is approved, represents a focused approach intended to scale with success. We believe that if we are able to successfully act on the items we reviewed today and execute on our launch plans, weâll see clinicians prescribing zuranolone in MDD with a sense of urgency, patients with MDD asking for zuranolone, and payers enabling access to this critically-needed treatment. We have a current focus on disease state education in MDD, scientific exchange and permitted interactions with payers. These efforts and other permitted pre-launch activities will continue to broaden and ramp up as we head towards a potential launch. As we look to the potential for commercial launch for zuranolone, we believe we have the ability to make a difference for people living with depression by helping to reduce the substantial unmet needs they face. We are excited about the opportunity to launch zuranolone, if approved. There are three key points that have surfaced in our interactions with stakeholders to date. First, there is unmet need in the MDD market. Second, we have seen an increasing amount of enthusiasm from physicians for the potential utilization of zuranolone in the treatment of MDD, and an understanding of when they may want to use it either after first line failure or early in the course of patient management. And third, early interaction with payers has been broadly positive, and we have already seen positive reactions to our potential innovative contracting structures. We are executing now to deliver on this potential launch, because together we believe we have an opportunity to advance the way depression is thought about and treated. Thank you, Chris. As a reminder, if youâd like to ask a question, you can type it into the Ask a Question box on the webcast viewer. So, our first question relates to pricing. Question is, should we expect a flat annual price of therapy regardless of the number of courses in order to keep things simpler? Or would the product be priced per 14-day course of therapy? And then related to that, how could pricing vary by dose? So, Alisha, would you like to start with that? Yes. Thank you, Mike. Without a final label, itâs really too early to speculate on pricing. However, what I can share at the stage is that if the zuranolone is approved in both indications, our current thinking is that we would expect to have one price per treatment course for zuranolone. We also plan on exploring value-based agreements as one part of our access strategy. We anticipate that we can price this product that reflects the value it can bring to patients and to HCPs. Yes. Thanks, Alisha. As I hit my opening remarks to truly be transformational with zuranolone, we must be accessible, thatâs absolutely paramount in all of this. And I think you summed it up well. In terms of what weâre doing in and around pricing, weâre thinking strategically around pricing, but also in concert with our access strategy more overarchingly. And as we think about the strategic approach that weâre taking to both pricing and access, weâre really working to design an approach that effectively meets the needs of physicians, payers and, most importantly, patients. And thatâs where we are today with respect to the pricing and access strategy. Okay. Our next question relates to how might physicians think about assessing the need for retreatment in patients in the real world? What sort of criteria might they use? And how do those compare to the criteria used to assess whether patients need to switch to another option or require adjunctive therapy today? Thank you for the question. This is Maha. We did talk earlier on in the presentation about the data from the SHORELINE study, which is a naturalistic study designed to follow adult patients in with MDD and evaluate the safety and tolerability of zuranolone, as well as a need to repeat dosing for up to one year. And as I mentioned earlier, the data shows us that those patients who responded to the initial 14-day treatment course, the median time to second treatment course was 249 days with the 50-milligram dose. So that being said, as I move to treatment in the real world, before I hand it over to Dr. Mattingly, I would like to emphasize some of the points in terms of what I have heard from a key medical expert or key opinion leaders in terms of needing to watch for improvements in the patients, needing to also monitor for symptoms of relapse, as well as making sure that overall wellness is encouraging these patients. As Dr. Mattingly said, âPatients donât want to feel better from being depressed, but they want to actually feel well.â And I would actually now like to hand it over to Dr. Mattingly to talk specifically maybe more about the PHQ-9 scale that he mentioned earlier, but also other assessments that will really help evaluate the need for retreatment of patients in the real world. Dr. Mattingly? Thank you. So, we already routinely use what we call our mental health vital statistics within our office. In the same way, if you came to see an internist and he was following your blood pressure, he would follow your blood pressure. We do the same thing with the PHQ-9. So, each patient, every visit, we check their PHQ-9, we make sure theyâve improved, we make sure weâre not leaving any symptoms behind. Of note is item number nine on the PHQ-9 is measuring suicidality. So, we make sure with each and every visit, if thereâs any signs of suicide, we want to pick it up, weâre measuring for it, weâre making sure itâs going away. So, weâre looking at mood, sleep, energy, concentration, anxiety, anhedonia, feeling pleasure in life, because we know each of those can contribute to both to patientsâ outcome, but also to disability rates, presentism, absenteeism in the workplace. So, we have already begun kind of a new language of taking care of mental health patients that is measuring outcomes. And I think with these treatment as needed, where weâre going to treat somebody, weâre going to try to get you better, and then weâre going to follow you and watch for the sign of a relapse. Thatâs going to be much like we do in other places of medicine. The goal isnât just to get you a little better, but leave you struggling. The goal is to get you all the way better and then treat again as needed. So, this is Jim. Iâm happy to answer that question, and thank you for the question. Weâre actually very confident in the sustained and durable profile of zuranolone. And I would point to several lines of evidence from the LANDSCAPE and NEST program. As you heard just a little while ago from Maha, in the SHORELINE study, we did see that the majority of patients who responded to that initial zuranolone two-week course of treatment only received one treatment. And 80% of the patients at 50 milligrams received only one or two courses of treatment over their time of participating in the study. Remember as well that we saw the response retained looking at change from baseline for MDD in all those studies. And I would also then point to the SF-36, the patient reported outcome data that Maha walked us through earlier where we saw significant improvements at both at day 15, but importantly also at the end of the study, either at day 45 or day 42. So, taken together we think that thereâs robust data showing the sustained response for zuranolone. And I would say if we -- if zuranolone is approved, we would also consider opportunities to generate additional data on its use in real world settings. Great. Our next question is, what are the timelines to broaden the PCP prescriber base? And how are you segmenting this market? And then, how will that impact the size of the ultimate field force? So, I think letâs first start with our go-to-market approach. Our go-to-market approach is designed to achieve the strategic objective of gaining early adoption and driving acceleration of uptake. The first key pillar of our go-to-market approach is how weâre going to prioritize our HCPs. Weâve segmented our customers and have prioritized the targeted set of psychiatrists, nurse practitioners and PAs, PCPs and OB-GYNs who are most likely to adopt zuranolone. Specifically, these are HCPs who treat a high patient volume. Theyâre writing scripts for branded products, and they practice advanced therapy management. For example, theyâre comfortable prescribing multiple medications at once to treat MDD symptoms. We also have ongoing research to understand, which doctors are the first to adopt new therapies based on new entrants in the market. Now, PCPs are a very large group with about 275,000 PCPs and another 250,000 PCPs that have PAs and NPs. So, our launch at first will be focused on those PCPs that behave most like psychiatrists. Theyâre going to have a higher volume of MDD patients, and they use branded therapies more frequently. Now, we will scale our PCP coverage, when we see success, of course, in the field. But another key pillar is how we broaden our HCP reach beyond just our field force and deepen our engagements. And to that end, weâve developed a very strong digital strategy that leverages our omnichannel capabilities, which I think Chris can discuss. Yes, so I think you hit it in your opening marks, Alisha, you said that we were going to be laser-focused at launch, and I think that really describes well how weâre thinking about approaching this market, being laser-focused, thinking really big for this medication in the long run, and scaling fast with success, and success as measured by data and analytics and insights that weâll be garnering or gathering from the very beginning moments of the launch as we move forward. In terms of the omnichannel component, thatâs absolutely paramount in terms of how we think about launching the product, because you can only get to so many clinicians with sales representatives out of the gate, but I think you hit it. There are so many other clinicians that are treating patients that are suffering from MDD that itâs critical that we use omnichannel and in particular digital to broaden our reach, ultimately to deliver the messages they need to hear in order to affect the change that they need for their patients. In all of this, I see this as more than just how weâre going to cover PCPs. I see this as how are we ultimately going to most effectively reach patients. And when you take a step back and you think about what patients are suffering from with depression, weeks matter, certainly days matter, and the moments that are missed really, really matter. So, itâs on us to make sure that we get to them as quickly and effectively as we can. Okay. Our next question is, what portion of MDD patients present as episodic versus chronic? Maha, would you like to start with that? So, what we see is based on the data we have is about it takes about four weeks to six weeks or longer sometimes for patients to see impact or response with the current antidepressant therapies. The side effect burden is also quite significant with chronic therapies. The reality is that patients who are undergoing chronic treatment are living still with a burden of depression. So, what we really need to be doing is to redefine depression as an episodic illness with recurrent episodes. So, I will look to Dr. Mattingly to kind of walk us through what heâs seeing in his real-life practice amongst the patients that are part of his office practice. Dr. Mattingly? Itâs a perfect question, and the answer is the vast majority of our patients have recurrent depression. In a clinical practice like mine, thatâs probably 70% to 80% of my patients come in not just with one episode that maybe sticks around for a while, but they come out to recurrent episodes throughout their life. Having been, once again, an investigator in the SHORELINE study and many other studies throughout the year, this ability to treat as needed during an episode is a whole new paradigm when we think about treating depression. And in my practice, itâs been interesting. Iâve asked fellow clinicians, nurse practitioners, doctors what they think about treatment as needed for depression, and everybodyâs excited and a little bit curious, and itâs a new way of thinking about depression. Whatâs even more exciting is when Iâve asked my patients about the option of having a treatment as needed for depression, a treatment that you take when youâre depressed, hopefully for a large percentage or a percentage of people, it makes the depression go away, and then we use it again only if the depression comes back. So, thereâs excitement with my clinicians, but even more so thereâs excitement among my patients. Okay, thank you, Dr. Mattingly. The next question we have is regarding the filing for both indications of MDD in the same package from our conversations with the FDA. Why are we confident that we wonât complicate the FDAâs review of the NDA? And then similarly, are we anticipating an advisory panel, and when would we find that out? Absolutely. So, I think the first thing to say is that both teams have been working very hard to finalize the NDA submission. So, weâre really excited to have announced this morning that the NDA for zuranolone in both MDD and PPD was submitted to the FDA. I think it really offers the opportunity to include the data across LANDSCAPE and NEST programs for both PPD and MDD into one comprehensive data set, and therefore, one comprehensive filing. I would also say from an efficiency point of view, it makes it a little more efficient for the agency to review in one package. So, put those things together and we are very confident in the single filing approach, and we think that it will really allow us to talk about the full scope of possibilities for zuranolone. I think the question around an AdCom first thing to say is the agencyâs decision whether or not to hold an AdCom. Having said that, we will prepare to be ready for a potential AdCom, and we would frankly quite welcome the opportunity to discuss the totality of data for zuranolone program and potentially hear from patients, patient advocates about the needs for therapeutic innovation. Great. The next question we have is what percentage of MDD patients would we estimate fall into the core launch target segments we talked about being partial response, adherence challenged or elevated anxiety? Maha, would you like to start with that? Yes. Thanks, Mike. I will start, and then I will have Dr. Mattingly respond, and then, we will have Chris comment as well, because this is a very important question. So, in terms of the types of patients as weâve described, weâve had various patient cases, zuranolone use cases in our clinical development program, starting with monotherapy to adjunctive therapy to co-initiation with new antidepressant treatment starts. That being said, we also recognize that the management for complex cases of patients with major depression, especially those with elevated anxiety, has been very complex. 50% or so patients fall in the category of patients with major depression with elevated anxiety. And we also hear from physicians that very often they resort to using other medications in addition to their core antidepressant therapy like anxiolytics, atypical antipsychotics, sedatives, et cetera, to manage those hard-to-treat patients who have elevated anxiety symptoms as well. So, I -- and obviously weâve also seen data from the STAR-D program in terms of the percent of patients who actually respond, which is quite low, which is less than one-third of patients who respond to initial courses of therapy. But I would like to, again, have Dr. Mattingly comment from what heâs seen in his clinical practice in terms of partial responders, endurance to treatment, as well as patients with MDD who have symptoms of elevated anxiety. Dr. Mattingly? Certainly. We know that anxiety is fairly ubiquitous in depression. Over half of my patients are struggling with significant anxiety. And the reason thatâs important is we know that significant anxiety predicts a negative long-term course. Our standard antidepressants have not worked as well for our anxious depressions. They tend to have more recurrences, they tend not to do well, they also have higher suicide rates. So, to have treatment options that have particular benefit in this anxious group of patients that have fairly rapid onset. And once again, one of the biggest unmet needs in healthcare, but especially in mental healthcare, is treatments that work quickly. Imagine if this is your wife whoâs struggling with a bad depression, sheâs trying to take care of the kids, sheâs trying to go to work, and you try a treatment thatâs going to take two to four weeks to see if itâs going to work. Whereas if we have a treatment in this case, we can start seeing some improvement in a matter of days to a couple of weeks. Thatâs going to be a different way of thinking about treating depression for our patients. So, I think that group that has high anxiety, I think that group thatâs looking for a faster treatment approach for depression -- I take care of a lot of university students. My office sits right between four large universities. Getting depressed in the middle of a college semester, quite often these days means losing a semester of college versus if we have treatment approaches that may be able to get somebody better in a couple of weeks, thatâll be a different way to think about depression for my patients. Yes. So, as to build on what Maha and Dr. Mattingly have already said, you take a step back and you think about it. There are 21 million people in the United States who suffer from one or more episode of depression on an annual basis. 6.5 million in a given year are making a treatment change. Many of those patients making a treatment change are the ones that are characterized in this question that weâre talking about right here. Now, as Iâve spent time at Congresses, talking to key opinion leaders, hearing whatâs being said from the podium, whether itâs the Psych Congress or itâs the most recent NEI conference, thereâs a tremendous amount of excitement around this next or third-generation, third wave of new antidepressants, of which the zuranolone is a part of it. With respect to what zuranolone offers the ability to rapidly impact patients, and to over the course of just a short 14-day course treatment, deliver the efficacy that would ultimately help some of these patients. Again, it raises a significant amount of excitement among clinicians that are really thinking about how to manage these patients. I think, Dr. Mattingly really hit it nicely. The earlier we can get to these patients with a therapy that works, patients show improvements, the earlier they show improvements, the greater the outcomes are for those patients, right? So, itâs really important for us to early and effectively manage the depression for many of these patients that we talked about, because it does improve overall the treatment outcomes for these patients as we move forward. And thatâs what weâre really talking about here is really reaching patients with what we do in changing or advancing the treatment paradigm, so that we can ultimately reach them. Great. And the next question we have is, how does the value-based agreement approach? How would that affect pricing as more patients are identified and dosed with zuranolone? All right. Thank you, Mike. Iâll go ahead and take this one. Obviously, Chris also has a lot of experience in this area as well. First of all, we are very committed to value-based agreements as part of the overall proposition to payers. We want meaningful VBAs that help address potential uncertainties and create aligned incentives. Our teams have been appropriately engaging key payers for several months now to educate them on this zuranolone clinical data. And interestingly, payers really understand the significant unmet needs in MDD, and they do share a desire for new tools. However, also, keep in mind, VBAs will be just one element in a holistic payer value prop. We also know that many payers, which is including most government payers, are unable to do VBAs, and also, that some payers perceive them as burdensome and not really worth the effort. So, itâs too early to say how much the market will be covered by VBAs. But it will be one of the tools in our arsenal. Yes, I think, for context on VBAs and more broadly the conversations weâve already had with payers, when you think about where we are today, weâve already spoken to all of the national payers and the vast majority of regional payers, inclusive of plans, TDMs and [IDF] (ph). Alisha, I think you hit it, the conversation so far have been very well received by payers. I feel like weâre in a really good place with respect to this conversation. VBAs in and of themselves are not the only tool that we use in conversations with payers. I think it's really important for us in these conversations first to set the stage around unmet need. And in the conversations that we've had with payers to-date, what we hear back is they recognize that with respect to their populations, they're not doing a particularly good job in managing overarchingly the way that they're thinking about or they're seeing the results in their MDD population. That comes from how they think about this as a group of patients that they're managing. But payers are people, too, right? They have loved ones like we all do, who suffer from MDD who not only knows some of the challenges of getting them to the efficacy that they need, but managing some of the side effects, the stigmatizing side effects, sometimes that can be associated with the utilization of some of these products like sexual dysfunction and weight gain. So, that conversation has been a really strong foundation or anchor point for our ability then to talk about the zuranolone data. And so, far in those conversations, the zuranolone data across the LANDSCAPE and NEST programs has been compelling. There's a great degree of interest from payers around what zuranolone can offer in addition to the other therapies that they may have available in the mix. So, we'll continue to engage with payers around the unique value proposition of zuranolone and the potential opportunity that it provides for some of the -- for many of those patients that are part of their plans. And then lastly, the VBA piece. Payers want predictability. Payers want cost containment. They want to understand what the implications are for the ability to add this medication to their armamentarium for managing depression. They also want to understand the implications on not just MDD but on the complexities and comorbidities associated oftentimes with MDD in this patient population. So, in terms of the VBAs, we believe that they will give us where payers are interested in these value-based agreements. The opportunity to really lean in into collaborating with payers around how best to make this medication available to their patients where Sage is along with Biogen sharing some of the risk associated with what it means to have a VBA in place. So, we're excited. We'll continue those conversations as we move forward. And we'll progress up through launch in and around having those dialogues, but it's an important part of our value and access strategy as we move forward. Thanks, Chris. I think we have time for maybe a few more questions. The next one is, do the side effects of zuranolone continue after a two-week course? And the question states, if not, this seems like a big advantage versus chronic therapies. Yes. So, it's a good question. As I would say, in any blinded trial, AEs can be in our reported during both the treatment and follow-up periods. However, it's clear from the LANDSCAPE and NEST programs that the frequency of AEs does drop after the dosing period ends. Similarly, from the SHORELINE study for those patients who have received retreatment, we see something similar, which is a reduction in AE frequency reported following a second or third dosing. Great. The next question we have is very little discourse today on the approach for PPD. And the question is, is there a similar marketing plan? So, the short answer to that one would be yes. And we're obviously extremely excited about PPD. Even though today's webcast is really focused on MDD, PPD is the most common medical complication of childbirth, and its estimated one in two women with postpartum depression are never diagnosed. So, this is again another very serious illness, and it's something that does need to be treated with urgency, especially in this population. So, we are very excited out there. We also have a plan, of course, for PPD. Yes. We've learned a significant amount from zuranolone with respect to what the PPD community looks like. We know that there are as you noted, 500,000 or so moms who are suffering from PPD on an annual basis who are in need of a medication, an oral medication specifically, for postpartum depression. We're excited to have the opportunity to capitalize on some of those insights and learnings from zuranolone and apply those to the launch of zuranolone, if approved. I think with that being said, what I'd like to underscore is that Sage and Biogen have a strong plan in place, not just for MDD, for PPD as well, too. The strategy is in place. We're operating and executing against the tactics, and we're looking forward to introducing zuranolone for both MDD and PPD at the right time, if approved. Great. Our next question is, whether we think physicians would want to see patients more or less frequently with an episodic treatment versus other chronic antidepressants? And again, how would we expect to monitor patients for relapse? So, Maha, would you like to start that? Sure. I will start, Mike, and then I will hand it over to Dr. Mattingly and Alisha who want to comment on this question as well. So, I think, first of all, I would like to actually focus on depression from a pathobiology standpoint. Depression can resolve some of balance [indiscernible] pathways, as we all know, including deficits in the GABAergic signaling in the brain. GABAergic neurotransmission is vital for normal brain functioning. Zuranolone's MOA is distinct because of its effect on GABAergic transmission. And amplifying GABAergic signaling may reset brain activity in regions thought to be disregulated in depression. I've also talked about the data from our program. So, we've seen the onset of effect as early as three days. So, when you look at the current paradigm or the current clinical care, where Dr. Mattingly also said there's where physicians are used to seeing treatment effect around the two- to four- to six-week timeframe. The question is that these physicians have the reset in their mind the expectations of what they would expect to see in terms of treatment response in patients if they were to put them on zuranolone, if approved. A day-three response obviously is going to meet them to start looking for signs of improvement very early on. And this is where I would like Dr. Mattingly to comment because he did mention about PHQ-9 and the various aspects that are crucial for physicians to keep in mind as they look at depression more as episodic illness with recurrent episodes more so than as a chronic element. Certainly, and thank you. I think from my perspective this has the potential to be an exciting new game changer for my patients struggling with depression. To have a treatment that they can take as needed, we try to get them better, and then we watch to make sure they stay better. And if they start slipping back, we have a treatment that we shown that works for their depression. That is going to mean measuring how they're doing. So, what I envision doing will be very similar to what we did in some of the research trials, which I'm going to use the PHQ-9. I'm going to use the PHQ-9 when I treat my patient. I'm going to use the PHQ-9 after two weeks to measure where they are to make sure they've truly gotten better. And then, Iâm going to send them home with a PHQ-9. And episodically, Iâm going to ask them to check in with that. And if they see that theyâre starting to slip backwards, I want them to give me a call. If it sounds like theyâre not doing well, weâre going to bring them back in for a visit. Weâre going to see if they need retreatment. I think weâve seen data that if you do the -- certain doses, itâs a portion of people that may need a retreatment. In my clinical experience, having that treatment theyâve tried once, knowing that if they need to use it again, if thereâs another treatment option, using a tool like the PHQ-9 to measure how theyâre doing, and then if they do show any signs of recurrence, Iâll bring them back in for another treatment. So, I think thatâs going to be the new model going forward, I think itâs an exciting new model that when I -- once again, when I talk to my patients, this ability to treat when needed to measure how youâre doing, I think itâs an exciting new option. Not for us, but for our patients. Thank you, Dr. Mattingly. And I think itâs also good to share what weâve learned from market research about the process for when a new treatment is actually prescribed for a patient, because that will give you the context of why zuranolone could be easily adopted into their existing clinical workflow with chronic therapies. So, generally speaking today after a patient receives a new therapy, there are two follow ups. One is to assess the side effects, and one to determine efficacy, because side effects are so prevalent amongst the current treatments, HCPs commonly follow up with patients two weeks after new treatment. So, with zuranolone, if approved, at this two-week check-in, the patient would have completed the full treatment course. So, the HCP can discuss the zuranolone was effective at that point in time. When we talk through this with HCPs, many of them share that this could have huge implications for being able to provide earlier intervention without any changes to their current clinical process. So now, because current treatments also take on average, six to eight weeks to determine efficacy, there is a follow up at eight to 12 weeks to see if a chronic therapy is working. So again, if zuranolone is approved, the HCP could leverage the same check-in to determine the need for potential re-dose. And we know the depression is a highly patient-driven market, just like Dr. Mattingly was speaking about, and HCPs do rely on patients to raise their hands in order to drive action. So, we do anticipate a similar dynamic if zuranolone is approved. Great. And I think we have time for one final question. Question is how significant of a product do we think this can be in light of the existing treatment landscape? Maha, would you like to maybe start on that? Yeah, I can definitely start on that and start with the data from our robust clinical trial program that provides information about the 3,500 patients; secondly, as I said earlier on in the webcast, the rapid onset of action seen in our clinical trials with an improvement in depressive symptoms observed as early as day three could be something that could help differentiate this program zuranolone, if approved; thirdly, the improvement in depressive symptoms observed across multiple zuranolone use cases and patient populations both in MDD and PPD, including those in patients with elevated anxiety; and fourthly, as we have described, a consistent safety and tolerability profile. Having said all of this, I also just mentioned the unique MOA, the mechanism of action, which really helps reset the neurotransmitters in the brain, we believe, if approved, will help bridge the gaps in the current unmet medical needs. But Dr. Mattingly, I would like for you to comment in terms of where do you see the role for zuranolone, if approved? How will this help bridge the current gaps in care that you see in your patients with major depression? Iâll just echo something Chris said earlier. Which of us havenât had a friend or a family member or loved one or someone we know thatâs struggled with depression? And if we had the option to take something that could get them better within two weeks that had the option we could take again, as needed, which of us wouldnât want to think about this as a treatment option if it was our loved one? So, I think itâll have wide acceptance. We maybe use a generic something first, but I can see quite often. Once again, I take care of university students. They donât have weeks to wait. So, in my -- a lot of my patient population, I think this will be, a very favorable tool that will rise at the top of the toolbox. Yeah, I think as a build on to what Maha and Dr. Mattingly said, so youâve heard words today used in the presentation, I think Dr. Mattingly used the word game changer, I think that feedback echoes what Iâve heard as Iâve been out and about at the various congresses talking to key opinion leaders and prescribers around how they see the place for zuranolone to be used. Thereâs a great degree of excitement around what zuranolone has the potential to offer, if approved, for patients suffering with both MDD and PPD. I think in terms of where it fits in the standard of care, I donât think it actually does fit in the standard of care. I think it actually advances the standard of care for many patients that are out there that are suffering with depression. I think we touched on it, the rapid efficacy, the 14-day course of treatment, the fact that itâs well tolerated, the ability to ultimately return patients back to a state of wellbeing and to potentially experience treatment free periods, that to me is something that is really significant for so many of the 6.5 million people that are seeking a new treatment on an annual basis. Where we stand with respect to bringing zuranolone to market? We touched on, obviously, the go-to-market work that we have to do in front of us. But weâll continue with scientific exchange over the course of the year, continuing to take the data from both the LANDSCAPE and the NEST programs and making sure that it is well understood, so that at the time of launch, that data is well incorporated into the thinking of clinicians. Weâll also advance disease state education or disease state awareness around the importance of treating with urgency in the extreme importance of innovation in this space as we move forward. And not only will we reach physicians at the time of launch, weâll also reach patients quite directly. We feel like itâs really important for us not only to reach prescribers, but to activate patients to ask for zuranolone by name. And again, thatâs at the approval of the product. So, we have a profound opportunity in front of us with zuranolone to advance the treatment paradigm here. We take that mission very, very seriously, because we know so many patients are counting on both Sage and Biogen to do that with zuranolone.
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EarningCall_1688
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Good day and thank you for standing by. Welcome to the Q3 2022 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded. Thank you, Heidi. Dear, ladies and gentlemen, welcome to our conference call. A press release including financial information for the third quarter of 2022 was released this morning. It is available on our website and on EDGAR platform. A full interim report will be published later this week. On today's call, we have our CEO, Laurin Hahn; our Chief Operating Officer, Thomas Hausch; and our Chief Financial Officer, Torsten Kiedel. Laurin and Thomas will first provide an update on our operations. Torsten will then review our Q3 financials. And Laurin will conclude today's presentation with some important news. After that, we will be happy to take your questions. Before we continue, please be reminded that today's presentation will contain forward-looking statements made under the Safe Harbor provisions of the U.S.s Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, the company's actual results may be materially different from the views expressed today. The information regarding the risks and uncertainties is included in the recent filings of the company with the U.S. Securities and Exchange Commission. The company doesn't assume any obligation to update any forward-looking statements except as required under applicable law. Hi there. And thanks, Kirill. Warm welcome to everyone on this call. As you know, we are working very hard every single day to deliver on our mission, solar on every vehicle. And I want to start today with this beautiful picture here. The Sion in front of the Golden Gate Bridge, while being successfully shown in our U.S. tour recently. As you all know, there are so many challenging things out there happening right now in the world. Inflation, recession, energy crisis, Russian-Ukraine war, the COVID-19 pandemic and a very challenging capital market. And in these difficult times, people become more cost sensitive and look for affordable, yet still innovative solutions for their everyday life. And the Sion is exactly one of these technical solution. Approximately â¬25,000, very affordable, solar charging, very convenient and reduces utility bills, bidirectional charging, a home storage on wheels. Our SEVs is the perfect answer for so many people and so many problems we have in the world right now. And I was thrilled to see how the Sion resonated in the U.S. with the people we met, including press and media, potential strategic partners and other interested individuals who attended our event. Same as in Europe, people are looking for an affordable, sustainable and yet innovative car. And that's not for just another luxury EV, which the majority just can't afford. That said, let's talk about the recent milestone we have achieved. One year has passed since we went public in November 2021. And we keep on delivering on our ambitious plans. Within the last 12 months, we achieved 30% growth and are now looking at 21,000 B2C Sion reservation holders. We achieved 44% growth on the B2B side of the Sion preorders. This sums up to an incredible amount of approximately 43,000 Sion preorders and reservations, which would equal a potential backlog of over $1 billion. We achieved 130% growth with our 23 B2B solar customers where we license and sell our solar technology. We achieved an impressive 240% growth with our total of 34 patents granted or filed. And we almost doubled our staff to over 418 engineers and industry experts. And lastly, we delivered on our IPO promise and built 17 vehicles and body-in-whites of our Sion's validation fleet. Let us walk you through the achievements in more detail. Let's start with our first business unit, Sono Solar, where we license and sell our solar technology to trucks, buses, vans and more. We entered several new markets with strong customers. 130% growth since our IPO, now at 23 customers. These are industry leaders like Mitsubishi, Scania or MAN. The latter both being Volkswagen subsidiaries. These are very renowned corporations, are now starting to integrate solar into their first product, still on a prototype basis, but with a massive potential once we achieve fuel integration. We now have solar customer in over 10 countries globally, running from Japan to the U.S. So let me give you some examples of the recent customers we signed. We recently announced Scania and LLT as new customers. Six Scania diesel buses have been equipped with our innovative solar technology and are already up and running in Sweden. It's a customized version of our Solar Bus Kit. And Scania is a subsidiary of Volkswagen with over 54,000 employees. Scania operates in more than 100 countries and delivered roughly 90,000 vehicles in 2021 alone. Another customer was Pepper. Pepper has integrated our solar tech in one of their electric buses. Pepper is the world's first digital OEM in the automotive industry for repowering and new vehicle. First solar integration by Sono Motors on e-buses. So, our Solar Bus Kit is now applicable for diesel and electric buses. We are expecting the e-bus market to gain significant market share over the next five plus years. We have 1.3 kilowatt peak installed on an electrified Mercedes-Benz Citaro. And more and more customers are beginning to understand the value of solar integration to reduce TCO and CO2 emission. This is especially the case for commercial vehicles. But there's more to that. We have made great progress with our seamless solar integration, going from vehicle applied photovoltaic, short VAPV, to now vehicle integrated photovoltaics, short VIPV. We have now developed our sixth generation of solar technology and this trailblazing solar technology is so unique and proprietary that other OEM started to approach us to find out more. And here, I'm not speaking about commercial vehicles, but passenger car OEM. So, let me share some exciting news with you today. We received the first purchase order from one of the world's largest car manufacturer. The scope of the order is the delivery of solar body panels for a first prototype. Together with Sono Motors, this OEM wants to explore solar integration into their high volume vehicle production. We have worked with that OEM customer now for several months, and believe this partnership shows the potential that our technology and business have to move to the next level. On that note, let me answer the question why other car manufacturers should license our solar technology. And yes, it's because of three simple answers. First, they want to avoid a huge reengineering effort. Second, they don't want to lose time to come to the market. Or to say it in another famous words, if a trend becomes obvious, you are too late. And third, they don't want to infringe our patents. So, our technology is an already developed technology, which saves time; ready for large scale production, it's industrialized; and it's protected with a very strong IP. Thank you, Laurin. And thank you for showing us the Sion in front of the Golden Gate Bridge in San Francisco. Here you can actually see the Sion in Brooklyn, where we calculated an average yearly free range from solar powered vehicle of nearly 5,000 miles or 8,000 kilometers. Overall, we're making good progress on our Sion. We are on track with testing and series validation. We have now produced and fully assembled 17 vehicles and bodies in white and plan to complete 32 of them within the next weeks. We're testing in several locations around the world including aerodynamics and wind tunnel tests in Sweden, steering and other driving dynamics tests in the Northern U.S. and consumption and efficiency testing in Spain. On the development side, overall, we're progressing as planned. We've entered a release process for series, which marks the completion of a core stage of development work. We continue to order series development tools. Key functionalities, such as discharging, charging, solar yield, drivability, infotainment, were successfully tested. And of course, the final validation is ongoing. Good news also on the series production. We have received more series tools. We've nominated more series suppliers. We continue to have detailed alignments with Valmet Automotive regarding our manufacturability and next line builder commitments for our body shop and general assembly. However, a reduced funding speed drives the delay of the SOP from the second half of 2023 into Q1 2024. Our definition of SOP continues to be handing over sellable product to customers, not just producing vehicles alone. You can see that we're preparing for series production and servicing. And that's why we are tied up now with a Europe-wide partnership with Bosch Automotive for the long term. We're working with them for servicing and repairing the Sion in Europe. This completes our three pronged approach to allow self-repair to the customer, empower independent workshops, but also create a Europe-wide dedicated partner network. In our case, for the Sion launch, we're starting with 50 Bosch Car Service locations in Germany to be trained and qualified. More locations in European countries are following in the course of the subsequent rollout. Bosch Automotive aftermarket gives us access to over 10,000 workshops in Europe as one of the world's largest grouping of repair locations. Another one of our important partner is Continental. We appreciate partnering with such a well-established Tier 1 supplier. And I'm showing here an advertisement created by Conti. Conti, and formerly also Vitesco â Conti in their former function also as Head of Vitesco already supplied us with our electric drive unit for our SEV2 years ago. Here in our SEV3, our series validation vehicles, you can see many applications from Continental including ADAS function, vehicle control unit software, and many others, just to name a few. So much about this Sion. Let's give a corporate update and start that one with the Sion here in Los Angeles where we calculated an average yearly free range from solar of nearly 6,000 miles or 9,000 kilometers. We created these real pictures just recently on our first U.S. tour for Sono Motors. The feedback we received on this tour from our Sion series rehabilitation vehicles, but also for our overall company and the solar business was quite rewarding. In October, we showcased this for three weeks. We had interviews with CNBC, Barron's, CNET, Axios, Boston Globe, among others. And receiving the broader interest for our solar EVs in the U.S. showed the generally huge and positive interest in solar technologies as well. As an impression for you, we selected seven pictures representing our seven locations we serve. Feedback from the people we met, including press, potential investors and other interested attendees, was very positive. For example, many followers and interested parties perceived the Sion as being much bigger, more spacious in real life than in pictures. There was excitement about the smooth integration of the solar wafers. Whoopi Goldberg was especially convinced by the affordability of the product. The wish and need to see our vehicle on the road and to see the application of our technology was evident to everyone on our small team on the tour. Further progress was made in our team composition and protecting our IP. We're now well over 400 employees by the end of Q3 2022. In December, 418, with more than 300 engineers. About 50% of our employees have an international background, with currently 45 nationalities represented at Sono Motors. Based on the aforementioned funding speed, we have implemented a hiring freeze since November to control our operational expenses. On the patent side, we continue with high speed for filing patents. We have now five patents and utility model applications filed in Q3. Three additional filings since the end of Q3. In total, we have now four patents granted. 30 patents or patent utility model applications filed as of December 8. Thank you, Thomas, for the warm welcome from my side. Let me start with our year-to-date financial results. In the first nine months of this year, we significantly increased our revenues and achieved â¬180,000 from Sono Solar and Sono Digital compared to no revenues at all in the same timeframe in 2021. In parallel, we made substantial R&D investments with almost â¬90 million spent in the last nine months in comparison to â¬27 million year-to-date September 2021. We also started purchasing necessary machinery and tooling in preparation of the start of production and capitalized approximately â¬42 million as of September 30, 2022 versus â¬1.5 million one year ago. I'm also glad to highlight that despite the strong growth in our operations and headcount, we were able to keep SG&A costs well under control with approximately â¬16 million for the first nine months in comparison to â¬13 million in the same timeframe last year. That's nearly an increase of â¬3 million. Let's look at the third quarter in more detail. The revenue growth accelerated particularly in Q3, with six times higher sales compared to the previous quarter, resulting in â¬138,000 in revenue. Our cash and cash equivalents were at roughly â¬33 million on September 30 of this year. Since liquidity is essential in such a challenging market environment, let me also update you on our current and expected liquidity. It's approximately â¬55 million as of November 30, which consists of â¬25 million of cash and cash equivalents and the signed agreement for the sale and issuance of up to $30 million of convertible debenture, on which I'll provide more details on in a minute. The substantial investment, combined with the SG&A, resulted in approximately â¬56 million net cash outflow in Q3 of this year. Looking ahead, I'd like to share with you a helicopter view of where we stand on the development side and how that connects with our funding needs. Overall, we've raised around [â¬300 million] over the last couple of years. This allowed us to achieve the series validation vehicle fleet in our car business. And on the solar side, we were able to develop the aforementioned sixth generation of solar panel integration and to deliver the first prototypes to many renowned vehicle manufacturers. You've come this far and now we have a fairly short distance towards launching Sion production. We currently estimate that we need approximately â¬130 million until the next crucial milestone, the pre series vehicle release next summer. Thereafter, we estimate that we'll require only an additional â¬80 million to start delivering the first Sion to our customers in Q1 of 2024. We're currently in the process of securing this funding. Just this morning, we announced an agreement for the sale of convertible debentures with Yorkville Advisors. We will get net proceeds of $30 million in three tranches. The first one upon signing, the second one upon signing a registration statement, and the third one upon effectiveness. We're quite happy with the favorable terms we received â a 4% interest, no warrants, FX conversion price of $1.75, unless the stock price is below that level, then a variable conversion of 96.5%, the lowest daily EVOP during the seven prior days. Conversion below the fixed conversion price are limited to the greater of either 20% of the monthly trading volume or $5 million per month. And the limitations can be waived at the company discretion. What I'd like to highlight here is that while the debentures provide us with meaningful upfront capital, the conversions related to them would effectively replace our use of the existing committed equity facility or our new ATM going forward since both are now limited to 2% of daily trading volume, subject to exceptions for days with high trading volume. Worth mentioning is that we also filed a registration statement on Form F-3. We made this move because we recently became self-eligible and wanted to add this vehicle to our finance toolbox. On December 7, Sono Group also entered into an at the market sales agreement with B. Riley, Berenberg, and Cantor Fitzgerald acting as sales agents. The size is up to $135 million and the sales agent commission is 3%. As mentioned before, once the debentures have been repaid, the ATM program will replace the existing committed equity facility that we have been using in the last 4.5 months and it's meant to enhance our access to capital. Given the same convertible debenture agreement, we don't plan to use the ATM extensively until the convertibles are redeemed. I've now shared the pillars of our funding strategy for Q4 that are already secured. We started with a â¬33 million in cash at the end of Q3, secured an agreement for the convertible debentures with $30 million and already had inflows via the committed equity facility of approximately $7 million this quarter. Summed up, we have secured â¬70 million in total. Let me now share with you how we plan to close the remaining gap of approximately â¬130 million to finance the next big milestone, the pre-series vehicles that will already come from our â at our production partner, Valmet Automotive, in Finland. The most significant source of funding will be a community marketing campaign we are launching right after this call. With the support of our strong community, we are planning to raise â¬84 million net, which translates to 3,500 full Sion down payments. In a moment, Laurin will provide more details on why we strongly believe this is the right next step. Let me just comment on the additional two instruments we are planning following the successful raise of the envisioned â¬84 million. We plan to tap capital markets again and raise a total of approximately â¬50 million via additional sale of new equity. We've had ongoing dialogues re IP lending and asset-based financing secured with our patent and the production machinery to further leverage the funding as much as possible and to keep dilution as low as feasible. Also, in our own interest. We will keep you updated once there's news. Before I hand over to Laurin, I'd like to share some more thoughts about the funding in general. We've achieved very important operational and commercial milestones since we went public one year ago. These include signing promising partnerships in our solar business and presenting our first Sion series validation vehicles. At the same time, high inflation and rising interest rates as central banks seek to curb inflation have resulted in negative sentiment in the financial markets since the second quarter of this year, with many tech companies losing between 50% to over 90% of their respective market cap. Shares in mobility tech companies have been particularly hard hit. As a result, financing our CapEx program through equity has become challenging and dilutive for existing shareholders. One view of the investment community is that we should focus on capital light revenue generating solar business and abandon the Sion project. We hear you, and we will be willing to streamline our business. As a public company with shareholders, we have to be open to any and all alternatives that are best for the long term prosperity of our company. However, we believe one aspect that makes Sion unique is our very strong and loyal community. They want us to bring the Sion on to the road as much as we do. We believe that, with our community, we can bridge that difficult market environment, reduce the overall funding need and prove to the capital market the strong demand for our solid technology and our affordable SEV design. Thanks, Torsten. I want to start with, we have an incredible â¬1 billion of potential backlog revenue, with over 40% with down payment. So, before we dare to decide to stop the Sion project, we want to give the approximately 21,000 reservation holders, our community, one last chance to prepay the car in full. And by doing so, partially solve our funding hurdle. These 21,000 reservations are an equivalent of approximately â¬460 million when converted into potential revenue, with almost â¬600 million worth of B2B preorders. On top of that, we have a potential order backlog of more than â¬1 billion. So why not asking the community to help to bridge the funding that? Well, this is exactly what we plan to do by launching a special marketing campaign. We are calling this special marketing campaign Save Sion. With it, we will give our customers community the chance to prepay the equivalent of 3,500 Sion within 50 days. To make this clear, our community is an invaluable asset. We believe no other company has such a strong community. So, the community engagement is planned like this. We launch a special marketing campaign today. We ask customers for an upfront payment of their car reservations equivalent to 3,500 Sion full price payments. This would lead to â¬100 million cash in, including VAT. And here's the simple message we give to our community. 21,000 people have reserved the car. The vast majority of people plan to pay us the full down payment as soon as they expect to get the vehicle. So now, we ask them to give us some of the money 12 to 18 months earlier in order to start the production of their car. And they will only have to pay if the campaign is successful. In order to support our message, we have planned a very intensive marketing campaign around it. Our planned activities are to start under the hashtag #SaveSion, an exceptional social media campaign, with transparency as a key factor of success. Additionally, we started a Sion tour from Germany, Austria, Switzerland, Netherlands, 12 cities, inviting 10,000 people. We give incentives for advance payment, up to 10% discount for full priced down payment. And the campaign will last for 50 days from December 8 until January 25. This is a complete new way of marketing. And we have great experience in it. We have been successfully funded by the community in the past. In 2019, we raised â¬63 million in payment commitments in 50 days through prepayment, loans, donations, but no dilution for equity. At that time, it was the largest of its kind for a hardware product in Europe. The public feedback was overwhelmingly positive. We received positive press coverage around the world. So we also believe this time in our strong community. We have done it once in 2019. Now, with the Sion in its final production design in comparably higher brand awareness and a shorter distance tour towards the start of production, we are confident that we can work this out and that we can be successful with this campaign. The numbers speak for themselves. We have since then doubled the amount of the community members and we plan to raise double the amount of the money now. So, it's doable. We can achieve it. If it doesn't go as expected, we will focus on the B2B solar only business case as a very attractive alternative, which is significantly less capital intensive. We believe we already have all the resources on hand to roll it out. Moreover, we have had a number of promising negotiations with potential strategic partners interested in our solar technology. So, we would not rule out some strategic alliances here. So, let us prove you and all investors out there that it's about a car that has massive potential, a community that has one belief, a belief that even a small group of people can make a difference. So, let's do it. Let's bring the Sion to series production for a world without fossil fuels. [Operator Instructions] We will take our first question. The first question comes from the line of Christopher Souther from B. Riley. Please go ahead. Your line is open. So maybe just, you called out initial shipments to automotive customer looking at integrated solar for potentially high volume vehicles? Can you talk through the steps and timelines that you have ahead of you in order to get design wins from that customer? I just wanted to frame where we think we are in that process. And great to see that process starting to kind of kick off. Sure. So usually, this goes in three main steps. The first step is a prototype in order to convince internally the management and the engineers to take a look and to test this solution. That's the first step. The second step is then series development where you have two to three years of series development until it goes into production. And that's the first step, series production. Got it. Okay. And as we're looking at â¬130 million that we need to get to pre series production, can you give us a sense of the timing of the cash out? It sounds like there's kind of a go or no go decision based on kind of the community? Can you just kind of walk through timelines that we should expect around the Sion cash needs and decisions there? First of all, it's good to see that we have access to the â¬70 million I mentioned, as a starting point. So that's already a big step towards the funding need. And the additional capital, this is why we're kicking it off today. The sooner we have transparency, the sooner we can kick off purchase orders for some of the bigger machineries and toolings that we need to kick off as soon as possible. So the timing Laurin talked about is a 50-day campaign, and hope to see along, over the next couple of weeks, how we're progressing there. And then, as soon as we have more transparency on the potential success of the campaign to kick off the required or necessary purchase order for the machineries. Okay. Got it. And just last one, are there any strategic opportunities as we're kind of entering kind of a new year as far as other OEMs out there that are looking for credits? Would it still be too early for you guys to start pre selling emission credits, that kind of thing? Are there other opportunities with kind of existing OEMs as far as strategic opportunities to help with the financing there? You know better than us, we're a publicly traded company, so we only give you the information that we can give out. Fact is, however, we continue to â are in discussions on the items you just mentioned with not only one passenger car OEM alone. So we continue on the business that we have started two years ago at CES at the end of -- at the beginning of 2021 to continue to talk about other opportunities, including the credits you just mentioned. Of course, as you know, they're effective in Europe only when you register the first cars. So, the priority for us is now to make sure that we are successful in the campaign we just presented to you. Thank you. We will take our next question. And the question comes from the line of Eric Stine from Craig-Hallum. Please go ahead. Your line is open. So just to kind of stick on the point from the previous question. So, on the 50-day campaign, it sounds like optimism on that front. Can you just talk about â in the scenario where you have to pause that affects the decision that you make, does that impact anything with Valmet? Does that -- I mean, is it something you're able to â I don't want to say easy, but you're able to stop and then start again if you're in a position to do so? Or how does that just kind of impact the relationships and the work you've done to date? Yes. Thank you. That's an awesome question. So as we inform the public, of course, we also inform our suppliers. And of course, as I mentioned earlier, with the funding that became more complicated, as Torsten described it over the last couple of months, we have made the decision that we presented today to move our SOP from the second half of 2023 into the first quarter of 2024. So we did, of course, this in concert with suppliers. And we do not expect any dramatic impact from delaying our SOP with any supplier. Can never rule it out. But specifically with Valmet Automotive, it's a very good partner. So, no, we do not expect from that campaign in the announcement today anything but the delay we just mentioned. Right. But if the -- let's say at the end of the 50-day campaign, you realize that maybe you need to push that a little further. Is that something that â I would assume you'll be kind of having conversations ongoing with your suppliers, so that they're aware of the situation. But is it fair to say that that wouldn't cause a great disruption and that is something that you can start up again or get back on that timeline pretty easily if you're able to do so. Well, we want to act now and to try not to drag it out endlessly. So we have been successful in the past with the 50 days, raising those â¬53 million in payment commitments. Now we have doubled the amount of community members. We have so much more visibility in the market. We cruised to such a corporation by now, so that we are very confident that we can make it. Okay. Got it. And then just on the good news on the PO signed with the large OEM, just curious, with financing top of mind, any thought or any interest from some of those large partners potentially in some sort of strategic investment to kind of help alleviate that. I know you're probably limited as to what you can say, but anything along those lines might be helpful. Yes. Sure, of course. We have some kind of confidentiality limitations here. But of course, we would be foolish not to speak to potential OEMs or to OEMs out there about a potential strategic investment. And of course, those who receive or are currently looking into our solar technology would be the ones most likely to invest. But you also know how it works. With big OEMs or big corporates, it does take time. So for us, it's great to see there's interest in technology. We take this as a first step and we believe, once we have proven the technology works, yeah, then, consequently, conversations will continue. [Operator Instructions]. We will take our next question. Our next question comes from the line of Andres Sheppard from Cantor Fitzgerald. Please go ahead. Your line is open. Yes, my pleasure. And so I wanted to maybe clarify a little bit on the funding strategy. So, I see you've raised -- you've mentioned your raise at â¬70 million. You expect to raise an additional â¬134 million. And so, I just want to make sure I understand this correctly. â¬40 million of that is expected to be a new capital raise or debt. â¬10 million will be from the ATM and then the rest is from the community down payments. I guess if there's any issues or delays in the community down payments, and would that change the amount that you expect to raise? -- I'm sorry. I just want to get more color on the capital funding strategies, particularly in regards to ATM and to the community down payments. Anything you can say there? Particularly given where the maybe the stock is trading, is the ATM â do you still expect to use that? First of all, let's start with the ATM. Or in the past, the committed equity facility. As you probably saw, our daily average trading stock volume increased significantly ever since we went to the U.S. in order to present our solar technology and the Sion. Prior to the U.S. tour, the weeks prior to that, we averaged around 300,000 on a single day. And now, we're looking at more than a million. I believe that latest number was 1.7 million for the last month of average daily trading volume. So significant improvement there. As I mentioned before, since we now signed the convertible debenture with Yorkville, we will limit the usage of the formerly committed equity facility, in the future ATM, in order not to put too much pressure on the stock. So, it's limited to 2%, and there's an exception for very high trading volume days where we can use it to a bigger extent. But of course, interest here is to keep dilution as low as possible. We spoke extensively about the community down payments, about the marketing campaign, and why we believe this is the right next step. It's non-dilutive. It's an incredible community we have out there. And this would reduce the overall funding amount significantly. And of course, as you can imagine, one of the feedbacks in the past was, you still need a lot of money. We know it's not a lot of money from an OEM perspective, it's not a lot of money in comparison to many of our peers. But having to raise more than â¬200 plus million still until start off production is quite some money. And this is why we believe achieving a successful community campaign or marketing campaign will reduce that amount significantly and that will make it easier for equity investors to realize the potential there is in our technology and in the stock as well. Got it. Thank you, Torsten, that's very helpful, very detailed. Appreciate it. Maybe as a follow up, can you just remind us what the kind of the cash burn or the cash outflow expectations are maybe on a quarterly or annual basis? I think in the past, you had mentioned the operating and investment cash flow outflow of about â¬165 million for the second half of this year and a little bit north of â¬150 million in 2023. So have those numbers changed? Are they kind of expected to be the same? Thanks. Yes. So what has changed is, of course, we try to adapt to market environment as much as possible. So we try to postpone some expenses. And we did the hiring freeze that Thomas talked about, and started that in November, to be as efficient as possible with the money we have received. I think this is key. We decided against layoffs. Of course, there are many tech companies right now laying off people. It comes at a price. And this is why we decided let's take the step of a hiring freeze. Looking forward, the internal burn rate is less than â¬5 million a month, mainly for salaries, the 400 plus employees we currently employ here in Munich, and then some other OpEx. Of course, what we need to do is continue to invest in CapEx. Majority of the use of funds, as indicated in the past, is for production machinery and toolings. We trigger the purchase orders, so we drive the - when we need to pay for those orders. And this then is connected to when do we get access to the money in order to then purchase the production machinery toolings. Thank you. We will take our next question. And the question comes from the line of Austin Zocco from Freedom Capital Markets. Please go ahead. Your line is open. Hi guys. Congrats on a successful third quarter. Just had a couple of questions here. So, like as you've probably seen, last month your competitor Lightyear announced that they've begun production and are planning to scale early next year. So, what is Sono's plans around staying ahead of a competitor in the space like Lightyear in the solar auto industry? Hi, thank you Austin. Awesome question. First of all, believe it or not, but we love every EV that gets produced and put online. We even love it more if solar electric vehicles get out there. We don't see any competitor in the next 10 years in the market that's increasing massively. Particularly, shoutout to Lightyear. If I'm not mistaken, the car is about 10 times our price. It's a wonderful product. It's a low volume, high priced product. And with that kind of production, you actually do a lot of work by hand. So you have a lot of high variable cost. While we have the first affordable solar electric vehicle, and that's why we're upfront investing into tools and machinery that makes this car sell at â¬25,000 or roughly $25,000 net. So that is the main difference. And we hope to see many more solar electric vehicles coming out in the future. Great. Thanks for answering that. And I just had one more around on the marketing campaign that you guys are running. So are you a little concerned about like upsetting your customer base if you don't hit the delivery milestones like you publicly announced of starting at Q1 of 2024? Are you concerned that maybe some of the people that paid down early are going to be upset if you guys have to push back products, I mean on delivery. So, we're trying to be very transparent with our community, publishing biweekly â every second week, a sprint report on our website. We're publishing even on our website, the exact time plan to production. And, yes, another delay is, of course, not a great news to our customers. But we are trying to be that very transparent OEM who delivers also the reason for it, the rationale behind it and we think our community can deal with it. Thank you, Heidi. Thank you all for joining our conference call. If you need more information, please take a look at our website or reach out directly to our IR team. Have a great day and hope to be talking to you soon. Bye-bye.
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EarningCall_1689
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All right. Good morning, everybody, and welcome to Victrex's Full Year Results Presentation for 2022. Welcome also to those that are joining us on the call today. So firstly, some introductions. I'm Jakob Sigurdsson, CEO of Victrex. We also have our relatively new CFO, Ian Melling, with us here today. And as you know, this is Ian's first outing as the CFO for Victrex, and that we're really pleased to have him on board. Also joined by Martin Court, our Commercial Officer - Chief Commercial Officer; and Andrew Hanson, our Director of Investor Relations, is also in the room. Firstly, a couple of housekeeping advises. So the slide presentation is on our website at www.victrexplc.com under the Investors tab. And by clicking on Reports and Presentation, you'll find it there. And we'll make sure we call out the slide numbers when we are speaking today to aid your navigation through the presentation. Secondly, we will have a Q&A at the end, and I will open up the questions to those in attendance here first and then we take any questions from those on the call thereafter. So turning to Slide 3. I thought it would be useful to summarize our key messages for FY '22. We're really pleased to have delivered a record revenue and record volumes in FY '22 with revenues up 11% to pound £341 million and sales volume of 4,727 tons, so up 8%. I'd like to put this in the context of where our core business was in 2015, feels like 8 years ago, which was at the height of the large consumer electronics contract, meaning that we have now seen our core business grow from 3,200 tons approximately to over 4,700 tons this year and near 50% increase, which represents a CAGR of around 6% over the 7 years despite the impact of COVID and despite the fact that there's still quite a bit of unmet demand out there from pre-COVID times. More importantly, as I said, we have a number of end markets which are not fully recovered to COVID and are, therefore, yet to show up in these numbers, and I'm particularly thinking about Aerospace, Automotive and Medical, as three examples. It's also interesting to note that we continue to further diversify our core business with new applications across both Industrial and Medical. For example, we're making some really good progress in applications for wind turbines in medical. We've seen advances in E-mobility, as well in wire coatings. And in Medical, we see a very good progress in craniomaxillofacial applications and in emerging applications in cardio also, including in artificial heart - artificial heart. And this is really before we turn to the progress of our mega programs which have seen a significant advancement during the year. So in summary, we're really pleased with our progress across the top line and most of our end markets. We know we have ongoing challenges from inflation, which impacts the level to the bottom line. But the growth opportunities for Victrex remains sizable, and we're making really good progress on improving the bottom line in correlation with great advances that we've seen both on volumes and revenues. Moving to Slide 4. Before we cover the '22 highlights, just want to spend a minute on what we're doing on sustainability in ESG. I think it's fair to say that sustainability is integral to everything we do and actually always has been that way at Victrex. It's a part of our purpose to enable transformational and sustainable solutions to our customers. It's a part of our business model as well. Remember that our sustainable products enabled environmental and social - societal benefits through supporting both CO2 reduction, energy efficiency and patient outcomes. So a brief word on FY '22 sustainability highlights. So our sustainable product revenues are at 48% now and tracking towards 50%. Although I have to point out that this excludes the volumes that we sell to value-added resellers because those are difficult to track still. We know that a good chunk of auto volumes go through VARs, some electronics too, particularly to semicon. So the actual number is probably quite a bit higher than this number would indicate. In resource efficiency, this year, we achieved 100% renewable electricity for all our U.K. sites and at 97% globally. We also completed our life cycle analysis and the initial Scope 3 emission project. And the good news is that Victrex PEEK is indicatively lower on CO2 global warming potential than the industry average. We will have more details on this in our annual report that is due shortly after Christmas. Finally, Social Responsibility is a key area for us. Continue to see employee volunteering and provides charity work. We also support STEM activities, and I'm pleased to say that our focus on diversity, equity and inclusion is progressing well with our female in leadership roles increasing this year and our target there is 40% by 2030. Turning to Slide 5. I signaled that our sustainable products were 48% of our revenues. At the current time, we do exclude oil and gas and value-added resellers from this definition. Given the emphasis that our value-added resellers are placing on ESG states, I'm confident that we can get added granularity on what fraction of what we sell to them actually ends up in sustainable applications. So as I said before, this number is likely to be significantly larger than this number that we're presenting today would indicate. We include auto, aero, medical and some energy and industrial applications. We also include some products within electronics where we have a quantifiable energy benefit associated with the use of PEEK in certain applications. As you can see from the slide, some really good examples, Headlines, you know, for example, we say three times more CO2 annually in aerospace through our sales there and replacing metal compared to what we produce in our own entire operations. In medical our materials are supporting better patient outcome and therefore, social benefit. One example is the brain study done using PEEK in craniomaxillofacial applications rather than metal as an example. So really strong and broad portfolio of sustainable products. Now moving on to Slide 6, looking at FY '22 highlights. Ian will cover the financial details shortly. But overall, we've seen really good progress across the core business and our mega programs. We also saw a much better average selling price in the second half, so price increases started to kick in more materially and we have broadened the range of options for pricing as well, now including surcharges as a part of a mechanism to recover what has been an unprecedented magnitude and speed of input cost rises. We are well aware of the macroeconomic challenges from inflation and how that held back PBT and gross margins. But importantly, we have seen better pricing, and we've also seen much better operating efficiency. In our mega programs, I will cover the detail later, but some very, very notable progress. Remember, our mega programs have all proven that they are technically feasible, and we're building a commercial traction now, so they're already well on the journey to greater revenues. Sales from new products, which include mega programs and new polymer grade or 6% of sales versus - or £19 million this year versus 4% and £12 million last year, so good progress. Really notable progress in medical with trauma and our In2Bones partnership, which I will speak a little bit about later. And with knee, we have 30 patients implanted now, 12 of them passed the 1-year mark with no intervention and really happy to talk about and announced a major development collaboration with Aesculap, which is one of the top 5 knee players in the world where we can look forward towards commercialization of our product line with them. On the industrial side, we saw really good progress in Gears and in E-Mobility, particularly around wire coatings. And in aerospace, you know, the first large structural PEEK parts are now real and starting to emerge the demonstrated parts for the Airbus Clean Sky 2 program. These are being exhibited as prototypes, and the loan offer - the potential for 10 times PEEK content increase compared to what we had in aerospace today. Really a fruit of a lot of hard work for many, many years and starting to show up in large structural parts that we think will make a significant contribution for our business going forward. And finally, on Magma, the bid programs have now been submitted and TechnipFMC is awaiting the outcome from that and are actually actively working on scaling up the production facilities in Brazil right now. And hopefully, we will have more news flow through TechnipFMC in the first quarter of next year. I'll now hand it over to Ian, but I would also like to say that none of the progress we've made would have been possible without us maintaining a strong financial position with high levels of cash generation, which also allows us to invest for growth. Like in China, as an example, or increasingly now in medical, as you've heard us talk about in recent times. And on top of that, we're also being able to pay dividends to our shareholders. Good morning, everyone. Firstly, I just wanted to say how pleased I am to be here with Victrex today. Having been here for nearly 6 months, I can say that what I saw from the outside looking in is true within the business. As you'd expect from the CFO, I must start with the strong financial position, but it's also important to note the significant growth opportunities, culture of innovation and growing ESG credentials through our sustainable products. Clearly, like many companies, we also have our own short-term challenges, which we are managing. I look forward to meeting you all and keeping you updated on our progress. Starting with Slide 8 and our P&L, an overview of our results for FY '22. As Jakob said, we are pleased to report record revenue and volume. At the revenue level, we reported full year revenues of £341 million, up 11% on the prior year, with revenue up 10% on a constant currency basis. We saw some benefits on revenue from currency during the second half, the sterling weakened. We saw particularly strong growth in value-added resellers, Electronics and Energy & Industrial, each of these saw double-digit growth during the year. VAR had a record quarter during Q3, 646 tons. We did see some sequential softening in our final quarter, primarily a normalization within VARs. Although we note how Q4 is typically seasonally weaker than Q2 and Q3. As we note in our outlook statement, several end markets are still to fully recover from the effects of the pandemic and continue to offer good growth opportunities even if the near-term macroeconomic - uncertain. Gross profit increased by 6% to £174.5 million or by 10% on a constant currency basis. As we measure the future success of our polymer and part strategy, the focus on volume will diminish in favor of gross profit and driving value from our solutions whilst continuing to measure return on capital. Our reported gross profit is stated after the impact of currency hedging, where we reported a net loss of £2.8 million compared to a £4.9 million gain in FY '21. The higher cost of manufacturing continues to impact us and consequently hit our gross margin, which we signaled will be lower in the second half and was 51.2% on a full year basis. With currency and sales mix also impacting us here. We also show here FX hedge adjusted gross margin, a measure which treats the hedging as within revenue rather than COGS in determining the margin and which was 51.6% this year. I'll come back to this later. Overheads excluding exceptional items were up 7% on the prior year, with innovation and growth investment driving this. As previously communicated, we also had to build up overhead to support the preparation and commissioning for our new PEEK manufacturing plant in China, which was approximately £3 million over the course of the year. This was offset by £3.4 million lower bonus accrual. Our underlying profit before tax increased by 4% to £95.6 million or by 12% on a constant currency basis. Reported PBT was down 5% to £87.7 million, which reflects the £7.9 million exceptional item incurred for our ERP system, this investment is progressing to plan. We expect the total investment for our ERP system to be in the range of £15 million to £20 million with completion in FY '24. As signaled previously, Software as a Service accounting rules mean we have to treat this as an expense rather than it being capitalized. Our effective tax rate of 13.9% was materially lower than FY '21s rate of 21.3%, which is primarily as a result of the restatement of deferred tax balances in the prior year. Our guidance for the effective tax rate remains in line with our previous communicated long run average range of 12% to 15%, which increased slightly from the previous 10% to 13%, reflecting the changes in U.K. corporation tax rates. We also continue to benefit from the lower rates available through the U.K. Government's Patent Box scheme with the patents in place since 2017. Earnings per share increased by 14% to 95p per share on an underlying basis and by 4% to 87.6p per share on a reported basis. Finally, a brief word on our dividend. Whilst we see an uncertain macroeconomic outlook, we've seen a steady start to the year, as noted in our outlook statement. The Board is, therefore, pleased to recommend a final dividend of 46.14p per share, giving total dividends of 59.56 per share for the year. It should be noted that the FY '21 dividend number shown on the slide reflects a 50p per share special dividend. Turning to Slide 9 and the underlying year-on-year profit before tax movements. We can see the effect of strong volume growth and the recovery in medical as elective surgeries returned in greater numbers. As I will come to on a later slide, sales mix was slightly weaker year-on-year, which impacted margins. This is mainly the effect of VAR and the other industrial end markets driving growth. We should note that within medical, we saw stronger growth in non-spine, which is now 50% of medical revenues. We have a significant range of growth opportunities as we have diversified the medical business over recent years with the mix now shifting towards non-spine, although we are making good progress in spine areas such as Porous PEEK, which offers us an attractive opportunity. The first round of price increases kicked in more materially within the second half to support inflation recovery with a benefit in the year of £6.5 million the large majority of which was in the second half. We expect to full annualization of this benefit in FY '23, along with further price increases in part in response to the further increased energy and raw material costs. We have broadened the range of options for price increases, including surcharge pricing and we have begun to implement these. Two remaining key items to flag, our operating efficiency and inflation, under recovery of our fixed manufacturing cost was the principal cause of the decline in PBT during FY 2020, and we have been seeing improvement since. Remember that in the prior year, we unwound a significant amount of inventory built up for Brexit, meaning our production volume of around 3,500 tons significantly liked our sales. In FY '22, we saw a £10 million improvement in under recovered fixed costs through much better operating efficiency with the production volume of around 4,600 tons much closer to sales volume. We do have some remaining under recovered fixed costs, primarily in our downstream assets manufacturing product forms or parts, and we're tackling those. Energy and raw material inflation was in line with our expectations at £18.3 million in the profit and loss account with approximately 60% of this being driven by U.K. energy costs, which, as most commentators have noted, grew among the fastest in Europe. For FY '23, as we noted in our announcement today, we are anticipating a further year-on-year cost inflation impact of potentially up to £20 million between raw materials and utilities even with the government - the U.K. government's price cap for 6 months. As I mentioned, we are already progressing a further wave of price increases to support recovery. I've already touched on start-up costs to support our China investments which will be higher in FY '23 with investment for growth being in support of mega programs and innovation. As Jakob will cover later, we're also seeking to prioritize investments in our medical business with the intention of this becoming a larger proportion of our revenues over the longer term. Finally, we saw a - sorry, £6.7 million headwind from currency at the underlying PBT level. Moving on to Slide 10, pricing. Our full year average selling price was £72 per kilogram, some 3% better than last year as we saw price increases kicking in during the second half and benefited from currency on revenue. In the second half, our ASP was £73 per kilogram, up 4% sequentially from H1 and also 4% versus H2 2021. Again, just to be clear, our sales mix was slightly weaker over the year with VAR driving growth. A quick word on ASP guidance for FY '23 with an anticipated normalization within VARs but further improvement likely in medical, as well as the indicators we are seeing for the aerospace end market and build rate increases, we do see the opportunity for ASP to improve close to £80 per kilogram, reflecting mix, price increases and the benefit of currency, even if volumes do not progress much versus FY '22. Turning to gross margin. Gross margin declined from 54% in FY '21 to 51.2% for FY '22, a 280 basis points movement. FX hedge adjusted gross margin, which treats the hedging impact within revenue showed a more modest decline from 53.1% to 51.6%, a 150 basis point movement. I'll cover the major movements on the next slide, but the key message here is how the unprecedented energy and raw material inflation - inflation impacted our cost of manufacture. Whilst we've been recovering that through price increases and efficiency it's been with a lag effect, reflecting the timing of contract renewals. Our intention remains to recover our gross margin percentage above the mid-50s once energy and raw material inflation starts to stabilize. For FY '23 specifically, margin will remain challenged. With shutdown work for our U.K. asset improvement program, we won't see the same asset utilization improvement we saw in FY '22, although mix and currency should be supportive with a higher cost of manufacture will remain a challenge in the short term. Moving to Slide 11. And the gross margin bridge, including the effect of currency. This chart is intended to show how gross margin was impacted by market conditions despite progress on price and operating efficiency. In FY '21, the principal drivers on margin were under absorption of overheads, inventory provisions and mix, as previously explained. Although sales mix was softer in FY '22, we saw a bigger improvement in the under recovery of fixed cost this year which benefited us by 780 basis points. Price increases helped improve gross margin by 450 basis points. Mix was slightly softer, as I previously explained. But unfortunately, the biggest impact on our gross margin was cost inflation equating to 10 percentage points or 1,000 basis points. This means that improvement in our gross margin from efficiency and price was held back by energy and raw material inflation. We're making progress on inflation recovery. As I signaled earlier, margin will remain challenged in FY '23. But we do see an opportunity to improve gross margin over the medium term based on operating efficiency, inflation recovery and mix once energy and raw material prices start to stabilize. On Slide 12, we cover currency. The impact of currency hedging is shown on the face of the P&L in line with IFRS 9. Note that the offsetting currency impacts on underlying trading are embedded in the other lines most significantly revenue. We saw a net £7 million headwind at the PBT level during FY '22. This was largely the impact of the strengthening of sterling in the prior year. The loss on forward contracts was £2.8 million compared to a £4.9 million gain in FY '21. As we all know, sterling depreciated against the U.S. dollar quite materially during the second half with the year-end rate at 1.1. Our effective rate was 1.38 for FY '22, including the effects of hedging. Against the euro, the effective rate was 1.14, unchanged from FY '21. If we look forward into FY '23, given the depreciation of sterling and the current effective rate of around 1.27, our guidance at this stage is for a currency tailwind of approximately £4 million to £6 million at the PBT level. Remember, we are largely hedged for FY '23. So any change to this will be limited. We're starting to hedge FY '24, and we'll update as we go through the year on the currency implications which at current rates would imply a modest tailwind. Moving to Slide 13 and CapEx. Total cash CapEx was £45.5 million, slightly ahead of FY '21. Beyond maintenance CapEx, our largest slug was in support of our China investments in assets and capability. As you can see on the slide, we made good progress in getting to mechanical completion by the end of FY '22. And this new facility in Panjin is in commissioning with the aim of commercial production later in 2023. I'd also like to mention safety performance as we saw over 700,000 hours worked during FY '22 with no recordable injuries. And in fact, we've seen 1.7 million hours worked on the project to date, again, with no recordable injuries. For FY '23, with our investments in China still to complete. In addition to our U.K. asset improvement CapEx, we anticipate a similar level of capital expenditure. On Slide 15, on cash, we're pleased to report another solid cash performance, although the higher capital expenditure, higher inventory and receivables and payments of the FY '21 special dividend meant that free cash flow was materially lower than the prior year at £34.5 million. Operating cash conversion was 49% as a result of the higher working capital and CapEx but this follows 2 years of 100% conversion. We are focused on maintaining Victrex's excellent record of cash generation. Our working capital movement of £27.5 million comprise an inventory increase of £13.4 million from recovery of inventory from lower levels during the pandemic and the higher production costs driven by inflation and an increase in receivables of £16.9 million from stronger sales performance in FY '22, offset by an increase in payables of £2.8 million. Our net tax outflow was £2 million higher at £10.6 million in total. We received the proceeds of TechnipFMC's acquisition of Magma, which we were a shareholder in of £4.5 million. Total dividends paid of £95.2 million reflects both the regular and FY '21 special dividend of 50p per share. This was materially higher than the £51.6 million of dividends paid in the prior year. As previously signaled, we did take on some bank borrowings in China to support investment in our assets there with £14.5 million drawn down in the year. This gave a closing cash position of £68.8 million, which includes £2.8 million of cash ring-fenced as part of our China investments. Excluding the cash for China, total available cash was £66 million. Whilst I have touched on working capital, it's worth flagging the impact of higher energy costs on inventory during the year. And this will likely also be the case in FY '23. We will need to add some inventory to support us as we shut down a proportion of our polymer assets for the U.K. asset improvement program. This means together with rebuilding raw material inventory to comfortable levels, total inventory could be above £100 million in the coming year. Moving to Slide 16. Before I close my section, I'd like to briefly flag that we intend to engage with shareholders on capital allocation, specifically around special dividends and buybacks. To reiterate, Victrex's priority is to invest to support growth. That can mean capacity and capability and in innovation. We've benefited significantly from previous investments, particularly in how they have supported our mega programs. As signaled previously, we do expect normalized CapEx after FY '23, which will remain higher, to be slightly above historical levels at around 8% to 10% of sales. This incorporates our ESG plans and potential costs to transition to renewable energy. In terms of excess cash, we will assess the options for both special dividends and buybacks whilst retaining flexibility following some shareholder interest through FY '22. We've historically paid special dividends when we have no other use for that cash at a minimum 50p per share level. We think that level is still reasonable to make a special dividend special. We will also consider buybacks, and we do already have shareholder approval to buy back up to 10% of our shares via our AGM resolutions. Recent feedback from shareholders support buybacks, particularly reflecting valuation at recent levels. These may well be smaller buybacks to ensure we retain flexibility. For example, a buyback could be utilized with less cash than that for a 50p per share special dividend. So we will take time to engage with our proposals. In summary, the key message is that we will continue to retain flexibility to ensure that investment for growth can remain the priority as we see CapEx nudge down in future years following the recent major CapEx capacity expansions. Thank you, Ian. So we now move to Slide 17. Turning to our business performance in more detail. Firstly, on medical, happy to report our strong growth performance here with revenue up 14% and growth in all regions and Asia up 40%, EU 11% and the U.S. 6. If you go back a few years, the question was always whether we could diversify enough into our Medical business. We've had then opportunities both in spine and non-spine. And I think we're now proving that we can do that. And that's really, I think, obvious in the numbers. Spine itself was up 2% year-on-year, but non-spine grew 28%. And non-spine is now half of our medical revenues. Remember that this year we also faced the impact of Omicron variant in the U.S. and China because of lockdowns. And this is why medical is still not back at pre-COVID surgeries, and we do see a good growth set of opportunities for the business in the short, medium and actually long term as well. Progress was driven by new application growth in a number of areas within non-spine. CMF. So skull plates using PEEK, which support better brain function than using metal plates, we saw 30% growth. And this business has now doubled in 5 years, and it's now at roughly £8 million business alone with further potential in both Asia and the U.S., Arthroscopy was up 30%, Cardio was up 11%, and Drug Delivery was also up in double digits and the inert nature of PEEK seems to serve us well in this space. If we move to Slide 18 and the opportunity for acceleration in Medical. Medical revenues in FY '22 were 17%, 1-7 of the group. But if we go back 10 years, they were 23% and had been in the mid-20s since the late 2000s. Yet in the past 10 years, we see much stronger growth in the Industrial division, all end markets with aerospace value-added resellers and electronics being notable highlights. However, our intention now that we see increased interest and pull-through in our medical mega programs from both Tier 1 and smaller companies is to focus on how we can accelerate our medical revenues as a proportion of group revenue to around one third of our total revenues in the next 10 years. This will definitely help our earnings stability with a less cyclical business in medical, but also medical tends to be stickier business, if I can phrase it that way, even if the adoption time, development time is a bit longer. How we do this will be driven by all of the segments on this slide but from Trauma and Knee particularly. We're getting close to an inflection point with Trauma having signed up a key player and with further partnership opportunities in the pipeline. And in Knee, potentially the largest of America programs with around $1 billion addressable market opportunity for us. So on Trauma specifically on Slide 19. Really pleased to have secured a U.S. FDA approval and I've seen the first patient implants of our PEEK composite trauma plate, as a part of our In2Bones partnership. Remember, we've seen PEEK based from our implants before, but - and we've built up the capability to make plates over several years. But what In2Bones gives us is access to a much wider market, and it is also the first place that Victrex mix entirely. In other words, we make the polymer, we make the tape and we make the plate itself. The picture on the slide is of foot and an ankle with PEEKs composite-based plate, trauma plates using PEEK have demonstrated better union rates and revision rates that are lower compared to metal-based implants, given the modulus of PEEK is being similar to the bone. So we're extremely pleased to deliver this milestone this year. And we will probably be reporting on a few other ones as we progress to the year ahead of us. We're also seeing a number of partnership opportunities in Asia to help us scale up the manufacturing of the plates. I will come on to our mega program revenue tracker soon, but we do see the opportunity now for revenue to start building from the trauma program, reaching double digits over a period of the next 2 to 3 years. Moving on to knee. Knee is probably the program that has the greatest revenue potential of all of our mega programs as well above £50 million a year in its peak sales here. After some challenges during the COVID pandemic, the clinical trial has really accelerated over the past year. Patient implants now, including 12 who have had their PEEK based knee for over 12 months with no clinical intervention needed. These implants were conducted in India in Belgium and Italy with our partner, Maxx Orthopaedics and it's good to keep in mind that the reason for change within the knee market is already there with 1 in 5 patients not happy with a metal-based impact, which are typically based on Cobalt Chrome. Metal knees can be heavy. They can be cold, but the most important part of the value proposition is the fact that PEEK-based knees will demonstrate and will lead to much lower bone loss over time, which is a big issue. Interest in metal-free implant is also growing on the back of increased awareness of sensitivities associated with the use of certain metals. So the signs look really promising for our solution and for some patients, we'll be coming up to 2 milestone already in early 2023. What I'm really pleased to announce today is the fact that we now have a new collaboration with Aesculap, one of the top 5 knee companies globally, which is obviously a significant milestone for us as we've been working hard on for a number of years. So we're incredibly pleased with the fact that we have a new collaboration with Aesculap that will aim at giving them PEEK based knees as a significant part of the product portfolio. So now we're not just working with the Tier 2 players who were also working with Tier 1 players. Remember also, we make the knees, and we have developed a significant amount of IP around them, as well as know-how. That is a part of our value proposition to our customers and partners, along with the clinical data that we accumulate over time. So whilst the clinical trial is progressing nicely, we're really working on the pathway towards commercialization in what we identify as an addressable market of around $1 billion a year. Pathway to commercialization. A brief word here on how we will increase the commercialization of these medical opportunities. Firstly, we've been building up capability in parts over several years by now. It's been a long journey as we acquired a lot of patients and resilience, and we're extremely pleased to see particularly these two programs now getting rapidly towards the inflection point of commercialization and adoption. For example, in Trauma, our composites plate facility plays a part, not just across Trauma, but also for Magma and Aerospace. So it is really a platform technology for us now for several mega programs. In Medical, the IP is held by Victrex and we have the opportunity to either manufacture ourselves or license the technology with partners, which is what we're doing with Trauma, as an example. The new news today on this slide is that we have opened or will be opening shortly a new product development center in LEEDS within the U.K., which is close to many medical device companies and academia. We'll have in excess of 20 highly skilled employees there to meet the increased demand for specific engineering and design requirements from our partners, both in Knee and Trauma. This will support how we move forward to capitalize early adoption to a greater mark â greater markets over the coming years. Now moving to Industrial on Slide 22. Overall, the majority of our end markets performed well this year with the exception of automotive, though the market indicators for this end market do look slightly more encouraging into 2023. IHS data now forecast around 79.6 million cars to be produced in 2022, but stepping up to roughly 83 million cars in 2023. It's worth putting in context that in 2019, there were around or in excess of 90 million cars built. So we know that there is some pent-up demand within automotive, but semiconductor chip shortages have held back this business. So we did see 2% growth in the second half over the prior year. So good medium-term opportunity and together with our progress on Gears and in E-Mobility, which I will talk about shortly, there's plenty of opportunities here. Aerospace. So whilst volume growth was 2%, revenues were up 21%, reflecting a better mix and price driven by gradual recovery in this end market with film and composite tape, creating new opportunities for us. Build rates are increasing on a number of models. We note that Airbus deliveries year-to-date are up 8%. You also know that pre-COVID build rates have still not been reached within Airbus. Airbus probably about 15% lower than pre-COVID builds on the A320 models and Boeing over 30% lower on the 737 MAX based on their published build rates. I will talk about our Aerospace Structures program on a separate slide later on. In Energy & Industrial, 9% volume growth. Energy within that was up 19%, 1-9, reflecting the buoyancy of this end market. Energy is less than half of this segment, but global rig count was up 111 rigs in the last year to 911 at the end of this financial year for us. We're also seeing some really good progress in renewables. PEEK is used in varying applications, reflecting its durability, mechanical strength and less maintenance requirements, relatively small revenue still, but currently, some exciting opportunities here. And we continue to explore and make progress on some potential applications for PEEK within the hydrogen supply chain. Electronics, 10% volume growth and well spread across the segments. Semicon did perform well, although our industry forecast of 4% growth in Semicon for the current year 2022 and then expecting 4% decline in 2023. And finally, in value-added resellers, they're up 12% during the year, and it's a record performance there. We continue to build closer relationship with our long-standing partnership in both stock shapes and in compounding. And whilst the visibility is never grade in value-added resellers, we're getting a greater line of sight to volumes here. Though as you note in our outlook statement, we're seeing a few signs of VARs normalizing and I stress that word normalizing where we come off Q2 and Q3 with record volumes here. So still good opportunities, but the industry's vast serves like electronics and energy manufacturing and engineering may see what you could call a cruising altitude as opposed to the takeoff slope that we have seen in the past couple of years. Moving on to Slide 23 on Gears. I'm talking about the mega programs in general. Firstly, Gears as delivering over £1 million in revenue here last year. We now see over £4 million in revenue delivered with this based on the path of Victrex mix, but also on what we call resin plus where Victrex has a key role in the development of the Gear application. This is classic innovation. As I've said countless times before, we do not intend to make the whole world's demand of PEEK Gears. It's about seeding the market and driving adoption with the own relationship that we have. And then when it comes to actually producing the Gears, we have created partnerships that allows us to execute and meet demand with different partners across the globe. On E-Mobility, Slide 24. So while Gears has moved ahead nicely and has a fit across combustion engines and electric vehicles, we also made some really good progress this year on E-Mobility applications. PEEK does offer a number of benefits in wire coating applications. It is very durable. It has dimensional stability. It is a great insulator for both electricity and heat. And it also is less intensive to manufacture than the enamel that is used in the lower well its motors. So also brings ESG benefits because of the absence of solvents used in the coating of the wire. And remember that we are really focused on the next generation of motors. So the 800 work motors where the performance requirements are higher. Overall revenue in this segment now is less than £1 million. But we have the opportunity to step this up significantly in the next couple of years. And with an opportunity of on average getting to way more than 100 grams of PEEK per vehicle, where we're now at around 10 grams per vehicle. We also secured some new business here on a number of platforms in Europe and in Asia this year that will start to have an impact in the years to come. Slide 25 on Aerospace, and this is probably one of my favorite ones. If you remember, back in 2018, which feels like ages ago, we signed an agreement with Airbus for development collaboration as a part of the Clean Sky2 program to focus on the wings and the fuselage of tomorrow. The approach is based on using our AE 250 low-melt PEEK. We can deliver time savings compared to thermoset composites with that polymer where we still have to cure the structures in an auto cloud, as an example. So thermoplastic composite enable much bigger structures to be made. They are formed through in-situ curing, don't meet the auto class, as I said before, and also have the major benefits of being able to be welded together as part and strengthened with streamers and structures that also can be welded to the skins and the structure as shown in the picture there in the middle and the picture there on the right as well. Thermoplastics offer around 60% weight savings, which translates into fuel savings and of course, then CO2 savings as well. But it also allows the planes to be built faster which is an important feature given the backlog of single-aisle planes that is still out there and thermoplastics offer a great potential for recyclability as well. So ESG benefits, time savings and ease of manufacture all contribute to the value proposition here. And it's really pleasing to see the parts - the large parts that are now starting to emerge as demonstrated part for a variety of different partners are playing in various trade shows around the world and in some of the published material from our collaboration partners from Clean Sky 2. And if we consider that on a wide body Airbus model, we might have currently over half a ton to plane, scaling the opportunity suggests that we could increase that by an order of magnitude going forward, and that's probably a relatively conservative estimate at this stage. So a great opportunity, unlikely to see revenues in the short term or before 2026, but in the meantime, we will be securing some prototype revenues over the next few years on the back of these programs. Slide 26 on Magma. The new news this year was the bid programs have been submitted by TechnipFMC for the packages with Petrobras in Brazil. Remember that Technip is looking to utilize a hybrid flexible pipe with PEEK, the PEEK at its core using our PEEK and our composite tape as well backed up by steel armoring. In a hybrid flexible pipe like that, typical weight savings is around 50% versus premium water for the hybrid pipe, Technip did visit our Board this year, and we've already moved ahead to support them with scale up with new pipe extrusion facility being built in Acu in Brazil, and that Technip is doing that. Victrex has licensed its extrusion technology to TechnipFMC, but also remember that all the qualifications are based on Victrex-based PEEK core and Victrex-based composite type that is then laser welded onto the core. So as it relates to this opportunity, it's for TechnipFMC to share sort of further news flow on this following the purchase of Magma Global last year. They are very positive on this opportunity. And 2024 is likely to be a key year for them. And we will play our part in supporting them in the pathway to much bigger revenues that if everything goes according to plan, like I said, should start to show up in 2024. Slide 27. So pathway to £10 million in revenues. I'm afraid the bubble chart fans from the part might be a bit disappointed. But now we have a new version of showing the progress and the potential associated with our mega programs. What we want to show here is the next step on the journey for mega programs. So aside from knee, which is making good progress in clinical trials, all of our mega programs have the technical and commercial feasibility now proven and the reason that I exclude knee is because we cannot really complain that until the clinical trials are completed. So they're no longer just a bubble. They are real. And what we wanted to show you was the potential roadmap to the £10 million revenue opportunity with some focused on that in the next couple of years through particularly Magma and Trauma. Some might have a longer adoption time, often driven by qualifications like the aerospace opportunity and Knee. And Knee, which is the biggest opportunity of all of them will probably take us a few years to get there still. In summary, we felt it was the right time to show the next step of the journey now for a mega programs, and we look forward to keeping you updated on progress. And it's interesting to note that, as I've said a number of times before, we've always known that these programs are technically doable. And it's proven that. We've done a number of analysis and assessment on the economic viability. So in other words, if you can do the - and meet the challenge technically, is it at a price and a cost that is acceptable for a given application. We know that these are the two questions that you always have to answer with this type technology has been absolutely convinced that we could answer them positively and we have. But that doesn't automatically guarantee you adoption and commercial success. But I think what we're seeing now is that we are really accelerating towards the inflection point of commercialization. And now we have blue chip companies lined up with almost every one of them creating the pull-through for that demand. And that is, I think, a milestone and a set of milestones that we've actually delivered on most of those throughout this year. So significant progress on these. Now if I move now to Slide 28 on the outlook. Then sort of a brief word on our industrial view on the end markets for 2023. So with unmet demand and performance not yet back at pre-COVID levels, we're relatively optimistic on aerospace with build rates sort of steadily anticipated to increase through the next 12 months. We're also optimistic on medical. The surgery rates still below COVID levels in many regions and the impact of further lockdowns in China having had an impact this year, and therefore, impacted the total number of surgeries are conducted there. We are neutral on Electronics, Energy and Automotive. Electronics, as I noted before, in my talk, you know that WSTS forecast at a 4% decline in semicon shipmen in 2023, though Asia is tracking the overall global picture down. On the Energy side, whilst still we're expecting buoyancy there. We know that rig count increases have slowed down and for example, both in Canada, while Canada was down a few rigs last month, and U.S. has been relatively flat now month-over-month. You also know that in the industrial part of Energy and Industrial, or what we call manufacturing and engineering, we see signs of CapEx being ran back as companies are conserving cash and trying to maintain a healthy balance sheet in view of the anticipated recessions in key markets. Automotive is a bit of a tough one to call. So whilst IHS data suggests growth in both car production to around 85 - 83 million, 85 million cars next year. I think we need to see further signs of the backlog coming through. And finally, as I said earlier, we have seen some signs of normalization in VARs in the current quarter not in drastic, but certainly not the run rates we have been seeing in the previous like the 18 months or so. And clearly, they are sensitive towards industries that are considered CapEx by many customers around the world, whether it's in food production or chemical industries and the like where as I said, the focus on cash conversation is quite high these days. So we had a record Q3 in 2022 with 700 tons with VARs and a record year of 2,100 tons roughly with them as well. So really a fabulous year with the value-added resellers and a true testimony of a strong relationship that we enjoy with them. They have not been in a position yet to reach an is their inventories but as I said, based on the set of macroeconomic assumptions that we are making and they are making, we are expecting to see this reaching more kind of a normalized level of demand in the year to come. So in summary, really, really good year for Victrex, record revenues, record volumes and further opportunities for growth in our core and in our mega programs. We are mindful of the macroeconomic outlook and the potential uncertainties that are associated with that. We have seen a steady start of the year. And I think we have shown resilience through previous recessions or pandemics. And we've always emerged from those stronger than we were when we went into it with a strong customer focus and with a strong focus on preparing ourselves for the upturn. I want to say as well that there are still challenges with inflation. As you heard Ian talk about before, have been mitigating that with both price increases with surcharges to cut out off the huge spikes that we have seen with contract modifications as well and through efficiency gains within the company. So overall, as we look towards the bottom line next year, we're focused on modest revenue growth and PBT. So even if volumes may be relatively flat, based on the normalization of VARs and the uncertainty in oil & electronics, as I mentioned before, modest profit growth assumption is based on the benefit of pricing, the benefit of a better sales mix, as Ian suggested, average selling prices now could be closer to the high 70s or around £80 this year. And clearly, the benefit of a tailwind from currency in FY '23 and a likely tailwind into FY '24 as well. Finally, as you heard today, our long-term programs are particularly strong and have made a significant advance during the year. So whilst navigating the periods ahead, might be challenging, I think the resilience of the company and the financial health with the strength of the core business with pent-up demand still out there from pre-COVID and with the fact that some of the mega programs will start to add significantly to our top line towards the end of what could be a recessionary period should bode well for us in the future. So thank you all for listening, and we'll now open up the floor for questions, and I will start with questions from the room Hi, morning. And just a couple of things. So first one is probably more on the pricing comments you just made and I think Ian referenced a delay in recovering costs through FY '23 as well as what you see in '22. Can you tell us where the delays are? Is that mainly in the longer-term contracts in Medical and in Aerospace? Or are there other areas I'm missing in that? That's the first question. The second one is in Knee, probably a question for Martin, actually. I saw there was a recall from Zimmer in the current knee implants after pretty serious rejection rates by patients in the U.K., I think I saw a number is 20%. Is this an opportunity for you? Or is that quite a niche area? Thank you. So on the pricing side, it is quite widely spread. The long-term contract has been quite widely spread, I should say, for our product. Consider the fact that we are quite often a single source of supply for PEEK into certain qualified and certified applications that can be Aero, Auto, Medical, in particular, Energy as an example. And that essentially has in the past, sort of the need for longer-term contracts with all kinds of contingency planning as well to secure â to secure your supply. And so it's not just on the Medical side, you would see typically in the contract on the Automotive side, on the Aero side with the VARs because remember also that they are exposed to the same end markets, as I'm referring to directly, so it is a significant part of our volume. And part of our mission this year has been to change these contractual elements as well as we go through price increases. So I think that will allow us to deploy a greater number of measures to meet such sudden spikes in such high spikes as well. We were reflecting on it a number of times this year that when we did sensitivity analysis to all kinds of factors a few years ago, we tested that the insight of energy price rises to the tune of doubling and more and it didn't really move the needle at the time. It certainly has moved the needle this time. And this has called for a change in the way you construct contracts. We have chosen to honor our contract and that's important to us. And I think that's truly taking a long-term view on the partnership and being a solid business partner through your partners. It's during times like this where it matters the most. It's easy to be kind and nice when the sun is shining. It's a bit more difficult at times to support your customers when times are tough. We have chosen to honor the contract. But we will - and we have been modifying our contracts to allow us greater flexibility to meet such dramatic changes as we have coped with this year. Then on the knee side. So any disturbance of any industry space that we're trying to get into is potentially an opportunity. But it's a bit early. So we're not far enough through the trial now to be ready to do anything very timely. So I actually think there's more - it's more a warning for us to say, make sure that you did the trial properly because the last thing we want is a recall on something that's radically different than our. So - if that happens in 3 years' time, then that will be a very nice opportunity for us to provide a sound alternative. We just don't have evidence yet. Really, to get to there, we need to do a broader trial that we got at the moment. So if you could introduce yourself when you make the question, that would help the callers on the line as well, please? Hi, thank you. Good morning. It's Adrien Tamagno from Berenberg. I have two, please. First, on the value-added reseller volume comment. Can you please maybe help us understand what are the current trends that you see on the demand front with slowdown in Europe and maybe the prospects for reopening in China? And secondly, on the gross margin bridge, you've showed a 7.8% improvement from operational efficiency. How should we think about this for next year, as the inventory build up might be and there could be more debottlenecking to come next year? Thank you. Sure, yes. So I don't think we can expect to see the level of improvement we've seen this year going in '22 going into '23. Clearly, we saw a big efficiency benefit. Some of that was in our monomer production as well as our polymer production. We are - we do have some shutdown time planned for the current year. So I wouldn't expect to see the same benefit year-over-year going into FY '23. Obviously, we'll - there will be some buildup ahead of a shutdown towards the end of the year as well. But I think it's much more balanced going into FY '23 as opposed to a big improvement in FY '22. Sort of on the key volume assumptions, Adrien, we clearly look at some of the published data, obviously, that I've been referring to throughout my presentation mixed with our market intelligence as it relates to new product launches and/or part of discontinuations. But if you look at it at a high level, we are anticipating a recession in Europe and we're in recession in Europe country. I think we are as well, and I think that the increasingly sort of I talked to you that we might see a recession in the U.S., although I think in general, the talk there is about a relatively mild one. And the question then is always about the duration of those. And I think we're looking at something in China that is probably going to be in the mid-3% to 4% range in terms of GDP. Now if we look at it on Auto, as I said before, we do follow IHS with our own sort of algorithmic interpretation of that. And that should indicate a modest growth there next year from roughly 9 million cars made this year to probably 83 million, 85 million cars produced next year. Still here rumors around issues in the supply chain not just on the back of chip shortages but on other things as well. And then you've got to wonder whether there will be a dampening effect on that by the fact that the people will be having less disposable income in the most sort of economically mature markets in the world. Energy, energy prices will still be high. So that's good for energy business, manufacturing and engineering. I mentioned it in my context here, we look at PMIs, and they have a strong correlation with our business in manufacturing and engineering, as we look at those across the board. And those are relatively subdued right now, and that's not a surprise given the focus on conserving cost and maintaining healthy balance sheets that we sell into a more sort of unchartered territory, if you wish. And then clearly, on the medical side, I think that's where we are starting to feel much more confident about the upside than in any of the other sectors, which is clearly an important part for us given the pricing and the impact that it has on our bottom line. So that's in a nutshell how we go about it and sort of the key assumptions at a very, very high rapid level, if that helps you. Hi. David Farrell from Jefferies. A couple of questions, please. Firstly, just to focus in on the gross margin again. I think you're talking about 10% average selling price increases, which is about £35 million, £36 million incremental revenue. You said that energy costs were probably £20 million higher along with raw materials. So what prevents gross margin going up next year? What am I missing in that calculation? And then my second question, could we just delve a bit deeper into kind of the semiconductor market, kind of what your exposure is there? I think you talked about 4% decline. You look at wafer fabrication equipment, they're talking about 20% decline next year? So kind of where are you positioned? Yeah, I'll start with the semicon first, and that's basically - the 4% that I was referring to is in chip manufacturing rate. CapEx is going down further. We are much bigger part of the consumables than we are on the CapEx side where PEEK is used in the polishing process of the wafers in CMP rings in particular. So you could look at what we do much more of the consumer as opposed to a capital-driven usage. Yes. I think if you - I don't think we quoted a 10% price increase, but there is the 70 to 80 - around 80 potential on ASP, which is probably what you're referring to, David, I think. I would - just a reminder, a 50 to - 50-plus percent gross margin business. If you want to maintain that gross margin with £20 million of cost increase, you have to pass on £40 million of price, right? So £35 million price on £20 million cost would still be a declining margin percentage. Clearly be improved gross profit, but the margin percentage is declining at that point. [Technical Difficulty] Yeah. I think we're more confident of gross margins going up when we see energy prices stabilize. The methodologies we're using to pass those prices on now, including surcharges will run at a lag to those energy prices. So when energy prices stabilize, then I think we can be more confident that we can kind of finish our price increases associated with the energy prices on a sort of 6 to 12-month lag, which is the kind of that we have a lot of 12-month contracts, as Jakob spoke to earlier and then see energy prices rise from there. I would say we have our factory in China coming online later in FY '23. Margins from that are likely to be under pressure initially as they often are with any kind of startup and starting our only factory that's starting up. That pressure is in overheads at the moment prior to startup, but post start that will move to gross margin. Hi. This is Wei Katara [ph] from Bank of America. I have a question about your pricing and your decision to include surcharges. I'm just wondering how sort of sticky you think these can be going forward? And more specifically, what is the lag between you sort of maybe normalizing the surcharges in a deflationary environment? Yes. So we're dealing with the price pressure in â our cost pressures in two different ways. So we believe there's an underlying escalation in our cost base based on inflation, and we're clearly trying to pass that through in consolidated price increases. And we believe the way in which we're doing it, we're doing that in a way which should be able to bring our customer base with us. So we expect that we will hold on to those price increases. When it comes to surcharge, then we're looking very carefully at what's our energy build, what is our real energy build? And how do we translate that across into a surcharge that we can then build against the changing energy costs, so we separate - we're separating the two very clearly. So will surcharge stick? No, because it's not supposed to. It will work against what the energy costs are well priced, we think so. Okay, thanks. And my second question is about VAR, more specifically. You said you've seen a normalization. I'm just wondering into sort of the first 2 months of this quarter, has that normalization sort of extended to indicate that maybe customers are destocking a bit more into the calendar year end? I'll take that one. So this â is a classical phenomenon though. And if you look at our performance from a historical perspective, the first quarter is always the lowest quarter of the fourth. And I think we're seeing sort of a steady state versus what we saw in the first quarter of last year, maybe slight decrease, but nothing drastic there, I would say. But it's a classical thing towards the end of the financial year that people will run down inventory. And that effect I think is probably increased given the economic circumstances that we're seeing where the focus is really on conserving cash and minimizing inventory across the whole supply chain around the world. Morning. Kevin Fogarty from Numis. Just going back on pricing, I think at the half year stage, you outlined pricing would kind of follow the contract renewal cycle. I just wondered if you can help us kind of where are you sort of quantifying just in that process, i.e., sort of how many more - or what percentage of contract renewals might sort of fall into FY '23? Or are you up to date currently, excluding any kind of surcharges, I guess, just to sort of quantify what that might look like for 2023. And just going back on inventories, when you look across your industries in terms of end markets, I just wondered sort of how much of your sort of caution or nervousness in end markets is around sort of customer inventory positions currently - on what they've - how they built out perhaps? Yeah. So we're probably into quite a busy period of negotiation there. So there are a number of contracts that come at the end of the year, at the end of the calendar year. So we've got a busy period coming. And then after that, we should be through the process. And some of those will be the second time around, right? So we'll have done something in the last cycle, and we're doing something more this time around on the annual contracts. Well, I think that we will be thinking about our pricing on an ongoing basis, and that's why we've adjusted our contracts and the way we adjusted our contracts. Okay. Okay. So I guess on that frequency kind of what would that look like then in terms of your ability to raise prices on a more frequent basis going forward? Well, we tend to have annual contracts. And if we've got contracts longer than that, we're making sure that we have more flexibility than we had in the past because you have to recognize the inflation environment we're in there. I think there are a number of sectors and segments where we've gone more than twice to increase prices. I wanted to state that. I mean - but the ones where we have the annual pricing mechanism, we've really been working on changing those for the year that's just ahead of us. And that's what Martin is also referring to that. We will be negotiating these when we are for an effect from the 1st of January. Then on your question on inventories, not concerned about high levels of inventory in the supply. I can think that we are seeing a destocking effect and I can trace this probably all the way back to 2018 almost or, let's say, 2019, when we had a mini recession on the back of diesel gate and all of that, followed by COVID, followed by the energy crisis right now. And I think inventories in the various channels that we serve has by and large not recovered. I think we've been running relatively thin. I think they'll be running thinner as we head into the year and right now because of what I mentioned before. And that is a classical pattern if you almost study Victrex from its inception. That in the lead up to subdued economic conditions, people will, again, conserve cash to maintain a healthy balance sheet and some safety margins and reduce inventory, particularly towards year-end. And we see that with kind of a canary in the coal mine to that effect. But then when the situation turns around, we see this rapid sometimes ahead of many others as well. But if your point was whether I'm worried about too high inventory levels, no, that's not my concern right now. H. It's Maggie Schooley from Stifel. You've been alluding for a while to growing the Medical business quite significantly on a longer-term basis. And I think the chart on Page say about '18 is actually relatively interesting. We know Knee is $1 billion, but can you give us a greater understanding of what you think the total addressable market is for those various applications? Point number one. And then it's this slightly like a flywheel in terms of the medical industry once a material gets into commercial acceptance that you can quickly or more quickly drive adoption and other applications. And those are the two. And then the last question, sorry. On the - I know the trial is going on. But in terms of the qualification of a med tech partner, how long would you anticipate once it's being picked up in commercial production that you need to have those qualification processes for the actual device itself? So on the flywheel, there's clearly credibility that comes from having a material in somebody's body and spent a long time there with no adverse reaction. And we sit in a very nice place with that having had 15-plus years of experience and never having any type of allergic reaction or any problem. So we start from the fact that people are people are bit comfortable to put PEEK in people's bodies, yes, they are. But in each application, you need to go through a safety demonstration approved of concept and also to make sure that you're not in a situation where you're putting patients at risk. So flywheel is probably a bit strong on the amount of momentum. You probably reduced the amount of resistance by the more things that are done with your material the easier the actual adoption is. But in terms of the process to get certified, it makes no difference. So if you look at it right now, I think the total number of operations per year is roughly around 4 million a year and it did grow 35% between 2009 and 2019. And I think it's actually anticipated to grow at a faster rate going forward given the aging population and the increase in knee-based arthritis as an example. So let's say, 4 million proceed during the year, roughly probably 3 million of them cement less, maybe 1 million of them cemented. Cement less clearly commands a premium. So the overall size of the market is - of this market is probably well in excess of £10 billion. And I think it is reasonable for us to what we would get, let's say, at least low single digits in revenue from pieces in there, and that may differ based on whether it's a severe part or familiar part. So I think it is a size of opportunity for us. But it will take time to get into it. But I think we all know that once you've got a proven sort of solution that works in this space is going to stay there for a long time because there is not a real incentive to change. And it's our belief that this will be a game-changing solution. And actually, I failed to mention as well when we're talking about medical and a lot of context. So you see the progress on CMS. This is really growing that, but we see the progress on cardiovascular and drug delivery devices. Spine where we have the first generation, we have the second. And the third one, we are aiming at filing an application with the FDA on porous 3D printed cases next year. That's our range, not saying absolutely there, but that is something we're aiming at for the current financial year. And then you couple the very tangible progress and the opportunities within trauma and knee and I think that's a very credible proposition for being able to change the mix and the proportion of medical within the overall revenue base on a growing industrial business at the same time. So think that's an obvious great opportunity for us. And that's why we're very focused on building up capabilities in that area. And we've been focused on that for years. Just think now we're really starting to see the sprout sort of popping up in a very tangible way. Something else to say about the flywheel as well. So once you're - when you're sort of approved in a particular application and the whole predicate system works pretty well and then make once you're into a particular application space, then you begin to get a more like the snowball rolling down the hill type. I didn't know if you could use any form of the data with which you've gathered to then apply to something else that you have to recreate? Andrew Stott, UBS. Can I just follow up on China on the comments on the commissioning. Am I right in thinking about 6 months delays or not? And is that to do with COVID and lockdown, I assume to be right. And is it - did I miss a guidance for this year on OpEx, you had the 3.1 for the year just finished. Is there a guidance for this year? I think it will be higher this year. So it's going to get worse before it gets better, I guess, is the guidance. So I expect a little bit more this year than in the previous year in terms of start-up costs through the P&L. And I would say no significant revenues in the current - in FY '23. I think all the assumptions that we made from we started are still holding out - and remember, it is a focused approach. It's a product line extension and sort of very much focused on China for China with some of our largest customers wanting to be supported by us over there. So that set of assumption still holds. Could you characterize the customer industries in China that are coming to you? Sorry, could you characterize the customer industries that are coming to you for the China... Auto and I would say, Energy and Industrial. These three would be the key ones that would be the end beneficiaries, if you wish - main channel through the value-added resellers. Thank you. Will now begin questions from the phone line. [Operator Instructions] We will take our first question from Chetan Udeshi of JPMorgan. Please go ahead. Hi, thanks. Maybe a quick one, but a bit more difficult one, I guess. But Jakob, you mentioned in your discussion, record revenue, record volumes, which is great - but when we look at the profitability, it's well below the record level. So I'm just curious, when do you think we can see the kind of profitability that Victrex used to do in 2017, '18? Again, I know there are headwinds, but we've seen headwinds now for a period of time. So I'm just curious when do you think maybe we can see Victrex going to those levels of profitability, 110, 120, 130 given the kind of momentum that you're talking about from a pipeline and demand perspective? Thank you, Chetan. I don't think you'd expect me to put a year on that. I mean you gave quite a broad range of potential outcomes there as well. What I would say is we're focused on driving that profitability. But at the same time, we're not going to compromise on investing in the programs that we've got and the significant opportunities that we think are out there such as those in the medical space that we were just talking about. So we're focused on driving the profitability. Clearly, there are going to be challenges this year, and we've talked about that. Our guidance is modest profit growth this year. I think in a world where inflation stabilizes a little bit, and we can benefit from our price increases kind of normalizing, if you like, we can drive the volumes and the end markets are strong, then we can look to drive profitability from that. Yeah, I don't think I can put a specific year on a specific number at this point beyond the guidance we've given. No, if I may add to it a little bit as well, then. And I partially sort of mentioned it in my part that when we enter, I think, the turbulent times that are ahead for global economies, we will be at a point where we've made the lion share of the investments that we need to make to be able to support the volumes of the future. And by that, I mean China, I mean debottlenecking [indiscernible] house, as an example, and we will be seeing the benefits of the leverage of, I think, the volume that will come our way at that point in time, from a growing core that will start to roll again and command greater volumes which will be proportional to GDP and maybe GDP plus from the fact that we have the unmet demand from pre-COVID number two, and from the fact that it's likely to confluence with some of the inflection points associated with some of the mega programs. And that's when I think you'll start to see real levers that will have an impact on profitability that could take us to the profitability of the period where we were not investing a lot. Remember that these investments are skewing the bottom line quite a bit these days, whether it's in capabilities and/or our assets as well. I think once we sail out of that, I think we will emerge quite rapidly, not just on the top line but on the bottom line as well. So thanks for all of you that attended today. Thanks for those on the phone as well, and we wish you all the best for the upcoming festive period and the new coming year. Thank you.
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EarningCall_1690
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Thanks everyone for sticking with us, Day 2 of the Wells Fargo TMT Summit. I am Michael Turrin, the software analyst. With us, we have Khozema Shipchandler from Twilio, COO of the company. Good, packed environment to take it all and even though there is a lot going on. So thatâs a good sign in terms of engagement. There has been a lot of metrics, a lot of disclosure, a lot of things have happened with Twilio over the past month or so. So maybe we can start with Q3, the puts and takes of what you reported and then we can get into some metrics. We will start with the top line and work through the rest. Thanks for joining. So I mean, the Q3 metrics, the growth profile continues to hold in relatively strong. I think you are not alone in calling attention to some of the macro considerations that you are seeing. But maybe just help us unpack or talk through what you are seeing in Q3 what informs guidance for Q4 and just how to think about just the moving pieces of the business model? Yes. I mean Iâd say maybe just to start off with on the top line, I mean we are just seeing a very different macro environment thatâs unfolded over really just a relatively short period of time than what we have seen previously. And I think you see it in what some other companies are talking about. I think our business is particularly sensitive to what ends up happening with end consumers. And so we have been really paying very close attention to like what retail is doing, what happened over the most recent holiday period, obviously. And as those things have played out, I would say, in an increasingly worse way thatâs had some impact on our business as well. I think when we looked at it maybe 120 days ago or so or even just prior to that, I think we were starting to see some possible headwinds. We called out at the time, in particular, like crypto was like kind of an obvious one that was really starting to come down. I think thatâs like effectively concluded now and we will see how that kind of shakes out. But we also saw some stuff around social, for example. And I think we are just starting to see all of those things manifest. I mean, we still see healthy growth levels, certainly not the growth levels that we want or that we have been previously forecasting. But I think, given the macro environment, we still feel good about the results. I do realize we are getting a lot of important feedback from investors, so I donât want to skirt that topic either and we are listening. And obviously, there is limited to what we can do on the top line, but we are obviously watching the bottom line pretty carefully, too. Yes. So, I mean you have put some parameters in place, you made some hard decisions, you have taken some controls. There was a headcount reduction. There is a margin target for next year. How much of that is just informed by the signals that you are seeing in the demand environment, the investor feedback and how do you make sure that you are not attacking too far in one direction if the world turns in a different direction? Yes, the macro is actually not informing that stuff too much. I think the reality is that, at our size and scale, I mean, kind of the number one conversation that weâve been having with investors for some time is that, well, at a nearly $4 billion run-rate, like itâs time to be a profitable company. We obviously agree with that. And I think we have been saying for a while now that we intend to be a profitable company in 2023. And I think what we are working through is obviously given some of the feedback that we are receiving is like what additional parameters can we potentially put around, what that profitability looks like in 2023, how much is there, etcetera? But I donât really think the macro is impacting that too much. Obviously, you have got other macro factors like with interest rates and what have you. But I think, at our size and scale, itâs really important for us to be a profitable company. I think itâs really important for us to be able to grow organically, not rely on acquisitions that we have done over the last several years. And Iâd take it one step further and say that itâs also important for us to be able to see a path and to be able to illustrate a path to investors around GAAP profitability as well. I mean we â and obviously, the big lever in the middle is stock-based compensation, if you strip out intangibles at least. And thatâs a topic that we are pretty focused on as well. There is some math that makes that one hard to bring down like instantaneously, but we are focused on it. And I think by having a lower headcount profile that will help. There is a few different directions I could take this, but on the gross margin side, itâs always been I think the case of the messaging business has just grown so fast. Itâs remained a disproportionate impact on the mix. How much of that is viewed as just thatâs the input that you work with and then the controls are on the OpEx side? Or are there things you can do on the messaging side to stabilize, drive improvement in the margin profile? And maybe talk through some of the stats that you gave on messaging, because there is a lot of detail at the Investor Day around the economics of U.S. versus international. So, what the takeaways for investors were intended to be just with that additional disclosure? Yes. I mean, I think the bottom line is and I will unpack it in a few different ways for you. But I think the bottom line is, is that we feel that messaging is a good business to be in. It does have structurally difficult gross margins relative to the rest of our portfolio. Those gross margins are obviously lower than when you comp against kind of a traditional SaaS software company. There is one reason for that which is carrier fees. And so, what we tried to do as best as we could was basically say, look, we have had the carrier fees go in a number of different directions over the last several years. You have had layers of them actually get added over the last couple of years. And in spite of any of that, in spite of the fact that we have been mixing more internationally, which has even lower structural gross margins, this is a good business to be in. And so, what we tried to do in particular was to break out what are the unit economics of messages as they end up terminating internationally, if they end up terminating in the U.S. markets. What do they look like? Are they stable? Because I think one of the issues that we have been hearing a lot from investors was, look, are you basically buying bad business? Are you chasing growth and not making any money on that growth? Or is there incredible price pressure? And neither of those things is really true, right? I mean the pricing, I think, is vetted by the fact that the unit economics are very strong. And I think, on the profitability side, I mean, we are very, very convicted about delivering profitability next year and given how large a piece of the business that that is, itâs going to be the big driver of that. I mean we have talked about marketing for a long time. And obviously, there are headwinds around marketing spend currently as well. But you have evidence, you have 27 customers that are spending $10 million with Twilio currently. I am just curious if you could just spend more time on what informs the importance of vesting. You have a gigantic customer base that you built on the back of messaging. A lot more companies have gotten comfortable with that as a very valuable way to reach end consumers. So just spending a bit more time on, I think the importance in what you are realizing there and then we can go into what it builds on top of? Yes, Iâd say itâs kind of two or threefold. I think the first is sort of obvious, I guess, in the sense that we have nearly 300,000 customers, right. Every single one of those customers at some time and maybe itâs early with many of them, but at some time there is an opportunity for us to convert one of those customers thatâs currently using messaging and, in many cases, using e-mail into a flex customer, into a segment customer. And if you look at the customer journey that we have often been on with some of these logos that end up being in excess of $10 million, like thatâs where they start, right. They start using one of our simpler use cases. They happen to really like it as they have been using it and they continue growing with us and then grow into some of these larger areas. And so, if it creates a relationship with a customer in the first place and itâs an opportunity for us to gain share, as long as we are doing it profitably and see a path one day to growing them to something else, I think thatâs kind of an overall positive. And I think we like that about the messaging business. I think the second dynamic is, is that when you think about delivering a marketing experience it has to be done ultimately through some communications vehicle, right. So any of the kind of pure-play marketers, if you will, they all use communications eventually right to be able to get these messages out to consumers. And so for us, itâs like, well, we own this amazing comms business. We are the market leader in that business. We have the best data platform in the world. The technology is excellent. And so doesnât it make just logical sense for us to kind of pair these things together and deliver a unique experience back to consumer using rich data paired with great communications? And then itâs not really kind of directly part of the whole thing, but I think what also is increasingly true is, even with our contact center product, what weâre starting to see is that â I mean most people donât want a contact center experience that has no communication in it, right? Like a lot of it happens through voice, a lot of it increasingly is moving over to text. But whatâs even interesting about that is, is that, increasingly, a lot of that is going the way of data to, and I think there is an opportunity for us to add more value to customers that use the contact center product. One of the questions we often get â Iâm sure you often get is just around, is selling the software applications piece very different than the core selling of the messaging piece was because there was such a strong inbound developer presence? And the way that, that was adopted was viral. And I think there is always been an optimistic case that developers have more pull and will have more decision-making and marketing decisions in other areas. In terms of the go-to-market motion and ability to supplement that and how important that is on the software selling side, whatâs your perspective as the portfolio expands? And is that something â are you able to do both and do both and also work towards cost controls? Yes. I think there is two different questions there, sort of. I think the short answer is yes, they are different, okay? And I think the easiest way to think about that is in terms of who the buyer is, right? So a lot of, as you pointed out, messaging and even e-mail is developer-led. In our e-mail business, when we bought the business, since weâve grown the business, weâve never really had that much sales attached to it. It kind of sells itself. I mean itâs a great console. Itâs a great product. Itâs easy to use, and youâre up and running. And SMS is more or less kind of the same thing. Now can you make it larger with salespeople? Absolutely, right? And so I think dialing in the right number is really important. But by and large, your customers, they start out being developers, they may grow into enterprise buyers over time. But generally speaking, the developer kind of drives that sale. I think when you look at both Flex and Segment, you have actually 2 different buyers there as well, right? Like your segment buyer, I think it tends to be your CMO, and sheâs often the decision-maker. I mean youâre talking about leveraging deep personal data about consumers using that in a way to create a rich consumer experience, like sheâs typically the person thatâs going to be making that buying decision. Itâs a different sales cycle. It takes a different persona. It takes a different person to be able to reach the CMO. So I think we have found that, that is quite different. And we sort of came clean on some of the issues that weâve had in the sales motion with segment recently by combining the sales forces. And so thatâs one of the reasons that we kind of broke that apart again. And then I think Flex is yet again different. I think it tends to be the head of operations. It tends to be head of customer service. It could be the CIO. We donât really find that thatâs the case typically, but itâs possible, certainly a stakeholder in the process. And I think the common thread, if there is one across these, is at the enterprise level. At the enterprise level, like these are big dollar decisions, and so they tend to get made by senior people regardless. And so I think where weâve seen synergy is when itâs an enterprise-oriented sale, you can sell any one of those kind of to the same people because youâre dealing with the same people. When itâs below that, I think weâre not finding the synergy, and so it does make sense to kind of conceive of those sales organizations a little bit differently. Now in terms of cost, which I think is the other part of your question, I think the trick is for us how do we dial the sales organizations that call on these different areas and use their skills to call on the different personas, but then have a common shared service underneath that, if you will, right? So common sales ops, common systems, common tools, common marketing, what have you. And then â so does that mean â is there a way to construct an industry overlay to get Segment and Flex to talk to certain enterprise buyers? Or what does that mean in terms of the composition? Iâm just curious what the decisions have looked like that have led to... I donât think you need much of an industry overlay. I think the area that we found success and that kind of took off is probably more in healthcare. I think it is true that you have like big financial services buyers, obviously. You have big retail buyers. I donât think we have to organize the sales force that way necessarily. I think healthcare is a little bit different because youâve got different aspects of privacy and HIPAA, obviously. So, you need a little bit different persona there. But I think for the rest of it, itâs kind of the same kind of individual that we end up hiring. It doesnât have to be that specialized. Letâs come up for a second and talk about just impressions of Segment since the acquisition outside of the go-to-market and just some of the things that are happening there. You mentioned itâs a best-in-class data platform. Thatâs blessed by a lot of industry experts that we talk to as well. So, maybe more on the product, the learnings since youâve worked to integrate the solution within Twilioâs portfolio? Yes, I guess, the way Iâd characterize it is that the product is even better than we thought it would be. I think that they actually had a decent sales motion that we screwed up, frankly. I think we could have done a much better job in the integration of that, and we didnât. We thought by pulling it back into the generalist sales force that, that would help, and that turned out not to be the case. I think the resonance with big marketing companies like â meaning big retailers, big financial services industries or institutions. I think the resonance of a marketing product that combines the CDP with communications is really, really powerful. I think we underestimated the amount of engagement â no pun intended â that we would have with Engage, so thatâs been really interesting. And I think the team is even better than we thought they would be when we acquired the company. Is it â do you have a view, Iâm sure you do, on are we so early in CDP that evangelism is more difficult because everyone is taking longer to evaluate new decisions? Or is it so focused and personalized on where marketers ultimately want to go that there is something that you can lean into that can help drive Segment towards greater growth in the 30% plus youâre targeting on the software side? Yes. I think, by and large, everybody knows that they want to better use data. I think, to be honest, like the greatest friction in the sales cycle is someone has a built-themselves solution, a DIY solution, and they like it. And so we just kind of wait it out, and we will show up again later. And I think the technology is superior. Thatâs really, really helpful, obviously. It pairs really well with the communications. Thatâs super helpful as we talked about earlier. And I think it just takes time. And I think we will grow the reps for that part of the business in a responsible way. I think we see great growth opportunities. Obviously, itâs a choppy environment right now. But I think in spite of that we will play through. And I think we will be able to reaccelerate that business, I think it will be fine. Can you talk more about just Engage and what else youâre doing on the marketing side? I think Segment and Flex weâve touched on a little bit, but the remainder of the software portfolio, just things youâre excited about, more of the four leading things kind of getting out of the meat of whatâs happening now and the metrics, more on just the forward-looking vision. Yes, I mean, look, Iâd say, in general, we are very excited about Engage. No question. Iâll come back to that in one second. I think that â weâre also just very excited to grow the products that we have. I think what â over the last couple of years, we pioneered a lot of interesting new features. Weâve pioneered a lot of interesting new products. And I think we have a great and very disruptive contact center product today that every time we win we end up displacing one of the other guys, right? So the growth characteristics there we really like. We like the margin characteristics there. I think we just have to grow it at a faster rate so that it becomes a bigger proportion of the business. I think the same is kind of true with segment. Again, like I think we know what works there. We have to kind of go back to that in a weird way. But we know it works and we just need to grow that part of the business faster. So, in terms of like where we are all focused as a management team, like we spend a tremendous amount of time talking and thinking about, okay, we have this great data asset. We have this great disruptive contact center product. How do we continue accelerating the growth of those two things, yes, we want to innovate on a bunch of other things, too, but the focus is really on those two things. Now, to answer your question on Engage, I mean I think Engage is an important new product from the perspective that itâs the first one really that combines all of the products within the Twilio umbrella, right. Through a singular API, you can deliver this really unique experience that previously was only available in the physical world and that in a kind of a post-COVID environment where some of our habits have changed, but many have not, itâs really, really important to be able to utilize data in a special way for a consumer to be able to deliver a really interesting experience, which creates loyalty. And I think thatâs what Engage is now â finally, the product thatâs able to deliver that. I want to go back to something that you said on Flex. You mentioned that you are often displacing legacy vendors in the contact center space. Is it more often the case that Flex comes in as a supplementary layer given you can flex up, flex down contact center agents within certain seasonal profiles, or is it a full-scale rip and replace currently in the way that you are generally approaching customers? Yes, itâs a great question. Itâs all of the above, honestly. I think initially, it was much more augmentation. And so you would go to an airline, letâs say, and they would actually have multiple contact center organizations, right. You would have customer service. You would have â some of that, that would face consumers, some of that, that would face other parts of the airline industry. And in many of those cases, what we would initially â just as an example, what we would see is they would say, look, we like your technology a lot. We are going to try it here. And then if it works, we will leverage it in some other part of the organization, or the other thing that we would see a lot of is, look, we are going to keep our current contact center product, but we are going to kind of run features of your side-by-side with it to augment what we do. And then if we like it, we will go from there. And I think in both cases, we are fine either way because they both allow us to grow faster. I think increasingly, what we are starting to see is a lot more rip and replace. Now, the one thing that we are cautious about with customers, and we were â we caution them to approach it this way is that if you are running 20,000-plus agents, itâs probably not a great idea to flip it on day one, right. So, we will graduate there. We will go 500 seats. We will go 5,000 seats, then we will go 10,000, 20,000. So, itâs meant to be a rip and replace, but itâs a gradual progression, if that makes sense. You gave an interesting stat on Flex as well on the â just the Tim O'Reilly has characterized that there was a slide that mentioned that this is Flex revenue, but there is also a pull-through where you are capturing additional revenue on the Twilio platform from those Flex seats. Can you walk through just the additional economics that you can realize beyond Flex? Yes. Basically, there is an attach that goes along with the pure software sale. I think we actually â we have debated this at times internally. Do we provide kind of a pure-play software number, how do we think about the attach, etcetera. So, we have just decided to provide both to make it, hopefully, clearer. But the way that we kind of conceptualize the business is those messaging sales or those voice sales or whatever they are, they wouldnât have happened had there not been a contact center play in the first place. Itâs probably how most kind of contact center companies evaluate themselves or present themselves to the public, and so we provided that with it. And typically, the way that it works is, is that for every dollar that you will end up having on Flex, you will probably spend another $0.70 on either voice or messaging or e-mail. One of the other questions we have gotten from investors since the Investor Day session was just on the changes that you are making and the margin improvements and a question on if they might not imply that itâs actually potentially more expansion than what the current targets assume. And I donât expect you to change your stance on what the current targets assume, but can you just talk through some of the cost-related impacts that you mentioned? There was real estate, moderation of new hiring. There are a few things that you laid out. And then just thinking about the sequencing of when margin progression from some of those things should start to show through in the model? Yes. I mean there is a lot in that question. And I want to be careful, obviously, about kind of restating anything either. But I think â first of all, I mean we feel quite good about like the medium-term targets, okay. And then obviously, we want to be on the higher end of those, okay. We provided ranges, but it would, of course, be our aim to the extent possible to do better than that. I mean thatâs always the goal of every company, obviously. And I think the short-term is just really choppy. And we are seeing, I think a macro environment that we just couldnât have imagined. We certainly didnât think about when we put out kind of our sort of a couple, a year ago 30% annual growth targets on an organic basis. And thatâs giving us a little bit of pause as we think about what transpires in terms of operating margin in 2023. All that said, I think that what we have done on headcount, what we have done in real estate, some of the other kind of other structural actions that we have taken internally, they all yield a really, really good setup in spite of what the macro environment is going to be in 2023. And we expect all of those things â itâs not all going to happen on January 1st, obviously. But through the balance of the year, all of that stuff is going to bleed into the bottom line and I think generate good profitability. And I think it creates a good base off of which we will get even more profitable in following periods. I think that the knock-on effect to some of those things too, is that some of â because we have lower headcount, because some of the moves that we have made also yield transfers from high cost to low cost as well as, in some cases, a shift to managed services, which donât involve headcount. I think all of that is an upside for stock-based compensation as well, which we have got to burn through the math, and I think we actually have to probably do a better job of just explaining like what our math problem is in the short-term. But I think over the medium-term, like we do see an â a significant improvement that will transpire in stock-based compensation as well. And it just has to happen at some level because you have lower headcount. The final thing I would say about it all is that, I mean obviously, we have gotten a lot of feedback from investors. And I mean I am â itâs not maybe about what transpired with the stock either, obviously. And I think we are listening, and that feedback has been helpful. And I think itâs causing us to kind of think about like how might we present the company differently and what things might we think about doing differently, but that feedback has been really constructive, and I think they are done in the right spirit. Just time for a couple more. I think focusing on just the path into 2023. One question we have been asking CFOs throughout the event is more just less on the Twilio investor-facing side and more on just the internal CFO side. One of the things we are hearing is just CFOs are more involved than signing up with sales processes and things. And so, just from your perspective, are there things that you are more focused on from a planning perspective heading into the coming year than was the case? I wouldnât say there has been like a really marked change or material change versus prior periods. I mean I have always been pretty involved in most of those things, so not really. And then the last question is for the investor-facing side, the things you are focused on that define success for the next year. We have talked about some of the baselines that you are setting, but we come back here and have this conversation next year. The metrics, I know you are contemplating, looking at a few different things there, but what the mile markers that are going to inform your perspective and how you define success going forward? Yes. I mean I think for us, probably the most important thing is that we have got to not just become a profitable company. But for that profit to give an indication to folks that we can be an incredibly profitable company over a long and sustained period of time. And then I think when the macro subsides that there are good signals, especially in the software side of our business where we put so much emphasis that there are good signs that we can reaccelerate growth there and that there is a really valuable franchise thatâs starting to build there. And I think for us that fundamentally means Segment and Flex. And I think for us on the communications side, especially messaging, it means we basically have to throw off a tremendous amount of profit so that we can keep growing in the other parts of the business in the way that we think we can.
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EarningCall_1691
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All right. Good morning, everyone. Thanks for joining us for our last day of the Wells Fargo TMT Summit. I'm Eric Luebchow and really pleased to be joined by Lumen's CFO, Chris Stansbury. Thanks for joining us. So, Chris, I know you joined back in April and we have a new CEO, Kate Johnson, who started in early November. So maybe if you could talk about generally speaking, you expect under Kate's leadership in terms of strategic priorities, any change of direction? I know it's early days and you don't want to speak on Kate's behalf, but any color you could give us would be great? Yeah, sure. I mean really and it's why I came to Lumen. I think there's a great growth opportunity. We've got a lot of work to do, but when you look at where the business sits today, the gift that we have, it is the strength of our network and how we can monetize that as we go forward. That's really where the company's focus is going to be, where Kate's focus is going to be. And when she came in to Lumen, she came in with strong knowledge of Lumen's business. When she was at Microsoft, she had a lot of interaction with Lumen. So she knows it well. And more importantly, she knows how to take a business that isn't growing to growth. And so she saw things, I guess, in a way that was very consistent with what I saw in terms of the opportunity and that's why she's here. So she's hard at work. I think you'll hear more from her in the New Year, but there's a lot of energy in the building, a lot of change underway and I think that's all going to be positive. That's great. So obviously, you had a big announcement on your last earnings call around capital allocation, electing to eliminate the dividend, which I'm sure was not an easy decision. But as you -- maybe you could walk us through some of the moving parts of your business that led you to that decision between the asset sales that have already closed, ones that are pending the Quantum Fiber investment and anything else that kind of led you to that being the most prudent decision for shareholders? Yeah, sure. And you're right, it was not an easy decision. I mean, the reason we're all here obviously is to return capital to shareholders. But our view on that is how do we best do that now and in the future. And when the 20 state ILEC sale was announced over a year ago. The company did say at the time that when the deal closed that they'd relook at had capital allocation priorities and that's exactly what we did. There was extensive conversation with the Board leading up to the close of that deal. Kate was involved in that before she joined so that she knew what was coming and had input to that decision. And really what it all boiled down to is, we've got a commitment on Quantum Fiber and that opportunity is real. We've got an enterprise business that in large enterprise and public sectors performing well, but that also requires capital. And really over the next four to five years, we're in investment mode while we position the company for long term strength and returning capital to shareholders. In the short term, there's really two levers. The first is with the stock price where it was before we made the decision, I would say that the market wasn't really fully rewarding the value of that dividend because of concerns over sustainability. And so converting that to a buyback, the $1.5 billion over the next a couple of years allows us or the next year and a half rather allows us to more aggressively return capital when the stock is at good prices and manage that guardrail of leverage that's so important. And so that flexibility is important, but we think buying stock at today's values is the right move given to our market conditions. So on the buyback, the $1.5 billion so really nothing other than trying to keep leverage as you said relatively leverage neutral in the 4 times below, or range or below I believe, nothing permitting you from being more aggressive on the front end of the buyback window if you think the stock is dislocated? It's really again, I don't want to get too much into timing. I would say that I think in the past when we've done buybacks, we were very aggressive about doing it all and doing it quickly. I think this has got a more measured approach around it. The board has informed we put a structure around how we can buy at what prices and what trading volumes. But the leverage factor is an important factor. We know that equity investors are harmed if we start to threaten debt ratings and we're not going to do that either. So it's going to be a dynamic process. I think itâs the best way to say it. As we look at coming quarters what the investment looks like in terms of uses of cash, how that's going to impact leverage versus when the EBITDA comes from those investments and where the stock price is at that moment. So it's not a simple a rule that we're going to follow. We're going to look at all those variables and make sure that we do the right thing at the right time. Okay. Fair enough. So just stepping back a little bit, kind of a broader business macro outlook. I think on your last earnings call, you've talked about some slower decision making from large enterprise customers. So maybe you could talk about your sales funnel of opportunities. Is it really just timing, getting people to go through their internal approvals and you see a good sales funnel of opportunity, maybe you could just talk generally about that and whether you've seen that change at all with some of the macroeconomic volatility that we're going through right now? Yeah. The funnel to date remains strong. So I think that's a really good sign. Decisions are taking a little longer. There's more layers to go through. I mean, it's happening at Lumen. There's things that I'm requiring to approve that I didn't require to approve six months ago. So I think that's normal. We're not seeing any change in cancellation behaviors. And I think that's another real positive. So I mean, look, when you get right down to it, the core of what we're selling in the enterprise space is really important to the operations of any companies that are buying those services. So I don't think it's about doing it on the cheap. I think it's just people are being a little more purposeful and how they approach the approval process and so it's just taking a little more time. Yeah. That makes sense. So you've re-segmented the enterprise or business segment into grow nurture and harvest the three buckets. And as you look toward that path in the next two to three years of returning to revenue growth, maybe you could talk about the grow bucket first. I mean, obviously, I know aspirationally you need that to grow faster. I think it was around 1% on a pro forma basis this past quarter. So what are kind of some of the steps you're taking to incentivize your sales force to attack that funnel of opportunities? Yeah. And it's -- I'll go with a couple of places there. So yeah, the growth wasn't great in the quarter. Obviously, I think the economic environment has impacted that somewhat. There was a normalizing factor, something that was in last year benefit that we had that didn't continue this year as well as a contract that ended. [indiscernible] had an impact of probably 150 basis points, but still not where we want to be to your point. So a few things. The low hanging fruit as we go into next year, sales comp has been changed to incent more around the growth bucket and less around nurture and harvest. So I think that's a change in the right direction. But most importantly, what you're going to see us do as a company is become far more kind of customer in rather than product out focused under Kate's leadership. And so we do have great product in those buckets, but a more specific customer focus on the problems they're trying to solve whether that be by vertical or just more broadly, that's how we get the growth bucket to grow faster. So you'll continue to see us make moves in that direction. I also think you'll see us continue to seek to bring product to market that customers need for problems that -- the problem solving that are focused more on the service layer around the network. And that's what's going to exist in that growth bucket as we go forward. So it's going to continue to evolve, but that is I would say the vast majority of Kate's focus right now is how do we do exactly that? That makes sense. So thinking about the nurture and the harvest bucket, I know in the quarter, I think the nurture bucket actually declined at a slightly higher rate. So maybe you could talk about as you think about those segments, largely managing them for cash and to be kind of NPV positive over time, what are your -- how should we think about the relative directions of those buckets as well? Yeah. So the -- if I start with the harvest bucket, I think the reason why harvest performed as well as it did is because you started to see re-rate activity yet. So when we broke the buckets apart, which I know seems like a long time ago, but it was really not all that long ago. It's as we exit the second quarter. We put a dedicated team focused on that business really around how do we make sure we're maximizing revenue and then also how do we get cost out? That easier if you will, not that it's easy, but a piece to approach was the revenue side. And so they've done a lot of work around rerates that started to hit. We'll see some of that actually in that thought process transition into the nurture bucket as we go forward. So more to come on that. And then the cost side, they'll get out later. But it really is about maximizing the cash flow from those businesses. And quite frankly, we're being very precise internally around cash flow is cash flow. I'm less concerned about EBITDA, if product is requiring CapEx and not generating any free cash flow and it's more of a distraction for the organization. So you're going to see us continue to make decisions around product lines as we go forward to make sure that we're not spending time and energy on products that really aren't generating anything for us over the long run and we'll spend more time on those products that are generating cash and where we can start to migrate customers up the stack from say a harvest voice TDM product to say VoIP. So those are the kinds of things we'll be focused on. As we think about the bucketing, is there any evidence kind of cannibalization across any of the products in terms of, I think one that has been talked about for years is people migrating from MPLS to SD WAN that has any material impact on your ability to get to kind of consolidated revenue growth in the next few years? Yeah. I mean, it's a great question, right. And let me just within the walls of Lumen, give you I think an example. If you think about the consumer business for a second, when you think about Quantum Fiber, that whole mindset about, hey, cannibalization is bad, is exactly why we have roughly 10% copper penetration in the markets where we are and why we're out doing quantum today. That mindset cannot influence the way we think about the enterprise segment. So my view on cannibalization is, cannibalization is good as long as we're the ones doing it. It's not somebody else doing it to us in the form of share loss, because ultimately the world is going where the world is going. And if we can be part of a solution that takes a customer and moves them to next-gen technologies brings more services to them and allows us to manage the NPV of that customer more efficiently than we'll do that all day long. Now how that plays out in terms of the shifts between buckets, that's a little harder to model. I think we'll definitely be back to the market with more around that as we get a little more thinking behind the moves that we'll make next year. But that is a definite mind shift change within the company, which is we can't. We absolutely cannot sit in our hands and say, cannibalization is bad. Let's try to preserve this dying asset because it's going to die. And I think as you've said as well, the gross margin contributions across the buckets are relatively consistent, which I think may have surprised some people who always thought that some of the legacy telecom products always had super high margins. So it sounds like we shouldn't see a big margin impact even if things do shift. No. And I think that's right. I mean, that's one of the reasons why we provided a little color on that last quarter. And it's just part of the march, we've been on to give more visibility into what's going on inside the business because those shifts are not harmful over the long run. If anything, they're beneficial we have to manage it appropriately. And I think that's the key thing that we're focused on right now. Yeah. Fair enough. So I definitely wanted to talk about Quantum Fiber. Fiber to the home has been a big topic of discussion at this conference. So you've called out a variety of labor, supply chain, permitting challenges as part of your Quantum Fiber build. And I know aspirationally in the past you've talked about wanting to get to a run rate of building out 1.2 million to 2 million locations on an annual basis. So maybe you could talk about the pathway or anything on the timing to get there and whether you see some light at the end of the tunnel on working through some of these supply chain challenges? Yeah. So when I came into Lumen, my biggest concern is that I didn't want us just to be focused on number of enablements and cost per enablement, right? We need to be focused on good enablements, right, enablements that allow us to generate solid penetration as we go forward. So there's no point in building fiber if a customer doesn't want that fiber, right? And so we have gone through extensive work to make sure that those are the kinds of enablements we're building. So that's a real thing. I think there's been very good thinking that's been done on that. And then, yes, that is -- you layer on top of that some of the issues we've had on the supply chain side and that's where we are today. So I'm not ready to give a time frame on when we get to necessarily those larger numbers. I do think that the scaling of the factory if you will is moving in the right direction, but it's not going to be quick. When you look out in terms of engineering and permitting, at any point in time, when you're having that discussion, you're really talking about something that's going to take place in nine months. And so I think we are doing the right things, but I think it's going to be a little while until we see that really start to ramp. Yeah. Understood. And has the current environment in terms of inflation and obviously higher interest rates today made you reevaluate at all whether $12 million which is kind of the addressable market you've talked about in the past. Does that still make sense or higher cost of capital raising the hurdle rates at which you look at certain markets? Yeah. So if you look at the cost per enablement, it's definitely a little higher right now. I don't think that changes the outlook for the product. Again, it's a three variable model. If we oversimplified it, it's the cost per enablement, it's your penetration rate and it's the ARPU. The only thing we know for sure right now is the cost per enablement. We don't know where the penetration of the ARPU is going to go. What we do know is that the penetration is ramping very nicely to our 40% expectation. If we can do better than that because again we're building in a smarter way where customers want that product, then that will raise the level at which we can spend on the front end, right? But the returns are looking good. So that's not a limiting factor today in our outlook. I also would say that even with our focus on making sure we're building the right enablements, these are growing markets and they're definitely -- we're in Western markets. There's definitely a shift west. I think that will continue to create future opportunity that we can't really measure today. But as building continues and population shift, that's in our favor. Fair enough. And one of those variables, ARPU, I think your ARPU is around $60 or so, on fiber. And I would imagine that there's an opportunity for that to scale over time. We all see some of the exploding bundles that the cable operators have. That could maybe give you some opportunity. I mean, is the plan to start at kind of a lower price to gain share? And then as you get scale you can start to grow ARPU a little more aggressively? I would say, yes. I mean the reality is that we wanted to bring simplified pricing to the market. We want to be easy to do business with this, that's why the NPS scores are so strong. And largely, as we go forward, it becomes and we build out enablements, it becomes a self-service product because the hardware that we're putting in the home allows scalability on the speeds that you're able to connect to. So all of that's really good. But until we get to scale, it doesn't make sense to do a ton of marketing, right? It makes more sense to have a sharper price point to create the penetration than it does trying to blast the market with marketing when you don't have the enablements built that would support that. So that's really the near term thinking. But yeah, I do think given the quality of the product, and the ability to do marketing behind that as we get to scale that probably gives us more tailwinds than headwinds. Have you noticed any type of competitive response at all from the cable companies in your markets where you're starting to build in terms of pricing or have they been relatively rational so far? It's been relatively rational. And again, I'm sure we're going to see activity at some point, but the reality is that the capabilities of that product cable can't meet. And again, we've already announced a symmetrical 8 gig product, not because we think there's huge demand for that today, but that's a statement. And it's a statement about how future proof this network is, as we build it out and the scalability of that and competition can't touch it. And at some point, the consumer will make those decisions based off their needs. Yeah. Fair enough. So last month you gave some -- a few guideposts on items in your 2023 outlook. So maybe you could kind of walk us through a couple of the main points from the 2023 outlook in the moving parts there? Yeah. So obviously, we're not ready to give guidance yet. Kate's been here for just a few weeks. She's hard at work, getting us aligned around where we go next year. So more to come on that in the New Year and you'll -- I guess I mentioned earlier, you'll hear more from her in the New Year. But what we wanted to do was provide some clarity given all the moving pieces with the divestitures and whatnot. So setting aside EMEA for a second because we don't expect that to close till late in â23. We talked about a roughly $1.4 billion reduction down in EBITDA for the impact of the assets that have been divested that were included in â22. So if you take our expectations for this year, which are the low end of guidance, you adjust the $1.4 billion that gives you a stepping off point. We also said there were some near term challenges around dyssynergies associated with those divestitures. We're hard to work on that. I've got a team working on how we can aggressively take out other costs. And my comments earlier on, the product portfolio would be part of that as well. We talked about CapEx being in about the same neighborhood that we guided this year, but that actually in real terms is about a 10% increase in capital spending because the businesses that we divested had CapEx associated with them. So that allows us to go invest in some of the areas that Kate is going to want to focus on. We will be a cash taxpayer next year. So 26% is the effective rate. We say that equates to about $300 million to $400 million. And our average interest rate in our debt is about 5.75% and our net debt after we pay a tax bill associated with that divestitures is going to be in the roughly $20.5 billion range next year. So those are⦠Yeah. That's helpful. Maybe just given the moving -- the volatility in the fixed rate or the fixed income market, you could talk about managing kind of the floating rate exposure in your market and then how you're going to balance that against your desire to repurchase stock and whether you'll need to fund any of that with incremental debt? Yeah. So the -- if you look at where leverage is today, so we're kind of 3.7%, 3.8% I think using leverage to buy back stock is not really in the cards today. Our fixed floating mix is roughly 60-40 today and that's manageable. We're not -- I normally say, we're not concerned, but we're not overly concerned that there's any major risk associated with the floating rate exposure that we have today. And if you look at how the debt is balanced out over the coming years, we don't feel any pressing need to make any major adjustments there, although, opportunistically we'll take advantage of the markets when that exists. So that's where we are on that. I feel good about a third of our debt being gone. Again, obviously, leverage hasn't changed a lot, but we're over time simplifying our debt structure and I think that's a positive as well. So on the CapEx front as well, you've provided some disclosures around Quantum Fiber around $1 billion of CapEx this year around $500 million of maintenance CapEx. I think enterprise CapEx for some of us is a little bit more of a black box at Lumen. So maybe you could talk about ways that you're seeking to be more capital efficient on the enterprise side going forward to help offset some of the ramp in Quantum Fiber for instance? Yeah. It's -- the enterprise number is always the toughest number to forecast because the biggest piece of that is success based. So we've made a number of announcements this year around public sector wins, right, DoD, USDA, USPS, border security. Every one of those projects has capital associated with it. So at the beginning of the year, we don't know if we're going to win a contract or not. We don't know if we do. We don't know when it's going to start. But the capital that goes into those projects is largely what sits in that roughly $1.5 billion that we've talked about. There are other things though that we will be investing in to improve the front end. So we've done some work around our digital marketplace. We've got a lot more work to do to be more customer friendly again with that, customer first mindset that Kate brings to Lumen. And so there will be work around digitizing the selling motion, digitizing more back office so we can get it to dyssynergies. So that's in there as well. That was helpful. And maybe you could walk us through some of the dyssynergies. I think some investors were a little confused around the moving pieces there. Obviously, one of those pieces is cost transformation that I think you can probably accelerate a little more now that you've closed on the two transactions and then there were a couple other dyssynergy buckets as well. Maybe you could talk about how those are trending and how we should think about those this year? Really the biggest dyssynergy at a high level is you've got a corporate overhead structure that is very difficult to change even though the business has gotten smaller, right? I can't make my SEC reporting team smaller. I can't make IR smaller and so those things are real. The things that we can focus on though, it gets back to the digitization efforts. There's a lot of manual work we do today. So we're in a situation where we've got to do an ERP upgrade because the product we're running on is getting old, but that opens a door to allow us to collapse 20 odd ERPs into one. That's an example of how we get the systemic cost change over time to help offset the dyssynergies that exist. So it's not necessarily saying this group is a dyssynergy, I got to figure out how to make it smaller. We'll do that where we can, but we also can't break anything. It's more about how do we look for ways to drive efficiency elsewhere in the organization. And I think there's ample opportunity to do that. Got you. So do you think over time as we look at kind of your consolidated EBITDA margins pro forma, there's an opportunity for those to scale as you work through some of these different transactions. There's moving pieces. So I would say longer term yes, but near term let's not lose sight of the fact that the 20 state ILEC sale with some of our highest EBITDA margin products. So there will be a step down. So on a pro forma basis, we will be lower going forward than we have in the past. But off of that base, yes, with dyssynergies, with more of a focus on service layers that customers want to solve their problems. I think that's an opportunity. Fair enough. So there have been some recent reports on you. Maybe exploring additional asset divestitures. And I know you won't comment on anything specific, but maybe you could generally talk about how you think about additional divestiture opportunities is another source of funds. And then related to that, obviously, you had a pretty nice multiple on the EMEA business, but any sick term, anything you see from infrastructure funds private capital, their willingness and demand for some of the assets in your portfolio? Yeah. I would say that from a geographic standpoint, there's not much that's left. By the time we're done, EMEA, there's maybe one or two things that we would look at. And again, the reason that we did what we did around LatAm and EMEA, we got great valuation for it, but those businesses needed capital, right? They needed capital to drive scale. And in Lumen's operations, they were generating very little free cash flow. So they needed more capital and we could afford to put in it. And frankly, it was a distraction given the task at hand on what we needed to do in North America. By divesting of those assets, we set them up for success in terms of scale and we have cross relationships with each other where we can sell each other's network to meet needs for our global customers on both sides of those transactions. So it's a win-win in that regard. And yeah, in the EMEA deal, we got another great multiple. I would say it goes more to my comment earlier in our conversation around product. And I don't want to get specific about product, but we're getting very focused about a product by product look and say, okay, why do we do this? This doesn't generate any free cash flow. We've got people working on it. We've got utilities exposure because we got to keep things turned on. We've got maintenance exposure. So you get into all those hidden costs that ultimately hit the P&L, but may not be getting allocated correctly or anything else. And so we can -- I think do a better job of saying, if that's not generating free cash flow and it's not part of our future success, then let's have a really challenging question as to why we're doing it. And if there's a buyer for it, great. If there's not a buyer for it, then how do we manage the exit of that business? That's great. I think we have time for just one more, Chris. So one of the other big industry events happening right now, the broadband maps are out for the infrastructure build, a $42.5 billion BEAD program. And I'm sure you have teams evaluating it, but how do you think about some of the government subsidy opportunities to maybe attack parts of your ILEC footprint with fiber over time. We'll obviously look at all of those. It's going to be a very competitive process though. And so, in our modeling, we're not counting on any of that. So I don't want to set a false expectation that then we don't deliver on. But to the extent that there's something that's economically viable for us to bid on and help use those funds to improve service to those areas, we'll absolutely do it. Okay. Well, I think we're just out of time now. So, Chris, appreciate you joining us and making the trip out to Vegas.
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EarningCall_1692
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Good morning, and welcome to the Vail Resorts Fiscal 2023 First Quarter Earnings Conference Call. Currently, all callers have been placed in a listen-only mode and following management's prepared remarks, the call will be open for your questions. [Operator Instructions] Please be advised, I will now turn the call over to Kirsten Lynch, Chief Executive Officer of Vail Resorts. You may begin. Thank you. Good morning, everyone. During our earnings call yesterday, the conference call system vendor for the event experienced a significant technical outage disrupting the call. The vendor was unable to reestablish their systems yesterday evening, therefore, we rescheduled the call for this morning. We apologize for the inconvenience this call caused and thank you for joining us this morning. Joining me on the call is Michael Barkin, our Chief Financial Officer. Before we begin, let me remind you that some information provided during this call may include forward-looking statements that are based on certain assumptions and are subject to a number of risks and uncertainties as described in our SEC filings and actual future results may vary materially. Forward-looking statements in our press release issued yesterday afternoon, along with our remarks on this call are made as of today, December 9th, 2022, and we undertake no duty to update them as actual events unfold. Today's remarks also include certain non-GAAP financial measures. Reconciliations of these measures are provided in the tables included with our press release, which along with our quarterly report on the Form 10-Q were filed yesterday afternoon with the SEC and are also available on the Investor Relations section of our website at www.vailresorts.com. With that said, let's turn to our fiscal 2023 first quarter results. We are pleased with our results for the quarter with resort reported EBITDA improving, compared to the prior year period, primarily driven by the strong demand and visitation at Australian resorts. Australian resorts continued to experience record visitation, driven by strong demand, following two years of COVID-19-related disruptions and supported by continued momentum in advanced commitment pass product sales following the addition of Hotham and Falls Creek in April 2019. Our North American summer operations continued to recover following the COVID-19 pandemic. Turning now to our 2022-2023 North American season pass sales and early season indicators. We are pleased with the results of our season pass sales, which continue to demonstrate the strength of the guest experience, our network of mountain resorts and commitment to continually investing in the guest experience. Pass product sales for the North American Ski season increased approximately 6% in units and approximately 6% in sales dollars through December 5th, 2022, as compared to the period in the prior year through December 6th, 2021, including sales for the Seven Springs Resorts in both periods and adjusted to eliminate the impact of foreign currency by applying an exchange rate of $0.74 between the Canadian dollar and U.S. dollar in both periods for Whistler Blackcomb sales. Advanced commitment is our core strategy shifting lift ticket guests across all of our mountain resorts into a commitment before the season starts driving stability for our company and long-term lifetime value. Our North American season pass program has grown dramatically over the last three-years. Season pass units have grown approximately 86% in units and approximately 53% in sales dollars, compared to the sale -- to sales for the 2019 and 2020 season through December 9th, 2019. We expect to have approximately 2.3 million guest in advanced commitment products this year, generating over $800 million of revenue in advance of the season and representing over 70% of all skier visits committed to our 40 North American and Australian resorts in advance of the season in a non-refundable pass, an increase of over 1.1 million guest in the program from the 2019-2020 season, including all pass products for our North American and Australian resorts. This substantial base of pre-committed local and destination guests, revenue and visits also creates a strong foundation for in-season ancillary spending across our 40 mountain resorts in North America and Australia. For the full pass sales season, the business achieved strong unit growth from renewing pass holders, especially guests in destination and international markets, including strong renewals among those who are new to our pass program last year. Our strongest growth occurred in destination markets, which represents the largest addressable market for conversion of guests into advanced commitment and is a particularly attractive guest segment given the higher ancillary attachment. Our Epic Day Pass continues to be our highest growth product segment, targeting the large market of lower frequency skiers into advanced commitment and particularly destination guests with valuable ancillary spend. Our local markets also grew over the prior year in excess of our expectations, remaining a critical foundation for our advanced commitment strategy and are the most developed and highly penetrated markets. Sales of Epic and Epic Local passes are consistent with our expectations and with the trends seen in our September results, with unit sales declining by 12% relative to the prior year and increasing 39% over the last two years and 55% over the last three years. This represents substantial growth in our highest priced products and among our most penetrated high frequency skier segment. And we expected this year's performance as a result of the significant growth after last year's price reset. We continue to expect that the majority of the future growth in advanced commitment will come from the large and attractive addressable market of destination guests, primarily through transitioning lower frequency lift ticket guests into Epic Day Pass products and transitioning guests at our local and regional resorts into advanced commitment. Pass sales dollars continue to benefit from the 7.5% initial price increase and subsequent incremental price increases relative to the 2021 and 2022 season, offset by the mixed impact from the growth of new pass holders purchasing Epic Day Pass products. This year, net migration among renewing pass holders is in line with our expectations of a 4% decline year-over-year, following last year's positive 10% net migration that resulted from pass holders trading up to higher value products with more access following the price reset. We proactively use the breadth of our product line and our data to retain guests in the advanced commitment program by offering and in certain cases, encouraging them to purchase lower priced products to best suit their needs based on their behavior. We are pleased that over the last three years, we have maintained renewal rates among our unlimited pass holders, including Epic, Epic Local and Unlimited Regional passes, while growing these pass holders almost 75% during that time period. As previously announced, we completed a multi-year extension of our pass partnership with Telluride Ski & Golf and are pleased to continue offering Epic Pass our four to seven day Epic Day Pass with all resort access and Epic Adaptive Pass guests access to Telluride. Starting next winter for the 2023/2024 North American ski season, reservations will be required for pass holders skiing or riding at Telluride. Reservations will not be required for pass holders visiting Telluride in the 2022/2023 North American ski season, and more details will be provided in advance of next season. Heading into the 2022/2023 North American ski season, we are pleased with our significant base of committed guests that provide meaningful stability for our company, especially during economic uncertainty. We have strong early season conditions at our resorts in the Rockies and West and typical seasonal variability at our resorts in the East. While our mountain resorts have not yet completed hiring for the winter season, we are on track to have the staff needed to achieve full operation of lifts and mountain terrain and deliver normal operations of important guest experiences such as our restaurants, lodging, ski and ride school, and rental and retail locations. Hiring is still ongoing and a top priority as our mountain resort teams focus on hiring for specific roles and continue hiring to manage staffing needs that occur throughout the season. Looking forward, we are pleased with lodging booking trends for the upcoming season, which are consistent with pre-COVID-19 levels. We are also seeing lodging bookings that indicate visitation patterns may shift this year from the December holiday period into January through April. We are pleased to welcome guests to all of our resorts as the 2022-2023 North American and European ski season kickoff with significant investments in the guest experience, including 18 new or replacement lifts across 12 resorts, which will meaningfully increase lift capacity and reduce wait times at those lift locations. At Vail Mountain, this includes the installation of a new four-person high speed lift in the Sun Down Bowl and replacement of a four-person lift with a new six-person high speed lift in the Game Creek Bowl. At Whistler Blackcomb, this includes the replacement of the four-person high speed Big Red Express lift with a new six-person high speed lift and replacement of the six-person Creekside Gondola with a new 10-person high speed Gondola. As discussed in prior announcements, this also includes the installation of new or replacement lifts at Breckenridge, Northstar, Heavenly, Stowe, Mount Snow, Attitash, Jack Frost, Big Boulder, Boston Mills and Brandywine. Now I would like to turn the call over to Michael to further discuss our financial results and fiscal 2023 outlook. Thanks, Kirsten, and good afternoon and good morning. As Kirsten mentioned, we're pleased with our first fiscal quarter performance. Net loss attributable to Vail Resorts was $137 million for the first quarter of fiscal 2023, compared to a net loss attributable to Vail Resorts of $139.3 million in the prior year. Resort reported EBITDA was a loss of $96.5 million in the first quarter of fiscal 2023, compared to resort reported EBITDA loss of $108.4 million in the prior year. This increase is primarily due to the greater impact of COVID-19 and related limitations and restrictions on results in the prior year. Our balance sheet and liquidity position remains strong. Our total cash and revolver availability as of October 31, 2022 was approximately $1.8 billion with $1.2 billion of cash on hand, $417 million U.S. revolver availability under the Vail Holdings credit agreement and $207 million of revolver availability under the Whistler credit agreement. As of October 31, 2022, our net debt was two times trailing 12-months total reported EBITDA. The company declared a quarterly cash dividend of $1.91 per share of Vail Resorts common stock that will be payable on January 10, 2023 to shareholders of record on December 27, 2022. We will continue to be disciplined stewards of our capital and remain committed to continuous investment in our people, strategic high return capital projects, strategic acquisition opportunities and returning capital to our shareholders through our quarterly dividend and share repurchase program. Moving now to our fiscal 2023 outlook. We are encouraged by the strength of our pass sales, the strong early season conditions for our Mountain Resorts and the Rockies and the West, and staffing levels, which are on track to deliver an outstanding guest experience. We are reaffirming our fiscal 2023 guidance for net income attributable to Vail Resorts of $321 million to $396 million and resort reported EBITDA guidance of $893 million to $947 million that was included in our September earnings release. Assuming a continuation of the current economic environment, normal weather conditions and no material impacts associated with COVID-19, for the 2022/2023 North American and European ski season or the 2023 Australian ski season. It is important to note that there continues to be uncertainty around the economic outlook and the impact that may have on travel and consumer behavior as we head into our primary operating season. Our guidance includes an estimated $4 million of acquisition and integration related expenses in fiscal year 2023 associated with the acquisitions of the Seven Springs Resorts and our majority ownership in Andermatt-Sedrun. Foreign exchange rates have experienced recent volatility. The guidance assumes the foreign currency exchange rates as of our original September 2022 guidance. Relative to the fiscal 2023 guidance, if the exchange rates as of Wednesday, December 7th, 2022 of $0.73 between the Canadian dollar and U.S. dollar related to the operations of Whistler Blackcomb in Canada, $0.67 between the Australian dollar and U.S. dollar related to the operations of Perisher, Falls Creek and Hotham in Australia and $1.06 between the Swiss franc and U.S. dollar related to the operations of Andermatt-Sedrun in Switzerland were to continue for the remainder of the fiscal year. We expect this would have an impact on fiscal 2023 guidance of approximately negative $6 million for resort reported EBITDA. Thank you, Michael. We remain dedicated to delivering an exceptional guest experience and we'll continue to prioritize reinvesting in the experience at our resorts, including consistently increasing capacity through lift, terrain and food and beverage expansion projects. As announced in September, the company expects to invest approximately $180 million to $185 million in calendar year 2023 capital expenditures, excluding one-time investments related to integration activities, deferred capital associated with the Keystone and Park City projects and $13 million of growth capital investments at Andermatt-Sedrun. At Keystone, we plan to complete the transformational lift served terrain expansion project in Bergman Bowl, increasing lift-served terrain by 555 acres with the addition of a new six-person high speed lift. At Whistler Blackcomb, we plan to replace the four-person high speed Jersey Cream lift with a new six-person high speed lift and replace the four-person high speed Fitzsimmons lift with a new eight-person high speed lift. At Breckenridge, we plan to upgrade the Peak 8 base area to enhance the beginner and children's experience and increase uphill capacity from this popular base area. The investment plan includes a new four-person high speed 5-Chair to replace the existing two-person fixed-grip lift, as well as significant improvements, including new teaching terrain and a transport carpet from the base, to make the beginner experience more accessible. At Stevens Pass, we are planning to replace the two-person fixed-grip Kehrâs Chair lift with a new four-person lift, which is designed to improve out-of-base capacity and guest experience. At Attitash, we plan to replace the three-person fixed-grip Summit Triple lift with a new four-person high speed lift to increase uphill capacity and reduce guestsâ time on the longest lift at the resort. These lift projects are subject to regulatory approvals and are currently planned to be completed in time for the 2023/2024 North American winter season. Additionally, the Company plans to expand parking across four resorts by more than 500 spaces, to improve the guest experience. The Company is planning to introduce new technology for the 2023/2024 North American ski season that will allow guests to store their pass product or lift ticket directly on their phone and scan at lifts hands-free, eliminating the need for carrying plastic cards, visiting the ticket window or waiting to receive a pass or lift ticket in the mail. Once loaded on their phones, guests can store their phone in their pocket, and get scanned hands free in the lift line using Bluetooth Low Energy technology. In addition to the significant enhancement of the guest experience, this technology will also reduce waste of printing plastic cards for pass products and lift tickets, and RFID chips, as a part of the Company's Commitment to Zero. Even after launch, the Company will continue to make plastic cards available to any guests, who cannot or do not want to use their phone to store their pass product or lift ticket. The Company is also investing in network-wide scalable technology that will enhance our analytics, e-commerce and guest engagement tools to improve our ability to target our guest outreach, personalize messages and improve conversion. In addition to these investments, we are pleased to announce plans to invest approximately $13 million at Andermatt-Sedrun in high-impact growth capital projects as an initial step in a multi-year strategic growth investment plan to enhance the guest experience on the mountain, which will be funded by the CHF110 million capital that was invested as part of the purchase of our majority stake in Andermatt-Sedrun. As part of the calendar year 2023 investments, we are planning to upgrade and expand Sedrunâs snowmaking to enhance the experience for key intermediate terrain. In addition, we plan to enhance the on-mountain dining experience with renovations to the Milez and Natschen restaurants and replacement of the Valtgeva restaurant. These investments are expected to be completed ahead of the 2023/2024 European ski season and remain subject to regulatory approvals. Including $1 million of one-time investments related to integration activities, $10 million of deferred capital associated with the Keystone and Park City projects, and $13 million of growth capital investments at Andermatt-Sedrun, our total capital plan for calendar year 2023 is expected to be approximately $204 million to $209 million. We will provide further detail on our calendar year 2023 capital plan in March 2023. In 2017 Vail Resorts announced an ambitious plan to take action to address our direct impact with a commitment to achieve zero net operating footprint by 2030, including zero net emissions, zero waste to landfill, and zero net operating impact on forests and habitat. As recently announced in our EpicPromise Progress Report, we are pleased to be on track to achieve a zero net operating footprint by 2030 and have achieved 100% renewable electricity across our North American mountain resorts within the past fiscal year. The Company is ahead of schedule to meet its emissions goals, and is on track to reach zero waste to landfill and zero net operating impact on forests and habitats to achieve a zero net operating footprint by 2030. We remain dedicated to doing our part as responsible stewards of the great outdoors and committed partners to our communities. More information about our Commitment to Zero and efforts towards sustainability can be found at EpicPromise.com. As announced last week, we are pleased to welcome Angela Korch back to Vail Resorts as our Executive Vice President and Chief Financial Officer, effective December 22, 2022. Angela rejoins Vail Resorts from CorePower Yoga, where she served as Chief Financial Officer since May 2020, after previously spending more than a decade in successive leadership roles within Vail Resortsâ finance organization, working closely with our current CFO, Michael Barkin. Angela originally joined Vail Resorts in 2010 and was most recently in the role of Vice President of Corporate & Mountain Finance, responsible for supporting the company's mountain division during a rapid expansion of its resort network. During her tenure, she managed financial and capital allocation strategies, transformed core processes, and played an integral role in the integration of 32 mountain resorts. Angela is a strong leader with deep experience in our industry, a passion for our sport, and a long history with our company. I wanted to take this moment to thank Michael Barkin for his service to the company. After 10-years with the company and nine years as CFO, Michael will be stepping down to pursue personal goals effective January 1, 2023. Michael has played a central role in the Company's national and global expansion, including the acquisition and integration of 34 resorts across four countries. Michael has built a best-in-class finance organization that has allowed Vail Resorts to grow and scale successfully. On a personal level, I will miss Michael tremendously. He has been a strategic thought partner and my friend for the past 10-years. I am grateful for his work to build an outstanding team of finance leaders, including our new CFO, Angela Korch, who will help lead our company into the future. Michael will be greatly missed. And on behalf of the company, I want to express my sincere gratitude to Michael, for his 10-years of service and leadership. In closing, I would like to thank all of our employees especially our frontline team for their passion, hard work, and commitment to creating an experience of a lifetime for our guests. The guest experience that our employees create is our mission as a company and lies at the center of our success. We all look forward to welcoming skiers and riders back to our mountain resorts this winter season. Hi, good morning, everyone. Michael maybe just start with thanking you for all your help, your guidance, maybe a little bit of your patience over the years, best wishes in your next venture here. To Kirsten, if we were going to kind of dig into one thing that was kind of new on this release, I think it would probably be around some of your commentary on the lodging bookings. So could we expand on that a little bit specifically the comment around, sort of, the patterns that you're seeing around the December holiday period this year? And sort of I think the perspective that a lot of questions we're receiving have to do with, is there an issue or something that's kind of changing the pattern around either the fiscal second quarter specifically around the holiday? Or is this sort of a kind of more natural yield management just as that period is always full and people are booking, kind of, further out in the pattern you're able to track kind of similar people? Just help us understand that comment and what you're getting at a little bit more there? Thank you, Sean. Yes, regarding our pacing on the books and bookings, they look good versus pre-COVID levels and we're pleased to see that, so that's in total. As noted, there we are seeing some shift in the timing within that and between December into January through April and wanted to be transparent about that. The pacing for the entire season is looking strong and good at this point. And as, you know, we noted last year, we have seen more of a move to off peak, which we consider to be a positive. It's still early in the season, but wanted to note that we're seeing some shifting within the total bookings from December into January through April. That's helpful. And then, curious to maybe just to, kind of, push or dig a little further on that. We talk about bookings or pacing. Are we talking about, sort of, nights and volumes? Or are we in including -- are we talking about dollars? So are we including rate increases? Obviously for those of us who, kind of, focus on lots of leisure categories, pricing it up quite dramatically in most leisure activities out there? So help us think about are we talking volume or dollars, because we would think that probably dollars should be doing materially better than just bookings? Hey, how's it going? Michael, just want to echo Shaun, say good luck with whatever comes next. It's been a pleasure and hopefully you can personally boost the FY â23 skier visit number. With regards to ancillary, there seems to be a push to move skiers into advanced ticket options, especially the lower frequency, presumably this brings you closer to a very valuable customer and thus better situate you to drive ancillary spend. I guess the two questions on that would be when you look at the existing base of lower frequency skiers that you have, this may be tough, but how underpenetrated do you think you are? Is that something you can quantify? Have you done it like internally and then set in? What -- can you kind of just talk about the levers you can pull once that advanced decision has been made? Is it as simple as email? I guess the question is basically saying like after the advanced purchase decision has been made by the customer, is that enough? Or is there still more work on your end? And then my frame of reference for these questions is again the lower frequency guests with the advanced purchase decision? Thanks. Yes. Hi, Ben. Thank you for the question. So we do believe that as it relates to advanced commitment, the largest addressable market to really penetrate is the lower frequency destination guests. And it is a large and attractive market. They are low frequency destination guests. Because their destination guests, they do tend to spend on ancillary businesses such as F&B, rentals, ski school. When we think about this coming season, I'd say overall, we are in a very good position in that we have over 2.3 million guests pre-committed to come visit our resorts this season. When you think about the value of that in the travel and leisure business of knowing 2.3 million people are pre-committed to coming and visiting that's the benefit of the units of pass sales and the dollars that we've sold, but also the ancillary attachment that naturally comes with that. Related to that, in terms of ancillary attachment there are some natural behaviors that occur in terms of ancillary attachment, but we also have a data-driven approach to connecting with those guests in a way that's relevant to them to encourage ancillary capture and also pass holders receive what I would call, like membership benefits with Epic Mountain rewards, with discounts on our ancillary. So as we pursue this addressable market, there's a natural spend behavior that already exists. And of course, our goal is to increase that share of wallet as they come to our resorts. Okay. That makes sense. So it's like almost two pronged, itâs increased the penetration of the existing lower frequency part one and then part two increase the deeper into the TAM of the potential lower frequency guest? And then just one quick follow-up. Is that something in terms of your existing lower frequency guest base, have you guys tried to take a swing at like quantifying how penetrated you are relative to where you would like to be? Is that something you've done? And would you share that ever? We're not sharing that number today, but we obviously quantify the TAM and the progress we're making on the TAM and continue to believe that there is a lot of upside potential in terms of penetrating that addressable market. Yes. So question is kind of on -- if you're seeing any discernible difference in, I guess, pass buying behavior among your local and say, Western, I guess, just trying to drill down a little bit into whether there's any noticeable impact yet from some of these economic pressures in terms of when people are buying or what kind of pass they're buying relative to what they did last year or maybe in 2019 for those that you have history with? Thanks, Chris. You know, overall, I think the underlying dynamic, I feel very good about. And do not see any underlying shifts in behavior dynamics that are concerning at this point. The key metric that I look at is our renewing pass holders and our renewing pass holders continued to be strong are including and especially the first time pass holders that joined last year were new to the program last year and to me that really validates the resort network, the guest experience and our investments that we're making into that experience. We are seeing both local and destination grew versus prior year, which I do feel very good about in terms of, yes, seeing growth in both of those especially after a really strong growth year last year to have growth on top of that is a pretty incredible accomplishment. I think what's happening in terms of our pass holder mix is the progress that we're making on penetrating that destination addressable market with Epic Day Pass and that is a product that's designed very specifically to attract and penetrate into that addressable market. And that is -- so it's very good news that we're making progress there on Epic Day Pass, and we think that, that's a really valuable guest. And so in terms of our overall pass mix, that's probably the biggest shifts that we've had is the introduction of Epic Day Pass and making progress against that market, that prior to launching Epic Day Pass, we really would not have seen a ton of success with that addressable market, because they were never going to come into an Epic or an Epic Local Pass given the high frequency nature of those products. Okay. Super helpful. And just as a follow-up, I know you mentioned you're not completely done with hiring yet for the full season, but any surprises positive or negative as you're going through that process in terms of cost or availability? And then anything new on the longer term employee housing projects or initiatives? Yes, I'm really pleased with where we are on recruiting, retention, talent overall. Our investments in the employee experience weâre seeing significant improvements versus where we were last year. Our hiring is ahead of schedule, we have significantly higher levels overall in staff than we did last year. And as I mentioned, hiring is still ongoing as a top priority for our Mountain Resort teams. They are still hiring for some specific roles and we'll see them continuing to hire through the season as staffing needs occur through the season. I feel very good that we're on track to have the staff that we need for full operation of lift and mountain train normal operations of some of the ancillary businesses that I shared earlier. I have noted that one of the biggest challenges to getting fully staffed is affordable housing. We as a company are committed to investing in affordable housing, we have increased our affordable housing options for employees versus last year. And this has been and continues to be a challenge in our market community -- in our mountain communities. So there's ongoing work that we need to do to make progress on this and continue to partner with our communities that they also make it a priority. Good morning. Thank you very much for taking my question. I wanted to follow-up on Ben's question with regards to ancillary revenue. Michael, should we assume that ancillary spend per visit gets back to pre-COVID levels? What's actually embedded in guidance? Or are you anticipating based on your commentary about economic uncertainty that it might not come back to the pre-pandemic levels? Thanks, Laurent. We -- on ancillary, we look at this at a much more granular level in terms of by resort and whether those guests are destination or local. And so I think one important thing to keep in mind relative to pre-COVID levels in particular is that the resort mix has shifted actually, right, as we incorporated peak resorts and as our Eastern resorts grow, the yield at those resorts is actually lower as you would imagine than at our destination resorts. And so there is going to be a mix shift component to that, when you look at historical financials over time, from this base going forward. Certainly, our goal is to increase attachment over time. That's certainly one of our goals and every year we look at that as we did this year in terms of guidance of what attachment we think we'll be able to achieve. And certainly as Kirsten mentioned, adding more destination guests into our Pass program should over time be helpful relative to that. And Laurent, I would just build on that to also note that our guidance assumes that the current economic conditions continue. And if there was a significant change that could impact our outlook. Okay. Very helpful. And Kirsten, it's great to hear about the smartphone initiative. Are there any learnings or are there any other initiatives that we should contemplate maybe not for this year, but maybe going forward that could maybe further elevate the consumer experience? And then once -- sorry, one housekeeping question, Michael, I didn't see this in the press release, but should we still anticipate $175 million investment in employee wages? Or was that up since that announcement earlier this spring? So I'll take that one, the $175 million investment in wages was incorporated into our guidance in September that we reaffirmed and so we are on track with that. And with regards to your question about the guest experience, we are very excited about mobile pass and mobile lift tickets that is actually being tested this season for a rollout to our guests next season. And we have not announced any other innovations at this point that I'm discussing, but I will tell you that, yes, we're constantly focused on every aspect of the guest experience and where can we make investments or innovate in order to make that better? Hey, good morning, everyone. Let me start by echoing some of my peer sentiment and say thank you, Michael, for all your help over the years and best of luck on your next venture. Starting off here, I wanted to hone back in on some of the lodging bookings color. Kirsten, you talked to bookings pacing in line with pre-COVID levels, if memory serves at this time last year, you were trending more ahead versus pre-COVID. So is that called deceleration? Is that more a function of some of the pent up demand that we saw last season? I do recall you did talk to tough RevPAR comps on the last earnings call? Or is there anything in here more on the macro? Thanks. Yes. Hi, Jeff. I think we did see some different dynamics last year with COVID, there was a lot of pent up demand for travel and people getting back to having experiences. And so there were some dynamics that we saw where decisions and bookings were made very early and much earlier than typical. There was a lot of enthusiasm and pent up demand. So I think last year, there were just some unique dynamics as people got back out doing things. And at least what we're seeing right now in our indicators is returning more to a pattern that we would have seen pre-COVID. Okay. That makes sense. Thank you, Kirsten. And then for my follow-up moving to call it the Epic Pass Tiering strategy, now that the selling season has wrapped up and you've been able to parse through some of the data. Any thoughts on potentially continuing to introduce new pricing tiers in order to succeed and penetrate that more lower frequency destination, currently window ticket skier and apologies for potentially front running the Investor Day here, but any thoughts there would be helpful? Thatâs, okay. We are always looking at that. We're always looking at the addressable market? And what do we think are the barriers among that addressable market. And what -- does our product and pricing portfolio address those barriers in order to convert them into an advanced commitment. So we're always assessing that. And last year, we created a new tier within Epic Day Pass that was specifically targeted to guests in our local and regional resorts. It's restricted to only 22 resorts, resorts like Mount Sunapee or Afton Alps and that product was designed and priced in such a way to convert those guests into advanced commitment. We still think that there is more potential there to grow that particular product and we're always looking at what are the other ways to address the barriers to convert into advanced commitment primarily because advanced commitment, we believe, is just so fundamental to the stability of our company but also to lifetime value and long-term growth and loyalty. Good morning. I have one question on behalf of my colleague, Patrick Scholes, and this relates to the booking pace. Could you discuss how ADR is tracking for this coming winter? I think we feel good about where ADR is in addition to how we feel about occupancy. And really the main kind of unique dynamics that we're seeing is what we called out and noted, which is some indications of potential shift in behavior between December and January through April. But otherwise, feeling good about the way ADR and occupancy is tracking. Good morning. Michael, thanks for everything and all the best. I wanted to just focus on Mountain margins, if I may. With a lot of the engine outs and a lot of the discussion around labor costs, et cetera, can you give us a little bit of kind of long-term aspirational margin levels or kind of a new normal margin given everything we've gone through and everything you've done? Well, I think that we -- as I -- to comment on long term, we are very focused on margin, and we are constantly looking for ways to improve margin. Obviously, this year, we had a significant investment in our employees. And we are constantly looking at one, cost discipline and two, efficiencies to continue to improve the margin and offset any investments that we make in the future. So while I can't commit to a specific margin at this point and maybe we can talk more about that at the investor conference and where we think we're headed as a company, what I would say is that we're very focused on it and very focused on cost discipline and efficiency. Yes. And maybe just to build on that. I think the -- I think with the employee investment that Kirsten talked about, right, in our guidance, we're guiding to 31%. EBITDA margins, which, of course, we've built up over time. And the fundamentals of our business model right result in very strong flow-through from revenue growth and very strong free cash flow conversion. And to Kirsten's point, I think the fact that we were able to invest as much as we are investing and continue to drive margins in the business and really setting that foundation up for the strength of our free cash flow, as Kirsten said, is something that we have been focused on. And yes, I'm confident that we'll continue to focus on. I appreciate that. And as my follow-up, I was hoping we could spend a minute or two on Andermatt and sort of a broader view about Europe. And again, I might be trying to front run your analyst meeting, but I'd love to get more of a sense for your vision for that property and whether we should look at this as one step in a journey and sort of building more of a European presence? Yes. Thank you for the question. We are incredibly excited about Andermatt. It is already an amazing Mountain resort with strong investment in the base area to attract a high-end European skier and we're excited to continue to invest in that. We believe that this is the perfect sort of first step for us in Europe. To come in with Andermatt to listen, to learn to build our reputation and that there is significant opportunity for Andermatt to grow its share of the luxury European skier market. Longer term, as we've shared it our investor conferences, the addressable market in Europe is almost 3 times the size of North America. And we believe that, that is a big opportunity for us for growth and we have not an easy market to penetrate. So a long-term strategy to build our experience, our credibility and hopefully, over time, build a network of resorts that can achieve value creation for our shareholders. This concludes the Q&A portion of today's call. I would now like to turn the call back over to Kirsten Lynch for closing remarks. Thank you, operator. This concludes our fiscal 2023 first quarter earnings call. Thank you to everyone who joined us today. Please feel free to reach out to me or Michael directly, should you have any further questions. Thank you for your time this morning and goodbye. This concludes today's Vail Resorts Fiscal First Quarter 2023 Earnings Call and Webcast. You may disconnect your line at this time, and have a wonderful day.
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EarningCall_1693
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Welcome to Rent the Runwayâs Third Quarter 2022 Earnings Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the call over to Rent the Runwayâs, CEO and Co-Founder, Jennifer Hyman. I wanted to take a moment before we begin todayâs earnings call to introduce our new Head of Investor Relations, Jackie Blatt. Jackie has been a Rent the Runway for over seven years, first within our Finance Department and for the last four years as my Chief of Staff. As a result, she knows an enormous amount about Rent the Runway and I am personally very excited for her to build strong relationship with all of our current and future investors. Hereâs Jackie. Thanks, Jen. Good afternoon, everyone. And thanks for joining us to discuss Rent the Runwayâs third quarter 2022 results. Joining me today to discuss our results for the quarter ended October 31, 2022, our CEO and Co-Founder, Jennifer Hyman; and Chief Financial Officer, Scarlett OâSullivan. Before we begin, we would like to remind you that this call will include forward-looking statements. These statements include our future expectations regarding financial results, guidance and targets, market opportunities and our growth. These statements are subject to various risks, uncertainties and assumptions that could cause our actual results to differ materially. These risks, uncertainties and assumptions are detailed in this afternoonâs press release, as well as our filings with the SEC, including our Form 10-Q that will be filed in the next few days. We undertake no obligation to revise or update any forward-looking statements or information, except as required by law. During this call, we will also reference certain non-GAAP financial information. The presentation of this non-GAAP financial information is not intended to be considered in isolation or as a substitute for financial information presented in accordance with GAAP. Reconciliations of GAAP to non-GAAP measures can be found in our press release, slide presentation posted on our Investor website and in our SEC filings. Thanks, Jackie, and thank you everyone for joining our earnings call today. We are very proud of our strong financial performance in the third quarter of 2022, as we beat both top and bottomlines of our guidance. We posted record quarterly revenue of $77.4 million, demonstrating strong 31% year-over-year revenue growth. We have seen an improving trend in subscriber acquisition, pause and retention rates since the end of Q2, as our Q3 ending active subscriber count grew 8% quarter-over-quarter. Despite the uncertain consumer environment, this tells us that our offering is still resonating with our target consumer. This quarter we delivered a gross margin above 40% for the second quarter in a row. We also posted a very strong adjusted EBITDA margin of 8.5%, our second consecutive quarter of positive adjusted EBITDA, beating our Q3 guidance and demonstrating adjusted EBITDA profitability significantly ahead of the timeline we shared at IPO. In the third quarter of 2022, we largely completed our restructuring plan to reduce costs, streamline our organizational structure and drive operational efficiency, which was previously announced in September. As a reminder, the restructuring had three main objectives. First, to transform the cash flow profile of our business, at approximately $400 million in revenue we expect to be able to reduce annual cash burn before interest expense to approximately $30 million. Second, to accelerate our path to breakeven on adjusted EBITDA after taking into account product depreciation, which we continue to expect to achieve in the near-term. Finally, and perhaps, most importantly, to allow us to reinvest into delivering value to our customers. The brands we offer are unmatched by other fashion rental companies and our cost actions allow us to deliver even more Rent the Runway to customers. Posting growth in our active subscriber count this quarter in a tough macro environment is a step in the right direction, but we are not satisfied. We are encouraged by recent performance trends as this Cyber Monday marked our second highest subscriber acquisition day in company history. As I will outline, we intend to further accelerate growth. Our plans for 2023 are bold and focus on providing our customer with even more reasons to love their Rent the Runway subscription. I am confident we will look back on 2023 as a year where we gave our customers more value, more choice and a better experience overall. Before I discuss where we are going in more detail, I want to take a step back and acknowledge how far we have come. I founded Rent the Runway over 13 years ago, and in this time, we created the market for fashion rental, where there was none before and have driven broad acceptance of secondhand apparel. In fact, our unaided awareness as the clothing rental service is 21%. In other words, 21% of women in our target demographics when asked to name a clothing rental service, say, Rent the Runway. I am really proud of that. I have never felt more confident in our opportunity to thrive and deliver tangible value to our customers, both because of what we have accomplished over the past few years and because of the plans we have for 2023 and beyond. Rent the Runway is not only already a larger business in 2022 than we were in 2019, but we are also fundamentally a stronger business in three key ways; first, we have built a more powerful revenue platform; second, we have transformed the cash needs of the business by innovating the way we acquire the fashion we rent; and third, we have dramatically improved our underlying cost structure. Now I will discuss how each of these levers makes us stronger today than three years ago. First, we have strategically built a more powerful revenue platform with multiple engines of growth, subscription, a-la-carte rental and resale that help us to capture the opportunity ahead of us and a large TAM customers who come to us for diverse reasons in different life stages. We are the only platform to offer all three of these revenue engines in one place. In 2019, resale was only available to our subscribers and now anyone can buy the fashion we have on our site. In addition, we have doubled the penetration of high margin add-on revenues since 2019 amongst our subscribers, by giving them the ability to personalize their programs. In the first nine months of fiscal 2022, nearly 30% of our subscribers have paid for at least one add-on slot. Our customer base is more diverse than ever before. Since 2019, we have seen a 14-point increase in the geographic diversification of our subscriber base away from our top five MSAs. And they use Rent the Runway across more use cases, broadening our utility in their lives. In 2019, customers used their subscription for work in special occasions, 55% of the time. Today, they use us for casual everyday life, 55% of the time. This means sheâs renting items like denims, sweaters, winter coats and handbags from us. Things that keep subscribers sticky in this program even when they donât have special events. That said, we are thrilled by the success of special occasion wear and workwear on our platform this year. We have seen and are continuing to see near record highs in terms of special occasion utilization, as well as nearly double the workwear demand in 2022 compared to last year and we still believe there is opportunity here. Second, itâs hard to overstate how much we have transformed how we acquire the fashion our customers love and how this has changed the cash needs of our business. In fiscal 2022, Share by RTR and Exclusive Designs are expected to together comprise around 60% of our product acquisition versus 26% in 2019. In 2019, we spent $118 million on upfront purchases of rental products, compared to our estimate of approximately $60 million this year, despite being a larger business. Further, we bear considerably less risk, as 30% of our inventory is procured on consignment. Finally, we have made significant advances in using our customer data and brand relationships to manufacture another 30% of inventory at significantly lower than wholesale costs via our Exclusive Designs. These designs are desired by our customers, and as Scarlett will discuss later on the call, show early signs of being sought after by other retailers. Over these three years, we believe we have also become an even more important partner to our brands, who value us for customer acquisition and data insights. In short, we believe our inventory leads the market in terms of quality and provides us with an enduring cost advantage. The third key transformation to our business since 2019 is our vastly improved cost structure and margin profile. The changes we made to our subscription program since 2020 have resulted in a 16-point reduction in fulfillment as a percent of revenue, which has decreased from 46% in 2019 to 30% in Q3 2022. As a result, we doubled our gross margins since 2019 to 41% in Q3 2022. Moreover, we restructured our fixed cost base allowing us to significantly improve the overall profitability of the business. In summary, these major changes to our business model over the past three years have a quantifiable and meaningful impact. The fact that our customers are more diverse and are using us for a wider variety of use cases means they have higher retention and stick with us longer, resulting in a long tail of loyal long-term customers. Our improvements to fulfillment and product acquisition costs mean we have gross margins after fulfillment costs that are better than many traditional retailers and online peers. All in as previously shared, at around $400 million in revenue, we expect to reduce annual cash burn before interest expense to approximately $30 million in the near-term. Shifting to this year, we are proud to have laid three primary foundations in 2022 that we believe will set us up for an exciting path forward in the next year. The first is our customer experience foundation. Our conversion and loyalty and thus our growth, our reliance on womenâs seamlessly browsing, finding and receiving inventory they love. Over the last 13 years, we believe we have collected more unique product metadata than many other retailers. Data on everything from fit to quality, customer feedback and reviews, attribute, garment longevity, style, sizing, occasions and the list goes on. Despite amassing this incredibly rich inventory database as one of our biggest competitive advantages, our technology is just now beginning to connect our data mode into the customer experience. This year we completed key foundational work to connect our proprietary inventory data system into our on-site search and discovery experiences. As a result of this, we expect that we will be able to significantly expand the way our customers are able to browse our site next year. In Q3, we also launched ElasticSearch, a third-party industry leader in enterprise search technology, which coupled with our enhanced product catalog is expected to provide a much richer search experience to our customers. Second is our technology foundation. We made improvements across our tech stack in 2022 in order to enable greater scale, enhanced resiliency and faster site speed. This year we completed our migration to the cloud, an important milestone, which we think will be key to unlocking even better resiliency, performance and reliability, increased developer velocity, as well as the ability to scale more efficiently to subscriber growth. Next year we plan to build upon this work to improve our site speed even more, which we believe will help us improve conversion. Lastly, in 2022, we solidified our fashion foundation by expanding our Exclusive Design capabilities and launching our first celebrity collection. Throughout 2022, we co-created Exclusive Design with a total of 18 brand partners, half of which were new to the program. We have increased the number of factories we work with, which has enabled us to manufacture more categories of clothing. For example, as a result of this diversification in our production capabilities, for the first time, our Exclusive Design channel is set up to manufacture black tie and evening wear, two of the most expensive categories we procure, where the relative cost savings versus wholesale are significant. This is an important lever as we continue to reduce our upfront cost per unit. Most recently this November, we launched our first celebrity collection with Ashley Park, the Co-Star of Netflixâs Emily in Paris. Celebrity collections enable us to develop fashion that our customers love, while simultaneously providing built in marketing as a result of the brand heat and cultural relevance of the personality. Ashley Park has a social following over -- of over 2.4 million across her platform and has been actively engaged in organically promoting the collection and Rent the Runway. To-date, around the launch of our capital collection with Ashley, we have been able to leverage her media bug for over 1 billion earned media impressions and counting. Last call we spoke about how even just small improvements in conversion and retention like the ones I just discussed, can have a substantial impact on growth and are within our control. We think that providing more value and a better user experience to our customers are key drivers of influencing these metrics. The purpose of our key 2022 investments is to deliver more to the customer in 2023 and to iterate quickly to accelerate growth. We will share more detailed plans on our Q4 call, but we believe 2023 will be a transformative year for Rent the Runway. Our plans are informed by a deep analysis of customer data, as well as by constant experimentation and testing. Our customers can expect to see significant improvements in plan design, site experience and in the clothing they love. In a tough macro environment, with inflation and price consciousness top of mind for many consumers, Rent the Runway plans to lead by offering more value and more fashion to our customers, as our customers benefit, so too should our brand partners. We expect these changes to provide lasting benefits for growth well past 2023. Thanks, Jen, and thanks, again, everyone, for joining us. I will provide an overview of our third quarter results for fiscal 2022 and we will end with guidance for the fourth quarter and full year. In Q3 we generated record revenue of $77.4 million, up 31% year-over-year. Ending active subscribers increased 15% year-over-year to $134,000, up 8% quarter-over-quarter. Total subscribers increased 17% year-over-year to 176,000 subs and up 2% quarter-over-quarter. As we pointed out last quarter, the macroeconomic environment remains tough and has had an impact on our business. Our active subscriber growth this quarter versus Q2 reflects 2 key factors; first, our acquisitions improved in Q3 versus a seasonally weaker Q2; second and with the benefit of more data from Q3, we believe that the reaction by customers for our April price increase was a significant contributor to our elevated levels of churn and post activity in Q2. As customers have adjusted, we have seen reduced rates of churn and pause in Q3. We also believe that this affected our Q2 acquisitions to some extent. In Q3, we have also seen a slightly higher proportion of new subscribers going into our lower price program, which we factored into our expectations for Q4. As Jen mentioned, we have plans for next year that are designed to accelerate subscriber growth. Rent the Runway has solid site traffic that we believe we could do more to monetize and thatâs why we are focused on strategies that drive conversion and loyalty. Our strong revenue beat versus our guidance was primarily due to strength in ARPU, driven by add-on spots and solid other revenue performance. 28% of active subs paid for one or more add-ons in the quarter. We are pleased that our subscribers are willing to spend more with us despite the inflationary environment. We are increasing our ARPU estimate for the year to be up approximately 7% for fiscal year 2022 versus last year. We also saw a healthy performance in our reserve business, which continues to be a strong funnel of new customer growth. Reserve orders from new customers in Q3 were up 27% year-over-year and 46% quarter-over-quarter, with the proportion of high formality rentals higher than last year and near record high in terms of utilization. We successfully increased assortment in Q3 real-time to address the increased need for special events preparing us for Q4 and fiscal 2023. Other revenue represented 11% of revenue in Q3 versus 8% in Q3 2021 and up 83% year-over-year. We saw a 14% increase in average items bought by subscribers in the quarter versus Q2 2022 and a 53% increase versus Q3 2021, resulting in 84% of total revenue being generated by subscribers in Q3. Other revenue also included $1.6 million from a pilot-to-wholesale brand new Exclusive Designs to a third-party, showcasing demand for our products from other retailers and the consumer appeal of our design. We generate strong margins from Exclusive Design sales, given the low cost of these items. Itâs too early to see how this pilot will evolve, but we believe it highlights the power of the Rent the Runway data and platform, and the monetization opportunities of our products. Our Q2 gross margin of 41% was 7 percentage points higher than prior year. Fulfillment costs as a percentage of revenue came in at 30% versus 33% in Q3 2021, primarily due to higher revenue per order. We improved transportation cost per shipment versus Q2 2022 by negotiating lower carrier rates and optimizing carrier and ship method mix, including a higher penetration of at-home pickup. We expect higher fulfillment cost per shipment in Q4 as we typically would see seasonally and now expect fulfillment costs as a percentage of revenue for the full year 2022 to be approximately 32%. Total product costs came in at 29% versus 34% last year, with rental product depreciation at 18% of revenue versus 23% in Q3 2021 as it was absorbed over a higher revenue base. We now expect gross margin to be up approximately 400 basis points versus full year 2021. Q3 adjusted EBITDA continued to be positive and came in significantly ahead of our guidance, at $6.6 million versus negative $5.6 million in Q3 last year, representing a positive 8.5% margin and an 18-point improvement versus negative 5.5% -- negative 9.5% in Q3 last year. Employee expenses in Q3 saw the partial positive impact of the restructuring. We largely expect the full impact in Q4 as we still carry approximately $2.4 million of employee expenses in Q3 that will go away by the end of Q4. As expected, when we provided guidance last quarter, we saw sales from a new liquidation partnership. Proceeds came in higher than anticipated this quarter, positively impacting the G&A line, where we usually recognize the net impact of liquidation sales by approximately $2.5 million this quarter. We partnered with a new third-party retailer to broaden our liquidation network and drive additional monetization of our products, while giving our rental garments a second life. Overall, the Exclusive Designs pilot and new liquidation partnership together contributed approximately $4.6 million to adjusted EBITDA. Even without these deals, we have made significant progress driving adjusted EBITDA to be positive, especially for our third quarter, which historically sees lower profitability. Going forward, as you will hear when we discuss guidance, we expect to continue to generate a strong positive adjusted EBITDA margin, reflecting the increased profitability of the business and full benefit of the restructuring. We are choosing to be opportunistic and take advantage of the current retail slowdown to buy attractive inventory from our brand partners at discounted prices. This pull-forward some of next yearâs buy into this year. Our anticipated cash usage now reflects incremental product spend this quarter. As a result, we currently expect our fiscal 2022 free cash flow margin to be slightly lower versus last year. A couple of housekeeping items I want to call out for the quarter. The restructuring-related severance charge came in at $2 million in Q3. In addition, we decided not to move forward with a long-term CapEx project in our warehouses as part of our restructuring work and we recognized a largely noncash loss of $3.8 million due to the asset impairment. Our Q3 results reflect our improved quarter-over-quarter subscriber trends and we believe showcases the strength of our offering and how it resonates with customers even with this macro backdrop. So we are pleased to be raising guidance. We continue to be an uncertain macro environment, and as we have mentioned, we typically see a higher rate of churn and pause in January due to the seasonality of our business at that time of year. For Q4, we expect revenue of $72 million to $74 million. We expect a positive adjusted EBITDA margin of 4% to 5%. In terms of full year, we now expect revenue in the range of $293 million to $295 million, representing 45% growth at the midpoint of the range versus full year 2021. Our adjusted EBITDA margin guidance for full year is revised to positive 1%, reflecting our strong Q3 performance, our cost discipline throughout the year and the cost restructuring employee base by the end of Q4. We have made a few weeks of our full year expectations for a few other items, so please refer to the guidance page of our earnings deck on our website. For fiscal 2023, we are not providing revenue guidance at this time, but I want to reinforce a few important points. First, as Jen mentioned, we are excited about our plans in fiscal 2023 and believe they will be impactful for growth. Second, we are reaffirming the estimated restructuring annual OpEx reduction of $25 million to $27 million for next year versus a Q2 2022 run rate, which is expected to boost adjusted EBITDA for next year. This means that we anticipate reducing annual cash burn substantially versus this year. This is expected to hold even if revenue growth is lower next year due to macro or other factors. We will provide additional details on our Q4 call. In the medium-term, we intend to maintain strict cost discipline and anticipate higher flow-through on incremental revenue, generating approximately 30% adjusted EBITDA margin. That represents a 15% margin on adjusted EBITDA less product depreciation. At that level, we believe we would be free cash flow profitable, fully internally self-funding the business even at strong growth rates and we aim to get there with the cash we have on hand. We continue to be intensely focused on balancing robust growth with profitability and we will seek to strike the right balance to attain both objectives and maximize the long-term value of Rent the Runway. Hi. This is Abbey Zvejnieks on for Ed. Thanks for taking our question. Just, first of all, in terms of the favorable terms on getting inventory in this excess inventory environment, can you talk a little bit about that and then the kind of flow-through impact on product depreciation going forward? And then on the brand seeking this data and this new marketing funnels in the current environment, can you talk about any potential to be more of a partner with these brands maybe from an advertising perspective on Rent the Runway? Thank you. Yeah. So, first, I want to address what makes us different than most other retailers and why this environment where thereâs kind of softness in overall retail is positive for Rent the Runway. Most of the retailers have to clear through 2022 inventory in 2022, because there wonât be any relevance of that inventory on a go-forward basis. We have proven over the past 13 years, that there is demand for and we monetize our inventory over multiple years. What the customer cares about is when she comes to Rent the Runway, she wants to wear something new every single time she comes. She doesnât care if that new thing that sheâs wearing is from last year or from a week ago or from a few years ago and we keep that inventory in high quality conditions for multiple years. So we can be opportunistic right now in the market, whereas everyone else needs to be promotional. So what we are doing is we are going to our 800-plus brand partners, we are looking at what they have available and we are acquiring inventory at very healthy discounts pulling forward some of the inventory spend that we would have spent in 2023. Now the other thing that is great about the environment that we are in. Itâs the very inventory that is available right now is inventory that is the highest performing inventory at Rent the Runway. So what we are seeing from our brand partners is the most fashionable inventory that isnât selling in store. The most colorful inventory, the trendiest inventory and that is exactly what performs the best on Rent the Runway. So not only are we getting inventory at a discount, we are getting the best inventory from some of our best brand partners at that competitive pricing. Now. of course, this will help to further accelerate upfront cost per unit going down and that decreases the depreciation expense. Abbey, what I would say here is, this is part of the overall philosophy that every year we want to be showing improvement in our upfront cost per unit. The items that we are acquiring is a combination of our three different methods. So, obviously, the ones where we own will have a nice impact on product depreciation. Some of them could be with assignment deals, which is also great for us that we can do that even in this environment and that would show up in the revenue share line. And one other point, the 800-plus brands that we work with are luxury or designer brands. So clearly, a highly promotional environment like the one that we are in right now is extremely brand dilutive to them. They have a choice. They could either mark their inventory down on sale or on clearance or they can work with Rent the Runway often through our consignment channel, which is brand accretive to them. We donât mark down the inventory on our platform. We are displaying the original retail price and by nature of putting it up on Rent the Runway, they are getting access to new younger customers. So itâs really a win-win for the brands of being brand accretive and adding to customer acquisition in an environment where that matters more than ever. Thanks. And then maybe just one more, can you just elaborate maybe a little bit on the wholesale partnership for liquidation and then will that continue in 4Q and how should we think about kind of the go-forward benefit to adjusted EBITDA from that? thanks. Yeah. So this pilot is really exciting and it showcases the consumer appeal and demand for our Exclusive Design products from other retailers. So, as Scarlett mentioned, we already generate strong margins from⦠We will talk about those. So we generate strong margins from Exclusive Designs, because of the lower cost of these items. And so for us, itâs too early to say how the pilot is going to evolve, but we really believe it highlights the power of the Rent the Runway data and our platform, and monetization opportunities of our products. Scarlett, do you want to talk to the partner -- the liquidation partner? Yeah. So here we are always looking to expand our network of partners. Itâs great for us to be able to have more partners that we are working with to be able to give our items a second life and to really create more opportunities for monetization. So we were really excited to see this partnership. It was a pretty significant one. Nothing -- no plans on a go-forward basis just yet, but for both of these, I think, they really showcased the power of our data, the appeal of our design, as well as the appeal of our items that we believe are at the end of their rental line and yet still have another life somewhere else. Hey, guys. Thanks for taking my questions here. You mentioned the pricing a little bit of hindsight here, diagnostics on the price increase in April, causing a little bit of churn in the second quarter that you think improved in third quarter. I know a lot of the vendors you deal with are still seeing some inflation today. Do you anticipate needing to take price next year, and if so, maybe any learnings you can point to on, as you look back at April and help you navigate that if the consumers still in value seeking mode with share household budgets? Yeah. So, first, on our Q2 call, we were going through some of the various reasons we thought why there might have been softness. And with the benefit of more data in Q3, we think that the reaction that our customers had to our April price increase was a significant contributor to the elevated levels of churn and pause activity that we saw in Q2. And the good news is as customers have adjusted, we have seen increased acquisition, reduced rates of churn and reduced rates of pause activity in this past quarter Q3 compared to Q2. So, the price increase we believe was the right thing to do at the time. We have been very focused on driving profitability as you know and there was a lot going on in the macro environment, our input costs were getting higher and we have seen a significant positive impact of that price increase in that revenue per order has gone up. You have seen it reflected in our profitability and our gross margin. Having said that, we take our obligation to provide value to our customers very seriously and our focus next year is all about how do we deliver even more value to the customer. We are very excited about the plans that we have in place. I guess maybe I can follow up one on marketing, could you speak to a little bit to the marketing mix, any changes you are seeing in the different channels or change in the returns you are seeing in generating the different channels? And maybe any -- just any update on trends in what you are seeing in organic versus inorganic trends on the marketing side as we think had to help us for next year? Yeah. So, in terms of marketing, like, no real news, our pack is stable and attractive in 2022. Itâs stable to last year. We believe that the traffic that we have on this runway, we are happy with the level of traffic that we have and our focus is not on using marketing dollars to drive more traffic, all of our focus is on doing a better job with the traffic that we have in terms of our conversion and our loyalty. So you are going to see us focus inherently on the customer experience and customer value. You are not going to see marketing costs go up that were us focusing on traffic, because we believe that the level of traffic we have right now is in a good spot. And Michael, just to add to that, thereâs really not been much change in terms of the channels that we use and the way that we do marketing. So thatâs to stay pretty consistent. Obviously, itâs helpful when you do celebrity deal, but we also have the amplification of celebrities and them being out there talking about us, but nothing in terms of our own internal efforts on the channel. I think that thereâs general tailwinds this year that we are seeing across culture and across the media related to rental overall. I mean an example from this week alone, we saw that Princess Kate rented a dress last week. If you would have told anyone 13 years ago when we launched Rent the Runway and people thought renting was disgusting and not cheap and not something that anyone would talk about that Princess Kate that royalty would be renting and talking about it publicly, thatâs really due to us starting this movement globally, making rental something thatâs normalized aspirational. And we are seeing that more and more in culture where the tailwinds, I think, of this becoming part of the consideration set is, are really improving. And we see that across the Board every day in the diversification of our customer base and her considering us for more of the use cases in their life. Thanks so much. Maybe two questions, if I can. First, in terms of what you are seeing on the gross addition side, is there any color you are able to give us on how much of that is people that are finding the brand for the first time and being driven by elements of either aided or unaided awareness from the platform driving gross additions versus your ability to go out and mine the database of former users, former subscribers continuing to remarket and we mine that base of potential former users to drive incremental growth -- addition growth? That would be number one. And then number two, you have started to see the beginning of sort of a return-to-work dynamic thatâs lagged sort of the reopening dynamic? How should we be thinking about what you are seeing from your subscribers in terms of return to work and how that might be a tailwind for the business in 2023? Thanks so much. Yeah. So starting with the second question first. We are really pleased with the performance of workwear, which has doubled for us year-over-year in 2022. So we are seeing that women are more solidly in the office a few days a week and this performance is in a world of hybrid work. We have also done a great job at shifting our inventory mix to reflect what our customers want. So itâs our job to highlight all of the use cases to customers that sheâs able to use her subscription for and we have done a great job at that, given that workwear is double last year, but at the same time, sheâs using 55% of her basket for everyday casual occasions. We are seeing that even in 2019, if you think about a world where she was in the office five days of me, she was using the subscription at the time only around quarter of the time to go to work. Now in that world, where you are going into the office five days a week, making an investment into workwear makes a lot more sense than a world where you donât know how much you are going to be in the office this month, next month. So we have a big opportunity to use the hybrid environment that we are in as a lever for acquisition. In terms of the first question of where the customer is coming from, are they new, are they from our database, we have actually seen strength across the Board. So we are seeing, in Q3 we saw a nice rejoin rate of folks who had previously churned who came back. We saw a good amount of new customers coming to Rent the Runway. We saw a really nice increase to our pause, people unpausing their subscriptions. So it was really a combination of acquisitions from all three of these sources. Thank you. Good afternoon. Can you talk about opportunities to lower product costs outside of the ongoing change in the product acquisition model. I am curious if you see opportunity to realize better cost, because of elevated inventories across the apparel industry, and perhaps, some brains trying to right-size a product that they might be sitting on? Yeah. As we just talked about we certainly think that this environment is right for us to be lowering our upfront product costs by working very closely with the 800 brands that we work with to acquire the very best inventory from the deeply discounted rates. We are seeing higher desire amongst our brands to work with us both on our consignment business Share by RTR and Exclusive Designs. And as you have seen mix shift towards Exclusive Designs and Share by RTR has been a major lever in helping us reduce the upfront cost of inventory. I will remind everyone again that our gross margin of 41% is inclusive of all of our fulfillment expenses and our inventory expenses and that 41% gross margin is significantly or slightly better than many of our retail peers already. So the reduction in our inventory cost that we expect over the next few years will only help to improve a gross margin that we already think is quite positive. Yeah. And Rick, I would just add, what Jen was talking on the first part of the answer to the question, itâs not hypothetical, right? We are in fact pulling forward some of the spend from next year. We are in market right now, getting some attractive deals. So we are excited about what that does for our numbers. And you talked about the progress of Exclusive Designs and the product being sought after by retailers. Can you provide some additional color on what you are doing to capture this demand and to what extent this can be a needle mover as we think about 2023. Right now itâs just a pilot and we are excited by that pilot. We think that itâs really interesting that another multi-brand retailer finds our Exclusive Designs to be so attractive that itâs something that they would buy from us wholesale. One of the things that I think it showcases about our business is that because of the data that we get, which is incredibly unique. Remember like, our data isnât just about what customers are doing on our site. Our data is about how they actually wear the item. Itâs about fit. Itâs about product quality. Itâs about manufacturing. How light it should be manufactured. And we have seen that when we use data to manufacture products, they become -- that sellers, best renders on our platform. So I think other retailers have recognized that our data provides a significant advantage and that these could be blockbuster styles on their sites as well and have approached us. Last week, as an example, in our recent celebrity collections that we did with Ashley Park. All eight pieces from that collection were in the top 5% of styles rented by volume on our platform and we have tens of thousands of styles on our platform. So this is quite a big set of the styles that we manufactured with our data. So I donât know whatâs going to happen related to us selling this to more retailers over time, but we will certainly kind of inform you more as this pilot progresses and we feel very encouraged by the reception that we are getting. And more directly we are not giving guidance at this point on 2023, but I am not building anything in my expectation at this moment. Hey. We have got Nathan Feather on for Lauren Schenk. Congrats on the quarter. Kind of going back to 2Q, there was some abnormal seasonality. You have talked about at least a little bit to the pricing change. Can you talk about the intra-quarter trends in 3Q and was that seasonality is much different from last year or pre-COVID? And then a second question, in terms of the special occasion mix in 3Q, how close are you to closing that gap, is it fully closed? And then kind of more broadly, whatâs your ability in terms of lead time to adjust that assortment across different chains? Thanks. Yeah. So Q3 is always seasonally better for us than Q2 and it was this year as well. But we did see in Q2 because of the price increase we saw that churn rates were higher than we would have anticipated, pause activity was higher than we would have anticipated, acquisition was slightly lower than we would have anticipated and all three of those metrics, which are the most important KPIs in our business have improved quarter-over-quarter and have delivered a quarter where we were able to grow sequentially. So we are seeing that the customer has really adjusted and the initial, letâs say, sticker shock she had to those increases in price, sheâs now feels comfortable and we have seen reductions in return, reductions in her pause activity and increases in acquisition. Yeah. So in terms of the second question, I think, you are referring to the fact that we had mentioned that there might have been some gaps in our assortment related to high formality. We have a good ability to react. We were able to quickly shift some of our buys and our kind of chases during the quarter. So we were able to -- be able to really address the customer demand for these types of items. We acquired quite a bit more in terms of high formality items starting in Q3. We have seen a significant improvement in terms of that penetration of those items that are our new receipts that came in during the quarter, in fact, they were double last yearâs level. So, we do have a very good ability when we see the data, we see data much more quickly given that our customer is constantly giving us feedback, we are able to react very quickly. Great. I think that thatâs really the difference and one of our competitive advantages that because every time that someone is wearing clothing from Rent the Runway, they are required to give us data. We are getting data real time. So we knew in Q2 that we were under assorted on the things that she wanted in higher formality. We were able to go to market, react really quickly, use the levers that we have in terms of our relationships with our brands, our consignment business to procure way more of that special occasion inventory for Q3 and as Scarlett said, we doubled receipts of that high formality inventory. So we feel very well assorted right now and we are encouraged by this really nice mix in the business we are seeing. Workwear is double what it was. Our special occasion utilization rates are at some of the highest levels that we have seen in Rent the Runway history. We are seeing over 50% of her use case for everyday casual occasions. So it feels really good right now that all three of these components of the business are growing. Yes. Hi. This is Kate on for Ike. Thanks for taking our questions. Scarlett, one for you really quickly, I am not sure I heard it. Can you speak to your net add expectations into Q4 tied to the current revenue expectations just given the improvement in 3Q. By my modeling here, it looks like you are expecting them to be down year-on-year. So I wanted to make sure we are thinking about it correctly. And then, secondly, pleased to see the improvement on the fulfillment cost expectation for the year, can you just speak to the contribution from your at-home pickup initiative and drivers of the improvement there and maybe how we should think about opportunities on that line item looking out to 2023? Thank you. Yeah. Thanks for the question. So in terms of Q4 and net adds, we donât specifically give guidance on net adds. I encourage you to take a look at Q4 in relation to a more normalized Q3 excluding the Exclusive Designs, right? So we said that, Iâd give you the expectation there with revenue coming down a little bit, but you should probably exclude the pilot that I had mentioned to give you a little bit more of a sense of that. And then in terms of Q4, generally, look, you have to recognize that some of the issues that we suffered in Q2 have impacted Q4 as well, right? So we are entering Q4 with kind of that negative impact from the price increase that we just talked about, it takes some time to build back the stubs. So we are pleased with the progress that we have seen and we do think that thereâs more work to do and we are especially focused on that for next year. And then in terms of -- anything⦠⦠anything you wanted to add there, Jen, before I talk about at-home pickup for a moment or if you want to go there. I just think that we have really exciting plans to accelerate our subscriber growth in 2023. In this market, the customer overall is looking for value, and of course, she comes to Rent the Runway because of the tremendous financial value that we provide. But she also thinks about value on our platform and in a few other ways. She thinks about how much fashion am I wearing from Rent the Runway. She thinks about how easy is it for me to find the fashion that I love. She thinks about how frictionless is the experience of receiving that fashion. And we plan to make significant improvements in all three of these areas next year that we think will provide tremendous value to the customer, where we reinvesting, what we said in last call is, part of why we did the restructuring in so that we can reinvest into customer value and you are going to see us do that in a big way in 2023 to the kind of hopeful improvement of our conversion and our loyalty rate. And then, Scarlett, maybe you can talk⦠Yeah. About at-home pickup last thing on Q4. I mentioned that on my call, but obviously, we typically do see seasonality in Q4 that you should be aware of. I think you were saying at the beginning of the call that you thought our sub count would be down year-over-year. So I would encourage you to take a look at that again. That should not be the case. And then in terms of a home pickup, maybe we will spend [Technical Difficulty] talking about that, okay. So a few things that I wanted to highlight there. So, yeah, we saw really nice fulfillment costs in this quarter. You see that it was at 30% versus 33% a year ago. A few contributors there, one of them being the revenue per order being quite strong. And then another, as I alluded on the call, we have done a really nice job continuing to work on transportation, diversifying our carriers, actually renegotiating some of our rates as well, which has been beneficial in this environment for us to be able to deliver on that. But, of course, at-home pickup, as we have talked about all year is also a contributor. So we are now live in 32 markets. We feel that we have delivered something that is resonating with the customers, 55% of our subscribers have access now thatâs ahead of our target. We thought we would be there at the end of the year and we continue to plan to increase that coverage. For me, the most important determinant of how sheâs feeling about it is the fact that the adoption has grown significantly. So in the codes that we offer this, we are seeing the adoption go from 29% to 39% during Q3. This really is what we think highlights the customer values, the service and trying the convenience use. And of course, we have said along the way, itâs also great for us from a cost standpoint. So the economics of that home pickup for us are as good, if not better, than our other return methods in those markets where we offer this convenience to our customers and itâs just because as we talked about, itâs all consolidation play. So we are excited about the fact that we are doing a lot more at-home pickup. We have seen the percentage of total inbound shipments be at-home pickup has more than doubled from Q1 to Q3 of this year. So you can see it is a really meaningful contributor. We are going to continue to do more. Maybe, Jen, do you want to talk a little bit about life swap and some of the things we are doing there, which I donât think we have talked about. Yeah. So part of how this company operates is we launch something and then we continue to iterate it and make it better. So a perfect example of this is a home pickup. We were seeing a really nice adoption of at-home pickup in the markets that we are in. Again, like a launch having 39% adoption a short time after itâs launched is remarkable. So what we did is we innovated on this and we now offer something that we call internally live swap. And what that means is that, customers can return their order at the exact same time that they are receiving their next order. So it reduces what used to be two transportation legs into 1. So we used to have someone come to the home to pick up the order from the customer that at-home pickup and then a separate courier or delivery service has come to deliver that order. We have consolidated this down to one pickup, which, of course, saves Rent the Runway money, but itâs also great for the customer, because it reduces the friction from the experience and we are seeing that for the -- we are seeing that 30% of our at-home pickups are live swap now. So we continue into next year. We are going to continue to build upon the success that we have seen this year in this transportation innovation. Hi. Thanks for taking my questions. Just a quick one for us. You mentioned customers are trading down to lower subscription tiers. We were wondering if you are seeing any trade down to lower-priced items or lower price rentals within the reserve business. Thanks. Ashley, we are not seeing that kind of trade down in the other businesses. Maybe just in terms of the mix shift, I just want to maybe spend a moment on that. We are excited about the fact that we have many offerings for our customers, many different ways for her to come in. Whatâs most important for us is that she comes in and we have seen the behavior when she comes in. We have seen, as you have already seen, what we have talked about in terms of add-on thought the fact that she may move up. So the most important thing for us is for her to come in to Rent the Runway and then itâs our job to then serve her and remind her of all the things that she can do. So we are excited about in this environment, the fact that we have an offering that is resonating with customers that we have seen different types of customers coming in. Itâs exactly what we would expect in this environment. So because we have a lower price program that enlarges the TAM for us, we have an acquisition funnel now where she can come in to reserve and then join a subscription program. She can come into lower price and then upgrade over time. And we have really factored this kind of mix shift that we would expect in this kind of macro environment into our guidance. And as a reminder, all of our subscription programs have similar margin profile. So we are kind of agnostic into where they come into our business and itâs our job to kind of just keep them within the business. And we have seen and shared that we have done a better job at -- we have seen higher loyalty from our customers now. We have done a better job in 2022 than we saw before the pandemic, and that was, of course, in 2019, we are talking about an environment where the macro was extremely positive. So the fact that loyalty is better than what we were seeing in that, I think, is really a testament to the value that we have been able to deliver to the customers. Thanks so much for fitting me in. Two, please. It sounds like next year will be more focused in terms of conversion. Jen, can you just talk about what you are most excited for, I think, fit was a key component earlier this year. You guys are adding ElasticSearch. What are you most excited for in terms of driving conversion on the platform as we think about 2023? And then, Scarlett, I think historically, we have talked about 4Q having COVID baked into the guide, is there any way to think about how you guys are thinking about COVID for 4Q and maybe quantify any impact as that may be lesser than what we previously thought? Thanks so much. Yeah. So what I am personally most excited by is what we are going to be doing related to search and discovery. So itâs really hard to shop on any e-commerce site, because you have the endless aisle and that is true of Rent the Runway as well. We have millions of products on Rent the Runway and right now we offer a traditional search and filtering experience. What is going to be different next year and what we have built the foundation for this year is we have talked a lot about the fact that we have a really unique data set. Well, in the past, we were using this really unique data set across things like manufacturing our Exclusive Designs and we use our unique data to determine what we should buy in the first place. But we have never really connected that data into the search and filter experience. And so you are going to see us really transform the site experience next year to provide way more delightful ways for customers to engage with our product, more intuitive ways to search and filter, more emotional and surprising ways. We feel like, because you donât have to buy anything on our platform, we can own fashion a motion. Like you donât have to have a rational reason for why you are going to wear something from Rent the Runway. That searching our sites could actually be more fun and more engaging. So we have built all of the foundation to be able to very quickly iterate on that. And thatâs the second point I would say that part of the foundation that we built this year isnât just kind of the connection of the pipe, but itâs also building out the resiliency of our platform so that we can continuously experiment and iterate, because though we have grand plans for certain discovery, we are probably going to run dozens and dozens of tests and so thatâs an area where I am extremely excited. I also am really excited to just increase the speed of our sites. Site speed is an area where I think we lag some of our competitors. We know that there is a direct correlation between site speed and conversion and because of all the infrastructure work we have done this year on technology, we are going to be able to make really nice advance insights feed next year, which we think will have a -- we believe we will have a nice correlation to increase conversion. And Andrew, thank you for the question on Q4 and COVID impact. Obviously, last time I did say that we were assuming some impact from the COVID variant. I donât specifically have something modeled this time in Q4 for COVID variant, obviously, we are still in an uncertain environment and frankly, at this point last year, we had no idea the impact that Omicron would have on events, on people going into offices. So that variance was very different than what we have seen before. So I feel that -- I feel good about the guidance that we are putting out there and I kind of remind you of the seasonality in the macro environment, but I have not specifically modeled anything related to COVID into Q4. We have reached the end of our question-and-answer session. I would like to turn the conference back over to management for closing remarks. Thanks for joining us today. We are really excited about not only our results this quarter, but our plans to accelerate our cost to profitability to deliver way more to our customers and the long runway that we have for growth ahead of us. So we look forward to continuing to update you on our progress on our Q call -- on our Q4 2022 call and thanks again for joining us. Thank you. This does conclude todayâs conference. You may disconnect your lines at this time and thank you for your participation.
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While it is late relative to the original commit dates. Once we reset the commit dates, we were actually thinking it was probably something towards the end of this year that we would get out. The fact that they were able to pull it in, they debugged a lot more quickly over the course of the last few months versus what's progressed from before that. So, we are actually in, I think, a pretty good position for Sapphire Rapids. Now that does not mean we'll gain share yet. It's a good product in certain workloads. It's not a good product in every workload. But I think it sets and establishes the execution that we expect to see when we bring out Emerald Rapids. And more importantly, in '24, when we bring out a power-efficient product, Sierra Forest, along with Granite Rapids, I think we start to reestablish ourselves. We're in a strong position on the data center side. We start to see the share erosion start to dissipate and actually turn around in the other direction. And then -- so that's on the product side on the two major products. We also have a number of product areas that get a little less focused. Our NEX business, our network business, we continue to gain share in that business. That business is doing quite well. Our graphics business, while we're relatively nascent at this point. We have started to introduce some products on the discrete graphics side, we see some good progress so far. Obviously, we've got a lot of work to do in the product portfolio into a competitive position. But I think I like our progress so far in terms of how we've executed. And then lastly, of course, is the foundry business that gets a lot of attention. We've had very good progress on customer engagement. This will be, I think, a really proof point to where we think we are from a process technology perspective that we are starting to establish ourselves and get good customer traction on the foundry side. And so, I think you'll see us -- we announced one customer earlier this year, MediaTek, I think you'll start to see as we progress into '23, more customer announcements that show that we have a real strength in the foundry space. Now transitioning to the other part of it, the last thing that I really wanted to execute on in addition to all those thing was the financial side. We do think -- I think we said on the call in October that we felt like we could reestablish ourselves as one of the best in terms of performance of the semiconductor space, and we associated that with a 60% gross margin, 40% operating margin business. Well, we're not ready to call that yet the model. I think we have a really good line of sight to be able to do that. And our first step in that was to get this $3 billion of spending out in 2023. We've got very good line of sight to the $1 billion reduction in cost. And keep in mind, that's net of $2 billion of depreciation increase that we'll see in cost of sales. So, really a $3 billion of cash flow improvement that we'll get in '23 on the cost of sales side. And then $2 billion of OpEx improvement, taking our OpEx roughly from about $22 billion to about $20 billion in '23, very good line of sight to that. And that's just the down payment on a larger cost takeout that I think we can do. We said that in total, it should be more like $8 billion to $10 billion. First $3 billion, obviously, we get in '23. We have very good line of sight into about half of the remaining. And then I think as we see the results of separating the business into a foundry business and a product business on top of Intel. We'll see a lot more accountability and transparency in both those organizations that I think will drive significant amount. I think $3 billion will turn out to be a relatively conservative number. Great. Since you brought up the cost cutting, I want to ask you about that. It's been a roller coaster. Obviously, you were short capacity, and now you've had to cut utilization. And you have a 300 basis point headwind to gross margin from that in Q4. The question all the time is that you take out $3 billion this year, you take that 8 billion to 10 billion by 2025. How does that impact the process road map? I mean if you -- if 2/3 of that $9 billion is cost, that's basically $6 billion on a variable cost base of $23 million this year. So if I exclude the depreciation, the question I get is that's a huge portion of your variable cost base. How do we then get convinced that, that doesn't impact your process aspiration? Yes. So from an OpEx perspective, I know yours is more about cost, but let me just talk about it from an OpEx perspective. From an OpEx perspective, the one area I did not touch is TD is technology development. Now that they had a higher aspiration of how much they wanted to grow, but they don't grow difficultly, but we made no reductions in technology development, and that's because that has got to go flawlessly. And we looked at other areas, mostly around overhead, some of the product portfolio. We felt like was relatively ancillary to what we were trying to do and didn't drive any meaningful growth. And so, we have kind of looked at areas where there was low ROI, low NPV, and we've kind of pruned the portfolio. And that will continue, by the way, as we progress into '23. On the cost side, I look at it as really efficiency. When you look at how we're structured now, the product area can with the manufacturing organization around quite a bit. They could do as many hot lots as they want, they can do as many samples as they want. They can do as many stepping as they want. They can change their forecast pretty much every week if they wanted to do that. And so there is a ton of inefficiency in the fab just by the way it's been structured and what we've optimized to. But by the way, we made a ton of sense when doing a monopoly. It just doesn't make sense anymore. And so one of I think the things that perhaps isn't quite well understood about this creating two P&Ls and really managing the P&Ls in a different way is to drive this behavior and make it way more efficient. The other thing that I feel was the right decision in a prior period in Intel's existence, but is no longer the right approach is this notion of kind of coming up with process technology, giving it to the fabs, not letting them adjust it in any way, running it for as long as its lifecycle is and then converting over to the next process technology. And I've heard from even my compatriots and CFOs in the equipment side is we don't have uptime to the level that we should. We're not getting the output that we should be getting -- and that comes from just relentless focus on improvement in manufacturing that just wasn't something that we did, which now partly as a result of now wanting to be in the foundry space where we extend these nodes a lot longer, we'll just need to do. And so fab managers will be empowered to go out and drive an eke-out efficiencies. It's just we just let go, yield improvements, relentlessly looking at overhead, make sure that we properly allocate the right overhead for what the spend is. So, I think there's a ton of just as we move progress, we are just going to get more wafers out than we would ordinarily have gotten just because we're driving more efficiency. They were, yes. I mean I've heard statistics of like uptime and certainties of equipment that were 20% for us that when you look at the best-in-class, it's 80% uptime, that piece of equipment. So it's meaningful. Now I understand it. This is just the way -- Intel, the ROI just wasn't there when you're converting over these nodes so quickly. But now that we plan to extend them hopefully, 10, 15 years, it makes a ton of sense to go drive that efficiency. Got it. Can we -- so you had talked about the separation of the foundry business, the separate P&L. Can you just talk about the sort of -- what that actually does for the Company? Is it being done because customers want to have a separate sort of an optically separate foundry business? Is it really just that the product groups are being held more accountable from a cost perspective? I'm sort of impressed to think that there were that many inefficiencies that resulted from the product groups being able to do what surprise. I think, Tim, who runs the factory, must complain every other day about something that he's been with around on. But the number one, originally, as I was thinking about this, first kind of thinking about how to approach this. I was really thinking about it in the form of standard cost because at Intel, do everything on a kind of on an actual cost basis, and there's a lot of noise around actual costs, what you think your cost would be versus what it turns out be in month one versus month seven versus month 10, can be all over the map. And it's very hard for the business, a plan around pricing and volume and loading and all those things, if they don't have a good sense of what their pricing curve is going to look or the cost curve is going to look like. So, I was originally thinking about it in the concept of that, hey, we need a more formalized senior cost approach to how we do it, which is basically how almost every other semiconductor operates, a semiconductor operates. And then, as I was kind of unpacking all of it, I realized that we needed more transparency between the fab organization or call the foundry organization, which is both supporting internal customers and supporting external customer versus the product company business because of these inefficiencies that I saw, but more importantly, because -- when you look at our margins and when you look at the margins of somebody that uses a foundry and then sells the product, the margin stacking just does not mathematically make sense. There's no way that -- I mean clearly, there could be slight differences between different companies in terms of their scale and so forth, but not to this magnitude. That made no sense. And so, when you look at what we call TMG, which is the technology organization manufacturing and foundry together, as one and look at the P&L. And we haven't finished it. Our hope is that we can provide something to investors by 2024. But in the just spreadsheet kind of exercise of this whole thing, I mean, this thing has a really rough P&L, Intel does not work. And so, I started -- so Pat and I started to realize, hey, we actually need to create more accountability. They need to be able to measure themselves against other foundry competitors. And they need to be eking out performance. They just aren't focused on -- they're focused on delivering and quality and those kind of things, which are the metrics that they were measured to in the past. So, that's really the primary reason. Now your other point is right. When you do this, it does have customers looking at this a little bit differently. Okay, I actually now see a clear bifurcation between the fab organization and the product organization. I feel more comfortable around my IP. And so, as we went out to customers within the days ahead of announcing this, just to get their take universally, it was pretty positive. Okay, this actually even makes me feel a little bit better. So, it was a fringe benefit, but it is a benefit. Yes. Got it. Obviously, a lot of people agree that there's a lot of potential for things to go right from here. I kind of think of '18 as being the most important full component for the Company over the next few years. But that process node is still a ways away. So, the thing I think many folks struggle with is, what are the mileposts that we can see tangibly over the next 12, 18 months on AT&A otherwise to justify people buying the stock? Is it selling up a big foundry customer? Is that the single biggest full complaint that we can see that's tangible that we cannot sure? Yes, I mean, from our own perspective, we have a whole set of milestones about when things detain, when they tape out and support, that when we power up that are going to be our own internal milestones. And we do provide breadcrumbs around those to help investors understand how we are progressing. But I recognize from an investor perspective that it seems a little more amorphous, not like something tangible. Clearly, from our perspective, if we hit all those things, I think we're going to be successful at AT&A. But from an external perspective, for sure, if you see -- if we get customers, which we expect to get customers, signed up on AT&A that's the validation that we're progressing. And so I think that you're right, that will be real evidence. And our hope is that earlier in '23, we'll be able to announce some of those customers. The progress has been very good. We're engaged with seven of the 10 largest customers within the foundry space. And so, I think you'll start to see some true points over the course of '23 that give you confidence that not only do we know we've got it going from an internal perspective, but somebody has put us through the paces externally. And it's interesting, we thought we were pretty good on Intel 16, but lo and behold, when you get another customer in there putting you through the paces, you learn a lot about things that you can do to improve, and we've already experienced it even in Intel 16. So do you think that once we get inside '23 that we could realistically expect to see big foundry customer sign up for SG&A? Let's -- I'm giving a question from the audience, which is leading into the next topic that I want to talk about I have a [indiscernible]. The question really is around the rationale for building the factories in Ohio and the choice of Brookfield as a partner. And then that's going to lead into a bunch of other questions that I got. Yes. Well, I mean, obviously, we looked for a location that we felt like had the right level of water, had the rates infrastructure, had a good set of universities around it that could -- we could attract talent, how -- was in a state where the government was highly supportive, educating and training the workforce, helping us do that because even the line workers have a level of capability that is not typical of just a generalized manufacturing facility. So those were all key components. Obviously, incentives played a factor in it. And so that drove part of it. I think the level of engagement from Ohio was pretty unmatched relative to any other states that we were looking at for that greenfield fab. No. Obviously, we're also expanding in Arizona. We have a facility that we're going to expand into in Germany. I think we got the same kind of vibe from the German government in terms of their level of interest engagement and support. And so, that's what drove most of the decision-making. Now on the Brookfield thing, was there a specific question on Brookfield or do you want to⦠Yes. So, the challenge with the fabs is there's -- you look at Arizona, to do those two months is going to be somewhere in the $30 billion range, maybe a TAM bit less. It's significant amount of cash outlay and it takes quite a while before you start seeing cash inflows from producing wafers and so forth. And so, we recognize that discrepancy between money going out, money going in, and we needed a structure that improved that balance. We also recognize that if you are trying to raise cattle for these fabs, the existing pools of capital are relatively limited. I mean, there's obviously availability, but there's a limit on any one-time what you can raise. This was an opportunity to leverage somebody had a lot of cash that they wanted to put to work, a big slug, and we needed a big slug. And so, we worked with them over months to kind of optimize this to work both for Brookfield and for Intel. And we came up with a structure that essentially looks a lot like a JV. We invest 51%, they invest 49%. We do it over time as we test to build out the factory. And then as the factory starts generating revenue income, the income kind of comes back to both parties. There's a certain amount of upside that we think we can drive that we get to keep. But there's a -- they are protected on the downside in case we can't load the factory as high as we want. When you look at it from an internal rate of return basis, the rate was below kind of our weighted average cost of capital, but it was higher than kind of a borrowing rate. But when you factor in how much money we needed, probably that borrowing rate had upward pressure on it anyway. And given that rates have moved quite a bit, it's now at a point where it's pretty commensurate with debt, and it accesses a pool of money that we just don't ordinarily have. We have bondholders. We have a certain set of banks. We get all of their limited partners providing equity to us. And then they will back leverage it. But when they back leverage most of that leverage is to institutions that we don't deal with. So, it was pretty attractive. Our goal will be to do more of these, but we're going to be thoughtful around which ones make sense based on our confidence around when loadings are at a level that will justify some structure like this. So, I would look for more of them, but I wouldn't necessarily say every one of the fabs I just mentioned are going to be candidates. We're going to have to be somewhat thoughtful about that. Got it. Yes, just on the point about third-party financing. Currently, you have three buckets. You have the CHIPS Act, you have tax credits and you have the Brookfield, right? My estimate it could be up to $10 billion per year, each of the next three to four years, I mean it's a lot of money when you actually add up the whole thing. I get the argument from a lot of investors that say, well, if they're that dependent on government money to be competitive, that I'm not going to pay a multiple for that. And I also hear that well, what if there's regime change. And there's not the type of commitment to subsidizing manufacturing onshore. How do you sort of think about that? Yes. I mean, first of all, hopefully, you're not investing in any other semiconductor company that manufactures because I guarantee you every one of them gets grant money. That happens in Asia, believe me. So everyone is already getting grant money outside of the U.S. and Europe. As I look at the -- how long can kind of count on this, the invest tax credit is basically four years. The CHIPS money is projects, it's a project base things that will extend beyond four to five years, but there's a limit to the time frame of the project. And as we are looking at the cost structure of those fabs and whether we can make it work from a cost competitive perspective, we're assuming this, but we're not assuming anything beyond this. So our assumptions are built around what's been -- what we know for sure. I'm hopeful that actually they use because I think in order to be competitive with Asia, it will need to continue. But I'm not too worried about it right now. I think that what we have gotten through assuming that we get the right level of CHIPS grant money that we think we will, assuming we get the rate level of CHIPS grant in Europe that we will together with the investment tax credit, I think we are in a position where we do have a competitive cost structure relative to Asia and that I think we can be pretty effective, as a foundry supplier and as a manufacturer of wafers in the U.S. and Europe. Just sort of dovetailing on that, can you talk about the dividend? I get a lot of people asking that, wondering how sacred that really is. And I -- in some ways, I think I would have maybe wanted you to just pull off the band-aid and just cut the dividend rather than acting all these other sources of -- so how safe [indiscernible] to the dividend and sort of how was the calculus that actually went into the potential to cut the dividend versus access to these third-party? Yes. I mean, I think, obviously, there's a Board decision ultimately. So, it's being a little out of turn probably. But I would say that our thinking, given the amount of investment that we've got to make is that growing the dividend, obviously, it doesn't make a ton of sense. And our goal is that to get to this 20% free cash flow as a percent of revenue as our optimal model. And once back in that place, of course, you might think differently about dividend growth. But until then, this is probably at the level we want. I think it is important. I think the Board feels it's important. It gives investors a yield when we're in an investment phase with the Company. And so that we felt like that was important, and we felt, given our balance sheet, remember, we're an eight-plus rated credit, it's not like we're putting pressure, undue pressure on the balance sheet or taking undue risk. That said, I guess the only other copy I could say is that, we do -- our best ROI is to invest in those in four years is to get our product portfolio to the right place is to leverage our manufacturing infrastructure for foundries. Those are the higher ROI opportunities. So, if something got dramatically different in terms of our cash flow, of course, that might change the calculus on the dividend, but that's not the case today. Got it. Can we talk just about the shape of next year and maybe also how to think about CapEx next year? I think at another conference last week, you suggested that March is likely to be, I think you had no better than seasonal. Seasonal is down 5% to 7%, roughly. And if anything, it sounds like it's a little worse the bias with each of the downside versus that. Is there any way to sort of characterize the macro as we kind of head into Q1? Yes. So, I'll call out this by saying our visibility isn't pristine in this case, it's somewhat unclear how the macro is going to behave. But the way we kind of looked at it was just taking a little bit of a peak into Q1, and that's all it is at this point is a peak. Our estimation is that inventory digestion that's been going on with our customers, probably doesn't finish at the end of this year, it continues into next year. That, coupled with macro headwinds in basically every geography out there, didn't give us a ton of confidence that there would be some reason for us to be better than seasonal. And so, we felt like sending a signal to investors to make sure they under said, hey, we won't be probably out of the woods in terms of inventory digestion at the end of Q4. So, we would model something more no better than seasonal. And -- and as you pointed out, Tim, I mean, depending on the analysis you do, if you go back three years, it's actually more like low single digit declines. If you go out more like five, seven years, you get more to this 5%, 7%, which I think is the right starting point for seasonality because the last couple of years have been so noisy with COVID and so forth, it's kind of hard to get good data. And so, that's kind of the near term. Obviously, it's macro-driven and as we progress out of this at some point cycles that are down, turn around the cycles that are up, and we'd expect to be able to take advantage of that. Great. Following on that, I want to ask about CapEx. And net CapEx this year is sort of mid-30% as a percent of revenue. But that includes a pretty big $4 million offset here in Q4. Is the right way to think about your net CapEx next year that it would be a similar mid-30% of revenue? Yes. I think what we -- the way we want to operate is to generally in our investment period, which is '22, '23, '24 operate in this kind of mid-30s as a percent of revenue. Obviously, we had a different view. Obviously, we had a different view on revenue back in the Investor Day. I think one thing you can take away from this is, we're operating within our guardrails. So if the top line changes, then the net CapEx intensity come for the dollar number changes to make sure the percentage stays the same. And so that's our intent. And after we get beyond that, my expectation is that our net CapEx intensity probably comes down to something more like mid-20s as a percent of revenue. Got it. And then on gross margin, can you talk about some of the put takes as we look into '23. 45% in Q4 is -- includes about 300 basis points, I think, of under utilization charges. So, is it fair to say about 48% as being the right baseline as you kind of head into next year -- I think maybe help us think about some of the puts and takes. Yes, I think so. I mean we probably will be underloaded in the first quarter. I don't know yet what the rest of the year would like, but clearly, they'll that will be a headwind until it's not. And as you point out, once we can load the fabs up to capacity that should take off a 300 basis point headwind for us. We're also getting this $1 billion of cost savings that I already talked about for next year. That should also help. Keep in mind also that pricing -- we made some pricing moves in the fourth quarter that will certain points in time that should start to show up more meaningfully in '23. ASPs are stronger in Sapphire Rapids that obviously helps as well. So, there's some definite tailwinds to our gross margins. Of course, it's more could it be more dominated by the cycle probably for the next few quarters. But I think that as things start to improve, we'll start to see some benefit. The other thing I didn't mention back to your question before around confidence around the gross margin longer term. Beyond just this 300 basis points headwind, we're also probably incurring about a 200 basis points or so headwind 4 to 5 nodes per year, just so many so much start-up costs jammed into current many years. So, as we get out of the 5 nodes in four years, we start to go towards a normalized rate. That should also help by a couple of hundred basis points. I won't have it in '23. That's not going to get a tailwind for '23. But out in the longer term, '26, '27, we'll be able to do that. Book value. And I get the sense that there are -- I get many calls from people who are sort of taking in on the stock, looking at book value. And I think people are looking at the replacement cost of your manufacturing assets and wondering whether you could, in this environment, you could replace your manufacturing assets for $100 million. So how do you think about it? Is there some way to think about the replacement cost for your existing assets? Yes. Did this a bunch at Micron because we have a way more value business. And it's hard to come up with a great number to be on doing replacement value. I would just say, given that we're depreciating these things pretty quickly. Equipment appreciate in five years, you can pretty much expect that the replacement was pretty meaningful because these things in year six aren't worth of zero, right, obviously. And so, it's at least 20% or 30% higher than the net book value when you look at it from a replacement value perspective. I thought the other thing where you're going, Tim was when you look at that as that's a lot of value that's kind of most your entire market cap. And then, we just got an unlock the value more recently with Mobileye. And you can look at the valuation has been pretty healthy. So as we look at it, I think one thing that maybe Pat hasn't gotten enough credit for externally is how pragmatic he is and how focus is on unlocking shareholder value through whatever means is necessary. And I think when you look at the Mobileye transaction, and I'm not saying there will be transactions like that, but there will be value unlock for sure. And so -- and Pat, I think, focuses on that almost as much as he focuses on all the execution-oriented aspects of as well as well. So, we will continue to look for ways where we feel like the market hasn't quite picked up the right value for the business and find ways to make that happen to enrich the shareholders. Well, the foundry business as you create a separate P&L, that's certainly another asset that you could do something with, some of that you do with Mobileye for sure. Last question, we have about two more minutes left. But Dave, you were talking about aspiring to be a 60% gross margin business longer term. TSMC is 55% gross margin, but it was more like 50 even a year ago before they put through all these price increases. Can you justify maybe how you get back to 60% unless we're talking about your product business, leveraging edge manufacturing, whether it's yours or TSMCs, how do you bridge sort of where you are now to get to 60%? Right. And keep in mind, I don't think we're ready to call that the model, but we have an eye towards 60% gross margin. I would say it's a number of different factors. Obviously, being meaningfully behind on the process technology side has hurt us a lot, not only just in terms of the costs associated with catching up, but also just our ability to have products that are highly differentiated that can command a stronger price. We're starting to make real progress now, but there's way more work to be done there to get products that generate what we view as a fair price. And I think that will obviously help. As I talked about all these cost improvements, I think, significantly help. Some of the markets that we are entering into, like the graphic space, like the high-performance part of the data center space, they command margins that are well north of 60%. So that should be -- we should be able to mix up in that regard. And I think the area that -- back to your original point, the area that hasn't generated a level of margin that would support 60% in total is potentially in the foundry business. And of course, will be coming from behind relative to the leader will have all work out for us. But assuming we get to process technology leadership and assuming we were right that customers will need as we want another provider in the leading-edge foundry space, I think the margins should be commensurate with where you think of in terms of more leadership margins. I think when you mix those together, I think 60% should be pretty simple, particularly when you don't have a margin stacking challenges that our competitors have.
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EarningCall_1695
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Greetings and welcome to the ABM Industries Inc. Fourth Quarter 2022 Earnings Call. At this time all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Paul Goldberg, Senior Vice President, Investor Relations. Thank you, Paul. You may begin. Good afternoon, everyone, and welcome to ABMâs fourth quarter 2022 earnings call. My name is Paul Goldberg, and I'm the Senior Vice President of Investor Relations at ABM. With me today are Scott Salmirs, our President and Chief Executive Officer; and Earl Ellis, our Executive Vice President and Chief Financial Officer. Please note that earlier this afternoon, we issued our press release announcing our fourth quarter 2022 financial results. A copy of the release and an accompanying slide presentation can be found on our website, abm.com. After Scott and Earl's prepared remarks, we will host a Q&A session. But before we begin today, I would like to remind you that our call and presentation today contain predictions, estimates, and other forward-looking statements. Our use of the word estimate, expect, and similar expressions are intended to identify these statements, and they represent our current judgment of what the future holds. While we believe them to be reasonable, these statements are inherently subject to risks and uncertainties that could cause our actual results to differ materially. These factors are described in a slide that accompanies our presentation, as well as our filings with the SEC. During the course of this call, certain non-GAAP financial information will be presented. A reconciliation of historical non-GAAP numbers to GAAP financial measures is available at the end of the presentation and on the company's website under the Investor tab. Thanks, Paul. Good afternoon, and thank you all for joining us today to discuss our fourth quarter results and 2023 guidance. ABM posted solid results in the fourth quarter, capping off a strong year. Organic revenue growth of 5.8% was broad-based, driven by robust growth in our e-mobility, aviation, manufacturing and distribution, and education businesses, complemented by consistent organic growth in B&I. The ABM team continued to execute well mitigating much of the impact from higher wage costs and labor shortages, while advancing our ELEVATE initiatives and moving toward our 2025 goals. ABM generated fourth quarter revenues of over $2 billion with an adjusted EBITDA margin of 6.8%. Our adjusted EBITDA margin remained well above pre-pandemic levels reflecting improved operational efficiency that we believe is sustainable and can be enhanced over time through our ELEVATE initiative. Our solid financial and operational performance in fiscal 2022 demonstrated ABM's underlying brand strength and enhanced competitive positioning in a challenging market environment. Despite the expected decline in high-margin disinfection-related work orders, significant wage inflation, rising interest rates, and a historically tough labor market, the ABM team delivered strong full-year EBITDA growth of 9.5% with an adjusted EBITDA margin of 6.6%. Additionally, with our expanded breadth of service offerings, we generated new sales totaling more than $1.3 billion, another record year. I'll now discuss the demand environment for each of our industry groups. Beginning with B&I, office occupancy rates in the fourth quarter remained at relatively low levels, but continue to modestly increase, a trend we expect to continue into 2023. Similar to 2022, we anticipate our operating margin to remain steady in 2023 as we maintain our base of existing customers, while leveraging our scale and unrivaled breadth of services to expand our growth opportunities. Recently, we won a sizable contract expansion with Google to serve their newly built Bay View Campus and we see additional opportunities to expand our partnerships with other significant customers. Moving to aviation, travel, including parking and transportation, has nearly returned to pre-pandemic levels. So, we expect our growth rate in aviation to moderate in 2023 from the elevated level we experienced in fiscal 2022. We expect continued growth in our ABM Vantage parking solution as our airport clients continue to migrate to integrated touchless parking solutions that generate higher revenue and improve the traveler experience. On the cost side, labor availability remains a challenge in the aviation market as time to hire is the biggest impediment due to the TSA's lengthy background check process. As we've discussed previously, in this labor market, speed to hire is important and a protracted background check process causes headwinds. Demand in manufacturing and distribution continued to be solid, in part reflecting our successful efforts to expand our business with existing customers in the e-commerce and automotive markets. ABM is also winning new business in faster growing and underpenetrated markets like Life Sciences. In fact, we just won a sizable new contract with a large pharmaceutical manufacturer in the fourth quarter. And given the significant growth opportunity in this sector, we view Life Sciences as a strategic priority for 2023. In education, the addition of important new clients in the fourth quarter helped drive organic growth of 7%. We're also seeing a good deal of new contract proposal activity, providing ample opportunity to win new business in 2023 from a variety of potential clients, both from those who currently outsource, as well as those who are contemplating outsourcing. However, labor cost inflation in non-unionized markets, especially in the southern eastern regions of the U.S., continues to be challenging for this segment. That being said, we've made steady progress in filling open positions. So, we're optimistic moving forward. In Technical Solutions, we continue to experience robust demand for our e-mobility charging solutions, where revenue more than doubled over the prior year period. For the fiscal full-year, e-mobility revenue grew to nearly $130 million from a base of just $36 million in 2021. We also saw strong growth in our mission critical end-markets where we provide comprehensive services for data centers, 911 call centers, and national defense-related facilities. We expect Technical Solutions to show strong growth in 2023, aided by the U.S. Infrastructure Bill and recent passage of the Inflation Reduction Act. In addition, our results should benefit from the contribution from RavenVolt, which recently signed a sizable contract with a national logistics solution provider to design and install a backup battery storage system at numerous locations over the next few years. So, Technical Solutions is well-positioned to benefit from long-term secular trends and remains an area of strategic focus as we seek to identify future acquisitions that broaden our capabilities. Over the past year, we made significant progress with respect to our ELEVATE initiative. Most recently, we developed a team member retention predictive model that forecasts where and why we may see attrition rise. With this predictive information, we can proactively implement an effective team member retention strategies, including bolstering HR recruiting support and ultimately reduce labor acquisition cost. We also developed and started piloting a workforce management tool that provides enhanced visibility into productivity levels across our portfolio of accounts. When fully shaped after our pilot period this year, we should start seeing scaled improvements in overall labor spend, and meaningful insight into low-performing buildings and how to solve the challenges we may have. Lastly, among all the other initiatives that are in flight, we continue to move forward with our cloud-based ERP system, which we expect will begin deployment mid-year 2023 as part of our ELEVATE Tech roadmap that runs through 2025. Before I turn the call over to Earl to discuss the Q4 financials and guidance, I want to make a few summary comments. First and most importantly, I'm extremely proud of our talented and dedicated team who delivered extraordinary financial and operational results this past year, despite the toughest labor market on record. By putting our customers first, our team has done a tremendous job in strengthening our client relationships and opening up new growth opportunities to provide additional value-added services. At the same time, we made significant progress on our ELEVATE initiatives laying the groundwork that will help accelerate our organic growth and enhance our profitability over the long-term. As we enter 2023, now is a good time to provide a status update on how we are progressing toward our 2025 goals of [$9 billion] [ph] in sales, adjusted EBITDA margin of 7.2%, and $400 million of free cash flow. We were already well on our way towards achieving $9 billion in revenue, driven by solid organic growth complemented by acquisitions, including Able, Momentum and RavenVolt with more to come. We also remain confident in our adjusted EBITDA margin and free cash flow targets. The 6.6% margin we posted this year is consistent with our expectations and represents a solidified base from which we aim to add 60 basis points of incremental margin over the next three years. Given current challenges in the labor market, this projected margin step-up is not likely to be a linear progression, but the end target remains fully achievable as we expect labor costs and inflation to ease in the coming couple of years. This will coincide with our evolving service mix. Additionally, margin should benefit over the next few years from increased operational efficiency and cost savings associated with our ELEVATE investments I outlined earlier. Our vision for ABM remains clear. We strive to be the leading facility solutions provider in terms of size, scale, and client and team member satisfaction. ABM remains strongly positioned supported by a substantial base of recurring maintenance related revenue, including janitorial and engineering services where we serve more than 20,000 clients. We will continue to invest in and grow our base businesses both organically and through acquisitions where it makes sense, and we will enhance our performance through a greater use of advanced technology. The free cash that our core business generates will be [re-invested] [ph] in adjacent businesses with large addressable markets and high growth rates and margins as we have done with acquisitions like RavenVolt, and organic investments in e-mobility. Through this strategy, we see ABM evolving into a higher growth, higher margin to [fully] [ph] solution provider, underpinned by resilient strength of our core business. We also intend to use our strong cash flow to return cash to shareholders through dividends and share repurchases. Thank you, Scott, and good afternoon, everyone. For those of you following along with our earnings presentation, please turn to Slide 5. Fourth quarter revenue increased 18.6% to $2 billion, reflecting the contribution by acquisitions, as well as broad-based organic revenue growth of 5.8%. Moving on to Slide 6, net income in the fourth quarter was $48.9 million or $0.73 per diluted share, up 43% and 46% respectively, over the same period last year. The increase in GAAP net income, primarily reflects higher segment earnings on significantly higher volume, and lower acquisition, and integration costs, partially offset by higher interest expense and higher ELEVATE related investments. Adjusted net income for the fourth quarter increased 2% to $59.4 million and adjusted earnings per share was $0.89, an increase of 5% over the prior year period. The increases in adjusted net income and adjusted EPS were due primarily to higher segment earnings, partially offset by higher interest expense. Adjusted EBITDA grew 18% over the prior year period to $130.7 million. Adjusted EBITDA margin for the quarter was 6.8%, flat with last year, largely reflecting tight cost controls and price escalation, which largely offset the anticipated decline in higher margin disinfection services, as well as higher operating costs, particularly for labor. I believe our margin performance was quite impressive given the labor environment we faced during the year and our team did a phenomenal job successfully negotiating price through escalations. Now turning to our segment results beginning on Slide 7. B&I revenue increased 27.5% to over $1 billion, primarily driven by the contribution from the acquisitions of Able and Momentum. Excluding acquisitions, organic revenue growth was 2.6%, reflecting modestly improved office occupancy rates, as well as solid demand for parking services, concerts, and sporting events. Operating profit in B&I increased 32.9% to $92.4 million, benefiting from significantly higher revenue. Our operating margin of 9% was slightly higher than that of the prior year period and largely reflected leverage on volume and strong execution with regard to price escalations and cost controls. Aviation revenue increased 9.1% to $214.4 million, marking the sixth consecutive quarter of robust year-over-year revenue growth. This improvement was largely due to increased leisure and business airline traffic and related increase in parking activities in a post-COVID environment. Looking ahead, we believe year-over-year growth rate in aviation will moderate as travel has essentially transitioned back to pre-COVID levels. Aviation operating profit was $1.3 million versus $13.2 million in the prior year period and margin was 0.6%. Operating earnings and margin were negatively impacted by work order approval timing related to a large parking construction project where ABM had completed significant work and await final customer approval. We expect to receive approvals in the first half of the calendar 2023. Turning to Slide 8, manufacturing and distribution revenue grew 8.7% to $371.2 million, reflecting solid market demand and expanded business with existing e-commerce and manufacturing clients. Operating profit increased 11.3% to $41.2 million, and operating margin improved 30 basis points to 11.1%. These results were driven by favorable customer mix and operating leverage on higher volume, partially offset by lower levels of disinfection related work orders. Education revenue increased 6.9% to $217.1 million, benefiting from new clients onboarded in the fourth quarter. With bidding activity in education fairly strong, we expect education to continue to post positive year-over-year growth in 2023. Education operating profit was $8.3 million, up 3% over the prior year period on higher volume. Margin decreased 20 basis points to 3.8%, due to lower enhanced clean revenue, as well as higher wage costs, including [overtime expenses] [ph]. Technical Solutions grew revenue 21.5% to $179.6 million, largely driven by continued strong growth in our e-mobility service offering, strong growth in mission critical markets, and from the recent RavenVolt acquisition. Operating profit was $20.9 million, compared to $18.8 million last year. Operating margin decreased to 11.7%, primarily reflecting service mix that was most heavily weighted to our e-mobility service line versus the prior year. Moving on to Slide 9. We ended the fourth quarter with total debt of $1.4 billion, including $158 million in standby letters of credit, resulting in a total debt to pro forma adjusted EBITDA ratio of 2.6x. At the end of Q4, we had available liquidity of $686 million, including cash and cash equivalents of $73 million. Free cash flow in the fourth quarter was $104 million. For the full-year, free cash flow was negative $30 million, reflecting $143 million legal settlement and another combined $146 million impact from our CARES Act repayment, integration costs, and elevated expenses. [Full 2022] [ph] free cash flow was over $250 million, excluding these items. Interest expense was $16 million in the fourth quarter, up nearly $10 million over the prior year period and about $5 million sequentially from Q3, reflecting significantly higher interest rates, as well as the year-over-year increase to total debt by [$380 million] [ph]. Turning to capital allocation. We repurchased roughly 580,000 shares in the fourth quarter at an average price of $39.69 per share, for a total cost of $23 million. For the fiscal 2022 year, we repurchased approximately 2.3 million for $97.5 million. We also recently received Board approval for $150 million expansion of ABM share repurchase authorization. The total authorization now stands at $197 million. Now let's move on to guidance for fiscal 2023 as shown on Slide 10. For 2023, we expect GAAP EPS to be in the range of $2.43 to $2.63 with adjusted EPS to be in the range of $3.40 to $3.60. Interest expense is expected to be between $71 million to $74 million in 2023, compared to $41 million in 2022. Our tax rate is expected to be between 29% and 30%. We expect to grow adjusted EBITDA at a mid-single-digit rate with an adjusted EBITDA margin between 6.4% and 6.8%. We expect full-year 2023 cash flow to be in the range of $270 million to $300 million before the second and final installment of our CARES Act repayment of $66 million and combined integration and elevated costs of about $75 million to $80 million. Turning to Slide 11, we expect to post solid mid-single-digit growth in operating earnings at the mid-point of our guidance, reflecting revenue growth supported by price escalations and other cost control measures that help mitigate higher labor costs and labor shortages. At the same time, we anticipate interest expense will be a $0.32 to $0.35 headwind to earnings per share in 2023, representing the primary cause of the year-over-year decline in our forecasted adjusted EPS. Overall, our anticipated growth in operating earnings in a tough macro environment speaks to the underlying strength of our business model and our team. Additionally, we expect the quarterly cadence of our adjusted EPS to return to a more typical pattern now that most of the impacts of COVID have subsided. Prior to the pandemic, for example, our Q1 earnings have represented on average approximately 21% to 22% of our full-year's adjusted EPS with about 45% of adjusted earnings per share generated in the first half of the year. We expect a similar performance in fiscal 2023. Thanks, Earl. I'm very excited about the future of ABM. Nobody in our industry matches the scope of our services, the scale of our operations, or the strength of our balance sheet. I'm confident we will deliver a solid 2023 and continue to make progress towards our 2025 goals. With that, let's take some questions. Thank you. [Operator Instructions] Thank you. Our first question is from Tim Mulrooney with William Blair. Please proceed with your question. Hey, this is Sam Kusswurm filling in for Tim. Thanks for taking our question here, guys. Maybe to start, we've seen recently some companies pull back hiring or even announced targeted layoffs. And the recent [indiscernible] seems to show some cooling in the labor market. It sounds like it's still a very difficult labor market for you guys, but are you guys seeing any signs of increased labor availability or even able to find talent easier than maybe say a few months ago? Yes, sure. That's a good question. Look, I think if you think of 2022, right, for us we're in 2023 now with our fiscal year. But when you think of 2022, I mean that was as bad as we've ever seen. So, we're expecting a little bit of moderation this year. We're starting to see the participation rate, which is people that will come into the market. We're starting to see applications go up a little bit. So, we're still cautious, Tim, for sure, and we still think it's going to be a very challenging year. We're hoping that it's going to be incrementally better than last year. That's helpful. Appreciate the color. For, maybe pivoting to ERP actually, you mentioned you expect to begin the rollout in 2023. I was wondering if you could provide us a bit more detail on that project. Will the rollout be targeting any segment or client type first? And I know you broadly talked about the margin benefit from the ELEVATE program, but can you share how you think about the ERP project as it relates to any margin benefit? Sure. I mean, look, we're going to be very prescriptive and careful on how we roll it out. We're going to start with our education group mid-year, next year. And it's probably a two-year process of rollout industry group by industry group. And I mean, we're just super excited about it because we're just going to have modern best-in-class systems for our financial data. And I think what people forget is that the ERP is, kind of in the center of the hub, the financial system, but every system that we have talks to the ERP, right. So, the data analytics we're going to have with our timekeeping system, our work order system like everything, think of the ERP as the heartbeat of every system that we have in the firm and workforce management tools that we're going to be rolling out through ELEVATE, everything ties into it. So, we just couldn't be more excited about it, but expect it to start cascading through mid-year, next year with education. And we're going to â we'll keep you guys close to it as we roll it out, because again there's so much in anticipation in the firm for it. Excellent. That's good to hear. And maybe if I could just squeeze one more real quick, just a housekeeping question. Your guidance, how much are you assuming a management reimbursement revenue? I know your EBITDA margin guidance excludes this. So, just want to level set for everybody. On our management, reimbursement, is that more for â on the parking side, which is something we talked about. It's about 30 basis points you can think about. Yes, great. Good evening, guys. Thanks for taking my question and sometime here tonight. I thought I would ask a question here just on some of the implications from your guidance on the revenue line. You went through this a little bit by the segment, but I guess, with EBITDA expected to be up mid-single-digits. You obviously have some inorganic contribution from RavenVolt and the other deal. I guess in margins basically at the mid-point guided, EBITDA margins guided flat year-over-year. I guess that means that the organic revenue guidance is probably what like in the 3% or 4% range. I guess I just wanted to see have you comment on that? And then it sounds like you're expecting good growth in Technical Solutions, it sounds like there's good momentum in education. M&D has been strong for years and had a good quarter here. So, it feels like the slower growing segments are Aviation and B&I. So, maybe Earl, do I have that right or is there some way I should be thinking about that differently? Yes. No. Thanks, Andy. To answer your first question with regards to revenue, so, I think one way of thinking about it is that we're planning on growing our revenue organically above GDP. And again, if you think about it, we're continuing to see good demand for our services across each of our IG's. And again, if you look at that plus the contributions associated with acquisitions and to your point flat margin, that kind of gets you to that mid-single-digit EBITDA growth year-over-year. With regards to the IGs, one thing to note, you're absolutely right. ATS, we will see probably above average growth as we continue to see the benefits associated with e-mobility and sustainability projects. However, Aviation, because we're still, you know if you think about the first couple of quarters of FY 2022 where we weren't still back to, kind of like pre-pandemic levels, as we now have been emerging to pre-pandemic levels and we lap those periods, you will see, kind of like outpaced growth in aviation as well. Okay. Speaking of Aviation, I guess, could you help us understand the magnitude of the work order or the change order that you're waiting for on the approval for that one? And why is â is there a dispute over the work? Is that why itâs taking longer to pay it, maybe just some background on that? It looks like just judging on the margins here versus, kind of historical level? It looks like it's fairly material. Yes. No, I mean, relatively speaking, not for the enterprise, but for aviation it was only because if you just think about half that we've had for aviation at 5% operating profit, right? So, now this gets a flat. So, you could do the math as well as I can. It's about a $10 million issue. And it's â this context, Andy, is weâre in this very large project with a client that involves construction operations. We're putting in our ABM Vantage. So, what happens, these projects are super dynamic, right? And there's changes that happen along the way. And as these changes are requested by clients, we'll do that even ahead of the formality of some approval processes that clients go through. So, in this case towards quarter-end, we were in the process where the work got ahead of the formality of the approval process. We're highly confident that in the first half of the year, we're going to get that payment. It's for us just a timing issue. Got it. Okay. Last question, Scott. You didn't mention it in the script, but it was in the press release here that you're targeting the 30% to 35% payout of adjusted EPS as the dividend over time. Now, maybe I missed it or maybe just haven't focused on it enough, but you paid out about 21% this year. So, I guess what's the realistic time period, not looking for specific guidance, but to get to that level, obviously, the dividend bump that you had here was a little bit bigger, it seems like you're starting to strive for that, but is this like something we can expect to happen by like 2024 to get to that payout ratio or how should we be thinking about that? Yes, I'll take that question, Andy. So, if you look at the increase that we've just announced, it really is what I will call a jump start to our longer-term strategy of getting back to that 30% to 35%, which again is where we were pre-pandemic. I would say from a time perspective, again, we're not rushing into this, so I'd say, it's not going to be linear, but probably about a 3-year to 5-year period. Yes. Hi. Thank you. So, first, I guess, Scott, I was wondering if you could reflect back on maybe the acquisition of Able and how you would characterize some of the cross-selling efforts or where are you in that cycle? Has the acquisition so far been in-line with your expectations, ahead of your expectations? Just some perspective on that would be helpful. Sure. Well, I could start by saying, we are just super excited that we consummated that transaction. And what this does for us Faiza, in like the, kind of that engineering space, right, and sustainability and all the headwinds in that area or I should say tailwinds in that area. Just phenomenal. So, we're super pleased with the acquisitions. It's on our expectation everything we thought we would get from Able. So, really, really excited, the cross-selling efforts just beginning now. I think that's something â and I think we've said from the start that's something that takes time because you put business development teams together, they got to get educated on the platform. So, that's a longer journey, but I would just say today we're as optimistic as ever, probably a little bit more optimistic now that we got a chance to look under the covers and we're just really happy with the acquisition. Great. And then on the e-mobility part of the business, could you help size it for us in terms of what it was in the year? I know, it's been growing very strongly. And maybe if there is a number that you can put in terms of how you're thinking about that for 2023? And are you thinking of RavenVolt as, I mean, I don't think it's part of e-mobility specifically, but would you put it in a similar box maybe like what's the growth trajectory that we should be thinking about for those two businesses? Sure, sure. So, like e-mobility, you know I can only tell you like, you saw the numbers, it went from 30 million plus to 130 million plus year-over-year. And it's like we have such [high hopes rate] [ph]. It's really hard to talk about the addressable market because it's so big. The numbers are crazy, right? Because â and you know this just intuitively, the demand for electric vehicles, the lack of charging stations out into the public, it's a huge addressable market. We love the fact that we are number one, number one installer. And that we're building a business around that because there's so many components of e-mobility that we're still not in yet. So, we're super excited about e-mobility, but it's really hard for me to tell you what the ultimate size will be other than we're putting a lot of effort into it and we're going to be growing. We're going to be growing obviously faster probably than any other place â than any other segment. And then RavenVolt, again, super excited about that. I mean, if there was anything with RavenVolt like their experiencing what everyone's experiencing in terms of supply chain issues, that hasn't led up, but the backlog is growing. I made mention in my prepared remarks about this massive contract that we just won. So, for us, it's about just rolling it out and actually like we said, we don't recognize revenue till we turn the wrench or install the micro grid. And I think we're all just hoping that in 2023, or at least the back half of 2023, we'll start seeing some relaxing on the supply chain. Great. And then just follow-up on the labor point. I think you said, although I could be wrong, that over time, you expect labor costs to ease, which I think is a fair point, but I also know that you do have a pretty heavily unionized work force and those contracts, I believe, are up for renewal in 2024, 2025. Give us a sense of like how far in advance do those negotiations start like are you anticipating that you might see, sort of a big increase, sort of almost like a catch-up payment with that, that might happen? Like how do you think about that? Yes. So, typically these negotiations start anywhere from six months to four months before. So, we have some time on that. And there could be a catch up. For us, it's less worrisome because with collective bargaining agreements, they're public documents. A lot of time Faiza, the management companies and the owners help negotiate this. So, it's very transparent and it's â when we're going for customer increases, it's the easier part of the market because they know about what the wage progression is going to be. They help negotiate it a lot of times. So, it's an easier conversation when you say to them. Listen, the wage and benefit portions going up 4.5%, you know we're a lower margin business we have to recapture that. So, that doesn't cause us a lot of [heartache] [ph]. Hi, everyone. Thanks for taking my questions. I just wanted to start with a granular one, just given the initial guidance came in below the forecast I had and I want to make sure we frame exactly why because the margin is coming in line with expectations was good to see. So, maybe one of the other, kind of missing pieces is the DNA, especially in light of RavenVolt being folded in there? Earl, would you be able to help us out with that? Yes. I would say, just based on what I've seen from some of the consensus, I think the biggest outline is really the interest and I think based on what we put out in the script where we're suggesting that our interest is going to be anywhere between $72 million to $74 million, which is a significant increase year-over-year. That's probably the biggest [indiscernible] that you actually have to your current consensus. Yes. And what I would say Sean is like if you strip out interest expense and you look at where we're guiding and the range we're guiding in, we are growing this firm, and the reason I wanted to jump in is we're just so proud of that, right? We all know the macroeconomic environment. We know the wage pressures. We know people are thinking about potential recession, all that good stuff. And we're continuing to grow this firm operationally, which says that weâre agile, we know how to manage our labor. We're aggressive in getting price escalations from our clients. So, like super, super proud of where we're coming in, you know ex the interest expense portion. The DNA? So, if we think â look DNA, we don't have the â I'm not guiding to the exact number, but what I can tell you is that the DNA is really associated with the acquisitions of RavenVolt. If you look at what we're guiding from an acquisition perspective, we have the RavenVolt as the latest acquisition. And again, what we shared last quarter is that we're anticipating that to be $0.03 to $0.04 of accretive EPS net of the interest expense. Okay. All right. That helps. Great. And over the past several quarters, we've been waiting for contract rebids to occur in a meaningful fashion. My understanding was lot of those decisions were, kind of being pushed out through the pandemic. And I wondered if those decisions have started to kick-off and how you would characterize how ABM is faring in terms of retention, and maybe market share gains? Sure. I mean, look, I think you saw we had a 93% retention rate this year, which was phenomenal from our perspective, right? And so, it hasn't been, yet, because I'll always be conservative. You know that, Sean, but It hasn't been yet this onslaught of all these clients saying, we have to go out to bid, we have to reprice. We've been pretty aggressive of working with clients on renewals, right ahead of bids, but this cascade of clients bidding out work hasn't been on the radar right now, doesn't mean it won't change, doesn't mean we won't come back from â I'm always going to be conservative, right? It doesn't mean we won't come back from the holidays, but I have to tell you this is not something that's keeping us awake at night right now, whereas maybe a year or so ago, we thought now when the pandemic ends or all these clients going to go out to bid and we're just â that's not the sentiment that we're getting from our clients right now. Okay. That's probably good. And then how would you characterize the economic sensitivity to, sort of the non-janitorial margin accretive growth story over the next couple of years? Yes. So look, I think for us, the tailwinds are incredible with some of the federal programs that they've put in place and availability towards everything around ESG, right? And with our Technical Solutions Group and what they offer in our manufacturing and distribution group, which is dealing with all the e-commerce, life science companies, we think there's tremendous tailwinds. I think the short-term impediment is the supply chain. And this isn't new news. I mean, this has been going on for a couple of years now, right? I think just the reason it's coming more to the fore is that we have thought by now that things would open up more, but you know some of the Asian markets where we got a lot of the supply from have had their COVID issues. So, hopefully towards the back half of this year, it will open up, but I think for us, if you look at our industry groups and our segments, we think we just have a lot of tailwinds in the next couple of years. So, I wanted to start with, you touched on it in your prepared remarks around the pace of return or the activity around return to office, and I was wondering if you could touch a little bit on that because I guess since we last spoke, when you reported your 3Q numbers, that change has been kind of gradual. I guess if you talk about from, call it September, the beginning of September, but now I'll call it Labor Day to now, that's been kind of gradual. So, I was wondering if you could talk a little bit about maybe what you're seeing and what your planning is going into next year as to how â what you're looking for as to how that plays into your planning and your expense matching in [the light] [ph]? Sure. I mean, look, the return to office has been slow, like we've said, but slow, but increasing, right? And I think we've seen it a little bit in the numbers. And I could just tell you anecdotally, as I travel in my circles and talk to some peer CEOs, there's definitely a push to get people back to the office. I don't think we're going to see five-day a week any time soon. And we may not even see four-day a week anytime soon, but like two to three is solidly in the crosshairs for 2023 and that should play to our benefit because we want people back to work, right. It's good for us. Generates work orders, it generates demand. So, we're optimistic that there'll be incremental return to work in 2023, but not outsized. I think it's going to be moderate, but up moderate. Got you. And then the second question I have is around, well, topic I guess is really around acquisition. And the overall pipeline, the valuations that you're seeing because certainly when you when you set the initial goals, the initial ELEVATE goals, I mean, with the answers you've already done [indiscernible] most of the way there as to the goals that you set at that time. So, I was wondering if you could talk a little bit about your own appetite for additional deal flow, as well as maybe what the pipeline looks like in valuations and the like? Yes. So look, we're still going to do acquisitions. I think they'll be probably more in the range of tuck-ins right now. It's a different interest rate environment at this moment. And we're hyper-focused on the Technical Solutions area and they tend to be smaller in size anyway. The acquisitions in that space don't have a [B] [ph] at the end or an [M] [ph] at the end, right? So, we'll still be active in the market. There is a pipeline, but â so I would say, what we're seeing is there are people that are â it's more pausing than stopping, I think. And that probably aligns well with what we're seeing in the capital markets as well, but we're not going to be shy about pulling the trigger on something that's strategic and makes sense, but as Earl has said, we're careful about our leverage ratio and you're not going to see it popping above 3x. That's not what we want to do here. So, rest assured, we're not going to get over our skis on acquisitions, but we will continue to grow this company through acquisition. Well, thanks everybody. I know that was the last question. Appreciate you getting on tonight and just we're excited about 2023. Hopefully, you can â it came through in our sentiment. And I just wish everyone has a happy and healthy holiday and we look forward to getting back and talking to you about our Q1 results. So, have a good night everybody.
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EarningCall_1696
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Welcome to the HEICO Corporation fourth quarter and full year fiscal 2022 financial results call. My name is Samara and Iâll be todayâs operator. Certain statements in todayâs call will constitute forward-looking statements which are subject to risks, uncertainties and contingencies. HEICOâs actual results may differ materially from those expressed in or implied by those forward-looking statements as a result of factors including but not limited to the COVID-19 pandemic, HEICOâs liquidity and the amount of and timing of cash generation, lower commercial air travel caused by the pandemic and its aftermath, airline fleet changes or airline purchasing decisions which could cause lower demand for our goods and services, product specification costs and requirements which could cause an increase to our cost to complete contracts, governmental and regulatory demands, export policies and restrictions, reductions in defense, space or Homeland Security spending by U.S. and/or foreign customers, or competition from existing and new competitors which could reduce our sales, our ability to introduce new products and services at profitable pricing levels which could reduce our sales or sales growth, product development or manufacturing difficulties which could increase our product development and manufacturing costs and delay sales, our ability to make acquisitions and achieve operating synergies from acquired businesses, customer credit risk, interest, foreign currency exchange and income tax rates, economic conditions including the effects of inflation within and outside of the aviation, defense, space, medical, telecommunications, and electronics industries which could negatively impact our cost and revenues, and defense spending or budget cuts which could reduce our defense-related revenue. Parties listening to this call are encouraged to review all of HEICOâs filings with the Securities and Exchange Commission, including but not limited to filings on Form 10-K, Form 10-Q and Form 8-K. We undertake no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise, except to the extent required by applicable law. Thank you and good morning to everyone on the call. We thank you for joining us and we welcome you to the HEICO fourth quarter fiscal 2022 earnings announcement teleconference. Iâm Larry Mendelson, Chairman and CEO of HEICOHEICO Corporation, and I am joined here this morning by Eric Mendelson, HEICOâs co-President and President of HEICOâs flight support group; Victor Mendelson, HEICOâs co-President and President of HEICOâs electronic technologies group; and Carlos Macau, our Executive Vice President and CFO. Today my comments will address our consolidated fiscal 2022 fourth quarter results, acquisitions and accomplishments, followed by a presentation for the segment results from Eric and Victor Mendelson, HEICOâs co-Presidents. Now before reviewing our record operating results, I would like to take a moment to thank all of HEICOâs exceptional team members for delivering another strong quarter. Your continued focus on exceeding customer expectations and operational excellence has translated into outstanding results for our shareholders. Iâm encouraged by the steady improvement in our businesses during fiscal â22 and I am very optimistic that this trend will continue into fiscal â23. Summarizing the highlights of our fourth quarter fiscal â22 results, consolidated fourth quarter fiscal year â22 net sales and operating income represents record results for HEICO, and that was driven principally by record results within the flight support group mainly arising from the continued rebound in demand for our commercial aerospace products and services. In addition, this marks the ninth consecutive quarter of sequential growth in net sales and operating income for the flight support group. Consolidated operating income and net sales in the fourth quarter of fiscal â22 improved 27% and 20% respectively as compared to the fourth quarter of fiscal â21. These results mainly reflect 11% quarterly consolidated organic net sales growth and the favorable impact from our fiscal â22 and â21 acquisitions. Consolidated operating margin improved to 24% in the fourth quarter of fiscal â22, and that was up from 22.6% in the fourth quarter of fiscal â21. Consolidated net income increased 13% to $97.2 million or $0.70 per diluted share in the fourth quarter of fiscal â22, and that was up from $86.1 million or $0.62 per diluted share in the fourth quarter of fiscal â21. HEICOâs effective tax rate was 23% in the fourth quarter of fiscal â22 as compared to 18.3% in the fourth quarter of fiscal â21. The increase in the effective tax rate for the fourth quarter of fiscal â22 principally reflects a 7.6% unfavorable impact from tax exempt unrealized losses in the cash surrender values of life insurance policies related to the HEICO leadership compensation plan, and that was recognized in the fourth quarter of fiscal â22 as compared to the tax-exempt unrealized gains recognized in the fourth quarter of â21. Later on in this call, if anyone has questions about the detail, this is a complicated matter, Carlos Macau is here and he will be able to explain that to you. Truthfully, it has no impact on our real operations. Our recent activity in acquisitions, in September â22 our ETG group completed the acquisition of Trad Test and Radiation located in Labege, France. Trad is a leader in the highly specialized field of radiation engineering, and their services and products are used primarily in space, nuclear and medical fields. In September â22, our ETG group completed the acquisition of Ironwood Electronics located in Eagan, Minnesota. Ironwood is a leading designer and manufacturer of high-performance test sockets and adaptors for both engineering and production use of semiconductor devices. As previously reported, our ETG group entered into a purchase agreement to acquire approximately 95% of Exxelia International, which is headquartered in Paris, France. Exxelia is a global leader in the design, manufacture and sale of high reliability, complex passive electronic components and rotary joint assemblies for mostly aerospace and defense applications. The transactionâs closing, which remains subject to government approval and customary closing conditions, is still expected to occur in the first quarter of fiscal â23 and would be HEICOâs largest ever acquisition in terms of purchase price and revenues. These acquisitions, all of them are expected to be accretive to HEICOâs earnings per share within a year of the transactionsâ closings. At this time, I would like to introduce Eric Mendelson, co-President of HEICO and President of HEICOâs flight support group, and he will discuss the fourth quarter results of the flight support group. Eric? The flight support groupâs net sales increased 33% to a record $346 million in the fourth quarter of fiscal â22, up from $260.4 million in the fourth quarter of fiscal â21. The net sales increase in the fourth quarter of fiscal â22 reflects strong 22% organic growth as well as the impact from our profitable fiscal â22 and â21 acquisitions. The organic growth mainly reflects increased demand for the majority of our commercial aerospace products and services resulting from continued recovery in global commercial air travel as compared to the fourth quarter of fiscal â21. The flight support groupâs operating income increased 60% to a record $77.8 million in the fourth quarter of fiscal â22, up from $48.6 million in the fourth quarter of fiscal â21. The operating income increase in the fourth quarter of fiscal â22 principally reflects the previously mentioned net sales growth, an improved gross profit margin mainly from increased sales within our specialty products and aftermarket replacement parts product lines, as well as efficiencies realized from the higher net sales volume. The flight support groupâs operating margin improved to a record 22.5% in the fourth quarter of fiscal â22, up from 18.7% in the fourth quarter of fiscal â21. The operating margin increase in the fourth quarter of fiscal â22 principally reflects decreased SG&A expenses as a percentage of net sales, mainly reflecting the previously mentioned efficiencies as well as the previously mentioned improved gross profit margin. Now I would like to introduce Victor Mendelson, Co-President of HEICO and President of HEICOâs Electronic Technologies Group, to discuss the fourth quarter results of the Electronic Technologies Group. The Electronic Technologies net sales increased 6% to a record $268.5 million in the fourth quarter of fiscal â22, up from $253 million in the fourth quarter of fiscal â21. The net sales increase is mainly attributable to the impact from our profitable fiscal â22 and â21 acquisitions partially offset by a slight decrease in organic net sales. The organic net sales decline is mainly attributable to decreased defense and space products net sales partially offset by increased other electronics, medical and commercial aerospace products net sales. Iâd like to point out that the Electronic Technologies Groupâs backlog remained elevated, reflecting strong orders and increasing delays in receiving components and raw materials from some suppliers. These delays have adversely impacted our planned production and shipment of some products during fiscal â22, but we expect that they should benefit us in fiscal â23 as these products ship. The Electronic Technologies Groupâs operating income increased 4% to a record $79.9 million in the fourth quarter of fiscal â22, up from $76.9 million in the fourth quarter of fiscal â21. The increase in operating income principally reflects the previously mentioned higher net sales volume, a favorable impact from changes in the estimated fair value of accrued contingent consideration and decreased performance-based compensation expense, partially offset by a lower gross profit margin mainly from decreased defense and space net sales. The Electronic Technologies Groupâs operating margin was 29.7% in the fourth quarter of fiscal â22 as compared to 30.4% in the fourth quarter of fiscal â21. The lower operating margin principally reflects the previously mentioned lower gross margin partially offset by the previously mentioned changes in the estimated fair value of accrued contingent consideration and a decrease in performance-based compensation expense. Thank you, Victor. As for the outlook, as we look ahead to fiscal â23, we anticipate net sales growth in both FSG and ETG principally driven by demand for the majority of our products. Our largest end market is commercial aerospace, which continued to grow during fiscal â22, and we expect the strong growth trends to continue into fiscal â23. Our second largest end market is defense. The defense markets were essentially flat for HEICO in fiscal â22. Though we would all prefer peace, global disputes and unrest means more defense equipment is required, providing a favorable environment for defense suppliers. We were negatively impacted by supply chain matters principally for electronic components in fiscal â22, and that delayed certain delivery schedules. We expect these external factors to mitigate in fiscal â23, but we canât predict when. However, we remain very optimistic on the defense industryâs future and have seen growth in our orders and our backlog, and that supports our optimism. We will not be providing detailed fiscal â23 net sales and earnings guidance at this time. We believe that our ongoing conservative policies, strong balance sheet and high degree of liquidity all enable us to continuously invest in new research and development and execute on our successful acquisition program, which collectively positions HEICO for continued growth and market share gains. In closing, I would again like to thank our incredible team members for their continued support and commitment to HEICO. Fiscal â23 looks very promising, and I believe that our culture of ownership and entrepreneurial excellence will provide excellent career growth and opportunities for all your success in fiscal â23 and beyond. Thank you for all that you do to make HEICO a great company. That is the extent of our prepared remarks, and I would now like to open the line for comments and questions from people who are listening. Nice finish to the year, very nice numbers today. You know, Larry just mentioned culture, and so I think this warrants a high-level question, for any of you. With all of the acquisitions over time for HEICO, I think many investors would have expected the company to inevitably change over time, so can you talk about how youâve been able to maintain the culture and the operational excellence, and essentially, what drives the consistency in the outperformance? Well, Eric is dying to answer that question, but since you posed it to me, I will respond. I donât want to duck anybodyâs question, Rob. The basic culture of HEICO is one of a decentralized organization where we give tremendous authority to the operating level. As you know, we have no mid-level vice presidents that filter everything that comes from the operating group up to corporate and to myself, Eric, Victor and Carlos. The first thing we do in acquisition, the most important is really scrutinize, analyze, get to know the person who is selling the company to us and how he manages. If he treats his people well - this is very important - as an example, if he goes through the factory and he sees somebody and he tell us, oh, thatâs a machine operator, thatâs a this and that, thatâs not very impressive, but some of these people go through the factory and they say--they stop at a machine and say, Charlie here, these are the Mendelsons, how is Anne, meaning his wife, family okay, everything good, Charlie, how long have you been working for, 22 years. This means an awful lot, Rob. We understand the relationship between the owner of the company and his workforce, his team members. That goes a long way and we understand how that all works, and thatâs the HEICO culture. The other thing is we give tremendous authority and responsibility to the operating person. We believe that the person running his organization knows more about his team members, his labor force, his customers, his manufacturers, everything else, than somebody in a corporate office a thousand or two thousand miles away. Again, itâs the authority that we give them, and people who are very talented respect the fact that we give them that authority. Talented people normally do not like somebody breathing down their neck and over-supervising them - what are you doing, what are you doing, so I think that has worked very well. Also, we have a very exceptional 401-K plan where we give employees, if they put in 6%, we match it normally with 5% in HEICO stock. Many, many of our working people - Iâm talking about factory workers, shipping clerks, secretarial help are millionaires, some multi-millionaires all as a result of the stock thatâs HEICOâs given them. They take a personal pride in being a HEICO team member. Itâs not as though, hey, Iâm working and I hate my job. They understand that they are being compensated and rewarded by having shares of HEICO stock given to them by the company, they didnât pay for it, so that brings their interest aligned with all shareholders. We think that most of our people are focused on building HEICO and being part of a team. Thereâs a psychological benefit to call somebody a team member as opposed to an employee. If youâre my employee, you work for me; if you are a team member, we all work together, so all of these things are what we call part of the HEICO culture, and I think a lot of that is responsible for our success. Yes, I mean, I think thatâs a good explanation of our acquisitions and our culture, but I think Rob, as I was thinking about this, I think itâs even more basic than that. Itâs that when we came to this company 33 years ago, we decided we wanted to build something for the long term, and it wasnât going to be built for years or a single decade, it was going to be built for multiple decades. Frankly, every single thing that weâve done and every decision that we take has been designed to drive sustained, long-term growth of the business as opposed to any short-term focus. When weâve got to make decisions on everything from inventory, capital expenditures, people, customer relationships, everything is focused on cash generation as a result of also maintaining low debt and being able to create a culture which drives long term performance. As a matter of fact, last night I was reviewing some of our capital expenditure plans and I saw some of our subsidiaries were buying equipment that, frankly, wasnât going to impact â23 or fiscal â24 earnings, but was going to impact it in â25, â26, â27 and after, and I realized that the results that we are showing today, which are frankly, I think, so far above whatâs normal for the industry, are as a result of that long term focus, and weâre really benefiting as a result of decisions that were made 10 years ago, 20 years ago, 30 years ago, that you canât make happen short term. People ask me all the time, why is it HEICO performs? If you look at over the length of the economic cycle, we donât have one-time write-offs, we donât do things that, if you will, goose the earnings in the short term, and I think our culture, which has been designed for a long-term approach, is very, very different than typical corporate culture or private equity, which obviously has--you know, which drives short term results as a result of their compensation structure and everything that theyâre set out to be. I really want to call out the people at HEICO because, frankly, the ones who get ahead and the ones who are in positions running our businesses today, are in positions of importance, are frankly the steady Eddies. Theyâre not the ones who came in and all of a sudden had a quick turnaround and a great success, a flash in the pan. Our people have worked hard year in, year out, most over decades, and itâs a result of that performance and that discipline and that rigor over decades which has driven the results that we have today. I just want to call out, frankly, all of our incredible people, our steady Eddies who just continue to work hard year after year and really make this happen. I think thatâs really what makes us unique. Great, good morning. Thanks guys. Larry, I can totally appreciate on the guidance. You guys have a long successful history, donât necessarily need to provide [indiscernible] guidance anyhow, so, but I do appreciate the sort of qualitative outlook. Just maybe a couple questions for Eric and Victor. Eric, obviously it feels like your aftermarket is strong, parts are strong Iâm sure, specialty I think also had a good quarter this quarter, but Iâm just trying to figure out, you had a little bit of an above-average margin year this year. Some of those drivers, has that sort of settled back into more of a historical range as we look out to the coming year? Hey Larry, this is Carlos. Let me jump in there. I think what weâre seeing in the flight support group, and itâs been amplified, letâs say starting in Q2 and running through the end of the year, is some disproportionate growth in specialty products, which has change the mix a little bit in FSG for the back half of this year, which normally isnât the case. Normally, all aspects of the flight support group grow in tandem, and usually our story is a margin thatâs based off volume growth. I think what we continue to see is our parts and specialty products outperforming some of the businesses within the flight support group, which has--because of mix has had an impact on--pulling the margin up a little bit. Weâre happy to see that. As Eric mentioned earlier, itâs a 22.5% margin for the quarter, all-time record. Weâre very happy to see that, but I think once the mix settles back into its footprint, once we get completely out of COVID, weâll see that margin moderate a little bit, would be my expectation. And Larry, also just to add, I think we did--you know, we have seen market share increases and, frankly, tremendous efficiency as a result of the effort of our people, but I also want to add that the margin that we have was--you know, we were still able to drive that margin, even having proper reserves, paying people frankly generous bonuses, and we did everything for the long term and still came out with those margins. We made all of our investments and did everything the right way, and I just couldnât be more pleased with those margins. Absolutely, and from a high level, Eric, obviously, it feels like commercial aviation seems to be in a good place right now. The economy may be slowing a little bit, or for sure itâs slowing. I just assume it feels like youâre going to have a good growth year again, but obviously you canât continue to grow like you did the last couple years, but just any color on how you feel that the industry is today? Yes, I feel very, very good about HEICOâs position in the industry. Thereâs no question that a rising tide lifts all boats, but I think that HEICO is in, frankly, a unique position because weâve positioned ourselves in our various businesses and Iâve seen in all of those businesses substantial margin increase, as well as market share increase. Weâre doing really well. I mean, as a matter of fact, and normally I wouldnât call it out but just so youâre getting to this, whatâs interesting is that our PMA sales are at an all-time record, and if you look, flights across the world are still down whatever - 20%, and we still havenât seen full recovery in Asia and somewhat in Europe and Middle East and South America, and even in the U.S. to a lesser extent, North America. But HEICO PMA sales are at an all-time record, so I think that weâve got plenty of power behind us and I think thatâs as a result of picking up market share and, frankly, treating the customers right. They know that weâve treated them right for 30 years and we donât take advantage of them, and weâre very fair, weâre very reasonable, and theyâve rewarded us with that market share. It wasnât stuff that we did short term that made it happen, it was stuff that we did long term and they trust us. I think weâre really very much in a virtuous cycle which is permitting this. Absolutely, great. Then if I can maybe just switch gears real quick, one more quickie for Victor - I know youâve been quiet back there. Just quickly, obviously it sounds like your largest market, defense, the macro is very favorable and maybe this year was impacted by some worse supply chain issues than anything else. How about some of your other larger markets - space, medical? It feels like the outlook there, [indiscernible] industrial, all consistently good. Is that sort of a fair assessment? Yes, I mean, good questions Larry. Those other markets have been very strong for us this year, and in fact I think really toward the end of last year as well. Theyâve really been star performers, all the ones you mentioned - medical, high-end electronics in particular, space a little--commercial space a little--you know, certainly less so and actually a little softer in some instances. I would expect, by the way, going forward, youâve heard me say this before that at some point, we see those other markets flatten out somewhat, and--still I think excellent markets for us, but I would expect them to flatten out or even soften up a little bit as the year wears on and as supply chains get worked out and customers deal with their own channels. I guess Victor, maybe just to continue that discussion a little bit, it looks like we might get sort of high single digit budget growth this year in the base DoD budgets, and a lot of Ukraine-related spending as well. Can you give us some puts and takes in terms of, you know, if we look at that budget growth but also consider--you know, youâve talked about the supply chain issues and some people talk about defense contracting officer kind of delays, whatâs the right way to think about all those puts and takes and the expectation I think we would all have, that you could at least grow at least in line with DoD budget growth, at least averaging it over time? Yes, I certainly think over time we should exceed DoD budget growth, just knowing our businesses and what weâre working on and the things that we do. But of course, in any given period, we may be tied to the defense budget directly or it could be negative, right--our correlation would be a negative one to the defense budget. I would think that youâre absolutely right on some of the procurement specialists at the DoD being, letâs say, overwhelmed in their workloads and dealing with work-from-home conditions and things like that, which have definitely in our view delayed deferred items from getting put under contract. The supply chain issues, I think have been bigger for us, and I think they were kind of record level for us in the fourth quarter. I was hoping that they would come off in the fourth quarter, maybe weâre starting to see a little bit--seeing some green shoots in the supply chain, but I think itâs too early to call victory there. Then of course, you mentioned the foreign engagements, which I think benefit us. I donât think that they are going to cause--you know, be major needle movers necessarily in the next quarter or two. I think actually if you look at what we make and how those things are getting inserted over there, I think theyâre a little longer burn in terms of just the order cycle and production cycle, but I think as we said in the comments that the dynamic is positive for us. Okay, appreciate it. Maybe last one from me, for Carlos maybe. Carlos, I think this year was a year of building some safety stocks, and if we expect revenue up next year, how do you think working capital trends--does the safety stock issue kind of reverse itself or do we continue to build because of these supply chain issues and higher growth? Just was wondering if you could provide some color there. Thanks guys. Sure, so we invested--I mean, HEICO, we invested in inventory this year. If you look at our balance sheet, youâll notice that we have a pretty big investment in working capital, particularly for inventory, so I suspect that, as youâre pointing out, a lot of companies around the world have done that also. The impact to us going into next year, I donât think there is a ton of impact on the flight support side because most of the business that we do in the flight support group is ordered and shipped in the same month, thereâs not a ton of backlog. Within our defense business on specialty products, thereâs backlog, but most of the aftermarket is really built and shipped in the same month, which implies that most of our customers arenât stocking our product. We have a model with our customers where the parts come when they need it, and they donât have to stock our stuff if they donât want to; in fact, if they do want that, we usually put consignment cages in their buildings and we handle all that for them, so not too much on the flight support side. In ETG, I do think that it has been in vogue, particularly with electronic parts, to go heavy on inventory - weâve done that, and yes, I think in â23, could there be some sort of inflection where people hit the pause button? Thatâs possible I think for our businesses, because weâre not stuffing channels and over-supplying our customers, I donât believe itâs going to be a major impact to HEICO, but I think globally thereâs something out there that weâll reckon with probably in â23 or early â24. Hey Victor, last quarter you kind of quantified the supply chain push-out - I think it was around $25 million of sales. You just mentioned it was kind of at record levels, so exceeding that number, or maybe if you could just give us a little--if you can quantify it, thatâd be helpful. Yes, sure. We estimate that in the fourth quarter, that number actually rose by a little more than $20 million to around $47 million. Now, I wonât identify which subsidiary. About half of it actually came in one subsidiary, and so--which had not been experiencing, actually had avoided the supply chain issues for quite a long time. Theyâre estimating they will ship that in fiscal â23. In some ways, there was some improvement over the prior period because a number of other companies saw their numbers shrink, but we had one in particular that was high and then a couple of others that were on the higher side, too, whereas in the past itâd been a little more broadly distributed. Okay, thatâs helpful. Then Carlos, maybe you could just talk to us a little bit about tax rate expectations when weâre thinking about fiscal â23. I think for HEICO, we typically run 20%, 21%, sometimes better than that. This year, our tax rate was amplified for pretty much most of the year except Q1 due to losses in the market, and as Larry mentioned earlier in the call, we have investments in life insurance policies which back whatâs called our leadership compensation plan, which is a deferred comp plan for our employees, our team members. When the losses on cash surrender value occur, which is impacted by general market trends, we donât recognize a loss on the P&L but what we do recognize is either gains or losses in our tax rate, as a result movement in those permanently deferred items, and so that can have a material impact on our tax rate. This year, it had about a $25 million impact on our tax rate and so that is not insignificant. That is the driver of what could move our rate off that 20% bogey that I would normally target, so if the markets grow, our tax rate will be a little lower. If the markets stay stable, youâll see our tax rate similar to what we had this year, and if we have big losses next year in the market overall, it could amplify our tax rate a point or two. Okay, thatâs super helpful. Just lastly from me, Eric, you mentioned youâve got record levels of PMA, but we still have a lot of traffic down in Asia. I was just wondering how you quantify when we see--you know, if China reopens fully, what the impact could be on FSG. I know youâre kind of already a global player in terms of your customer base. Yes, I mean, weâre already doing very well in China, and if China presumably--I mean, my expectation, speaking with various experts, is that China is going to experience hundreds of millions of cases of COVID. Whether they get reported or not is another thing. That should have a chilling effect on their domestic travel. The real question is whether that spreads. Based on the vaccination rates and therapeutics that are available around the world and our natural immunities as a result of everybody else getting infected, hopefully it doesnât impact the rest of the world, but I think China, weâre going to see fits and starts. The air travel went up a lot a couple days ago and now itâs come down. Theyâre going to be in for a tough 12 months, I think, as a result of where they are with the virus. But we feel very strongly, and thatâs why weâre wired to continue to take market share, and I think weâre in a very strong position to do well regardless of how China does, but we are doing very well in China currently. Victor, just following up on Peteâs question, could you talk a bit more about supply chain trends at ETG? I know you mentioned that some things have gotten worse this quarter, but you also talked about seeing some green shoots, so maybe just spend a minute talking about some of the details behind that, so what got worse and what the green shoots have been. Thank you. This is Victor. The answer is itâs particularly on the components side. I mean, weâre finding and a lot of our companies have been finding that FPGAs, for example - field programmable gate arrays are slow to come in, theyâre behind in delivery schedules. We have some other very complex microwave components that are designed specifically for some of the products we make, and there are only a few vendors for those in the world and they are well behind schedule. Weâve also seen some lead times pull out--push out for, I wonât go into which subsidiaries, but some polymer-related products that are used in some of the things that we make, so that has been--I guess thatâs been where itâs extended out. Where itâs been better has been on some of the lower cost and more common electronic components that are used in circuit boards and other things that we make, as well as for some silicones and products, interestingly enough some polymer-related products, so itâs kind of a mixed bag. Okay, thatâs super helpful, thank you. Carlos, is 1.5% of sales still the right way to think about capex for next year? I think so. Weâre probably targeting somewhere around $40 million next year in capex roughly, so thatâs about what your math should produce. Okay, and then last question for you, just as we incorporate Exxelia into the models, anything important to reflect on in terms of cadence there? Is there seasonality to that business, more Q4-weighted, anything like that that we should be mindful of? Thank you. Sure. I mean, look - Exxelia, Iâve often said that it almost mirrors--itâs like a mini ETG. Itâs got very similar business strategy and markets, so I think as the electronic technology group flexes throughout the year, I think youâll see Exxelia perform the same way. The only caveat to that is they are a European-based company, so there can be external factors in Europe that would impact them that wouldnât impact us here in the States, but those macro things we canât control, so that will be well known as you read the paper. But no, I donât think thereâs any--thereâs nothing on the table that would cause that business to perform much differently than the overall ETG. Maybe Eric, I wanted to start off--I wanted to see within FSG, if youâre seeing anything yet that may lead you to believe that there is some potential slowdown or recession risk amongst your airline customers. Iâm curious if youâre seeing anything yet in terms of delayed maintenance spending, downward revisions on work scopes, inventory adjustments, anything like that, and if you think about a potential recession risk, for instance here in the United States, how would that flow through your business? Which parts would be initially hit, and how should we think about the impact or potential impact of that on the segment? Yes, good question Ken. To start out, no, we have not seen any change in order patterns from our customers as a result of the most recent economic data. Things are continuing to be extremely strong, and as a matter of fact, we just keep on hitting new highs. However, we all know that if a recession comes and air travel is curtailed, there will ultimately be an impact. Now, I think the impact on air travel could be a little less perhaps than itâs been in other periods, only because we were sort of starved for air travel for about two years, so that may mitigate a little bit of it. But certainly, the industry will be impacted, and clearly you could see it in cargo load factors and dedicated cargo aircraft flying, that those would definitely be curtailed. But I would anticipate that as far as HEICO goes, weâre in a unique position, I believe because of the products that weâve developed. Although I donât want to cite on this call what they are, I can tell you that a large part of our rebound has been new products that, frankly, hadnât been sold pre-COVID, and a large part of that is new products that we didnât even offer pre-COVID. I think that weâre in a unique position to be able to mitigate that, and that is why our PMA results are at a record whereas the industry is--you know, the number of flights is still down 20%, so that would imply upside to us. I think one of the things, though, that you also have to consider is--and historically youâve asked the question about destocking and restocking and all that, thereâs no question it would be normal behavior in a time of shortage to over-buy, and I think that all recoveries do hit a period of over-buying, the question is when that occurs. Nobody tells you, hey, Iâve ordered 100 parts but I really only need 80 of them right now, and the extra 20 are for the shelf, because they want to get those 20 on the shelf because theyâre afraid they canât get them. I think thatâs a natural risk for the industry, but I think HEICOâs got the ability to mitigate. Clearly parts and repair would be impacted first and then ultimately new aircraft build rates would be impacted second, if that answers your question. Just as a follow-up, maybe for Eric or for Carlos, the incremental margins in the fourth quarter of â22 were sequentially the strongest weâve seen all this year within the FSG segment - you know, mid 40s. How should we think about--it sounded like maybe some moderation on margins from mix in â23 could potentially be a scenario, but how should we think about incremental margins as we think about â23, based on the comments you just had and what youâre seeing today? Hey Ken, I would--you know, in a normal run for HEICO, as Iâve talked about in the past, you should expect the fixed cost at around 15% plus our normal margin, so that would put us around 35% or 36%. That would be a normal run on growth. That can vacillate depending on events in a quarter and whatâs happening, but once we settle into our footprint, once all the businesses have kind of settled down and theyâre growing in tandem again, I think that thatâs what you should expect. Hopefully as we get into â23, that will be what I would expect to see. Good morning, guys, thank you for the time. I wanted to start off, I think it was Peterâs question, Eric, that question to you on FSG and your thoughts on the recovery in China. You said you were doing really well in China. How much of your FSG business has recovered in China, and of your 35% of sales of international, how do we think about that split between FSG and ETG, and geographically? Yes, good questions. Our sales into China in the flight support group are at an all-time record. Weâre frankly well ahead of our 2019 numbers, so weâre doing very well there. I think there is obviously upside from here. I remember--I think it was about a year ago or so, and you asked me did I think by the end of â22, narrow body in the U.S., would it be recovered, and I said I didnât know and I thought it would be hard. But in fact, not only did narrow body U.S. recover but, frankly, the whole world overall recovered for us. I think weâre in a very good position in all of our markets. Itâs hard to say exactly whatâs going to happen, to sort of lay out the next 12 months over in China. I think itâs going to be fits and starts. I like reading your weekly report on number of flights, and thatâs got a lot of great data in it, but I think weâre well positioned there to grow our market share and weâre gaining market share all the time in China. In terms of--Victor, youâve been very busy yourself, and I know people have skirted around margins at ETG a little bit, but they were very strong to end the year. How do we think about that going forward, and I think Exxelia is 150 basis points dilutive to 2023 margins, how do we think about that long term opportunity? Well, a couple things. Exxelia does carry a lower margin than the ETG average. We havenât said what that is, so I canât comment on what it might be, but without Exxelia, excluding Exxelia when I look at--and I think youâve heard me say this before, that I think weâre within a couple of points on what I call the real operating margin, right, which is--you can sort of think of as a cash flow margin before intangibles amortization but after depreciation. I think that somewhere within a point or two of 30%, either up or down on that, is the right level - I think Iâve been pretty consistent on it, and Exxelia of course will change that somewhat. I continue to believe thatâs the case. There are always headwinds and tailwinds, and as youâve heard me say before, I donât really come down with a club on people, the people running our businesses, if theyâre giving us a 31% margin instead of 32% or a 28% instead of 30%, or a 29%, et cetera. I look at it on a gross basis, an overall basis, so I think our margins should remain healthy and weâll continue to be pretty proud of them. I guess Carlos, maybe to dig in, I know youâre not giving the detailed guidance, but you do have that one liner in the press release where you called out potentially higher material and labor costs, so how should we think about that into â23? Obviously, we already covered the FSG margins, they may normalize. It sounds like ETG - you know, pre-Exxelia could pick up. Then I guess just on the revenue side as well, do we expect the normal FSG seasonality, or are we still in the recovery mode here from COVID? I think the way to answer that question is we arenât giving guidance, but we do expect the company to perform, letâs say better than the industry, just like our history has been. We do expect growth in our sales. I think the stated goal of the company every year when we come out of the box is to grow the bottom line 15% to 20%, and that will be our management teamâs goal for the year. Weâve done it pretty consistently for 33 years, and you can see this year we grew 16% on the bottom line, so I think you could reverse engineer it. If youâre thinking about how to get the pieces of that pie, just reverse engineer up from that 15% to 20% bottom line expectation and come up with your numbers, but weâre not going to give detailed guidance at this time. Thatâs fair. The only other one I had, it kind of relates to guidance, but if we look at ETG, should we expect a pick-up of that $47 million - I mean, that would give you almost five points of growth there, and then think about just kind of a normal potential organic recovery, supply chain easing, because it seems like youâre going to have--youâre going to be off to a good start in ETG if you pick up the lost sales from â22 here. Well, we donât know, Michael, when the disruptions from the supply chain fully bleed out, right, so we could have more pushes. But what I will say is that we did have a down year in defense which was in total greater than that $47 million youâre referring to, so I think what our expectations are is that as we get into â23, we do expect the overall defense market to improve, at least as it relates to HEICO, and that should be a nice little tailwind for ETG going into â23. Just as demand grows for HEICOâs PMAs, and I think youâre developing around 400 parts per year, one, what is the duration of the PMA approval process with the FAA look like at this point? Is it getting better? I know youâve talked a little bit about the work-from-home dynamic. But then two, how are you looking at the PMA opportunity set? Are you looking to move up the value chain at all? Hi Josh, this is Eric. With regard to the FAA, our cycle time is great, itâs outstanding, so that doesnât hold us up at all. With regard to the value set, we continue to go after parts similar to what weâve done in the past, as well as what Iâll call adjacent white spaces, so we continue to really grow the product portfolio. Weâve got the largest portfolio in the industry by far, and weâre very well diversified across a very, very wide group, so I think weâre going to continue to grow. Our customers are asking us to go into more spaces, so weâre continuing to do that. You know, weâve treated them very well over the decades and weâve been very reasonable with regards to pricing, and they greatly appreciate that, so theyâve been encouraging us and rewarding us with, frankly, much more business, so I think weâre in a unique position there to continue to grow market share. Got it. And then maybe just moving over to the space exposure, thereâs been a number of M&A transactions in the market on new programs evolving. How are you looking at the space market and that balance between legacy programs versus gaining some exposure to these growth programs that are ramping up in areas like LEO and the lunar markets? Thanks, this is Victor. Weâre looking at that very carefully, as always. There is opportunity in the LEO market for us. Weâve been doing business in the LEO market very strongly and successfully for a long time, and of course we still think thereâs some good opportunity in the GEO market and even smaller satellites now in the GEO market. But we are very careful to avoid some of the more experimental, if you will, parts of the satellite business where we would be more of a financial risk partner, where weâre concerned about margins, pricing, stability, reliability and so on. We havenât taken the bait to go out and buy -- I canât count the number of exciting space companies that we hear about, we get a deal book or a teaser on, and itâs just, pun intended, straight to the moon. Weâve really been resistant to those opportunities because we also know that theyâre highly speculative, so weâre going to proceed but proceed carefully. We want to be of very good value to our customers and the ones we have been serving historically, as well as a number of the new ones who we think are serious about buying our products long term. Sorry, I joined a little late, so I was wondering at ETG, did you guys describe the changes in the estimated fair value of accrued contingent consideration? I was just curious like how big that was and what that related to? Sure. This is Carlos. We use contingent earn-outs to bridge deal value gaps when weâre dealing with sellers. Right now, on the balance sheet, we have roughly $85 million in contingent earn-out obligations, fair value of $85 million. What winds up happening, Gautam, is a couple things: one, you have to evaluate performance of each of the units and re-compute, if you would, what that earn-out may be. But what really impacted us this fiscal year, fourth quarter end throughout the year, was the interest rates going up, because you have to fair value those liabilities, and as the rates go up, those liabilities shrink, right, so we did have some noise throughout the year for these earn-outs. In particular, we had maybe $2 million or something run through the numbers for the fourth quarter as credits to expense to reduce that liability as a result of the Fedâs moving the interest rate, and ultimately what that does to longer term or intermediate term risk-free rates. I was curious, you know, a couple quarters ago I think specialized products started to come back within flight support, and if you could just talk a little bit about how thatâs trending and if thereâs any discernible difference on the defense piece of that, versus the defense piece of ETG in terms of supply chain or just demand trends. This is Eric. With regard to specialty products, weâre doing very well. In particular, we also have a lot of exposure to, frankly, to missile defense, and weâre doing particularly well in that area, but as well as commercial aviation. Again, weâve got a unique value proposition in those businesses and I think theyâre going to continue to grow and gain market share over time, especially as the aircraft--the commercial aircraft build rates increase. Okay, and just one last one for me, maybe Victor on ETG, broadly speaking what is your visibility on the defense and space side? Iâm just curious, like how far out do you have orders through, and how has that changed maybe over the last year? Sure. Right now, the backlog for ETG is fairly typical. Itâs a record backlog, by the way, and weâve had record backlog throughout the year, in fact I was looking at every month through the year with the exception of one, we had record backlog, so as a percent of revenue, it seems to be very strong. We have some additional visibility into future shipments, in part because of those supply chain issues, right - thatâs a little bit of it, although that is a pretty small fraction, actually, overall, the slippage of our backlog. And in terms of defense outlook, I would generally say we are not short lead time on our products, and so itâs at least kind of a good flavor for the next six months at any given moment, typically, and then sort of it starts to deteriorate from there, which is our typical situation. I would say weâre probably in a fairly typical situation now. Larry, I think you havenât had the opportunity, so I guess letâs get your take on the M&A marketplace right now. Iâve kind of heard some mixed things recently. Obviously, you guys have been busy this past year, but what are you seeing out there right now? I think I would say itâs normal. Weâre spending a lot of time trying to work with the Exxelia closing, but we are looking for--at a number of acquisitions in both areas, in ETG and in-flight support. The market is a little strange now because sellers want high prices that they saw with low interest rates, and buyers, particularly private equity, is having more of a struggle raising money, so I think I would expect to see prices coming down as long as interest rates are up. We are very disciplined buyers, as you know, and I think--Iâm hopeful that we will see some good opportunities. Weâre looking at many now. Some of the things that weâre rejected, honestly, recently weâve seen some companies and they were overpriced, well overpriced, and we made offers and those offers were not accepted, but the deals didnât go either, so the people didnât sell the company. We have to see whatâs going to happen. Weâre not going to change our discipline, and as you know, we look for strong cash flow and we want to see our money back, our investment in somewhere between 7 to 11 years, and when you pay 16 times EBITDA, you canât do it, so weâre not playing in that market - we never did, we never will. I think overall Iâm optimistic that we will make our fair share of investments. This past year, we concluded how many, Carlos - six? Eight deals, you know, so thatâs enough in a year, eight transactions. Deals, we are opportunistic, we donât force deals. When deals are priced properly, when we have the right type of company, thatâs what we will move on it. I hope that answers your question. No, thatâs great color, thank you. Carlos, maybe just one, I understand no guidance, but what is the acquired sales growth based on deals that closed so far look like for FY23? Is it $150 million, or whereabouts? Yes, I think it will be between 100 and 150. I know thatâs a wide range, but thatâs about what itâs going to look like. Hi, good morning. Thank you very much for the question and the time. I had a couple, maybe Iâll just throw them out in the table all at once here. Carlos, wondered if you could just speak briefly to--just comment on wage pressure and inflation, what youâre feeling now and what youâre hearing from the subsidiaries particularly as you roll forward into 2023, and also talk about the capex, a little muted actually from what I may have expected this past year. You mentioned the step-up as we look forward 12 months. Can you just talk a little bit more about where that money is going? Then maybe for Eric, you addressed the how in terms of margin expansion with FSG. You talked about specialty strength. Can you talk a little bit about the why - you know, not in tandem demand in terms of the different components moving together, but why are customers in particular kind of pulling through specialty here? Then maybe Iâll pause there, and Iâve got one or two follow-ups for Larry, thanks. On the wage and labor front, weâre highly sensitive to that. We watch it very closely. Because we are spread out, really, all over the country and all over the world, there are different dynamics in each market. The best way that we have found to deal with those dynamics is to allow our folks in the field, the general managers running our businesses to deal with their local marketplace, to deal with the wage pressures and material pressures on the raw material side. Weâve also told them that as it relates to pricing, to try to work with our customers to protect our margins. Our objective is to not be those guys - you know, we donât want to be the guys that are known as jacking prices indiscriminately. We want to get paid fairly for what we do, and of course if our input costs do go up, we are asking our customers to help us out in that regard to protect our margins and so far, knock on wood, that strategy has worked very well for us. On the capex side, I did discuss around a $40 million number for next year. This year was a little light in aggregate dollars. It wasnât because we didnât buy what we needed. I feel like itâs a broken record, but itâs because our folks are frugal, and if they need a million dollar brand-new machine, our guys will put that in as a capex request and then theyâll go out and spend $80,000 on a used piece of equipment, drop another $10,000 into it to refurbish it and use that machine for the next decade. Thatâs generally what Iâm dealing with. Our capex budgets, while Iâd give you that $40 million number for next year, not including Exxelia by the way, thatâs just our core businesses of today, there is a high probability, like in the past, that we under-spend that, but it will not be because our folks didnât get exactly what they need to conduct business and plan for the future. And Colin, you asked why - you know, why we have these results in terms of the sales and the earnings, and I really do believe it starts with our low debt decentralized culture. That permits us to make decisions well in advance and always keep our eye on the long term. When you do that, people are then able to spend their energy on creating true economic value. When you look at the crisis that we just went through, we had plenty of inventory, we continued to develop parts, we continued to treat our customers extremely well as a result of that and, frankly, treat our team members very well because they were critical to our business. I think that is the reason why HEICO continues to outperform, and itâs not just in parts and repair but itâs also in the specialty products business. There are all sorts of cases that I can give you where we can significantly jack price on customers and we donât do it. We donât do it because we want to make sure that we retain that business for the long haul. In the short term, people can play all sorts of games with regard to pricing, inventory, all sorts of metrics that you see in the short term; but in the long term, you canât get away with that, and if we want to build this market share like weâre doing, the only way to do it is to build the long term and to really have that level of trust, and frankly thatâs how we incentivize our people. Victor and I each have a whole bunch of businesses that we go and we visit, we know the people not only running them but we know the people in charge of the different departments, all the way down very often to people on the shop floor. We understand who has a long-term culture and who fits with the way we do things and who just plays games, so thatâs honestly the why in why this happens. This management team has been here for 33 years - I canât think of many management teams, and I certainly canât think of any off the tip of my tongue, that have been there for 33 years and plan on being there decades longer, so. Maybe just a quick follow-up for you, Eric there, just in terms of maybe digging into the why. The role of value-added distribution, I mean, youâve got smaller private peers that have made distribution in particular central to their business strategy, and you guys yourselves did several quarters ago a string of deals which added--bolstered your muscle, as it were, in this particular area. Typically, youâve got some quasi-exclusive relationships that go along with those types of segments and businesses, and Iâm trying to link back to your comments on todayâs call on wallet share expansion, and Iâm wondering what, if any, critical role value-added distribution in the deals youâve done in prior quarters are playing today with the wallet share gains that weâre now seeing from you guys, versus other factors like the price umbrella with OEMs, et cetera. Maybe to round out, a final question for Larry, is just Exxelia has a--you know, great deal here, largest ever, has the potential to be a buy-and-build on that continent for you all. Can you just speak to your--the relative maturity of your deal flow model on that continent, meaning are you satisfied with the width of your M&A funnel there? Is it as wide and mature as we perceive the U.S. and North American M&A funnel to be for you all? Thank you very much. Colin, this is Eric. Iâll take the first part of your question that you asked me - you know, the why on the distribution. Our distribution companies are, in my opinion, the single most successful distribution companies in the industry. They started out as small entrepreneurial companies and they continue to run that way. Theyâve got the financial muscle of HEICO behind them so weâre able to buy inventory that makes sense, but we also are very, very realistic on the value of the inventory and the value that we bring to the table. You know, you mentioned other companies that are getting into this space and itâs becoming an interesting space for others, and I would throw out that youâve got to be very, very careful in the distribution business because what we see very often, and if you look into a number of companies, youâll understand what Iâm saying, is they have big one-time write-offs. They report whatever it is their margin is throughout the economic cycle and then they wait until there is a 9/11, a global financial crisis, a COVID in order to write off the inventory. If you look at HEICO, thereâs not a single time that weâve done that, and the reason is because all of the people in those businesses are geared to make the correct economic decisions to drive cash flow and long term value and not create short term earnings. We start with, number one, low debt which permits us to hold the correct inventory, not the wrong inventory; and number two, we are incredibly rigorous, and Iâm not aware of anybody else in t his industry that is as rigorous as HEICO when it comes to inventory. We make sure that if weâve got a problem, we take it off the books and we donât spend management time or peopleâs time focusing on that. The final thing that weâve got in the distribution business, which frankly differentiates us and permits us to do things that nobody else can do, is our PMA reach. Weâre the largest in PMA, weâre in at all the airlines, and we have a very, very broad group of products, so if somebody, for example, is distributing a widget on a 737 but theyâre not on the A320, HEICO is in a unique position to be able to get them in that market. There is nobody else in this industry who can do that, so when you combine all the things that I said - the low leverage, the correct inventory, and the PMA combined with an entrepreneurial approach that is second to none, and these folks are into the details unlike anything that youâve ever seen, and so I think itâs a remarkable business and I want to call it out, because HEICO distribution and our companies in there, in particular led by Seal Dynamics, Blue Aerospace, Air Cost Control are really just absolutely phenomenal and unbeatable in the stuff that they do. Okay, so you asked me about our reach in Europe. Weâre an opportunistic buyer. We have reach throughout the U.S., we have reach in Europe. We have a number of operations, very successful operations in France and weâve been operating in France for a number of years. When we started, we put our toe in the water and we were very successful, and our companies in France have expanded multiple times. Weâve increased employment, and actually the economic development people in France visit us often throughout the year and they want us to invest in France. They like what theyâve seen and they like how weâve performed. Weâre a big taxpayer over there and weâre a big employer, so yes, we have reach. The Exxelia transaction, we had been looking at that, we knew that company for four or five years. We looked at it, discussed it, and so forth. Yes, we do have reach in Europe, and when we see a good opportunity there, we will take it; but itâs not just Europe, itâs Europe, the U.S., the U.K. too. You know, guys, the attractiveness of the PMA market is clear. You guys have made that industry very lucrative. Now weâre seeing another company expand PMA into the hot section of the jet engine, like high pressure turbine blades. How do you think of that market - is that ripe for PMA to enter, and would you consider going into that part of the aircraft? Hey Kristine, this is Eric. You know, weâre very familiar with everybody in the PMA market, and I know exactly what youâre speaking about. That has been a market that HEICO has decided to not enter and to not participate in. It is a potential high reward but it is also a potential very high-risk market as well, and weâre very happy in the spaces in which we operate and we think that that really makes a lot of sense from certification, manufacturing, customer acceptance, so weâve decided really to focus in this market and weâre very happy with that decision. We get along with all of the companies that provide complementary products and we hope that they succeed, but it just--you know, weâve picked our spots, I would say, very carefully. Thanks Eric. If that company were to be successful and actually get these parts certified, would that change how you evaluate that industry? Kristine, can I just add a little color on how we look at the world and what our strategy is? Our strategy, as I think you know, is controlled growth. We focus on 15, 20% bottom line growth. We donât want to hit home runs. We want to control our cash flow, which is very strong, and everything we do is really focused on cash flow, not so much earnings per share. As long as we get strong cash flow from our businesses, including PMA, that is what weâre looking for. We donât have to have one spectacular thing in the hot section or that type of thing, but we want a broad offering of parts, highly diversified, and the company HEICO in general is very highly diversified. I donât know how many parts we make altogether, but Iâm going to guess itâs going to be at 50,000, 100,000--I mean, and itâs highly diversified and thatâs intentional. We donât want to get into one particular product that stands out; in other words, if any one product that we make failed to sell or was discontinued, nobody would even notice it. It wouldnât affect the bottom line at all, and thatâs our strategy. That goes to the idea of making these hot section parts and so, but remember we do have some hot section parts. We used to make blades and so forth, and we have of course combustors, but we want to spread it across a wide number of parts and we donât have to have one spectacular part to accomplish our objectives. Dad, Iâm glad you mentioned that. One of the other things thatâs very, very important to us is, as you can gather from our comments on the call and knowing us for so many years, is our reputation. We donât want to--you know, when you offer lots of parts, you better be very, very careful that the performance of one part doesnât impact the rest of the portfolio. We have a unique relationship with our customers, I believe with the FAA, and even our competitors, and therefore weâve made the decisions that weâve made which are right for HEICO and right for our risk profile and for the benefits that we want to bring to our customers. Iâm one of the minorities, thank you. A question for Victor. According to ETG, when you have sort of marginal sales increase and a 1% decrease in margin, are there parts of the company that maybe you should de-emphasize or spin off and that maybe at the end of the day really wasnât worth your investment and your time? Itâs a very good question and itâs something that our subsidiaries look at all the time, which is to say the appropriateness of making a part or not making a part, and there are a lot of decisions that go into that. Itâs not always purely economic, although the economics obviously are the overwhelming majority of it. There are times when thereâs a part that we will make or thereâs something weâll make because weâre selling something related to that. What we donât do is get into loss making or low margin positions, but if something is lower than the rest of the margin and we feel, or the business feels they need to continue to offer it or itâs still very profitable, i.e., if maybe a contribution margin of 35% and the business is running at 36%, so you wouldnât turn away 35% business because itâs not 36%. You wouldnât make in a sense phenomenal the enemy of excellence, so thatâs how we do it. Itâs a good question, and thatâs a part of the business all the time. Iâd like to add one other thing. If weâre running an operating margin of 28%, 30% in ETG, and we discover a company that has a 24% operating margin, weâll buy that company and it will lower the overall operating margin of the ETG group. Why would we buy it? Because a 24% or 25% operating margin is a hell of a good margin, and we want that company, so you canât--we donât get that focused on absolute margin because there are reasons that we might have reduced margin, increased margin, and we have to be very careful. Weâre talking, if you heard me earlier, about overall cash profitability, cash flow, and at 24%, even though itâs not our 30%, we get a hell of a good cash flow, so. You have to take all that--when you think about margin, you have to understand cash flow is more important than margin, but high margin brings cash flow. Okay, thatâs perfect. But at the same time, are there times that you really look at an acquisition and say, maybe we made a mistake? Over the dozen years Iâve been with you, youâve always bought-bought-bought, and I can probably count the two or three companies that Iâve read that youâve spun off. Yes, so we buy to own forever, we try to make the right decisions. Weâve never had any disasters, blowouts in acquisitions. Weâve had ones that donât perform as well as others for some period of time and then our jobs are to improve those, and they do eventually - we get them to where they want to be. We do ask ourselves this question, Mike, all the time - are we better off with an acquisition than without it? We do that, we look back, we analyze it historically, and we view is as our jobs to make sure that what we buy performs, even if itâs not as good of a performance as something else. By the way, you mentioned that we spin off companies. We have only sold two companies in the entire 30-some years that weâve run the business. One was a medical company which we wanted to be out of that industry - it was profitable-- It was a services business, it was highly related to labor and so forth, and we sold that business, I believe in 1996, or â95-- The other one was a business that, honestly, we bought for $7 million and we sold it for something like $72 million in about, how many years, Victor? About four years, and the reason we sold it is that the operating margin was low. It was an interesting business, we sold it to a company that liked that--wanted to be in that business and wasnât focused on operating margin. That business had about a 10% operating margin and it was sucking up cash, it was using so much cash that it didnât make sense to own the business. But we paid 7 and we sold it for 72, so it wasnât a bad day. Aside from that, we have not sold any or eliminated any other businesses, and as Victor pointed out, thank God weâve never had a bust. Some businesses have performed better, some have been not so good, but if you take the overall package, again weâre talking about diversification at HEICO, which is a critical strategy for us, putting all those businesses together, as you see, they generated fabulous cash flow and I think that our acquisition performance has been pretty good - you know, close to 100 acquisitions, not having a bust. I think weâve done pretty well. Mike, Iâve got a note from the Operator, weâve actually gone over time, but Iâll just--I will comment, we have not sold a business in 22 years, so that part I can tell you. But unfortunately, Iâm getting this note from the Operator that we are over our time by five minutes now, but thank you for the questions. This is Larry Mendelson. I want to thank you all for participating in this call and for your interest in HEICO. We remain available to you if you want to call Eric, Victor, myself, Carlos if you have any questions or you want clarification on anything. Otherwise, I want to wish everybody a happy holiday season, a healthy one. If youâre driving or traveling, be safe, and we look forward to speaking to you sometime in mid to late February with our first quarter â23 results.
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EarningCall_1697
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All right. Welcome, everybody. Thank you for being here with us in person and on the webcast. Weâre very excited to have 3M with us. With me on the stage is Mike Roman, Chairman and CEO. And before we head into the fireside, I think Mike had a couple of opening remarks. Yes thanks John and thanks for hosting this. A pleasure to be here. Yes, Iâd thought I start with you were still facing as everyone is aware a pretty fluid situation, a lot of uncertainty. We are seeing our industrial businesses and markets performing okay. Iâll touch a little more in detail on that. Our consumer facing businesses are seeing incremental weakness in their markets and Iâll touch more on that. And a good examples are consumer electronics where youâve seen softness in end market demand, retail, the big box retailers continue to focus on inventory and weâre seeing incremental softness in the retail side of it. Weâre also seeing some softness in elective procedures in healthcare. We talked about getting back to 90% to 95% of 2019. By the end of the year, we're probably looking at lower part of that range as we go through Q4. So that said, two months in, I would say we're still confirming the implied guidance for our Q4, which is $7.9 million to $8.2 million on the top line, which is 1% to 3%, organic, and then our EPS in the range of $2.28 to $2.53. So it's -- you take those businesses, you look at our Safety and Industrial business, for example. Again, broader-based industrial markets look good. The demand looks good. We're still working through the year-over-year declines in our disposable respirators, so the PPE coming off of the peak year and actually the peak year in 2021 of N95 sales. So we had said $150 million to $200 million of headwinds in Q4. We're still in that range as we look at it. Broad industrial doing okay otherwise. Transportation, electronics, automotive, we're seeing Q4 year-over-year positive growth and build rates. And still the outlook is for that and we're seeing opportunities there. And maybe we'll talk a little more about the innovation opportunities, but we still see the ability to outgrow the build rates in transportation and automotive in particular. Electronic side, as I said, seeing softness in consumer electronics incrementally, being challenged broadly across mobile devices, notebook tablets, televisions, all part of the consumer electronics. Health care, as I said, elective procedures part of that. Part of the big driver of that is staffing shortages that are persisting and so you see that impacting in. The other notable dynamic is about half the hospitals in the U.S. are in the red in their income right now. And so they're, they're holding back on investments. And we see that to some degree in healthcare, IT in our health information systems business. We're also seeing oral care impacted by some of the consumer trends. Those are number a significant part of oral care procedures are consumer choice, their out of pocket expenses. So you see some impact there. Consumer retail, like I said, the big box retailers really driving a focus on inventory. But also there's a shift in consumer spending from hardline categories to other categories. And consumer spending is moving into areas like food, and we've heard a lot about that, but it's also shifting into services and other areas. So that's part of part of the incremental weakness. If you look geographically, U.S. is softening, the outlook for demand in the U.S. along with those same trends that I highlighted. Europe is weaker demand impacted. They're, they're facing into obviously, high inflation, they've got the energy challenges, geopolitics, all impacting that. The latest PMI is showing that, we're already signaling contraction in Europe in the industrial segments. And then Asia is, again an area that's very fluid. We're watching China closely with the latest lockdowns. We had recovered from the impact of the lockdowns in Q2 as we went through Q3. And now we're watching closely what's going to happen with what's what the impact is going to be on. On the end markets, we see some impacts already in the electronics side of that. So in the meantime, we stay focused on delivering for customers, focus on controlling what we can executing and managing cost discipline to continue to deliver and in the face of that uncertainty and some of those challenges. We're also focused on some strategies that we announced in our Q2 earnings call, the spin of health care we've got our team stood up and executing and focused on delivering a successful spin of health care, which really is going to enable us to position two world class leaders well capitalized health care, going out with three to three and a half times leverage, well positioned to execute the growth strategies there. ParentCo 3M as we go forward will, will have as takes a strong balance sheet today and makes it even stronger with the healthcare spin and will maintain a 19.9% equity stake which we do intend to monetize over the first five years. So it positions both companies be well capitalized for what they have ahead, and we're excited about the opportunities in both companies. We see great opportunities for innovation, as we look at ParentCo going forward, some of the markets that are still going well, we see opportunities and transportation and automotive the innovation and, and disruption in the technology and automotive is creating opportunities for 3M company. We see an opportunity to continue to win and build and grow above the build rates there and broader factory automation opportunities, areas like electronics, there's growth segments in electronics that continue to be areas we're investing in and excited about as we look forward and, and also in our consumer segment home improvement, seeing some softness right now. But it's a trend that will continue. And we've got a great position with our innovation and in our capabilities there. We also are focused on what we've been doing even as we've gone through the last couple of years of some of the dynamics we faced in the markets and coming out of the pandemic. We continue to invest, invest in growth, invest in productivity and invest in sustainability. And we're following through on the commitment with our, our focus on the big areas of sustainability that we talked about driving to carbon neutrality over time, driving a big step forward in our water use and water quality, coming through our operations, and then reducing our use of plastics. And we made a commitment to invest a billion dollars in CapEx and OpEx over time, and we're on track a little actually a little ahead of pace on those strategies. So we'll continue to focus on those investments and navigate the uncertainty and take actions as we move forward the rest of this year and into 2023. Great. Well, that was a great kind of state of the union there so we'll kind of dig in a little bit here. So I guess one of the things I'd love to get kind of a little bit more color on as you think about the industry is just, from a price and volume perspective, are you seeing anything discernible on where some of that incremental change you mentioned is coming from? Yes, I prior to that in my walk around, I probably didn't touch on supply chain. So that's certainly an area where we're seeing inflation still. We continue to see disruptions in our supply chains, although there's some things that are some areas that we're seeing some easing logistics We're starting to get -- we're seeing coming off the peak costs and logistics. We're seeing some easing ends in raw material supply, although we do purchase a number of specialty raw materials that are still challenged. And so as we look at how that's been impacting us, certainly inflation was part of that, the cost of raw materials, logistics, labor, third party purchases, third party manufacturing still challenged in terms of high inflation. So we, we saw inflation broaden out as we came through the year. We had $600 million of impact from inflation and raw materials and logistics in 2021. We laid out and still are guiding to a $750 million to $850 million impact this year. So $1.4 billion of challenges on the inflation side. And so when we look at taking that on, it's in the face of some of those disruptions, driving yield productivity, multiple sources, we've made progress and stepping up and in really driving to increasing the diversity of our sourcing activities, and then we manage it with price. And together, we have been able to offset that, that inflation as we've come through this year. And we're confident we continue to do that. And price is part of that. We're, it's there's two components to pricing in this environment; one of it is your price value in the marketplace. And the other is the inflation that you're trying to offset, you have to, you have to manage to protect your gross margin so you can continue to invest in the future. And I think that's an important part of it. All of those strategies are part of that. So as we move forward, we'll see where inflation goes. If it moderates, then you'll see a bigger focus on price value and your price elasticity in the marketplace and your real value. Our pricing, I would say strength over time has really been a reflection on our innovation, companies that lead in their marketplace with innovation, leading in margins, and that value shows up there and pricing is important part of that. And that price value understanding is an important part of our strategy. And when you think about that price value piece, are there particular areas of the portfolio where you think you're able to execute that better than others? Or is it a kind of a broad paintbrush? Well, as inflation came on, there was we talked about it a bit. We were a quarter or so behind in reacting. And some of that is how to execute price changes. And when you're in a B2B and Industrial Marketplace, you have a lot of distribution partners. You've got to work all your prices through that kind of model. And that takes time. So that takes some time to even once you make the decision to execute certain price. There's other areas where you have contracts. So healthcare is a good example, you have contracts. And so taking price in the healthcare plus it's a, bid environment. And so there's a dynamic there, retails got its own focus on that. There's been a lot of discussion around both the big box retailers, the online retailers, the brands, how we're all managing that price in the consumer environment. So each of our business models has a little different dynamic. In general, you saw us from when we first started talking about inflation being persistent and significant. It was in February of â21. And by I would say the end of third quarter we were where we wanted to be in terms of our pricing plans. So it took us a couple of quarters to get caught up. We were taking actions early, but it took some time to get that executed. And then there's, there's continued inflation, continued pricing dynamics and, and you make adjustments around price value in the marketplace is important part of that. Great. As we take a little bit of a longer term view and we think about like automotive aftermarket or automotive market that you mentioned. How does the transition from ICE to EV, the investments we're seeing the major OEMs talk about in the U.S. around battery, how does that impact the industry and how does it impact 3M? Yes, so I would start in general, markets that are highly innovative and driving new demands for technology themselves create a significant opportunity for us as a company. It's always been true electronics, thatâs why electronics continues to be even though it has its ups and downs and in cycles. It's a place where innovation takes place, and automotive is and other dynamics that you just highlighted in your question. Moving to electric power trains is such a dramatic innovation in impacting all OEMs really and new companies emerging coming in and it demands new material science solutions. In battery technology, we've got solutions in construction of the battery, the electric powertrain. We've got solutions in thermal management as part of that. At the same time, you're seeing the electrification of the automobile, whether it's an internal combustion engine, automobile or an electric or hybrid electric vehicle. They're all bringing in greater penetration of electronics. Displays come with that, sensor technology, new demands on material science in an automobile. In many ways, the automobile is becoming the next consumer electronics device. And so we see opportunities, increased, I would say, denominator of opportunities to invest in. And so electronics is one of those areas. We've talked about our automotive electrification priority and strategy for a number of years. It's now $0.5 billion business, growing double digits. And we see that as a way to continue to outgrow the build rate. So you look at it in terms of an attractive market for us, automotive. The build rates, what will depend on what happens in transportation and the transportation kind of evolution to some degree and how people use their automobiles. But beyond that, the opportunity within the build has gone up significantly with both those trends, that electric powertrain and increasing use of electronics in the model. Then beyond that, I was just -- came from Europe, as I mentioned to you, John, before we got up here. And I was talking to customers there and they're talking about now the need for solutions on electric vehicles that they didn't have in internal combustion. So sound noise vibration harshness has new requirements. And we have solutions, material science solutions that can make a difference in that. You've got -- you noticed road noise more when you don't have an internal combustion engine, and they've got to think about that in different ways. How do you solve that? How do you do that in an automobile environment and how you do that in a cost-effective way and that's material science? And then thinking about another kind of end market where there's a lot of data around unit in the marketplace, electronics, right? So I would just love to kind of get your thoughts around a similar thing there. What is -- what are you able to do to actually outgrow that market, as you mentioned earlier? Yes. Consumer electronics has been the larger part of our business in electronics for over the years and continues to be a space of innovation. Every generation is demanding new solutions in display technology and battery life, going to thinner profiles. There's if you can help make displays thinner, then you have more room for batteries, and you can have bigger batteries, longer life batteries. And so there's a number of dynamics that continue to drive innovation, and there's always pressure on better and better displays and cameras and other capabilities on the device. Semiconductor manufacturers are pushing the leading edge to support consumer electronics. So we play in each of those areas. And that continues to be an important area. The build rates are a big factor. There are people going to be replacing their devices on a more frequent basis, less frequent basis, that will drive it. But there is underlying very attractive market for innovation, valuable innovation. So we see an opportunity to leverage the things that differentiate 3M. Our technologies, our process technologies, importantly, to make some of the film technologies that you need for new electronic devices. It's new levels of processing capability that people haven't known how to do, and that's a great place for us. Then you've got other growth segments, as we talked about, we've got this continued focus on consumer electronics and the opportunities that are there. And you've got growth segments, factory automation, automotive electrification, which we've already talked about is an example of that. Data centers, semiconductor manufacturing, all needing additional innovation in material science. So we see those as growth strategy. I mean those are long-cycle growth markets that if we can innovate for our customers, we can carve out new opportunities in new growth segments. So our transportation and electronics business to see both of these topics as areas that we have this continued drive for innovation where we are already positioned and then we have all these new opportunities in these growth segments that we can also bring solutions into. One of the ones we can talk a bit about is AR/VR, ER technologies as those start to be another looking like they will be a high-growth segment and require new levels of innovation and material science. And so that brings up a question. So 3M's always talked a lot about innovation. So one of the things I'd love to kind of talk a little bit about is how you, as a CEO, kind of prioritize and actually measure that the investment dollars that you're making in innovation are the right dollars. Yes. It's really important. It's -- there's a creative process behind it. There's a collaborative culture in 3M around innovation, and we have things like 15% time where we really encourage our people to pursue projects that they're excited about. That's helped us build new opportunities. So there's this creative side of it. And as CEO, it's important that to foster that. And you're part of that, right? That's a part of who we are and it's how we connect with customers. And so that's an important part of it. At the same time, you can't leave it to happenstance. It's a strategy, and we have a focus on that. And like any strategy, you're going to decide what you're going to prioritize, you're going to set objectives around it. You're going to hold yourselves accountable to what will enable you to get there. And we have that in our performance indicators and how we think about our R&D in it. There's certainly, I would say, a focus for us on prioritization amongst that. We look -- and this kind of brings in the idea of portfolio management, too. Our innovation model is what we do to create differentiated opportunities for us to grow and deliver value, strong margins, cash flow, shareholder returns over time. We couple that with portfolio management to -- first of all, we'll prioritize where we're going to make our organic investments. Not every portfolio, not every market is -- gets the same level even as we look at capital allocation, the first priority R&D and CapEx, we're looking at where do we -- it's not -- we have at the company level kind of an average of what across the company, but we are prioritizing areas. So prioritizing markets that are more attractive, where we can differentiate ourselves, where we have opportunities that are ready to ramp. One of the things that we do when we talked about priority growth platforms, I talked about large commercial platforms. We have significant innovation prioritizing those for R&D and CapEx and make sure that we're accelerating those opportunities. And we also then measure kind of each of the components of that journey. How are we doing on the -- where we're spending our R&D on the bigger R, little kinds of this? How are we doing in terms of spending into those priority areas? And what kind of returns are we getting? What are we seeing in the health of the pipeline that we have in front of us, how are we doing in our first year sales, how are we doing in our revenue off of the five years of new products, which is an important measure for us on how we continue to replenish the pipeline and see it come through and make a difference for customers and make a difference in our top line and our bottom line. So we've got key measures across all of that. So it's as CEO, it's one of the strategic priorities that I stay focused on. And I spent a lot of time, I would say, with employees and customers around it. Certainly, that's an area of a topic that we spend a lot of time on. But we hold ourselves accountable. Our Board as well is a very strong Board, and we formed a committee actually three years ago and now the Science, Technology and Sustainability Committee. And they have kind of two big responsibilities. One is their -- they've got to focus on environmental health safety, environmental stewardship and things like PFAS, for example, the Board has strong oversight through that committee. They also have a very much of an offensive focus on innovation and delivering on that. The Board is very focused. So it's not -- doesn't stop at the CEO or the Board has a big responsibility for making sure we're holding ourselves very clear about where we're going with our strategy and our priorities, but also then holding ourselves accountable to continue to take that collaborative, innovative culture and deliver from it. So it's a senior management. It's a front and center priority all the way up through the board. Great. Earlier in your prepared remarks, right, you talked about the health care separation. Maybe just remind us the time line and what investors should be watching for there? Yes. When we announced in July, we talked about the end of next year, and that's what we're focused on as the plan for our team. And our team -- we stood up a separate team and their executing well and focused on all the steps that go into that. It's interesting just as you asked that question, I get that question a lot inside the company or people want to know, certainly, our health care team wants to know, but everybody wants to know how are we progressing. It's one of those areas where we've been probably more transparent than ever. It seems like that's a general challenge for company leaders is to be more transparent. Now there's not a lot to say until you make certain decisions. Our team is, of course, interested in where will the company be located and who will be the CEO and what will be the name of the company and what's the impact on capital investments and so on and pensions and things like that. So we're working through all of those work streams. And then I would say, important for us is it's also a focus on ParentCo. This is an opportunity to really make sure we position ParentCo. When we made this decision ultimately with the Board, it was a carefully thought-out strategy over time. But when we got to the decision there -- the three answers that we had to have, is health care going to create better value as a stand-alone health care company, be a leader, be a top 10 health care technology company, and what does that look like? And is this the right decision to do that? Do we have a strategy for ParentCo going forward that will also create this world-class company that can drive growth and continue to be able to outgrow the economies we're part of and deliver strong margins and leverage off of that growth and strong cash flow. And then can we capitalize both companies to be successful? And those are the big questions. And so our efforts are positioned to do all of that. So focus on successful spin of health care, but also positioning ParentCo, 3M Company as we go forward to do that as well. Great. Maybe just kind of pivoting to a broader question. There's been a lot of conversations around just stimulus, be it U.S. or global, right, very global view 3M. Are you seeing any of that impact? Is that something you expect to see? Any kind of color around that? Yes, it's -- we've been talking about it for a while, but it's still early days. We're watching things like the CHIPS Act and the Inflation Reduction Act. And other programs, economic stimulus around the world. Those in particular, there's -- there are aspects of that, that are focused on technology and sustainability and will be incentives as part of that. And some of that can be important for us as we look at our opportunities as we go forward. But it's early to understand exactly how that's going to play out. There's also obviously in things like the CHIPS Act, the incentive to reshore. And generally, there's a lot of focus on regionalization of supply chains. Now 3M, that's our model. We've built out our capabilities and our capacity over generations to be close to customers. So we manufacture a majority of what we sell in region around the world, every region of the world, whether it's China, Asia, Latin America, Europe, we manufacture in region close to customers, positions us well as supply chains move. And electronics is a great example. It's moved around Asia in different ways, and we've been able to adapt to that. And I would say maybe the one notable kind of difference in all of that is the U.S., we're a net exporter. So we export $5 billion of goods out of the U.S. and that's to a degree the historical origins of the company. There's also certain capacity you don't need to replicate everywhere around the world. We serve electronics markets out of the U.S. We export into Asia. We export into certain markets in Europe as well. So if there is a reshoring of some of those markets into the U.S., we're well positioned today with capacity. But in general, we've been able to adapt to the automotive industries a case where they built new capacity around the world, and we've adapted to it with our own investments and capacity and aligning ourselves to that. So we'll be ready to adapt as we go. And we're engaged with our customers and their plans, and we'll -- I think that we're well positioned to be able to make those changes as they do. Got you. And just on that topic of nearshoring, right, are you actually seeing it? Or is it still something that is less tangible today? I think there's -- there are plans for it, but it's starting. And some of the near shoring, there's kind of a couple of dynamics. One is investing in new capacity. So that's the semiconductor industry, right? They're going to build plants in the U.S. That's going to take time. And so that's at the beginning of the capacity investment. They're making investments. You see some of that in Europe as well and maybe other parts of the world. And then you have supply chains, in general, companies looking at localizing your supply chains, more regionalizing your supply chains, where your capacity is, that's also been part of our model. When we build capacity in Asia or Europe, we localize our supply chains too, we aren't importing raw materials from other parts of the world. Our model is to be regional. And so we're well positioned for that, but you see that dynamic playing out to some degree with other companies. It hasn't been an impact on us, but more for us is a focus on our customers, where are they going to go with their capacity. Yes. I got a couple more, but I'll toss it out to the audience if there's a question. So one of the things I also wanted to talk about, you've brought it up several times is this kind of 3M's digital journey, right, and what it means for 3M. And so from a customer perspective, from our own ability to drive margins, I mean I would just love to -- if you have some kind of quantifiable examples you can share us about 3M's kind of digital burn? Yes. There's quantifiable, it certainly has had a measurable impact on our business. And we think of it in four strategies really, digital is a broad term, right? It applies to many things. But for us, it's digital customer and e-commerce as part of that. But importantly, it's our digital capabilities, data, data science and analytics and our ability to really position ourselves for greater success in the marketplace. Our consumer business has been one of the leaders in that area with -- they've been -- when you look at our growth in e-commerce, they lead the way for us. And the company, they lead the way for some of the digital capabilities that we're building with our retail partners. And so that's an exciting area. We're seeing that impact our position in categories, in the departments, in the e-commerce world. And it's also helping us to better serve our customers through e-commerce. So that continues to be an area that we see opportunity we invest in. We see the opportunity in the other businesses as well. And we're benefiting, I would say, to some degree, from the capabilities we've built in the consumer packaged goods kind of model. We have digital operations, which is a big focus for us. We have been taking advantage of that to get better visibility, of course, across our supply chains, but it's also enabled us to streamline our supply chains, and it's every aspect of it, commercialize what we do in our -- to commercialize products in our supply chain gives us better visibility, analytics, better integration of our innovation model all the way through our scale-up capabilities. It's in our planning capabilities, we've been able to streamline and drive cycle time improvements in our planning operations, it's in our sourcing, really getting better visibility and we buy a lot of raw materials and some in small quantities that were sole sourced, and we're getting better visibility that's helping us on some of the things we're doing with multiple sources. And then you get into make deliver these capabilities, it enables us to run more efficiently. It's driving clear visibility on where we can continue to drive improvement. And then you get into digital enterprise for us, and we've been deploying ERP, new ERP capabilities. We've been migrating to the cloud in much of what we've done, and we've been very successful in that progress, and that's an important strategy for us. Positions us for many things that are important to us, capabilities but also better positioning for cyber. And I would say competitive positioning of our operations globally. And then the fourth one, which is exciting, too, is digital product for us. We -- of course, we have digital businesses like health information system, which are part of our health care business, but we also have opportunities in our businesses and digital products. It's -- can you solve every customer problem if you don't have a digital solution? We're seeing opportunities to step into new digital solutions. We highlighted a couple of examples in our industrial business and our consumer business where we're taking that on. We've make that acquisition of a small company, LeanTec, where it enables us to bring a digital solution into the automotive repair shop where we have a strong presence with all of our capabilities. Now we help them with their efficiency, and we really integrate us into their operations. And it's a nice step forward in solving customer problems. Consumer business, we announced a partnership with Microsoft on a Teams platform, innovative approach to the collaboration use of posted notes in a Team's environment, a digital environment. So it's an organic approach to digital products and solutions. We have them in factory automation. Our material science in many ways, is because of the differentiated capabilities we have in areas like adhesives and abrasives, we're well positioned to be in the automation. We've got robotics solutions that other abrasives companies can't bring to the table because we have consistent, reliable, predictable performance of our abrasives. And we're doing things in the painting process of automobiles, for example, where it's automating completely that process. And so there's exciting areas of digital, and we continue to see that as a growth opportunity for us as we go forward, too. Very interesting. And then maybe just you talked sustainability when you were discussing it up to the Board level, right, maybe just a little bit of kind of what you guys are doing to drive both sustainability in the organization and then helping your customers, right, achieve their goals as well. Yes. And sustainability is a core value 3M as it has been. As a manufacturer, our generations ago said we have to be reducing waste. We have to be a driver of that. Pollution prevention was a big focus for us. In the last 20 years, we focused on greenhouse gas emissions and reducing that. We're down 70% from 2002 to today, in our greenhouse gas emissions. So it takes a lot less energy to produce a postal today than it did or a film for electronics than it did previously. So it's a process that we're going through. And we see that as an important part for our customers and our shareholders, our employees all care deeply the communities that we're part of that hold our license to operate, they all care about that, and we do too. And so we focused on the engineering to do that. So we -- when we announced going carbon-neutral as a manufacturer, we saw that as a step forward in our leadership and sustainability. Importantly to us, we said, we'll be down 50% by 2030 and 80% by 2040. And we got the math and the path to do that. And what are the investments and capital we need to do to drive that, but are the changes in our portfolio that we need to do to drive that. So those are -- that's kind of a frame for how we look at it. We think in terms of our strategies, we're driving a circular economy. So reducing air, water and solid waste. So we made a commitment to take our factories, and we have about 150 sites globally that we're committed to take the zero landfill waste. Now we have 40% of them at zero landfill waste today. And it's progress, we were just a few years ago at 30%. So we're making progress incrementally on that. We talk a lot about water because that was a big part of our commitment, reducing the use of water, improving the quality of water that comes through our operations. And we're on pace to do that. And we had big steps. We said we are going to reduce -- we're starting being in compliance with the regulations out there, and then we said we're going to reduce by 99%, anything that comes out of our plant. And that's -- that was the math and path that we could see with state-of-the-art technology, and we've implemented those capabilities in our U.S. operations. And we said we'd be there by the end of this next year. We're ahead of that pace with those commitments. So those are -- we've decided those are priorities for us as a company. We took all of the kind of grassroots interest in sustainability and then we prioritized and made commitments and the Board holds me accountable in my CEO objectives to each year's progress report. And then I would say it carries into our innovation. I don't want to leave without talking about that because we try to do this for our customers. We're helping them reduce their emissions. 75 million metric tons of emissions from our customers over the last, I think, 3 to 4 years now is the output of that innovation, helping them to reduce their energy consumption, their waste, their consumer electronics extending battery life as part of that. So we actually have a review in our new product introduction that says you don't get the past the gate to scale up unless you have a path to addressing sustainability -- improving sustainability with this portfolio. So those are how we ultimately prioritize it and then do what companies do well. Once we decide goal as a priority, we allocate resources, we set intermediate goals and we hold ourselves accountable. And that's like another one of those areas, it goes all the way up to the Board. Great. And I think with that, that's where we'll wrap up. So I would like to thank Mike and 3M for being here and hope everyone as well.
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EarningCall_1698
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I would now like to turn the meeting over to Mr. Dan McConnell, President and Chief Executive Officer. Mr. McConnell, please go ahead. So, I'm joined here today by -- with John King, our Chief Financial Officer; and Amanda Sutton, our Vice President of Legal and Corporate Secretary. Before we begin, I'll remind you that certain information presented today may constitute forward-looking statements. Such statements reflect North West's current expectations, estimates, projections and assumptions. These forward-looking statements are not guarantees of future performance and are subject to certain risks, which could cause actual performance and financial results in the future to vary materially from those contemplated in the forward-looking statements. For additional information on these risks, please see North West's annual information form and its MD&A under the heading Risk Factors. Dan? So, let me start by outlining the key highlights of our call today. Consolidated sales in the quarter increased 6%, driven by inflation and the impact of foreign exchange. Also similar to what we've noted over the previous quarters, we continue to cycle through the COVID-19 related tailwinds from last year. This has resulted in customer sifting their spending towards food and essentials and away from discretionary and general merchandize items. These factors were the primary reasons for the changes in our same store sales. Inflation also continues to negatively impact our gross profit rate and expenses, as we've been taking a balanced approach and not fully passing through all the cost increases in retail prices, which I'll unpack for you in just a minute. The inflationary cost pressures this year combined with the COVID-19-related factors from last year resulted in lower earnings for the quarter. That said, our overall sales and earnings trends remain positive compared to the third quarter of 2019. Okay, let me provide some color in terms of the sales for the quarter. Starting with the Canadian operations, sales increased 2.7%, with food mitigating some of the impacts of lower general merchandize sales. As I previously noted, customers have reduced discretionary spending. They're not only shifting away from general merchandize to food, but they also are focusing their purchases on value items within the food categories. Sales on the international side increased 4.1%, led by overall performance in Alaska, which was mitigated with mixed results in the Caribbean and Pacific. Particularly, it's worth highlighting that the tail winds came from two factors: one, our new stores in Alaska; and two, the increase in the Permanent Fund Dividend payment, which was around $3,200 per person this year, which was -- about $1,100 paid late in Q3 of last year. And although this quarter was typically slower in terms of tourism, the year-to-date pickup in travel has had a positive effect in local economies like the British Virgin Islands. On the flip side, to certain territories in the Pacific and the Caribbean, we continue to cycle through the impact of income support payments from the American Rescue Plan last year, while tourism numbers are still below pre-pandemic levels. What was a common thread across all of our markets is that our customers have been trying to adapt the best they can to lower income support and higher inflation. Now, let me expand on this for just a minute. We are concerned about the impacts of inflation for our customers. This is a global issue that affects all regions where we operate. But this is particularly sensitive for our Northern customers in Canada and Alaska, as they are impacted by two factors. First, merchandize cost inflation. We buy products from suppliers for resale. And so, we're dependent on the prices they determine for the products. Although we continue to closely monitor all these increases and work with our vendors to minimize them, the fact is that around the world, these costs are all escalating. Secondly, more importantly, freight costs are also increasing. When we factor in higher fuel and transportation costs, the impact of inflation on the shelf prices is even greater in the North compared to Southern retailers. That's why we need to take a balanced approach in passing through these increases, which are coming through at unprecedented rates. This includes providing promotions on essential items through a Price-Drop and Price-Lock campaigns in order to help mitigate some of the impact of our customers and ensure we're delivering on our value proposition. That said, other factors affected the performance of our gross profit rate included changes in our sales blend, and increases in markdowns, as well as shrink. The shift in sales from general merchandize to food is affecting categories like seasonal and apparel, where we've incurred markdowns to clear some of the slower moving merchandize. We also experienced higher inventory shrink in the quarters, some purchase orders in certain categories were not adjusted fast enough for the changes in customer shopping behaviors. As a result, our gross profit rate was down 84 basis points this quarter. Iâll just take a minute to talk about inventory here. The increase in our inventory levels is largely due to the higher inflation in our supplier costs that I just referred to and the impact of foreign exchange, which saw an increase in the quarter compared to last year. Overall, the increase in the inventory levels was largely in center store grocery and category like motorized products and home furnishings that were impacted by the supply chain disruptions. Our expenses have also been negatively impacted by inflation in the foreign exchange rates. We're feeling most of the pressure on utility expenses. Given high fuel costs, our operations teams and all around the company have -- and have been practicing and bearing down on some of the energy conservation routines and practices. And this is just to help mitigate the impacts. But at the end of the day, we're still subject to inflation and fuel costs. Expenses related to our new stores and operations were also a factor. Okay, now, I'll give a brief talk about North Star Air. We do continue to see a recovery in the passenger business as travel restrictions have been eliminated. The cargo business also saw increases, as third-party freight and charter work bumped up the utilization of Baslers and our ATRs. Increases from fuel surges on -- fuel surcharges, I apologize, on both cargo and passengers were also a factor on the revenue increases consistent with what other air carriers have been doing throughout this inflationary cycle. I think I'll leave it at that in terms of the recap of key factors that impacted our results for the quarter. And now looking ahead, I'll just briefly -- we do expect to lap COVID-19-related impacts by the end of the fourth quarter of this year. Keeping in mind, there were still some travel restrictions and income support payments present in our markets last year in the fourth quarter. I also want to point out as a reminder that we had a $6.2 million after-tax insurance related gain in the fourth quarter last year as well. In terms of the fourth quarter of this year, the outlook continues to be uncertain, as we expect inflationary pressures to continue in the short term. Considering all these factors, our net earnings in the fourth quarter are expected to be lower than last year, but above pre-pandemic levels. Beyond Q4, macroeconomic circumstances are also difficult to forecast. There are some analysts that expect a recession next year, especially after the measures taken by the central bank to reduce inflation. The impact of a recession is difficult to forecast. However, our focus on food and everyday products and services provides us downside protection. As noted in our report to shareholders, the medium- and longer-term outlook for the company is positive, and it's based on the expected impact of government transfer payments and higher infrastructure spending in the indigenous communities. And we're excited for the future of our business. We continue to open store -- new stores. In Canada, we opened two new stores this quarter; one in Little Grand Rapids, another in Sheshatshiu, Labrador. In Alaska, we also opened two stores and we now expect to open another one before the end of the fiscal year. Overall, we've been getting great feedback from new communities where we're operating in, and they are all very excited to have North West Company store. We're also getting great reception from new communities we're currently working with to potentially expand to, which signals that we're doing the right thing and filling a need within the markets. We continue to focus across all banners on providing the best value to our customers within this high-end inflation environment, striving to deliver on our purpose of making people's lives better, and the communities that we serve. Thank you. We will now take questions from the telephone lines. [Operator Instructions] The first question is from Michael Van Aelst from TD Securities. Please go ahead. Your line is open. Hi, good afternoon, and thank you. First question is on Canada. And looking at your same store sales down 1.8%, but then your revenues are up 2.7%, you said. Is that - how much of that is tied to the new stores? And how much of that is tied to NSA with the increased passenger business and the increased freight business, third-party freight? All right. Hi, Mike. It's John. Yeah, both of those were factors. We're not going to break out the individual components there, but they were both factors. Last quarter, you talked about increasing competition, not allowing you to pass through some of the costs a little, and fully, at least at this point. And can you talk about how that competition has changed, if at all from Q2 into Q3, and what you're seeing now? Yeah, as we're still taking a balanced approach, Mike, as I indicated, that said, the competitors are definitely increasing their pricing, just with the environment, as we're all kind of living and experiencing. And as I indicated the significance of it in the north. If they weren't passing it on, I'm afraid they'd be out of business. So definitely, there's more movement, and that's allowing, obviously us to follow suit. Okay. And so, would you say that they're passing on a higher percentage of it now? Or is it like -- it seems like your costs have increased -- your cost inflation seems to have increased from Q2 to Q3, particularly on the OpEx side? So, are you seeing more --- are you seeing, like a similar amount of cost being absorbed let's call it from Q2 to Q3? Or did that decrease or increase? I would say it's decreases, there's been probably more pass-through. But what you are seeing obviously utilities were a major factor. So that's probably what you're seeing in some of that bump. Okay. All right. And the utility increases and the other OpEx increases that we saw that propped up the OpEx expense this quarter, is there anything in there that is short term in nature? Do you see all of this basically as the new norm, and you've got to cycle through that? I'd say, it's probably the new norm that we'd have to cycle through. It's not getting -- I don't know if you know, Iâm in Winnipeg, but it's minus 26 today, so heat is required. Yeah, thanks. Good afternoon. I just following up on that whole -- the topic of cost versus being able to pass on price. Just to be clear, this is still an issue, but it's not as significant as an issue as it was in Q2 or earlier in the year, is that the right way to characterize that? Okay. I guess, sort of with regards to the sort of shifts in consumer behavior that you're seeing, and it sounds like that's accelerated based on your comments, I guess, just confirm that that's true. And then curious if that's different in sort of the different markets that you operate in, and I guess that being sort of north and south and kind of remote versus just rural? I'd say it'd be pretty consistent amongst all our markets. Everybody is looking for less expensive solutions in order to feed their families or to sustain their wellbeing. So, yeah, I would say it's pretty -- it's wide set, it's across all the stores. We're continuing to look at obviously solutions there and the solutions would be lower cost product, whether it be some other branded items that we can pass on to sustain margin, but then create a more effective solution for our customers. So that's work that's ongoing. Yeah. That was sort of my next question, I guess is just the status of private label within your assortment, the percentage penetration now. I'm sort of -- obviously specifically to food, the percentage penetration now versus pre-pandemic, and if there's sort of accelerated efforts to continue to grow that? Yes. That is -- well, as far as -- it is an opportunity that we're exploring, because we do think it's a -- it's, again a considerable value prop to our customers. But as far as our ratios of penetration now versus prior, intuitively I would say it's -- we got higher penetration now. But as far as the quantum, I couldn't give you that. Okay. And the margin within the general merchandize business, does that -- do you think that there's an expectation of fluctuation within that based on the consumer behavior that you're seeing? Yeah, I guess what I'm getting at is if people are shifting spending from discretionary to staples, does that affect your profitability of your general merchandize business? Or do you sort of -- it affects sales and not so much margin? I was just going to say, as I indicated, like, we have had to take some write downs on some of the inventory, but there's others of which thatâs -- it's planned, as we talked about for particular big ticket. It's opportune time now. So, we have -- we're ready and â weâre inventoried and ready for selling season. I just wanted to -- just with respect to your commentary around acquisitions, and new stores and things like that. Just curious through the economic weakness that we've been seeing, and you cited as well, in one of your in response to the questions about, if people aren't putting through price they're going out of business. Just curious if any potential acquisition opportunities have come up or accelerated over the last couple of quarters in any of your markets. No macro -- look, no major acquisitions, Stephen. But there's definitely a lot of tuck-ins qualify that. There's definitely been some tuck-ins, that I indicated to you earlier that we've taken advantage of, and we see there to be a few more that we'll be looking at over the next number of quarters. And our eyes are open. And we're definitely -- we've looked at a lot of things, but we'll make sure that it's a strong -- it aligns with our kind of core competencies and our capabilities to ensure that we can add value and/or derive value from whatever acquisition we venture into. But I would say that there's no major acquisitions in the immediate future. Yeah. Okay. No, that's right. And then, just with respect to the PFD in Alaska, did you -- do you think you realized the entire benefit from that in the quarter or is there some that may trickle into the next quarter? We did derive a strong benefit in this quarter. And typically, it does trickle on into the next quarter. So, I would say, I would expect that we're going to still see some benefit from that in the fourth quarter, ramping up for some of the holiday season selling events. Okay, that's great. Thank you. And then maybe just finally, with respect to general merchandize and your assortment. Given the consumer spending shifts that you're seeing, I would assume that holiday is a big general merchandize period for you. So just curious on any changes you've made to your assortment planning for Q4. Yeah, no problem. So, I was just wondering if you could -- if you have any changes to your general merchandise, assortment planning for the holiday period, given the shifts we're seeing in the consumer spending away from GM towards food. No, I wouldn't say that I've seen any shifts currently. Itâs -- purchases we did scale down as you recall. But we're expecting the same trajectory on our general merchandize sales throughout Q4. It's probably the best way to phrase it. Thank you. Just a follow-up. On -- in the international business, can you tell us what the gross margin change was there? No, I probably wouldn't -- I wouldn't disclose that, Michael. I'll leave that to -- for you to kind of take a look and hypothesize. You're usually pretty accurate. Okay. And then, if you look at the change -- the drop in the EBITDA margin in Canada versus what we're seeing in the international markets, can you kind of compare and contrast the main factors behind the margin contraction in each? Well, I've identified kind of globally, like what the contraction items are for each. And I would say that the benefits, as I indicated in the international were related to the PFD to the Alaska stronger performance. I think itâs probably -- that's the answer really. I mean, I outlined why we were stronger in our performances in Alaska, and why -- what the overall drags were on the operations, and I'd say you could attribute all those draws to not only the some of the international markets that we suffered in that regard, but also into Canada. And the fuel surcharges we talked about, obviously, that would be considerable draw to the inflation, some of the higher the inflation, some of the expenses. You can appreciate that fuel has us considerable impact not only from the heating, but from the distribution and freight. So, I think that that gives you⦠Okay. Well, thank you. I appreciate the questions. And I hope everybody has a great holiday season, and weâll be busy focusing on driving sales. So, have a great rest of the day. Thank you. Thank you. The conference has now ended. Please disconnect your lines at this time. And we thank you for your participation.
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EarningCall_1699
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Greetings, and welcome to Torrid Holdings Third Quarter Fiscal 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] Please note, this conference is being recorded. Good afternoon, everyone. Thank you for joining Torridâs call today to discuss third quarter financial results for 2022, which we released this afternoon and can be found on our website at investors.torrid.com. With me today on the call are Lisa Harper, Chief Executive Officer of Torrid; and Tim Martin, Chief Operating Officer and Chief Financial Officer. Before we get started, I would like to remind you of the companyâs Safe Harbor language, which Iâm sure youâre familiar with. Management may make forward-looking statements, including guidance and underlying assumptions. Forward-looking statements are based on expectations that involve risks and uncertainties that could cause actual results to differ materially. For a further discussion of risks related to our business, see our filings with the SEC. This call will contain non-GAAP financial measures, such as adjusted EBITDA and adjusted EBITDA margin. Reconciliations to these non-GAAP measures to the most comparable GAAP measures are included in the earnings release furnished to the SEC and available on our website. I'd like to start the call by recognizing the Torrid team for their continued dedication towards the business as we face a choppy macroeconomic backdrop. Despite external pressures, we've remained steadfast in our goal to deliver exceptional product, anchored on our world-class fit. I'd also like to officially introduce Tim Martin, who is joining today's call as our Chief Operating Officer and Chief Financial Officer. Tim brings a wealth of experience to Torrid and he will be instrumental in helping us deliver on our strategic priorities. I look forward to you learning more about Tim and Torrid as we move forward. Now moving into our third quarter results. Despite the challenging environment in late Q3, our net sales and adjusted EBITDA were within our expectations. During the quarter, we saw the customer respond favorably to new product introductions, including the launch of our Studio line of wear-to-work styles. However, similar to the trends experienced at other retailers, we saw a slowdown in consumer demand during the month of October that coincided with our Torrid Cash event, which typically makes up a large portion of quarterly sales. As a result of this softness, the comparable Torrid Cash event was down double digits versus last year and prior quarters, which negatively impacted performance. As we worked to right-size our inventory levels in the third quarter, we added incremental discounts and promotions, which pressured margins. We were able to make headway clearing through inventory, ending the quarter with total inventory of 25% from last year. While this was a significant improvement relative to the second quarter, it is still somewhat higher than we would like, primarily due to the softer demand we experienced late in the quarter. We are focused on ending the year with clean inventory and expect to be promotional in the fourth quarter to end the year well-positioned for 2023. We also continue to work on the priorities that I laid out previously. Key among these was enhancing our promotional and marketing strategies to better balance margin and sales growth. We are still in the test-and-learn stage of our promotional changes and there continues to be significant opportunity for us to improve margins. Elevated inventory levels have limited our ability to pull back heavily on promotions this year. As we move into 2023, we expect inventory levels to be much more balanced, which should enable us to further adjust our promotional strategy with the goal of expanding margin. We have had an opportunity to test different types of margin-enhancing promotions that we will be able to implement more fully next year. In terms of marketing, we are focused on driving customers to store and building the quality and quantity of our customer files. We know that stores are where the majority of new customers first discover and fall in love with our brand, and we view stores as a critical acquisition and engagement vehicle. For example, during the quarter, approximately 30% of the customers shopping in new stores were new to the Torrid brand, and these customers typically spend 25% more in their first year compared to those acquired on the web. Stores and store acquisition is clearly an important strategy of growth for us. In order to build a healthy customer file, we are focused on reengagement of lapsed customers and improving retention. Our marketing efforts to reengage lapsed customers continue to show promise, and we generated another 500 basis point improvement in reactivated customers on top of the improvement seen last quarter. On social media, we're more focused than ever on product. We saw 160% increase in product conversations versus the prior quarter, largely driven by the success of our Studio collection and the strong reception to the launch. We also executed an influencer campaign last quarter focused on jeans, which highlighted our world-class fit. Customers consistently note that our fit is what compels them to shop at Torrid, and we continue to see low return rates, which speak to the integrity of that fit. Turning to merchandising and products. We introduced new growth categories within the product assortment starting with the launch of the Studio collection in September, which was executed with a full 360-degree integrated marketing campaigns that spanned all channels. Given the shift in customer preference for wear-to-work styles, this was the ideal time for the launch. The collection was very strong and drove a 30 percentage point improvement in workwear sales growth versus the prior quarter. We also launched a new collection called Festi that was a nod to the iconic trends that defined the 2000s. This collection featured classic styles, including baby tees and retro graphics, and we saw our most loyal customers respond to the product with a VIP customer penetration that was more than double our typical VIP penetration across other categories. As we moved through the quarter, we offered new fashion and color, including cozy and cold weather product and novelty fabrics and prints. We are encouraged to see her response to new product and we have even more newness slated for the fourth quarter. Our holiday assortment features an expanded breadth of product focusing on glitz, glam and pretty for all of our holiday occasions. Our most loyal customers respond well to our special collections, and we have many planned for this fourth quarter, including the Retro Chic collection. a new Curve assortment with holiday colors, and we've added another drop of our Betsey Johnson collection. In closing, our team remains focused on making products and operational improvements that will position us to deliver sustainable long-term growth. We're seeing [signs that] (ph) strategy refinements are working, and we're excited about [more product newness] (ph) as we continue to capture her interest with relevant fashion and perfect fitting base. The positive feedback and momentum that we received with our Studio launch is carrying forward into next year as we bring our customer-compelling assortments anchored on an exceptional fit. Our new product launches and seamless customer experience build relevancy with our customer, which would lead to increased visit frequency and higher conversion rates. We are excited about our changes and how they build going into next year. And with that, I'll turn the call over to Tim to provide more detailed financials on the quarter and our updated guidance. I'm incredibly excited to be joining the company as Torrid's Chief Operating Officer and Chief Financial Officer. Torrid is an amazing brand with strong potential, and I look forward to being part of its success. We have a significant opportunity for growth, and I am happy to be working with Lisa and the Torrid team as we strive to consistently deliver on the company's potential. I will begin with a detailed discussion of our financial results followed by an update on our outlook for the rest of the year. Starting with the third quarter results. Net sales came in at the low end of our guidance at $290 million, which was down 5% compared to $306 million last year. Comparable sales in the quarter declined 8% compared to a 14% increase in the third quarter of 2021. As a further comparable, we were up 9% to the 2019. Similar to trends reported at other retailers, we experienced a slowdown during the month of October. This coincided with the timing of our quarterly Torrid Cash event, which negatively impacted our third quarter results. However, we were pleased to see our customer respond favorably to new product offerings during the quarter, including the Studio collection, and demand early in the quarter was more in line with our expectations. Gross profit for the third quarter was $92 million or 31.6% of net sales. This compares to $125 million or 40.9% of net sales in the third quarter of last year. During the quarter, we continued to focus on rightsizing our inventory levels, which resulted in an increase in discounts and promotions over the last year. Approximately, 850 basis points of the decline was due to higher discounts and promotions to clear inventory. The remainder of the decline was inflationary and related to higher product and transportation costs, partially offset by price increases. Selling, general and administrative expenses in the quarter were $59 million compared to $66 million for the third quarter in the prior year. As a percentage of sales, SG&A decreased to 20.4% from 21.7% compared to the third quarter of last year, due to higher private label credit card income and lower performance bonus expense. As a reminder, the terms of our new private label credit card agreement provide a benefit to SG&A expense compared to a year ago. This benefit was partially offset by higher store and web payroll, primarily caused by inflationary pressures, including higher wages. Excluding the benefit from private label credit card income, SG&A as a percentage of sales increased 70 basis points, driven by the deleverage in sales. Marketing expenses in the quarter came in at $13 million compared to $15 million last year. As a percentage of sales, marketing expense was 4.4% and decreased approximately 50 basis points compared to 4.9% in the third quarter of last year. As we navigate a difficult macroeconomic backdrop, we remained disciplined in our marketing investments and made the strategic decision to allocate expenses towards customer reactivation where we are seeing better returns. As a result, we've been able to drive improved spend efficiency versus the prior year. Turning to profitability. Net income for the quarter was $7 million or $0.07 per share compared to a net loss of $59 million or a loss of $0.54 per share for the same period last year. We did not have any adjustments to net income in the third quarter of '22, but for comparison purposes, adjusted net income last year was $28 million or $0.25 per share. In addition to the GAAP measures, we believe that adjusted EBITDA is an important measure that we use to evaluate and manage our business. Adjusted EBITDA came in at the low end of our guidance range at $32 million or 11.1% of net sales. Turning to the balance sheet. Our cash and cash equivalents at the end of the quarter totaled $19 million. Total liquidity at the end of the third quarter, including available credit, was $159.4 million. Total debt at the end of the quarter was $327 million compared to $341 million in the third quarter of 2021. Our net debt to adjusted EBITDA was 1.9 times at quarter end. Inventory at the end of the quarter was $200 million, an increase of 25% compared to $159 million in the prior year. This is a significant improvement compared to the 64% growth at the end of the second quarter. We continue to focus on reducing our inventory levels and expect to clear through any remaining seasonal inventory by the end of the year. While we plan to end the year with inventory up to last year, it will be clean and comprised mostly of basics and early spring receipts. We opened five stores in the third quarter, including two Curve stores, and we closed three stores. We have opened 14 stores year-to-date. We now plan to open approximately 27 total stores for the year, including eight Curve stores. Turning to the outlook. Given the challenging macroeconomic environment and the volatility in our demand trend, we're updating our outlook for the remainder of the year. For the fourth quarter, we project net sales to be between $285 million and $300 million, and adjusted EBITDA to be between $9 million and $14 million. The outlook for our gross margin rate will remain pressured as we continue to reduce inventory to bring levels in line with demand. For the full year, we are forecasting sales to be between $1.244 billion and $1.259 billion. For the adjusted EBITDA, we are now projecting it to be between $145 million and $150 million. Capital expenditures are projected to be between $27 million and $30 million for fiscal '22, reflecting infrastructure investments and approximately 27 new store openings. We are also planning to close 13 stores this year. In closing, we are facing an uncertain and dynamic environment, and Torrid is certainly not immune to these challenges. While I've only been at the company a short time, I have been impressed with the strength of the Torrid brand, its relationship with the customer, and the Torrid team. I believe we are putting the right strategies and priorities in place to deliver consistent long-term growth. In the near term, we are going to focus on controlling the controllables and setting the company up for success going forward. Hi, thanks very much, Lisa and Tim. On the inventory situation now, what are the main strategies to clear through it? And also, is there a risk in terms of the depth of promotions you may need to take? What are you seeing in the consumer environment that give you a conviction, you can get through it? As we look ahead to modeling inventory in the new year, would love your take on how you see that in terms of the growth rate relative to sales? And then the second question, Lisa, zooming out, what's your hypothesis for driving greater consistency in terms of what the brand and/or strategies may need to take place for that to happen? And Tim lastly on the debt, what's your target ratio? Would love your refreshment on your priorities in terms of the debt level and the debt to EBITDA ratio you seek to maintain. Thank you very much. Okay, thanks, Oliver. I'll start with the inventory question. Our aging on our inventory is actually very, very positive, meaning we have very current inventory. There is a lot of moving pieces with inventory, particularly the only bulk of inventory that has a long trajectory in terms of clearing is basics, and that's primarily basics in bras and denim and other bottoms. And we are, of course, not promoting that heavily and not burning down that inventory, but we'll land the plane on that and feel comfortable that we can manage that appropriately. The other increase in inventory is actually receiving our spring product in the correct timetable, because last year, we consider a resort, which is just setting the stores to be a spring line and so we count that in our spring inventory. So, we receded that on time and we're receding spring one, which will set the end of December on time as well. And so, last year, those lines were late. So, I'm not worried about the timeliness of managing the inventory. We are just very committed to making sure that we stay on top of it and that we turn it quickly. I think actually the opportunity for us is we are much cleaner than we've been all year, and the inventory is very current, and that we can moderate promotions as we move forward. So, I don't actually expect in the first quarter to have to accelerate any more than we have, and I think that we have some possibility of being able to moderate that as we deliver a new product and have the customer respond to that. But overall, with inventory, I'm comfortable with the aging. It's actually quite clean. There's moving pieces associated with it. We're just committed to making sure that we stay on top of it and keep it as current as possible, so that we are not kicking a problem down the road. On my hypothesis for consistency, if I understand what that means, so I've been here a few months and one of the things that we've really focused on, aside from building the right team and building the right operational foundation for the business, is the process for developing our product assortment flow and those assortments by channel. And some of that discipline had been lost over the pandemic time period, and we've reinstated processes that are very straightforward, that are very typical and well-known in kind of this environment, and moving more of our analysis and development earlier in the process, meaning a template for the development and then being able to really test and react more appropriately as we move down the path. So, we've changed the process for development, and we also have reinstated our chase mode, our chase capabilities in the business, so we're being able to chase as we go into the first quarter, and just basically put some core disciplines into place, particularly in assortments by category and by channel, meaning stores versus online assortments. So, I feel very comfortable with the disciplines that we put in place that will help deliver some consistency as we move into spring and throughout the balance of next year and putting chase back in place, leaving liquidity in our inventory will allow us to react to the customer more appropriately and help build some of that consistency. So, last one over to me. So, Oliver, to also answer a little bit of the question you had on inventory, we believe our guidance appropriately reflects any of the promotional activity weâll need to do in the fourth quarter to keep that inventory as clean as Lisa mentioned and position us for success going into the first quarter of 2023, which kind of dovetails into the conversation around debt levels. We can generate as a business pretty healthy returns on operating cash flows when our working capital and inventory are aligned with sales and demand. As such, we're going to generate a lot of free cash flow in the future of this business. We'll look to invest that in the growth opportunities that we see. We have a significant amount of incremental store opportunities both in Canada and the U.S. that weâll want to invest in and continue to grow this business at the appropriate times, and we also will look at investing in technology where necessary or other things to bring the customer experience to a higher level. As such, though, we are comfortable with our overall debt level at this point in time and I don't see any need to do anything in the short term to do that. But if we have extra cash flow beyond our investment capability to grow the business, we'll look at doing something at that time. Hi everyone. Can you expand upon the customer base and the improving retention? Where are you now in terms of retention? How does it look? Does it look different online versus in-store? And can you expand on the product conversion into different categories? It sounds like the Studio collection got a strong response too. What are you seeing in the other categories? And lastly, with the impact of inflation, what are you seeing both on a channel basis and regionally with your core customers? How does it differ? Thank you. Thanks, Dana. I'll just talk generally. As we have an approach to our customer -- I spoke about it before, and we're maintaining a consistent approach here as we have new customer acquisition that we pay attention to retention and frequency and reactivation. We talked on the prepared remarks that our reactivation campaigns continue to yield very positive results. Our retention numbers are actually quite strong. And we do think we can improve that a couple of hundred basis points as we move into next year. And what we're trying to do in addition to retention is to build frequency. What we found and what we know is that every time we have a launch like Studio, like Festi, like a new bra offering that, that engages our core customer at the highest levels and drives them to build frequency. So next year, we have a multiple launch plan that will have launches -- four to five major launches throughout the year of new product categories that really do drive frequency with that core customer. And then on the new customer piece, it's -- as we mentioned in the remarks, it's primarily driven through store acquisition, that's the healthiest piece of that. But we are also -- we also have new customer acquisitions that will be driven through a digital campaign next year as well. So, happy with the retention overall, building frequency among those customers and focused on reactivation in the short term. But next year, we'll continue with a full 360-degree approach to building that customer file and maintaining the quality of that customer. On the product conversion, I think I spoke a little bit to that in terms of new product. Yes, Studio works very well for us. It continues to work well. I'm very happy with the product that the team delivered for holiday in terms of a balance between cozy and then glitz and glam and feminine that really responded to the correct timing. And I think our stores look -- I think they look very, very good, and have -- and our customers actually have been asking us if we remodeled. And I think that is a great comment on the quality of the merchandising assortment and how that was presented to the customer. So, we are seeing -- as we are bringing in relevant fashion products for the season at the right level and presenting it appropriately that the customer response among not just our existing customers, but among new customers, is positive. And so, we're excited and think that that's a great indicator of some of the things that could be in store for us next year from a product perspective. The inflation channel question, one of the things that we've been talking about is that in the first several quarters of this year that the inflationary impact really was most prominent in our lower household income customers. And for the first time in the third quarter, it impacted all categories of the customer. So, they had been immune -- the upper income levels have been immune up until the end of third quarter, and we did see that for the first time impacting that level. Hi. This is Alice Xiao on for Lorraine Hutchinson. Thanks for taking our question. I had a quick follow-up on Oliver's question. Can you give us a more detailed breakdown of your inventory composition, and just percentages of inventory in each category, whether it's basics, evergreens versus fashion versus things you need to clear? And then secondly, on the upgrade -- updated development process you mentioned just now, how much are you leaving open to chase in 1Q versus what you normally would leave open to chase? Thank you. Yes. I'll take the first portion. We don't break out the total detail level of inventory. As Lisa mentioned, what we've seen weâre the deepest in right now are things that are mostly basics and evergreen categories that we have the time to work through. We are very clean on seasonal and liability product. So, we're confident that we're going to continue to maintain that and that's what we're very much focused on. On the development process, we are leaving -- I'm not going to go into percentages, but we're leaving more open on a liquid basis in order to test and react. We also are testing products in the third quarter with the idea of reordering that product into subsequent quarters. So, it's -- there's a quick turn aspect of the liquidity. And then there's also a test and then holding liquidity later as we get the results of those tests to buy into those specific categories. So, it's a multipronged approach. I'm comfortable with the amount that we have opened at this point. And our sourcing team is working diligently and finding opportunities for us to be more efficient and react more quickly to some of these wins. Thank you. And then lastly, does the updated guidance for sales really assume performance kind of in line with the exit rate? Or are you contemplating any more sort of incremental macroeconomic pressure? I would say that our guidance contemplates a couple of different things. One is the trend that we've seen going through the third quarter, the uncertainty of the overall macroeconomic environment, and our desire to maintain cleanliness in our inventory position and set us up for 2023 that we're pretty optimistic about where our product development as we roll into spring will position us for. Hi. This is Amy Teske on for Mark. Thank you for taking our questions. Can you give us any commentary on your Black Friday performance and how that informs your view on the holiday season? And then, with respect to the updated guidance, what are the underlying assumptions that you've baked in for January as you cycle last year's supply chain disruptions? I'll take the first part of the question related to Black Friday. What we did see is, as Lisa mentioned, we are seeing the customer respond to some of the newness. Unfortunately, given our inventory position, we were still very promotional throughout the holiday. We did see actually a pretty surprising and slightly better-than-we-expected response in store. But I think as Lisa mentioned, the way the new product is resonating in the stores has been well received by the customer. But again, we had to be highly promotional to continue to clear through product. Our January expectations are that the trends that we've been dealing with over the last quarter would retain itself through the holiday, less around the supply chain disruption that really didn't impact us all that much as a comparable benefit. So, we've kind of just assumed basically the current trend of the business will carry forward in our guidance. Okay. Thank you. And then if I could ask one more. When you're approaching 2023 internally, what scenarios are you baking into your operational planning? Yes. So not asking about 2023 guidance, but when you're approaching the year internally, what macro scenarios are you baking into your operational planning? We maintain as much flexibility as we can right now with the -- given the uncertainties in the overall macroeconomic environment. We're going to continue to focus on maintaining our inventory investments in line with the demand trends. And as Lisa mentioned, by keeping a little bit more open in our open-to-buy process, it allows us flexibility to throttle up or throttle back as needed to react to the demand. Hi. This is [indiscernible] on for Alex Stratton. Thank you for taking my question. I was wondering how you view the health of the consumer. Are you seeing maybe any different impacts in terms of income level? And are you seeing any signs of trade down? Thank you. For the first two quarters of '22, we only saw an impact to our lower income customer and that was pretty consistent. And for the first time in the third quarter, we saw an impact throughout all income levels. I don't have the data for fourth quarter, but we'll talk about that as we move -- at our next call. But for the first time, as I mentioned, in third quarter, we did see it impact all income levels. And then to answer your question about if the customer is trading down, we have not seen them actively trading down when the product is right and they're responding to the newness. We've seen some strong response there regardless of price. However, we have been so highly promotional that our average unit retail is lower than it has been historically. So, she hasn't actually had the trade down. Thank you. There are no further questions at this time. I'd like to turn the floor back over to management for any closing comments. Thanks, everyone, for joining us on this call. We look forward to returning on the fourth quarter and full year call. And I want to wish everyone a happy holiday season. So, thanks so much.
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